U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 2006
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
Incorporation or Organization) Identification No.)
9485 HAVEN AVENUE, SUITE 100
RANCHO CUCAMONGA, CALIFORNIA 91730
(Address of Principal Executive Offices) (Zip Code)
(909) 987-9220
(Registrant's Telephone Number, Including Area Code)
NOT APPLICABLE
(Former Name, Former Address And Former Fiscal Year,
if Changed Since Last Report)
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
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes | | No |X|
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act): Large Accelerated Filer | | Accelerated Filer | | Non-Accelerated Filed |
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|
As of January 17, 2007, there were 38,081,750 shares of the issuer's
common stock, $0.0033 par value, outstanding.
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.......................................................... F-1
Condensed Consolidated Balance Sheets as of March 31, 2006 (unaudited)
and December 31, 2005......................................................... F-1
Condensed Consolidated Statements of Operations for the Three Months
Ended March 31, 2006 and 2005 (restated) (unaudited).......................... F-2
Condensed Consolidated Statements of Comprehensive Income for the
Three Months Ended March 31, 2006 and 2005 (restated) (unaudited)............. F-3
Condensed Consolidated Statements of Stockholders' Equity for the
Three Months Ended March 31, 2006 (unaudited)................................. F-4
Condensed Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2006 and 2005 (restated) (unaudited)................................ F-5
Notes to Condensed Consolidated Financial Statements (restated) (unaudited)........ F-6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS........................................... 2
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK................................................................... 19
ITEM 4. CONTROLS AND PROCEDURES....................................................... 20
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS............................................................. 23
ITEM 1A. RISK FACTORS.................................................................. 23
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND
USE OF PROCEEDS............................................................... 23
ITEM 3. DEFAULTS UPON SENIOR SECURITIES............................................... 23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........................... 23
ITEM 5. OTHER INFORMATION............................................................. 24
ITEM 6. EXHIBITS...................................................................... 24
SIGNATURES .............................................................................. 25
See accompanying notes to condensed consolidated financial statements.
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EMRISE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2006 AND DECEMBER 31, 2005
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
March 31, December 31,
ASSETS 2006 2005
------------- -------------
(unaudited)
Current assets:
Cash and cash equivalents $ 2,690 $ 4,371
Accounts receivable, net 8,355 9,413
Inventories, net 11,113 10,277
Deferred income taxes 1,390 1,386
Prepaid and other current assets 687 536
------------- -------------
Total current assets 24,235 25,983
Property, plant and equipment, net 2,004 2,073
Goodwill 12,035 12,066
Intangible assets other than goodwill, net of accumulated
amortization of $443 and $350, respectively 3,604 3,709
Other assets 552 630
------------- -------------
$ 42,430 $ 44,461
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Borrowings under lines of credit $ 1,928 $ 3,283
Current portion of long-term debt 464 504
Notes payable to stockholders, current portion 500 500
Accounts payable 4,048 4,949
Income taxes payable 147 218
Accrued expenses 3,629 3,571
Total current liabilities 10,716 13,025
Long-term debt, less current portion 660 742
Notes payable to stockholders, less current portion 1,625 1,750
Deferred income taxes 1,108 1,108
Other liabilities 1,077 823
Total liabilities 15,186 17,448
Commitments and contingencies (Notes 8 and 14)
Stockholders' equity:
Common stock, $0.0033 par value. Authorized 150,000,000 shares;
issued and outstanding 38,082,000 and 37,550,000, respectively 126 124
Additional paid-in capital 43,302 42,877
Accumulated deficit (15,440) (15,118)
Accumulated other comprehensive loss (744) (870)
Total stockholders' equity 27,244 27,013
------------- -------------
$ 42,430 $ 44,461
============= =============
See accompanying notes to condensed consolidated financial statements.
F-1
EMRISE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended March 31,
2006 2005
------------- -------------
(restated)(1)
Net sales $ 10,734 $ 7,523
Cost of sales 6,350 4,245
------------- -------------
Gross profit 4,384 3,278
Operating expenses:
Selling, general and administrative 3,767 2,844
Engineering and product development 722 532
------------- -------------
Loss from operations (105) (98)
Other income (expense)
Interest income 25 72
Interest expense (124) (102)
Other, net 8 (3)
Income (loss) before income taxes (196) (131)
Income tax (benefit) expense 126 66
------------- -------------
Net loss $ (322) $ (197)
============= =============
Basic loss per share $ (0.01) $ (0.01)
============= =============
Diluted loss per share $ (0.01) $ (0.01)
============= =============
-------------
(1) See Notes to Condensed Consolidated Financial Statements--"Note 2--Restatement of Quarterly
Financial Statements."
See accompanying notes to condensed consolidated financial statements.
F-2
EMRISE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
(IN THOUSANDS)
Three Months
Ended March 31,
--------------------------------
2005
2006 (restated)(1)
------------- -------------
Net loss $ (322) $ (197)
Other comprehensive income (loss):
Foreign currency translation adjustment 126 (441)
------------- -------------
Comprehensive loss $ (196) $ (638)
============= =============
--------------
(1) See Notes to Condensed Consolidated Financial Statements--"Note 2--Restatement of
Quarterly Financial Statements."
See accompanying notes to condensed consolidated financial statements.
F-3
EMRISE CORPORATION AND SUBSIDIARIES
THREE MONTHS ENDED MARCH 31, 2006
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
(IN THOUSANDS)
Accumulated
Common Stock Additional Other
----------------------------- Paid-In Accumulated Comprehensive
Shares Amount Capital Deficit Income (Loss) Total
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 2005 37,550 $ 124 $ 42,877 $ (15,118) $ (870) $ 27,013
------------ ------------ ------------ ------------ ------------ ------------
Stock option exercises 181 1 97 -- -- 98
Warrant exercises 351 1 287 -- -- 288
Stock option issuance expense -- -- 26 -- -- 26
Warrants issued for services -- -- 15 -- -- 15
Comprehensive loss -- -- -- (322) 126 (196)
------------ ------------ ------------
Balance at March 31, 2006 38,082 $ 126 $ 43,302 $ (15,440) $ (744) $ 27,244
============ ============ ============ ============ ============ ============
See accompanying notes to condensed consolidated financial statements.
F-4
EMRISE CORPORATION AND SUBSIDIARIES
THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (RESTATED)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
Three Months
Ended March 31,
--------------------------------
2005
2006 (restated)(1)
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (322) $ (197)
Adjustments to reconcile net income (loss) to cash provided used in
operating activities:
Depreciation and amortization 288 97
Provision for inventory obsolescence 229 640
Deferred taxes (4) (20)
Stock option expense 26 --
Warrants issued for services 15 --
Changes in operating assets and liabilities net of businesses acquired:
Accounts receivable 1,057 1,597
Inventories (1,085) (549)
Prepaid and other assets (73) (380)
Accounts payable and accrued expenses (660) (2,548)
------------- -------------
Cash used in operating activities (529) (1,360)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net purchases of property, plant and equipment (45) (33)
Cash paid for acquisition of Pascall, net of cash acquired -- (9,341)
------------- -------------
Cash used in investing activities (45) (9,374)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments of current notes payable (1,355) 68
Repayments of long-term debt (122) (206)
Proceeds from long-term debt -- 198
Proceeds from issuance common stock offering -- 16,892
Payments of notes to stockholders (125) --
Proceeds from exercise of stock options and warrants 386 36
------------- -------------
Cash provided by (used in) financing activities (1,216) 016,988
------------- -------------
Effect of exchange rate changes on cash 109 (450)
------------- -------------
Net increase (decrease) in cash and cash equivalents (1,681) 5,804
Cash and cash equivalents at beginning of period 4,371 1,057
------------- -------------
Cash and cash equivalents at end of period $ 2,690 $ 6,861
============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 115 $ 96
============= =============
Income taxes $ 12 $ 71
============= =============
-----------------
(1) See Notes to Condensed Consolidated Financial Statements--"Note 2--Restatement of Quarterly
Financial Statements."
See accompanying notes to condensed consolidated financial statements.
F-5
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
(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 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 accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with the rules and regulations of the
Securities and Exchange Commission and therefore do not include all information
and footnotes necessary for a complete presentation of the financial position,
results of operations and cash flows in conformity with accounting principles
generally accepted in the United States of America.
The unaudited condensed consolidated financial statements do, however,
reflect all adjustments, consisting of only normal recurring adjustments, which
are, in the opinion of management, necessary to state fairly the financial
position as of March 31, 2006 and the results of operations and cash flows for
the related interim periods ended March 31, 2006 and 2005. However, these
results are not necessarily indicative of results for any other interim period
or for the year. It is suggested that the accompanying condensed consolidated
financial statements be read in conjunction with the Company's audited
consolidated financial statements included in its amended annual report on Form
10-K for the year ended December 31, 2005 filed with the Securities and Exchange
Commission on December 15, 2006.
STOCK-BASED COMPENSATION
ADOPTION OF SFAS 123(R)
Prior to January 1, 2006, the Company accounted for its stock-based
compensation plans under the recognition and measurement provisions of
Accounting Principles Board ("APB") Opinion No. 25, "ACCOUNTING FOR STOCK ISSUED
TO EMPLOYEES," and related interpretations, as permitted by Statement of
Financial Accounting Standards ("SFAS") No. 123, "ACCOUNTING FOR STOCK-BASED
COMPENSATION." The Company did not recognize compensation cost related to stock
options granted to its employees and non-employee directors that had an exercise
price equal to or above the market value of the underlying common stock on the
date of grant in its condensed consolidated statement of income prior to January
1, 2006.
F-6
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
Effective January 1, 2006, the Company adopted the fair value
recognition provisions of SFAS No. 123(R), "SHARE-BASED PAYMENT," and related
interpretations, using the modified prospective transition method. Under that
method, compensation cost recognized in the quarterly period ended March 31,
2006 includes: (a) compensation cost for all share-based awards granted prior
to, but not yet vested as of January 1, 2006, based on the grant-date fair value
estimated in accordance with the original provisions of SFAS No. 123, and (b)
compensation cost for all share-based payments granted beginning January 1,
2006, based on the grant-date fair value estimated in accordance with the
provisions of SFAS 123(R). In accordance with the modified prospective
transition method, results for prior periods have not been restated.
The Black-Scholes option-pricing model was used to estimate the option
fair values. The option-pricing model requires a number of assumptions, of which
the most significant are, expected stock price volatility, the expected
pre-vesting forfeiture rate and the expected option term (the amount of time
from the grant date until the options are exercised or expire). Expected
volatility was calculated based upon actual historical stock price movements
over the most recent periods ending March 31, 2006 equal to the expected option
term. Expected pre-vesting forfeitures were estimated based on actual historical
pre-vesting forfeitures over the most recent periods ending March 31, 2006 for
the expected option term.
Prior to the adoption of SFAS No. 123(R), the Company presented any tax
benefits from deductions resulting from the exercise of stock options within
operating cash flows in its condensed consolidated statements of cash flow. SFAS
No. 123(R) requires that the portion of benefits resulting from tax deductions
in excess of recognized compensation (the "excess tax benefits") be presented as
financing cash flows. There were no excess tax benefits for the three months
ended March 31, 2006 and would have been presented as an operating cash inflow
prior to the adoption SFAS No. 123(R) if there were any.
In November 2005, the Financial Accounting Standards Board ("FASB"),
issued FASB Staff Position FAS123(R)-3, Transition Election to Accounting for
the Tax Effects of Share-Based Payment Awards ("FSP"). This FSP requires an
entity to follow either the transition guidance for the
additional-paid-in-capital pool as prescribed in SFAS No. 123(R) or the
alternative transition method as described in the FSP. An entity that adopts
SFAS No. 123(R) using the modified prospective method may make a one-time
election to adopt the transition method described in this FSP. An entity may
take up to one year from the later of its initial adoption of SFAS No. 123(R) or
the effective date of this FSP to evaluate its available transition alternatives
and make its one-time election. This FSP became effective in November 2005. The
Company is still evaluating whether it will adopt the alternative method for
calculating its additional-paid-in-capital pool described in the FSP.
F-7
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
STOCK OPTIONS AS OF THE QUARTERLY PERIOD ENDED MARCH 31, 2006
The following table summarizes stock options outstanding and changes
during the quarterly period ended March 31, 2006:
WEIGHTED
NUMBER OF AVERAGE
SHARES EXERCISE PRICE
--------- --------------
Options outstanding at January 1, 2006......................... 2,108,000 $ 1.05
Granted........................................................ 50,000 $ 1.00
Exercised...................................................... (181,000) $ 0.54
Canceled or forfeited.......................................... --
---------
Options outstanding at March 31, 2006.......................... 1,977,000 $ 1.09
=========
Stock options outstanding and currently exercisable at March 31, 2006
are as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------------- ----------------------------
WEIGHTED AVERAGE
NUMBER OF REMAINING WEIGHTED NUMBER OF WEIGHTED
OPTIONS CONTRACTUAL LIFE AVERAGE OPTIONS AVERAGE
RANGE OF EXERCISE PRICES OUTSTANDING (IN YEARS) EXERCISE PRICE EXERCISABLE EXERCISE PRICE
------------------------ ----------- ---------------- -------------- ----------- --------------
$0.20 to $1.00 1,186,000 6.04 $ 0.56 1,090,000 $ 0.53
$1.01 to $2.00 780,000 9.13 $ 1.87 705,000 $ 1.92
$3.01 to $4.00 11,000 0.38 $ 3.13 11,000 $ 3.13
----------- ----------
1,977,000 7.23 $ 1.09 1,806,000 $ 1.09
=========== ==========
Shares available for grant under the Plan as of March 31, 2006 were
365,000.
The fair value of options granted during the three months ended March
31, 2006 was $39,000, at a weighted average per share fair value of $0.78. The
fair value was estimated as of the grant date using the Black-Scholes option
pricing model with the following assumptions: no dividend yield; expected
volatility of 87% in 2006, 88% to 92% in 2005, 92% to 107% in 2004 and 92% in
2003; risk-free interest rate of 3.0% to 4.75%; and average expected lives of
seven years.
As a result of adopting SFAS No. 123(R) on January 1, 2006, the Company
incurred $26,000 in compensation expense during the three months ended March 31,
2006.
Total estimated unrecognized compensation cost from unvested stock
options as of March 31, 2006 was approximately $133,000, which is expected to be
recognized over a weighted average period of approximately 18 months.
The total intrinsic value, or the difference between the exercise price
and the market price on the date of exercise, of all options exercised during
the quarterly period ended March 31, 2006, was approximately $141,000. Cash
received from stock options exercised during the quarterly period ended March
31, 2006 was $98,000.
F-8
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
PRO FORMA STOCK COMPENSATION EXPENSE FOR THE QUARTERLY PERIOD ENDED MARCH 31,
2005
For the quarterly period ended March 31, 2005, the Company applied the
intrinsic value method of accounting for stock options as prescribed by APB No.
25. Since all options granted during the quarterly period ended March 31, 2005
had an exercise price equal to the closing market price of the underlying common
stock on the grant date, no compensation expense was recognized. If compensation
expense had been recognized based on the estimated fair value of each option
granted in accordance with the provisions of SFAS No. 123, as amended, our net
loss and net loss per share would have been reduced to the following pro forma
amounts (in thousands, except per share amounts):
Three Months
Ended March 31,
2005 (restated)
---------------
Net loss, as reported $ (197)
Deduct: Stock-based compensation expense, determined
under the fair value method (47)
---------------
Net loss, pro forma $ (244)
===============
Loss per share -- basic, as reported $ (0.01)
===============
Loss per share -- diluted, as adjusted $ (0.01)
===============
Loss per share -- basic, pro forma $ (0.01)
===============
Loss per share --diluted, pro forma $ (0.01)
===============
Pro forma compensation expense under SFAS No. 123, among other
computational differences, does not consider potential pre-vesting forfeitures.
Because of these differences, the pro forma stock compensation expense presented
above for the prior quarterly period ended March 31, 2005 under SFAS No. 123 and
the stock compensation expense recognized during the current quarterly period
ended March 31, 2006 under SFAS 123(R) are not directly comparable. In
accordance with the modified prospective transition method of SFAS 123(R), the
prior comparative quarterly results have not been restated.
F-9
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
(2) RESTATEMENT OF QUARTERLY FINANCIAL STATEMENTS
In connection with an internal investigation by the Company's Audit
Committee in response to an inquiry by the staff of the Securities and Exchange
Commission's Division of Enforcement, the Company has determined that during the
quarter ended December 31, 2004, the Company prematurely recognized certain net
sales of communications test equipment units that were not actually delivered to
the customer until the first quarter of 2005 and thus did not meet all
applicable revenue recognition criteria until the first quarter of 2005. The
Company has determined the effect of this premature recognition of revenues on
its previously issued financial statements and has restated the unaudited
quarterly financial information below, reconciling the restatement adjustments
for the first quarterly period in the year ended December 31, 2005. Other than
the restatement of the fourth quarterly period in the year ended December 31,
2004 and the first quarterly period in the year ended December 31, 2005, the
Company did not restate its quarterly financial information for any other
quarterly periods for the years ended December 31, 2004 and 2005.
As Originally Restatement
Quarter Ended March 31, 2005 Reported Adjustments As Restated
---------------------------- ------------- ----------- -----------
(in thousands, except per share data)
Net sales $ 7,299 $ 224 $ 7,523
Cost of sales 4,187 58 4,245
Gross profit 3,112 166 3,278
Operating expenses 3,363 13 3,376
Loss from operations (251) 153 (98)
Net loss $ (350) $ 153 $ (197)
Basic and diluted loss per share $ (0.01) $ -- $ (0.01)
F-10
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
(3) EARNINGS (LOSS) PER SHARE
The following table illustrates the computation of basic and diluted
earnings per share (in thousands, except per share amounts):
Three Months
-----------------------------
Ended March 31,
2005
2006 (restated)
------------ ------------
NUMERATOR:
Net loss $ (322) $ (197)
------------ ------------
Loss attributable to common stockholders $ (322) $ (197)
============ ============
DENOMINATOR:
Weighted average number of common shares outstanding during the period-basic 37,678 36,788
Incremental shares from assumed conversions of warrants and options -- --
------------ ------------
Adjusted weighted average number of outstanding shares-diluted 37,678 36,788
------------ ------------
Basic loss per share $ (0.01) $ (0.01)
============ ============
Diluted loss per share $ (0.01) $ (0.01)
============ ============
The following table shows the common stock equivalents that were
outstanding as of March 31, 2006 and 2005 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 have been anti-dilutive:
Number of Exercise Price
Shares Per Share
------------ --------------
Anti-dilutive common stock options:
As of March 31, 2006 736,000 $1.35 - $3.13
As of March 31, 2005 1,459,000 $0.20 - $3.44
Anti-dilutive common stock warrants:
As of March 31, 2006 3,886,000 $1.86 - $2.00
As of March 31, 2005 4,606,000 $0.39 - $2.00
F-11
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
(4) INVENTORIES
Inventories are summarized as follows (in thousands), net of reserves
of $4,181 and $4,160 as of March 31, 2006 and December 31, 2005, respectively:
March 31, December 31,
2006 2005
----------- ------------
Raw materials $ 4,867 $ 4,668
Work-in-process 3,074 2,716
Finished goods 3,172 2,893
----------- ------------
$ 11,113 $ 10,277
=========== ============
(5) REPORTABLE SEGMENTS
The Company has two reportable segments: electronic components and
communications equipment. The electronic components segment operates in the
United States, European and Asian markets and designs, manufactures and markets
digital and rotary switches, electronic power supplies , RF and microwave
components and subsystems and subsystem assemblies. The communications equipment
segment also operates in the United States, European and Asian markets and
designs, manufactures and distributes network access and transmission products,
communications test instruments and network timing and synchronization products.
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 March 31, 2006:
Reporting Units Within Electronic Components Segment:
-----------------------------------------------------
o EMRISE Electronics - Rancho Cucamonga, California: Digitran
Division - manufacturer of digital and rotary switches, and
electronic subsystem assemblies for defense, aerospace and
industrial applications.
o EMRISE Electronics - Monrovia, California: XCEL Circuits
Division - manufacturer of printed circuit boards mostly for
intercompany use but with a small base of outside customers.
F-12
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
o RO Associates Incorporated - 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 EMRISE Electronics Ltd. - Ashford, Kent, England/Isle of
Wight, England - manufacturer of power supplies and radio
frequency products for defense and aerospace applications and
for a broad range of applications, including in-flight
entertainment systems; this reporting unit also includes XCEL
Power Systems, Ltd., Belix Wound Components Ltd., Pascall
Electronic (Holdings) Limited and Pascall Electronics Limited.
Reporting Units Within Communications Equipment Segment:
--------------------------------------------------------
o CXR Telcom division of CXR Larus - San Jose, California -
manufacturer of telecommunications test equipment for the
field and central office applications.
o Larus division of CXR Larus - San Jose, California -
manufacturer of telecommunications synchronous timing devices
and network access equipment.
o CXR-AJ - Abondant, France - manufacturer of network access and
modem equipment.
F-13
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
There were no differences in the basis of segmentation or in the basis
of measurement of segment profit or loss from the amounts disclosed in the
Company's audited consolidated financial statements included in its amended
annual report on Form 10-K for the year ended December 31, 2005. Selected
financial data for each of the Company's operating segments is shown below (in
thousands):
Three Months
Three Months Ended March 31,
Ended March 31, 2005
2006 (restated)
--------------- ---------------
Sales to external customers:
---------------------------
Electronic Components $ 7,853 $ 3,807
Communications Equipment 2,881 3,716
--------------- ---------------
Total $ 10,734 $ 7,523
=============== ===============
Interest expense
----------------
Electronic components $ 60 $ 30
Communications equipment 64 72
--------------- ---------------
Total $ 124 $ 102
=============== ===============
Depreciation and amortization
-----------------------------
Electronic components $ 223 $ 47
Communications equipment 54 37
--------------- ---------------
Total $ 277 $ 84
=============== ===============
Segment profits (loss)
----------------------
Electronic components $ 929 $ 517
Communications equipment (232) $ (38)
--------------- ---------------
Total $ 697 479
=============== ===============
March 31, December 31,
2006 2005
--------------- ---------------
Segment assets:
---------------
Electronic components $ 24,594 $ 25,144
Communications equipment 15,335 16,358
--------------- ---------------
Total $ 39,929 $ 41,502
=============== ===============
F-14
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
The following is a reconciliation of the reportable segment revenues,
profit or loss and assets to the Company's consolidated totals (in thousands):
Three Months
Three Months Ended March 31,
Ended March 31, 2005
2006 (restated)
--------------- ---------------
Net sales:
----------
Total sales for reportable segments $ 10,734 $ 7,523
Elimination of intersegment sales -- --
--------------- ---------------
Total consolidated net sales $ 10,734 $ 7,523
=============== ===============
Loss before income taxes
------------------------
Total income for reportable segments $ 697 $ 479
Unallocated amounts: (893) (610)
--------------- ---------------
Net loss before income taxes $ (196) $ (131)
=============== ===============
Interest expense
----------------
Interest expense for reportable segments $ 124 $ 102
Other interest expense -- --
--------------- ---------------
Total interest expense $ 124 $ 102
=============== ===============
Depreciation and amortization
-----------------------------
Depreciation and amortization expense
for reportable segments $ 277 $ 84
Other depreciation and amortization expense 11 13
--------------- ---------------
Total depreciation and amortization $ 288 $ 97
=============== ===============
As of As of
March 31, December 31,
2006 2005
--------------- ---------------
Assets
------
Total assets for reportable segments $ 39,929 $ 41,502
Other assets 2,501 2,959
--------------- ---------------
Total consolidated assets $ 42,430 $ 44,461
=============== ===============
s
(6) NEW ACCOUNTING PRONOUNCEMENTS
New accounting pronouncements are discussed under the heading "Impacts
of New Accounting Pronouncements" in Part I, Item 2 of this report.
(7) INCOME TAXES
The effective tax rate for the three-month period ended March 31, 2006
was different than the 34% U.S. statutory rate primarily because of foreign
taxes on foreign source income that cannot be offset by domestic tax loss
carryforwards.
F-15
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
(8) 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 $3,000,000 at any time (a "conversion event"). The bank increased
this amount from $2,000,000 to $3,000,000 on March 28, 2006. 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 $3,000,000. 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 March 31, 2006 was 7.75%.
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 March 31, 2006, the Company had no outstanding balance owing
under the revolving credit line, and the Company had $3,000,000 of availability
on the non-formula based portion of the credit line. As of March 31, 2006, 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.
F-16
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
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 $62,000
at March 31, 2006.
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 $116,000
was outstanding at March 31, 2006. The interest rate is equal to the 90-day
London InterBank Offered Rate ("LIBOR") (5.010% at March 31, 2006) 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 March 31, 2006, the Company had approximately $172,000 of capital
leases outstanding, which is included in long term debt in the accompanying
condensed consolidated financial statements.
As of March 31, 2006, 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
March 31, 2006, the balances outstanding under the Company's United Kingdom,
France and Japan credit facilities were $2,143,000, $530,000 and $29,000,
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. $3,653,000 based on the exchange rate in effect on March 31,
2006). 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 March 31, 2006. 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. As of March 31, 2006,
the revolving loan had an outstanding balance of $1,169,000.
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.
$522,000 based on the exchange rate in effect on March 31, 2006), 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. $4,175,000 based on the exchange rate in effect on
March 31, 2006). As of March 31, 2006, the outstanding balance was $262,000 and
is included in borrowings under lines of credit in the accompanying Financial
Statements.
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 March 31, 2006 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.
F-17
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
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 (equivalent to U.S. $870,000 based on the
exchange rate in effect on March 31, 2006). 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 March 31, 2006 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. The Company failed to comply with this covenant and
received a waiver. The Company and the bank are reviewing the covenants for
possible amendment. 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. As of March 31, 2006,
the term loan had an outstanding balance of $712,000.
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.
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 $1,449,000
based on the exchange rate in effect at March 31, 2006 for the conversion of
euros into United States dollars. CXR-AJ also had $33,000 of term loans with
another French bank outstanding as of March 31, 2006. The IFN Finance facility
is secured by accounts receivable and carries an annual interest rate of 1.6%
above the French "T4M" rate. At March 31, 2006, the French T4M rate was 2.2506%,
and this facility had a balance of $497,000. 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 March 31, 2006 were $29,000 as of March 31, 2006 for the
conversion of Japanese Yen into U.S. Dollars, using the exchange rate in effect.
There are no financial performance covenants applicable to this loan.
(9) 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 11). 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 March 31, 2006, the
30-day LIBOR was 4.84%.
F-18
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
Future maturities of notes payable to stockholders are as follows:
Year Ending
December 31,
--------------
2006 $ 375,000
2007 500,000
2008 500,000
2009 500,000
2010 250,000
-------------- --------------
$ 2,125,000
============== ==============
Interest paid on these notes in the three months ended March 31, 2006
and 2005 was $39,000 and $179,000, respectively.
There are no guarantees by officers or fees paid to officers or loans
to or from officers.
(10) JANUARY 2005 PRIVATE PLACEMENT
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 11. The Company used the remaining proceeds from this financing for
additional acquisitions and for investments in new products and enhancements to
existing products.
(11) 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.
F-19
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
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 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 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.
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.
F-20
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
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.
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.
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 Associates Incorporated, a California corporation
("RO"). 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.
F-21
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
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 was 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. The Company commissioned a valuation firm to
determine what portion of the purchase price should be allocated to identifiable
intangible assets. The valuation study of RO's intangibles was completed in June
2006. The Company initially estimated the intangibles to be valued as follows:
technology, $484,000, trademarks, $300,000 and customer relationships, $200,000.
The valuation study resulted in the following valuations: technology, $500,000,
trademarks, $350,000 and customer relationships, $350,000. The intangibles were
adjusted to the appraised values in the second quarter of 2006. The technology
and customer relationships are being amortized over 10 years on their appraise
values and the trademarks are not being amortized due to the inability to
determine an estimated life.
F-22
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2005 AND 2006 (RESTATED)
(UNAUDITED)
(12) GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets by segment as of March 31, 2006 are as follows (in thousands):
Trademarks Technology Customer Covenant Not
and Trade Acquired -- Relationships to Compete Backlog Patents in
Goodwill 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 $ 6,672 $ 800 $ 484 $ 200 $ 200 $ 200 $ 64
Communications
equipment 6,428 750 1,150 200 -- --
----------- ----------- ------------ ----------- ----------- ----------- ----------
Total $ 13,100 $ 1,550 $ 1,634 $ 400 $ 200 $ 200 $ 64
=========== =========== ============ =========== =========== =========== ==========
Accumulated
-----------
amortization
------------
Electronic
components $ 193 $ -- $ 28 $ 12 $ 67 $ 101 $ --
Communications
equipment 872 -- 201 35 -- -- --
----------- ----------- ------------ ----------- ----------- ----------- ----------
Total $ 1,065 $ -- $ 229 $ 47 $ 67 $ 101 $ --
=========== =========== ============ =========== =========== =========== ==========
Carrying
--------
value
-----
Electronic
components $ 6,479 $ 800 $ 456 $ 188 $ 133 $ 99 $ 64
Communications
equipment 5,556 750 949 165 -- -- --
----------- ----------- ------------ ----------- ----------- ----------- ----------
Total $ 12,035 $ 1,550 $ 1,405 $ 353 $ 133 $ 99 $ 64
=========== =========== ============ =========== =========== =========== ==========
F-23
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
Changes in goodwill by segment (in thousands):
Electronic Communications
Components Equipment Total
---------- ------------- ----------
Balance at January 1, 2006 $ 6,510 $ 5,556 $ 12,066
Reclassed to leasehold improvements at RO (71) -- (71)
Foreign currency translation 40 -- 40
---------- ------------- ----------
Balance March 31, 2006 $ 6,479 $ 5,556 $ 12,035
========== ============= ==========
(13) ACCRUED EXPENSES
Accrued expenses were as follows (in thousands):
March 31, 2006 December 31, 2005
Accrued salaries $ 710 $ 675
Accrued payroll taxes and benefits 928 762
Advance payments from customers 252 219
Other accrued expenses 1,739 1,915
---------- ------------
Total accrued expenses $ 3,629 $ 3,571
========== ============
(14) SUBSEQUENT EVENTS
STOCK ISSUANCE
In May 2006, the Company determined that its recent periodic filings
could not be relied upon and underwent a reaudit for the years 2003, 2004 and
2005 that had been audited previously. This matter caused the Company's S-3
filing to become no longer effective and caused the obligation of the Company
under the Registration Rights Agreement to pay 1% liquidated damages to the
remaining shareholders from their remaining shares still owned of the private
offering. Aggregate payments in the amount of $323,135 were made from June
through December 2006. These payments were charged to administrative expenses.
EXECUTIVE MANAGEMENT
On August 18, 2006, the company's Chief Financial Officer, Randolph D.
Foote, resigned from all positions with the Company and its subsidiaries, and
entered into a Resignation and Separation Agreement with the Company, which
became effective on August 25, 2006. Under the agreement, Mr. Foote resigned all
of his positions with the Company and, the Company and Mr. Foote jointly
terminated his employment agreement dated effective as of January 1, 2006. The
agreement provides that effective as of August 21, 2006, Mr. Foote will be
assigned to temporary employment with the Company, which the parties anticipate
will terminate by approximately December 31, 2006. On December 31, 2006, the
Company and Mr. Foote amended the separation agreement to extend Mr. Foote's
temporary employment to March 30, 2007. During the time of his temporary
employment, Mr. Foote will assist the Company in, among other things, the
preparation of the Company's restated financial statements and its filings with
the Securities and Exchange Commission and will continue to receive his base
salary and employment benefits (other than paid vacation benefits, bonus or
incentive compensation).
F-24
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
CREDIT FACILITIES
On September 19, 2006, the Company entered into a Third Amendment to
Credit Agreement effective as of September 1, 2006 with Wells Fargo Bank. The
amendment provided for the waiver by Wells Fargo Bank of certain violations of
financial covenants in the Company's existing credit facility. The amendment
also provided for the reduction in the amount of the credit facility from $9.0
million to $1.5 million and limited borrowings to 80% of eligible accounts
receivable. In connection with the amendment, the Company executed a Revolving
Line of Credit Note dated September 1, 2006 in the amount of $1.5 million. On
October 9, 2006, the Company executed a letter agreement dated effective October
1, 2006 with Wells Fargo Bank extending the maturity date of the $1.5 million
note to October 20, 2006.
On November 13, 2006, Wells Fargo Bank issued a notice of default and
demand for payoff with respect to the $1.5 million note. All obligations under
the note were due and payable on November 20, 2006. On November 24, 2006, the
Company entered into a Forbearance Agreement with Wells Fargo Bank, dated
effective as of November 20, 2006, whereby Wells Fargo Bank agreed to forbear
from exercising its rights under the credit facility as described in the notice
of default and demand for payoff through December 1, 2006. On December 1, 2006,
EMRISE Corporation, EMRISE Electronics, CXR Larus, RO and Wells Fargo Bank
acting through its Wells Fargo Business Credit operating division ("WFBC")
entered into a Credit and Security Agreement providing for a revolving line of
credit and term loan. On December 5, 2006, the Company paid off the $1.5 million
Wells Fargo Bank credit facility in full.
The credit facility with WFBC provides for a $5.0 million revolving
line of credit that expires on December 1, 2009. If WFBC terminates the credit
facility during a default period, or if the Company terminates or reduces the
credit facility prior to the maturity date, or if the Company prepays the term
loan portion of the facility, the Company will be subject to penalties as
follows: if the termination or prepayment occurs during the one year period
after the initial funding date, the penalty is equal to 3% of the maximum line
amount and/or prepayment amount; if the termination or prepayment occurs during
second year after the initial funding date, the penalty is equal to 2% of the
maximum line amount and/or prepayment amount; and if the termination or
prepayment occurs at any time after the second anniversary of the initial
funding date and prior to the maturity date, the penalty is equal to 1% of the
maximum line amount and/or prepayment amount . The credit facility is subject to
an unused line fee equal to 0.25% per annum, payable monthly based on the
average daily unused amount of the line of credit described in the following
paragraph. The credit facility is also subject to a minimum monthly interest
charge of $8,500 with respect to the revolving line of credit.
The WFBC credit facility provides a $5,000,000 revolving line of credit
secured by accounts receivable, other rights to payment and general intangibles,
inventories and equipment. The line of credit is formula-based which generally
provides that the outstanding borrowings under the line of credit may not exceed
an aggregate of 80% of eligible accounts receivable plus 10% 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 plus 1%. The
prime rate at December 1, 2006 was 8.25%.
F-25
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2006 AND 2005 (RESTATED)
(UNAUDITED)
The credit facility is subject to various financial covenants on a
consolidated basis as follows. The minimum debt service coverage ratio must be
greater than 1.20:1.00 on a trailing quarterly basis. "Debt service coverage
ratio" is defined as net income after taxes, plus depreciation, plus
amortization, plus or minus changes in deferred taxes, minus capital
expenditures and minus any dividends or distributions, divided by the current
maturities of long-term debt paid or scheduled to be paid plus any payments on
subordinated debt. The credit facility also requires that the Company maintain a
minimum book net worth, determined at the end of each calendar month, in an
amount not less than $26,900,000 for the months ended December 31, 2006, January
31, 2007 and February 28, 2007 and of not less than that amount plus 80% of the
Company's net income for each calendar quarter ending on or after March 31, 2007
for each calendar month ending March 31, 2007, and each calendar month
thereafter. The Company must not incur a net loss of greater than $1,150,000 for
2006 and for each quarterly period occurring after December 31, 2006, the
Company's net income must not be less than $0. Management expects that the
Company will not be in compliance with the bank's financial covenants as of
December 31, 2006 and expects to obtain a waiver. If a waiver is not obtained
and the loan is immediately payable, management believes that the Company has
the resources to meet such a requirement.
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 credit facility, or any earlier date that all principal owing under
the credit facility 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 3% above the rate of interest in effect from
time to time under the credit facility.
The credit facility also provides for a term loan of $200,000 secured
by accounts receivable, other rights to payment and general intangibles,
inventories and equipment, amortizable over 36 months at a variable rate equal
to the prime rate plus 1%.
F-26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis should be read in conjunction
with our condensed consolidated financial statements and notes to financial
statements included elsewhere in this document. This report and our condensed
consolidated financial statements and notes to financial statements contain
forward-looking statements, which generally include the plans and objectives of
management for future operations, including plans and objectives relating to our
future economic performance and our current beliefs regarding revenues we might
earn if we are successful in implementing our business strategies. The
forward-looking statements and associated risks may include, relate to or be
qualified by other important factors, including, without limitation:
o the projected growth or contraction in the electronic
components and communications equipment markets in which we
operate;
o our business strategy for expanding, maintaining or
contracting our presence in these markets;
o our ability to efficiently and effectively integrate and
operate the businesses of our newly-acquired subsidiaries;
o our ability to identify, fund and integrate additional
businesses;
o anticipated trends in our financial condition and results of
operations; and
o our ability to distinguish ourselves from our current and
future competitors.
We do not undertake to update, revise or correct any forward-looking
statements.
The information contained in this document is not a complete
description of our business or the risks associated with an investment in our
common stock. Before deciding to buy or maintain a position in our common stock,
you should carefully review and consider the various disclosures we made in this
report, and in our other materials filed with the Securities and Exchange
Commission that discuss our business in greater detail and that disclose various
risks, uncertainties and other factors that may affect our business, results of
operations or financial condition. In particular, you should review our amended
annual report on Form 10-K for the year ended December 31, 2005 filed with the
Securities and Exchange Commission on December 15, 2006, and the "Risk Factors"
we included in that report.
Any of the factors described above could cause our financial results,
including our net income or loss or growth in net income or loss to differ
materially from prior results, which in turn could, among other things, cause
the price of our common stock to fluctuate substantially.
OVERVIEW
GENERAL
We are a leading supplier of timing and synchronization systems, rotary
and digital switches, electronic power supplies and radio frequency, or RF,
devices. We sell our products to communications service providers, defense and
aerospace contractors and industrial customers. We are a multinational company
operating out of facilities located in the United States, United Kingdom, France
and Japan. As of December 31, 2006, we had approximately 300 employees.
2
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").
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") devices.
In September 2005, EMRISE Electronics acquired all of the outstanding
common stock of RO Associates Incorporated ("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
-- RF and microwave devices
o Communications Equipment
-- network access and transmission products
-- 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 73.2% and 52.1% of our total net sales during the three months
ended March 31, 2006 and 2005, respectively. Sales of communications equipment
and related services, primarily to private customer premises and public carrier
customers, were approximately 26.8% and 47.9% of our total net sales during the
three months ended March 31, 2006 and 2005, respectively.
Sales of our electronic components segment increased $4,047,000
(106.3%) for the three months ended March 31, 2006 as compared to the three
months ended March 31, 2005. Without the increase of sales of $2,629,000 and
$1,239,000, 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 increased by $179,000 (4.7%) for the first
quarter of 2006 as compared to the same period in 2005, primarily due to
increased sales of switches.
3
We experienced a $836,000 (22.5%) decrease in sales in our
communications equipment segment for the three months ended March 31, 2006. This
decrease 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 for network
access equipment.
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
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 $72,000 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, 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 conjunction with our 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.
4
PASCALL ACQUISITION
On March 18, 2005, our subsidiary, EEL, 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 $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.
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.
In conjunction with the acquisition of Pascall, we commissioned 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, patents, covenants not to compete, customers,
workforce, technology and software. We have 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. We believe that no other
identifiable intangible assets of value were acquired. No patents were acquired.
We have not ascribed any value to Pascall's customer base because our 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. 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.
5
In accordance with the valuation study and taking into consideration
post-closing adjustments, we have 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, 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.
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 commissioned a valuation firm to
determine what portion of the purchase price should be allocated to identifiable
intangible assets. The valuation study of RO's intangibles was completed in June
2006. We initially estimated the intangibles to be valued as follows:
technology, $484,000, trademarks, $300,000 and customer relationships, $200,000.
The valuation study resulted in the following valuations: technology, $500,000,
trademarks, $350,000 and customer relationships, $350,000. The intangibles were
adjusted to the appraised values in the second quarter of 2006. The technology
and customer relationships are being amortized over 10 years on their appraise
values and the trademarks are not being amortized due to the inability to
determine an estimated life.
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.
6
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 distributor requests and receives authorization to return a
product, the request is accompanied by a purchase order for a replacement
product. When an end-user requests to return a product, we either repair or
replace the 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.
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 5.2%
and 4.8% of net sales for the three months ended March 31, 2006, respectively.
7
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
53.4% of our net revenues, 48.4% of our assets and 46.1% of our total
liabilities as of and for the three months ended March 31, 2006. 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)."
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.
8
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 $744,000 and gains of $870,000 that were included as part of accumulated
other comprehensive income within our balance sheets at March 31, 2006 and
December 31, 2005, respectively. During the three months ended March 31, 2006
and 2005, we included translation adjustments of a gain of approximately
$126,000 and a loss of $441,000, 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 the three months ended 2006 and 2005. 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
March 31, 2006. This loan is 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
the three months ended March 31, 2006, we did not record any impairment losses
related to goodwill and other intangible assets.
RESULTS OF OPERATIONS
The table presented below, which compares our results of operations for
the three months ended March 31, 2006 to our results of operations for the three
months ended March 31, 2005, presents 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 show the absolute results for each
period presented.
9
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 show the results for each period as a
percentage of net sales.
RESULTS AS A PERCENTAGE
OF NET SALES FOR THE
THREE MONTHS ENDED DOLLAR PERCENTAGES THREE MONTHS ENDED
MARCH 31, VARIANCE VARIANCE MARCH 31,
------------------------ ----------- ----------- ----------------------------
2005 FAVORABLE FAVORABLE 2005
2006 (RESTATED) (UNFAVORABLE) (UNFAVORABLE) 2006 (RESTATED)
--------- ---------- ----------- ----------- ----------- -----------
(IN THOUSANDS)
Net sales
Electronic components $ 7,853 $ 3,806 $ 4,047 106.3% 73.2% 50.6%
Communications equipment 2,881 3,717 (836) (22.5)% 26.8% 49.4%
--------- ---------- ----------- ----------- ----------- -----------
Total net sales 10,734 7,523 3,211 42.7% 100% 100.0%
--------- ---------- ----------- ----------- ----------- -----------
Cost of sales
Electronic components 4,787 2,368 (2,419) (102.2)% 44.6% 31.5%
Communications equipment 1,563 1,877 314 16.7% 14.6% 25.0%
--------- ---------- ----------- ----------- ----------- -----------
Total cost of sales 6,350 4,245 (2,105) (49.6)% 59.2% 56.4%
--------- ---------- ----------- ----------- ----------- -----------
Gross profit
Electronic components 3,066 1,438 1,628 113.2% 28.6% 19.1%
Communications equipment 1,318 1,840 (522) (28.4)% 12.3% 24.5%
--------- ---------- ----------- ----------- ----------- -----------
Total gross profit 4,384 3,278 1,106 33.7% 40.8% 43.6%
--------- ---------- ----------- ----------- ----------- -----------
Selling, general and administrative
expenses 3,767 2,844 (923) (32.5)% 35.1% 37.8%
Engineering and product development 722 532 (190) (35.7)% 6.7% 7.1%
--------- ---------- ----------- ----------- ----------- -----------
Operating loss (105) (98) (7) (7.1)% (1.0)% (1.3)%
Interest expense (124) (102) (22) (21.6)% (1.2)% (1.4)%
Interest income 25 72 (47) (65.3)% 0.2% 1.0%
Other income and expense 8 (3) 11 (366.7)% 0.1% 0.0%
--------- ---------- ----------- ----------- ----------- -----------
Loss before income tax expense (196) (131) (65) (49.6)% (1.8)% (1.7)%
Income tax expense 126 66 (60) (90.9)% 1.2% 0.9%
--------- ---------- ----------- ----------- ----------- -----------
Net loss $ (322) $ (197) $ (125) (63.5)% (3.0)% (2.6)%
========= ========== =========== =========== =========== ===========
NET SALES. The $3,211,000 increase in total net sales resulted from the
combination of a $4,047,000 increase in net sales of our electronic components
and an $836,000 decrease in net sales of our communications equipment products
and services.
ELECTRONIC COMPONENTS. The increase in net sales of our electronic
components segment was attributable to, among other things, $2,629,000 in sales
of Pascall power supplies and $1,239,000 in sales of RO power supplies. Because
Pascall was acquired on March 18, 2005, sales attributable to Pascall during the
first quarter of 2005 were negligible. We acquired RO on September 1, 2005 and,
as a result, we did not report any RO sales in the first quarter of 2005. We
also experienced an increase in sales of switches from Emrise Electronics'
Digitran Division of $337,000, or 22.9%, to $1,810,000 from $1,473,000 in the
prior year period, due to increased volume. Excluding the increased sales
contributed by Pascall and RO, our net sales for this segment would have been
$3,985,000, which represents a $179,000 (4.7%) increase over net sales of
$3,806,000 for the three months ended March 31, 2005. This increase was caused
by an increase in switch sales, partially offset by a small decrease in power
supply sales from XPS.
10
COMMUNICATIONS EQUIPMENT. The decrease in sales of our communication
equipment segment was largely due to a $534,000 (73.9%) decrease in net sales to
$189,000 as compared to $723,000 in the prior period attributable to a delay in
expected orders from a government refurbishment project. We also incurred a
$302,000 (13.6%) decrease in sales of network access equipment to $1,925,000
from $2,227,000 in the prior year. This decrease consisted of a $217,000
decrease in net sales of network access products from CXR Larus due to lower
volume. CXR-AJ experienced an $85,000 reduction in net sales of network access
products. These decreases were slightly offset by an increase in sales of
synchronous timing products of $28,000 (8%) to $378,000 as compared to $350,000
in the prior year period. We anticipate that sales of our communications test
equipment will be less in 2006 than in 2005. However, we 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 the first
quarter of 2006.
GROSS PROFIT. The decrease in gross profit as a percentage of total net
sales and the dollar increase in total gross profit resulted from an increase in
gross profit in our electronic components segment that was partially offset by a
decrease in gross profit in our communications equipment segment.
ELECTRONIC COMPONENTS. The increase in gross profit for our electronic
components segment was primarily due to contributions from Pascall and RO which
amounted to $897,000 and $390,000, respectively, of the overall increase. In
addition, gross profit from Digitran, which produces digital and rotary
switches, increased $331,000 (51.6%) to $973,000, as compared to $642,000 in the
prior year period, due to increased sales volume, higher prices and favorable
product mix. Gross profit from XPS's power supply operations decreased slightly
by $36,000 to $462,000 from $498,000 in the prior year period due to lower sales
volume.
COMMUNICATIONS EQUIPMENT. The decrease in gross profit for our
communications equipment segment was primarily due to a $481,000 (87.6%)
decrease in gross profit from test instruments produced by CXR Larus to $68,000
from $549,000 in the prior year due to lower sales. We also experienced a
reduction of $162,000 (26.3%) in gross profit of CXR-AJ network access products
to $453,000 from $615,000 in the prior year period due to product mix. Partially
offsetting these decreases was an increase in gross margins of CXR Larus
synchronous timing devises and network access products of $121,000 (17.9%) to
$797,000 from $676,000 in the prior year period due to greater per-unit overhead
absorption due to higher production.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. The increase in selling,
general and administrative expenses was primarily due to:
o a $54,000 (31.2%) increase in sales commissions primarily
attributable to the inclusion of Pascall and RO sales
commissions;
o a $211,000 (17.5%) increase in other selling and marketing
expenses primarily due to the increase and inclusion of
Pascall and RO selling expenses of $253,000 and $203,000,
respectively, offset by a $199,000 reduction in such expenses
in our communication equipment segment, especially at CXR
Larus due to staff reductions from a reorganization of the
sales and market functions;
11
o a $123,000 increase in the estimated liability of a defined
compensation arrangement due to an obligation acquired with
the 1997 merger of Microtel International Inc. and XET
Corporation, our corporate predecessor;
o a $453,000 (27.9%) increase in administrative expenses
primarily due to the inclusion of $311,000 and $127,000 of
administrative costs for Pascall and RO, respectively; and
o an approximate $200,000 increase due to the revised estimate
of a liability for a deferred compensation arrangement and
other miscellaneous matters.
We anticipate that selling, general and administrative expenses for the
remainder of 2006 will remain at levels higher than those we experienced during
2005 due to increased investments in new products, 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 recently adopted rules and regulations of the
Securities and Exchange Commission.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES. Engineering and product
development expenses consist primarily of research and product development
activities. The increase in these expenses resulted primarily from the inclusion
of $95,000 and $103,000 of expenses attributable to Pascall and RO,
respectively. The increase was partially offset by a reduction in engineering
expenses of $13,000 to $117,000 from $130,000 for rotary switch development. We
expect this higher level of expense to continue throughout 2006 as we continue
to develop our new family of rotary switches and pursue long-term opportunities
in the timing and synchronization market.
INTEREST EXPENSE, NET. Interest expense increased due to increased loan
balances at our U.K. operations at XPS and Pascall. We reported a reduction in
interest income due to the use of cash for the acquisition of Pascall on March
18, 2005 and the acquisition of RO on September 1, 2005.
INCOME TAX EXPENSE. Income tax expense of $126,000 was made up of
$96,000 foreign income tax applicable to income of our foreign subsidiaries and
$30,000 state income and franchise tax. There was no U.S. federal tax accrued
due to U.S. source losses.
NET INCOME. A significant contributing factor to the increase in net
income was a $350,000 increase in operating earnings for our Digitran Division.
In addition, our CXR Larus timing and network access operations reported a
$248,000 increase in operating earnings. The overall increase in net income was
partially offset by a small decrease in operating earnings at other operating
units.
12
LIQUIDITY AND CAPITAL RESOURCES
During the quarter ended March 31, 2006, we funded our operations
primarily through revenue generated from our operations and through our previous
lines of credit with Wells Fargo Bank, N.A. and various foreign banks. During
the quarter ended March 31, 2006, 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 March 31, 2006, we had working
capital of $13,519,000, which represented a $561,000 (4.3%) increase from
working capital of $12,958,000 at December 31, 2005, primarily due to the
addition of the working capital of Pascall and RO. At March 31, 2006 and
December 31, 2005, we had accumulated deficits of $15,025,000 and $15,118,000,
respectively, and cash and cash equivalents of $2,690,000 and $4,371,000,
respectively.
Accounts receivable decreased $1,058,000 (11.2%) during the first three
months of 2006 from $9,413,000 as of December 31, 2005 to $8,355,000 as of March
31, 2006 due to high collections. Days sales outstanding, which is a measure of
our average accounts receivable collection period, increased from 61 days for
2005 to 65 days for the first three months of 2006. 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 $836,000 (8.1%) during the first three
months of 2006, from $10,277,000 at December 31, 2005 to $11,113,000 at March
31, 2006. Inventory represented 26.1% and 23.1% of our total assets as of March
31, 2006 and December 31, 2005, respectively. Inventory turnover, which is a
ratio that indicates how many times our inventory is sold and replaced over a
specified period, decreased to 2.4 times for the first three months of 2005 as
compared to 2.8 times for the same period in 2005.
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.
Cash used in our operating activities totaled $529,000 for the first
three months of 2006 as compared to cash used in operating activities of
$1,360,000 for the prior year period. This $831,000 increase in operating cash
flows primarily resulted from a slower increase in the amounts paid down on
accounts payable and accrued expenses.
Cash used in our investing activities totaled $45,000 for the first
three months of 2006 as compared to $9,374,000 for the first three months of
2005. Included in the results for 2005 are net cash of $9,374,000 used to
acquire Pascall, including acquisition costs.
Cash used in our financing activities totaled $1,216,000 for the first
three months of 2006 as compared to $16,988,000 of cash provided by our
financing activities for the first three months of 2005. The change is primarily
due to the net proceeds from the issuance of common stock in the January 2005
private placement.
13
Outstanding borrowings under our revolving lines of credit were as
follows:
March 31, December 31
2006 2005
------------- ------------
Line of credit with a U.S. commercial lender $ -- $ 118,000
Lines of credit with foreign banks 1,928,000 760,000
------------- ------------
$ 1,928,000 $ 878,000
============= ============
On August 25, 2005, we and two of our subsidiaries, CXR Laurus and
EMRISE Electronics, acting as guarantors, obtained a $9,000,000 revolving line
of credit facility from Wells Fargo Bank, N.A. for the our domestic operations.
As guarantors, each of CXR Larus and EMRISE Electronics was jointly and
severally liable with EMRISE for up to $9,000,000. This facility was initially
effective through September 1, 2006. The credit facility had no prepayment
penalty and was 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.
As of March 31, 2006, we had no outstanding balance owing under the
revolving credit line, and we had $3,000,000 of availability on the non-formula
based portion of the credit line. As of March 31, 2006, we were in compliance
with each of the covenants of the credit facility. 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 $62,000 at March 31, 2006.
As of March 31, 2006, we had approximately $172,000 of capital leases
outstanding, which amount is included in long term debt in the accompanying
condensed consolidated financial statements.
On September 19, 2006, we entered into a Third Amendment to Credit
Agreement effective as of September 1, 2006 with Wells Fargo Bank. The amendment
provided for the waiver by Wells Fargo Bank of certain violations of financial
covenants in our existing credit facility. The amendment also provided for the
reduction in the amount of the credit facility from $9.0 million to $1.5 million
and limited borrowings to 80% of eligible accounts receivable. In connection
with the amendment, we executed a Revolving Line of Credit Note dated September
1, 2006 in the amount of $1.5 million. On October 9, 2006, we executed a letter
agreement dated effective October 1, 2006 with Wells Fargo Bank extending the
maturity date of the $1.5 million note to October 20, 2006.
On November 13, 2006, Wells Fargo Bank issued a notice of default and
demand for payoff with respect to the $1.5 million note. All obligations under
the note were due and payable on November 20, 2006. On November 24, 2006, we
entered into a Forbearance Agreement with Wells Fargo Bank, dated effective as
of November 20, 2006, whereby Wells Fargo Bank agreed to forbear from exercising
its rights under the credit facility as described in the notice of default and
demand for payoff through December 1, 2006. On December 1, 2006, EMRISE
Corporation, EMRISE Electronics, CXR Larus, RO and Wells Fargo Bank acting
through its Wells Fargo Business Credit operating division ("WFBC") entered into
a Credit and Security Agreement providing for a revolving line of credit and
term loan. On December 5, 2006, we paid off the $1.5 million Wells Fargo Bank
credit facility in full.
The credit facility with WFBC provides for a $5.0 million revolving
line of credit that expires on December 1, 2009. If WFBC terminates the credit
facility during a default period, or if we terminate or reduce the credit
facility prior to the maturity date, or if we prepay the term loan portion of
the facility, we will be subject to penalties as follows: if the termination or
prepayment occurs during the one year period after the initial funding date, the
penalty is equal to 3% of the maximum line amount and/or prepayment amount; if
the termination or prepayment occurs during second year after the initial
14
funding date, the penalty is equal to 2% of the maximum line amount and/or
prepayment amount; and if the termination or prepayment occurs at any time after
the second anniversary of the initial funding date and prior to the maturity
date, the penalty is equal to 1% of the maximum line amount and/or prepayment
amount . The credit facility is subject to an unused line fee equal to 0.25% per
annum, payable monthly based on the average daily unused amount of the line of
credit described in the following paragraph. The credit facility is also subject
to a minimum monthly interest charge of $8,500 with respect to the revolving
line of credit.
The WFBC credit facility provides a $5,000,000 revolving line of credit
secured by accounts receivable, other rights to payment and general intangibles,
inventories and equipment. The line of credit is formula-based which generally
provides that the outstanding borrowings under the line of credit may not exceed
an aggregate of 80% of eligible accounts receivable plus 10% 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 plus 1%. The
prime rate at December 1, 2006 was 8.25%.
The credit facility is subject to various financial covenants on a
consolidated basis as follows. The minimum debt service coverage ratio must be
greater than 1.20:1.00 on a trailing quarterly basis. "Debt service coverage
ratio" is defined as net income after taxes, plus depreciation, plus
amortization, plus or minus changes in deferred taxes, minus capital
expenditures and minus any dividends or distributions, divided by the current
maturities of long-term debt paid or scheduled to be paid plus any payments on
subordinated debt. The credit facility also requires that we maintain a minimum
book net worth, determined at the end of each calendar month, in an amount not
less than $26,900,000 for the months ended December 31, 2006, January 31, 2007
and February 28, 2007 and of not less than that amount plus 80% of our net
income for each calendar quarter ending on or after March 31, 2007 for each
calendar month ending March 31, 2007, and each calendar month thereafter. We
must not incur a net loss of greater than $1,150,000 for 2006 and for each
quarterly period occurring after December 31, 2006, our net income must not be
less than $0. We expect we will not be in compliance with the bank's financial
covenants as of December 31, 2006 and we expect to obtain a waiver. If we do not
obtain a waiver and the loan is immediately payable, we believe that we will
have the resources to meet such a requirement.
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 credit facility, or any earlier date that all principal owing under the
credit facility 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 3% above the rate of interest in effect from
time to time under the credit facility.
The credit facility also provides for a term loan of $200,000 secured
by accounts receivable, other rights to payment and general intangibles,
inventories and equipment, amortizable over 36 months at a variable rate equal
to the prime rate plus 1%.
As of March 31, 2006, 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
March 31, 2006, the balances outstanding under our United Kingdom, France and
Japan credit facilities were $2,143,000, $530,000 and $29,000, respectively.
15
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
(equivalent of U.S. $3,653,000 based on the exchange rate in effect on March 31,
2006). 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 March 31, 2006. 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. As of March 31, 2006,
the revolving loan had an outstanding balance of $1,169,000.
On August 26, 2005, XPS entered into an agreement with Lloyds for an
unsecured cashflow loan of 300,000 British pounds sterling (equivalent of U.S.
$522,000 based on the exchange rate in effect on March 31, 2006 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 (equivalent of U.S. $4,175,000 based on the exchange rate in effect on
March 31, 2006). As of March 31, 2006, the outstanding balance was $262,000 and
is included in borrowings under lines of credit in the accompanying financial
statements.
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 March 31, 2006 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.
On August 26, 2005, EEL entered into an agreement with Lloyds TSB for
an unsecured term loan for 500,000 British pounds sterling (equivalent to U.S.
$870,000 based on the exchange rate in effect on March 31, 2006). 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 March 31, 2006 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. As of March 31, 2006,
the term loan had an outstanding balance of $712,000.
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 $1,449,000
based on the exchange rate in effect at March 31, 2006 for the conversion of
euros into United States dollars. CXR-AJ also had $33,000 of term loans with
another French bank outstanding as of March 31, 2006. The IFN Finance facility
is secured by accounts receivable and carries an annual interest rate of 1.6%
above the French "T4M" rate. At March 31, 2006, the French T4M rate was 2.2506%,
and this facility had a balance of $497,000. This facility has no financial
performance covenants.
16
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 March 31, 2006 were $29,000 as of March 31, 2006 for the
conversion of Japanese Yen into U.S. Dollars, using the exchange rate in effect.
There are no financial performance covenants applicable to this loan.
Our backlog was $22,135,000 as of March 31, 2006 as compared to
$15,021,000 as of March 31, 2005. The increase in backlog of $7,114,000 was
primarily due to the increase of $7,230,000 of backlog for Pascall and XPS in
the UK. Our backlog as of March 31, 2006 was 97.5% 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 2.5%
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.
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 prior credit facility with Wells Fargo Bank 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.
17
On May 5, 2006, our audit committee concluded that our financial
statements for the years ended December 31, 2005 and 2004 and the interim
periods during 2005 and 2004 should no longer be relied upon. The audit
committee reached this conclusion after having discussions with our former
independent registered public accountants and management as part of an
investigation conducted by the audit committee in response to an inquiry by the
staff of the Securities and Exchange Commission's Division of Enforcement. As a
result of the audit committee's conclusion regarding our financial statements,
on May 9, 2006, the registration statement was no longer effective. This event
triggered the liquidated damages provision contained in the registration rights
agreement. During the months of June through December 2006, we paid to the
remaining investors liquidated damages in the aggregate amount of $323,135.
We used a portion of the proceeds from the January 2005 private
placement to fund the acquisition of Pascall. 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.
We used another portion of the proceeds from the January 2005 private
placement to partially fund the acquisition of RO. 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 was due on March 31, 2006.
Offsetting these amounts was $35,000 received from the former RO shareholders to
compensate for balance sheet adjustments.
We included in our amended annual report on Form 10-K for the year
ended December 31, 2005 a contractual obligations table that outlines payments
due from us or our subsidiaries under our lines of credit and other significant
contractual obligations through 2010, exclusive of interest. During the three
months ended March 31, 2006, no material changes in this information occurred
outside the ordinary course of business.
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.
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.
18
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.
In May 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
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 growth of our international subsidiaries.
However, because historically the majority of our currency exposure has related
to financial statement translation rather than to particular transactions, we do
not intend to enter into, nor have we historically entered into, forward
currency contracts or hedging arrangements in an effort to mitigate our currency
exposure.
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 amended annual report on Form 10-K for the year ended
December 31, 2005 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 three months ended March 31, 2006.
19
ITEM 4. CONTROLS AND PROCEDURES.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
We conducted an evaluation, with the participation of our Chief
Executive Officer and Acting Chief Financial Officer, of the effectiveness of
the design and operation of our disclosure controls and procedures, as defined
in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended, or the Exchange Act, as of March 31, 2006, 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 Securities Exchange Commission's rules and forms,
including to ensure that information required to be disclosed by us in the
reports filed or submitted by us under the Exchange Act is accumulated and
communicated to management, including our principal executive and principal
financial officers, or persons performing similar functions, as appropriate to
allow timely decisions regarding required disclosure. Based on that evaluation,
our Chief Executive Officer and Acting Chief Financial Officer has concluded
that as of March 31, 2006, our disclosure controls and procedures were not
effective at the reasonable assurance level due to the material weaknesses
described below.
A material weakness is a control deficiency (within the meaning of the
Public Company Accounting Oversight Board ("PCAOB") Auditing Standard No. 2) 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. In connection with its audit of
our consolidated financial statements for the year ended December 31, 2005,
Grant Thornton LLP ("GT"), our former independent registered public accounting
firm, advised management and our audit committee of two matters that GT
considered to be material weaknesses.
GT indicated that in the area of accounting and financial reporting, it
believed that we had 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.
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.
In connection with its audit of our consolidated financial statements
for the years ended December 31, 2005, 2004 and 2003, Hein & Associates LLP
("Hein"), our independent registered pubic accounting firm, advised management
and our audit committee that they concur with GT's assessment of the material
weaknesses described above. Hein also noted that our accounting department did
not provide us with the appropriate resources, adequate technical skills and
supervision to accurately account for our revenues, as evidenced by our need to
restate our 2005 and 2004 financial statements.
20
To initially address these material weaknesses, management performed
additional analyses and other procedures to ensure that the financial statements
included herein fairly present, in all material respects, our financial
position, results of operations and cash flows for the periods presented.
REMEDIATION OF MATERIAL WEAKNESS
To remediate the material weakness in our disclosure controls and
procedures identified above, we have done or intend to do the following, in the
periods specified below:
To remediate the material weakness in the area of accounting and
financial reporting identified by GT and Hein, during the second and third
quarters of 2006 we sought, and we intend to seek in the future, 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.
During the second and third quarters of 2006, we developed procedures to
document all non-routine transactions on a quarterly, including support for the
final accounting treatment, and now 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.
In the third quarter of 2006, we developed plans to alter the current
organization of our accounting department and to hire additional personnel to
assist in our financial reporting processes. We seek to hire a Chief Financial
Officer and a Controller, each with expertise in public company financial
reporting compliance
We believe that a new Chief Financial Officer and a new Controller,
once hired, will contribute additional expertise to our team of finance and
accounting personnel and will assist us in our financial reporting processes. We
believe that once our accounting department is strengthened through the addition
of these additional staff members, we will have in place an adequate supervisory
structure to ensure accurate accounting for and disclosure of all transactions
in a timely manner.
Management is unsure, at the time of the filing of this report, when
the actions described above will remediate the material weakness also described
above. Although management intends to hire a new Chief Financial Officer and a
new Controller as soon as practicable, it may take an extended period of time
until suitable candidates can be located and hired. Management is, however,
optimistic that these personnel can be located and hired by the end of the first
quarter of 2007. Until we hire a new Chief Financial Officer and a new
Controller, as planned, management may hire outside consultants to assist us in
satisfying our financial reporting obligations.
21
Management believes that a new Chief Financial Officer will have an
annual base salary in the range of $185,000 to $200,000 and a new Controller
will have an annual base salary in the range of $130,000 to $150,000, not
including benefits and other costs of employment. Management is unable, however,
to estimate our expenditures related to fees paid or that may be paid in the
future to financial consultants in connection with their guidance in identifying
and evaluating complex accounting and reporting matters. Management is also
unable to estimate our expenditures related to the development of new internal
processes for identifying and disclosing both routine and non-routine
transactions and for researching and determining proper accounting treatment for
those transactions. Management is also unable to estimate our expenditures
related to the hiring of other outside consultants to assist us in satisfying
our financial reporting obligations. In addition, management is unable to
estimate our expenditures related to higher fees to be paid to our independent
auditors in connection with their review of this remediation.
To remediate the material weakness with regard to our controls over
inventory reserves, we have adjusted 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.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
The changes noted above, specifically, the changes relating to our (i)
efforts to locate suitable candidates for the positions of Chief Financial
Officer and Controller, (ii) engaging of financial consultants who are certified
public accountants to assist us in identifying and evaluating complex accounting
and reporting matters, (iii) new internal processes for identifying and
disclosing both routine and non-routine transactions and for researching and
determining proper accounting treatment for those transactions, and (iv)
assignment of individuals to perform these processes and provision to those
individuals of technical and other resources to help ensure the proper
application of accounting principles and the timely and appropriate disclosure
of routine and non-routine transactions, are the only changes during our most
recently completed fiscal quarter that have materially affected or are
reasonably likely to materially affect, our internal control over financial
reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.
22
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We are not a party to any material pending legal proceedings.
ITEM 1A. RISK FACTORS.
Item 1A of Part I of our Amendment No. 1 to Form 10-K for the fiscal
year ended December 31, 2005 summarizes various material risks that investors
should carefully consider before deciding to buy or maintain an investment in
our common stock. Any of those risks, if they actually occur, would likely harm
our business, financial condition and results of operations and could cause the
trading price of our common stock to decline. There are no material changes to
the risk factors set forth in the above-referenced report.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
RECENT SALES OF UNREGISTERED SECURITIES
During the quarter ended March 31, 2006, we issued 351,000 shares of
common stock to four individuals upon exercise of warrants that had exercise
prices of $0.75 or $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 sophisticated or
accredited with access to the kind of information registration would provide.
DIVIDENDS
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
WFBC, 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.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
23
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS.
NUMBER DESCRIPTION
------ -----------
10.1 Executive Employment Agreement dated February 24, 2006 by and
between EMRISE Corporation and Carmine T. Oliva (1)
10.2 Executive Employment Agreement dated February 24, 2006 by and
between EMRISE Corporation and Randolph D. Foote (1)
10.3 Executive Employment Agreement dated February 24, 2006 by and
between EMRISE Corporation and Graham Jefferies (1)
31.1 Certification of Chief 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 Chief 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 Acting Chief
Financial Officer Pursuant to 18 U.S.C. Section 350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
--------------
(1) Filed as an exhibit to our Form 8-K for February 24, 2006 and
incorporated herein by reference.
24
SIGNATURES
Pursuant to the requirements of 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.
EMRISE CORPORATION
Dated: January 17, 2007 By: /S/ CARMINE T. OLIVA
--------------------------------------------
Carmine T. Oliva, Chairman of the Board,
Chief Executive Officer (principal executive
officer), President, Secretary and Acting
Chief Financial Officer (principal financial
and accounting officer)
25
EXHIBITS ATTACHED TO THIS REPORT
EXHIBIT
NUMBER DESCRIPTION
31.1 Certification of Chief 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 Chief 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
26