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UNITED STATES
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 JUNE 30, 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 [X] No [ ]
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]
The number of shares outstanding of the Registrant's common stock, $0.0033 par
value, as of August 9, 2007 was 38,254,250.
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EMRISE CORPORATION
TABLE OF CONTENTS
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2007
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets as of June 30, 2007
(unaudited) and December 31, 2006.............................. 1
Condensed Consolidated Statements of Operations for the Three
and Six Months Ended June 30, 2007 and 2006 (unaudited)........ 2
Condensed Consolidated Statements of Stockholders' Equity
for the Six Months Ended June 30, 2007 (unaudited)............. 3
Condensed Consolidated Statements of Cash Flows for the Six
Months Ended June 30, 2007 and 2006 (unaudited)................ 4
Notes to Condensed Consolidated Financial Statements (unaudited)..... 5
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.......................... 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK.................................................. 27
ITEM 4T. CONTROLS AND PROCEDURES...................................... 27
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS............................................ 31
ITEM 1A. RISK FACTORS................................................. 31
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND
USE OF PROCEEDS.............................................. 31
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.............................. 31
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.......... 31
ITEM 5. OTHER INFORMATION............................................ 31
ITEM 6. EXHIBITS..................................................... 32
SIGNATURES ............................................................. 33
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EMRISE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
JUNE 30, DECEMBER 31,
2007 2006
-------- --------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 2,824 $ 3,802
Accounts receivable, net of allowances for doubtful accounts of
$297 at June 30, 2007 and $391 at December 31, 2006 8,224 9,220
Inventories 11,473 10,575
Deferred income taxes 729 726
Prepaid and other current assets 1,227 1,082
-------- --------
Total current assets 24,477 25,405
Property, plant and equipment, net 2,309 2,245
Goodwill 13,091 12,995
Intangible assets other than goodwill, net 3,384 3,546
Other assets 743 594
-------- --------
Total assets $ 44,004 $ 44,785
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,283 $ 4,640
Accrued expenses 5,658 5,309
Borrowings under lines of credit 4,017 4,310
Current portion of long-term debt 501 516
Notes payable to stockholders, current portion 500 500
Income taxes payable 775 519
-------- --------
Total current liabilities 16,734 15,794
Long-term debt 301 533
Notes payable to stockholders, less current portion 1,000 1,250
Deferred income taxes 1,053 1,053
Other liabilities 917 982
-------- --------
Total liabilities 20,005 19,612
Commitments and contingencies (See Note 7)
Stockholders' equity:
Preferred stock,$0.01 par value. Authorized 10,000,000 shares,
zero shares issued and outstanding -- --
Common stock,$0.0033 par value. Authorized 150,000,000 shares;
38,144,000 and 38,082,000 shares issued and outstanding at
June 30, 2007 and December 31, 2006, respectively 126 125
Additional paid-in capital 43,149 43,083
Accumulated deficit (20,148) (18,733)
Accumulated other comprehensive income 872 698
-------- --------
Total stockholders' equity 23,999 25,173
-------- --------
Total liabilities and stockholders' equity $ 44,004 $ 44,785
======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1
EMRISE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share amounts)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
2007 2006 2007 2006
-------- -------- -------- --------
Net sales $ 12,067 $ 10,817 $ 23,989 $ 21,551
Cost of sales 7,991 7,025 16,065 13,375
-------- -------- -------- --------
Gross profit 4,076 3,792 7,924 8,176
Operating expenses:
Selling, general and administrative 3,849 3,698 7,585 7,465
Engineering and product development 665 892 1,375 1,614
-------- -------- -------- --------
Total operating expenses 4,514 4,590 8,960 9,079
-------- -------- -------- --------
Loss from operations (438) (798) (1,036) (903)
Other income (expense):
Interest income 36 21 55 46
Interest expense (170) (93) (320) (217)
Other, net 100 (44) 165 (36)
-------- -------- -------- --------
Total other income (expense), net (34) (116) (100) (207)
-------- -------- -------- --------
Loss before income taxes (472) (914) (1,136) (1,110)
Income tax provision (benefit) 151 96 279 222
-------- -------- -------- --------
Net loss $ (623) $ (1,010) $ (1,415) $ (1,332)
======== ======== ======== ========
Earnings per share:
Basic $ (0.02) $ (0.03) $ (0.04) $ (0.04)
======== ======== ======== ========
Diluted $ (0.02) $ (0.03) $ (0.04) $ (0.04)
======== ======== ======== ========
Weighted average shares outstanding
Basic 38,141 38,082 38,130 37,880
======== ======== ======== ========
Diluted 38,141 38,082 38,130 37,880
======== ======== ======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
2
EMRISE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)
(in thousands)
Accumulated
Common Stock Additional Other
--------------------------- Paid-in Accumulated Comprehensive
Shares Amount Capital Deficit Income Total
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 2006 38,082 $ 125 $ 43,083 $ (18,733) $ 698 $ 25,173
Stock option exercises 62 1 21 -- -- 22
Stock-based compensation -- -- 45 -- -- 45
Net loss and comprehensive income -- -- -- (1,415) 174 (1,241)
------------ ------------ ------------ ------------ ------------ ------------
Balance at June 30, 2007 38,144 $ 126 $ 43,149 $ (20,148) $ 872 $ 23,999
============ ============ ============ ============ ============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
3
EMRISE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
SIX MONTHS ENDED
JUNE 30,
-------------------
2007 2006
------- -------
CASH FLOWS FROM OPERTING ACTIVITIES
Net loss $(1,415) $(1,332)
Reconciliation to net cash provided by
(used in) operating activities:
Depreciation and amortization 541 585
Provision for inventory obsolescence 517 927
Deferred taxes (3) (79)
Stock-based compensation expense 45 74
Provision for doubtful accounts (93) --
Changes in assets and liabilities:
Accounts receivable 1,089 2,183
Inventories (1,415) (2,389)
Prepaid and other assets (295) (256)
Accounts payable and accrued expenses 1,184 (373)
------- -------
Total adjustments 1,570 672
------- -------
Net cash provided by (used in) operating activities 155 (660)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (427) (156)
------- -------
Net cash used in investing activities (427) (156)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments of lines of credit (293) (1,733)
Repayments of long-term debt (247) (210)
Payments of notes to stockholders (250) (250)
Proceeds from exercise of stock options and warrants 22 385
------- -------
Net cash used in financing activities (768) (1,808)
------- -------
Effect of exchange rate changes on cash 62 457
------- -------
Net decrease in cash and cash equivalents (978) (2,167)
Cash and cash equivalents at beginning of period 3,802 4,371
------- -------
Cash and cash equivalents at end of period $ 2,824 $ 2,204
======= =======
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
4
EMRISE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
EMRISE Corporation (the "Company") operates through two operating
segments: electronic devices and communications equipment. The Company's
subsidiaries within its electronic devices segment design, develop, manufacture
and market electronic devices for defense, aerospace and industrial markets. The
Company's subsidiaries within its communications equipment segment design,
develop, manufacture and market network access equipment, including network
timing and synchronization products. The Company conducts its operations out of
various facilities in the United States ("U.S."), France, the United Kingdom
("U.K.") and Japan. The following reflects the Company's direct and indirect
subsidiaries and the locations of operation:
ELECTRONIC DEVICES SEGMENT
--------------------------
EMRISE Electronics Corporation ("Emrise Electronics"), a subsidiary of the
Company - U.S.
EMRISE Electronics Limited ("EEL") - U.K.
Pascall Electronics Limited ("Pascall") - U.K.
XCEL Power Systems, Ltd. ("XPS") - U.K.
RO Associates Incorporated ("RO") - U.S.
EMRISE Japan Ltd. ("EJL") - Japan
COMMUNICATIONS EQUIPMENT SEGMENT
--------------------------------
CXR Larus Corporation ("CXR Larus"), a subsidiary of the Company - U.S.
CXR Anderson Jacobson ("CXR-AJ"), a subsidiary of the Company - France
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 U.S. ("GAAP"). The year end
balance sheet was derived from the audited financial statements at that date,
but does not include all of the information and footnotes required by GAAP for
complete financial statements. 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 June 30, 2007 and the results of
operations and cash flows for the related interim periods ended June 30, 2007
and 2006. However, these results are not necessarily indicative of results for
any other interim period or for the year. The accompanying unaudited condensed
consolidated financial statements should 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.
5
EMRISE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) includes all changes in equity during a
period except those that resulted from investments by or distributions to the
Company's stockholders. Other comprehensive income (loss) refers to revenues,
expenses, gains and losses that, under GAAP, are included in comprehensive
income (loss), but excluded from net loss as these amounts are recorded directly
as an adjustment to stockholders' equity. The Company's other comprehensive
income consists of foreign currency translation adjustments. The following table
reflects the components of comprehensive income (loss) (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------ ------------------
2007 2006 2007 2006
------- ------- ------- -------
Net loss $ (623) $(1,010) $(1,415) $(1,332)
Other comprehensive income (loss):
Foreign currency translation adjustment 197 557 174 682
------- ------- ------- -------
Comprehensive loss $ (426) $ (453) $(1,241) $ (650)
======= ======= ======= =======
EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is computed by dividing net income
(loss) by the weighted average common shares outstanding during a period.
Diluted earnings (loss) per share is based on the treasury stock method and
includes the dilutive effect of stock options and warrants outstanding during
the period. Common share equivalents have been excluded where their inclusion
would be anti-dilutive. As a result of the loss incurred by the Company for all
periods presented, the potentially dilutive common shares have been excluded
because their inclusion would have been anti-dilutive. The following table
illustrates the computation of basic and diluted earnings per share (in
thousands, except per share amounts):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- --------------------
2007 2006 2007 2006
------- -------- -------- --------
NUMERATOR:
Net loss $ (623) $ (1,010) $ (1,415) $ (1,332)
======= ======== ======== ========
DENOMINATOR:
Basic weighted average common
shares outstanding 38,141 38,082 38,130 37,880
Effect of dilutive securities:
Dilutive stock options and warrants -- -- -- --
------- -------- -------- --------
Diluted weighted average common
shares outstanding 38,141 38,082 38,130 37,880
======= ======== ======== ========
Basic loss per share $ (0.02) $ (0.03) $ (0.04) $ (0.04)
======= ======== ======== ========
Diluted loss per share $ (0.02) $ (0.03) $ (0.04) $ (0.04)
======= ======== ======== ========
6
EMRISE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table shows the common stock equivalents that were
outstanding as of June 30, 2007 and 2006, but were not included in the
computation of diluted earnings per share as a result of the loss incurred by
the Company or 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 June 30, 2007 1,943,000 $0.20 - $3.13
As of June 30, 2006 1,121,000 $1.00 - $3.13
Anti-dilutive common stock warrants:
As of June 30, 2007 4,192,000 $0.85 - $2.00
As of June 30, 2006 4,136,000 $1.30 - $2.00
RECENT ACCOUNTING PRONOUNCEMENTS
On January 1, 2007, 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." FIN
48 clarifies the accounting for the uncertainty in recognizing income taxes in
an organization in accordance with FASB Statement No. 109 by providing detailed
guidance for financial statement recognition, measurement and disclosure
involving uncertain tax positions. FIN 48 requires an uncertain tax position to
meet a more-likely-than-not recognition threshold at the effective date to be
recognized both upon the adoption of FIN 48 and in subsequent periods. The
implementation of FIN 48 did not have a material effect on the Company's
financial statements. See Note 6 - Income Taxes.
On January 1, 2007, the Company adopted FASB Statement of Financial
Accounting Standards ("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." 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 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. The Company is evaluating the effect
that adoption of SFAS No. 159 would have on its financial condition or results
of operations.
7
EMRISE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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. The Company is evaluating the effect this
statement may have on its consolidated financial statements.
NOTE 2 - 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.
As a result of the Company's adoption of SFAS No. 123 (revised 2004),
"Share-Based Payment," as of January 1, 2006, total stock-based compensation
expense included in wages, salaries and related costs was $6,000 and $39,000 for
the three months ended June 30, 2007 and 2006, respectively, and $42,000 and
$59,000 for the six months ended June 30, 2007 and 2006, respectively. These
compensation expenses were charged to selling, general and administrative
expenses. As of June 30, 2007, the Company had $43,000 of total unrecognized
compensation expense related to stock option grants, which will be recognized
over the remaining weighted average period of two years.
During the quarter ended June 30, 2007, the Company issued to a
financial advisor a five-year warrant to purchase up to 31,250 shares of the
Company's common stock on a cash or cashless basis at an exercise price equal to
$1.15 per share. Total stock-based compensation expense included in selling,
general and administrative expenses with respect to this warrant was $3,000. The
remaining unrecognized compensation related to this warrant of $21,000 will be
recognized over the remaining period of 2 years.
NOTE 3 - INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out
method) or market (net realizable value) and consisted of the following (in
thousands):
June 30, December 31,
2007 2006
------------- -------------
Raw materials $ 9,734 $ 8,771
Work-in-process 4,273 3,588
Finished goods 3,640 3,873
Reserves (6,174) (5,657)
------------- -------------
Total inventories $ 11,473 $ 10,575
============= =============
8
EMRISE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 4 - OPERATING SEGMENTS
The Company has two reportable operating segments: electronic devices
and communications equipment. The electronic devices segment manufactures and
markets digital and rotary switches, electronic power supplies, radio frequency
("RF") and microwave devices and subsystems and subsystem assemblies. The
electronic devices segment consists of the operating entities EMRISE Electronics
and its subsidiaries, which offer the same or similar products to similar
customers. The communications equipment segment designs, manufactures and
distributes network access and transmission products, including timing and
synchronization products. The communications equipment segment consists of
operating entities CXR Larus and CXR-AJ, which offer the same or similar
products to similar customers. Both segments operate in the U.S., European and
Asian markets, but have distinctly different customers, design and manufacturing
processes and marketing strategies. Each segment has discrete financial
information and a separate management structure.
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 pre-determined prices negotiated
between the individual segments.
There were no differences in the basis of segmentation or in the basis
of measurement of segment operating income 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. Included in the
Company's reconciliation of segment financial data to the consolidated amounts
is unallocated corporate expenses. Selected financial data for each of the
Company's operating segments reconciled to the consolidated totals is shown
below (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------ ------------------------------
2007 2006 2007 2006
------------- ------------- ------------- -------------
Net sales
---------
Electronic devices $ 8,440 $ 7,920 $ 16,967 $ 15,773
Communications equipment 3,627 2,897 7,022 5,778
------------- ------------- ------------- -------------
Total $ 12,067 $ 10,817 $ 23,989 $ 21,551
============= ============= ============= =============
Operating income (loss)
-----------------------
Electronic devices $ 535 $ 798 $ 1,076 $ 1,843
Communications equipment (81) (589) (197) (733)
Corporate and other (892) (1,007) (1,915) (2,013)
------------- ------------- ------------- -------------
Total $ (438) $ (798) $ (1,036) $ (903)
============= ============= ============= =============
June 30, December 31,
2007 2006
------------- -------------
Total assets
------------
Electronic devices $ 27,966 $ 27,514
Communications equipment 15,082 15,912
Corporate and other 956 1,359
------------- -------------
Total $ 44,004 $ 44,785
============= =============
9
EMRISE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 5 - GOODWILL
The following table reflects changes in our goodwill balances, by
segment, for the six months ended June 30, 2007 (in thousands):
Electronic Communications
Devices Equipment Total
----------- ----------- -----------
Balance at December 31, 2006 $ 7,161 $ 5,834 $ 12,995
Foreign currency translation 96 -- 96
----------- ----------- -----------
Balance at June 30, 2007 $ 7,257 $ 5,834 $ 13,091
=========== =========== ===========
NOTE 6 - INCOME TAXES
The effective tax rate for the three and six-month periods ended June
30, 2007 was different than the 34% U.S. statutory rate primarily because of
foreign taxes on foreign source income that cannot be offset by domestic tax
loss carryforwards.
On January 1, 2007, the Company adopted FIN 48. 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 second quarter of 2007, the Company had recorded no net unrecognized tax
benefits. The Company does not believe that it will record unrecognized tax
benefits for 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
half of 2007. As of June 30, 2007, the Company had nothing accrued for interest
and penalties in this regard.
The Company files income tax returns in the U.S. federal jurisdiction,
the U.K., France and Japan, and in the state jurisdictions of California, Texas
and New Jersey. The Company is no longer subject to U.S. federal and state tax
examinations for years before 2003 and 2002, respectively, and is no longer
subject to tax examinations for the U.K. and Japan for years prior to 2005, and
for France for years prior to 2003.
NOTE 7 - LINES OF CREDIT
Outstanding borrowings under the Company's revolving lines of credit
described below were as follows:
June 30, December 31,
2007 2006
---------- ----------
Line of credit with a U.S. commercial lender $ 1,033 $ 1,978
Lines of credit with foreign banks 2,984 2,332
---------- ----------
$ 4,017 $ 4,310
========== ==========
10
EMRISE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
EMRISE Corporation, EMRISE Electronics, CXR Larus, RO and Wells Fargo
Bank, acting through its Wells Fargo Business Credit operating division
("WFBC"), are parties to a Credit and Security Agreement ("WFBC credit
facility"). The WFBC credit facility provides for a $5.0 million 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 Company is subject to certain financial covenants associated with
the WFBC credit facility, including minimum net worth, minimum net income
(loss), and minimum debt service coverage ratio. In August 2007, the Company
amended the WFBC credit facility to reset these covenants and, as a result of
this amendment at June 30, 2007, the Company was in compliance with the WFBC
credit facility's financial covenants
The Company's indirect subsidiaries, Pascall and XPS, are parties to a
credit facility with Lloyds TSB Commercial Finance Limited ("Lloyds") ("Lloyd's
credit facility") that provides a revolving loan secured by receivables, with a
maximum availability of 2.1 million British pounds sterling (approximately $4.2
million based on the exchange rate in effect on June 30, 2007). The Company is
subject to certain financial covenants associated with the Lloyd's credit
facility. As of June 30, 2007, the Company was in compliance with all such
covenants.
CXR-AJ is party to a credit facility with IFN Finance, a subsidiary of
ABN AMRO N.V ("IFN credit facility"). This credit facility is for a maximum of
$1.6 million based on the exchange rate in effect at June 30, 2007 for the
conversion of euros into U.S. dollars. The IFN credit facility is secured by
accounts receivable. The IFN credit facility has no financial performance
covenants.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
CAUTIONARY STATEMENT
You should read the following discussion and analysis in conjunction
with our unaudited condensed consolidated financial statements and the related
notes thereto contained in Part I, Item 1 of this Report. The information
contained in this Quarterly Report on Form 10-Q is not a complete description of
our business or the risks associated with an investment in our common stock. We
urge you to carefully review and consider the various disclosures made by us in
this Report and in our other reports filed with SEC, including our Annual Report
on Form 10-K for the year ended December 31, 2006 and subsequent reports on
Forms 10-Q and 8-K, which discuss our business in greater detail.
The section entitled "Risk Factors" set forth below, and similar
discussions in our other SEC filings, describe some of the important risk
factors that may affect our business, financial condition, results of operations
and/or liquidity. You should carefully consider those risks, in addition to the
other information in this Report and in our other filings with the SEC, before
deciding to purchase, hold or sell our common stock.
All statements included or incorporated by reference in this Report,
other than statements or characterizations of historical fact, are
forward-looking statements. Examples of forward-looking statements include, but
are not limited to, statements concerning projected net revenue, costs and
expenses and gross margin; our accounting estimates, assumptions and judgments;
the impact of the January 2007 restatement of our financial statements for prior
periods; estimates related to the amount and/or timing of the expensing of
unearned stock-based compensation expense; our success in pending litigation;
the demand for our products; the effect that seasonality and volume fluctuations
in the demand for our customers' consumer-oriented products will have on our
quarterly operating results; our dependence on a few key customers for a
substantial portion of our revenue; our ability to scale operations in response
to changes in demand for existing products and services or the demand for new
products requested by our customers; the competitive nature of and anticipated
growth in our markets; our ability to migrate to smaller process geometries;
manufacturing, assembly and test capacity; our ability to consummate
acquisitions and integrate their operations successfully; our potential needs
for additional capital and inventory and accounts receivable levels. These
forward-looking statements are based on our current expectations, estimates and
projections about our industry and business, management's beliefs, and certain
assumptions made by us, all of which are subject to change. Forward-looking
statements can often be identified by words such as "anticipates," "expects,"
"intends," "plans," "predicts," "believes," "seeks," "estimates," "may," "will,"
"should," "would," "could," "potential," continue," ongoing," similar
expressions, and variations or negatives of these words. These statements are
not guarantees of future performance and are subject to risks, uncertainties and
assumptions that are difficult to predi ct. Therefore, our actual results could
differ materially and adversely from those expressed in any forward-looking
statements as a result of various factors, some of which are listed under the
section "Risk Factors" contained in Part II, Item 1A of this Report. These
forward-looking statements speak only as of the date of this Report. We
undertake no obligation to revise or update publicly any forward-looking
statement for any reason, except as otherwise required by law.
GENERAL
We are a Delaware corporation that was formed July 14, 1989 and
operates through subsidiaries in two operating segments: electronic devices and
communications equipment. Our subsidiaries within our electronic devices segment
design, develop, manufacture and market electronic devices for defense,
aerospace and industrial markets, including digital and rotary switches,
electronic power supplies and radio frequency ("RF") devices. Our subsidiaries
within our communications equipment segment design, develop, manufacture and
market network access equipment, including network timing and synchronization
products for communications service providers. We are a multinational company
operating out of facilities located in the United States ("U.S."), United
Kingdom ("U.K."), France and Japan. The following reflects our direct and
indirect subsidiaries and their locations of operation:
ELECTRONIC DEVICES SEGMENT
--------------------------
EMRISE Electronics Corporation ("Emrise Electronics"), a subsidiary of
EMRISE - U.S.
EMRISE Electronics Limited ("EEL") - U.K.
Pascall Electronics Limited ("Pascall") - U.K.
XCEL Power Systems, Ltd. ("XPS") - U.K.
RO Associates Incorporated ("RO") - U.S.
EMRISE Japan Ltd. ("EJL") - Japan
COMMUNICATIONS EQUIPMENT SEGMENT
--------------------------------
CXR Larus Corporation ("CXR Larus"), a subsidiary of EMRISE - U.S.
CXR Anderson Jacobson ("CXR-AJ"), a subsidiary of EMRISE - France
12
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the U.S.
The preparation of those financial statements requires us to make estimates and
judgments that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amount of net sales and expenses for each period.
The following represents a summary of our critical accounting policies, defined
as those policies that we believe are the most important to the portrayal of our
financial condition and results of operations and that require management's most
difficult, subjective or complex judgments, often as a result of the need to
make estimates about the effects of matters that are inherently uncertain.
REVENUE RECOGNITION
We derive revenues from sales of electronic 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 and/or services
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 U.K.
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.
Revenues from services such as repairs and modifications are recognized
when the service is 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 contribute less than 5% of total revenue
and, therefore, are immaterial.
PRODUCT WARRANTY LIABILITIES
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 typically are tested and
repaired or replaced at our option. Historically, we have not experienced
significant warranty costs or returns.
13
We record a liability for estimated costs that we expect to incur under
our basic limited warranties when product revenue is recognized. Factors
affecting our warranty liability include the number of units sold, historical
and anticipated rates of claim and costs per claim. We periodically assess the
adequacy of our warranty liability accrual based on changes in these factors.
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
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 cycle counts of inventories using the ABC
inventory methodology or conduct 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. As of June 30, 2007, our total inventory reserves amounted to $6.2
million of which $4.5 million, or 25.3% of total inventory, related to our
electronic devices segment and $1.7 million, or 9.8% of total inventory, related
to our communications equipment segment.
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
69.9% and 62.0% of our net revenues, 58.6% and 51.2% of our assets and 59.2% and
53.9% of our total liabilities as of and for the six months ended June 30, 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 U.S.
dollars. This process results in exchange gains and losses which, under relevant
accounting guidance, are included either within our statement of operations
under the caption "other income (expense)" 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.
14
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 U.S. dollars, then any gain or
loss associated with the translation of these financial statements would be
included in other income (expense) 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 U.S. dollars, then any translation gains or losses arising after
the date of the change would be included within our statement of operations.
Based on our assessment of the factors discussed above, we consider the
functional currency of each of our international subsidiaries to be each
subsidiary's local currency. Accordingly, we had cumulative translation gains of
$0.9 million and $0.7 million that were included as part of accumulated other
comprehensive income (loss) within our balance sheets at June 30, 2007 and
December 31, 2006, respectively. During the six months ended June 30, 2007 and
2006, we included translation gains of $0.2 million and $0.7 million,
respectively, under accumulated other comprehensive income (loss).
If we had determined that the functional currency of our subsidiaries
was U.S. dollars, these gains or losses would have decreased or increased our
net loss for the six months ended June 30, 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 U.S.
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 $5.5 million loan payable from EEL to EMRISE was outstanding as of
June 30, 2007. As of June 30, 2007, $0.6 million of this loan was classified as
current and, as such, the exchange rate gains or losses on the current portion
are recorded in other income (expense) in our statement of operations.
Exchange rate losses and gains on the long-term portion of 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 Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets",
we are required to analyze our goodwill for impairment issues at least annually
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 June 30, 2007, our reported goodwill totaled $13.1 million. During
the six months ended June 30, 2007, we did not record any impairment losses
related to goodwill and other intangible assets.
15
OVERVIEW
Overall sales increased 11.6% and 11.3% in the three months and six
months ended June 30, 2007, respectively, from the same periods in 2006. Sales
for both of our operating segments continue to be strong, with the increases
being generated by our foreign subsidiaries offset, in part, by what we believe
are temporary decreases at some of our domestic subsidiaries. Sales growth is
primarily related to our military power supply and in-flight entertainment
products and sales of our network access communication products. We believe that
these are all high growth markets that can provide us with long-term
sustainability. Additionally, as orders for our new TiemPo(TM) Edge Network
timing and synchronization product line increase, we expect to see continued
improvements in our communications equipment segment's sales in both our U.S.
and foreign markets.
Overall gross margins decreased 1.3 and 4.9 percentage points for the
second quarter and year-to-date periods in 2007, respectively, from the same
periods in 2006. The declines in gross margins are primarily due to product mix
as we have experienced delays in sales of some of our higher margin
digital switches as a result of delayed receipts of government stocking orders
that were received more consistently throughout the first half of 2006. The
declines in gross margin were offset by increases in sales of our lower margin
rotary switches and in-flight entertainment products. We have made a conscious
effort to pursue the opportunities within the lower margin commercial in-flight
entertainment market as we see substantial growth potential as compared to our
traditional higher margin aerospace and defense market resulting in lower
average margins for those products. We believe our rotary switch products have a
promising future, but are still requiring some investment in engineering design,
which increases our cost for the product. We expect to see improvements in
margins over time for our rotary switch business. Additionally, we are
experiencing pricing pressures on our central office timing products due
to competition. Our new TiemPo(TM) Edge Network products have more advanced
features with higher margins. Although the product is currently being sold in
both the U.S. and Europe, a longer qualification time required by our customers
will push some orders into late 2007, resulting in most of the initial impact of
this new product appearing in 2008.
We are investing in sales and marketing of our new and existing
products. We have increased our sales force in the U.K. in an effort to expand
our military power supply sales in Europe and are beginning to see results via
increased orders associated with those sales and marketing efforts.
During the second quarter of 2007, we focused our efforts on promoting
our new products, meeting sales forecasts and reducing administrative costs.
Sales for the second quarter of 2007 are stronger than for the second quarter of
2006 as well as the full year-to-date period. We are encouraged by our sales,
order entry and backlog growth and the opportunities both in new products and
new markets.
The following is a further, more detailed discussion of our results of
operations by segment.
16
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2007 AND THE THREE MONTHS ENDED
JUNE 30, 2006
NET SALES
Three Months Ended Variance
June 30, Favorable (Unfavorable)
------------------ ------------------
(in thousands) 2007 2006 Dollar Percent
------- ------- ------- ------
Electronic devices $ 8,440 $ 7,920 $ 520 6.6%
AS % OF NET SALES 69.9% 73.2%
Communications equipment 3,627 2,897 730 25.2%
AS % OF NET SALES 30.1% 26.8%
------- ------- -------
Total net sales $12,067 $10,817 $ 1,250 11.6%
======= ======= =======
ELECTRONIC DEVICES SEGMENT
The increase in sales of electronic devices in the second quarter of
2007 as compared to the second quarter of 2006 is primarily due to an increase
in sales of $0.8 million at our foreign subsidiaries. This was primarily the
result of military power supply sales in our U.K. subsidiary due to shipments
for some key contracts delivered in the second quarter of 2007. This increase
was slightly offset by sales declines in our domestic operations of $0.3 million
primarily due to delays in government stocking orders for our digital switches.
Additionally, the consolidation of our RO and CXR Larus operations into a single
facility at the beginning of the second quarter of 2007, combined with our
efforts to transition to a contract manufacturer for the manufacture of RO
products caused a disruption in sales. Approximately $0.4 million in scheduled
second quarter sales were diverted to the third quarter as a result of this
disruption. We expect continued improvements in military power supply sales in
the U.K. in the second half of 2007 related to in-flight entertainment and
communications products as well as increased sales of rotary switches, which we
anticipate will be offset somewhat by a reduction in sales of our digital
switches. We believe that the decline in sales of our digital switches is
temporary and will improve as government stocking orders are released.
COMMUNICATIONS EQUIPMENT SEGMENT
The increase in sales of communications equipment in the second quarter
of 2007 as compared to the second quarter of 2006 is primarily due to a $0.8
million increase at our French subsidiary of sales of network access equipment
as a result of a long-term effort to focus on our core military and
telecommunications markets. This improved focus helped us streamline sales
efforts for foreign communications equipment. The increase was partially offset
by slight declines in our domestic operations as a result of decreases in our
central office and other timing product sales. Sales of our
central office timing products have been slower than in 2006 due to competitive
pricing pressures. We expect to experience strong sales from our French
subsidiary for the remainder of the year as evidenced by increased backlog of
$1.5 million at June 30, 2007 as compared to $0.9 million at June 30, 2006. We
also expect improved sales in both our domestic and foreign operations as we
have now begun shipments of our new TiemPo(TM) Edge Network product in both the
U.S. and Europe.
17
GROSS PROFIT
Three Months Ended Variance
June 30, Favorable (Unfavorable)
----------------- ----------------------
(in thousands) 2007 2006 Dollar Percent
------- ------- ------- -------------
Electronic devices $ 2,794 $ 2,713 $ 81 3.0%
GROSS MARGIN 33.1% 34.3%
Communications equipment 1,282 1,079 203 18.8%
GROSS MARGIN 35.3% 37.2%
------- ------- -------
Total gross profit $ 4,076 $ 3,792 $ 284 7.5%
======= ======= =======
TOTAL GROSS MARGIN 33.8% 35.1%
ELECTRONIC DEVICES SEGMENT
The decline in gross margin for our electronic devices segment from
34.3% in the second quarter of 2006 to 33.1% in the second quarter of 2007 is
primarily the result of changes in product mix. Margins remained relatively
stable in our U.K. subsidiary, whereas our domestic subsidiaries experienced a
delay in sales of higher margin digital switches. Additionally, as a result of
the disruption in sales at RO due our efforts to transition to a contract
manufacturer for the manufacture of RO products, we did not generate sufficient
volumes of products to obtain the optimal pricing from the contract manufacturer
resulting in lower margins for those products. We anticipate that margins will
improve at RO as our contract manufacturing volumes increase. However, we expect
overall segment margins to remain near second quarter levels as we expand our
business with the higher growth, lower margin rotary switch products and with
expansion into the higher growth, lower margin commercial in-flight
entertainment market.
COMMUNICATIONS EQUIPMENT SEGMENT
The decline in gross margin for our communications equipment segment
from 37.2% in the second quarter of 2006 to 35.3% in the second quarter of 2007
is primarily the result of a decrease in margins of at our domestic subsidiaries
due to continued competitive pricing pressures related to our legacy central
office timing and other products, offset in part by increased sales for higher
margin military network access products at our French subsidiary. We expect the
launch of our TiemPo(TM) Edge Network product line in the U.S. and Europe to
help stabilize the declining gross margins during the remainder of 2007.
18
OPERATING EXPENSES
Three Months Ended Variance
June 30, Favorable (Unfavorable)
----------------- ----------------------
(in thousands) 2007 2006 Dollar Percent
------- ------- ------- -------------
Selling, general and administrative $ 3,849 $ 3,698 $ (151) (4.1)%
AS % OF NET SALES 31.9% 34.2%
Engineering and product development 665 892 227 25.4%
AS % OF NET SALES 5.5% 8.2%
------- ------- -------
Total operating expenses $ 4,514 $ 4,590 $ 76 1.7%
------- ------- -------
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
The increase in selling, general and administrative expenses is due to
an approximate $0.2 million increase in non-recurring costs related to the
consolidation of RO and CXR Larus operations into a single facility and the
costs of exiting the old RO premises. There was also an approximate $0.2 million
increase in sales and marketing expenses related to increased sales force to
promote military component sales in Europe and additional marketing expenses
related to the launch of our new TiemPo(TM) product line partially offset by a
$0.2 million decrease in general and administrative expenses primarily as the
result of a reduction in head count associated with the RO and CXR Larus
facility consolidation and other general and administrative cost reductions.
ENGINEERING AND PRODUCT DEVELOPMENT
The decrease in engineering and product development costs is primarily
due to reduced expenses for the development of the new TiemPo(TM) product line
for which most of the costs were incurred in 2006. Development costs incurred
for this new product were $0.1 million in the second quarter of 2007 compared to
$0.3 million in the second quarter of 2006.
INTEREST EXPENSE
Interest expense was $0.2 million for the three months ended June 30,
2007 compared to $0.1 million for the three months ended June 30, 2006 due to
increased loan balances for our U.S., U.K. and French operations and increased
interest rates.
OTHER INCOME (EXPENSE)
Other income (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. We generated other income of $0.1
million for the three months ended June 30, 2007 compared to other expense of
approximately $44,000 for the same period of 2006. The favorable variance during
the second quarter 2007 as compared to the same period in 2006 is related
primarily to the volatility of the British pound sterling and euro compared to
the U.S. dollar.
INCOME TAX EXPENSE
Income tax expense amounted to $0.2 million for the three months ended
June 30, 2007 compared to $0.1 million for the same period of 2006. Income tax
expense is the result of foreign income tax as the foreign subsidiaries maintain
profitability.
19
NET LOSS
We generated a net loss of $0.6 million and $1.0 million for the three
months ended June 30, 2007 and 2006, respectively. Our second quarter 2007 net
loss position improved significantly over the net loss for the prior year second
quarter. Factors that contributed to the current quarter net loss were the
delays in stocking orders from the U.S. government for our digital
switches, the disruption in sales at RO as a result of the consolidation of our
RO and CXR Larus facilities, the conversion of the manufacturing of RO products
to contract manufacturing and the additional costs incurred to move the RO
operations and exit the existing premises.
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2007 AND THE SIX MONTHS ENDED JUNE
30, 2006
NET SALES
Six Months Ended Variance
June 30, Favorable (Unfavorable)
----------------- ----------------------
(in thousands) 2007 2006 Dollar Percent
------- ------- ------- -------------
Electronic devices $16,967 $15,773 $ 1,194 7.6%
AS % OF NET SALES 70.7% 73.2%
Communications equipment 7,022 5,778 1,244 21.5%
AS % OF NET SALES 29.3% 26.8%
------- ------- -------
Total net sales $23,989 $21,551 $ 2,438 11.3%
======= ======= =======
ELECTRONIC DEVICES SEGMENT
The increase in sales of electronic devices in the first half of 2007
as compared to the same period of 2006 is primarily due to an increase in sales
of $2.1 million at our foreign subsidiaries. This was primarily the result of
military power supply sales in our U.K. subsidiary as a result of shipments for
some key contracts delivered in the first half of 2007. This increase was
partially offset by $0.9 million of sales declines in our domestic operations
primarily due to delays in government stocking orders for our digital switches.
Additionally, the consolidation of our RO and CXR Larus operations into a single
facility at the beginning of the second quarter of 2007 combined with the
manufacturing of RO product being converted to a contract manufacturer further
impacted sales with a disruption in sales. Approximately $0.4 million in
scheduled second quarter sales were diverted to the third quarter as a result of
this disruption. We expect continued improvements of military power supply sales
in the U.K. in the second half of 2007 related to the Eurofighter and in-flight
entertainment and communications products as well as increased sales of rotary
switches, which we anticipate will be offset somewhat by a reduction in sales of
our digital switches.
COMMUNICATIONS EQUIPMENT SEGMENT
The increase in sales of communications equipment in the six months
ended June 30, 2007 as compared to the same period of 2006 is primarily due to a
$1.4 million increase in sales at our French subsidiary of network access
equipment as a result of a long-term effort to focus on our core military and
telecommunications markets. This improved focus helped us streamline sales
efforts for foreign communications equipments. The increase was partially offset
by slight declines in our domestic operations as a result of decreases in
central office and other timing product sales due to increased competition. We
expect to experience strong sales from our French subsidiary for the remainder
of the year as evidenced by increased backlog of $1.5 million at June 30, 2007
as compared to $0.9 million at June 30, 2006. We also expect improved sales in
both our domestic and foreign operations as we are now shipping orders for our
new TiemPo(TM) Edge Network product in both the U.S. and Europe.
20
GROSS PROFIT
Six Months Ended Variance
June 30, Favorable (Unfavorable)
----------------- ----------------------
(in thousands) 2007 2006 Dollar Percent
------- ------- ------- -------------
Electronic devices $ 5,422 $ 5,779 $ (357) (6.2)%
GROSS MARGIN 32.0% 36.6%
Communications equipment 2,502 2,397 105 4.4%
GROSS MARGIN 35.6% 41.5%
------- ------- -------
Total gross profit $ 7,924 $ 8,176 $ (252) (3.1)%
======= ======= =======
TOTAL GROSS MARGIN 33.0% 37.9%
ELECTRONIC DEVICES SEGMENT
The decline in gross margin for our electronic devices segment from
36.6% in the second quarter of 2006 to 32.0% in the second quarter of 2007 is
primarily the result of changes in product mix. Margins on military power supply
products have continued to increase in our U.K. subsidiary, whereas our domestic
subsidiaries have experienced what we believe is a temporary delay in sales of
higher margin digital switches. Additionally, as a result of the disruption in
sales at RO due to the conversion of the manufacturing of product to a contract
manufacturer, we did not generate sufficient volumes of products to obtain the
optimal pricing from the contract manufacturer resulting in lower margins for
those products. We anticipate that margins will improve at RO as our
manufacturing volumes increase. However, we expect overall segment margins to
remain at second quarter levels as we expand our business with the higher
growth, lower margin rotary switch products and expansion into the higher
growth, lower margin commercial in-flight entertainment market.
COMMUNICATIONS EQUIPMENT SEGMENT
The decline in gross margin for our communications equipment segment
from 41.5% in the second quarter of 2006 to 35.6% in the second quarter of 2007
is primarily the result of a decrease in margins at our domestic subsidiaries
due to continued competitive pricing pressures related to our central office and
other timing products, offset in part by increased sales for higher margin
military network access products at our French subsidiary. We expect the launch
of our TiemPo(TM) Edge Network product line in the U.S. and Europe to help
stabilize the declining gross margins during the remainder of 2007.
21
OPERATING EXPENSES
Six Months Ended Variance
June 30, Favorable (Unfavorable)
----------------- ----------------------
(in thousands) 2007 2006 Dollar Percent
------- ------- ------- -------------
Selling, general and administrative $ 7,585 $ 7,465 $ (120) (1.6)%
AS % OF NET SALES 31.6% 34.6%
Engineering and product development 1,375 1,614 239 14.8%
AS % OF NET SALES 5.7% 7.5%
------- ------- -------
Total operating expenses $ 8,960 $ 9,079 $ 119 1.3%
------- ------- -------
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
The increase in selling, general and administrative expenses is due to
an increase of $0.3 million in general and administrative expenses as a result
of U.S.-based audit fees related to cost overruns and quarterly reviews for 2006
being performed in the first quarter of 2007 instead of during 2006 and legal
fees all of which were related to the re-audit and restatement of our 2003, 2004
and 2005 earnings. General and administrative expenses also included
approximately $0.2 million of non-recurring costs related to the consolidation
of RO into our CXR Larus facility and the costs of exiting the old premises.
These increases were substantially offset with a reduction of $0.4 million in
compensation related expenses.
ENGINEERING AND PRODUCT DEVELOPMENT
The decrease in engineering and product development costs is primarily
due to reduced expenses for the development of the new TiemPo(TM) Edge Network
product line for which most of the costs were incurred in 2006. Development
costs incurred for this new product were $0.2 million for the six months ended
June 30, 2007 compared to $0.3 million for the same period of 2006.
INTEREST EXPENSE
Interest expense was $0.3 million for the six months ended June 30,
2007 compared to $0.2 million for the six months ended June 30, 2006 due to
increased loan balances for our U.S., U.K. and French operations and increased
interest rates.
OTHER INCOME (EXPENSE)
Other income (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. We generated other income of $0.2
million for the six months ended June 30, 2007 compared to other expense of
approximately $36,000 for the same period of 2006. The favorable variance during
the first half of 2007 as compared to the same period in 2006 is related
primarily to the volatility of the British pound sterling and euro compared to
the U.S. dollar.
INCOME TAX EXPENSE
Income tax expense amounted to $0.3 million for the six months ended
June 30, 2007 compared to $0.2 million for the same period of 2006. Income tax
expense is the result of foreign income tax as the foreign subsidiaries maintain
profitability.
22
NET LOSS
We generated a net loss of $1.4 million and $1.3 million for the six
months ended June 30, 2007 and 2006, respectively. Our 2007 net loss position
has remained relatively consistent with the net loss incurred for the prior
year. Factors that contributed to the 2007 net loss were the audit and legal
costs incurred related to the re-audit and restatement of our 2003, 2004 and
2005 earnings, the costs incurred to move the RO operations and exit the
existing premises, the delays in stocking orders from the U.S. government for
our digital switches and the disruption in sales at RO as a result of the
consolidation of our RO and CXR Larus facilities and the conversion of the
manufacturing of products to contract manufacturing.
LIQUIDITY AND CAPITAL RESOURCES
In making an assessment of our liquidity, we believe that the items in
our financial statements that are most relevant are our working capital, cash
generated from our operating activities and cash available from our financing
activities. We fund our daily cash flow requirements through funds provided by
operations and through borrowings from short-term revolving credit facilities,
both foreign and domestic. Working capital at June 30, 2007 was $7.7 million
compared to $9.6 million at December 31, 2006. The decrease in working capital
is primarily the result of decreases in our cash and accounts receivable
balances and increases in our inventory, accounts payable and accrued expenses
balances.
Net cash provided by operating activities for the six months ended June
30, 2007 amounted to $0.2 million compared to $0.7 million used in operating
activities for the six months ended June 30, 2006. Significant sources of cash
from operations for the first half of 2007 were a decrease in accounts
receivable related to collections from customers and an increase in accounts
payable as a result of slower timing of payment to domestic vendors related to a
temporary cash deficit at our U.S. operations. The most significant use of cash
from operations was related to increases in inventory primarily in anticipation
of government stocking orders for switches and the build up of "in-flight
entertainment" product for shipment in the second half of 2007.
Other significant uses of cash during the six months ended June 30,
2007 include $0.4 million for investment in property, plant and equipment and
$0.8 million used to repay lines of credit and other long-term debt.
Our backlog increased to $27.4 million as of June 30, 2007 from $24.9
million as of June 30, 2006. 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.
Our backlog as of June 30, 2007 was approximately 93% 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 7% related to our communications equipment business, which
business tends to deliver standard or modified standard products from stock as
orders are received. 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.
CONTRACTUAL OBLIGATIONS
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, term loans and other
significant contractual obligations through 2011, exclusive of interest. During
the six months ended June 30, 2007, no material changes in this information
occurred outside the ordinary course of business.
As of June 30, 2007, outstanding borrowings and availability under our
revolving lines of credit were as follows (in thousands):
23
Outstanding Remaining
Borrowings Availability
------------ ------------
Line of credit with a U.S. commercial lender $ 1,033 $ 841
Lines of credit with foreign banks 2,984 1,303
------------ ------------
$ 4,017 $ 2,144
============ ============
Remaining availability is presented as of June 30, 2007 and is
effected by timing of advances, payments, collections and shipments. In addition
to the revolving lines of credit, at June 30, 2007 we had long-term loans and
capitalized lease and equipment loan obligations of $2.3 million, the current
portion of which loans and obligations was $1.0 million.
CREDIT FACILITIES
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 to a Credit and Security Agreement
("WFBC credit facility"). The WFBC credit facility provides for a $5.0 million
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 June 30, 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.
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.
We are subject to certain financial covenants associated with the WFBC
credit facility on a consolidated basis. In August 2007, we amended the WFBC
credit facility to reset these covenants 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 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 the sum of (i) $23 million and (ii) 90% of
consolidated net income for each calendar quarter ending on or after September
30, 2007, but only to the extent such net income for each such quarter is
positive. We were not permitted to incur a net loss of greater than $1.5 million
for the six months ended June 30, 2007. For the year-to-date period ending
September 30, 2007 we are not permitted to incur a net loss of greater than $1.2
million and for the year-to-date period ending December 31, 2007 our net income
must not be less than $100,000. As a result of the amendment, at June 30, 2007
we were in compliance with the WFBC credit facility's financial covenants.
On July 8, 2005, XPS and Pascall obtained a credit facility with Lloyds
TSB Commercial Finance Limited ("Lloyds") that provides a revolving loan secured
by receivables, with a maximum availability of 2.1 million British pounds
sterling (approximately $4.2 million based on the exchange rate in effect on
June 30, 2007). The annual interest rate on the revolving loan is 1.5% above the
Lloyds TSB base rate. The Lloyds TSB base rate was 5.5% at June 30, 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. This facility can be
terminated by either party with 90 days' notice. We are not aware of any
termination notice or expected termination notice by either party.
24
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 $1.6
million based on the exchange rate in effect at June 30, 2007 for the conversion
of euros into U.S. dollars. CXR-AJ also had approximately $28,000 of term loans
with another French bank outstanding as of June 30, 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 June 30, 2007, the French T4M rate was
4.4%, and this facility in addition to small loans with other banks had a
balance of $0.8 million. This facility has no financial performance covenants.
Availability on the IFN Finance credit line was $0.6 million as of June 30,
2007, in addition to approximately $37,000 availability with several other
banks.
We intend to grow our business through both internal growth and further
acquisitions or mergers. Any additional acquisitions would likely be funded
primarily through the use of cash and/or a combination of cash, seller provided
notes, and additional third-party debt. Although these acquisitions may also
include an equity component; our intent is to minimize the use of equity in any
such transactions. In any case, our focus would be on acquisitions or mergers
that we identify as being potentially both synergistic and accretive of our
earnings.
Due to the significant accounting, legal fees and other costs incurred
in 2006 and 2007 associated with our 2005/2006 re-audit and restatement and the
losses incurred in the first and second quarters of 2007 in our domestic
operations, we experienced a cash flow deficit at our U.S. operations beginning
in the second quarter of 2007. As of June 2007, the combined U.S. operations
were cash flow neutral. Further, we anticipate that the combined U.S. operations
will be cash flow positive throughout the remainder of 2007. However, our
domestic operations are past due with some of our key vendors in the U.S. We
have negotiated extended payment terms with certain key vendors. In nearly all
cases, we have continued to receive products in a timely manner from all key
vendors and no significant disruptions in sales have occurred as a result of the
domestic U.S. cash flow situation. We expect to return to normal payment terms
with most domestic U.S. vendors during the fourth quarter of 2007.
Throughout 2006 and continuing in 2007, we have utilized the positive
cash flow from our foreign subsidiaries and leveraged existing lending
relationships with Lloyds and other foreign-based banks to help fund the cash
flow deficit in the U.S. However, if our vendors do not continue to support us
in this regard, if our foreign operations are unable to continue to provide cash
to our U.S. operations, and/or if we were unable to continue to utilize the
foreign banks to fund U.S. operations for any reason, then our U.S. operations
sales and profitability could be adversely affected.
Overall, we believe that current and future available capital
resources, revenues generated from operations, and other existing sources of
liquidity, including the credit facilities we have with WFBC and Lloyds will be
adequate to meet our anticipated short term working capital and capital
expenditure requirements for at least the next twelve months. However, we
believe that our ability to fund internal growth opportunities and our potential
to fund possible future acquisitions is somewhat limited by our current
financing structure.
We are investigating alternative financing options, primarily with the
intent of funding possible future acquisitions as well as possibly consolidating
our current lending obligations. There is no assurance that we will be
successful in obtaining such a facility. If we do obtain such a facility, it is
possible that such a facility would be more costly than our current credit
facilities, (both in the form of upfront closing fees and ongoing interest and
other fees), which could adversely affect our profitability. Our failure to
secure a new credit facility could restrict our growth, limit our development of
new products, limit our ability to secure acquisitions or hinder our ability to
compete.
25
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
On January 1, 2007, we adopted Financial Accounting Standards Board
("FASB") Financial Interpretation No. ("FIN") 48, "Accounting for Uncertainty in
Income Taxes - an interpretation of FASB Statement No. 109." FIN 48 clarifies
the accounting for the uncertainty in recognizing income taxes in an
organization in accordance with FASB Statement No. 109 by providing detailed
guidance for financial statement recognition, measurement and disclosure
involving uncertain tax positions. FIN 48 requires an uncertain tax position to
meet a more-likely-than-not recognition threshold at the effective date to be
recognized both upon the adoption of FIN 48 and in subsequent periods. The
implementation of FIN 48 did not result in a material effect on our financial
statements. See Note 6 - Income Taxes in the Notes to Consolidated Financial
Statements in this Form 10-Q.
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
years beginning after November 15, 2007. We currently are evaluating the effect
that adoption of SFAS No. 159 would have on our financial condition or results
of operations.
26
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Foreign Currency Exchange Risk
------------------------------
We have 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 U.S. dollars, and the statements of operations are converted
using weighted average exchange rates for the applicable period. Foreign
currency fluctuations also affect our foreign currency cash flows related to
third party purchases, intercompany loans, and product shipments. We are also
exposed to the translation of foreign currency earnings to the U.S. dollar. Our
principal exposures are to British pound sterling, Euro, and Japanese yen.
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended, establishes accounting and reporting standards
requiring that every derivative instrument be recorded in the balance sheet as
either an asset or a liability measured at its fair value. SFAS No. 133 also
requires that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met, and that a company
must formally document, designate and assess the effectiveness of transactions
that receive hedge accounting. We currently use derivatives to manage foreign
currency rate risk.
In particular, one of our U.K. subsidiaries that conducts business in
British pounds sterling, and has the most foreign currency exchange risk, has a
program whereby they utilize forward currency contracts denominated in U.S.
dollars to offset the risk associated with the effects of currency exposure for
sales in U.S. dollars. Under this program, increases or decreases in the
subsidiary's foreign currency exposure are offset by gains or losses on the
forward contracts, to mitigate the possibility of foreign currency translation
gains or losses. These forward contracts generally have terms of 180 days or
less. We do not use these forward contracts for trading or speculative purposes.
All outstanding foreign currency forward contracts used in this program are
marked to market at the end of each reporting period with unrealized gains and
losses included in other income and expense.
Our ultimate realized gain or loss with respect to currency
fluctuations will depend on the currency exchange rates and other factors in
effect as the contracts mature. Net foreign exchange translation gains and
losses included in other income and expense in the accompanying condensed
consolidated statements of operations were gains of approximately $76,000 and
losses of approximately $13,000 for the six months ended June 30, 2007 and 2006,
respectively.
Interest Rate Sensitivity
-------------------------
A substantial portion of our notes payable and long-term debt have
variable interest rates based on the prime interest rate and/or the lender's
base rate, which exposes us to risk of earnings loss due to changes in such
interest rates. Our amended annual report on Form 10-K for the year ended
December 31, 2006 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 six months ended June 30, 2007.
ITEM 4T. CONTROLS AND PROCEDURES.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
We conducted an evaluation under the supervision and with the
participation of our Chief Executive Officer, who is our principal executive
officer, and Vice President of Finance and Administration, who is our principal
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
27
periods specified in the Securities and Exchange Commission's rules and forms.
Disclosure controls and procedures also include, without limitation, controls
and procedures designed 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 this evaluation, our Chief Executive Officer and our Vice
President of Finance and Administration have concluded as of June 30, 2007 that
our disclosure controls and procedures were not effective at the reasonable
assurance level due to the material weakness described below.
Management concluded as of December 31, 2006 in our Annual Report on
Form 10-K ("Annual Report"), for the year then ended, that our internal control
over financial reporting was not effective. You should refer to management's
discussion under "Item 9A - Controls and Procedures" in our Annual Report for a
complete description of the criteria applied by management and the factors based
upon which management concluded that our internal control over financial
reporting was not then effective.
In our Annual Report, management identified the following two material
weaknesses in our internal control over financial reporting:
1. We did not have a sufficient complement of personnel with
appropriate training and experience in accounting principles generally accepted
in the United States of American ("GAAP") and with Securities and Exchange
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 GAAP and with Securities and
Exchange 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.
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.
28
Changes in Internal Control Over Financial Reporting
During the quarter ended June 30, 2007, we implemented a variety of
changes to our internal control over financial reporting intended to remediate
these material weaknesses. Based on management's evaluation of the effectiveness
of the design and operation of our disclosure controls and procedures, our Chief
Executive Officer and Vice President of Finance and Administration concluded
that, as of June 30, 2007, the first material weakness identified above had been
fully remediated while the second material weakness identified above remained.
Following is a summary description of the changes in our internal
control over financial reporting implemented during the quarter ended June 30,
2007.
With respect to the first material weakness identified above, effective
May 16, 2007, D. John Donovan was appointed as our Vice President of Finance and
Administration. Mr. Donovan assumed the role of principal financial and
accounting officer on that date. Also in May 2007, we established the position
of and appointed a new Corporate Controller for our U.S. operations. Mr. Donovan
and the new Corporate Controller each have expertise in public company financial
reporting compliance. As a result, we believe we now have a sufficient
complement of personnel with appropriate training and experience in GAAP and
Securities and Exchange Commission disclosure requirements.
With respect to the second material weakness identified above, through
the efforts of our Vice President of Finance and Administration and Corporate
Controller we began the process of developing 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 U.S., Europe and Asia. In addition, our Vice President of Finance and
Administration and Corporate Controller began the process of establishing
policies and procedures necessary to ensure that personnel familiar with GAAP
and with Securities and Exchange 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. Our Vice President
of Finance a nd Administration and Corporate Controller are working closely with
our Director of Financial Controls for Europe, whom we hired in late 2005 to
oversee our three European Controllers and who reports 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 second material weakness identified above. Management may need to hire
outside consultants to assist us in satisfying our financial reporting
obligations.
The changes noted above are the only changes during our most recently
completed fiscal quarter that have materially affected or are reasonably likely
to materially affect, our internal control over financial reporting, as defined
in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.
29
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Various legal actions and claims are pending against us in the ordinary
course of business. In the opinion of management, the ultimate resolution of
such pending legal actions and claims will not have a material adverse effect on
our consolidated financial position or our results of operations.
ITEM 1A. RISK FACTORS.
Item 1A of Part I of our Form 10-K for the 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
During the quarter ended June 30, 2007, we issued to a financial
advisor a five-year warrant to purchase up to 31,250 shares of our common stock
on a cash or cashless basis at an exercise price equal to $1.15 per share.
Exemption from the registration provisions of the Securities Act of
1933 for the transaction described above is claimed under Section 4(2) of the
Securities Act of 1933, among others, on the basis that the transaction did not
involve any public offering and the purchaser was sophisticated or accredited
with access to the kind of information registration would provide.
DIVIDENDS
We have not declared or paid any cash dividends on our capital stock in
the past, and we do not anticipate declaring or paying cash dividends on our
common stock in the foreseeable future. In addition, our credit facility with
WFBC, described in "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources," restricts the
payment of dividends without the bank's consent.
We will pay dividends on our common stock only if and when declared by
our board of directors. Our board of directors' ability to declare a dividend is
subject to restrictions imposed by Delaware law. In determining whether to
declare dividends, the board of directors will consider these restrictions as
well as our financial condition, results of operations, working capital
requirements, future prospects and other factors it considers relevant.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
ITEM 5. OTHER INFORMATION.
None.
30
ITEM 6. EXHIBITS.
NUMBER DESCRIPTION
------ -----------
31.1 Certification of Principal Executive Officer Required by Rule
13a-14(a) of the Securities Exchange Act of 1934, as amended, as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Principal Financial Officer Required by Rule
13a-14(a) of the Securities Exchange Act of 1934, as amended, as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Principal Executive Officer and Principal
Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
31
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: August 14, 2007 By: /S/ CARMINE T. OLIVA
-----------------------------------------
Carmine T. Oliva,
Chief Executive Officer, (duly authorized
officer)
Dated: August 14, 2007 By: /S/ D. JOHN DONOVAN
-----------------------------------------
D. John Donovan, Vice President of Finance
and Administration (principal financial
officer)
32
INDEX TO EXHIBITS ATTACHED TO THIS REPORT
NUMBER DESCRIPTION
------ -----------
31.1 Certification of Principal Executive Officer Required by Rule
13a-14(a) of the Securities Exchange Act of 1934, as amended, as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Principal Financial Officer Required by Rule
13a-14(a) of the Securities Exchange Act of 1934, as amended, as
Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Principal Executive Officer and Principal
Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
33