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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, 2007
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. (Check one):
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 May 9, 2007, there were 38,144,250 shares of the issuer's common
stock, $0.0033 par value, outstanding.
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PART I
ITEM 1. FINANCIAL STATEMENTS....................................................... F-1
Condensed Consolidated Balance Sheets as of March 31, 2007 (unaudited)
and December 31, 2006..................................................... F-1
Condensed Consolidated Statements of Operations for the Three Months
Ended March 31, 2007 and 2006 (unaudited)................................. F-2
Condensed Consolidated Statements of Comprehensive Income for the
Three Months Ended March 31, 2007 and 2006 (unaudited).................... F-3
Condensed Consolidated Statements of Stockholders' Equity for the
Three Months Ended March 31, 2007 (unaudited)............................. F-4
Condensed Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 2007 and 2006 (unaudited)....................................... F-5
Notes to Condensed Consolidated Financial Statements (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................................................................ 15
ITEM 4T. CONTROLS AND PROCEDURES.................................................... 15
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.......................................................... 18
ITEM 1A. RISK FACTORS............................................................... 18
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND
USE OF PROCEEDS............................................................ 18
ITEM 3. DEFAULTS UPON SENIOR SECURITIES............................................ 18
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........................ 18
ITEM 5. OTHER INFORMATION.......................................................... 19
ITEM 6. EXHIBITS................................................................... 19
SIGNATURES ........................................................................... 20
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EMRISE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF MARCH 31, 2007 AND DECEMBER 31, 2006
(In Thousands, Except Share and Per Share Amounts)
March 31, December 31,
ASSETS 2007 2006
-------- --------
(unaudited)
Current assets:
Cash and cash equivalents $ 3,269 $ 3,802
Accounts receivable, net of allowances for doubtful accounts of $287
and $391 at March 31, 2007 and December 31, 2006, respectively 8,503 9,220
Inventories, net of allowances for inventory obsolescence of $5,892
and $5,657 at March 31, 2007 and December 31, 2006, respectively 10,975 10,575
Deferred income taxes 730 726
Prepaid and other current assets 1,180 1,082
-------- --------
Total current assets 24,657 25,405
Property, plant and equipment, net 2,193 2,245
Goodwill 12,975 12,995
Intangible assets other than goodwill, net of accumulated
amortization of $840 and $443 at March 31, 2007 and December 31, 2006,
respectively 3,452 3,546
Other assets 697 594
-------- --------
$ 43,974 $ 44,785
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Borrowings under lines of credit $ 4,286 $ 4,310
Current portion of long-term debt 503 516
Notes payable to stockholders, current portion 500 500
Accounts payable 4,521 4,640
Income taxes payable 621 519
Accrued expenses 5,592 5,309
-------- --------
Total current liabilities 16,023 15,794
Long-term debt, less current portion 420 533
Notes payable to stockholders, less current portion 1,125 1,250
Deferred income taxes 1,053 1,053
Other liabilities 953 982
-------- --------
Total liabilities 19,574 19,612
Stockholders' equity:
Preferred stock, $0.01 par value. Authorized 10,000,000 shares, zero
issued and outstanding -- --
Common stock, $0.0033 par value. Authorized 150,000,000 shares;
issued and outstanding 38,137,000 shares and 38,082,000 shares at
March 31, 2007 and December 31, 2006, respectively 126 125
Additional paid-in capital 43,124 43,083
Accumulated deficit (19,525) (18,733)
Accumulated other comprehensive income 675 698
-------- --------
Total stockholders' equity 24,400 25,173
-------- --------
$ 43,974 $ 44,785
======== ========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
F-1
EMRISE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2007 AND 2006
(Unaudited)
(In Thousands, Except Per Share Amounts)
Three Months Ended March 31,
----------------------------
2007 2006
-------- --------
Net sales $ 11,922 $ 10,734
Cost of sales 8,074 6,350
-------- --------
Gross profit 3,848 4,384
Operating expenses:
Selling, general and administrative 3,736 3,767
Engineering and product development 710 722
-------- --------
Loss from operations (598) (105)
Other income (expense):
Interest income 19 25
Interest expense (150) (124)
Other, net 65 8
-------- --------
Loss before income taxes (664) (196)
Income tax expense 128 126
-------- --------
Net loss $ (792) $ (322)
======== ========
Basic loss per share $ (0.02) $ (0.01)
======== ========
Diluted loss per share $ (0.02) $ (0.01)
======== ========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
F-2
EMRISE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
THREE MONTHS ENDED MARCH 31, 2007 AND 2006
(Unaudited)
(In Thousands)
Three Months
Ended March 31,
------------------------------
2007 2006
------------ ------------
Net loss $ (792) $ (322)
Other comprehensive income (loss):
Foreign currency translation adjustment (23) 126
------------ ------------
Comprehensive loss $ (815) $ (196)
============ ============
The accompanying notes are an integral part of these
condensed consolidated financial statements.
F-3
EMRISE CORPORATION AND SUBSIDIARIES
THREE MONTHS ENDED MARCH 31, 2007
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)
(In Thousands)
Accumulated
Additional Other
Common Stock Paid-In Accumulated Comprehensive
Shares Amount Capital Deficit Income (Loss) Total
-------- -------- -------- -------- -------- --------
Balance at December 31, 2006 38,082 $ 125 $ 43,083 $(18,733) $ 698 $ 25,173
Stock option exercises 55 1 19 -- -- 20
Stock option issuance expense -- -- 22 -- -- 22
Net loss and comprehensive income -- -- -- (792) (23) (815)
-------- -------- -------- -------- -------- --------
Balance at March 31, 2007 38,137 $ 126 $ 43,124 $(19,525) $ 675 $ 24,400
======== ======== ======== ======== ======== ========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
F-4
EMRISE CORPORATION AND SUBSIDIARIES
THREE MONTHS ENDED MARCH 31, 2007 AND 2006
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In Thousands)
Three Months
Ended March 31,
2007 2006
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (792) $ (322)
Adjustments to reconcile net loss to used in operating activities:
Depreciation and amortization 277 288
Provision for inventory obsolescence 251 229
Deferred taxes (4) (4)
Stock option expense 22 26
Warrants issued for services -- 15
Provision for doubtful accounts 4 0
Changes in operating assets and liabilities net of businesses acquired:
Accounts receivable 712 1,057
Inventories (681) (1,085)
Prepaid and other assets (201) (73)
Accounts payable and accrued expenses 237 (660)
------- -------
Cash used in operating activities (175) (529)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net purchases of property, plant and equipment (135) (45)
Cash paid for acquisition of Pascall, net of cash acquired --
------- -------
Cash used in investing activities (135) (45)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments of current notes payable (24) (1,355)
Repayments of long-term debt (126) (122)
Payments of notes to stockholders (125) (125)
Proceeds from exercise of stock options and warrants 20 386
------- -------
Cash used in financing activities (255) (1,216)
------- -------
Effect of exchange rate changes on cash 32 109
------- -------
Net decrease in cash and cash equivalents (533) (1,681)
Cash and cash equivalents at beginning of period 3,802 4,371
------- -------
Cash and cash equivalents at end of period $ 3,269 $ 2,690
======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 121 $ 115
======= =======
Income taxes $ 9 $ 12
======= =======
The accompanying notes are an integral part of these
condensed consolidated financial statements.
F-5
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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 devices 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 devices 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 ("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, 2007 and the results of operations and cash flows for
the related interim periods ended March 31, 2007 and 2006. 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, 2006 filed with the Commission.
STOCK-BASED COMPENSATION
The Company has four stock option plans:
o Employee Stock and Stock Option Plan, effective July
1, 1994;
o 1993 Stock Option Plan;
o 1997 Stock Incentive Plan; and
o Amended and Restated 2000 Stock Option Plan.
Total stock-based compensation expense related to Statement of
Financial Accounting Standard ("SFAS") No. 123 (revised 2004), SHARE-BASED
PAYMENT, included in wages, salaries and related costs was $22,000 and $26,000
for the three months ended March 31, 2007 and 2006, respectively. These
compensation expenses were charged to selling, general and administrative
expenses. As of March 31, 2007, $20,000 of compensation cost attributable to
future service related to plan awards that are probable of being achieved had
not yet been recognized. This amount will be recognized as expense over a
weighted-average period of six months.
F-6
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(2) 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,
2007 2006
-------- --------
NUMERATOR:
Net loss $ (792) $ (322)
-------- --------
Loss attributable to common stockholders $ (792) $ (322)
======== ========
DENOMINATOR:
Weighted average number of common shares outstanding during the period-basic 38,110 37,678
Incremental shares from assumed conversions of warrants and options -- --
-------- --------
Adjusted weighted average number of outstanding shares-diluted 38,110 37,678
-------- --------
Basic loss per share $ (0.02) $ (0.01)
======== ========
Diluted loss per share $ (0.02) $ (0.01)
======== ========
The following table shows the common stock equivalents that were
outstanding as of March 31, 2007 and 2006 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, 2007 715,000 $1.35 - $3.13
As of March 31, 2006 736,000 $1.35 - $3.13
Anti-dilutive common stock warrants:
As of March 31, 2007 4,061,000 $1.21 - $2.00
As of March 31, 2006 3,886,000 $1.86 - $2.00
F-7
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) INVENTORIES
Inventories are summarized as follows (in thousands), net of reserves
of $5,892,000 and $5,657,000 as of March 31, 2007 and December 31, 2006,
respectively:
March 31, December 31,
2007 2006
--------------- ---------------
Raw materials $ 4,612,000 $ 4,689,000
Work-in-process 3,319,000 3,247,000
Finished goods 3,044,000 2,639,000
--------------- ---------------
$ 10,975,000 $ 10,575,000
=============== ===============
(4) REPORTABLE SEGMENTS
The Company has two reportable segments: electronic devices and
communications equipment. The electronic devices segment operates in the United
States, European and Asian markets and designs, manufactures and markets digital
and rotary switches, electronic power supplies, radio frequency ("RF") and
microwave devices 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 devices 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, 2007:
Reporting Units Within Electronic Devices Segment:
--------------------------------------------------
o EMRISE Electronics - Rancho Cucamonga, California: Digitran
Division - digital and rotary switches, and electronic
subsystem assemblies for defense and aerospace applications
and keypads
o EMRISE Electronics - Monrovia, California: XCEL Circuits
Division - printed circuit boards mostly for intercompany
sales
o RO Associates, Incorporated ("RO") - San Jose, California:
manufacturer of standard power supplies using proprietary
technology.
o XCEL Japan Ltd. ("XJL")- Tokyo, Japan: reseller of Digitran
switches and other third party electronic devices
F-8
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
o EMRISE Electronics Limited ("EEL") - 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.
("XPS"), 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 Corporation - San Jose,
California: manufacturer of telecommunications test
equipment for the field and central office applications
o Larus division of CXR Larus Corporation - San Jose,
California: manufacturer of telecommunications synchronous
timing devices and network access equipment
o CXR-Anderson Jacobson - Abondant, France: manufacturer of
network access and modem equipment
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 annual
report on Form 10-K for the year ended December 31, 2006. 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,
2007 2006
----------------- -----------------
Sales to external customers:
----------------------------
Electronic devices $ 8,528 $ 7,853
Communications equipment 3,394 2,881
----------------- -----------------
Total $ 11,922 $ 10,734
================= =================
Interest expense
----------------
Electronic devices $ 40 $ 60
Communications equipment 110 64
----------------- -----------------
Total $ 150 $ 124
================= =================
Depreciation and amortization
-----------------------------
Electronic devices $ 216 $ 223
Communications equipment 54 54
----------------- -----------------
Total $ 270 $ 277
================= =================
Segment profits (loss) before income taxes
------------------------------------------
Electronic devices $ 487 $ 929
Communications equipment (212) (232)
----------------- -----------------
Total $ 275 $ 697
================= =================
F-9
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, December 31,
2007 2006
----------------- -----------------
Segment assets:
Electronic devices $ 27,490 $ 27,514
Communications equipment 15,663 15,912
----------------- -----------------
Total $ 43,153 $ 43,426
================= =================
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,
2007 2006
----------------- -----------------
Net sales:
Total sales for reportable segments $ 11,922 $ 10,734
Elimination of intersegment sales -- --
----------------- -----------------
Total consolidated net sales $ 11,922 $ 10,734
================= =================
Loss before income taxes
Total income for reportable segments $ 275 $ 697
Unallocated amounts: (939) (893)
----------------- -----------------
Net loss before income taxes $ (664) $ (196)
================= =================
Interest expense
Interest expense for reportable segments $ 150 $ 124
Other interest expense -- --
----------------- -----------------
Total interest expense $ 150 $ 124
================= =================
Depreciation and amortization
Depreciation and amortization expense
for reportable segments $ 270 $ 277
Other depreciation and amortization expense 7 11
----------------- -----------------
Total depreciation and amortization $ 277 $ 288
================= =================
As of As of
March 31, 2007 December 31, 2006
----------------- -----------------
Assets
Total assets for reportable segments $ 43,153 $ 43,426
Other assets 821 1,359
----------------- -----------------
Total consolidated assets $ 43,974 $ 44,785
================= =================
F-10
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Goodwill and other intangible assets by segment as of March 31, 2007 are as follows (in thousands):
Technology
Relationships Customer Covenant Not Patents in
Trademarks and Acquired -- -- to Compete -- Backlog -- Progress
Goodwill -- Trade Names -- 10-Year Life 10-Year Life 3-Year Life 2-Year Life -- Not
Not Amortizable Not Amortizable Amortizable Amortizable Amortizable Amortizable Amortizable
--------------- --------------- ----------- ----------- ----------- ----------- -----------
Gross cost
----------
Electronic devices $ 7,358 $ 850 $ 500 $ 350 $ 200 $ 200 $ 92
Communications equipment 6,706 750 1,150 200 -- -- --
------- ------- ------- ------- ------- ------- -------
Total $14,064 $ 1,600 $ 1,650 $ 550 $ 200 $ 200 $ 92
======= ======= ======= ======= ======= ======= =======
Accumulated amortization
------------------------
Electronic devices $ 217 $ -- $ 79 $ 55 $ 134 $ 200 $ 1
Communications equipment 872 -- 316 55 -- -- --
------- ------- ------- ------- ------- ------- -------
Total $ 1,089 $ -- $ 395 $ 110 $ 134 $ 200 $ 1
======= ======= ======= ======= ======= ======= =======
Carrying value
--------------
Electronic devices $ 7,141 $ 850 $ 421 $ 295 $ 66 $ -- $ 91
Communications equipment 5,834 750 834 145 -- -- --
------- ------- ------- ------- ------- ------- -------
Total $12,975 $ 1,600 $ 1,255 $ 440 $ 66 $ -- $ 91
======= ======= ======= ======= ======= ======= =======
F-11
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007 AND 2006
(UNAUDITED)
Changes in goodwill by segment (in thousands):
Communications
Electronic Devices Equipment Total
---------------- ---------------- ----------------
Balance at December 31, 2006 $ 7,161,000 $ 5,834,000 $ 12,995,000
Foreign currency translation (22,000) -- (22,000)
---------------- ---------------- ----------------
Balance March 31, 2007 $ 7,141,000 $ 5,834,000 $ 12,975,000
================ ================ ================
(5) NEW ACCOUNTING PRONOUNCEMENTS
The Company adopted Financial Accounting Standards Board ("FASB")
Financial Interpretation No. ("FIN") 48, ACCOUNTING FOR UNCERTAINTY IN INCOME
TAXES - AN INTERPRETATION OF FASB STATEMENT NO. 109, on January 1, 2007. The
implementation of FIN 48 did not result in a material adjustment to the
Company's liability for unrecognized income tax benefits. At the time of
adoption and as of the end of the first quarter of 2007, the Company had
recorded no net unrecognized tax benefits. The Company does not believe that it
will record unrecognized tax benefits within the year following the first
quarter of 2007.
The Company recognizes interest and penalties related to uncertain tax
positions in interest expense and selling, general and administrative expense,
respectively, in the condensed consolidated statements of operations and
comprehensive income. No interest or penalties were recognized during the first
quarter of 2007. As of March 31, 2007, the Company had nothing accrued for
interest and penalties.
The Company files income tax returns in the United States federal
jurisdiction, the United Kingdom, France and Japan, and in the state
jurisdictions of California, Texas and New Jersey. The Company is no longer
subject to United States federal and state tax examinations for years before
2003 and 2002, respectively, and is no longer subject to tax examinations for
the United Kingdom and Japan for years prior to 2005, and for France for years
prior to 2003.
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain
Hybrid Financial Instruments, which amends SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities and SFAS No. 140, Accounting for
the Impairment or Disposal of Long-Lived Assets. Specifically, SFAS No. 155
amends SFAS No. 133 to permit fair value remeasurement for any hybrid financial
instrument with an embedded derivative that otherwise would require bifurcation,
provided the whole instrument is accounted for on a fair value basis.
Additionally, SFAS No. 155 amends SFAS No. 140 to allow a qualifying special
purpose entity to hold a derivative financial instrument that pertains to a
beneficial interest other than another derivative financial instrument. SFAS No.
155 applies to all financial instruments acquired or issued after the beginning
of an entity's first fiscal year that begins after September 15, 2006. The
Company's adoption of SFAS No. 155 on January 1, 2007 has not had a material
effect on its results of operations or financial position.
In September 2006, the FASB issued SFAS No. 157, Fair Value
Measurements. This new statement provides a single definition of fair value,
together with a framework for measuring it, and requires additional disclosure
about the use of fair value to measure assets and liabilities. SFAS No. 157 also
emphasizes that fair value is a market-based measurement, not an entity-specific
measurement, and sets out a fair value hierarchy, with the highest priority
F-12
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007 AND 2006
(UNAUDITED)
being quoted prices in active markets. The required effective date of SFAS No.
157 is the first quarter of 2008. The Company is evaluating the effect this
statement may have on its consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option
for Financial Assets and Financial Liabilities. SFAS No. 159 permits an entity
to irrevocably elect fair value on a contract-by-contract basis as the initial
and subsequent measurement attribute for many financial assets and liabilities
and certain other items including insurance contracts. Entities electing the
fair value option would be required to recognize changes in fair value in
earnings and to expense up front cost and fees associated with the item for
which the fair value option is elected. SFAS No. 159 is effective for fiscal
years beginning after November 15, 2007. Early adoption is permitted as of the
beginning of a fiscal year that begins on or before November 15, 2007, provided
the entity also elects to apply the provisions of SFAS No. 157, Fair Value
Measurements. The Company is evaluating the effect that adoption of SFAS No. 159
would have on its financial condition or results of operations.
(6) INCOME TAXES
The effective tax rate for the three-month period ended March 31, 2007
was different than the 34% United States statutory rate primarily because of
foreign taxes on foreign source income that cannot be offset by domestic tax
loss carryforwards.
(7) LINES OF CREDIT
Outstanding borrowings under the Company's revolving lines of credit
described below were as follows:
March 31, December 31,
2007 2006
------------ -------------
Line of credit with a U.S. commercial lender $ 1,447,000 $ 1,978,000
Lines of credit with foreign banks 2,839,000 2,332,000
------------ -------------
$ 4,286,000 $ 4,310,000
============ =============
On August 25, 2005, the Company, together with two subsidiaries, CXR
Larus and EMRISE Electronics, acting as guarantors, obtained a credit facility
from Wells Fargo Bank, N.A. (the "Bank credit facility") for the Company's
United States operations. The Bank credit facility provided a $9,000,000
revolving line of credit secured by accounts receivable, other rights to payment
and general intangibles, inventories and equipment, with an interest rate
adjusted monthly based on the prime rate.
The Bank credit facility also provided 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%. In addition, Wells Fargo Bank provided the Company with
credit for the purchase of new capital equipment when needed, with an interest
rate equal to the 90-day London InterBank Offered Rate ("LIBOR") (5.35% at March
31, 2007) plus 3.75% per annum. Amounts borrowed under this arrangement are
being amortized over 60 months from the respective dates of borrowing and
secured by the purchased equipment.
F-13
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007 AND 2006
(UNAUDITED)
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 ("WFBC credit
facility") providing for a revolving line of credit and term loan. On December
5, 2006, the Company paid off the $1,500,000 Bank credit facility in full.
The WFBC credit facility provides for a $5,000,000 revolving line of
credit that expires on December 1, 2009 and is secured by accounts receivable,
other rights to payment and general intangibles, inventories and equipment. The
line of credit is formula-based and generally provides that the outstanding
borrowings under the line of credit may not exceed an aggregate of 85% 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 March 31,
2007 was 8.25%.
The WFBC 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. The WFBC 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 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 WFBC 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 and for each calendar month ending on or after March 31, 2007. The
Company was not permitted to 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.
If WFBC terminates the WFBC credit facility during a default period, or
if the Company terminates or reduces the WFBC 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.
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 WFBC credit facility, or any earlier date that all
principal owing under the WFBC 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 WFBC credit facility.
F-14
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007 AND 2006
(UNAUDITED)
The WFBC 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, 2007, the Company had balances of $1,447,000
outstanding on the WFBC revolving line of credit and $183,000 outstanding on the
term loan. Availability on the WFBC revolving line of credit was $651,000. As of
March 31, 2007, the Company was not in compliance with the loan's financial
covenants for net worth, net income and debt service coverage. The Company
obtained a waiver from WFBC for those covenant violations. WFBC is currently in
the process of resetting the covenants for 2007.
As of March 31, 2007, 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., in France, and Johnan
Shinkin Bank in Japan. At March 31, 2007, the balances outstanding under the
Company's United Kingdom, France and Japan credit facilities were $2,134,000,
$1,206,000 and $11,000, respectively.
On July 8, 2005, XPS and Pascall obtained a credit facility with Lloyds
that provides a revolving loan secured by receivables, with a maximum
availability of 2,100,000 British pounds sterling (approximately $4,121,000
based on the exchange rate in effect on March 31, 2007). The annual interest
rate on the revolving loan is 1.5% above the Lloyds TSB base rate. The Lloyds
TSB base rate was 5.25% at March 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. Based on the Company's long-term relationship with
Lloyds Bank, the Company anticipates but can give no assurance that it will be
able to renew or obtain a new credit facility from Lloyds Bank when this
existing facility expires July 31, 2007.
On August 26, 2005, XPS entered into an agreement with Lloyds for an
unsecured cashflow loan of 300,000 British pounds sterling (approximately
$589,000 based on the exchange rate in effect on March 31, 2007), 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 $4,709,000 based on the exchange rate in effect on March
31, 2007). The interest rate is variable and is adjusted monthly based on the
base rate of Lloyds TSB plus 1.9%. 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.
The balance on the XPS and Pascall revolving loans at March 31, 2007 was
$1,661,000. Availability on the XPS and Pascall revolving loans was $1,753,000
as of March 31, 2007.
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 of
500,000 British pounds sterling (approximately $981,000 based on the exchange
rate in effect on March 31, 2007). 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
loan also includes financial covenants. EEL must maintain profit before taxation
and interest paid and payable of no less than 150% of interest paid and payable.
F-15
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007 AND 2006
(UNAUDITED)
In the event of a default, Lloyds may make the loans, including any
outstanding principal and interest that 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 $1,600,000
based on the exchange rate in effect at March 31, 2007 for the conversion of
euros into United States dollars. CXR-AJ also had $28,000 of term loans with
another French bank outstanding as of March 31, 2007. 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, 2007, the French T4M rate was 3.69%,
and this facility, in addition to several small loans with other banks, had an
aggregate balance of $1,178,000. This facility has no financial performance
covenants. Availability on the IFN Finance credit line was $161,000 as of March
31, 2007, in addition to $12,000 availability with several other banks.
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 balance of the loan as of March
31, 2007 was $11,000. There are no financial performance covenants applicable to
this loan.
(8) 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. 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, 2007, the 30-day LIBOR was
5.32%.
Future maturities of notes payable to stockholders are as follows:
Year Ending
December 31,
------------
2007 $ 375,000
2008 500,000
2009 500,000
2010 250,000
2011 --
----------------
$ 1,625,000
================
Interest paid on these notes in the three months ended March 31, 2007
and 2006 was $35,000 and $39,000, respectively.
There are no guarantees by officers or fees paid to officers or loans
to or from officers.
F-16
EMRISE CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2007 AND 2006
(UNAUDITED)
The Company entered into an above-market real property lease with the
former stockholders of Larus Corporation. The lease represented an obligation
that exceeded the fair market value by approximately $756,000. The lease term is
for 7 years and expires on June 30, 2011. It is renewable for a 5-year term
priced under market conditions. The base rent is based on a minimum rent of $.90
per square foot per month, which is $27,000 monthly or $324,000 per year,
subject to monthly adjustments of the interest rate based on the Federal Reserve
Discount Rate that match the lessor's variable interest rate mortgage payments
on the building. The maximum increase in any year is 1.5%, with a cumulative
maximum increase of 8% over the life of the lease. The increases apply to that
portion of the rent that corresponds to the interest portion of the lessor's
mortgage. Lease payments paid to the related parties during 2006 and 2005
totaled $456,000 and $378,000, respectively.
The Company entered into a lease for the RO building with Caspian
Associates ("Caspian"), a California general partnership. Richard Okada, who was
President of RO prior to the Company's acquisition and is currently the
President of RO, is a general partner of Caspian. The lease provided for a
two-year term commencing on September 1, 2005 and ending on August 31, 2007, at
a base rent of $9,210 per month. Additionally, the lease provided for an
extension of the lease term for an additional three years, to August 31, 2010,
and a rent increase if RO achieves certain net sales and cumulative gross profit
targets. However, the targets were eliminated from the lease when the property
was sold on November 1, 2006. Also, on March 1, 2007, the lease converted into a
month-to-month tenancy where either party may provide the other with 30 days'
notice to terminate the lease. As of March 1, 2007, the lease obligation was
$12,280 per month, which was more than the original $9,210 because a sublessee
terminated its sublease in May 2006. The Company paid $138,000 and $37,000 on
the lease in 2006 and 2005, respectively. The Company terminated the lease on
March 31, 2007.
(10) ACCRUED EXPENSES
Accrued expenses were as follows (in thousands):
March 31, 2007 December 31, 2006
Accrued salaries $ 730,000 $ 717,000
Accrued payroll taxes and benefits 1,244,000 830,000
Advance payments from customers 1,924,000 1,840,000
Other accrued expenses 1,694,000 1,922,000
----------------- -------------------
Total accrued expenses $ 5,592,000 $ 5,309,000
================= ===================
F-17
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 the related notes and
the other financial information included elsewhere in this report. This report
and the following discussion contain forward-looking statements regarding, among
other items, the electronic devices and communications equipment industries and
our expectations regarding our future performance, liquidity and capital
resources. Our actual results could differ materially from those expressed in
these forward-looking statements as a result of any number of factors, including
those set forth below and elsewhere in this report:
o the projected growth or contraction in the electronic devices 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 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 ("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 annual report on Form 10-K for the year ended December 31,
2006 filed with the Commission 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 May 4, 2007, 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").
Through our three wholly-owned operating subsidiaries, 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 Devices
-- digital and rotary switches
-- electronic power supplies
-- radio frequency ("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 devices segment, primarily to
aerospace customers, defense contractors and industrial customers, were
approximately 71.5% and 73.2% of our total net sales during the three months
ended March 31, 2007 and 2006, respectively. Sales of communications equipment
and related services, primarily to private customer premises and public carrier
customers, were approximately 28.5% and 26.8% of our total net sales during the
three months ended March 31, 2007 and 2006, respectively.
Sales in our electronic devices segment increased $675,000 (8.6%) for
the three months ended March 31, 2007 as compared to the three months ended
March 31, 2006, primarily due to increased power supply sales volume. We also
experienced a $513,000 (17.8%) increase in sales in our communications equipment
segment for the three months ended March 31, 2007. This increase was primarily
due to increased sales volume of network access equipment.
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.
3
REVENUE RECOGNITION
We derive revenues from sales of electronic devices 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 devices and
communications equipment at the point of shipment of those products. Product
returns are infrequent and require prior authorization because our sales are
final and we quality test our products prior to shipment to ensure they meet the
specifications of the binding purchase orders under which they are shipped.
Normally, when a customer requests and receives authorization to return a
product, the request is accompanied by a purchase order for a replacement
product.
Revenue recognition for products and services provided by our United
Kingdom subsidiaries depends upon the type of contract involved.
Engineering/design services contracts generally entail design and production of
a prototype over a term of up to several years, with all revenue deferred until
all services under the contracts have been completed. Production contracts
provide for a specific quantity of products to be produced over a specific
period of time. Customers issue binding purchase orders for each suborder to be
produced. At the time each suborder is shipped to the customer, we recognize
revenue relating to the products included in that suborder. Returns are
infrequent and permitted only with prior authorization because these products
are custom made to order based on binding purchase orders and are quality tested
prior to shipment. Generally, these products carry a one-year limited parts and
labor warranty. We do not offer customer discounts, rebates or price protection
on these products.
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 devices, network access and transmission
products and 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 3.2%
and 5.2% of net sales for the three months ended March 31, 2007 and 2006,
respectively.
INVENTORY VALUATION
Our finished goods electronic devices 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
4
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
69.3% and 53.4% of our net revenues, and 58.0% and 48.4% of our assets and 59.9%
and 46.1% of our total liabilities as of and for the three months ended March
31, 2007 and 2006, respectively. 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.
5
Based on our assessment of the factors discussed above, we consider the
functional currency of each of our international subsidiaries to be each
subsidiary's local currency. Accordingly, we had cumulative translation gains of
$675,000 and losses of $698,000 that were included as part of accumulated other
comprehensive income (loss) within our balance sheets at March 31, 2007 and
December 31, 2006, respectively. During the three months ended March 31, 2007
and 2006, we included translation adjustments of a loss of approximately $23,000
and a gain of approximately $126,000, 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 2007 and 2006. 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 $5,790,000 loan payable from EMRISE Electronics Ltd. ("EEL") to
EMRISE was outstanding as of March 31, 2007. The majority of 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. Under Statement of Financial
Accounting Standard ("SFAS") No. 142, GOODWILL AND OTHER INTANGIBLE ASSETS, we
are required to analyze our goodwill for impairment issues 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 March 31, 2007, our reported goodwill totaled
$12,975,000. During the quarter ended March 31, 2007, 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, 2007 to our results of operations for the three
months ended March 31, 2006, 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.
6
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 number and unfavorable
changes as a negative number. 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 number 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,
-------------------- ----------- -------- --------------------
FAVORABLE FAVORABLE
2007 2006 (UNFAVORABLE) (UNFAVORABLE) 2007 2006
--------- --------- ----------- -------- ------- -------
(IN THOUSANDS)
Net sales
Electronic devices $ 8,528 $ 7,853 $ 675 8.6% 71.5% 73.2%
Communications equipment 3,394 2,881 513 17.8% 28.5% 26.8%
--------- --------- ----------- -------- ------- -------
Total net sales 11,922 10,734 1,188 11.1% 100.0% 100%
--------- --------- ----------- -------- ------- -------
Cost of sales
Electronic devices 5,900 4,787 (1,113) (23.3%) 49.5% 44.6%
Communications equipment 2,174 1,563 (611) (39.1%) 18.2% 14.6%
--------- --------- ----------- -------- ------- -------
Total cost of sales 8,074 6,350 (1,724) (27.1%) 67.7% 59.2%
--------- --------- ----------- -------- ------- -------
Gross profit
Electronic devices 2,628 3,066 (438) (14.3%) 22.0% 28.6%
Communications equipment 1,220 1,318 (98) (7.4%) 10.2% 12.3%
--------- --------- ----------- -------- ------- -------
Total gross profit 3,848 4,384 (536) (12.2%) 32.3% 40.8%
--------- --------- ----------- -------- ------- -------
Selling, general and administrative
expenses 3,736 3,767 31 0.8% 31.3% 35.1%
Engineering and product development 710 722 12 1.7% 6.0% 6.7%
--------- --------- ----------- -------- ------- -------
Operating loss (598) (105) (493) 469.5% (5.0%) (1.0%)
Interest expense (150) (124) (26) (21.0%) (1.3%) (1.2%)
Interest income 19 25 (6) (24.0%) 0.2% 0.2%
Other income and expense 65 8 57 712.5% 0.5% 0.1%
--------- --------- ----------- -------- ------- -------
Loss before income tax expense (664) (196) (468) (238.8%) (5.6%) (1.8%)
Income tax expense 128 126 (2) 1.6% 1.1% 1.2%
--------- --------- ----------- -------- ------- -------
Net loss $ (792) $ (322) $ (470) 146.0% (6.6%) (3.0%)
========= ========= =========== ======== ======= =======
NET SALES. The $1,188,000 increase in total net sales resulted from the
combination of a $675,000 increase in net sales of our electronic devices and a
$513,000 increase in net sales of our communications equipment products and
services.
ELECTRONIC DEVICES. The increase in net sales of electronic devices was
due to a $1,677,000 (38.7%) increase in sales of power supplies to $6,011,000 as
compared to $4,334,000 in the prior year period, primarily for military
applications. XPS and Pascall Electronics Limited ("Pascall"), both located in
the United Kingdom, contributed $1,273,000 and $587,000, respectively, to this
increase. These increases were partially offset with a decrease of $178,000
(15.6%) in power supply sales by RO Associates Incorporated ("RO") mainly due to
the temporary disruption caused by RO's relocating to the facility it now shares
with CXR Larus in San Jose, California. Switch sales decreased by $256,000
(14.1%) in the first three months of 2007 as compared to the 2006 period due to
EMRISE Electronics' Digitran division's delayed receipt of expected year-end
2006 orders from two of our largest customers, which orders we have begun to
receive in the second quarter of 2007. Radio frequency components from Pascall
shipped at a lower rate in the first three months of 2007, resulting in a
$570,000 (43.3%) reduction to $745,000 as compared to $1,315,000 in the prior
year due to delays in receipt of expected orders, which have subsequently been
received and are expected to ship in the second quarter of 2007.
7
COMMUNICATIONS EQUIPMENT. The increase in net sales of communications
equipment was primarily the result of a $464,000 (24.1%) increase in net sales
of network access equipment to $2,389,000 from $1,925,000 in the prior year
period. This was due to a $584,000 increase in volume for such equipment sold by
CXR-AJ in France, primarily for military applications, and was partially offset
by a $120,000 reduction in sales of network access equipment at CXR Larus. CXR
Larus sold $163,000 (43.1%) more synchronous communication timing systems in the
first quarter of 2007 as compared to the first quarter of 2006. These increases
were partially offset with a $37,000 decrease in net sales of test equipment and
a $78,000 decrease in service and miscellaneous sales. This is consistent with
our business strategy of minimizing sales efforts for test equipment, which we
feel have limited growth potential, and focusing more on network timing devices,
where we believe we have good growth opportunities. We expect our synchronous
communication timing device sales to continue to improve in the remainder of
2007 as we introduce our new TiemPo(TM) 6400 product.
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 decrease in
gross profit in both our electronic devices segment and our communications
equipment segment.
ELECTRONIC DEVICES. The decrease in gross profit for our electronic
devices segment was primarily due to a reduction in Digitran's gross profit for
switches of $344,000 (35.4%) to $629,000 from $973,000 due to the delayed
receipt of expected year-end 2006 orders from two of our largest customers,
which orders we have begun to receive in the second quarter of 2007. These
orders are for higher margin product, so the delay affected our gross profit
more than our net sales. Also, the gross profit for power supplies from RO
decreased by $263,000 (67.4%) to $127,000 from $390,000 due to lower sales
volume primarily caused by disruption during RO's move to our CXR Larus facility
and the fact that RO's prior year gross profit included a one-time $100,000
royalty with unusually high gross margin. We do not expect significant royalty
income in future periods. These decreases were partially offset with a $139,000
increase in gross profit from our United Kingdom-based power supply operations
due to higher sales associated with Eurofighter Typhoon aircraft and other
defense-related aerospace shipments. Also included in gross profit for the first
quarter of 2007 is a $23,000 increase in gross profit from XCEL Japan Ltd.
("XJL"), our Japanese subsidiary.
COMMUNICATIONS EQUIPMENT. The decrease in gross profit for our
communication equipment segment was primarily caused by a $348,000 (40.2%)
reduction in gross profit at our CXR Larus facility to $517,000 from $865,000 in
the prior year period. This reduction was primarily due to lower sales of high
margin end-of-life test equipment. These reductions in gross profit were
partially offset by a $251,000 (55.4%) increase in gross profit for our network
access products sold by CXR-AJ in France, primarily from greater shipments of
high margin military products as compared to the first quarter of 2006.
SELLING, GENERAL & ADMINISTRATIVE EXPENSES. Total selling, general and
administrative ("SG&A") expenses decreased slightly by $31,000 (0.8%) to
$3,736,000 from $3,767,000 in the prior year period. However, some components of
SG&A expenses changed. United States-based audit fees increased $241,000 due to
a cost overrun and the quarterly reviews for 2006 being performed in the first
quarter of 2007 instead of during 2006 due to the re-audit of our 2003, 2004 and
2005 earnings. For similar reasons, corporate legal fees increased $47,000. We
do not expect 2006 audit or related legal expenses to affect subsequent periods
of 2007. These increases were offset with a reduction of $278,000 in
compensation-related expenses.
ENGINEERING & PRODUCT DEVELOPMENT EXPENSES. Engineering and product
development expenses consist primarily of research and product development
activities. Such expenses decreased slightly in the first quarter of 2007 to
$710,000 as compared to $722,000 in the prior year period. These expenses
increased by $30,000 in our electronic components devices segment mainly due to
increased development cost on our new line of very low profile rotary switches.
These expenses declined by $42,000 for our communications equipment segment due
to moderately less development expenses for both timing and network access
products, as the bulk of development expense for our new synchronous timing
device called the TiemPo(TM) 6400 product was incurred in 2006.
8
INTEREST EXPENSE, NET. Interest expense increased from $124,000 to
$150,000 due to increased loan balances for our United States and French
operations.
OTHER INCOME AND EXPENSE. Other income and expense consists primarily
of short-term exchange rate gains and losses associated with foreign currency
fluctuations on the current portion of certain assets and liabilities. Other
income and expense increased by $57,000 in the first quarter of 2007 as compared
to the first quarter of 2006.
INCOME TAX EXPENSE. Income tax expense of $128,000 was slightly more
than the $126,000 of the prior year period and consisted almost entirely of
foreign income tax.
NET LOSS. The net loss of $792,000 as compared to a net loss of
$322,000 in the prior period was primarily the result of lower gross margin at
CXR Larus, CXR-AJ and Digitran. Also, we incurred a $288,000 increased in
accounting and legal expenses due to a cost overrun and the timing of quarterly
reviews.
LIQUIDITY AND CAPITAL RESOURCES
During the quarters ended March 31, 2007 and 2006, we funded our
operations primarily through revenue generated from our operations and through
our previous line of credit with Wells Fargo Bank, N.A. ("Bank credit
facility"), a new credit facility ("WFBC credit facility") with Wells Fargo Bank
acting through its Wells Fargo Business Credit operating division ("WFBC"), and
facilities with various foreign banks. As of March 31, 2007, we had working
capital of $8,634,000, which represented a $977,000 (10.2%) decrease from
working capital of $9,611,000 at December 31, 2006, primarily due to the loss we
incurred in the first quarter of 2007. At March 31, 2007 and December 31, 2006,
we had accumulated deficits of $19,525,000 and $18,733,000, respectively, and
cash and cash equivalents of $3,269,000 and $3,802,000, respectively.
Accounts receivable decreased $717,000 (7.8%) during the first three
months of 2007, from $9,220,000 as of December 31, 2006 to $8,503,000 as of
March 31, 2007. 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 $400,000 (3.8%) during the three months
ended March 31, 2007, from $10,575,000 at December 31, 2006 to $10,975,000 at
March 31, 2007. Inventory represented 25.0% and 23.6% of our total assets as of
March 31, 2007 and December 31, 2006, respectively. Inventory turnover, which is
a ratio that indicates how many times our inventory is sold and replaced over a
specified period, was 3.0 times for the first three months of 2007 as compared
to 2.4 for the prior year period.
We have taken various actions to reduce costs. In 2005, we contracted
with a contract manufacturer, Hitachi, for production of communication timing
and synchronization products at lower prices than our previous cost for in-house
manufacturing for production that began in the second quarter of 2006. In the
first quarter of 2007, we moved RO to the CXR Larus facility, as a result of
which we expect to save at least $180,000 annually in facility related costs.
Cash used in our operating activities totaled $175,000 for the three
months ended March 31, 2007 as compared to cash used in our operating activities
of $529,000 during the first three months of 2006. This $354,000 increase in
operating cash flows primarily resulted from an increase in accrued expenses.
9
Cash used in our investing activities totaled $135,000 for the first
three months of 2007 as compared to $45,000 for the prior year period. The 2007
amount consists of an increase in additions of property, plant and equipment of
$90,000 over the prior year.
Cash used in our financing activities totaled $255,000 for the current
period in 2007 as compared to $1,216,000 for 2006. The $961,000 reduction in
cash used in financing is the result of a lesser amount paid on bank loans as
compared to the prior year period.
At March 31, 2007, we had $2,839,000 of outstanding borrowings under
lines of credit with foreign banks. At March 31, 2007, outstanding borrowings
and availability under our revolving lines of credit were as follows:
Maximum Actual
Contractual Outstanding Remaining
Availability Borrowings Availability
------------ ---------- ------------
Line of credit with a U.S. commercial lender $ 2,098,000 $ 1,447,000 $ 651,000
Lines of credit with foreign banks 4,765,000 2,839,000 1,926,000
------------- ------------- -------------
$ 6,863,000 $ 4,286,000 $ 2,577,000
============= ============= =============
Actual remaining availability represents the additional amount we were
eligible to borrow as of March 31, 2007. Maximum contractual availability
represents the maximum amount of availability provided under the contract as of
that date and includes the actual remaining availability.
In addition to the revolving lines of credit, at December 31, 2006, we
had long-term loans and capitalized lease and equipment loan obligations
totaling $1,049,000, the current portion of which loans and obligations totaled
$516,000.
Below are descriptions of key terms of our various domestic and foreign
credit facilities and debt obligations.
On August 25, 2005, we and two of our subsidiaries, CXR Larus and
EMRISE Electronics, acting as guarantors, obtained the Bank credit facility for
our United States operations. The Bank credit facility provided a $9,000,000
revolving line of credit secured by accounts receivable, other rights to payment
and general intangibles, inventories and equipment, with an interest rate
adjusted monthly based on the prime rate.
The Bank credit facility also provided 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%. In addition, Wells Fargo Bank provided us with credit for
the purchase of new capital equipment when needed, with an interest rate equal
to the 90-day London InterBank Offered Rate ("LIBOR") (5.35% at March 31, 2007)
plus 3.75% per annum. Amounts borrowed under this arrangement are being
amortized over 60 months from the respective dates of borrowing and secured by
the purchased equipment.
On December 1, 2006, EMRISE Corporation, EMRISE Electronics, CXR Larus,
RO and WFBC entered into a Credit and Security Agreement ("WFBC credit
facility") providing for a revolving line of credit and term loan. On December
5, 2006, we paid off the $1,500,000 Bank credit facility in full.
The WFBC credit facility provides for a $5,000,000 revolving line of
credit that expires on December 1, 2009 and is secured by accounts receivable,
other rights to payment and general intangibles, inventories and equipment. The
line of credit is formula-based and generally provides that the outstanding
borrowings under the line of credit may not exceed an aggregate of 85% of
10
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 March 31,
2007 was 8.25%.
The WFBC 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. The WFBC 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 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 WFBC 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 and for
each calendar month ending on or after March 31, 2007. We were not permitted to
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.
If WFBC terminates the WFBC credit facility during a default period, or
if we terminate or reduce the WFBC 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 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.
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 WFBC credit facility, or any earlier date that all principal owing under
the WFBC 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 WFBC credit facility.
The WFBC 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, 2007, we had balances of $1,447,000 outstanding on the
revolving line of credit and $183,000 outstanding on the term loan. Availability
on the WFBC revolving line of credit was $651,000. As of March 31, 2007, we were
not in compliance with the loan's financial covenants for net worth, net income
and debt service coverage. We obtained a waiver from WFBC for those covenant
violations. WFBC is currently in the process of resetting the covenants for
2007.
11
As of March 31, 2007, 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., in France, and Johnan Shinkin
Bank in Japan. At March 31, 2007, the balances outstanding under our United
Kingdom, France and Japan credit facilities were $2,134,000, $1,206,000 and
$11,000, respectively.
On July 8, 2005, XPS and Pascall obtained a credit facility with Lloyds
that provides a revolving loan secured by receivables, with a maximum
availability of 2,100,000 British pounds sterling (approximately $4,121,000
based on the exchange rate in effect on March 31, 2007). The annual interest
rate on the revolving loan is 1.5% above the Lloyds TSB base rate. The Lloyds
TSB base rate was 5.25% at March 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. Based on our long-term relationship with Lloyds
Bank, we anticipate but can give no assurance that we will be able to renew or
obtain a new credit facility from Lloyds Bank when this existing facility
expires July 31, 2007.
On August 26, 2005, XPS entered into an agreement with Lloyds for an
unsecured cashflow loan of 300,000 British pounds sterling (approximately
$589,000 based on the exchange rate in effect on March 31, 2007), 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 $4,709,000 based on the exchange rate in effect on March
31, 2007). The interest rate is variable and is adjusted monthly based on the
base rate of Lloyds TSB plus 1.9%. 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. The
balance on the XPS and Pascall revolving loans at March 31, 2007 was $1,661,000.
Availability on the XPS and Pascall revolving loans was $1,753,000 as of March
31, 2007.
On August 26, 2005, EEL, a United Kingdom-based subsidiary of ours,
entered into an agreement with Lloyds TSB for an unsecured term loan of 500,000
British pounds sterling (approximately $981,000 based on the exchange rate in
effect on March 31, 2007). 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 loan also
includes financial covenants. EEL must maintain profit before taxation and
interest paid and payable of no less than 150% of interest paid and payable.
In the event of a default, Lloyds may make the loans, including any
outstanding principal and interest that 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 $1,600,000
based on the exchange rate in effect at March 31, 2007 for the conversion of
euros into United States dollars. CXR-AJ also had $28,000 of term loans with
another French bank outstanding as of March 31, 2007. 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, 2007, the French T4M rate was 3.69%,
and this facility in addition to small loans with other banks had a balance of
$1,178,000. This facility has no financial performance covenants. Availability
on the IFN Finance credit line was $161,000 as of March 31, 2007, in addition to
$12,000 availability with several other banks.
12
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, 2007 and 2005 was $11,000, using the exchange rates in effect at those dates
for conversion of Japanese yen into United States dollars. There are no
financial performance covenants applicable to this loan.
Our backlog was $23,446,000 as of March 31, 2007 as compared to
$22,135,000 as of March 31, 2006. The increase in backlog was primarily due to
an increase of $702,000 in backlog of network access equipment at CXR-AJ in
France and $625,000 in power supplies and RF components at XPS and Pascall, our
United Kingdom subsidiaries. Our backlog as of March 31, 2007 was approximately
95% related to our electronic devices business, which business tends to provide
us with long lead-times for our manufacturing processes due to the custom nature
of the products, and approximately 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.
We included in our annual report on Form 10-K for the year ended
December 31, 2006 a contractual obligations table that outlines payments due
from us or our subsidiaries under our lines of credit and other significant
contractual obligations through 2011, exclusive of interest. During the three
months ended March 31, 2007, 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 notes.
We believe that current and future available capital resources,
revenues generated from operations, and other existing sources of liquidity,
including the credit facility we have with WFBC, will be adequate to meet our
anticipated working capital and capital expenditure requirements for at least
the next twelve months. If, however, we are unable to renew or replace the XPS
and Pascall credit facility with Lloyds Bank that expires July 31, 2007, or if
our capital requirements or cash flow vary materially from our current
projections or other unforeseen circumstances occur, or if we require a
significant amount of cash to fund future acquisitions, we may require
additional financing. Our failure to raise capital, if needed, could restrict
our growth, limit our development of new products or hinder our ability to
compete.
EFFECTS OF INFLATION
The impact of inflation and changing prices has not been significant on
the financial condition or results of operations of either our company or our
operating subsidiaries.
IMPACTS OF NEW ACCOUNTING PRONOUNCEMENTS
In June 2006, the Financial Accounting Standards Board ("FASB") issued
Financial Interpretation No. ("FIN") 48, ACCOUNTING FOR UNCERTAINTY IN INCOME
TAXES--AN INTERPRETATION OF FASB STATEMENT NO. 109. This interpretation
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return. The interpretation contains a two-step approach to
13
recognizing and measuring uncertain tax positions accounted for in accordance
with SFAS No. 109. The first step is to evaluate the tax position for
recognition by determining if the weight of available evidence indicates that it
is more likely than not that the position will be sustained on audit, including
resolution of related appeals or litigation processes, if any. The second step
is to measure the tax benefit as the largest amount that is more than 50% likely
of being realized upon ultimate settlement. The interpretation also provides
guidance on derecognition, classification, interest and penalties, and other
matters.
We adopted FIN 48 on January 1, 2007. The implementation of FIN 48 did
not result in a material adjustment to our liability for unrecognized income tax
benefits. At the time of adoption and as of the end of the first quarter of
2007, we had recorded no net unrecognized tax benefits. We do not believe that
we will record unrecognized tax benefits within the year following the first
quarter of 2007.
We recognize interest and penalties related to uncertain tax positions
in interest expense and selling, general and administrative expense,
respectively, in our condensed consolidated statements of operations and
comprehensive income. We did not recognize interest or penalties during the
first quarter of 2007. As of March 31, 2007, we had nothing accrued for interest
and penalties.
We file income tax returns in the United States federal jurisdiction,
the United Kingdom, France and Japan, and in the state jurisdictions of
California, Texas and New Jersey. We are no longer subject to United States
federal and state tax examinations for years before 2003 and 2002, respectively,
and are no longer subject to tax examinations for the United Kingdom and Japan
for years prior to 2005, and for France for years prior to 2003.
In February 2006, the FASB issued SFAS No. 155, ACCOUNTING FOR CERTAIN
HYBRID FINANCIAL INSTRUMENTS, which amends SFAS No. 133, ACCOUNTING FOR
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES and SFAS No. 140, ACCOUNTING FOR
THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. Specifically, SFAS No. 155
amends SFAS No. 133 to permit fair value remeasurement for any hybrid financial
instrument with an embedded derivative that otherwise would require bifurcation,
provided the whole instrument is accounted for on a fair value basis.
Additionally, SFAS No. 155 amends SFAS No. 140 to allow a qualifying special
purpose entity to hold a derivative financial instrument that pertains to a
beneficial interest other than another derivative financial instrument. SFAS No.
155 applies to all financial instruments acquired or issued after the beginning
of an entity's first fiscal year that begins after September 15, 2006. Our
adoption of SFAS No. 155 on January 1, 2007 has not had a material effect on our
results of operations or financial position.
In September 2006, the FASB issued SFAS No. 157, FAIR VALUE
MEASUREMENTS. This new statement provides a single definition of fair value,
together with a framework for measuring it, and requires additional disclosure
about the use of fair value to measure assets and liabilities. SFAS No. 157 also
emphasizes that fair value is a market-based measurement, not an entity-specific
measurement, and sets out a fair value hierarchy, with the highest priority
being quoted prices in active markets. The required effective date of SFAS No.
157 is the first quarter of 2008. We currently are evaluating the effect this
statement may have on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, THE FAIR VALUE OPTION
FOR FINANCIAL ASSETS AND FINANCIAL LIABILITIES. SFAS No. 159 permits an entity
to irrevocably elect fair value on a contract-by-contract basis as the initial
and subsequent measurement attribute for many financial assets and liabilities
and certain other items including insurance contracts. Entities electing the
fair value option would be required to recognize changes in fair value in
earnings and to expense up front cost and fees associated with the item for
which the fair value option is elected. SFAS No. 159 is effective for fiscal
14
years beginning after November 15, 2007. Early adoption is permitted as of the
beginning of a fiscal year that begins on or before November 15, 2007, provided
the entity also elects to apply the provisions of SFAS No. 157, FAIR VALUE
MEASUREMENTS. We currently are evaluating the effect that adoption of SFAS No.
159 would have on our financial condition or results of operations.
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, 2007.
ITEM 4T. CONTROLS AND PROCEDURES.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
We conducted an evaluation, with the participation of our Chief
Executive Officer, who is also our Acting Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. The term "disclosure controls and procedures," as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended
("Exchange Act"), means controls and other procedures of a company that are
designed to ensure that information required to be disclosed by the company in
the reports filed or submitted by it under the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
Commission's rules and forms. Disclosure controls and procedures also include,
without limitation, controls and procedures designated to ensure that
information required to be disclosed by a company in the reports filed or
submitted by it under the Exchange Act is accumulated and communicated to the
company's management, including its 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 as of
March 31, 2007 that our disclosure controls and procedures were not effective at
the reasonable assurance level due to the material weaknesses described below.
A material weakness is internal control over financial reporting is
defined by the Public Company Accounting Oversight Board's Audit Standard No. 2
as being a significant deficiency, or combination of significant deficiencies,
that results in more than a remote likelihood that a material misstatement of
the financial statements would not be prevented or detected. A significant
deficiency is a control deficiency, or combination of control deficiencies, that
adversely affects the company's ability to initiate, authorize, record, process,
15
or report external financial data reliably in accordance with generally accepted
accounting principles such that there is more than a remote likelihood that a
misstatement of the company's annual or interim financial statements that is
more than inconsequential will not be prevented or detected.
In connection with its audit of our consolidated financial statements
for the year ended December 31, 2006, Hein, our independent registered public
accounting firm, advised management and our audit committee of the following two
matters that Hein considered to be material weaknesses in the area of accounting
and financial reporting:
1. We did not have a sufficient complement of personnel with
appropriate training and experience in generally accepted accounting principles
in the United States and with Commission disclosure requirements.
2. We lacked procedures to ensure that our principal accounting and
financial officer can closely monitor information submitted to our corporate
headquarters by our subsidiaries and oversee accounting for reserves and other
areas that involve significant judgment at all of our locations. We also lacked
procedures to ensure that personnel familiar with accounting principles
generally accepted in the United States and with Commission disclosure
requirements can thoroughly evaluate activities and transactions at all of our
locations in order to make all required disclosures in a timely manner.
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.
INHERENT LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS
Management does not expect that our disclosure controls and procedures
or our internal control over financial reporting will prevent or detect all
errors and all fraud. A control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control systems are met. Further, the design of a control
system must reflect the fact that there are resource constraints, and the
benefits of controls must be considered relative to their costs. Because of the
inherent limitations in a cost-effective control system, no evaluation of
internal control over financial reporting can provide absolute assurance that
misstatements due to error or fraud will not occur or that all control issues
and instances of fraud, if any, have been or will be detected.
These inherent limitations include the realities that judgments in
decision-making can be faulty and that breakdowns can occur because of a simple
error or mistake. Controls can also be circumvented by the individual acts of
some persons, by collusion of two or more people, or by management override of
the controls. The design of any system of controls is based in part on certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions. Projections of any evaluation of controls effectiveness to
future periods are subject to risks. Over time, controls may become inadequate
because of changes in conditions or deterioration in the degree of compliance
with policies or procedures.
REMEDIATION OF MATERIAL WEAKNESSES
To remediate the material weaknesses in our disclosure controls and
procedures identified above, we have done or intend to do the following, in the
periods specified below:
16
Our former Chief Financial Officer functioned in that position through
August 18, 2006, the date of his resignation from employment with EMRISE
Corporation. Upon his resignation, overall responsibility for the accounting
functions and reporting was delegated to our Chief Executive Officer who
currently is filling the role of Acting Chief Financial Officer. Management and
our audit committee launched a recruitment effort in September 2006, and
recently selected two candidates to fill the positions of Vice President of
Finance and Administration (our principal financial and accounting officer) and
Controller for our United States operations, each with expertise in public
company financial reporting compliance. We anticipate that the candidate for
Vice President of Finance and Administration will assume that position effective
May 16, 2007 pursuant to an executive employment agreement that we recently
executed with him, and that the candidate for Controller for our United States
operations will assume that position effective May 16, 2007.
Once the Vice President of Finance and Administration and the new
Controller for our United States operations assume those roles, we intend that
those individuals will develop policies and procedures, including an adequate
supervisory structure, necessary to ensure that our principal accounting and
financial officer can closely monitor financial information throughout our
company and oversee all accounting that involves significant judgment on the
part of personnel located at our operating subsidiaries, within the United
States, Europe and Asia. In addition, we intend that our Vice President of
Finance and Administration and new Controller for our United States operations
will establish policies and procedures necessary to ensure that personnel
familiar with accounting principles generally accepted in the United States and
with Commission disclosure requirements are capable of evaluating activities and
transactions at all of our operating subsidiaries in order to make all required
disclosures in a timely manner. We anticipate that our Vice President of Finance
and Administration and our new Controller for our United States operations will
work closely with our Director of Financial Controls for Europe, whom we hired
in late 2005 to oversee our three European Controllers and who will report to
our Vice President of Finance and Administration, on these matters.
Management is unsure, at the time of the filing of this report, when
the actions described above will remediate the material weaknesses also
described above. Management may continue to hire outside consultants to assist
us in satisfying our financial reporting obligations.
We have agreed that the Vice President of Finance and Administration
will have an annual base salary of $223,000 during the first twelve-month period
and $245,300 during the second twelve-month period that his executive employment
agreement is in effect, and will be eligible for additional compensation as
described in that agreement. We anticipate that the new Controller for our
United States operations will have an annual base salary of $115,000. Management
is unable, however, to estimate our expenditures related to the hiring of
outside consultants to assist us in satisfying our financial reporting
obligations.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There were no changes during the quarter ended March 31, 2007 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.
17
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, 2006 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
None.
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.
On February 14, 2007, we held our 2006 annual meeting of stockholders.
The total number of outstanding votable shares was 38,081,750. Our stockholders
were asked to consider and vote upon the following two proposals:
(1) Re-election of Otis W. Baskin as a Class I director to serve a
three-year term.
(2) Ratification of the selection of Hein & Associates LLP as our
independent registered public accounting firm to audit our consolidated
financial statements for 2006.
18
Results of the vote were as follows:
Proposal For Against Withheld
-------- --- ------- --------
(1) 34,246,041 -- 210,473
(2) 34,339,915 61,738 54,861
As a result, Mr. Baskin was re-elected to serve as a Class I member of
our board of directors. Carmine T. Oliva, Laurence P. Finnegan, Jr. and Richard
E. Mahmarian continued to serve on our board of directors following the meeting.
The selection of our independent registered public accounting firm to audit our
consolidated financial statements for 2006 was ratified.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS.
NUMBER DESCRIPTION
------ -----------
10.1 Executive Employment Agreement effective as of May 16, 2007 between
EMRISE Corporation and John Donovan
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
19
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: May 15, 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)
20
EXHIBITS ATTACHED TO THIS REPORT
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.1 Executive Employment Agreement effective as of May 16, 2007 between
EMRISE Corporation and John Donovan
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
21