AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 31, 2005
REGISTRATION NO. 333-______
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
----------------
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.)
3825
(Primary standard industrial
classification code number)
---------------
9485 HAVEN AVENUE, SUITE 100
RANCHO CUCAMONGA, CALIFORNIA 91730
(909) 987-9220
(Address, including zip code, and telephone number, including area code,
of registrant's principal executive offices)
----------------
CARMINE T. OLIVA
PRESIDENT AND CHIEF EXECUTIVE OFFICER
EMRISE CORPORATION
9485 HAVEN AVENUE, SUITE 100
RANCHO CUCAMONGA, CALIFORNIA 91730
(909) 987-9220
(909) 987-9228 (FAX)
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
----------------
COPIES OF ALL CORRESPONDENCE TO:
LARRY A. CERUTTI, ESQ.
CRISTY LOMENZO PARKER, ESQ.
RUTAN & TUCKER, LLP
611 ANTON BOULEVARD, 14TH FLOOR
COSTA MESA, CALIFORNIA 92626
(714) 641-5100
(714) 546-9035 (FAX)
----------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this registration statement becomes effective.
----------------
If any of the securities being registered on this Form are to be offered on a
delayed or continuous basis pursuant to Rule 415 under the Securities Act, check
the following box. |X|
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [ ]
CALCULATION OF REGISTRATION FEE
======================================= ===================== ====================== ====================== ======================
Amount Proposed maximum Proposed maximum
Title of each class of to be offering price aggregate Amount of
securities to be registered registered(1) per share(2) offering price(2) registration fee
--------------------------------------- --------------------- ---------------------- ---------------------- ----------------------
Common stock, $0.0033 par value 18,388,777(3) $1.49 $27,399,277.73 $3,224.89
======================================= ===================== ====================== ====================== ======================
(1) In the event of a stock split, stock dividend, anti-dilution adjustment or
similar transaction involving common stock of the registrant, in order to
prevent dilution, the number of shares registered shall be automatically
increased to cover the additional shares in accordance with Rule 416(a)
under the Securities Act.
(2) The proposed maximum offering price per share has been estimated solely for
the purpose of calculating the registration fee pursuant to Rule 457(c) of
the Securities Act and is based upon the average of the high and low sale
prices of the registrant's common stock reported on the OTC Bulletin Board
on January 25, 2005.
(3) Includes 4,606,685 shares of common stock issuable upon exercise of
warrants.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
================================================================================
SUBJECT TO COMPLETION, DATED JANUARY 28, 2005
PROSPECTUS
18,388,777 SHARES
EMRISE CORPORATION
COMMON STOCK
---------------------
This a public offering of 18,388,777 shares of our common stock. All
shares are being offered by selling security holders identified in this
prospectus. We will not receive any of the proceeds from the sale of shares by
the selling security holders. Our common stock is quoted on the OTC Bulletin
Board under the symbol "EMRI." On January 24, 2005, the closing sale price of
our common stock on the OTC Bulletin Board was $1.52 per share.
The mailing address and the telephone number of our principal executive
offices are 9485 Haven Avenue, Rancho Cucamonga, California 91730, (909)
987-9220.
---------------------
Investing in our shares of common stock involves risks. See "Risk
Factors" beginning on page 6 for some of the factors you should consider
before buying shares of our common stock.
---------------------
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED.
WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES, AND WE ARE NOT SOLICITING OFFERS TO BUY THESE
SECURITIES, IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS ACCURATE OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
THE DATE OF THIS PROSPECTUS IS __________, 2005.
TABLE OF CONTENTS
Page
----
Prospectus Summary ............................................. 2
Risk Factors.................................................... 6
Special Note Regarding Forward-Looking Statements.............. 12
Use of Proceeds................................................ 13
Dividend Policy................................................ 13
Price Range of Common Stock.................................... 13
Capitalization................................................. 14
Selected Consolidated Historical Financial Data................ 15
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 17
Business....................................................... 40
Management..................................................... 65
Certain Relationships and Related Transactions................. 79
Principal Stockholders......................................... 80
Selling Security Holders....................................... 82
Plan of Distribution........................................... 89
Description of Capital Stock................................... 91
Legal Matters.................................................. 94
Experts........................................................ 94
Where You Can Find Additional Information...................... 94
Index to Financial Statements and Financial Statement
Schedule................................................... F-1
PROSPECTUS SUMMARY
TO FULLY UNDERSTAND THIS OFFERING AND ITS CONSEQUENCES TO YOU, YOU
SHOULD READ THE FOLLOWING SUMMARY ALONG WITH THE MORE DETAILED INFORMATION AND
OUR CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES TO THOSE STATEMENTS
APPEARING ELSEWHERE IN THIS PROSPECTUS. IN THIS PROSPECTUS, THE WORDS "WE,"
"US," "OUR" AND SIMILAR TERMS REFER TO EMRISE CORPORATION TOGETHER WITH ITS
SUBSIDIARIES.
EMRISE CORPORATION
We are a Delaware corporation that was formed July 14, 1989. In
September 2004, we changed our name from MicroTel International Inc. to Emrise
Corporation. We have three wholly-owned operating subsidiaries, CXR Larus
Corporation, a Delaware corporation formed in 1984 under the name CXR Telcom
Corporation and based in the United States ("CXR Larus"), CXR Anderson Jacobson,
a company organized under the laws of France in 1973 and based in France
("CXR-AJ"), and XET Corporation, a company organized under the laws of New
Jersey in 1983. CXR Larus and CXR-AJ manufacture, assemble and distribute
communications test equipment, communication timing and synchronization
products, and network access and transmission products. XET Corporation designs,
manufactures and markets electronic components for defense, aerospace and
industrial markets.
Through our operating subsidiaries, XET Corporation, CXR Larus and
CXR-AJ, and through the divisions and subsidiaries of those subsidiaries, we
design, develop, manufacture, assemble, and market products and services in the
following two material business segments:
o Electronic Components
-- digital and rotary switches
-- electronic power supplies
-- subsystem assemblies
o Communications Equipment
-- network access and transmission products
-- communication timing and synchronization products
-- communications test instruments
Our sales are primarily in North America, Europe and Asia. Sales to
customers in the electronic components segment, primarily to defense and
aerospace customers, defense contractors and industrial customers, were 58.2%,
63.4% and 59.1% of our total net sales for the nine months ended September 30,
2004 and the years 2003 and 2002, respectively. Sales of communications
equipment and related services, primarily to telecommunications equipment
customers, were 41.8%, 36.6% and 40.9% of our total net sales during the nine
months ended September 30, 2004 and the years 2003 and 2002, respectively.
Our objective in our electronic components business is to become the
supplier of choice for harsh environment digital and rotary switches and custom
power supplies. Our objective in our communications equipment business is to
become a leader in quality, cost-effective solutions to meet the requirements of
communications equipment customers. We believe that we can achieve these
objectives through customer-oriented product development, superior product
solutions, and excellence in local market service and support.
2
CORPORATE INFORMATION
Our principal executive offices are located at 9485 Haven Avenue, Suite
100, Rancho Cucamonga, California 91730. Our telephone number is (909) 987-9220.
Our Internet address is http://www.emrise.com. Information contained on, or that
is accessible through, our websites should not be considered to be part of this
prospectus.
THE OFFERING
Common stock offered by the selling security holders 18,388,777 shares
Common stock to be outstanding after this offering 41,937,643 shares
Use of proceeds All proceeds of this offering will be received by
selling security holders for their own accounts. See
"Use of Proceeds."
OTC Bulletin Board symbol EMRI
The number of shares of common stock being offered by the selling
security holders includes 13,782,092 outstanding shares of common stock held by
certain security holders and assumes the exercise of warrants whose underlying
shares of common stock are covered by this prospectus in exchange for 4,606,685
shares of common stock, and the immediate resale of all of those 4,606,685
shares of common stock.
The number of shares of common stock that will be outstanding upon the
completion of this offering is based on the 37,330,958 shares outstanding as of
January 24, 2005, and excludes the following:
o 3,214,558 shares of common stock reserved for issuance under our
stock option plans, of which options to purchase 2,133,256 shares
were outstanding as of January 24, 2005, at a weighted average
exercise price of $0.97 per share; and
o any additional shares of common stock we may issue from time to
time after January 24, 2005.
You should read the discussion under "Management -- Stock Option Plans"
for additional information about our stock option plans.
3
SUMMARY CONSOLIDATED HISTORICAL FINANCIAL DATA
The following financial data should be read in conjunction with the
consolidated financial statements and the notes to those statements beginning on
page F-1 of this prospectus, and the section entitled "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included
elsewhere in this prospectus. The consolidated statements of operations and
comprehensive income data for the years ended December 31, 2003 and 2002 and the
consolidated balance sheet data at December 31, 2003 and 2002 are derived from,
and are qualified in their entirety by reference to, the consolidated audited
financial statements included in this prospectus, which were audited by Grant
Thornton LLP. The consolidated statements of operations and comprehensive income
data for the year ended December 31, 2001 are derived from, and are qualified in
their entirety by reference to, the consolidated audited financial statements
included in this prospectus, which were audited by BDO Seidman, LLP. The
consolidated statements of operations and comprehensive income data with respect
to the years ended December 31, 2000 and 1999 and the consolidated balance sheet
data at December 31, 2000 and 1999 are derived from, and are qualified in their
entirety by reference to, our audited financial statements not included in this
prospectus. The consolidated statements of operations data and comprehensive
income data for the nine months ended September 30, 2004 and 2003 and the
consolidated balance sheet data at September 30, 2004 and 2003 are derived from,
and are qualified in their entirety by reference to, our unaudited consolidated
financial statements included in this prospectus. The historical results that
appear below are not necessarily indicative of results to be expected for any
future periods.
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
CONSOLIDATED STATEMENTS OF OPERATIONS AND -------------------- -----------------------------------------------------
COMPREHENSIVE INCOME DATA: 2004 2003 2003 2002 2001 2000 1999
--------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net sales ....................................... $ 20,093 $ 18,922 $ 25,519 $ 22,664 $ 27,423 $ 28,050 $ 25,913
Cost of sales ................................... 11,217 11,237 14,835 14,147 15,456 15,529 17,066
--------- --------- --------- --------- --------- --------- ---------
Gross profit .................................... 8,876 7,685 10,684 8,517 11,967 12,521 8,847
Selling, general and administrative expenses .... 6,749 5,532 7,812 7,731 10,129 9,827 10,584
Engineering and product development expenses .... 1,033 697 951 1,015 1,076 1,167 1,841
--------- --------- --------- --------- --------- --------- ---------
Income (loss) from operations ................... 1,094 1,456 1,921 (229) 762 1,527 (3,578)
Total other income (expense) .................... (369) (313) (474) (361) (414) 207 (492)
--------- --------- --------- --------- --------- --------- ---------
Income (loss) from continuing operations
before income taxes ........................... 725 1,143 1,447 (590) 348 1,734 (4,070)
Income tax (benefit) expense .................... 128 236 286 (20) 77 31 128
--------- --------- --------- --------- --------- --------- ---------
Income (loss) from continuing operations ........ 597 907 1,161 (570) 271 1,703 (4,198)
Discontinued operations:
Loss from operations of discontinued segment .. -- -- -- -- 56 (212) (847)
Gain (loss) on disposal of discontinued
segment including provision for phase
out period of $122 in 2000 ................... -- -- -- -- -- (487) 449
--------- --------- --------- --------- --------- --------- ---------
Net income (loss) ............................... 597 907 1,161 (570) 327 1,004 (4,596)
Foreign currency translation adjustment ......... (58) 361 705 446 (312) (505) (325)
--------- --------- --------- --------- --------- --------- ---------
Total comprehensive income (loss) ............... $ 539 $ 1,268 $ 1,866 $ (124) $ 15 $ 499 $ (4,921)
========= ========= ========= ========= ========= ========= =========
Basic earnings (loss) per share from
continuing operations ......................... $ 0.03 $ 0.04 $ 0.05 $ (0.03) $ 0.01 $ 0.09 $ (0.26)
========= ========= ========= ========= ========= ========= =========
Diluted earnings (loss) per share from
continuing operations ......................... $ 0.02 $ 0.04 $ 0.05 $ (0.03) $ 0.01 $ 0.07 $ (0.26)
========= ========= ========= ========= ========= ========= =========
Basic earnings (loss) per share from
discontinued operations ....................... $ -- $ -- $ -- $ -- $ -- $ (0.04) $ (0.02)
========= ========= ========= ========= ========= ========= =========
Diluted earnings (loss) per share from
discontinued operations ....................... $ -- $ -- -- $ -- $ -- $ (0.03) $ (0.02)
========= ========= ========= ========= ========= ========= =========
Basic earnings (loss) per share ................. $ 0.03 $ 0.04 $ 0.05 $ (0.03) $ 0.02 $ 0.05 $ (0.28)
========= ========= ========= ========= ========= ========= =========
Diluted earnings (loss) per share ............... $ 0.02 $ 0.04 $ 0.05 $ (0.03) $ 0.01 $ 0.04 $ (0.28)
========= ========= ========= ========= ========= ========= =========
Weighted average shares outstanding, basic ...... 23,833 22,280 22,567 21,208 20,594 19,504 16,638
Weighted average shares outstanding, diluted .... 24,599 23,604 23,811 21,208 23,782 23,027 16,638
4
AT DECEMBER 31,
AT SEPTEMBER 30, --------------------------------------
CONSOLIDATED BALANCE SHEET DATA: 2004 2003 2002 2001 2000 1999
-------- -------- -------- -------- -------- --------
(IN THOUSANDS)
Cash and cash equivalents ................. $ 379 $ 1,174 $ 254 $ 604 $ 756 $ 480
Working capital ........................... 4,599 5,696 3,961 3,686 2,780 1,080
Total assets .............................. 22,072 17,169 16,786 17,688 19,484 16,489
Long-term debt, net of current portion .... 2,435 819 927 763 282 143
Stockholders' equity ...................... 9,542 7,916 5,732 5,862 5,807 3,801
Convertible redeemable preferred stock .... -- -- 282 270 259 588
No cash dividends on our common stock were declared during any of the
periods presented above.
Various factors materially affect the comparability of the information
presented in the above table. These factors relate primarily to the acquisition
of Larus Corporation in July 2004, changes in foreign currency conversion rates
and new accounting pronouncements that may affect the consistency in the
generally accepted accounting principles that we use.
5
RISK FACTORS
THE FOLLOWING SUMMARIZES MATERIAL RISKS WHICH YOU SHOULD CAREFULLY
CONSIDER BEFORE YOU DECIDE TO BUY OUR COMMON STOCK IN THIS OFFERING. ANY OF THE
FOLLOWING RISKS, IF THEY ACTUALLY OCCUR, WOULD LIKELY HARM OUR BUSINESS,
FINANCIAL CONDITION AND RESULTS OF OPERATIONS. AS A RESULT, THE TRADING PRICE OF
OUR COMMON STOCK COULD DECLINE, AND YOU COULD LOSE THE MONEY YOU PAID TO BUY OUR
COMMON STOCK.
RISKS RELATED TO OUR BUSINESS
OUR LACK OF LONG-TERM PURCHASE ORDERS OR COMMITMENTS MAY ADVERSELY AFFECT
OUR BUSINESS IF DEMAND IS REDUCED.
During the nine months ended September 30, 2004, the sale of electronic
components accounted for 58.2% of our total net sales, and the sale of
communications equipment and related services accounted for 41.8% of our total
net sales. In many cases we have long-term contracts with our electronic
components and communications equipment customers that cover the general terms
and conditions of our relationships with them but that do not include long-term
purchase orders or commitments. Rather, our customers issue purchase orders
requesting the quantities of communications equipment they desire to purchase
from us, and if we are able and willing to fill those orders, then we fill them
under the terms of the contracts. Accordingly, we cannot rely on long-term
purchase orders or commitments to protect us from the negative financial effects
of a reduced demand for our products that could result from a general economic
downturn, from changes in the electronic components and communications equipment
industries, including the entry of new competitors into the market, from the
introduction by others of new or improved technology, from an unanticipated
shift in the needs of our customers, or from other causes.
OUR BUSINESS COULD SUFFER IF WE ARE UNABLE TO OBTAIN COMPONENTS OF OUR
PRODUCTS FROM OUTSIDE SUPPLIERS.
The major components of our products include circuit boards,
microprocessors, chipsets and memory components. Most of these components are
available from multiple sources. However, we currently obtain some components
used in our products from single or limited sources. Some modem chipsets used in
our data communications equipment products have been in short supply and are
frequently on allocation by semiconductor manufacturers. We have, from time to
time, experienced difficulty in obtaining some components. We do not have
guaranteed supply arrangements with any of our suppliers, and there can be no
assurance that our suppliers will continue to meet our requirements. Further,
disruption in transportation services as a result of enhanced security measures
in response to terrorism threats or attacks may cause some increases in costs
and timing for both our receipt of components and shipment of products to our
customers. If our existing suppliers are unable to meet our requirements, we
could be required to alter product designs to use alternative components or, if
alterations are not feasible, we could be required to eliminate products from
our product line.
Shortages of components could not only limit our product line and
production capacity but also could result in higher costs due to the higher
costs of components in short supply or the need to use higher cost substitute
components. Significant increases in the prices of components could adversely
affect our results of operations because our products compete on price and,
therefore, we may not be able to adjust product pricing to reflect the increases
in component costs. Also, an extended interruption in the supply of components
or a reduction in their quality or reliability would adversely affect our
financial condition and results of operations by impairing our ability to timely
deliver quality products to our customers. Delays in deliveries due to shortages
of components or other factors may result in cancellation by our customers of
all or part of their orders. Although customers who purchase from us products,
such as many of our digital switches and all of our custom power supplies, that
are not readily available from other sources would be less likely than other
customers of ours to cancel their orders due to production delays, we cannot
assure you that cancellations would not occur.
6
WE RELY HEAVILY ON OUR MANAGEMENT, AND THE LOSS OF THEIR SERVICES COULD
ADVERSELY AFFECT OUR BUSINESS.
Our success is highly dependent upon the continued services of key
members of our management, including Carmine T. Oliva, our Chairman of the
Board, President and Chief Executive Officer, Graham Jefferies, our Executive
Vice President and Chief Operating Officer, and Randolph Foote, our Senior Vice
President, Chief Financial Officer and Secretary. Mr. Oliva co-founded XET
Corporation and has developed personal contacts and other skills that we rely
upon in connection with our financing, acquisition and general business
strategies. Mr. Jefferies is a long-time employee of Emrise who we have relied
upon in connection with our United Kingdom acquisitions and who fulfills
significant operational responsibilities in connection with our foreign and
domestic operations. We rely upon Mr. Foote's skills in financial reporting,
accounting and tax matters in addition to his skills in the analysis of
potential acquisitions and general corporate administration. Consequently, the
loss of Mr. Oliva, Mr. Jefferies, Mr. Foote or one or more other key members of
management could adversely affect us. Although we have entered into employment
agreements with each of our executive officers, those agreements are of limited
duration and are subject to early termination by the officers under some
circumstances. We maintain key-man life insurance on Mr. Oliva and Mr.
Jefferies. However, we cannot assure you that we will be able to maintain this
insurance in effect or that the coverage will be sufficient to compensate us for
the loss of the services of Mr. Oliva or Mr. Jefferies.
MANY OF OUR COMPETITORS HAVE GREATER RESOURCES THAN US. IN ORDER TO COMPETE
SUCCESSFULLY, WE MUST KEEP PACE WITH OUR COMPETITORS IN ANTICIPATING AND
RESPONDING TO THE RAPID CHANGES INVOLVING THE ELECTRONIC COMPONENTS AND
COMMUNICATIONS EQUIPMENT INDUSTRIES.
Our future success will depend upon our ability to enhance our current
products and services and to develop and introduce new products and services
that keep pace with technological developments, respond to the growth in the
electronic components and communications equipment markets in which we compete,
encompass evolving customer requirements, provide a broad range of products and
achieve market acceptance of our products. Many of our existing and potential
competitors have larger technical staffs, more established and larger marketing
and sales organizations and significantly greater financial resources than we
do. Our lack of resources relative to our competitors may cause us to fail to
anticipate or respond adequately to technological developments and customer
requirements or to experience significant delays in developing or introducing
new products and services. These failures or delays could reduce our
competitiveness, revenues, profit margins or market share.
IF WE ARE UNABLE TO SUCCESSFULLY IDENTIFY OR MAKE STRATEGIC ACQUISITIONS OR
ALLIANCES, OUR LONG-TERM COMPETITIVE POSITIONING MAY SUFFER.
Our business strategy includes growth through acquisitions, strategic
alliances and original equipment manufacturer resale agreements, among other
arrangements, that we believe will improve our competitive capabilities or
provide additional market penetration or business opportunities in areas that
are consistent with our business plan. Identifying and pursuing strategic
acquisition or other opportunities and integrating acquired products and
businesses requires a significant amount of management time and skill.
Acquisitions and alliances may also require us to expend a substantial amount of
cash or other resources, not only as a result of the direct expenses involved in
the acquisition transaction or the creation of the alliance, but also as a
result of ongoing research and development activities that may be required to
maintain or enhance the long-term competitiveness of acquired products,
particularly those products marketed to the rapidly evolving telecommunications
industry. If we are unable to make strategic acquisitions, alliances or other
arrangements due to our inability to identify appropriate targets, allies or
arrangements, or to manage the difficulties or costs involved in the
acquisitions, alliances or arrangements, our long-term competitive positioning
may suffer.
7
IF WE ARE UNABLE TO FULFILL BACKLOG ORDERS DUE TO CIRCUMSTANCES INVOLVING
US OR ONE OR MORE OF OUR SUPPLIERS OR CUSTOMERS, OUR ANTICIPATED RESULTS OF
OPERATIONS WILL SUFFER.
As of September 30, 2004, we had $7,307,000 in backlog orders for our
products. These orders were due in large part to the long lead-times associated
with our electronic components products. The amount of backlog orders represents
revenue that we anticipate recognizing in the future, as evidenced by purchase
orders and other purchase commitments received from customers, but on which work
has not yet been initiated or with respect to which work is currently in
progress. However, we cannot assure you that we will be successful in fulfilling
orders and commitments in a timely manner or that we will ultimately recognize
as revenue the amounts reflected as backlog.
FINANCIAL STATEMENTS OF OUR FOREIGN SUBSIDIARIES ARE PREPARED USING THE
RELEVANT FOREIGN CURRENCY THAT MUST BE CONVERTED INTO UNITED STATES DOLLARS
FOR INCLUSION IN OUR CONSOLIDATED FINANCIAL STATEMENTS. AS A RESULT,
EXCHANGE RATE FLUCTUATIONS MAY ADVERSELY AFFECT OUR REPORTED RESULTS OF
OPERATIONS.
We have established and acquired international subsidiaries that
prepare their balance sheets in the relevant foreign currency. In order to be
included in our consolidated financial statements, these balance sheets are
converted, at the then current exchange rate, into United States dollars, and
the statements of operations are converted using weighted average exchange rates
for the applicable period. Accordingly, fluctuations of the foreign currencies
relative to the United States dollar could affect our consolidated financial
statements. Our exposure to fluctuations in currency exchange rates has
increased as a result of the growth of our international subsidiaries. Sales of
our products and services to customers located outside of the United States
accounted for approximately 68.8% and 62.7% of our net sales for 2003 and for
the nine months ended September 30, 2004, respectively. However, because
historically the majority of our currency exposure has related to financial
statement translation rather than to particular transactions, we do not intend
to enter into, nor have we historically entered into, forward currency contracts
or hedging arrangements in an effort to mitigate our currency exposure.
IF OUR PRODUCTS FAIL TO COMPLY WITH EVOLVING GOVERNMENT AND INDUSTRY
STANDARDS AND REGULATIONS, WE MAY HAVE DIFFICULTY SELLING OUR PRODUCTS.
We design our products to comply with a significant number of industry
standards and regulations, some of which are evolving as new technologies are
deployed. In the United States, our communications equipment products must
comply with various regulations defined by the United States Federal
Communications Commission, or FCC, and Underwriters Laboratories as well as
industry standards established by Telcordia Technologies, Inc., formerly
Bellcore, and the American National Standards Institute. Internationally, our
communications equipment products must comply with standards established by the
European Committee for Electrotechnical Standardization, the European Committee
for Standardization, the European Telecommunications Standards Institute,
telecommunications authorities in various countries as well as with
recommendations of the International Telecommunications Union. The failure of
our products to comply, or delays in compliance, with the various existing and
evolving standards could negatively affect our ability to sell our products.
8
BECAUSE WE BELIEVE THAT PROPRIETARY RIGHTS ARE MATERIAL TO OUR SUCCESS,
MISAPPROPRIATION OF THESE RIGHTS COULD ADVERSELY AFFECT OUR FINANCIAL
CONDITION.
Our future success will be highly dependent on proprietary technology,
particularly in our communications equipment business. However, we do not hold
any patents and we currently rely on a combination of contractual rights,
copyrights, trademarks and trade secrets to protect our proprietary rights. Our
management believes that because of the rapid pace of technological change in
the industries in which we operate, the legal intellectual property protection
for our products is a less significant factor in our success than the knowledge,
abilities and experience of our employees, the frequency of our product
enhancements, the effectiveness of our marketing activities and the timeliness
and quality of our support services. Consequently, we rely to a great extent on
trade secret protection for much of our technology. However, there can be no
assurance that our means of protecting our proprietary rights will be adequate
or that our competitors or customers will not independently develop comparable
or superior technologies or obtain unauthorized access to our proprietary
technology. Our financial condition would be adversely affected if we were to
lose our competitive position due to our inability to adequately protect our
proprietary rights as our technology evolves.
RISKS RELATED TO THIS OFFERING
OUR COMMON STOCK PRICE HAS BEEN VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL
LOSSES FOR INVESTORS PURCHASING SHARES OF OUR COMMON STOCK AND IN
LITIGATION AGAINST US.
The market prices of securities of technology-based companies currently
are highly volatile. The market price of our common stock has fluctuated
significantly in the past. In fact, during 2004, the high and low closing sale
prices of a share of our common stock were $1.62 and $0.54, respectively. The
market price of our common stock may continue to fluctuate in response to the
following factors, many of which are beyond our control:
o changes in market valuations of similar companies and stock market
price and volume fluctuations generally;
o economic conditions specific to the electronic components or
communications equipment industries;
o announcements by us or our competitors of new or enhanced
products, technologies or services or significant contracts,
acquisitions, strategic relationships, joint ventures or capital
commitments;
o delays in our introduction of new products or technological
innovations or problems in the functioning of these new products
or innovations;
o third parties' infringement of our intellectual property rights;
o changes in our pricing policies or the pricing policies of our
competitors;
o foreign currency translations gains or losses; o regulatory
developments;
o fluctuations in our quarterly or annual operating results;
9
o additions or departures of key personnel; and
o future sales of our common stock or other securities.
The price at which you purchase shares of common stock may not be
indicative of the price of our stock that will prevail in the trading market.
You may be unable to sell your shares of common stock at or above your purchase
price, which may result in substantial losses to you. Moreover, in the past,
securities class action litigation has often been brought against a company
following periods of volatility in the market price of its securities. We may in
the future be the target of similar litigation. Securities litigation could
result in substantial costs and divert management's attention and resources.
THE UNPREDICTABILITY OF OUR QUARTERLY OPERATING RESULTS MAY CAUSE THE PRICE
OF OUR COMMON STOCK TO FLUCTUATE OR DECLINE.
Our quarterly operating results have varied significantly in the past
and will likely continue to do so in the future due to a variety of factors,
many of which are beyond our control. Fluctuations in our operating results may
result from a variety of factors.
For example, the general decline in telecommunications market activity
and other changes affecting the telecommunications industry, including
consolidations and restructuring of United States and foreign telephone
companies, cause our sales to decrease or increase. Our sales may increase if we
obtain new customers as a result of the consolidations or restructurings.
However, our sales may decrease, either temporarily or permanently to the extent
our customers are acquired by or combined with companies that are and choose to
remain customers of our competitors.
In addition, the cyclical nature of the telecommunications business due
to the budgetary cycle of Regional Bell Operating Companies, or RBOCs, has had
and will continue to have for the foreseeable future an effect on our quarterly
operating results. RBOCs generally obtain approval for their annual budgets
during the first quarter of each calendar year. If an RBOC's annual budget is
not approved early in the calendar year or is insufficient to cover its desired
purchases for the entire calendar year, we are unable to sell products to the
RBOC during the period of the delay or shortfall.
Quarter to quarter fluctuations may also result from the uneven pace of
technological innovation, the development of products responding to these
technological innovations by us and our competitors, our customers' acceptance
of these products and innovations, the varied degree of price, product and
technological competition and our customers' and competitors' responses to these
changes.
Due to these factors and other factors, including changes in general
economic conditions, we believe that period-to-period comparisons of our
operating results will not necessarily be meaningful in predicting future
performance. If our operating results do not meet the expectations of investors,
our stock price may fluctuate or decline.
10
FUTURE SALES OF SHARES OF OUR COMMON STOCK BY OUR STOCKHOLDERS COULD CAUSE
OUR STOCK PRICE TO DECLINE.
We cannot predict the effect, if any, that market sales of shares of
our common stock or the availability of shares of common stock for sale will
have on the market price prevailing from time to time. As of January 24, 2005,
we had outstanding 37,330,958 shares of common stock. An aggregate of 13,782,092
of these shares are included for resale under this prospectus. As of January 24,
2005, we also had outstanding options and warrants that were exercisable for
6,739,941 shares of common stock. Of these, 4,606,685 shares of common stock
underlying warrants are being included for resale under this prospectus. Sales
of shares of our common stock in the public market after this registration
statement is declared effective, or the perception that those sales may occur,
could cause the trading price of our common stock to decrease or to be lower
than it might be in the absence of those shares or perceptions.
BECAUSE WE ARE SUBJECT TO THE "PENNY STOCK" RULES, THE LEVEL OF TRADING
ACTIVITY IN OUR COMMON STOCK MAY BE REDUCED.
Broker-dealer practices in connection with transactions in "penny
stocks" are regulated by penny stock rules adopted by the Securities and
Exchange Commission. Penny stocks, like shares of our common stock, generally
are equity securities with a price of less than $5.00 per share that trade on
the OTC Bulletin Board or the Pink Sheets. The penny stock rules require a
broker-dealer, prior to a transaction in a penny stock not otherwise exempt from
the rules, to deliver a standardized risk disclosure document that provides
information about penny stocks and the nature and level of risks in the penny
stock market. The broker-dealer also must provide the customer with current bid
and offer quotations for the penny stock, the compensation of the broker-dealer
and its salesperson in the transaction, and, if the broker-dealer is the sole
market maker, the broker-dealer must disclose this fact and the broker-dealer's
presumed control over the market, and monthly account statements showing the
market value of each penny stock held in the customer's account. In addition,
broker-dealers who sell these securities to persons other than established
customers and "accredited investors" must make a special written determination
that the penny stock is a suitable investment for the purchaser and receive the
purchaser's written agreement to the transaction. These requirements may have
the effect of reducing the level of trading activity in a penny stock, such as
our common stock, and investors in our common stock may find it difficult to
sell their shares.
BECAUSE OUR COMMON STOCK IS NOT LISTED ON A NATIONAL SECURITIES EXCHANGE,
YOU MAY FIND IT DIFFICULT TO DISPOSE OF OR OBTAIN QUOTATIONS FOR OUR COMMON
STOCK.
Our common stock trades under the symbol "EMRI" on the OTC Bulletin
Board. Because our common stock trades on the OTC Bulletin Board rather than on
a national securities exchange, you may find it difficult to either dispose of,
or to obtain quotations as to the price of, our common stock.
11
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements, including
statements concerning future conditions in the electronic components and
communications equipment industries, and concerning our future business,
financial condition, operating strategies, and operational and legal risks. We
use words like "believe," "expect," "may," "will," "could," "seek," "estimate,"
"continue," "anticipate," "intend," "future," "plan" or variations of those
terms and other similar expressions, including their use in the negative, to
identify forward-looking statements. You should not place undue reliance on
these forward-looking statements, which speak only as to our expectations as of
the date of this prospectus. These forward-looking statements are subject to a
number of risks and uncertainties, including those identified under "Risk
Factors" and elsewhere in this prospectus. Although we believe that the
expectations reflected in these forward-looking statements are reasonable,
actual conditions in the electronic components and communications equipment
industries, and actual conditions and results in our business, could differ
materially from those expressed in these forward-looking statements. In
addition, none of the events anticipated in the forward-looking statements may
actually occur. Any of these different outcomes could cause the price of our
common stock to decline substantially. Except as required by law, we undertake
no duty to update any forward-looking statement after the date of this
prospectus, either to conform any statement to reflect actual results or to
reflect the occurrence of unanticipated events.
12
USE OF PROCEEDS
We will not receive any of the proceeds from the sale of shares of our
common stock in this offering. Rather, all proceeds will be received by selling
security holders.
DIVIDEND POLICY
We have not declared or paid any cash dividends on our capital stock in
the past, and we do not anticipate declaring or paying cash dividends on our
common stock in the foreseeable future. In addition, our credit facility with
Wells Fargo Bank, N.A., described in "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources," restricts the payment of dividends without the bank's consent.
We will pay dividends on our common stock only if and when declared by
our board of directors. The board of director's 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.
PRICE RANGE OF COMMON STOCK
Our common stock has been traded on the OTC Bulletin Board under the
symbol "EMRI" since September 15, 2004. Throughout 2003 and until September 14,
2004, our common stock traded on the OTC Bulletin Board under the symbol "MCTL."
The table below shows, for each fiscal quarter indicated, the high and low
closing bid prices for shares of our common stock. This information has been
obtained from the OTC Bulletin Board. The prices shown reflect inter-dealer
prices, without retail mark-up, mark-down or commission, and may not necessarily
represent actual transactions.
HIGH LOW
---- ---
YEAR ENDED DECEMBER 31, 2003
First Quarter........................................... $0.20 $0.15
Second Quarter.......................................... 0.37 0.20
Third Quarter........................................... 1.00 0.28
Fourth Quarter.......................................... 1.37 0.85
YEAR ENDED DECEMBER 31, 2004
First Quarter........................................... $1.18 $0.87
Second Quarter.......................................... 1.28 0.76
Third Quarter........................................... 0.82 0.52
Fourth Quarter.......................................... 1.68 0.60
YEAR ENDING DECEMBER 31, 2005
First Quarter (through January 27, 2005)................ $1.56 $1.46
As of January 24, 2005, we had 37,330,958 shares of common stock
outstanding held of record by approximately 2,900 stockholders. These holders of
record include depositories that hold shares of stock for brokerage firms which,
in turn, hold shares of stock for numerous beneficial owners. On January 24,
2005, the closing sale price of our common stock on the OTC Bulletin Board was
$1.52 per share.
13
CAPITALIZATION
The following table sets forth our capitalization as of September 30,
2004 and as adjusted to reflect the sale by us of 12,503,500 shares of common
stock on January 5, 2005 and the application of the net proceeds after deducting
placement agent fees and estimated offering expenses. The information in the
table below is qualified in its entirety by, and should be read in conjunction
with, our consolidated unaudited financial statements and related notes
beginning on page F-1 of this prospectus. The following table excludes the
following shares:
o 3,214,558 shares of common stock reserved for issuance under our
stock option plans, of which options to purchase 2,133,256 shares
are outstanding at a weighted average exercise price of $0.97 per
share; and
o 830,500 shares of common stock reserved for issuance under
outstanding warrants to purchase shares of common stock, at a
weighted average exercise price of $0.84 per share.
SEPTEMBER 30, 2004
---------------------------------
ACTUAL AS ADJUSTED
---------------- ---------------
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
------------- -------------
Cash and cash equivalents..................................... $ 379 $ 17,423
------------- -------------
Long-term debt, less current portion.......................... $ 3,325 $ 3,325
------------- -------------
Stockholders' equity:
Preferred Stock, $0.01 par value per share, 10,000,000
shares authorized; no shares issued and outstanding...... -- --
Common Stock, $0.0033 par value, 50,000,000 shares
authorized; 24,777,458 shares issued and outstanding,
actual; and 37,280,958 shares issued and outstanding,
as adjusted ............................................. 81 122
Additional paid-in capital................................. 26,700 43,703
Accumulated deficit........................................ (17,289) (17,289)
------------- -------------
Accumulated other comprehensive loss....................... 50 50
------------- -------------
Total stockholders' equity............................... 9,542 26,586
------------- -------------
Total capitalization................................... $12,867 $ 29,911
============== =============
14
SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA
The following financial data should be read in conjunction with the
consolidated financial statements and the notes to those statements beginning on
page F-1 of this prospectus, and the section entitled "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included
elsewhere in this prospectus. The consolidated statements of operations and
comprehensive income data for the years ended December 31, 2003 and 2002 and the
consolidated balance sheet data at December 31, 2003 and 2002 are derived from,
and are qualified in their entirety by reference to, the consolidated audited
financial statements included in this prospectus, which were audited by Grant
Thornton LLP. The consolidated statements of operations and comprehensive income
data for the year ended December 31, 2001 are derived from, and are qualified in
their entirety by reference to, the consolidated audited financial statements
included in this prospectus, which were audited by BDO Seidman, LLP. The
consolidated statements of operations and comprehensive income data with respect
to the years ended December 31, 2000 and 1999 and the consolidated balance sheet
data at December 31, 2000 and 1999 are derived from, and are qualified in their
entirety by reference to, our audited financial statements not included in this
prospectus. The consolidated statements of operations data and comprehensive
income data for the nine months ended September 30, 2004 and 2003 and the
consolidated balance sheet data at September 30, 2004 and 2003 are derived from,
and are qualified in their entirety by reference to, our unaudited consolidated
financial statements included in this prospectus. The historical results that
appear below are not necessarily indicative of results to be expected for any
future periods.
NINE MONTHS ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
CONSOLIDATED STATEMENTS OF OPERATIONS AND -------------------- -----------------------------------------------------
COMPREHENSIVE INCOME DATA: 2004 2003 2003 2002 2001 2000 1999
--------- --------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Net sales........................................ $ 20,093 $ 18,922 $ 25,519 $ 22,664 $ 27,423 $ 28,050 $ 25,913
Cost of sales ................................... 11,217 11,237 14,835 14,147 15,456 15,529 17,066
--------- --------- --------- --------- --------- --------- ---------
Gross profit .................................... 8,876 7,685 10,684 8,517 11,967 12,521 8,847
Selling, general and administrative expenses .... 6,749 5,532 7,812 7,731 10,129 9,827 10,584
Engineering and product development expenses .... 1,033 697 951 1,015 1,076 1,167 1,841
--------- --------- --------- --------- --------- --------- ---------
Income (loss) from operations ................... 1,094 1,456 1,921 (229) 762 1,527 (3,578)
Total other income (expense) .................... (369) (313) (474) (361) (414) 207 (492)
--------- --------- --------- --------- --------- --------- ---------
Income (loss) from continuing operations
before income taxes ........................... 725 1,143 1,447 (590) 348 1,734 (4,070)
Income tax (benefit) expense .................... 128 236 286 (20) 77 31 128
--------- --------- --------- --------- --------- --------- ---------
Income (loss) from continuing operations ........ 597 907 1,161 (570) 271 1,703 (4,198)
Discontinued operations:
Loss from operations of discontinued
segment ...................................... -- -- -- -- 56 (212) (847)
Gain (loss) on disposal of discontinued
segment including provision for phase
out period of $122 in 2000 ................... -- -- -- -- -- (487) 449
--------- --------- --------- --------- --------- --------- ---------
Net income (loss) ............................... 597 907 1,161 (570) 327 1,004 (4,596)
Foreign currency translation adjustment ......... (58) 361 705 446 (312) (505) (325)
--------- --------- --------- --------- --------- --------- ---------
Total comprehensive income (loss) ............... $ 539 $ 1,268 $ 1,866 $ (124) $ 15 $ 499 $ (4,921)
========= ========= ========= ========= ========= ========= =========
Basic earnings (loss) per share from
continuing operations ......................... $ 0.03 $ 0.04 $ 0.05 $ (0.03) $ 0.01 $ 0.09 $ (0.26)
========= ========= ========= ========= ========= ========= =========
Diluted earnings (loss) per share from
continuing operations ......................... $ 0.02 $ 0.04 $ 0.05 $ (0.03) 0.01 $ 0.07 (0.26)
========= ========= ========= ========= ========= ========= =========
Basic earnings (loss) per share from
discontinued operations ....................... $ -- $ -- $ -- $ -- $ -- $ (0.04) $ (0.02)
========= ========= ========= ========= ========= ========= =========
Diluted earnings (loss) per share from
discontinued operations ....................... $ -- $ -- $ -- $ -- $ -- $ (0.03) $ (0.02)
========= ========= ========= ========= ========= ========= =========
Basic earnings (loss) per share ................. $ 0.03 $ 0.04 $ 0.05 $ (0.03) $ 0.02 $ 0.05 $ (0.28)
========= ========= ========= ========= ========= ========= =========
Diluted earnings (loss) per share ............... $ 0.02 $ 0.04 $ 0.05 $ (0.03) $ 0.01 $ 0.04 $ (0.28)
========= ========= ========= ========= ========= ========= =========
Weighted average shares outstanding, basic ...... 23,833 22,280 22,567 21,208 20,594 19,504 16,638
Weighted average shares outstanding, diluted .... 24,599 23,604 23,811 21,208 23,782 23,027 16,638
15
AT DECEMBER 31,
AT SEPTEMBER 30, ------------------------------------------------
CONSOLIDATED BALANCE SHEET DATA: 2004 2003 2002 2001 2000 1999
-------- -------- -------- -------- -------- --------
(IN THOUSANDS)
Cash and cash equivalents ................. $ 379 $ 1,174 $ 254 $ 604 $ 756 $ 480
Working capital ........................... 4,599 5,696 3,961 3,686 2,780 1,080
Total assets .............................. 22,072 17,169 16,786 17,688 19,484 16,489
Long-term debt, net of current portion .... 2,435 819 927 763 282 143
Stockholders' equity ...................... 9,542 7,916 5,732 5,862 5,807 3,801
Convertible redeemable preferred stock .... -- -- 282 270 259 588
No cash dividends on our common stock were declared during any of the
periods presented above. In October 2000, we decided to discontinue our circuits
segment's operations. Accordingly, all current and prior financial information
related to the circuits segment operations have been presented as discontinued
operations in historical financial data above.
16
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH OUR
CONSOLIDATED AUDITED FINANCIAL STATEMENTS AND THE RELATED NOTES AND THE OTHER
FINANCIAL INFORMATION INCLUDED ELSEWHERE IN THIS PROSPECTUS. THIS DISCUSSION
CONTAINS FORWARD-LOOKING STATEMENTS REGARDING THE ELECTRONIC COMPONENTS AND
COMMUNICATIONS EQUIPMENT INDUSTRIES AND OUR EXPECTATIONS REGARDING OUR FUTURE
PERFORMANCE, LIQUIDITY AND CAPITAL RESOURCES. OUR ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE EXPRESSED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT
OF ANY NUMBER OF FACTORS, INCLUDING THOSE SET FORTH UNDER "RISK FACTORS" AND
UNDER OTHER CAPTIONS CONTAINED ELSEWHERE IN THIS PROSPECTUS.
OVERVIEW
Through our three wholly-owned operating subsidiaries, XET Corporation,
CXR Larus (formerly, CXR Telcom Corporation) and CXR-AJ, and through the
divisions and subsidiaries of those subsidiaries, we design, develop,
manufacture, assemble, and market products and services in the following two
material business segments:
o Electronic Components
-- digital and rotary switches
-- electronic power supplies
-- subsystem assemblies
o Communications Equipment
-- network access and transmission products
-- communication timing and synchronization products
-- communications test instruments
Our sales are primarily in North America, Europe and Asia. Revenues are
recorded when products are shipped if shipped FOB shipping point or when
received by the customer if shipped FOB destination.
Sales to customers in the electronic components segment, primarily to
aerospace customers, defense contractors and industrial customers, were 63.4%,
59.1% and 46.1% of our total net sales during 2003, 2002 and 2001, respectively,
and 58.2% of our total net sales during the nine months ended September 30,
2004. Sales of communications equipment and related services, primarily to
private customer premises and public carrier customers, were 36.6%, 40.9% and
53.9% of our total net sales during 2003, 2002 and 2001, respectively, and 41.8%
of our total net sales during the nine months ended September 30, 2004.
During the nine months ended September 30, 2004, we achieved a 25.8%
sales increase in our communications equipment segment as compared to the nine
months ended September 30, 2003. Excluding sales of $1,468,000 from Larus
Corporation, which we acquired in July 2004, our communications equipment sales
increased 3.8% in the nine months ended September 30, 2004 as compared to the
prior year period. Sales of our electronic components segment during the nine
months ended September 30, 2004 decreased 4.5% as compared to the comparable
prior year period. As discussed below, our improved sales, cost reductions and
Asian outsourcing have reduced the breakeven point in our communications
equipment segment, which enabled us to produce an improved operating profit in
this segment despite the historically low sales volume that reflects a
three-year downturn in the telecommunications market.
17
In 2003, our communications equipment segment sales increased slightly
from the historically low level experienced in 2002. As a result of the
telecommunications business downturn in 2001 and 2002, we experienced
significant reductions in sales and gross profit as well as changes in our
product mix. Consequently, during 2003 we shifted our overall focus toward
growing our electronic components business. However, we also continued working
to improve the growth and performance of our communications equipment business,
particularly customer premises network access and transmission products. These
efforts continued during 2004 and included our recent acquisition of Larus
Corporation as discussed below. We expect this acquisition to enhance our
performance based upon synergies anticipated to occur through the merger of
Larus Corporation with and into CXR Telcom Corporation and the change in the
name of CXR Telcom Corporation to CXR Larus Corporation, all of which occurred
in December 2004.
In addition to shifting our overall focus toward growing our electronic
components business, during the first half of 2003 we reduced costs at CXR Larus
by reducing its work force and increasing our sourcing of test equipment
components from Asian manufacturers that produce components for lower prices
than we previously paid to our former suppliers. We also reduced costs elsewhere
in our communications equipment segment and lowered the breakeven point both in
our United States and France operations through various cost-cutting methods,
such as using Asian contract manufacturers, reducing facility rent expense and
downsizing our administrative office in Paris, France. These cost-cutting
efforts were a major factor in restoring our communications equipment segment to
profitability in 2003 and the first nine months of 2004. However, we cannot
predict if the recent improvement in telecom sales we are experiencing indicates
the end of the severe telecommunications market downturn or the extent to which
the downturn may continue to negatively affect our ability to sell our products
and services to customers in the telecommunications industry.
In July 2004, we acquired Larus Corporation. Larus Corporation was a
San Jose, California-based manufacturer and seller of telecommunications
products that has one wholly-owned subsidiary, Vista Labs, Incorporated, or
Vista, which provided engineering services to Larus Corporation. The basic
purchase terms of the acquisition are described below. We consolidated the
results of operations of Larus Corporation beginning from the date of
acquisition, July 13, 2004. Based on current sales projections, we anticipate
that the acquisition of Larus Corporation will be accretive to our earnings per
share despite the associated expenses relating both to the payment of the
purchase price and the operation and integration of Larus Corporation's
business. We expect increased sales of our French subsidiary's products in the
United States market as a result of sales and marketing support for the French
products by CXR Larus' United States-based sales and marketing staff. We have
consolidated our CXR Larus subsidiary's operations into Larus Corporation's
facility, which we anticipate will result in significant administrative and
facilities cost savings.
We acquired all of the assets and liabilities of Larus Corporation,
including the intellectual property, cash, accounts receivable and inventories
owned by each of Larus Corporation and Vista. The purchase price for the
acquisition consisted of $1,000,000 in cash, the issuance of 1,213,592 shares of
our common stock, $887,500 in the form of two short-term, zero interest
promissory notes that have since been repaid, $3,000,000 in the form of two
subordinated secured promissory notes, and warrants to purchase up to an
aggregate of 150,000 shares of our stock at $1.30 per share. In addition, we
assumed $245,000 in accounts payable and accrued expenses and entered into an
above-market real property lease with the sellers. This lease represents an
obligation that exceeds the fair market value by approximately $756,000 and is
part of the acquisition purchase price. The cash portion of the acquisition
purchase price was funded with proceeds from our credit facility with Wells
Fargo Bank, N.A. and cash on-hand.
18
The following table summarizes the unaudited assets acquired and
liabilities assumed in connection with this acquisition:
Amount in
Thousands
---------
Current assets....................................... $ 2,488
Property, plant and equipment........................ 90
Goodwill............................................. 5,535
---------
Total assets acquired................................ 8,113
Current liabilities.................................. (685)
Other liabilities.................................... (132)
---------
Total liabilities assumed............................ (817)
---------
Net assets acquired.................................. $ 7,296
=========
The following table summarizes, on an unaudited pro forma basis, the
combined results of operations of Emrise and Larus Corporation, as though the
acquisition occurred as of January 1, 2003. The pro forma amounts give effect to
appropriate adjustments for interest expense and income taxes. The pro forma
amounts presented are not necessarily indicative of future operating results (in
thousands, except per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- -----------------------
2004 2003 2004 2003
--------- --------- ---------- ----------
Revenues $ 7,469 $ 7,893 $ 22,718 $ 23,234
Net income 158 761 869 1,639
Earnings per share of common stock:
Basic $ 0.01 $ 0.03 $ 0.04 $ 0.07
========= ========= ========== ==========
Diluted $ 0.01 $ 0.03 $ 0.04 $ 0.07
========= ========= ========== ==========
CRITICAL ACCOUNTING POLICIES
We believe our most critical accounting policies include inventory
valuation, foreign currency translation and goodwill impairment.
INVENTORY VALUATION
We value our inventory at the lower of the actual cost to purchase or
manufacture the inventory or the current estimated market value of the
inventory. 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. Demand for our products can fluctuate significantly. A significant
increase in the demand for our products could result in a short-term increase in
the cost of inventory purchases, while a significant decrease in demand could
result in an increase in the amount of excess inventory quantities on hand.
19
In addition, the communications equipment industry is characterized by
rapid technological change, frequent new product development, and rapid product
obsolescence that could result in an increase in the amount of obsolete
inventory quantities on hand. Also, our estimates of future product demand may
prove to be inaccurate, in which case we may have understated or overstated the
provision required for excess and obsolete inventory. In the future, if our
inventory is determined to be overvalued, we would be required to recognize such
costs in our cost of goods sold at the time of such determination. Likewise, if
our inventory is determined to be undervalued, we may have over-reported our
costs of goods sold in previous periods and would be required to recognize
additional operating income at the time of sale. Therefore, 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 effect on the value of our inventory and our reported
operating results.
FOREIGN CURRENCY TRANSLATION
We have foreign subsidiaries that together accounted for 68.8% of our
net sales, 70.6% of our assets and 70.3% of our total liabilities as of and for
the year ended December 31, 2003, and 62.7% of our net sales, 46.9% of our
assets and 29.7% of our total liabilities as of and for the nine months ended
September 30, 2004. In preparing our consolidated financial statements, we are
required to translate the financial statements of our foreign subsidiaries from
the currencies in which they keep their accounting records into United States
dollars. This process results in exchange gains and losses which, under relevant
accounting guidance, are either included within our statement of operations or
as a separate part of our net equity under the caption "cumulative translation
adjustment."
Under relevant accounting guidance, the treatment of these translation
gains or losses depends upon our management's determination of the functional
currency of each subsidiary. This determination involves consideration of
relevant economic facts and circumstances affecting the subsidiary. Generally,
the currency in which the subsidiary transacts a majority of its transactions,
including billings, financing, payroll and other expenditures, would be
considered the functional currency. However, management must also consider any
dependency of the subsidiary upon the parent and the nature of the subsidiary's
operations.
If management deems any subsidiary's functional currency to be its
local currency, then any gain or loss associated with the translation of that
subsidiary's financial statements is included in a cumulative translation
adjustment. However, if management deems the functional currency to be United
States dollars, then any gain or loss associated with the translation of these
financial statements would be included within our statement of operations.
If we dispose of any of our subsidiaries, any cumulative translation
gains or losses would be realized into our statement of operations. If we
determine that there has been a change in the functional currency of a
subsidiary to United States dollars, then any translation gains or losses
arising after the date of the change would be included within our statement of
operations.
Based on our assessment of the factors discussed above, we consider the
functional currency of each of our international subsidiaries to be each
subsidiary's local currency. Accordingly, we had cumulative translation gains of
$108,000 and $50,000 that were included as part of accumulated other
comprehensive income within our balance sheets at December 31, 2003 and
September 30, 2004, respectively. During the year ended December 31, 2003 and
the nine months ended September 30, 2004, we included foreign currency
translation adjustments of a gain of approximately $705,000 and a loss of
$58,000, respectively, under other comprehensive income or loss.
If we had determined that the functional currency of our subsidiaries
was United States dollars, these gains or losses would have decreased or
increased our loss for these periods. The magnitude of these gains or losses
depends upon movements in the exchange rates of the foreign currencies in which
we transact business as compared to the value of the United States dollar. These
currencies include the euro, the British pound and the Japanese yen. Any future
translation gains or losses could be significantly higher or lower than those we
recorded for these periods.
20
GOODWILL IMPAIRMENT
We periodically evaluate acquired businesses for potential impairment
indicators. Our judgments regarding the existence of impairment indicators are
based on legal factors, market conditions and operational performance of our
acquired businesses.
In assessing potential impairment of goodwill, we consider these
factors as well as forecasted financial performance of the acquired businesses.
If forecasts are not met, we may have to record additional impairment charges
not previously recognized. In assessing the recoverability of our goodwill and
other intangibles, we must make assumptions regarding estimated future cash
flows and other factors to determine the fair value of those respective assets.
If these estimates or their related assumptions change in the future, we may be
required to record impairment charges for these assets that were not previously
recorded. If that were the case, we would have to record an expense in order to
reduce the carrying value of our goodwill. On January 1, 2002, we adopted
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets," or SFAS No. 142, and were required to analyze our goodwill
for impairment issues by June 30, 2002, and then at least annually after that
date. At December 31, 2003, the reported goodwill totaled $2,447,000 (net of
accumulated amortization of $1,070,000). During 2003 and the nine months ended
September 30, 2004, we did not record any impairment losses related to goodwill
and other intangible assets.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2004 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 2003
The following table sets forth, for the periods indicated, certain
statement of operations data expressed as a percentage of total net sales:
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------
2004 2003
--------- ---------
Net sales............................................ 100.0% 100.0%
Cost of sales........................................ 55.8 59.4
--------- ---------
Gross profit......................................... 44.2 40.6
Selling, general and administrative expenses......... 33.7 29.2
Engineering and product development expenses......... 5.1 3.7
--------- ---------
Operating income..................................... 5.4 7.7
Interest expense..................................... (1.5) (1.7)
Other income......................................... (0.3) --
--------- ---------
Income before income tax expense..................... 3.6 6.0
Income tax expense................................... 0.6 1.2
--------- ---------
Net income .......................................... 3.0% 4.8%
========= =========
NET SALES. Net sales for the nine months ended September 30, 2004
increased by $1,171,000 (6.2%) to $20,093,000 as compared to $18,922,000 for the
nine months ended September 30, 2003.
21
Net sales of our electronic components decreased by $548,000 (4.5%) to
$11,703,000 as compared to $12,251,000 for the nine months ended September 30,
2003. Net sales of power supplies and related electronic subsystem assemblies by
XCEL Power Systems, Ltd., or XPS, decreased by $1,384,000 (19.4%) to $5,753,000
as compared to $7,137,000 for the nine months ended September 30, 2003 due to
delayed required delivery schedules. Net sales of switches manufactured by XET
Corporation's Digitran Division increased by $361,000 (8.6%) to $4,541,000 as
compared to $4,180,000 for the nine months ended September 30, 2003. The
increase in net sales of digital switches was a result of increased orders from
our customers for military equipment spare parts that we believe were partially
due to the war in Iraq. Sales of electronic subsystem assemblies manufactured by
the Digitran Division were $122,000 for the nine months ended September 30, 2004
as compared to $266,000 in the prior year period.
Net sales of our communications equipment products and services for the
nine months ended September 30, 2004 increased by $1,719,000 (25.8%) to
$8,390,000 as compared to $6,671,000 for the nine months ended September 30,
2003. The increase was primarily due to the inclusion of sales by Larus
Corporation totaling $1,468,000. Net sales of test equipment increased by
$184,000 (11.7%) to $1,755,000 as compared to $1,571,000 for the nine months
ended September 30, 2003 primarily due to increased market penetration into the
central region of the United States and $115,000 of sales related to a new
contract for test equipment for an agency of the Department of Homeland
Security.
Sales by Larus Corporation of communication timing and synchronization
products were $510,000 for the nine months ended September 30, 2004. This
product line is new to us, having acquired it with the purchase of Larus
Corporation, hence we had no communication timing and synchronization product
sales in the prior year period.
Net sales of network access equipment and transmission products
increased by $1,058,000 (23.8%) to $5,511,000 as compared to $4,453,000 for the
prior year period primarily due to $956,000 in sales by Larus Corporation.
GROSS PROFIT. Gross profit as a percentage of total net sales increased
to 44.2% for the nine months ended September 30, 2004 as compared to 40.6% for
the comparable period in 2003. In dollar terms, total gross profit increased by
$1,191,000 (15.5%) to $8,876,000 for the nine months ended September 30, 2004 as
compared to $7,685,000 for the nine months ended September 30, 2003.
Gross profit for our electronic components segment increased slightly
in dollar terms by $31,000 (0.6%) to $4,894,000 for the nine months ended
September 30, 2004 as compared to $4,863,000 for the nine months ended September
30, 2003, and increased as a percentage of related net sales to 41.8% for the
nine months ended September 30, 2004 from 39.7% for the nine months ended
September 30, 2003. This increase primarily resulted from increased profit
margins of switches at XET Corporation's Digitran Division due to changes in
product mix to a greater proportion of high margin military spare parts that
resulted in a gross profit of $2,606,000 as compared to $2,313,000 in the prior
year period. The gross profit for XPS, producer of power supplies, decreased to
$1,865,000 from $2,117,000 in the prior year period primarily due to lower
shipments.
Gross profit for our communications equipment segment increased in
dollar terms by $1,159,000 (41.1%) to $3,982,000 for the nine months ended
September 30, 2004 as compared to $2,823,000 for the nine months ended September
30, 2003, and increased as a percentage of net sales to 47.5% for the nine
months ended September 30, 2004 from 42.3% for the nine months ended September
30, 2003. The increase in gross profit was due to the inclusion of Larus
Corporation's gross profit of $873,000 from July 13, 2004, and the reduction in
costs at CXR Larus for test equipment primarily due to Asian outsourcing. The
gross margin for test instruments increased significantly to 65.4% for the nine
months ended September 30, 2004 from 40.3% for the prior year period and to
$1,260,000 for the nine months ended September 30, 2004 as compared to $748,000
for the prior year period. CXR-AJ's gross profit, which is mainly generated by
sales of network access equipment, increased to $2,127,000 for the nine months
ended September 30, 2004 from $2,075,000 for the prior year period primarily due
to increased sales volumes of network access products, and CXR-AJ's gross margin
declined slightly to 42.6% for the nine months ended September 30, 2004 from
43.1% for the prior year period due to a larger proportion of resale products in
the sales base as compared to the proportion of our in-house manufactured
products in the sales base.
22
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by $1,217,000 (22.0%) to $6,749,000 for the
nine months ended September 30, 2004 as compared to $5,532,000 for the nine
months ended September 30, 2003. Selling, general and administrative expenses
also increased as a percentage of total net sales, to 33.7% of net sales during
the nine months ended September 30, 2004 from 29.2% of net sales during the
comparable period in 2003. The increase in selling, general and administrative
expenses was due to several factors discussed below.
Sales expenses increased by $667,000 (36.4%) to $2,497,000 for the nine
months ended September 30, 2004 as compared to $1,830,000 for the prior year
period due to the addition of sales managers at XET Corporation's Digitran
Division and XPS, and increased marketing expenses for our new very low profile
rotary and digital switches, test instruments and network access products,
attendance at tradeshows, increased advertising and the development of English
language literature for our products produced in France. Administrative expenses
increased by $550,000 (14.9%) to $4,252,000 for the nine months ended September
30, 2004 as compared to $3,702,000 for the nine months ended September 30, 2003
due to increases in legal, accounting and investor relations expenses and
investment banking fees that primarily related to searching for and analyzing
potential acquisitions.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES. Engineering and product
development expenses consist primarily of product development activities. These
expenses increased by $336,000 (48.2%) to $1,033,000 for the nine months ended
September 30, 2004 as compared to $697,000 for the prior year period. The
majority of the increase was due to the inclusion of $110,000 of expenses
incurred by Larus Corporation, and additional engineering and patent expenses
for our new patent-pending low profile rotary and digital switch products,
including the hiring of two engineers.
OTHER INCOME AND EXPENSE. Interest expense decreased to $305,000 for
the nine months ended September 30, 2004 as compared to $317,000 for the nine
months ended September 30, 2003 due to lower loan balances. Other expense was
$64,000 for the nine months ended September 30, 2004 as compared to other income
of $4,000 for the nine months ended September 30, 2003.
INCOME TAX EXPENSE. Income tax expense for the nine months ended
September 30, 2004 was $128,000 as compared to $236,000 for the comparable prior
year period. The majority of the tax relates to United Kingdom income tax. The
reduction was primarily due to a reduced United Kingdom income tax payable
related to an increase in available loss carryforwards.
NET INCOME. The net income for the nine months ended September 30, 2004
decreased by $310,000 (34.2%) to $597,000 as compared to the net income of
$907,000 for the nine months ended September 30, 2003. This reduction was
generally due to an increase in product development, selling and administrative
expenses that reduced the effect of our greatly improved gross profit and gross
profit margins.
23
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
The following table sets forth, for the periods indicated, selected
statements of operations data expressed as a percentage of total net sales.
YEARS ENDED DECEMBER 31,
------------------------
2003 2002
-------- --------
Net sales........................................... 100.0% 100.0%
Cost of sales....................................... 58.1 62.4
-------- --------
Gross profit........................................ 41.9 37.6
Selling, general and administrative expenses........ 30.6 34.1
Engineering and product development expenses........ 3.8 4.5
-------- --------
Operating income (loss)............................. 7.5 (1.0)
Interest expense.................................... (1.6) (1.9)
Other income (expense).............................. (0.2) 0.3
-------- --------
Income (loss) before income taxes................... 5.7 (2.6)
Income tax expense (benefit)........................ 1.2 (0.1)
-------- --------
Net income (loss)................................... 4.5% (2.5)%
======== ========
NET SALES. Net sales for 2003 increased by $2,855,000 (12.6%) to
$25,519,000 as compared to $22,664,000 for 2002.
Net sales of our electronic components for 2003 increased by $2,778,000
(20.7%) to $16,168,000 as compared to $13,390,000 for 2002. Net sales of power
supplies by XPS for 2003 increased by $1,665,000 (23.5%) to $8,763,000 as
compared to $7,098,000 for 2002 due to an increase in the number of products
shipped under long-term programs. XPS also shipped $1,226,000 of electronic
subassemblies in 2003 as compared to $50,000 in 2002. However, we anticipate
that sales of power supplies in 2004 will decline from 2003 levels based on
expected timing of shipments. Sales of digital switches manufactured by XET
Corporation's Digitran Division for 2003 increased by $563,000 (11.9%) to
$5,307,000 as compared to $4,744,000 for 2002. The increase in sales of digital
switches was primarily a result of an increase in orders for spare parts that we
believe was mainly due to increased military activities. Sales of electronic
subsystem assemblies were $1,226,000 in 2003 as compared to $1,125,000 in 2002
due to an increased volume of subsystem assemblies sold by XPS, which was offset
by a reduction in subsystem assembly sales by XET's Digitran Division due to the
completion of a major contract in 2002.
Net sales of our communications equipment products and services for
2003 increased slightly by $77,000 (0.8%) to $9,351,000 as compared to
$9,274,000 for 2002. We improved sales of network access and transmission
equipment products by $740,000, which improvement was partially offset by a
$583,000 decline in sales of test equipment by CXR Larus and CXR-AJ. Network
access and transmission equipment net sales for 2003 increased by $740,000
(13.7%) to $6,139,000 as compared to $5,399,000 for 2002. Test equipment net
sales for 2003 decreased by $528,000 (18.3%) to $2,353,000 as compared to
$2,881,000 for 2002. The sales decrease resulted from a reduction in orders from
telecommunication customers in the United States, which we believe was primarily
due to the weak telecom market and the continuing effect of CXR-AJ's
discontinuation of test equipment resales.
CXR-AJ produces all of our transmission products and network access
equipment. Total net sales by CXR-AJ, including both test equipment and
networking and transmission equipment, increased by $771,000 (13.2%) to
$6,626,000 as compared to $5,855,000 for 2002. This sales increase was achieved
even though we terminated our resale of test equipment business in Europe,
except for residual obligations, at the end of 2002.
24
Net sales of our CXR HALCYON 704 series field test equipment increased
slightly by $37,000 (1.9%) to $1,994,000 as compared to $1,957,000 for 2002. We
have aggressively marketed to non-telecommunication customers, such as
government agencies, electric utilities and transportation agencies and this has
resulted in improved sales of our CXR HALCYON products to non-telecommunications
customers. Nevertheless, CXR Larus' major customers are the large U.S.
telecommunication companies, and their capital budget expenditures for CXR
HALCYON equipment are still low in terms of our historical experience.
GROSS PROFIT. Gross profit as a percentage of total net sales increased
to 41.9% for 2003 as compared to 37.6% for 2002. In dollar terms, total gross
profit increased by $2,167,000 (25.4%) to $10,683,000 as compared to $8,517,000
for 2002.
Gross profit for our electronic components segment increased in dollar
terms by $1,434,000 (27.6%) to $6,637,000 as compared to $5,203,000 for 2002,
and increased as a percentage of related net sales to 41.1% for 2003 from 38.9%
for 2002. This increase primarily was the result of increases in the profit
margins of both digital switches and power supplies due to changes in product
mix for both switch and XPS's power supply products. Also, increased volume
helped increase gross margins of power supplies by reducing per unit costs.
Gross profit for our communications equipment segment increased in
dollar terms by $733,000 (22.1%) to $4,046,000 as compared to $3,313,000 for
2002, and increased as a percentage of net sales to 43.3% for 2003 from 35.7%
for 2002. The increase in gross profit as a percentage of net sales primarily
was due to reduced costs. CXR Larus and CXR-AJ increased their gross margins as
a percent of sales to 45.0% and 42.6% from 34.1% and 36.7%, respectively, due to
cost reductions and higher sales at CXR-AJ.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses for 2003 increased slightly by $81,000 (1.0%) to
$7,812,000 as compared to $7,731,000 for 2002. Selling, general and
administrative expenses decreased as a percentage of total net sales, to 30.6%
of net sales during 2003 from 34.1% of net sales during 2002. Selling expenses
remained static in 2003 as compared to 2002. General and administrative expenses
increased modestly by $77,000 or 1.5%.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES. Engineering and product
development expenses consist primarily of research and product development
activities of our communications equipment segment and XET Corporation's
Digitran Division. These expenses decreased by $64,000 (6.3%) to $951,000 as
compared to $1,015,000 for 2002, primarily because of cost reductions in the
communications equipment segment.
OTHER INCOME (EXPENSE). Interest expense decreased by $25,000 (5.7%) to
$416,000 for 2003 as compared to $441,000 for 2002 generally due to lower
average debt balances at XPS and CXR-AJ. Other expense was $58,000 for 2003 as
compared to other income of $80,000 for 2002 primarily due to foreign currency
losses.
INCOME TAX EXPENSE (BENEFIT). Income tax expense for 2003 was $286,000
as compared to an income tax benefit of $20,000 for 2002. The majority of the
increase related to the recording by XPS of a provision for U.K. income tax that
was required because XPS produced greater taxable income for 2003 than in 2002
and has consumed its net operating loss carryforwards.
25
NET INCOME (LOSS). The net income for 2003 was $1,161,000 as compared
to the net loss of $570,000 for 2002, an improvement of $1,731,000. The largest
contributions to this positive change were the $1,099,000 and $856,000 increases
in operating income of XPS and CXR-AJ, respectively, due to increased sales of
XPS and increased sales and reduced costs at CXR-AJ. In addition, CXR Larus
improved its operating income by $486,000 by reducing costs. We continue to
closely monitor costs throughout our operations and have reduced costs through
staffing reductions in our communications equipment operations in the United
States and France and through various other cost-cutting methods, such as using
contract manufacturers and reducing facility rent expense. These actions
substantially reduced the sales volume required to produce profitability at both
CXR Larus and CXR-AJ.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
The following table sets forth, for the periods indicated, selected
statements of operations data expressed as a percentage of total net sales.
YEARS ENDED DECEMBER 31,
------------------------
2002 2001
---------- ----------
Net sales............................................. 100.0% 100.0%
Cost of sales......................................... 62.4 56.4
---------- ----------
Gross profit.......................................... 37.6 43.6
Selling, general and administrative expenses.......... 34.1 36.9
Engineering and product development expenses.......... 4.5 3.9
---------- ----------
Operating income (loss)............................... (1.0) 2.8
Interest expense...................................... (1.9) (1.4)
Other income (expense)................................ 0.3 (0.1)
---------- ----------
Income (loss) from continuing operations before
income taxes........................................ (2.6) 1.3
Income tax expense (benefit).......................... (0.1) 0.3
---------- ----------
Income (loss) from continuing operations.............. (2.5) 1.0
Income (loss) from discontinued operations............ -- 0.2
---------- ----------
Net income (loss)..................................... (2.5)% 1.2%
========== ==========
CONTINUING OPERATIONS
NET SALES. Net sales for 2002 decreased by $4,759,000 (17.4%) to
$22,664,000 as compared to $27,423,000 for 2001.
Net sales of our electronic components increased by $744,000 (5.9%) to
$13,390,000 for 2002 as compared to $12,646,000 for 2001. Sales of power
supplies by XPS increased by $1,616,000 (29.5%) to $7,098,000 for 2002 as
compared to $5,482,000 for 2001 due to an increase in the number of products
shipped under long-term programs. Sales of digital switches manufactured by XET
Corporation's Digitran Division declined by $1,593,000 (25.1%) to $4,744,000
for 2002 as compared to $5,405,000 for 2001. The decline in sales of digital
switches was a result of lower than expected orders, which we believe was
primarily due to a deferral of government orders. XET Corporation increased
its sales of subassemblies by $892,000 (383%) to $1,125,000 for 2002 as compared
to $233,000 for 2001 due to new contracts for electronic subsystems from a major
aerospace company. These contracts were executed beginning in January 2002, and
the final shipments under these contracts were in November 2002.
26
Net sales of our communications equipment products and services for
2002 declined by $5,503,000 (37.2%) to $9,274,000 as compared to $14,777,000 for
2001. Test equipment net sales for 2002 declined by $4,439,000 (60.6%) to
$2,881,000 as compared to $7,320,000 for 2001. The sales decline resulted from a
$2,546,000 reduction in sales of test equipment by CXR Larus and a $1,893,000
reduction in resales by CXR-AJ of test equipment not manufactured by us
following our decision to discontinue those resales due to the lower gross
margin trends on resale products. Management believes the sales decline for CXR
Larus resulted primarily from reductions in capital spending in 2002 as compared
to capital spending in 2001 by many of our telecommunications customers due to
generally weak telecommunications markets. The sales decline for CXR-AJ occurred
primarily because the exclusive distribution agreement that CXR-AJ had with
Sunrise Telecom, Inc. terminated as of November 1, 2001, and CXR-AJ decided not
to remain in the test instruments resale business except to support a limited
number of existing customers.
Net sales of our CXR HALCYON 704 series field test equipment decreased
by $1,892,000 (49.2%) to $1,957,000 for 2002 as compared to $3,849,000 for 2001.
Net sales of our T-Com central office test equipment product line declined by
$643,000 (54.1%) to $527,000 for 2002 as compared to $1,186,000 for 2001,
primarily due to continued weakening in the market for central office test
equipment.
We believe that many of the United States telecom customers that CXR
Larus serves built networks to handle an anticipated demand for voice and data
traffic that has not yet occurred. Consequently, many of these customers reduced
their purchasing budgets for 2002. This had a negative effect on CXR Larus'
sales.
Net sales of transmission products and networking equipment produced by
CXR-AJ decreased by $1,379,000 (20.3%) to $5,399,000 for 2002 as compared to
$6,778,000 for 2001. We believe this decrease occurred primarily because of the
weak telecom market and the disruption caused by the French elections in
mid-2002. Total net sales by CXR-AJ, including both test equipment and
transmission and networking equipment, decreased by $1,992,000 (25.4%) to
$5,855,000 for 2002 as compared to $7,847,000 for 2001. We believe that the
decreases in CXR-AJ's and CXR Larus' sales relate to the overall slowdown in the
telecom markets and the termination of the Sunrise Telecom contract discussed
above, and that the French national and local elections in April and May 2002
may have caused a delay in purchases by major governmental customers of CXR-AJ.
GROSS PROFIT. Gross profit as a percentage of total net sales decreased
to 37.6% for 2002 as compared to 43.6% for 2001. In dollar terms, total gross
profit decreased by $3,450,000 (28.8%) for 2002 to $8,517,000 as compared to
$11,967,000 for 2001.
Gross profit for our electronic components segment decreased in dollar
terms by $271,000 (5.0%) to $5,203,000 for 2002 as compared to $5,505,000 for
2001, and decreased as a percentage of related net sales from 43.3% for 2001 to
38.9% for 2002. This decrease primarily was the result of a larger proportion of
power supply sales in comparison to sales of digital switches and electronic
subassemblies, both of which carry higher gross margins than power supplies.
Gross profit for our communications equipment segment decreased in
dollar terms by $3,149,000 (48.7%) to $3,313,000 for 2002 as compared to
$6,462,000 for 2001, and decreased as a percentage of net sales from 43.7% for
2001 to 35.7% for 2002. The decrease in gross profit as a percentage of net
sales primarily was due to the substantial reduction in sales volume that
increased overhead costs on a per unit basis.
27
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses decreased by $2,398,000 (23.7%) to $7,731,000 for 2002
as compared to $10,129,000 for 2001. Selling, general and administrative
expenses also declined as a percentage of total net sales, from 36.9% of net
sales during 2001 to 34.1% of net sales during 2002. The decrease in selling,
general and administrative expenses was due to several factors. For example, we
incurred $608,000 in legal and accounting fees during 2001 in connection with
amendments to a securities registration statement and periodic reports but did
not incur any of those expenses during 2002. Selling expenses were reduced by
$624,000 in our communications equipment segment and $117,000 in our electronic
components segment primarily due to lower commissions on reduced sales and cost
reductions during 2002. Administrative costs were reduced by $546,000 in our
communications equipment segment primarily due to staff reductions at CXR Larus
and CXR-AJ. Also, because of the new accounting rules of SFAS No. 142, effective
January 1, 2002 we no longer amortize goodwill. Goodwill accounted for $326,000
of our amortization expense in 2001.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES. Engineering and product
development expenses consist primarily of research and product development
activities of our communications equipment segment. These expenses remained
relatively unchanged at $1,015,000 for 2002 as compared to $1,076,000 for 2001.
We achieved cost savings from the closure of our St. Charles, Illinois
engineering facility in August 2001 and the relocation, consolidation and
downsizing of that engineering function into a facility we used to maintain in
Fremont, California. The cost savings were partially offset with increases in
engineering expenses for the development of a new rotary switch at XET
Corporation's Digitran Division operation in Rancho Cucamonga, California.
OTHER INCOME AND EXPENSE. Interest expense increased by $45,000 (11.4%)
to $441,000 for 2002 from $396,000 for 2001 due to higher debt loads at our
foreign subsidiaries. Other income was $80,000 in 2002 as compared to $18,000 of
other expense reported in 2001. This positive change primarily resulted from
miscellaneous tax refunds and miscellaneous expense reductions that occurred
during 2002.
INCOME TAX EXPENSE (BENEFIT). Income tax benefit for 2002 was $20,000
as compared to $77,000 of income tax expense for 2001. The income tax benefit in
2002 consisted of United Kingdom income tax refundable amounts due to the
availability of net operating loss deductions. This benefit was net of $19,000
of state income taxes and $14,000 of French income tax.
NET LOSS. Net loss for 2002 was $570,000 as compared to net income of
$327,000 for 2001. The major cause of this change was the reduction in sales of
our communications equipment segment below the level needed to cover fixed
costs. We took in 2002 and 2001 various actions to reduce costs through staffing
reductions in our communications equipment operations in the United States and
France and through various other cost-cutting methods, such as using contract
manufacturers, reducing facility rent expense and phasing out our administrative
office in Paris, France. These actions substantially reduced the sales volume
required to turn a profit at both CXR Larus and CXR-AJ.
DISCONTINUED OPERATIONS
As a result of our decision to discontinue our last remaining material
circuits subsidiary in October 2000, our circuits segment has been accounted for
as discontinued operations. We reported income of $56,000 in 2001 as a result of
reversal of excess accruals.
LIQUIDITY AND CAPITAL RESOURCES
During the year ended December 31, 2003 and the nine months ended
September 30, 2004, we funded our operations primarily through revenue generated
from our operations and through our existing and previous lines of credit with
Wells Fargo Bank, N.A., Wells Fargo Business Credit, Inc. and various foreign
banks. As of September 30, 2004, we had working capital of $4,599,000, which
28
represented a $1,097,000 decrease from working capital of $5,696,000 at December
31, 2003, primarily due to the acquisition of Larus Corporation. Also at
September 30, 2004, we had an accumulated deficit of $17,289,000, accumulated
other comprehensive gains of $50,000, cash and cash equivalents of $379,000, and
$5,381,000 of accounts receivable. At December 31, 2003, we had an accumulated
deficit of $17,886,000, accumulated other comprehensive gains of $108,000, cash
and cash equivalents of $1,174,000, and $5,393,000 of accounts receivable.
Cash provided by our operating activities increased by 49.2% to
$1,579,000 for the nine months ended September 30, 2004 as compared to cash
provided by our operating activities of $1,058,000 for the nine months ended
September 30, 2003. This $521,000 increase in cash provided by operations during
the nine months ended September 30, 2004 as compared to the comparable prior
year period primarily resulted from improved accounts receivable collections.
Cash used in our investing activities totaled $1,923,000 for the nine
months ended September 30, 2004 as compared to $17,000 for the nine months ended
September 30, 2003. Included in the results for the nine months ended September
30, 2004 are net cash of $1,492,000 to acquire Larus Corporation and $431,000 of
fixed asset purchases for telecommunications, management information systems and
support of prototype and production quantities of our new low profile rotary and
digital switches.
Cash used in our financing activities totaled $373,000 for the nine
months ended September 30, 2004 as compared to $1,050,000 of cash used in our
financing activities for the first nine months of 2003, primarily due to
repayment of bank debt in both periods.
On June 1, 2004, our subsidiaries, XET Corporation and CXR Larus,
together with Emrise acting as guarantor, obtained a credit facility from Wells
Fargo Bank, N.A. for our domestic operations. This facility is effective through
July 1, 2005 and replaced the previous credit facility we had with Wells Fargo
Business Credit, Inc. No prepayment penalty was due because the prior loan
contract excluded from prepayment penalties loans replaced with new credit
facilities from Wells Fargo Bank, N.A. Also, the new credit facility has no
minimum interest but is subject to an unused commitment fee equal to 0.25% per
annum, payable quarterly based on the average daily unused amount of the line of
credit described in the following paragraph.
The new credit facility provides a $3,000,000 revolving line of credit
secured by accounts receivable, other rights to payment and general intangibles,
inventories and equipment. Borrowings do not need to be supported by specific
receivables or inventory balances unless aggregate borrowings under the line of
credit and the term loan described in the following paragraph exceed $2,000,000
for 30 consecutive days (a "conversion event"). If a conversion event occurs,
the line of credit will convert into a formula-based line of credit until the
borrowings are equal to or less than $2,000,000 for 30 consecutive days. The
formula generally provides that outstanding borrowings under the line of credit
may not exceed an aggregate of 80% of eligible accounts receivable, plus 15% of
the value of eligible raw material inventory, plus 30% of the value of eligible
finished goods inventory. The interest rate is variable and is adjusted monthly
based on the prime rate plus 0.5%. The prime rate at September 30, 2004 was
4.75%.
The new credit facility also provides a term loan of $150,000 secured
by equipment, amortizable over 36 months at a variable rate equal to the prime
rate plus 1.5%. In addition, Wells Fargo Bank, N.A. has provided us with
$300,000 of credit available for the purchase of new capital equipment when
needed, of which a balance of $60,000 was outstanding at September 30, 2004.
29
As of September 30, 2004, we had a balance owing under the revolving
credit line of $1,567,000, and we had $433,000 of availability on the
non-formula based portion of the credit line. The credit facility is subject to
the following financial covenants: debt service; annual profitability;
debt-to-tangible net worth; current ratio; and minimum tangible net worth. As of
September 30, 2004, we were not in compliance with three of those covenants:
debt-to-tangible net worth; current ratio; and minimum tangible net worth. We
obtained a waiver of non-compliance as of September 30, 2004. We are currently
in discussion with Wells Fargo Bank, N.A. to amend the existing financial
covenants effective as of the next measurement date of December 31, 2004.
Management believes that the amendments to the financial covenants will be
completed in the first quarter of 2005 and that we will be able to comply with
the revised covenants over the next twelve months.
On July 13, 2004, we issued two promissory notes to the former
shareholders of Larus Corporation totaling $3,000,000 in addition to paying cash
and issuing shares of common stock, in exchange for 100% of the capital stock of
Larus Corporation. These notes are subordinated to our bank debt and are payable
in 72 monthly equal payments of principal totaling $41,667 per month plus
interest at the monthly LIBOR rate plus 5% with a maximum interest rate of 7%
during the first two years of the term of the notes, 8% during the third and
fourth years and 9% thereafter. During September 2004, the LIBOR rate was 1.84%.
The total balance on these promissory notes as of September 30, 2004 was
$2,875,000.
As of September 30, 2004, our foreign subsidiaries had credit
facilities, including lines of credit and term loans, with Venture Finance PLC,
a subsidiary of the global Dutch ABN AMRO Holdings, N.V. financial institution,
in England, IFN Finance, a subsidiary of ABN AMRO Holdings, N.V., Banc National
de Paris, Societe Generale in France and Sogelease and Johnan Shinkin Bank in
Japan. At September 30, 2004, the balances outstanding under our United Kingdom,
France and Japan credit facilities were $774,000, $688,000 and $59,000,
respectively.
XCEL Japan Ltd., or XJL, obtained a term loan on November 29, 2002 from
Johnan Shinkin Bank. The loan is amortized over five years and carries an annual
fixed interest rate of 3.25%. The balance of the loan as of September 30, 2004
was $59,000 using the exchange rate in effect at that date for conversion of
Japanese yen into United States dollars.
XPS, a second tier subsidiary of XET Corporation located in the United
Kingdom, obtained a credit facility with Venture Finance PLC as of November 12,
2002. This credit facility expires on November 15, 2005. Using the exchange rate
in effect at September 30, 2004 for the conversion of British pounds into United
States dollars, the facility is for a maximum of $2,685,000 and includes a
$627,000 unsecured cash flow loan, a $143,000 term loan secured by fixed assets,
and the remainder is a loan secured by accounts receivable and inventory. The
interest rate is the base rate of Venture Finance PLC (4.75% at September 30,
2004) plus 2%, and is subject to a minimum rate of 4% per annum. There are no
financial performance covenants applicable to this credit facility.
On April 8, 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 $1,488,000,
based on the exchange rate in effect at September 30, 2004 for the conversion of
euros into United States dollars. CXR-AJ also had a $31,000 revolving loan
balance with Bank Hervet as of September 30, 2004. In addition, CXR-AJ had
outstanding term loans with two other French banks totaling $98,000 as of
September 30, 2004. The IFN Finance facility is secured by accounts receivable
and carries an annual interest rate of 1.6% above the French "T4M" rate. The
French T4M rate was 2.05% at September 30, 2004.
Our backlog was $7,307,000 as of September 30, 2004 as compared to
$8,785,000 as of September 30, 2003. The reduction in backlog was primarily due
to substantial shipments under long-term contracts by XPS in the United Kingdom.
Our backlog as of September 30, 2004 was 82.5% related to our electronic
components business, which business tends to provide us with long lead-times for
30
our manufacturing processes due to the custom nature of the products, and 17.5%
related to our communications equipment business, which business tends to
deliver standard products from stock as orders are received. The amount of
backlog orders represents revenue that we anticipate recognizing in the future,
as evidenced by purchase orders and other purchase commitments received from
customers, but on which work has not yet been initiated or with respect to which
work is currently in progress. However, there can be no assurance that we will
be successful in fulfilling such orders and commitments in a timely manner or
that we will ultimately recognize as revenue the amounts reflected as backlog.
We took various actions to reduce costs in 2003. These actions were
intended to reduce the cash outlays of our telecommunications equipment segment
to match its revenue rate. We also have contracted with Asian manufacturers for
production of test equipment components at lower prices than we previously paid
to our former suppliers and have received shipments of quality components from
these Asian suppliers.
As described above under the heading "Overview," we acquired Larus
Corporation and Vista in July 2004. As a result of the acquisition, we acquired
all of the assets and liabilities of Larus Corporation, including the
intellectual property, cash, accounts receivable and inventories owned by each
of Larus Corporation and Vista. The purchase price consisted of $1,000,000 in
cash, the issuance of 1,213,592 shares of our common stock, $887,500 in the form
of two short-term, zero interest promissory notes that have since been repaid,
$3,000,000 in the form of two subordinated secured promissory notes, and
warrants to purchase up to an aggregate of 150,000 shares of our common stock at
$1.30 per share. In addition, we assumed $245,000 worth of accounts payable and
accrued expenses and entered into an above-market seven-year real property lease
with the sellers. This lease represents an obligation that exceeds the fair
market value by approximately $756,000 and is part of the acquisition purchase
price.
We funded the cash portion of the Larus Corporation acquisition
purchase price using proceeds from our credit facility with Wells Fargo Bank,
N.A. and our cash on-hand. In determining the purchase price for Larus
Corporation, we took into account the historical and expected earnings and cash
flow of Larus Corporation, as well as the value of companies of a size and in an
industry similar to Larus Corporation, comparable transactions and the market
for such companies generally.
We believe that current and future available capital resources,
revenues generated from operations, and other existing sources of liquidity,
including the $17 million in net proceeds received by us in connection with our
January 2005 private placement of common stock and warrants and credit
facilities we and our subsidiaries have, will be adequate to meet our
anticipated working capital and capital expenditure requirements for at least
the next twelve months.
Set forth below is a contractual obligations table that outlines
payments due from us or our subsidiaries under our lines of credit and other
significant contractual obligations through 2008, exclusive of interest. During
the nine months ended September 30, 2004, no material changes in this
information occurred outside the ordinary course of business, except as
described elsewhere with respect to the Larus Corporation acquisition and the
new credit facility with Wells Fargo Bank, N.A. The symbol "P" represents the
prime rate. The symbol "B" represents the lender's base rate.
31
(IN THOUSANDS)
CONTRACTUAL OBLIGATIONS AT --------------------------------------------------------------------------------
DECEMBER 31, 2003 2004 2005 2006 2007 2008 THEREAFTER TOTAL
--------------------------------- --------- --------- --------- --------- --------- --------- ---------
Line of Credit (Domestic) $ 1,077 $ -- $ -- $ -- $ -- $ -- $ 1,077
Average Interest Rate P+1%
Line of Credit (U.K.) $ 1,227 $ -- $ -- $ -- $ -- $ -- $ 1,227
Average Interest Rate B+2%
Overdraft (France) $ 578 $ -- $ -- $ -- $ -- $ -- $ 578
Average Interest Rate 5.2%-7.2%
Term Loan (Domestic) $ 72 $ 42 $ -- $ -- $ -- $ -- $ 114
Average Interest Rate P+1%
Term Loan (U.K.) $ 50 $ 669 $ -- $ -- $ -- $ -- $ 719
Average Interest Rate B+2%
Term Loan (France) $ 68 $ 11 $ -- $ -- $ -- $ -- $ 79
Average Interest Rate 5.2%-5.6%
Term Loan (Japan) $ 19 $ 19 $ 18 $ 17 $ -- $ -- $ 73
Average Interest Rate 3.25%
Capitalized Lease Obligations $ 108 $ 39 $ 3 $ -- $ -- $ -- $ 150
Operating Leases $ 718 $ 497 $ 425 $ 404 $ 589 $ -- $ 2,633
--------- --------- --------- --------- --------- --------- ---------
$ 3,917 $ 1,277 $ 446 $ 421 $ 589 $ -- $ 6,650
EFFECTS OF INFLATION
The effect 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.
32
IMPACTS OF NEW ACCOUNTING PRONOUNCEMENTS
In November 2002, the Emerging Issues Task Force ("EITF") reached a
consensus on Issue No. 00-21, Accounting for Revenue Arrangements with Multiple
Deliverables. This Issue provides guidance on when and how to separate elements
of an arrangement that may involve the delivery or performance of multiple
products, services and rights to use assets into separate units of accounting.
The guidance in the consensus is effective for revenue arrangements entered into
in fiscal periods, interim or annual, beginning after June 15, 2003. We adopted
Issue No. 00-21 on July 1, 2003. The adoption of Issue No. 00-21 did not have a
material effect on our consolidated financial position, results of operations,
or cash flows.
In December 2002, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and
Disclosure-An Amendment of SFAS 123." SFAS No. 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this statement amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. We have chosen to continue to account for stock-based compensation
using the intrinsic value method prescribed in APB Opinion No. 25, "Accounting
for Stock Issued to Employees" and related interpretations. Accordingly,
compensation expense for stock options is measured as the excess, if any, of the
estimate of the market value of our stock at the date of the grant over the
amount an employee must pay to acquire the stock. We adopted the annual
disclosure provisions of SFAS No. 148 for our financial reports for the year
ended December 31, 2002 and also adopted the interim disclosure provisions for
our financial reports beginning with the quarter ended March 31, 2003. Because
this standard involves disclosures only, the adoption of SFAS No. 148 did not
effect our results of operations, financial position or liquidity.
In January 2003, the FASB issued FASB Interpretation No. ("FIN") 46,
Consolidation of Variable Interest Entities - An Interpretation of ARB No. 51.
FIN 46 requires that if an entity has a controlling financial interest in a
variable interest entity, the assets, liabilities and results of activities of
the variable interest entity should be included in the consolidated financial
statements of the entity. FIN 46 requires that its provisions are effective
immediately for all arrangements entered into after January 31, 2003. For
arrangements entered into prior to January 31, 2003, the FIN 46 provisions were
required to be adopted at the beginning of the first interim or annual period
beginning after June 15, 2003. The provisions of FIN 46 have not had have a
material effect on our results of operations or financial position.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity." This
statement establishes standards for how an issuer classifies and measures in its
statement of financial position certain financial instruments with
characteristics of both liabilities and equity. In accordance with the standard,
financial instruments that embody obligations for the issuer are required to be
classified as liabilities. SFAS No. 150 is effective for all financial
instruments created or modified after May 31, 2003, and otherwise became
effective at the beginning of the first interim period beginning after June 15,
2003. The adoption of SFAS No. 150 did not have a material effect on
our consolidated financial condition or results of operations.
In November 2003, the EITF reached a consensus on Issue No. 03-1, "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments." EITF Issue No. 03-1 provides guidance on other-than-temporary
impairment and its application to debt and equity investments. The requirements
apply to investments in debt and marketable equity securities that are accounted
for under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." The provisions of Issue No. 03-1 are effective for annual periods
ending after December 15, 2003. The adoption of this Statement is not expected
to have a material effect on our financial condition or results of operations.
33
In December 2003, the FASB issued SFAS No. 132 (revised 2003),
"Employers' Disclosures about Pensions and Other Postretirement Benefits," an
amendment of SFAS No. 87, 88 and 106, and a revision of SFAS No. 132. The
statement is effective for fiscal years and interim periods ending after
December 15, 2003. This Statement revises employers' disclosures about pension
plans and other postretirement benefit plans. It does not change the measurement
or recognition of those plans required by SFAS No. 87, 88 and 106. The new rules
require additional disclosures about the assets, obligations, cash flows, and
net periodic benefit cost of defined benefit pension plans and other
postretirement benefit plans. The adoption of this Statement is not expected to
have a material effect on our financial condition or results of operations.
In December 2003, the FASB issued FASB Staff Position No. FAS 106-1
(FSP 106-1), "Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003." The guidance is
effective for initial interim or annual fiscal periods ending after December 7,
2003. FSP 106-1 permits employers that sponsor postretirement benefit plans
(plan sponsors) that provide prescription drug benefits to retirees to make a
one-time election to defer accounting for any effects of the Medicare
Prescription Drug, Improvement, and Modernization Act of 2003, or the "Act."
Without FSP 106-1, plan sponsors would be required under SFAS No. 106 to account
for the effects of the Act in the fiscal period that includes December 8, 2003,
the date the President signed the Act into law. The adoption of this Statement
is not expected to have a material effect on our financial condition or results
of operations.
In December 2003 the SEC issued Staff Accounting Bulletin (SAB) No.
104, Revenue Recognition. SAB 104 codifies, revises and rescinds certain
sections of SAB No. 101 in order to make this interpretive guidance consistent
with current authoritative accounting and auditing guidance and SEC rules and
regulations. Accordingly, there is no effect on our results of operations,
financial position or cash flows as a result of the issuance of SAB No. 104.
In December 2003, the FASB issued FASB Interpretation No. 46R,
Consolidation of Variable Interest Entities (FIN 46R). FIN 46R requires the
application of either FIN 46 or FIN 46R by Public Entities to all Special
Purpose Entities ("SPEs") created prior to February 1, 2003 as of December 31,
2003 for calendar year-end companies. FIN 46R is applicable to all non-SPEs
created prior to February 1, 2003 at the end of the first interim or annual
period ending after March 15, 2004. For all entities created subsequent to
January 31, 2003, Public Entities were required to apply the provisions of FIN
46. The adoption of FIN 46 did not have a material effect to our consolidated
financial position, results of operations or cash flows. The adoption of FIN 46R
for SPEs did not have an effect on our consolidated financial position, results
of operations or cash flows, and we do not believe the adoption of FIN 46R for
non-SPEs will have a material effect on our consolidated financial position,
results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
Share-Based Payment, which addresses the accounting for employee stock options.
SFAS No. 123R eliminates the ability to account for shared-based compensation
transactions using APB Opinion No. 25 and generally would require instead that
such transactions be accounted for using a fair value-based method. SFAS No.
123R also requires that tax benefits associated with these share-based payments
be classified as financing activities in the statement of cash flow rather than
operating activities as currently permitted. SFAS No. 123R becomes effective for
interim or annual periods beginning after June 15, 2005. Accordingly, we are
required to apply SFAS No. 123R beginning in the quarter ending September 30,
2005. SFAS No. 123R offers alternative methods of adopting this final rule. At
the present time, we have not yet determined which alternative method we will
use.
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4." SFAS No. 151 clarifies that abnormal
inventory costs such as costs of idle facilities, excess freight and handling
costs, and wasted materials (spoilage) are required to be recognized as current
period costs. The provisions of SFAS No. 151 are effective for our fiscal 2006.
We are currently evaluating the provisions of SFAS No. 151 and do not expect
that adoption will have a material effect on our financial position, results
of operations or cash flows.
34
SELECTED QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table sets forth selected quarterly financial data for
each of the last eleven fiscal quarters. This quarterly information is
unaudited, has been prepared on the same basis as our annual financial
statements, and, in our opinion, reflects all adjustments, consisting only of
normal recurring accruals, necessary for a fair presentation of the information
for periods presented. Operating results for any quarter are not necessarily
indicative of results for any future period.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME DATA: QUARTER ENDED,
--------------------------------------------------------------------------------------------------
SEPT. JUNE MAR. DEC. SEPT. JUNE MAR. DEC. SEPT. JUNE MAR.
30, 30, 31, 31, 30, 30, 31, 31, 30, 30, 31,
2004 2004 2004 2003 2003 2003 2003 2002 2002 2002 2002
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Net sales ...................... $ 7,469 $ 6,432 $ 6,192 $ 6,597 $ 6,420 $ 6,834 $ 5,668 $ 5,962 $ 5,764 $ 6,118 $ 4,820
Cost of sales .................. 4,239 3,533 3,445 3,598 3,705 4,005 3,527 3,568 3,680 3,608 3,291
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Gross profit ................... 3,230 2,899 2,747 2,999 2,715 2,829 2,141 2,394 2,084 2,510 1,529
Selling, general and
administrative expenses ..... 2,465 2,067 2,217 2,280 1,916 1,918 1,698 1,917 2,094 1,855 1,865
Engineering and product
development expenses ........ 438 312 283 254 230 246 221 276 242 259 238
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Income (loss) from operations .. 327 520 247 465 569 665 222 201 (252) 396 (574)
Other income (expenses), net ... (143) (124) (102) (161) (39) (164) (110) (25) (175) (75) (86)
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Income (loss) before income
taxes ....................... 184 396 145 304 530 501 112 176 (427) 321 (660)
Income tax expense ............. 26 27 75 50 26 142 68 (28) (97) 66 39
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) .............. $ 158 $ 369 $ 70 $ 254 $ 504 $ 359 $ 44 $ 204 $ (330) $ 255 $ (699)
Other comprehensive gain
(loss), net ................. 6 (62) (2) 344 109 224 28 85 17 382 (38)
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total comprehensive income
(loss) ...................... $ 164 $ 307 $ 68 $ 598 $ 613 $ 583 $ 72 $ 289 $ (313) $ 637 $ (737)
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Basic earnings (loss) per
share ....................... $ 0.01 $ 0.02 $ 0.00 $ 0.01 $ 0.02 $ 0.02 $ 0.0 $ 0.01 $ (0.02) $ 0.01 $ (0.03)
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Diluted earnings (loss) per
share ....................... $ 0.01 $ 0.02 $ 0.00 $ 0.01 $ 0.02 $ 0.02 $ 0.0 $ 0.01 $ (0.02) $ 0.01 $ (0.03)
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
The following table sets forth a portion of the above unaudited information as a percentage of net sales.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME DATA: QUARTER ENDED,
--------------------------------------------------------------------------------------------------
SEPT. JUNE MAR. DEC. SEPT. JUNE MAR. DEC. SEPT. JUNE MAR.
30, 30, 31, 31, 30, 30, 31, 31, 30, 30, 31,
2004 2004 2004 2003 2003 2003 2003 2002 2002 2002 2002
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Net sales....................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales................... 56.8 54.9 55.6 54.5 57.7 58.6 62.2 59.8 63.9 59.0 68.3
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Gross profit.................... 43.2 45.1 44.4 45.5 42.3 41.4 37.8 40.2 36.1 41.0 31.7
Selling, general and
administrative expenses...... 33.0 32.1 35.8 34.6 29.8 28.1 30.0 32.2 36.3 30.3 38.7
Engineering and product
development expenses......... 5.9 4.9 4.6 3.9 3.6 3.6 3.9 4.6 4.2 4.2 4.9
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Income (loss) from operations... 4.3 8.1 4.0 7.0 8.9 9.7 3.9 3.4 (4.4) 6.5 (11.9)
Other income (expenses), net.... (1.9) (2.0) (1.7) (2.4) (0.6) (2.4) (1.9) (0.4) (3.0) (1.3) (1.8)
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Income (loss) before income
taxes........................ 2.4 6.1 2.3 4.6 8.3 7.3 2.0 3.0 (7.4) 5.2 (13.7)
Net income (loss)............... 2.1 5.7 1.1 3.9 7.9 5.3 0.8 3.4 (5.7) 4.2 (14.5)
Other comprehensive gain
(loss), net.................. 0.0 (1.0) 0.0 5.2 1.7 3.3 0.5 1.4 0.2 6.2 (0.8)
-------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total comprehensive income
(loss)....................... 2.1% 4.7% 1.1% 9.1% 9.6% 8.6% 1.2% 4.8% (5.5)% 10.4% (15.2)%
======== ======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Our operating results have fluctuated from quarter to quarter due to a
variety of reasons. We note below some of the larger changes in various line
items in the table above.
35
QUARTER ENDED SEPTEMBER 30, 2004 COMPARED TO QUARTER ENDED JUNE 30, 2004
Net sales increased by $1,037,000 (16%) to $7,469,000 from $6,432,000
in the previous period. In July 2004, we acquired Larus Corporation, a
manufacturer of communication timing and synchronization products, which
contributed $1,468,000 in sales in the third quarter. The additional sales
provided by Larus Corporation were partially offset with a $197,000 decline in
test instruments sales and a $126,000 reduction in sales of our European network
access products. Our gross profit increased by $331,000 (11%) to $3,230,000 from
$2,899,000 in the prior period. Larus Corporation contributed $595,000 of gross
profit, which was partially offset with a reduction in gross profit of test
instruments of $153,000 primarily due to lower sales and switches of $111,000
due mainly to product mix. Gross margin was 43% as compared to 45% for the
previous quarter. Operating costs increased by $524,000 (22%) to $2,903,000 from
$2,379,000 primarily because of the addition of $534,000 of Larus Corporation's
operating expenses. Net income declined to $158,000 as compared to $369,000 for
the second quarter primarily because operating expenses increased more than the
increase in gross profit.
QUARTER ENDED JUNE 30, 2004 COMPARED TO QUARTER ENDED MARCH 31, 2004
Net sales increased by $240,000 (4%) to $6,432,000 from $6,192,000 in
the prior quarter primarily due to increased test equipment sales of $735,000,
which was $253,000 above the prior period. Net sales in other product lines
remained relatively consistent. Gross profit increased by $152,000 (6%) to
$2,899,000 from $2,747,000 in the prior period mainly due to increased test
equipment sales. The gross margin increased to 45% from 44% in the previous
quarter. Operating costs decreased $121,000 (5%) to $2,379,000 from $2,500,000
in the prior quarter primarily mainly due to lower sales commission expense. Net
income rose to $369,000 from $70,000 in the first quarter primarily due to
higher sales, higher gross profit margin, lower income tax expense and lower
operating costs.
QUARTER ENDED MARCH 31, 2004 COMPARED TO QUARTER ENDED DECEMBER 31, 2003
Net sales decreased by $405,000 (6%) to $6,192,000 from $6,597,000 in
the prior quarter. The primary reason for the decrease was a $300,000 decrease
in test instrument sales mostly due to the budget cycles of our large test
instrument customers. Also, lower power supply product shipments were partially
offset with increased switch sales. Gross profit decreased by $252,000 (8%) to
$2,747,000 from $2,999,000 in the previous quarter primarily due to lower sales.
The gross margin declined to 44% from 46% mainly due to the decrease in test
equipment sales. Operating expenses stayed consistent. Net income declined to
$70,000 from $254,000 mainly because of the lower test instrument sales.
QUARTER ENDED DECEMBER 31, 2003 COMPARED TO QUARTER ENDED SEPTEMBER 30,
2003
Net sales increased by $177,000 (3%) to $6,597,000 from $6,420,000 in
the prior period. Communication equipment sales increased by $662,000 due to a
large increase in the sales of network access products in Europe and a modest
increase in test equipment sales. This increase was partially offset with a
$485,000 decrease in sales of electronic components of both power supplies and
switches. Despite a small decrease in total sales, gross profit increased
$284,000 (10%) to $2,999,000 from $2,715,000 in the prior quarter due mainly to
a higher gross margin on power supplies. Gross margin increased to 46% as
compared to 42% in the prior quarter. Operating expenses increased $388,000
(18%) to $2,534,000 from $2,146,000 due to increases in sales and administrative
expenses. Net income was $254,000 as compared to $504,000 in the third quarter.
36
QUARTER ENDED SEPTEMBER 30, 2003 COMPARED TO QUARTER ENDED JUNE 30, 2003
For the third quarter of 2003, net sales decreased $414,000 (6%) to
$6,420,000 from $6,834,000 in the prior quarter. This decrease was primarily due
to reduced network access equipment sales in Europe. Sales of electronic
components increased slightly despite a 6% decrease in sales of power supplies.
Gross profit was $2,715,000, which was $114,000 (4%) less than the prior quarter
gross profit of $2,829,000. Despite lower sales, we increased our gross profit
margin in both of our business segments by reducing costs. Our gross margin
improved to 42% from 41% in the prior period. Operating costs were relatively
unchanged with administrative costs declining slightly and sales and marketing
increasing slightly. Net income was $504,000 as compared to $359,000 in the
prior period. The difference in net income was primarily caused by income tax
expense that was $116,000 less in the third quarter as compared to the second
quarter related to changes in United Kingdom tax liability.
QUARTER ENDED JUNE 30, 2003 COMPARED TO QUARTER ENDED MARCH 31, 2003
Net sales increased by $1,166,000 (21%) to $6,834,000 from $5,668,000
in the prior quarter. Communications equipment sales increased $259,000 due to
increased sales of test instruments, and electronic components sales increased
$907,000 due to stronger switch and power supply sales. Gross profit increased
by $688,000 (32%) to $2,829,000 from $2,141,000 in the prior quarter due to
higher gross margins across our product lines. Gross margins improved to 41%
from 38%. Operating expenses increased by $245,000 (13%) to $2,164,000 from
$1,919,000 in the prior quarter primarily due to higher administrative costs
because of increased staffing at our electronic components segment. The higher
sales of the second quarter and improved margins resulted in net income of
$359,000 in the second quarter as compared to net income of $44,000 in the first
quarter.
QUARTER ENDED MARCH 31, 2003 COMPARED TO QUARTER ENDED DECEMBER 31, 2002
For the three months ended March 31, 2003, net sales decreased by
$294,000 (5%) to $5,668,000 from $5,962,000 in the prior quarter. This decrease
was primarily due to a sharp decline in test equipment sales due to budgeting
delays of several large test instrument customers. Increased sales of network
access products partially offset the lower test equipment sales, and sales of
electronic components were relatively unchanged. Gross profit was $2,141,000
which was $253,000 (11%) less than the prior quarter's gross profit of
$2,394,000 primarily due to the lower test instrument sales. Gross margins
declined to 38% from 40%. Operating expenses declined by $274,000 (12%) to
$1,919,000 from $2,193,000 in the previous quarter because of reduced
administrative expenses due to some staffing cuts in our communications segment
and lower sales and marketing costs. Net income for the first quarter of 2003
was $44,000 compared to $204,000 in the prior quarter.
QUARTER ENDED DECEMBER 31, 2002 COMPARED TO QUARTER ENDED SEPTEMBER 30,
2002
For the quarter ended December 31, 2002, our sales increased $198,000
(3%) to $5,962,000 from $5,764,000 for the third quarter of 2002 due to
increased sales of network access products, switches and power supplies. Our
gross profit increased by $310,000 (15%) to $2,394,000 from $2,084,000 in the
third quarter due to higher gross margins primarily for our communications
equipment. Gross margins improved to 40% from 36%. Operating expenses were lower
in the fourth quarter by $143,000 (6%), totaling $2,193,000 as compared to
$2,336,000 in the third quarter primarily due to lower administration costs.
These improvements resulted in a net income of $204,000 for the quarter as
compared to a net loss of $330,000 in the third quarter.
37
QUARTER ENDED SEPTEMBER 30, 2002 COMPARED TO QUARTER ENDED JUNE 30, 2002
Net sales decreased by $354,000 (6%) to $5,764,000 from $6,118,000 in
the prior quarter. The decrease resulted primarily from a $214,000 reduction in
test instruments sales and a $342,000 reduction in subsystem assembly sales.
This was partially offset with a $266,000 increase in switch sales. Gross profit
fell $426,000 (17%) to $2,084,000 from $2,510,000 in the prior quarter. This was
caused by the lower sales of test instruments and lower sales of relatively high
margin subsystem assemblies. The gross margin was 36% as compared to 41% in the
previous quarter. Operating expense increased $222,000 (10%) to $2,336,000 from
$2,114,000 in the second quarter due to $152,000 increases in administrative
costs and increased selling costs. As a result of the decline in sales,
reduction in gross margin and increased operating costs, we incurred a net loss
of $330,000 as compared to reporting a net income of $255,000 in the second
quarter.
QUARTER ENDED JUNE 30, 2002 COMPARED TO QUARTER ENDED MARCH 31, 2002
Net sales increased by $1,298,000 (27%) to $6,118,000 from $4,820,000
in the prior quarter. Test instrument sales improved to $969,000 from $635,000
in the prior quarter. Sales of network access equipment increased $465,000 (43%)
to $1,540,000 from $1,075,000 in the prior quarter. Sales of our electronic
components also increased, due to sales of power supplies that increased
$341,000 (35%) to $1,814,000 from $1,473,000. We also had $662,000 sales of
subsystem assemblies compared to no sales in the prior quarter due to a new
contract from a major aerospace company. As result of increased sales and cost
reductions, our gross profit increased by $981,000 (64%) to $2,510,000 from
$1,529,000 in the previous quarter. Our gross margin improved to 41% from 32% in
the prior quarter. Operating expenses were $2,114,000 which was slightly higher
than the $2,103,000 in the prior quarter. We reported a net income of $255,000
in the second quarter, a great improvement over the $699,000 loss in the first
quarter. This was the result of higher sales coupled with cost reductions.
QUARTER ENDED MARCH 31, 2002 COMPARED TO QUARTER ENDED DECEMBER 31, 2001
Net sales decreased by $1,710,000 (26%) to $4,820,000 from $6,530,000
in the prior quarter. The first quarter was affected by delayed budget releases
due to the United States telecommunications downturn of our large test
instrument customers. Sales of our test instrument company, CXR Larus fell
$1,225,000 (79%) from $1,546,000 in the fourth quarter of 2001 to $621,000, a
$925,000 drop. Sales of our European network access and transmission instruments
declined $446,000 (25%) to $1,335,000 from $1,781,000 in the prior quarter.
Switch and subassembly sales also declined in the first quarter of 2002 by
$350,000 (25%) to $1,030,000 from $1,380,000 in the fourth quarter of 2001 due
to temporarily lower orders. These substantial sales decreases were paramount in
causing our gross profit to fall $1,480,000 (49%) to $1,529,000 from $3,009,000
in the previous quarter. The gross margin was 32% as compared to 46% in the
prior quarter. Operating expenses decreased by $262,000 (11%) due to reduced
administrative costs such as cost reductions due to staff reductions and the end
of the requirement to amortize goodwill. Due to the sharp reduction in sales
volume during the first quarter of 2002, we incurred a net loss of $699,000 as
compared with net income from continuing operations of $391,000 in the prior
quarter.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Exchange Rate Sensitivity
-------------------------
We have established and acquired international subsidiaries that
prepare their balance sheets in the relevant foreign currency. In order to be
included in our consolidated financial statements, these balance sheets are
converted, at the then current exchange rate, into United States dollars, and
the statements of operations are converted using weighted average exchange rates
for the applicable period. Accordingly, fluctuations of the foreign currencies
relative to the United States dollar affect our consolidated financial
38
statements. Our exposure to fluctuations in currency exchange rates has
increased as a result of the growth of our international subsidiaries. However,
because historically the majority of our currency exposure has related to
financial statement translation rather than to particular transactions, we do
not intend to enter into, nor have we historically entered into, forward
currency contracts or hedging arrangements in an effort to mitigate our currency
exposure. For further information regarding our exchange rate sensitivity, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Critical Accounting Policies - Foreign Currency Translation."
Interest Rate Sensitivity
-------------------------
A substantial portion of our notes payable and long-term debt have
variable interest rates based on the prime interest rate and/or the lender's
base rate, which exposes us to risk of earnings loss due to changes in such
interest rates.
The following table provides information about our debt obligations
that are sensitive to changes in interest rates. All dollars are in thousands.
The symbol "P" represents the prime rate. The symbol "B" represents the lender's
base rate. Balances are as of December 31, 2003.
During the nine months ended September 30, 2004, no material changes in
this information occurred outside the ordinary course of business, except as
described elsewhere with respect to the Larus Corporation acquisition and the
new credit facility with Wells Fargo Bank, N.A. The symbol "P" represents the
prime rate. The symbol "B" represents the lender's base rate.
FAIR
THERE- VALUE
LIABILITIES 2004 2005 2006 2007 2008 AFTER TOTAL 12/31/03
------------------------- --------- --------- --------- --------- --------- --------- --------- ---------
Line of Credit (Domestic) $ 1,077 $ -- $ -- $ -- $ -- $ -- $ 1,077 $ 1,077
Average Interest Rate P+ 1%
Line of Credit (U.K.) $ 1,227 $ -- $ -- $ -- $ -- $ -- $ 1,227 $ 1,227
Average Interest Rate B+ 2%
Overdraft (France) $ 578 $ -- $ -- $ -- $ -- $ -- $ 578 $ 578
Average Interest Rate 5.5%7.2%
Term Loan (Domestic) $ 72 $ 42 $ -- $ -- $ -- $ -- $ 114 $ 114
Average Interest Rate P+ 1%
Term Loan (U.K.) $ 50 $ 669 $ -- $ -- $ -- $ -- $ 719 $ 719
Average Interest Rate B+ 2%
Term Loan (France) $ 68 $ 11 $ -- $ -- $ -- $ -- $ 79 $ 79
Average Interest Rate 5.2%-5.6%
Term Loan (Japan) $ 19 $ 19 $ 18 $ 17 $ -- $ -- $ 73 $ 73
Average Interest Rate 3.25%
39
BUSINESS
CORPORATE OVERVIEW
We are a Delaware corporation that was formed July 14, 1989. We have
three wholly-owned operating subsidiaries, CXR Larus Corporation, a Delaware
corporation formed in 1984 under the name CXR Telcom Corporation and based in
the United States ("CXR Larus"), CXR Anderson Jacobson, a company organized
under the laws of France in 1973 and based in France ("CXR-AJ"), and XET
Corporation, a company organized under the laws of New Jersey in 1983. CXR Larus
and CXR-AJ manufacture, assemble and distribute communications test equipment,
communication timing and synchronization products, and network access and
transmission products. XET Corporation designs, manufactures and markets
electronic components for defense, aerospace and industrial markets.
In December 2004, CXR Larus succeeded by merger to the assets and
liabilities of Larus Corporation, a San Jose, California-based manufacturer and
seller of telecommunications products, and Vista Labs, Incorporated, a
subsidiary of Larus Corporation that provided engineering services to Larus
Corporation. As described in more detail elsewhere in the prospectus, we
acquired Larus Corporation and Vista Labs, Incorporated in July 2004.
Through our operating subsidiaries, XET Corporation, CXR Larus and
CXR-AJ, and through the divisions and subsidiaries of those subsidiaries, we
design, develop, manufacture, assemble, and market products and services in the
following two material business segments:
o Electronic Components
-- digital and rotary switches
-- electronic power supplies
-- subsystem assemblies
o Communications Equipment
-- network access and transmission products
-- communication timing and synchronization products
-- communications test instruments
Our sales are primarily in North America, Europe and Asia. Sales to
customers in the electronic components segment, primarily to defense and
aerospace customers, defense contractors and industrial customers, were 58.2%,
63.4% and 59.1% of our total net sales for the nine months ended September 30,
2004 and the years 2003 and 2002, respectively. Sales of communications
equipment and related services, primarily to telecommunications equipment
customers, were 41.8%, 36.6% and 40.9% of our total net sales during the nine
months ended September 30, 2004 and the years 2003 and 2002, respectively.
Our objective in our electronic components business is to become the
supplier of choice for harsh environment digital and rotary switches and custom
power supplies. Our objective in our communications equipment business is to
become a leader in quality, cost effective solutions to meet the requirements of
communications equipment customers. We believe that we can achieve these
objectives through customer-oriented product development, superior product
solutions, and excellence in local market service and support.
40
INDUSTRY OVERVIEW
ELECTRONIC COMPONENTS
The electronic components industry comprises three basic segments,
which are active components, passive components and electromechanical
components. We compete in the active and electromechanical segments of this
industry. These segments can be further segmented by industry into
telecommunications, aerospace, defense, commercial, industrial and other
environments, each of which places constraints that define performance and
permitted use of differing grades of components.
We are active only in the industry segments that are characterized by
low volume, high margin and long lead-times, namely the aerospace, defense and
industrial segments. To support the myriad customers that rely on digital and
rotary switches and electronic power supplies, we believe that our electronic
components must offer high levels of reliability and in many cases must be
tailored to the size, appearance, functionality and pricing needs of each
particular customer.
The defense market, which is a predominant market for our electronic
components, makes use of sophisticated electronic assemblies in diverse
applications that involve both original equipment and retrofit of existing
equipment.
The Digitran Division of our subsidiary XET Corporation, which was
acquired by XET Corporation from Becton Dickinson in 1985, has been
manufacturing digital switches since the division was formed in the 1960s. XCEL
Power Systems Ltd., or XPS, a second tier subsidiary of XET Corporation, has
been manufacturing electronic power supplies since 1989.
COMMUNICATIONS EQUIPMENT
Over the past decade, telecommunications and data communications
infrastructures have undergone major growth and have become a critical part of
the global business and economic infrastructure that has been driven by:
o a surge in demand for broadband access used to conduct e-commerce
activities and transmit growing volumes of data, voice and video
information;
o the adoption of Internet protocol, or IP, which is a protocol
developed to enable the transmission of information as packets of
data from a source to a recipient using dynamically changing
routes, with the data being reassembled at the recipient's
location into the original information format; and
o an apparent worldwide trend toward deregulation of the
communications industry, which has enabled a large number of new
communications service providers to enter the market.
This rapid growth has been succeeded by a period of consolidation.
According to industry sources, consumer demand for broadband access continues to
grow at a moderate pace, but existing carrier infrastructures generally have the
backbone capacity to more than accommodate this moderate growth, which has
resulted in substantially reduced capital spending by telecommunications
carriers. Private and corporate communications providers have been less severely
affected, and growth is still evident in this sector. Data traffic volumes
continue to exceed voice traffic volumes, with both types of traffic moving
toward more efficient IP transmission methods.
41
Private and corporate communications providers and other businesses
that rely heavily on information technology continue to devote significant
resources to the purchase of network access and transmission equipment, such as
high-speed DSL and fiber optic modems, through which data and voice information
may be transmitted. DSL, or digital subscriber line, technology transmits data
up to 50 times faster than a conventional dial-up modem using existing copper
telephone wires. We believe that the demand for test equipment with which to
test, deploy, manage and optimize communications networks, equipment and
services remains depressed for public carrier markets.
To support the rapidly changing needs of telecommunications companies
and information technology dependent businesses, we believe that network access
and transmission products and communications test instruments must offer high
levels of functional integration, automation and flexibility to operate across a
variety of network protocols, technologies and architectures. Because the
competition for subscribers for high-speed bandwidth access is intense, the
quality and reliability of network service has become critical to
telecommunications companies due to the expense, loss of customers and negative
publicity resulting from poor service. Quality and reliability of network
service are also important to information technology dependent businesses that
rely on broadband high-speed data links for a variety of purposes.
Technicians who use service verification equipment in the field or in
central or branch offices assist businesses in verifying and repairing service
problems effectively and, thus, increase the quality and reliability of their
networks. We believe that as broadband services are deployed further and as
competition for telecommunications subscribers and e-commerce customers
proliferates, telecommunications companies and other information
technology-reliant businesses will increasingly depend on new and improved
integrated access transmission devices and advanced field and central or branch
office testing and monitoring solutions.
OUR SOLUTION
We have developed a range of electronic components, such as digital and
rotary switches and custom electronic power supplies, used primarily by
aerospace, defense and industrial customers. We have developed and we
manufacture and market various network access and transmission devices used by
businesses and other users to efficiently transmit data, voice and video
information to destinations within and outside of their respective networks.
We have developed and we manufacture and market a broad range of test
instruments used by operators of public and private telecommunications networks
for the installation, maintenance and optimization of advanced communications
networks.
We have also developed and we manufacture and market an extensive range
of communication timing and synchronization products used by operators of public
and private telecommunications networks to provide a consistent source of timing
alignment, or synchronization, for digital networks when the principal network
timing source is lost.
Our extensive knowledge and understanding of our customers' needs,
together with the broad capabilities of our network access and transmission
products, test instrumentation products and our sophisticated electronic
components, enable us to provide the following features and benefits to our
customers:
42
DEVELOPMENT OF NEW SWITCH TECHNOLOGY. We have complemented our
long-established range of products with a new range of patent-pending
space-saving rotary switches we refer to as VLP(TM), or very low profile
switches, and ELP(TM), or extremely low profile switches. These products have
been specifically designed to target harsh environment and aerospace
applications where space is at a premium, providing a substantial advantage over
larger switches offered by our competitors.
DEVELOPMENT OF COMMUNICATION TIMING AND SYNCHRONIZATION EQUIPMENT.
We have extended the existing range of communication timing and synchronization
products with a new range of equipment designed specifically to target the more
extensive RBOC market.
PROVISION OF MORE EFFICIENT AND COST-EFFECTIVE POWER SYSTEMS. We have
developed and we provide high and low voltage power systems that are highly
integrated within the application hardware, which minimizes cost, space and
complexity and maximizes overall system reliability and efficiency. We believe
that our ability to partner with major international defense contractors and to
provide power systems solutions based on both standard modules and custom
designs provides us with an important competitive advantage.
BROAD RANGE OF NETWORK ACCESS AND TRANSMISSION PRODUCTS FOR A WIDE
RANGE OF APPLICATIONS. We have developed a broad range of professional network
access and transmission products that are capable of connecting to a wide range
of remote monitoring devices and equipment. Many of these products are designed
to operate in extended temperatures and harsh environments and generally exceed
the surge protection standards of the industry and are adaptive to wide ranges
of AC or DC power inputs. The design of many of our data transmission products
enables them to either interface with or complement one another. The versatility
of this concept has enabled us to offer numerous different product combinations
to our customers. These variations include customized selection of data speeds,
data interfaces, power inputs, operating temperatures, data formats and power
consumption. In addition, our desktop and rack mount transmission product lines
allow us to serve both central site data communications needs and remote access
and transmission sites on both the enterprise-wide and single location level.
HANDHELD DESIGN OF FIELD TEST EQUIPMENT. We design many of our test
equipment products to be used in the field. Most of our digital and analog
products weigh less than four pounds and offer handheld convenience. The
compact, lightweight design of these products enables field technicians to
access problems and verify line operation quickly.
RAPID AND EFFICIENT DIGITAL SERVICES DEPLOYMENT. Our test equipment
products allow field and office technicians to test lines rapidly and
efficiently to ensure that they are properly connected to the central office and
that they can support a specific type and speed of service. In a single device,
our products can be used to pre-qualify facilities for services, identify the
source of problems and verify the proper operation of newly installed service
before handing service over to customers.
COMPREHENSIVE CONNECTIVITY. Our network access and transmission
products and communications test instruments are the result of significant
product research and engineering and are designed to connect to a broad range of
operation configurations and to connect over a wide range of prevailing
transmission conditions. Our products incorporate a wide range of standard
international connectivity protocols as well as proprietary protocols.
CUSTOMER-DRIVEN FEATURES. Most of our digital and rotary switches and
each of our power supplies are highly tailored to our customers' needs. We
manufacture digital and rotary switches for insertion into new equipment as well
as for retrofit into existing equipment. Our engineers continually interact with
our customers during the design process to ensure that our electronic components
are the best available solution for them. For example, based on conversations
with our customers, we delivered a compact multiple output power supply to allow
BAE Systems to produce a single-heads up display suitable for fitting on a large
range of commercial and military aircraft.
43
CUSTOMER RELATIONS. Our electronic components business currently enjoys
a preferred supplier status with several key accounts, which means that we work
in close association with the customer to develop custom products specifically
addressing their needs. Our electronic components also are considered qualified
products with many key accounts, which means that our products are designed into
equipment specifications of some of our customers for the duration of their
production of their equipment.
LONG-TERM RELATIONSHIPS. Market procurement methods encourage long-term
relationships between electronic components suppliers and customers, with
customers committing to a single source of supply because of the high cost
involved in qualifying a product or its alternative for use. For example, a
large proportion of XPS' products are qualified products that have been involved
in many hours of flight trials.
OUR STRATEGY
Our objectives are to become the supplier of choice for harsh
environment switches and custom power supplies in the aerospace, defense and
industrial markets, in addition to becoming a leading provider of network access
and transmission products and communications test instruments for a broad range
of applications within the global communications industry. The following are the
key elements of our strategy to achieve these objectives:
CONTINUE TO FOCUS ON OUR ELECTRONIC COMPONENTS BUSINESS. We plan to
continue to grow our electronic components business by marketing our electronic
components products in their established market niches and identifying
opportunities to broaden our customer base for our power supply products.
CONTINUE TO FOCUS ON OUR COMMUNICATION TIMING AND SYNCHRONIZATION
PRODUCTS AND NETWORK ACCESS AND TRANSMISSION PRODUCTS. We plan to build upon our
existing strong base businesses in the communications equipment market
introducing additional new products and utilizing our broader reach with CXR
Larus to address new markets.
CONTINUE TO INVEST IN RESEARCH AND DEVELOPMENT TO ADDRESS HIGH GROWTH
MARKET OPPORTUNITIES. We plan to continue investing in markets and technologies
that we believe offer substantial growth prospects. We believe that the
expertise we have developed in creating our existing products will permit us to
enhance these products, develop new products and respond to emerging
technologies in a cost-effective and timely manner.
PURSUE STRATEGIC ACQUISITIONS. The communication timing and
synchronization products market and network access and transmission market are
large and highly fragmented. We plan to extend our market position by acquiring
or investing in complementary businesses or technologies on a selected basis. We
also intend to expand our United Kingdom-based electronic power supplies
division's United States presence through acquisition of businesses that offer
complementary products or technology for manufacture in the United States.
LEVERAGE EXISTING CUSTOMER BASE. We believe that many of our existing
customers will continue to purchase network access and transmission products and
test instrument products and services. We intend to aggressively market new and
enhanced products and services to our existing customers. We also believe that
our existing customer base represents an important source of references and
referrals for new customers in new markets.
44
PURSUE FOLLOW-ON SALES OPPORTUNITIES. We plan to continue to increase
the functionality of our communications equipment products, enabling products to
be upgraded by the downloading of software or the addition of hardware to an
existing unit, allowing customers to protect their investment in test equipment
and generating follow-on sales opportunities as we develop new modules in the
future. We plan to continue to approach our existing digital switch customers to
determine whether they need rotary switches that we do not currently manufacture
for them.
SEEK COMPETITIVE WORLD-CLASS MANUFACTURING IN ASIA FOR SELECTED
PRODUCTS. Toward the end of 2002, we cut costs by using Asian manufacturing
sources for selected communications equipment products and subassemblies. We
intend to build on this strategy to increase our competitiveness in the
marketplace.
SEEK ALTERNATIVE MARKET OPPORTUNITIES. We plan to expand our focus and
efforts to identify and capture more new customers, such as private network
utilities and transit customers, for our test equipment.
DEVELOP AND ExPAND STRATEGIC RELATIONSHIPS. We plan to continue to
develop our strategic relationships with network access and transmission and
test instrument manufacturers in order to enhance our product development
activities and leverage shared technologies and marketing efforts to build
recognition of our brands. In particular, in Europe, we intend to continue to
expand our relationships with offshore vendors as a reseller of their products
to enhance our position and reputation as a provider of a comprehensive line of
test equipment products.
PURSUE TECHNOLOGY TRANSFER AND LICENSING. We plan to continue our
established practice of purchasing or licensing core technologies where this
reduces time and cost to market, as we did with the base platform for our remote
access server products purchased from Hayes Corporation.
DEVELOP CUSTOMER-FOCUSED SOLUTIONS. We design, develop, and manufacture
many products and provide services that are tailored to the specific needs of
our customers with an emphasis on ease of use. We intend to continue to adapt
our core communications technologies to deliver focused products that improve
our customers' ability to test and manage increasingly large and complex
networks and that are easily used by field technicians and central office
personnel.
EXTEND OUR GLOBAL PRESENCE. Our customers' needs evolve through
industry expansion and consolidation as well as with the deployment of new
technologies and services. To support our customers more effectively, we intend
to augment our sales, marketing and customer support organizations.
PRODUCTS AND SERVICES
Our products and services currently are divided into the following two
main business segments:
o Electronic Components
-- digital and rotary switches
-- electronic power supplies
-- subsystem assemblies
45
o Communications Equipment
-- network access and transmission products
-- communication timing and synchronization products
-- communications test instruments
During the nine months ended September 30, 2004 and the years ended
December 31, 2003 and 2002, our total net sales were $20,093,000, $25,519,000
and $22,664,000, respectively, and the percentages of total net sales
contributed by each product group within our two main business segments were as
follows:
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------- ----------------------------
SEGMENT AND PRODUCT TYPE 2004 2003 2002
------------------------ ------------------- ------------ -------------
Electronic Components
Digital and Rotary Switches 22.6% 20.9% 20.9%
Electronic Power Supplies 28.6% 34.3% 31.3%
Subsystem Assemblies 0.6% 5.9% 5.0%
Other Products and Services 6.4% 2.3% 1.9%
------------- ------------ -------------
58.2% 63.4% 59.1%
Communications Equipment
Network Access and Transmission Products 27.4% 24.0% 23.8%
Test Instruments 8.8% 9.2% 12.7%
Other Products and Services 5.6% 3.4% 4.4%
------------- ------------ -------------
41.8% 36.6% 40.9%
Totals 100.0% 100.0% 100.0%
============= ============ =============
BACKLOG
Our business is not generally seasonal, with the exception that
purchases of our communications equipment by telecommunications customers tend
to be lower than average during the first quarter of each year because capital
equipment budgets typically are not approved until late in the first quarter. At
September 30, 2004 and December 31, 2003, our backlog of firm, unshipped orders
was approximately $7.3 million and $9.6 million, respectively. Our September 30,
2004 backlog was related approximately 82.5% to our electronic components
business, which tends to provide us with long lead-times for our manufacturing
processes due to the custom nature of the products, and 17.5% our communications
equipment business, the majority of which portion relates to our network access
and transmission products. Of these backlog orders, we anticipate fulfilling
approximately 75% of our electronic components orders and 100% of our
communications equipment orders within the current fiscal year. However, we
cannot assure you that we will be successful in fulfilling these orders in a
timely manner or that we will ultimately recognize as revenue the amounts
reflected as backlog.
WARRANTIES
Generally, our electronic components carry a one-year limited parts and
labor warranty and our communications equipment products carry a two-year
limited parts and labor warranty. Typically our communications equipment
products may be returned within 30 days of purchase if a new order is received,
and the new order will be credited with 80% of the selling price of the returned
item. Products returned under warranty typically are tested and repaired or
replaced at our option. Historically, product returns have not had a material
effect on our operations or financial condition. However, we cannot assure you
that this will continue to be the case or that disputes over components or other
materials or workmanship will not arise in the future.
46
OUR ELECTRONIC COMPONENTS BUSINESS
Our electronic components segment includes digital and rotary switches
and electronic power supplies and subsystem assemblies. During the nine months
ended September 30, 2004 and the years ended December 31, 2003 and 2002, this
segment accounted for 58.2%, 63.4% and 59.1%, respectively, of our total net
sales.
DIGITAL AND ROTARY SWITCHES
XET Corporation's Digitran Division, based in Rancho Cucamonga,
California, manufactures, assembles and sells digital and rotary switch products
serving aerospace, defense and industrial applications. Digital and rotary
switches are manually operated electromechanical devices used for routing
electronic signals. Thumbwheel, push button, lever-actuated and rotary modules,
together with assemblies comprised of multiple modules, are manufactured in many
different model families. The Digitran Division also offers a wide variety of
custom keypads and digital and rotary switches for unique applications.
Our switches may be ordered with different combinations of a variety of
features and options, including:
o 8, 10, 11, 12, 16 or a special number of dial positions;
o special markings and dial characters;
o fully sealed, dust sealed or panel (gasket) sealed switch chambers
to increase resistance to the elements in hostile environments,
such as dust, sand, oils, salt spray, high humidity and
temperature and explosive atmospheres;
o available with radio frequency interference shielding;
o rear mount (flush) or front mount switches that are sold with the
needed installation hardware, or snap in mount switches that do
not require installation hardware;
o provision for mounting components on output terminals on special
personal computer boards; o wire wrap terminals, pin terminals or
special terminations;
o night vision compatibility;
o rotary; and
o VLP(TM) (very low profile) and ELP(TM) rotary.
47
ELECTRONIC POWER SUPPLIES
XPS, based in Ashford, Kent, England, produces a range of high and low
voltage, high specification, high reliability custom power conversion products
designed for hostile environments and supplied to an international customer
base, predominantly in the military and civil aerospace, military vehicle and
telecommunications markets.
Power conversion units supplied by XPS range from 10VA to 1.5 KVA power
ratings, low voltage (1V) to high voltage (20KV+), and convert alternating
current, or AC, to direct current, or DC, convert DC to AC and convert DC to AC.
Units can be manufactured to satisfy input requirements determined by military,
civil aerospace, telecommunications or industrial businesses, and sophisticated
built-in test equipment, or BITE, and control circuitry often is included.
Operating environments for our units are diverse and range from fighter aircraft
to roadside cabinets.
SUBSYSTEM ASSEMBLIES
Subsystem assemblies incorporate various input and display devices and
are manufactured for integration with various aerospace, defense, industrial and
transportation industry systems.
OUR COMMUNICATIONS EQUIPMENT BUSINESS
Our communications equipment business comprises communication timing
and synchronization products, network access and transmission products and
communications test equipment. During the nine months ended September 30, 2004
and the years ended December 31, 2003 and 2002, the sale of communications
equipment products and related services accounted for 41.8%, 36.6% and 40.9%,
respectively, of our total net sales. These products, many of which are
described below, are configured in a variety of models designed to perform
analog and digital measurements or to transmit data at speeds varying from
low-speed voice grade transmission to high-speed broadband access.
Some of the acronyms and terms used most frequently in the product
discussions on the following pages include:
o Time division multiplexing, or TDM, which is a technique for
consolidating multiple data sources into a single data stream by
allocating time slots to each data source
o Traditional telephone services, such as modems and plain old
telephone service, or POTS
o Competitive local exchange carriers, or CLECs
o Bit error rate test, or BERT
o Dial tone multi-frequency, or DTMF
o Transmission impairment measurement, or TIMS
o Central office and private business exchange, or CO/PBX, services,
where the central office houses the local exchange equipment that
routes calls to and from customers and to Internet service
providers and long-distance carriers
o Synchronous - in digital telephone transmission, synchronous means
that the bits from one call are carried within one transmission
frame
o Digital data services, or DDS, including the USA and worldwide
standards described below: I. USA standards, including:
-- ISDN, which is an enhanced digital network that offers
more bandwidth and faster speed than the traditional
telephone network
-- Caller identification or caller-ID services
48
-- Digital subscriber line technology, or DSL, technology
which transmits data up to 50 times faster than a
conventional dial-up modem using existing copper
telephone wires
-- Multi-rate symmetric DSL, or MSDSL, which allows the
transmission of data over longer distances than
single-rate technologies by adjusting automatically or
manually the transmission speed
-- T-1, which is a standard for digital transmission in
North America used by large businesses for broadband
access
-- FT-1, or fractional T-1, which uses only a selected
number of channels from a T-1
-- T-3, which is the transmission rate of 44 megabits, or
millions of bits, per second, or 44 Mbps, with 672
channels
-- Digital signal level 0, or DS0, which is 64 kilobits,
or thousands of bits, per second, or 64 kbps, with one
channel of a T-1, E-1, E-3 or T-3
-- Digital signal level 1, or DS1, which is the T-1
transmission rate of 1.54 Mbps, with 24 channels
-- Digital signal level 3, or DS3, which is the T-3
transmission rate of 44 Mbps, with 672 channels
-- Router, which is an intelligent device used to connect
local and remote networks
-- Terminal adapter, which is situated between telephones
or other devices and an ISDN line and allows multiple
voice/data to share an ISDN line
-- Transmission control protocol/Internet protocol, or
TCP/IP
-- STS/SONET, which is an acronym for synchronous
transport signal/synchronous optical networks or fiber
optic networks
-- SDH is an acronym for synchronous digital hierarchy
-- STM1 (SDH) is a standard technology for synchronous
data transmission on optical media and is the
international equivalent of synchronous optical
network; SDH uses the following synchronous transport
modules, or STMs, and rates: STM1- 155 Mbps, STM-4 -
622 Mbps, STM-16 - 2.5 gigabits per second (Gpbs), and
STM-64 - 10 Gbps
-- G703/G704 is a standard for transmitting voice over
digital carriers such as T-1 and E-1; G703 provides the
specifications for pulse code modulation at data rates
from 64 Kbps to 2.048 Mbps and is typically used for
interconnecting data communications equipment such as
bridges, routers and multiplexers
-- V11/V35/X21 are types of serial interfaces; serial
interfaces work best for short (perhaps less than 20
meters), low-speed applications
-- X.25 is a protocol that allows computers on different
public networks or a TCP/IP network to communicate
through an intermediary computer at the network layer
level
II. International standards, including:
-- E-1, which is the European standard for international
digital transmission used by large businesses for
broadband access, with 2.108 Mbps, with 30 channels
-- FE-1, or fractional E-1, which uses only a selected
number of channels from an E-1
-- E-3, which is the European standard for T-3, with
34.368 Mbps and 480 channels
NETWORK ACCESS AND TRANSMISSION PRODUCTS
CXR-AJ develops, markets and sells a broad range of network access and
transmission products that are manufactured in France by CXR-AJ and sold under
the name "CXR Anderson Jacobson." These products include high-quality network
access devices such as fiber optic, DSL and voice frequency, or VF, modems, ISDN
terminal adapters, ISDN concentrators, multiplexers, terminal servers, interface
converters and remote access servers, which combine to provide users with a
complete solution for voice and data transmission.
49
Modems
------
Our modem product range includes professional grade traditional VF
modems covering the performance spectrum, a range of fiber optic modems and a
range of DSL modems. Our modems are sold as standalone devices for remote sites
or as rack-mountable versions for central sites. Our customers use our
high-quality professional grade modems worldwide for networking and for central
office telecommunications applications such as voicemail and billing systems and
secure communications. Our modems are feature rich and we believe generally
offer more capabilities and better performance than competing products,
especially when operating over poor quality lines. This characteristic alone has
made our modems the modems of choice for voicemail applications throughout the
United States. Our modems are also available in more rugged versions for
industrial applications such as telemetry and remote monitoring in harsh
environments.
ISDN Terminal Adapters
----------------------
Together with modems, we offer a line of ISDN terminal adapters, which
are the popular digital equivalent of analog modems used primarily in Europe.
These terminal adapters are used in a broad range of applications, including
point-of-sale and videoconferencing, and are available in standalone as well as
rack-mountable versions.
Terminal Servers
----------------
Terminal servers include a range of products that enable the connection
of asynchronous applications to the Ethernet Network. These products were
designed to meet the requirements of our customers to interface equipment to the
corporate local area network, commonly called the LAN, and therefore to the
outside world, via our range of network access products.
Drop and Insert Multiplexers
----------------------------
Our broad range of drop and insert multiplexers covers E-1, T-1, FE-1,
E-3, T-3 and STM1 (SDH) over both copper wires and fiber optic networks. The
units enable users to manage the consolidation of their information from a
variety of voice or data sources (G703, G704, X21, V11 and V35) through an
easy-to-use menu-driven and Microsoft Windows-based user interface.
Modular Routers
---------------
Our commercial/industrial router product range is modular, which
provides users the flexibility to configure or have configured a unit that meets
their specific requirements. Our routers provide access to the Internet or
remote sites via ISDN, leased line, X.25, frame relay and DSL connections. The
router creates or maintains a table of available routes and their conditions and
uses this information, along with distance and cost algorithms, to determine the
best route for a given packet of data.
Interface Converters
--------------------
Our range of interface converters provides users the ability to
interface data from LAN, V11 or V35 to E-1, T-1, E-3, T-3 and STM1. A channel
service unit/data service unit, or CSU/DSU, converts a digital data frame from a
LAN into a frame appropriate to a wide area network, or WAN.
50
ISDN Concentrators
------------------
We also manufacture and offer a line of ISDN intelligent concentrators
called CB2000. These products, which were designed primarily for the European
market, allow for better use of ISDN resources.
TDMoIP Voice and Data transmission
----------------------------------
Our IP-Jet TDMoIP products facilitate the use of TDM services and
equipment over the Packet Switched Network bringing simplicity with lower cost
without the costly need to replace existing TDM hardware for both carrier and
enterprise users. TDM over IP, or TDMoIP, takes advantage of the internet
protocol, or IP, infrastructure and changing economics of data services delivery
to deliver high revenue leased line services such as E1 and T1. TDMoIP is also
ideal for the enterprise looking to reduce network expenses without compromising
features of their existing PBX and TDM equipment allowing all TDM traffic to be
carried transparently over Ethernet and IP networks irrespective of protocols or
signaling. Typical TDMoIP applications include: transmission of E1/T1, voice,
video and TDM data and IP, centralized voice services over Ethernet or IP,
secure data transmission E1/T1, and transmission of HDLC over IP.
The following are descriptions of a few of our more prominent network
access and transmission products:
PRODUCT NAME KEY USES, FEATURES AND FUNCTIONS
------------ --------------------------------
POWER MODEMS A family of products that allow asynchronous and synchronous
transmission over dial-up or leased lines; asynchronous
transmission is a very high-speed transfer mode that allows
telephone companies to mix formerly incompatible signals, such
as voice, video and data.
-- in dial-up applications, a unique line qualification
mechanism assesses the quality of the line and
automatically redials before entering the
transmission mode when a poor line is detected, which
avoids having to transmit in a degraded mode and
leads to money savings in long transmission sessions
-- available in standalone units or as rack mountable
cards to be inserted into our Smart Rack
-- industrial versions designed for harsh environments
are available with features such as extra line
protection, metallic enclosures, extended temperature
ranges and high humidity protection
MD 2000 RANGE A multi-rate MSDSL modem that has the ability to manually or
automatically adjust line transmission speed to provide the
optimum performance for a particular pair of copper wires.
-- operates over a single twisted pair of copper wires,
which allows telecommunications companies to take
advantage of the large installed base of copper
twisted pairs that has been deployed around the world
over many years and upon private copper wire
infrastructures that exist for networking purposes in
locations such as universities, hospitals, military
bases, power plants and industrial complexes
-- allows data transmission over a single copper pair at
E-1 speed over a distance of up to 8.0 miles
-- available as both a standalone unit and as a
rack-mountable card
51
CB 2000 RANGE The primary function of this unit is to split one or two
primary rate interface links, or PRIs, into multiple basic
rate interfaces, or BRIs.
-- this allows substantial cost savings by allowing more
effective use of available ISDN resources without the
limitations of conventional voice PBX
-- this allows for migration from BRI to PRI when the
number of ports needs to be increased while
preserving the user's investment in existing
BRI-based terminal equipment
-- this unit can be used in a wide variety of situations
where multiple BRI and PRI access is required, such
as:
- videoconferencing, where the unit can be
used to aggregate bandwidth of multiple BRI
lines to provide the necessary bandwidth,
and to connect the videoconferencing system
to the ISDN network through a PRI access
while still providing connectivity to other
ISDN devices, or to connect two or more
videoconferencing systems together within
the same building or campus without going
through the ISDN public network
- ISDN network simulation, which can be used
in places such as showrooms, exhibition and
technical training centers to eliminate the
need to have access to, and pay for access
to, the ISDN public network for telephone or
data calls
- remote access servers, which usually use
multiple BRIs, often need a method for
migration from multiple BRIs to a single PRI
as traffic and the number of users expands
ISDN TERMINAL These devices are the ISDN equivalent of a modem.
ADAPTERS -- these devices connect non-ISDN devices to the ISDN
via a network termination unit, or NT1, which
converts the "U" interface from the telephone company
into a 4-wire S/T interface
-- allow users to access the data rates of the digital
network
-- available as both a standalone unit and as a
rack-mountable card
TERMINAL SERVERS This range of products is used to provide the connection of
asynchronous applications to the TCP/IP Ethernet network.
These can include point-of-sale terminals, industrial
machines, point-to-point RS232 connections and the visual
display units/keyboards.
DROP AND INSERT These products provide users the ability to manage the
MULTIPLEXERS consolidation of data and/or voice information over a variety
of TDM networks such as E-1, T-1, E-3, T-3 and STM (SDH).
-- easily configured via management software
-- remotely manageable over IP or dedicated time slot
ROUTERS A router provides connection between the primary rate ISDN and
local area networks.
-- dynamically route incoming and outgoing data packets
to the appropriate destination
-- available as both a standalone unit and as a
rack-mountable card to supplement the functions of
our Smart Rack system
52
Smart Rack
----------
Our modem cards and our ISDN terminal adapter cards generally are
available in standalone versions or in versions that can be mounted in our Smart
Rack, our universal card cage that provides remote management through a
menu-driven user interface. Each part of the framework, or chassis, of the Smart
Rack has slots to house up to 16 cards (or up to 4 cards in a smaller
installation) plus one optional management card. Each slot can be used to insert
any member of our transmission products family, such as analog modems, ISDN
terminal adapters, ISDN digital modems and high-speed MSDSL modems. The optional
Simple Network Management Protocol/Internet Protocol, OR SNMP/IP, management
card that can be inserted into each chassis can be used to configure any card in
the chassis and can provide additional features, including alarm reporting,
tracking of configurations, running of diagnostic routines and generation of
statistics. Up to eight chassis can be linked together to form a fully-managed
node with 128 slots. Our Smart Rack arrangement allows each chassis to be used
to its full capacity while reducing floor space needed to house complex systems.
COMMUNICATIONS TEST INSTRUMENTS
Our primary field test instruments, built by our CXR Larus subsidiary
in San Jose, California, are our CXR HALCYON 700 series of products, which we
believe provide performance and value in integrated installation, maintenance
and testing of communications services. These test instruments are modular,
rugged, lightweight, hand-held products used predominantly by telephone and
Internet companies to pre-qualify facilities for services, verify proper
operation of newly installed services and diagnose problems. Original equipment
manufacturers, or OEMs, also use service verification equipment to test
simulated networks during equipment development and to verify the successful
production of equipment.
The unique modular nature of our CXR HALCYON 700 series test equipment
provides an easy configuration and upgrade path for testing of the specific
services offered by the various national and international service providers.
Key performance enhancements to this product family address the trend toward
conversion of analog service installations to high-speed digital access lines.
Some of these key features include:
o ability to conduct the 23-tone test, which is an automated single
key-stroke test that performs the equivalent of over 12 individual
test sequences;
o load-coil analysis, which identifies the presence of voice coils
that prevent high-speed digital access; and
o voice analysis and testing of individual T-1 channels.
We believe that these enhancements will allow further penetration of
CXR HALCYON 700 series test equipment into the telecommunications services
market. Some of the key test equipment products we offer are described below:
PRODUCT NAME KEY USES, FEATURES AND FUNCTIONS
------------ --------------------------------
BASE UNITS
----------
HALCYON 704A-400 SERIES -- handheld transmission and signaling wideband
test set for ISDN, HDSL, DDS and ADSL
facility testing
-- optimized for use in installation and
maintenance of analog voice and data
services
-- provides users with single-button test
execution, which allows quick circuit
diagnosis and repair without extensive
training
53
PRODUCT NAME KEY USES, FEATURES AND FUNCTIONS
------------ --------------------------------
HALCYON 756A -- handheld integrated test set for
installation and maintenance of digital data
circuits, including DDS, Switched 56K,
2-wire Datapath, ISDN, T-1 and FT-1
-- provides users with intuitive user interface
allowing quick circuit diagnosis and repair
without extensive training
HALCYON 764A -- handheld integrated test set for
installation and maintenance of T-1
facilities
-- can be used for T-1 and FT-1 access and
testing
-- T-1 monitor testing occurs automatically
upon plugging in the test set and returns
information; test pattern; customer data
detected and errors, if any.
-- T-1 BERT testing can be accomplished in
automatic mode, which automatically frames
and detects pattern if present and displays
an all clear message or the type and count
of errors, or in the manual mode, which
allows the technician to do a simple set up
where the technician dictates the variety of
test patterns and measurements used
TYPICAL OPTIONAL CONFIGURATIONS
-------------------------------
HALCYON 704A-NTS1 -- 704A universal data test set with 1.5 MHz
TIMS, full signaling, caller ID and full
4-wire loop DDS test functions, as well as
DDS/DS0 test functions and T-1, DS1, DS0 and
FT-1 test package
-- T-1 test package includes reference receiver
for T-1 level, frequency and slip
measurements
HALCYON 704A-NTS2 -- universal data test set
-- handheld wideband test set for installation
and maintenance of analog voice and data and
digital data circuits including Switched 56K
-- expands upon the features of the 704A-400 to
add DDS BRI/ISDN and DS1/T-1/FT-1 test
functions
HALCYON 704A-PKG2 -- 704A universal data test set with 1.5 MHz
TIMS, full signaling, full 4-wire loop DDS
test functions, as well as DDS/DS0 test
functions for DS0-DP and OCU-DP DS0 and
sub-rate testing
HALCYON 756A-PG -- handheld integrated test set designed for
the testing and performance monitoring of
digital data communication links for
"protective relaying backbone
communications" for power utility companies
-- provides users with a test set which closely
emulates the live operating conditions of
the data links while providing an intuitive
user interface allowing quick circuit
diagnosis and repair without extensive
training
CENTRAL OFFICE TEST EQUIPMENT
-----------------------------
T-COM 440B T-ACE This is a high-performance integrated
digital communications test instrument.
-- used to monitor and assure service
reliability of high-density digital test
nodes and switch centers
-- provides comprehensive digital test
measurements ranging from STS/SONET, DS3,
through T-1, FT-1, DSO and DDS services
54
COMMUNICATION TIMING AND SYNCHRONIZATION PRODUCTS
CXR Larus, located in San Jose, California, manufactures a series of
communication timing and synchronization products that provide a consistent
source of timing alignment, or synchronization, for digital communication
networks. When the principal network timing source is lost, a CXR Larus
communication timing system can provide an alternative source of reference
synchronization until the principal source can be restored. This is called
operating in the "holdover" state. The various levels of accuracy in holdover
mode are referred to as "stratum levels." Stratum 1 is the most precise,
followed by Stratum 2, Stratum 3E, Stratum 3, and finally Stratum 4. Stratum 4
has no holdover mode and is the least precise. All CXR Larus communication
timing products offer Stratum 3E stability, or better, and all are available
with options that meet or exceed Stratum 1.
Some of the key communication timing and synchronization products we
offer are described below:
PRODUCT NAME KEY USES, FEATURES AND FUNCTIONS
------------ --------------------------------
STAR SYNC(TM) 5850 PRIMARY The Larus StarSync(TM) Model STS 5850 is an
REFERENCE SOURCE economical GPS timing clock designed for
retrofits of existing BITS clocks and for remote
sites that require timing. The StarSync(TM)
provides GPS Stratum 2 clock with Stratum 2 or 3E
holdover performance.
The STS 5850 features two accurate T1 timing
references that are synthesized from GPS for use
by BITS clocks, SONET NEs, intelligent
multiplexers, and PCS systems as well as other
systems requiring synchronization. Options permit
the STS 5850 to be configured for Stratum 1 Input
Track and either Stratum 2 or Stratum 3E Hold.
Superior performance is achieved by Kalman
filtering, patented digital frequency synthesis
technology, and use of GPS UTC information to
measure a rubidium oscillator (Stratum 2) or an
ultra stable ovenized reference oscillator
(Stratum 3E).
STARCLOCK(TM) STS 5800 The Larus StarClock(TM) STS 5800 Timing System
TIMING SYSTEM provides GPS Stratum 1 clock and/or network
tracking with Stratum 2 or Stratum 3E holdover
performance. The Larus StarClock(TM) represents
the optimal local synchronization solution for
the new distributed network. The STS 5800 is an
economical extended temperature timing system
that is designed for small installations and
remote sites requiring timing (cell sites, PCS
networks, customer premises, etc.). The output
MTIE of the STS 5800 meets the mask performance
specified by GR-2830 for Stratum 1 clocks,
resulting in an improvement of ten to twenty
times over other GPS solutions.
55
PRODUCT NAME KEY USES, FEATURES AND FUNCTIONS
------------ --------------------------------
STARCLOCK(TM) 100 AND The innovative StarClock(TM) 100 and 200
STARCLOCK(TM) 200 Synchronization Timing Systems offers flexible
T1/E1 SYNCHRONIZATION and cost-effective solutions for Stratum 1,
TIMING SYSTEMS Stratum 2E, and Stratum 3E timing for digital
transmission and synchronization applications.
The systems provide a redundant and jitter-free
source of framed ones and composite clock and are
synchronized to an equal or higher stratum framed
reference source. The StarClock(TM) 100 and 200
systems can be employed in either DS1 or E1
digital transmission environments simply by
selecting the appropriate modules.
The StarClock(TM) 100 and 200 systems are the
next generation of Larus'
industry-performance-standard STS 5400
Synchronization System and features backward
compatibility with the STS 5400. StarClock(TM)
100 and 200 circuit card switch settings and
operating functions are software generated,
affording both speed and flexibility for system
application changes, testing, and monitoring.
The StarClock(TM) 100 system supplies up to 100
timing outputs for use in the synchronization of
transmultiplexers, digital cross-connect systems,
and SONET equipment as well as other equipment
requiring network synchronization. Hundreds of
these systems have been deployed into major
local exchange carriers, and international
central offices worldwide.
The StarClock(TM) 200, designed specifically for
the RBOC and large central office environment,
offers up to 200 timing outputs unprotected, or
100 timing outputs with 1:1 protection. Expansion
shelves can be added to the StarClock(TM) 200
system that will boost the number of timing
outputs into the thousands, enough for the
largest central office.
Optional modules for both systems include a GPS
Stratum 1 track and Stratum 2E hold or Stratum 1
track and Stratum 3E hold card, with integral GPS
receiver, a Composite Input Signal module, a
module that uses 5 or 10 MHz inputs, and the
Model 54580 Network Time Server.
CUSTOMERS
ELECTRONIC COMPONENTS
We sell our components primarily to OEMs in the electronics industry,
including manufacturers of aerospace and defense systems, industrial instruments
and test equipment. During 2003, our top five electronic components customers in
terms of revenues were the BAE Systems companies, MBDA (U.K.) Ltd., Thales
Defense Ltd., Essential Components, Inc. and Raytheon Systems. Sales to the BAE
Systems companies represented approximately 12.5% percent of our total net sales
revenues during 2003. No other customer represented 10% or more of our total
revenues net sales during 2003. Currently we are experiencing an increase in our
electronic components business which we believe to be due primarily to the war
on terrorism and a general expansion of defense-related business in Europe, the
United States and Asia.
56
COMMUNICATIONS EQUIPMENT
We market our network access and transmission products and
communications test instruments primarily to public, private and corporate
telecommunications service providers and end users. Typically, communications
service providers use a variety of network equipment and software to originate,
transport and terminate communications sessions. Communications service
providers rely on our products and services as elements of the communications
infrastructure and to configure, test and manage network elements and the
traffic that runs across them. Also, our products help to ensure smooth
operation of the network and increase the reliability of services to customers.
The major communications service providers to whom we market our
telecommunications test instruments and network access and transmission products
and services include inter-exchange carriers, incumbent local exchange carriers,
competitive local exchange carriers, Internet service providers, integrated
communications providers, cable service providers, international post, telephone
and telegraph companies, banks, brokerage firms, government agencies and other
service providers. During 2003, our top five communications test instruments and
network access and transmission products customers in terms of our net sales
were Verizon, Siemens, SBC, Coris and Carte, SA. None of our communications
equipment customers represented 10% or more of our revenues during 2003.
Because we currently derive a significant portion of our revenues from
sales to RBOCs and other telecommunications service providers, we have
experienced and will continue to experience for the foreseeable future an effect
on our quarterly operating results due to the budgeting cycles of the RBOCs.
RBOCs generally obtain approval for their annual budgets during the first
quarter of each calendar year. If an RBOC's annual budget is not approved early
in the calendar year or is insufficient to cover its desired purchases for the
entire calendar year, we are unable to sell products to the RBOC during the
period of the delay or shortfall.
Due to a general downturn in business activity in the public carrier
telecommunications capital equipment market during 2002 and 2003, all RBOCs
reduced their capital expenditures, which negatively affected our 2002 and 2003
sales of test instruments. Our observance was that capital expenditure levels of
RBOCs and other telecommunications carriers remained at reduced levels in 2003.
However, we have reduced costs and improved our business operations so that our
current monthly break-even sales requirement is approximately 50% of our
requirement in 2002. This, coupled with our observed signs of increased buying
activities of the RBOCs in the fourth quarter of 2003 and fourth quarter of
2004, gives us reason to believe that the RBOCs will increase purchases of test
equipment in 2005.
Communications equipment manufacturers design, develop, install and
maintain voice, data and video communications equipment. Network equipment
manufacturers such as Cisco and Nortel rely on our test equipment products to
verify the proper functioning of their products during final assembly and
testing. Increasingly, because communications service providers are choosing to
outsource installation and maintenance functions to the equipment manufacturers
themselves, equipment manufacturers are using our instruments, systems and
software to assess the performance of their products during installation and
maintenance of a customer's network.
The continuing general downturn in business activity in the
telecommunications market during 2003 also seriously affected communications
equipment manufacturers, particularly following the collapse of many
Internet-based companies. As a result, sales of our telecommunications central
office equipment to telecommunications carriers and communications equipment
manufacturers have been seriously affected.
57
SALES, MARKETING AND CUSTOMER SUPPORT
ELECTRONIC COMPONENTS
We market and sell our electronic components through XET Corporation's
Digitran Division, XCEL Corporation Ltd., a wholly-owned subsidiary of XET
Corporation based in England, XPS, a wholly-owned subsidiary of XCEL Corporation
Ltd. based in England, and XCEL Japan, Ltd., a wholly-owned subsidiary of XET
Corporation based in Japan. In some European countries and the Pacific Rim,
these products are sold through a combination of direct sales and through
third-party distributors.
We sell our electronic components primarily to OEMs in the electronics
industry, including manufacturers of aerospace and military systems,
communications equipment and industrial instruments. Our efforts to market our
electronic components generally are limited in scope since we rely on sales to a
broad base of historical customers with whom we have long-term business
dealings.
XCEL Japan, Ltd. resells digital and rotary switch and keypad products
of the Digitran Division and some third-party-sourced components primarily into
Japan and also into other highly industrialized Asian countries. Other marketing
of our electronic components is primarily through referrals from our existing
customers, with sales either direct or via a small number of selected
representatives.
We rely on long-term orders and repeat business from our existing
customers. We also approach our existing customers and their competitors to
discuss opportunities for us to provide them with additional types of switches
they may need. Also, the Digitran Division's history spans over 40 years in the
electronic components industry and major OEMs have designed many of our switches
and subsystem assemblies into their product specifications. These factors have
frequently resulted in customers seeking us out to manufacture for them unique
subsystem assemblies as well as special variations of our standard digital
switches.
COMMUNICATIONS EQUIPMENT
Our sales and marketing staff consist primarily of engineers and
technical professionals. Our staff undergo extensive training and ongoing
professional development and education. We believe that the skill level of our
sales and marketing staff has been instrumental in building longstanding
customer relationships. In addition, our frequent dialogue with our customers
provides us with valuable input on systems and features they desire in future
products. We believe that our consultative sales approach and our product and
market knowledge differentiate our sales forces from those of our competitors.
Our local sales forces are highly knowledgeable about their respective
markets, customer operations and strategies and regulatory environments. In
addition, our representatives' familiarity with local languages and customs
enables them to build close relationships with our customers.
We provide repair and training services to enable our customers to
improve performance of their networks. We also offer on-line support services to
supplement our on-site application engineering support. Customers can also
access information regarding our products remotely through our domestic,
European and Japanese technical assistance centers.
58
We sell many of our communications test instruments and network access
and transmission products to large telecommunications service providers. These
prospective customers generally commit significant resources to an evaluation of
our and our competitors' products and require each vendor to expend substantial
time, effort and money educating them about the value of the vendor's solutions.
Consequently, sales to this type of customer generally require an extensive
sales effort throughout the prospective customer's organization and final
approval by an executive officer or other senior level employee. The result is
lengthy sales and approval cycles, which make sales forecasting difficult. In
addition, even after a large telecommunications service provider has approved
our product for purchase, their future purchases are uncertain because while we
generally enter into long-term supply agreements with those parties, these
agreements do not require specific levels of purchases. Delays associated with
potential customers' internal approval and contracting procedures, procurement
practices, testing and acceptance processes are common and may cause potential
sales to be delayed or foregone. As a result of these and related factors, the
sales cycle of new products for large customers typically ranges from six to
twelve months or more.
COMPETITION
ELECTRONIC COMPONENTS
The market for our components is highly fragmented and composed of a
diverse group of OEMs, including Power One, Interpoint/Grenson, Martek and Celab
Ltd. for power supplies and Esterline (Janco), Greyhill, Inc., Omron
Electronics, Transico Inc. and C&K Components Inc. for digital switches. We
believe that the principal competitive factors affecting our components business
include:
o capability and quality of product offerings;
o status as qualified products; and
o compliance with government and industry standards.
We have made substantial investments in machinery and equipment
tooling. In addition, XET's Digitran Division's history spans over 40 years in
the electronic components industry, and major OEMs have designed many of our
digital switches into their product specifications. We believe that these
factors have acted as barriers to entry for other potential competitors and
aided us in establishing and maintaining both distribution channels and
customers for our products by making us a sole source supplier for approximately
30% to 50% of the digital switches that we sell and causing some customers to
seek us out to manufacture for them unique as well as our standard digital
switches.
Some of our competitors have greater sales, marketing, technological,
research and financial resources than we do. Our competitors' advantage with
regard to these resources may reduce our ability to obtain or maintain market
share for our products in cases where our competitors are better able than us to
satisfy the above competitive factors.
COMMUNICATIONS EQUIPMENT
The markets for our communications equipment and services are
fragmented and intensely competitive, both inside and outside the United States,
and are subject to rapid technological change, evolving industry standards and
regulatory developments. We believe that the principal competitive factors
affecting our communications equipment business include:
o quality of product offerings;
59
o adaptability to evolving technologies and standards;
o ability to address and adapt to individual customer requirements;
o price and financing terms;
o strength of distribution channels;
o ease of installation, integration and use of products;
o system reliability and performance; and
o compliance with government and industry standards.
Our principal competitors for our communications equipment include
Symettricom and Oscilloquartz, for communication timing and synchronization
products, RAD, Paradyne, Patton Electronics Corporation, Digital Engineering,
Ltd. and GDC, for network access and transmission products, and TTC Corporation
(a subsidiary of Dynatech Corporation), Ameritech Corporation, Fluke, Sunrise
Telecom, Inc. and Electrodata, Inc., for communications test instruments.
The design of many of our data transmission products enables us to
offer numerous different product combinations to our customers and to serve both
central site data communications needs and remote access and transmission sites
on both the enterprise-wide and single location level. We believe that this
design flexibility helps us to excel at many of the above competitive factors by
enabling us to offer quality products that meet and are adaptable to evolving
customer requirements, technologies and government and industry standards.
We currently derive a significant portion of our revenues from sales to
RBOCs. We believe we derive a competitive advantage from efforts we expended to
establish many of our communications equipment products as approved products for
all of the RBOCs and for other key customers in the United States and abroad.
Our products' approved status facilitates the ability of our customers to order
additional products from us as their needs arise without the long delays that
might otherwise be needed to obtain the approval of our customers' upper
management or governing body prior to each purchase.
Some of our competitors have greater sales, marketing, technological,
research and financial resources than we do. Our competitors' advantage with
regard to these resources may reduce our ability to obtain or maintain market
share for our products in cases where our competitors are better able than us to
satisfy the above competitive factors.
MANUFACTURING, ASSEMBLY AND QUALITY ASSURANCE
Our network access and transmission communications test instruments
generally are assembled from outsourced components, with final assembly,
configuration and quality testing performed in house.
Manufacturing of our electronic components, including injection
molding, fabrication, machining, printed circuit board manufacturing and
assembly, and quality testing is done in house due to the specialized nature and
small and varied batch sizes involved. Although many of our electronic
components incorporate standard designs and specifications, products are built
to customer order. This approach, which avoids the need to maintain a finished
goods inventory, is possible because long lead-times for delivery often are
available. Typically, our electronic components segment produces products in
one- to 300-piece batches, with a ten- to thirty-week lead-time. The lead-time
is predominantly to source sub-component piece parts such as electronic
components, mechanical components and services. Typical build time is six to
eight weeks from receipt of external components.
60
We operate four manufacturing and assembly facilities worldwide. All of
these facilities are certified as ISO 9001- or 9002-compliant. We have
consolidated all of our network access and transmission manufacturing for our
North American and European markets at our French manufacturing facility at
CXR-AJ. We manufacture all of our test equipment and communication timing and
synchronization products at the San Jose, California facility of CXR Larus. We
manufacture all of our digital and rotary switches in our Rancho Cucamonga,
California facility. We manufacture our electronic power supplies in Ashford,
Kent, England.
The purchased components we use to build our products are generally
available from a number of suppliers. We rely on a number of limited-source
suppliers for specific components and parts. We do not have long-term supply
agreements with these vendors. In general, we make advance purchases of some
components to ensure an adequate supply, particularly for products that require
lead-times of up to nine months to manufacture. If we were required to locate
new suppliers or additional sources of supply, we could experience a disruption
in our operations or incur additional costs in procuring required materials.
We intend to increase the use of outsource manufacturing for our
communications equipment products. We believe that outsourcing will lower our
manufacturing costs, in particular our labor costs, provide us with more
flexibility to scale our operations to meet changing demand, and allow us to
focus our engineering resources on new product development and product
enhancements.
PRODUCT DEVELOPMENT AND ENGINEERING
We believe that our continued success depends on our ability to
anticipate and respond to changes in the electronics hardware industry and
anticipate and satisfy our customers' preferences and requirements. We
continually review and evaluate technological and regulatory changes affecting
the electronics hardware industry and seek to offer products and capabilities
that solve customers' operational challenges and improve their efficiency.
For the nine months ended September 30, 2004 and the years ended
December 31, 2003 and 2002, our engineering and product development costs were
approximately $1,033,000, $950,000 and $1,020,000, respectively.
Our product development costs during the past three years were related
to development of new communications test equipment and voice, data and video
transmission equipment and development of a new line of rotary switches at our
Digitran facility. We have continued incurring engineering costs applicable to
the development of rotary switches during and since 2004. Current research
expenditures in the communications equipment segment are directed principally
toward enhancements to the current test instrument product line and the
expansion of our range of network access and transmission products. These
expenditures are intended to improve market share and gross profit margins,
although we cannot assure you that we will achieve these improvements.
61
We strive to take advantage of the latest computer-aided engineering
and engineering design automation workstation tools to design, simulate and test
advanced product features or product enhancements. Our use of these tools helps
us to speed product development while maintaining high standards of quality and
reliability for our products. Our use of these tools also allows us to
efficiently offer custom designs for OEM customers whose needs require the
integration of our electronic components with their own products.
INTELLECTUAL PROPERTY
We regard our software, hardware and manufacturing processes as
proprietary and rely on a combination of patent, copyright and trademark laws,
trade secrets, confidentiality procedures and contractual provisions to protect
our proprietary rights. We have filed patent applications, and intend to file
additional patent applications in the future, for various products with the
United States Patent and Trademark Office and in the European Union, Japan,
Canada and Brazil. We seek to protect our software, documentation and other
written materials under trade secret and copyright laws, which afford some
limited protection. The laws of some foreign countries do not protect our
proprietary rights to the same extent as do the laws of the United States. Our
research and development and manufacturing process typically involves the use
and development of a variety of forms of intellectual property and proprietary
technology. In addition, we incorporate technology and software that we license
from third party sources into our products. These licenses generally involve a
one-time fee and no time limit. We believe that alternative technologies for
this licensed technology are available both domestically and internationally.
We may receive in the future notices from holders of patents that raise
issues as to possible infringement by our products. As the number of test
equipment products and transmission instruments increases and the functionality
of these products further overlaps, we believe that we may become subject to
allegations of infringement given the nature of the telecommunications and
information technology industries and the high incidence of these kinds of
claims. Questions of infringement and the validity of patents in the fields of
telecommunications and information technology involve highly technical and
subjective analyses. These kinds of proceedings are time consuming and expensive
to defend or resolve, result in substantial diversion of management resources,
cause product shipment delays or could force us to enter into royalty or license
agreements rather than dispute the merits of the proceeding initiated against
us.
GOVERNMENT REGULATION AND INDUSTRY STANDARDS AND PROTOCOLS
We design our products to comply with a significant number of industry
standards and regulations, some of which are evolving as new technologies are
deployed. In the United States, our products must comply with various
regulations defined by the United States Federal Communications Commission, or
FCC, and Underwriters Laboratories as well as industry standards established by
Telcordia Technologies, Inc., formerly Bellcore, and the American National
Standards Institute. Internationally, our products must comply with standards
established by the European Committee for Electrotechnical Standardization, the
European Committee for Standardization, the European Telecommunications
Standards Institute and telecommunications authorities in various countries, as
well as with recommendations of the International Telecommunications Union. The
failure of our products to comply, or delays in compliance, with the various
existing and evolving standards could negatively affect our ability to sell our
products.
Our product lines are subject to statutes governing safety and
environmental protection. We believe that we are in substantial compliance with
these statutes and are not aware of any proposed or pending safety or
environmental rule or regulation that, if adopted, would have a material affect
on our business or financial condition.
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EMPLOYEES
As of January 24, 2005, we employed a total of 215 persons in our
various divisions and subsidiaries. None of our employees are represented by
labor unions, and there have not been any work stoppages at any of our
facilities. We believe that our relationship with our employees is good.
PROPERTIES
As of January 24, 2005, we leased or owned approximately 119,000 square
feet of administrative, production, storage and shipping space. All of this
space was leased other than the Abondant, France facility.
FUNCTION /
BUSINESS UNIT LOCATION LEASE EXPIRATION DATE
------------- -------- ---------------------
Emrise Corporation Rancho Cucamonga, California Administrative;
(corporate headquarters) Expires October 2005
XET Corporation/Digitran Rancho Cucamonga, California Manufacturing;
(electronic components) Expires November 2005
Monrovia, California Expires February 2005
XCEL Power Systems, Ltd. Ashford, Kent, United Kingdom Administrative/Manufacturing;
and XCEL Corporation Ltd. Expires March 2013
(electronic components)
XCEL Japan, Ltd. Higashi-Gotanda Tokyo, Japan Sales;
(electronic components) Expires December 2005
CXR-AJ Paris, France Administration/Sales;
(network access and transmission products) Expires April 2007
CXR-AJ Abondant, France Manufacturing/Engineering;
(network access and transmission products) Facility is owned
CXR Larus San Jose, California Administrative/Engineering/
(network access and transmission Manufacturing;
products, communications test Expires June 30, 2011 and is
instruments, communication timing and renewable
synchronization products)
On November 1, 2004, CXR Larus relocated from its Fremont facility to
the facility in San Jose occupied by Larus Corporation at the time it was
acquired in July 2004. We have a lease on the facility that expires June 30,
2011, with an option to renew.
The lease for the Ashford, Kent, United Kingdom facility is a
fifteen-year lease that expires in March 2013, subject to the rights of the
landlord or us to terminate the lease after ten years.
We believe the listed facilities are adequate for our current business
operations.
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LEGAL PROCEEDINGS
We are not presently involved in any material legal proceedings.
64
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The names, ages and positions held by our directors and executive
officers as of January 24, 2005 are as follows:
NAME AGE POSITIONS HELD
---- --- --------------
Carmine T. Oliva................... 61 Chairman of the Board, President,
Chief Executive Officer and
Director
Graham Jefferies................... 47 Executive Vice President, Chief
Operating Officer and Managing
Director of various subsidiaries
Randolph D. Foote.................. 55 Senior Vice President, Chief
Financial Officer and Secretary
Robert B. Runyon (1)(2)............ 78 Director
Laurence P. Finnegan, Jr. (1)(3)... 67 Director
Otis W. Baskin..................... 59 Director
-----------
(1) Member of the compensation committee.
(2) Member of the nominating committee.
(3) Member of the audit committee.
CARMINE T. OLIVA has been Chairman of the Board, President and Chief
Executive Officer and a Class III director of Emrise since March 26, 1997 and of
our subsidiary, XET Corporation, since he founded XET Corporation in 1983. Mr.
Oliva has been Chairman of the Board of XCEL Corporation, Ltd. since 1985, and
Chairman and Chief Executive Officer of CXR Larus since March 1997. In 2002, Mr.
Oliva obtained a French government working permit and assumed responsibility as
President of our CXR-AJ subsidiary. From January 1999 to January 2000, Mr. Oliva
served as a director of Digital Transmission Systems Inc. (DTSX), a publicly
held company based in Norcross, Georgia. From 1980 to 1983, Mr. Oliva was Senior
Vice President and General Manager, ITT Asia Pacific Inc. Prior to holding that
position, Mr. Oliva held a number of executive positions with ITT Corporation
and its subsidiaries over an eleven-year period. Mr. Oliva attained the rank of
Captain in the United States Army and is a veteran of the Vietnam War. Mr. Oliva
earned a B.A. degree in Social Studies/Business from Seton Hall University and
an M.B.A. degree in Business from The Ohio State University.
GRAHAM JEFFERIES was appointed as Executive Vice President on October
21, 1999. Mr. Jefferies was also appointed as our Chief Operating Officer on
January 3, 2005, after having served as Chief Operating Officer of our
Telecommunications Group since October 21, 1999. Mr. Jefferies served as
Executive Vice President of Emrise from April 1999 through October 1999. Mr.
Jefferies has served CXR-AJ as a director since March 1997 and as General
Manager since July 2002, has served as Managing Director of Belix Power
Conversions Ltd., Belix Wound Components Ltd. and Belix Company Ltd. since our
acquisition of those companies in April 2000, as Managing Director of XCEL Power
Systems, Ltd. since September 1996 and as Managing Director of XCEL Corporation,
Ltd. since March 1992. Prior to joining us in 1992, he was Sales and Marketing
Director of Jasmin Electronics PLC, a major United Kingdom software and systems
provider, from 1987 to 1992. Mr. Jefferies held a variety of project management
positions at GEC Marconi from 1978 to 1987. Mr. Jefferies earned a B.S. degree
in Engineering from Leicester University, and has experience in mergers and
acquisitions. Mr. Jefferies is a citizen and resident of the United Kingdom.
65
RANDOLPH D. FOOTE was appointed as our Senior Vice President and Chief
Financial Officer on October 4, 1999 and as our Assistant Secretary on February
12, 2001. Mr. Foote has been our Secretary since September 2004 and the Vice
President and Chief Financial Officer of CXR Larus and XET Corporation since
March 2000. Mr. Foote was the Corporate Controller of Unit Instruments, Inc., a
publicly traded semiconductor equipment manufacturer, from October 1995 to May
1999. From March 1985 to October 1995, Mr. Foote was the Director of Tax and
Financial Reporting at Optical Radiation Corporation, a publicly traded company
that designed and manufactured products using advanced optical technology. Prior
to 1985, Mr. Foote held positions with Western Gear Corporation and Bucyrus Erie
Company, which were both publicly traded companies. Mr. Foote earned a B.S.
degree in Business Management from California State Polytechnic University,
Pomona and an M.B.A. degree in Tax/Business from Golden Gate University.
ROBERT B. RUNYON has served as a Class III director since March 26,
1997 and also served as our Secretary from that date through August 2004. He has
been the owner and principal of Runyon and Associates, a human resources and
business advisory firm, since 1987. He has acted as Senior Vice President of Sub
Hydro Dynamics Inc., a privately held marine services company based in Hilton
Head, South Carolina, since September 1995. Prior to our merger with XET
Corporation, Mr. Runyon served XET Corporation both as a director since August
1983 and as a consultant in the areas of strategy development and business
planning, organization, human resources and administrative systems. He also
consults for companies in environmental products, marine propulsion systems and
architectural services sectors in these same areas. From 1970 to 1978, Mr.
Runyon held various executive positions with ITT Corporation, including Vice
President, Administration of ITT Grinnell, a manufacturing subsidiary of ITT.
From 1963 to 1970, Mr. Runyon held executive positions at BP Oil including Vice
President, Corporate Planning and Administration of BP Oil Corporation, and
Director, Organization and Personnel for its predecessor, Sinclair Oil
Corporation. Mr. Runyon was Executive Vice President, Human Resources at the
Great Atlantic & Pacific Tea Company from 1978 to 1980. Mr. Runyon earned a B.S.
degree in Economics/Industrial Management from University of Pennsylvania.
LAURENCE P. FINNEGAN, JR. has served as a Class II director since March
26, 1997. In addition to being a director of XET Corporation from 1985 to March
1997, Mr. Finnegan was XET Corporation's Chief Financial Officer from 1994 to
1997. Mr. Finnegan has held positions with ITT (1970-1974) as controller of
several divisions, Narco Scientific (1974-1983) as Vice President Finance, Chief
Financial Officer, Executive Vice President and Chief Operating Officer, and
Fischer & Porter (1986-1994) as Senior Vice President, Chief Financial Officer
and Treasurer. Since August 1995, he has been a principal of GwynnAllen
Partners, Bethlehem, Pennsylvania, an executive management consulting firm.
Since December 1996, Mr. Finnegan has been a director and the President of GA
Pipe, Inc., a manufacturing company based in Langhorne, Pennsylvania. From
September 1997 to January 2001, Mr. Finnegan served as Vice President Finance
and Chief Financial Officer of QuestOne Decision Sciences, an efficiency
consulting firm based in Pennsylvania. Since August 2001, Mr. Finnegan has
served as a director and the Vice President and Chief Financial Officer of
VerdaSee Solutions, Inc., a consulting and software company based in
Pennsylvania. Mr. Finnegan earned a B.S. degree in Accounting from St. Joseph's
University.
OTIS W. BASKIN has served as a Class I director since February 6, 2004.
He is a Professor of Management at The George L. Graziadio School of Business
and Management at Pepperdine University in Malibu, California where he served as
dean from 1995 to 2001. He has been a member of the full-time faculty of the
University of Houston - Clear Lake (1975-87) where he served as Coordinator of
the Management Faculty and Director of the Center for Advanced Management
Programs. He has also been Professor of Management at Arizona State University,
66
West Campus (1987-91) and The University of Memphis (1991-95), in addition to
serving as dean at both universities. Dr. Baskin has worked with AACSB
International (Association for the Advancement of Collegiate Schools of
Business) as Special Advisor to the President and as Chief Executive Officer
since 2002. He is an Associate with the Family Business Consulting Group, where
he advises family owned and closely held businesses. He has served as an advisor
to Exxon/Mobile Research and Engineering Corporation, NASA and the United States
Air Force. He earned a Ph.D. in Management, Public Relations and Communication
Theory from The University of Texas at Austin, an M.A. degree in Speech
Communication by the University of Houston, and a B.A. degree in Religion from
Oklahoma Christian University.
Our business, property and affairs are managed under the direction of
our board. Directors are kept informed of our business through discussions with
our executive officers, by reviewing materials provided to them and by
participating in meetings of our board and its committees.
Our bylaws provide that our board of directors shall consist of at
least four directors. Our board is divided into three classes of directors:
Class I, Class II and Class III. The term of office of each class of directors
is three years, with one class expiring each year at our annual meeting of
stockholders. We currently have four directors on our board, with no vacancies.
Our current board consists of one Class I director whose term expires at our
2006 annual meeting, one Class II director whose term expires at our 2007 annual
meeting, and two Class III directors whose term expires at our 2005 annual
meeting.
Our officers are appointed by and serve at the discretion of our board
of directors. There are no family relationships among our executive officers and
directors.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended
("Exchange Act"), requires our executive officers and directors, and persons who
beneficially own more than 10% of a registered class of our common stock, to
file initial reports of ownership and reports of changes in ownership with the
Securities and Exchange Commission ("Commission"). These officers, directors and
stockholders are required by the Commission regulations to furnish us with
copies of all reports that they file.
Based solely upon a review of copies of the reports furnished to us
during the year ended December 31, 2004 and thereafter, or any written
representations received by us from directors, officers and beneficial owners of
more than 10% of our common stock ("reporting persons") that no other reports
were required, we believe that, during 2004, all Section 16(a) filing
requirements applicable to our reporting persons were met, except that Otis
Baskin filed a late Form 3 to report his becoming a reporting person.
CODE OF ETHICS
Our board of directors has adopted a Code of Business Conduct and
Ethics that applies to all of our directors, officers and employees and an
additional Code of Business Ethics that applies to our Chief Executive Officer
and senior financial officers.
We intend to satisfy the disclosure requirement under Item 10 of Form
8-K relating to amendments to or waivers from provision of these codes that
relate to one or more of the items set forth in Item 406(b) of Regulation S-K,
by describing on our Internet website, located at http://www.emrise.com, within
five business days following the date of a waiver or a substantive amendment,
the date of the waiver or amendment, the nature of the amendment or waiver, and
the name of the person to whom the waiver was granted.
67
Information on our Internet website is not, and shall not be deemed to
be, a part of this report or incorporated into any other filings we make with
the Commission.
COMPENSATION OF EXECUTIVE OFFICERS
The following table provides information concerning the annual and
long-term compensation for the years ended December 31, 2004, 2003 and 2002
earned for services in all capacities as an employee by our Chief Executive
Officer and each of our other executive officers who received an annual salary
and bonus of more than $100,000 for services rendered to us during 2004
(collectively, the "named executive officers"):
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION AWARD
SECURITIES ALL OTHER
NAME AND PRINCIPAL POSITION ANNUAL COMPENSATION UNDERLYING OPTIONS COMPENSATION
--------------------------- ----------------------- ------------------ ------------
YEAR SALARY BONUS
---- ------ -----
Carmine T. Oliva ........................ 2004 $300,000 $ * 26,000 $4,821(1)
President and Chief Executive Officer 2003 $262,510 $70,000 53,000 $4,821(1)
2002 $250,010 -- -- $4,821(1)
Graham Jefferies ........................ 2004 $223,646 $ * 40,000 $10,924(3)
Executive Vice President and Chief 2003 $200,801 $55,000 54,000 $10,320(3)
Operating Officer (2) 2002 $152,093 -- -- $9,000(3)
Randolph D. Foote........................ 2004 $166,667 $ * 25,000 $1,965(4)
Senior Vice President, Chief Financial 2003 $150,000 $30,000 35,000 $1,886(4)
Officer and Assistant Secretary(4) 2002 $144,168 -- -- $1,604(4)
---------------
* Bonus awards for 2004 have not been determined.
(1) Represents the dollar value of insurance premiums we paid with respect to a
$1,000,000 term life insurance policy for the benefit of Mr. Oliva's
spouse.
(2) Mr. Jefferies is based in the United Kingdom and receives his remuneration
in British pounds. The compensation amounts listed for Mr. Jefferies are
shown in United States dollars, converted from British pounds using the
average conversion rates in effect during the time periods of compensation.
Mr. Jefferies served as Chief Operating Officer of our Telecommunications
Group until he was appointed Chief Operating Officer of Emrise in January
2005.
(3) Represents company contributions to Mr. Jefferies' retirement account.
(4) Represents company contributions to Mr. Foote's 401(k) retirement account.
RETIREMENT ACCOUNT MATCHING CONTRIBUTIONS
We match up to the lesser of $2,000 and 20% of Mr. Foote's
contributions to his 401(k) account. During 2004, our matching contribution
amounted to $1,965. This matching arrangement was generally made available to
all employees of Emrise and provides for the same method of allocation of
benefits between management and non-management participants.
Also, XPS makes matching contributions of up to 6% of Mr. Jefferies'
salary to an executives' defined contribution plan. Other employees of XPS may
receive matching contributions to a defined contribution plan of up to 4% of
their salary. Amounts contributed to the defined contribution plans are intended
to used to purchase annuities upon retirement. During 2004, 2003 and 2002, Mr.
Jefferies received matching contributions of $10,924, $10,320 and $9,000,
respectively.
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OPTION GRANTS IN LAST FISCAL YEAR
The following table provides information regarding options granted in
the year ended December 31, 2004 to the executive officers named in the summary
compensation table. We did not grant any stock appreciation rights during 2004.
This information includes hypothetical potential gains from stock options
granted in 2004. These hypothetical gains are based entirely on assumed annual
growth rates of 5% and 10% in the value of our common stock price over the
ten-year life of the stock options granted in 2004. These assumed rates of
growth were selected by the Commission for illustrative purposes only and are
not intended to predict future stock prices, which will depend upon market
conditions and our future performance and prospects.
POTENTIAL
REALIZABLE VALUE
AT ASSUMED RATES
NUMBER OF PERCENTAGE OF OF STOCK PRICE
SECURITIES TOTAL OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OPTION TERM(3)
GRANT OPTIONS EMPLOYEES IN PRICE EXPIRATION -----------------
NAMED OFFICER DATE GRANTED(1) FISCAL YEAR(2) PER SHARE DATE 5% 10%
------------- ---- ---------- -------------- --------- ---- -----------------
Carmine T. Oliva....... 2/24/04 26,000 8.3% $1.00 2/24/14 $16,351 $41,437
Graham Jefferies....... 2/24/04 40,000 12.7% $1.00 2/24/14 $25,156 $63,750
Randolph D. Foote...... 2/24/04 25,000 7.9% $1.00 2/24/14 $15,722 $39,844
-------------------------
(1) Options vest in two equal annual installments commencing February 24, 2005.
(2) Based on options to purchase 314,698 shares granted to our employees during 2004.
(3) Calculated using the potential realizable value of each grant.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES
The following table provides information regarding the value of
unexercised options held by the named executive officers as of December 31,
2004. None of the named executives officers acquired shares through the exercise
of options during 2004.
NUMBER OF
SECURITIES UNDERLYING VALUE ($) OF UNEXERCISED
UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT
DECEMBER 31, 2004 DECEMBER 31, 2004 (1)
--------------------------------- -------------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ----------- -------------
Carmine T. Oliva................... 283,663 26,000 179,360 16,120
Graham Jefferies................... 180,287 40,000 168,480 24,800
Randolph D. Foote.................. 85,000 25,000 115,450 15,500
--------------
(1) Based on the last reported sale price of our common stock of $1.62 on
December 30, 2004 (the last trading day during 2004) as reported on the OTC
Bulletin Board, less the exercise price of the options.
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS
CARMINE T. OLIVA
As of January 1, 2001, we entered into an employment agreement with
Carmine T. Oliva, our Chairman of the Board, President and Chief Executive
Officer. The agreement is subject to automatic renewal for two consecutive
two-year terms beginning on January 1, 2006, unless, during the required notice
periods (which run from September 1 to November 1 of the second year preceding
the year in which a two-year renewal period is to begin), either party gives
written notice of its desire not to renew. The agreement provides for an initial
69
base salary of $250,000 per year and states that Mr. Oliva is eligible to
receive merit or promotional increases and to participate in other benefit and
incentive programs we may offer.
If the board of directors makes a substantial addition to or reduction
of Mr. Oliva's duties, Mr. Oliva may resign upon written notice given within 30
days of the change in duties. Within 30 days after the effective date of a
resignation under these circumstances, we will be obligated to pay to Mr. Oliva
the value of three years of his annual salary or the value of his annual salary
that would have been due through January 1, 2006, whichever is greater.
If we terminate Mr. Oliva for cause, our obligation to pay any further
compensation, severance allowance, or other amounts payable under the agreement
terminates on the date of termination. If we terminate Mr. Oliva without cause
(including by ceasing our operations due to bankruptcy or by our general
inability to meet our obligations as they become due), we must provide him with
60 days' prior written notice. If the termination without cause occurs prior to
the expiration of the initial term of the agreement on December 31, 2005, Mr.
Oliva will be entitled to be paid his annual salary for three years following
the termination or until December 31, 2005, whichever is the longer period. If
the termination occurs during a renewal period, Mr. Oliva will be entitled to be
paid his annual salary through the expiration of the particular renewal period
or for two years, whichever is the longer period, and to be paid all other
amounts payable under the agreement.
We may terminate the agreement upon 30 days' written notice in the
event of a merger or reorganization in which our stockholders immediately prior
to the merger or reorganization receive less than 50% of the outstanding voting
shares of the successor corporation and in the event of a sale of all or
substantially all of our assets or a sale, exchange or other disposition of
two-thirds or more of our outstanding capital stock. If Mr. Oliva is terminated
without cause within two years following a change of control, then:
o if the termination occurs prior to the expiration of the initial
term of the agreement on December 31, 2005, Mr. Oliva will be
entitled to be paid his annual salary and all other amounts
payable under the agreement for three years following the
termination or until December 31, 2005, whichever is the longer
period, which amounts shall be payable at his election in a lump
sum within 30 days after the termination or in installments;
o if the termination occurs during a renewal period, Mr. Oliva will
be entitled to be paid his annual salary through the period ending
two years after the expiration of the particular renewal period,
and to be paid all other amounts payable under the agreement;
o Mr. Oliva will be entitled to receive the average of his annual
executive bonuses awarded to him in the three years preceding his
termination, over the same time span and under the same conditions
as his annual salary;
o Mr. Oliva will be entitled to receive any executive bonus awarded
but not yet paid;
o Mr. Oliva will be entitled to receive a gross up of all
compensatory payments listed above so that he receives those
payments substantially free of federal and state income taxes; and
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o Mr. Oliva will continue to receive coverage in all benefit
programs in which he was participating on the date of his
termination until the earlier of the end of the initial term or
renewal term in which the termination occurred and the date he
receives equivalent coverage and benefits under plans and programs
of a subsequent employer.
If Mr. Oliva dies during the term of the agreement, amounts payable
under the agreement to or for the benefit of Mr. Oliva will continue to be
payable to Mr. Oliva's designee or legal representatives for two years following
his death. If Mr. Oliva is unable to substantially perform his duties under the
agreement for an aggregate of 180 days in any 18-month period, we may terminate
the agreement by ten days' prior written notice to Mr. Oliva following the 180th
day of disability. However, we must continue to pay amounts payable under the
agreement to or for the benefit of Mr. Oliva for two years following the
effective date of the termination.
If the agreement is terminated for any reason and unless otherwise
agreed to by Mr. Oliva and us, then in addition to any other severance payments
to which Mr. Oliva is entitled, we must continue to pay Mr. Oliva's annual
salary until:
o all obligations incurred by Mr. Oliva on our behalf, including any
lease obligations signed by Mr. Oliva related to the performance
of his duties under the agreement, have been voided or fully
assumed by us or our successor;
o all loan collateral pledged by Mr. Oliva has been returned to Mr.
Oliva; and
o all personal guarantees given by Mr. Oliva or his family on our
behalf are voided.
The agreement provides that we will furnish a life insurance policy on
Mr. Oliva's life, in the amount of $1 million, payable to Mr. Oliva's estate in
the event of his death during the term of the agreement and any renewals of the
agreement. This benefit is in return for, and is intended to protect Mr. Oliva's
estate from financial loss arising from any and all personal guarantees that Mr.
Oliva provided in favor of us, as required by various corporate lenders. This
benefit is also intended to enable Mr. Oliva's estate to exercise all warrants
and options to purchase shares of our common stock.
The agreement contains non-competition provisions that prohibit Mr.
Oliva from engaging or participating in a competitive business or soliciting our
customers or employees during the initial term and any renewal terms and for two
years afterward if termination is for cause or for one year afterward if
termination is without cause or following a change of control. The agreement
also contains provisions that restrict disclosure by Mr. Oliva of our
confidential information and assign ownership to us of inventions created by Mr.
Oliva in connection with his employment.
RANDOLPH D. FOOTE
On July 2, 2001, we entered into an employment agreement with Randolph
D. Foote at an initial annual salary of $130,000 and with an initial term of
three years. The agreement automatically renewed for a one-year term on July 2,
2004 and is scheduled to automatically renew for one additional one-year term on
July 2, 2005. Mr. Foote is to act as Senior Vice President and Chief Financial
Officer and is to perform additional services as may be approved by our board of
directors.
If the board of directors makes a substantial addition to or reduction
of Mr. Foote's duties, Mr. Foote may resign upon written notice given within 30
days of the change in duties. Within 30 days after the effective date of a
resignation under these circumstances, we will be obligated to pay to Mr. Foote
the value of one year of his annual salary within 30 days after the effective
date of the resignation.
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If we terminate Mr. Foote for cause, our obligation to pay any further
compensation, severance allowance, or other amounts payable under the agreement
terminates on the date of termination. If we terminate Mr. Foote without cause
(including by ceasing our operations due to bankruptcy or by our general
inability to meet our obligations as they become due), we must provide him with
60 days' prior written notice. Mr. Foote will be entitled to be paid his annual
salary through the expiration of the then current renewal period, and to be paid
all other amounts payable under the agreement.
We may terminate the agreement upon 30 days' written notice in the
event of a merger or reorganization in which our stockholders immediately prior
to the merger or reorganization receive less than 50% of the outstanding voting
shares of the successor corporation and in the event of a sale of all or
substantially all of our assets or a sale, exchange or other disposition of
two-thirds or more of our outstanding capital stock. If Mr. Foote is terminated
without cause within two years following a change of control, then:
o Mr. Foote will be entitled to be paid in installments or, at his
election in a lump sum within 30 days after termination, his
annual salary and other amounts payable under the agreement
through the expiration of the then current renewal period plus one
additional year;
o Mr. Foote will be entitled to receive the average of his annual
executive bonuses awarded to him in the three years preceding his
termination, over the same time span and under the same conditions
as his annual salary;
o Mr. Foote will be entitled to receive any executive bonus awarded
but not yet paid; and
o Mr. Foote will continue to receive coverage in all benefit
programs in which he was participating on the date of his
termination until the earlier of the end of the initial or current
renewal term and the date he receives equivalent coverage and
benefits under plans and programs of a subsequent employer.
If Mr. Foote dies during the term of the agreement, amounts payable
under the agreement to or for the benefit of Mr. Foote will continue to be
payable to Mr. Foote's designee or legal representatives for one year following
his death. If Mr. Foote is unable to substantially perform his duties under the
agreement for an aggregate of 180 days in any 18-month period, we may terminate
the agreement by ten days' prior written notice to Mr. Foote following the 180th
day of disability; provided, however, that we must continue to pay amounts
payable under the agreement to or for the benefit of Mr. Foote for one year
following the effective date of the termination.
The agreement contains non-competition provisions that prohibit Mr.
Foote from engaging or participating in a competitive business or soliciting our
customers or employees during the initial term and any renewal terms and for one
year afterward. The agreement also contains provisions that restrict disclosure
by Mr. Foote of our confidential information and assign ownership to us of
inventions created by Mr. Foote in connection with his employment.
GRAHAM JEFFERIES
On July 2, 2001, we entered into an employment agreement with Graham
Jefferies at an initial annual salary of 100,000 British pounds (approximately
$141,000 at the then current exchange rates) and with an initial term of three
years. The agreement automatically renewed for a one-year term on July 2, 2004
and is scheduled to automatically renew for one additional one-year term on July
2, 2005. Mr. Jefferies is to act as Managing Director of XCEL Corporation, Ltd.
and as Executive Vice President and Chief Operating Officer of our Telecom Group
and is to perform additional services as may be approved by our board of
directors. He was appointed as Chief Operating Officer of Emrise in January
2005. This agreement replaced a substantially similar agreement that had been
effective since May 1, 1998.
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If the board of directors makes a substantial addition to or reduction
of Mr. Jefferies' duties, Mr. Jefferies may resign upon written notice given
within 30 days of the change in duties. Within 30 days after the effective date
of a resignation under these circumstances, we will be obligated to pay to Mr.
Jefferies the value of one year of his annual salary within 30 days after the
effective date of the resignation.
If we terminate Mr. Jefferies for cause, our obligation to pay any
further compensation, severance allowance, or other amounts payable under the
agreement terminates on the date of termination. If we terminate Mr. Jefferies
without cause (including by ceasing our operations due to bankruptcy or by our
general inability to meet our obligations as they become due), we must provide
him with 60 days' prior written notice. Mr. Jefferies will be entitled to be
paid his annual salary through the expiration of the then current renewal period
plus one additional year, and to be paid all other amounts payable under the
agreement.
We may terminate the agreement upon 30 days' written notice in the
event of a merger or reorganization in which our stockholders immediately prior
to the merger or reorganization receive less than 50% of the outstanding voting
shares of the successor corporation and in the event of a sale of all or
substantially all of our assets or a sale, exchange or other disposition of
two-thirds or more of our outstanding capital stock. If Mr. Jefferies is
terminated without cause within two years following a change of control, then:
o Mr. Jefferies will be entitled to be paid in installments or, at
his election in a lump sum within 30 days after termination, his
annual salary and other amounts payable under the agreement
through the expiration of the current renewal period plus one
additional year;
o Mr. Jefferies will be entitled to receive the average of his
annual executive bonuses awarded to him in the three years
preceding his termination, over the same time span and under the
same conditions as his annual salary;
o Mr. Jefferies will be entitled to receive any executive bonus
awarded but not yet paid; and
o Mr. Jefferies will continue to receive coverage in all benefit
programs in which he was participating on the date of his
termination until the earlier of the end of the initial or current
renewal term and the date he receives equivalent coverage and
benefits under plans and programs of a subsequent employer.
If Mr. Jefferies dies during the term of the agreement, amounts payable
under the agreement to or for the benefit of Mr. Jefferies will continue to be
payable to Mr. Jefferies' designee or legal representatives for one year
following his death. If Mr. Jefferies is unable to substantially perform his
duties under the agreement for an aggregate of 180 days in any 18-month period,
we may terminate the agreement by ten days' prior written notice to Mr.
Jefferies following the 180th day of disability; provided, however, that we must
continue to pay amounts payable under the agreement to or for the benefit of Mr.
Jefferies for one year following the effective date of the termination.
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The agreement contains non-competition provisions that prohibit Mr.
Jefferies from engaging or participating in a competitive business or soliciting
our customers or employees during the initial term and any renewal terms and for
two years afterward if termination is for cause or for one year afterward if
termination is without cause or following a change of control. The agreement
also contains provisions that restrict disclosure by Mr. Jefferies of our
confidential information and assign ownership to us of inventions created by Mr.
Jefferies in connection with his employment.
BOARD COMMITTEES
Our board of directors currently has an audit committee, a compensation
committee and a nominating committee. Our board of directors has determined that
Robert Runyon, Otis Baskin and Laurence Finnegan, each of whom is a member of
one or more of these committees, are "independent" as defined in NASD
Marketplace Rule 4200(a)(15).
The audit committee selects our independent auditors, reviews the
results and scope of the audit and other services provided by our independent
auditors and reviews our financial statements for each interim period and for
our year end. From June 26, 1999 to March 21, 2004, this committee consisted
of Laurence Finnegan. Since March 22, 2004, this committee has consisted of
Mr. Finnegan, who serves as chairman, and Otis Baskin. The audit committee
operates pursuant to a charter approved by our board of directors and
audit committee.
The compensation committee is responsible for establishing and
administering our policies involving the compensation of all of our executive
officers and establishing and recommending to our board of directors the terms
and conditions of all employee and consultant compensation and benefit plans.
Our entire board of directors also may perform these functions with respect to
our employee stock option plans. Since June 26, 1999, this committee has
consisted of Messrs. Runyon and Finnegan. The compensation committee operates
pursuant to a charter approved by our board of directors and compensation
committee.
The nominating committee selects nominees for the board of directors.
Beginning in and since 2000, the nominating committee has consisted of Mr.
Runyon. There is one vacancy on the nominating committee. The nominating
committee utilizes a variety of methods for identifying and evaluating nominees
for director, including candidates that may be referred by stockholders.
Stockholders that desire to recommend candidates for the board for evaluation
may do so by contacting Emrise in writing, identifying the potential candidate
and providing background information. Candidates may also come to the attention
of the nominating committee through current board members, professional search
firms and other persons. In evaluating potential candidates, the nominating
committee will take into account a number of factors, including, among others,
the following:
o independence from management;
o whether the candidate has relevant business experience;
o judgment, skill, integrity and reputation;
o existing commitments to other businesses;
o corporate governance background;
o financial and accounting background, to enable the nominating
committee to determine whether the candidate would be suitable for
audit committee membership; and
o the size and composition of the board.
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The nominating committee operates pursuant to a charter approved by our
board of directors and Nominating Committee.
COMPENSATION OF DIRECTORS
During 2004, each non-employee director was entitled to receive $1,000
per month as compensation for their services. In addition, since November 1,
2002, each board member chairing a standing committee has been entitled to
receive $500 per month as compensation for their services. We reimburse all
directors for out-of-pocket expenses incurred in connection with attendance at
board and committee meetings. We may periodically award options or warrants to
our directors under our existing option and incentive plans. On February 24,
2004, we granted to two non-employee directors an option to purchase up to
30,000 shares of our common stock at an exercise price of $1.00 per share. The
options vested in two equal installments on February 24, 2005 and February 24,
2006. In addition, we granted our newly-appointed non-employee director an
option to purchase 50,000 shares of our common stock upon the same terms as the
options granted to the other two non-employee directors.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No member of the board of directors has a relationship that would
constitute an interlocking relationship with executive officers and directors of
another entity. During 2004, Mr. Oliva made salary recommendations to our
compensation committee regarding salary increases for key executives.
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STOCK OPTION PLANS
We currently have four stock option plans: the 1993 Stock Option Plan,
the Employee Stock and Stock Option Plan, the 1997 Stock Incentive Plan and the
2000 Stock Option Plan. These plans are administered by our compensation
committee, which currently consists of Messrs. Runyan and Finnegan.
The 1993 Stock Option Plan authorizes the issuance of incentive stock
options, commonly known as ISOs, and non-qualified stock options, commonly known
as NQOs, to our employees and independent contractors for the purchase of up to
300,000 shares of our common stock. The 1993 Stock Option Plan terminated on
August 31, 2003.
The Employee Stock and Stock Option Plan authorizes the issuance of
NQOs and restricted and unrestricted stock grants to our employees (including
officers and directors who are employees) and consultants for up to an aggregate
of 520,000 shares of common stock. The Employee Stock and Stock Option Plan
terminated on July 1, 2004.
The 1997 Stock Incentive Plan authorizes the issuance of ISOs, stock
appreciation rights or stock awards to our employees and directors for up to an
aggregate of 1,600,000 shares of common stock, except that ISOs may not be
granted to non-employee directors. Our board of directors' adoption of the 1997
Stock Incentive Plan was ratified by our stockholders at our 1998 annual meeting
of stockholders. The 1997 Stock Incentive Plan terminates on June 15, 2007. Our
board does not intend to issue any additional options under the 1997 Stock
Incentive Plan.
Our 2000 Stock Option Plan was adopted by our board of directors in
November 2000 and approved by our stockholders on January 16, 2001. The 2000
Stock Option Plan authorizes the issuance of ISOs and NQOs to our employees,
officers, directors and consultants and to employees of companies that do
business with us for the purchase of up to 2,000,000 shares of common stock. As
of January 24, 2005, we had approximately 215 employees, officers and directors
eligible to receive options under the 2000 Stock Option Plan, and 1,081,302
options had been issued under this plan. The following is a description of
some of the key terms of the 2000 Stock Option Plan.
SHARES SUBJECT TO THE 2000 STOCK OPTION PLAN
A total of 2,000,000 shares of our common stock are authorized for
issuance under the 2000 Stock Option Plan. Any shares of common stock that are
subject to an award but are not used because the terms and conditions of the
award are not met, or any shares that are used by participants to pay all or
part of the purchase price of any option, may again be used for awards under the
2000 Stock Option Plan.
ADMINISTRATION
It is the intent of the 2000 Stock Option Plan that it be administered
in a manner such that option grants and exercises would be "exempt" under Rule
16b-3 of the Exchange Act. The compensation committee is empowered to select
those eligible persons to whom options shall be granted under the 2000 Stock
Option Plan; to determine the time or times at which each option shall be
granted, whether options will be ISOs or NQOs and the number of shares to be
76
subject to each option; and to fix the time and manner in which each option may
be exercised, including the exercise price and option period, and other terms
and conditions of options, all subject to the terms and conditions of the 2000
Stock Option Plan. The compensation committee has sole discretion to interpret
and administer the 2000 Stock Option Plan, and its decisions regarding the 2000
Stock Option Plan are final, except that our board of directors can act in place
of the compensation committee as the administrator of the 2000 Stock Option Plan
at any time or from time to time, in its discretion.
OPTION TERMS
ISOs granted under the 2000 Stock Option Plan must have an exercise
price of not less than 100% of the fair market value of a share of common stock
on the date the ISO is granted and must be exercised, if at all, within ten
years from the date of grant. In the case of an ISO granted to an optionee who
owns more than 10% of the total voting securities of Emrise on the date of
grant, the exercise price may be not less than 110% of fair market value on the
date of grant, and the option period may not exceed five years. NQOs granted
under the 2000 Stock Option Plan must have an exercise price of not less than
85% of the fair market value of a share of common stock on the date the NQO is
granted.
Options may be exercised during a period of time fixed by the committee
except that no option may be exercised more than ten years after the date of
grant. In the discretion of the committee, payment of the purchase price for the
shares of stock acquired through the exercise of an option may be made in cash,
shares of our common stock or a combination of cash and shares of our common
stock.
AMENDMENT AND TERMINATION
The 2000 Stock Option Plan may be wholly or partially amended or
otherwise modified, suspended or terminated at any time and from time to time by
our board of directors. However, our board of directors may not materially
impair any outstanding options without the express consent of the optionee or
materially increase the number of shares subject to the 2000 Stock Option Plan,
materially increase the benefits to optionees under the 2000 Stock Option Plan,
materially modify the requirements as to eligibility to participate in the 2000
Stock Option Plan or alter the method of determining the option exercise price
without stockholder approval. No option may be granted under the 2000 Stock
Option Plan after November 14, 2010.
FEDERAL INCOME TAX CONSEQUENCES
NQOs. Holders of NQOs do not realize income as a result of a grant of
the option, but normally realize compensation income upon exercise of an NQO to
the extent that the fair market value of the shares of common stock on the date
of exercise of the NQO exceeds the exercise price paid. We will be required to
withhold taxes on ordinary income realized by an optionee upon the exercise of a
NQO.
In the case of an optionee subject to the "short-swing" profit
recapture provisions of Section 16(b) of the Exchange Act, the optionee realizes
income only upon the lapse of the six-month period under Section 16(b), unless
the optionee elects to recognize income immediately upon exercise of his or her
option.
ISOs. Holders of ISOs will not be considered to have received taxable
income upon either the grant of the option or its exercise. Upon the sale or
other taxable disposition of the shares, long-term capital gain will normally be
recognized on the full amount of the difference between the amount realized and
the option exercise price paid if no disposition of the shares has taken place
within either two years from the date of grant of the option or one year from
the date of transfer of the shares to the optionee upon exercise. If the shares
are sold or otherwise disposed of before the end of the one-year or two-year
periods, the holder of the ISO must include the gain realized as ordinary income
to the extent of the lesser of the fair market value of the option stock minus
the option price, or the amount realized minus the option price. Any gain in
excess of these amounts, presumably, will be treated as capital gain. We will be
entitled to a tax deduction in regard to an ISO only to the extent the optionee
has ordinary income upon the sale or other disposition of the option shares.
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Upon the exercise of an ISO, the amount by which the fair market value
of the purchased shares at the time of exercise exceeds the option price will be
an "item of tax preference" for purposes of computing the optionee's alternative
minimum tax for the year of exercise. If the shares so acquired are disposed of
prior to the expiration of the one-year or two-year periods described above,
there should be no "item of tax preference" arising from the option exercise.
POSSIBLE ANTI-TAKEOVER EFFECTS
Although not intended as an anti-takeover measure by our board of
directors, one of the possible effects of the 2000 Stock Option Plan could be to
place additional shares, and to increase the percentage of the total number of
shares outstanding, in the hands of the directors and officers of Emrise. Those
persons may be viewed as part of, or friendly to, incumbent management and may,
therefore, under some circumstances be expected to make investment and voting
decisions in response to a hostile takeover attempt that may serve to discourage
or render more difficult the accomplishment of the attempt.
In addition, options may, in the discretion of the committee, contain a
provision providing for the acceleration of the exercisability of outstanding,
but unexercisable, installments upon the first public announcement of a tender
offer, merger, consolidation, sale of all or substantially all of our assets, or
other attempted changes in the control of Emrise. In the opinion of our board of
directors, this acceleration provision merely ensures that optionees under the
2000 Stock Option Plan will be able to exercise their options as intended by the
board of directors and stockholders prior to any extraordinary corporate
transaction which might serve to limit or restrict that right. Our board of
directors is, however, presently unaware of any threat of hostile takeover
involving Emrise.
INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law permits a
corporation to indemnify its directors and officers against expenses, judgments,
fines and amounts paid in settlement actually and reasonably incurred in
connection with a pending or completed action, suit or proceeding if the officer
or director acted in good faith and in a manner the officer or director
reasonably believed to be in the best interests of the corporation.
Our certificate of incorporation provides that, except in certain
specified instances, our directors shall not be personally liable to us or our
stockholders for monetary damages for breach of their fiduciary duty as
directors, except liability for the following:
o Any breach of their duty of loyalty to our company or our
stockholders.
o Acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law.
o Unlawful payments of dividends or unlawful stock repurchases or
redemptions as provided in Section 174 of the Delaware General
Corporation Law.
o Any transaction from which the director derived an improper
personal benefit.
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In addition, our certificate of incorporation and bylaws obligate us to
indemnify our directors and officers against expenses and other amounts
reasonably incurred in connection with any proceeding arising from the fact that
such person is or was an agent of ours. Our bylaws also authorize us to purchase
and maintain insurance on behalf of any of our directors or officers against any
liability asserted against that person in that capacity, whether or not we would
have the power to indemnify that person under the provisions of the Delaware
General Corporation Law. We have entered and expect to continue to enter into
agreements to indemnify our directors and officers as determined by our board of
directors. These agreements provide for indemnification of related expenses
including attorneys' fees, judgments, fines and settlement amounts incurred by
any of these individuals in any action or proceeding. We believe that these
bylaw provisions and indemnification agreements are necessary to attract any
retain qualified persons as directors and officers. We also maintain directors'
and officers' liability insurance.
The limitation of liability and indemnification provisions in our
certificate of incorporation and bylaws may discourage stockholders from
bringing and lawsuit against our directors for breach of their fiduciary duty.
They may also reduce the likelihood of derivative litigation against our
directors and officers, even though an action, if successful, might benefit us
and other stockholders. Furthermore, a stockholder's investment may be adversely
affected to the extent that we pay the costs of settlement and damage awards
against directors and officers as required by these indemnification provisions.
At present, there is no pending litigation or proceeding involving any of our
directors, officers or employees regarding which indemnification is sought, and
we are not aware of any threatened litigation that may result in claims for
indemnification.
Insofar as the provisions of our certificate of incorporation or bylaws
provide for indemnification of directors or officers for liabilities arising
under the Securities Act of 1933, as amended ("Securities Act"), we have been
informed that in the opinion of the Commission this indemnification is against
public policy as expressed in the Securities Act and is therefore unenforceable.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We are or have been a party to employment and compensation arrangements
with related parties, as more particularly described above under the headings
"Compensation of Executive Officers," "Employment Contracts and Termination of
Employment and Change-in-Control Arrangements" and "Compensation of Directors."
We have entered into an indemnification agreement with each of our
directors and executive officers. The indemnification agreements and our
certificate of incorporation and bylaws require us to indemnify our directors
and officers to the fullest extent permitted by Delaware law.
As described below under the heading "Private Placements Through Which
the Selling Security Holders Obtained Beneficial Ownership of the Offered
Shares," we issued in a January 2005 private placement common stock and warrants
to investors who thereby became beneficial owners of more than 5% of our then
outstanding common stock.
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PRINCIPAL STOCKHOLDERS
The following table sets forth information with respect to the
beneficial ownership of our common stock as of January 24, 2005, the date of the
table, by:
o each person known by us to beneficially own more than 5% of the
outstanding shares of our common stock;
o each of our directors;
o each of the executive officers named in the summary compensation
table contained in the "Management" section of this prospectus;
and
o all of our directors and executive officers as a group.
Beneficial ownership is determined in accordance with the rules of the
Commission, and includes voting or investment power with respect to the
securities. To our knowledge, except as indicated by footnote, and subject to
community property laws where applicable, the persons named in the table below
have sole voting and investment power with respect to all shares of common stock
shown as beneficially owned by them. Except as indicated in the discussion of
contractual beneficial ownership limitations contained in the private placement
description titled "January 2005 Private Placement of Common Stock and Warrants"
following the selling security holder table included in this prospectus under
the heading "Selling Security Holders," and except as indicated in the footnotes
to the principal stockholders table below, shares of common stock underlying
derivative securities, if any, that currently are exercisable or convertible or
are scheduled to become exercisable or convertible for or into shares of common
stock within 60 days after the date of the table are deemed to be outstanding in
calculating the percentage ownership of each listed person or group but are not
deemed to be outstanding as to any other person or group. Percentage of
beneficial ownership is based on 37,330,958 shares of common stock outstanding
as of the date of the table.
The address of each of the following stockholders, unless otherwise
indicated in the footnotes to the table, is c/o Emrise Corporation, 9485 Haven
Avenue, Suite 100, Rancho Cucamonga, California 91730. Messrs. Oliva, Runyon,
Finnegan and Baskin are directors of Emrise. Messrs. Oliva, Jefferies and Foote
are executive officers of Emrise.
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AMOUNT AND NATURE PERCENT
NAME OF BENEFICIAL OWNER TITLE OF CLASS OF BENEFICIAL OWNERSHIP OF CLASS
------------------------ -------------- ----------------------- --------
Carmine T. Oliva................................... Common 1,463,968(1) 3.9%
Robert B. Runyon................................... Common 419,206(2) 1.1%
Laurence P. Finnegan, Jr........................... Common 283,231(3) *
Otis W. Baskin..................................... Common 50,000(4) *
Graham T. Jefferies................................ Common 223,563(5) *
Randolph D. Foote.................................. Common 115,000(6) *
The Pinnacle Fund, L.P............................. Common 3,125,000(7) 8.24%
JLF Asset Management, LLC and Jeffrey L. Feinberg.. Common 3,800,461(8) 9.999%
JLF Offshore Fund, Ltd............................. Common 1,992,367(9) 5.29%
Marathon Capital Management, LLC Common 2,057,100(10) 5.51%
All executive officers and directors as a group (6
persons)........................................ Common 2,554,968(11) 6.64%
-------------------
* Less than 1.00%
(1) Includes 81,889 shares held individually by Mr. Oliva's spouse, and
309,663 shares underlying options.
(2) Includes 239,060 shares underlying options.
(3) Includes 239,060 shares underlying options.
(4) Represents 50,000 shares underlying options.
(5) Includes 220,287 shares underlying options.
(6) Includes 110,000 shares underlying options.
(7) Includes 625,000 shares underlying a warrant. Power to vote or dispose of
the shares is held by Barry M. Kitt, as sole member of Pinnacle Fund
Management, LLC, which entity is the general partner of Pinnacle
Advisers, L.P., which entity is the general partner of The Pinnacle Fund,
L.P. The address for Mr. Kitt is c/o The Pinnacle Fund, L.P., 4965
Preston Park, Blvd., Suite 240, Plano, TX 75093.
(8) Includes an aggregate of 3,123,000 outstanding shares held by JLF
Offshore Fund, Ltd., JLF Partners I, L.P., Guggenheim Portfolio Company
XXVIII, and JLF Partners II, L.P., and an aggregate of 677,461 shares
underlying warrants held by those four entities. Due to a contractual
9.999% beneficial ownership limitation that cannot be waived, excludes
22,539 shares underlying warrants held by those four entities. If the
beneficial ownership limitation were disregarded, JLF Asset Management,
LLC and Mr. Feinberg would have beneficially owned 10.05% of the shares
of our common stock outstanding as of the date of the table. Power to
vote or dispose of the shares is held by Jeffrey L. Feinberg, as managing
member of JLF Asset Management, LLC, which entity is investment manager
of the four entities named in the preceding sentence. The address for Mr.
Feinberg is c/o JLF Asset Management, LLC, 2775 Via de la Valle, Suite
204, Del Mar, CA 92014.
9) Includes 364,750 shares underlying a warrant. Power to vote or dispose of
the shares is held by Jeffrey L. Feinberg, as managing member of JLF
Asset Management, LLC, which entity is investment manager of JLF Offshore
Fund, Ltd. See footnote (8) above for information regarding JLF Asset
Management, LLC.
(10) Based on information included by Marathon Capital Management, LLC
("Marathon") in a Schedule 13G for January 13, 2005. Marathon reported
that it holds sole voting power over 125,000 shares and sole disposal
power over 2,057,100 shares. The Schedule 13G was executed by James G.
Kennedy, as President of Marathon. The address for Marathon is P.O. Box
771, Hunt Valley, MD 21030.
(11) Includes 1,168,070 shares underlying options and 81,889 outstanding
shares held individually by Mr. Oliva's wife.
81
SELLING SECURITY HOLDERS
SELLING SECURITY HOLDER TABLE
This prospectus covers the offer and sale by the selling security
holders of up to an aggregate of 18,388,777 shares of common stock, including an
aggregate of 13,782,092 issued and outstanding shares of our common stock and an
aggregate of 4,606,685 shares of our common stock underlying warrants. The
following table sets forth, to our knowledge, certain information about the
selling security holders as of January 24, 2005, the date of the table, based on
information furnished to us by the selling security holders. Except as indicated
in the private placement descriptions or footnotes following the table, each
selling security holder has indicated to us that it is acting individually, not
as a member of a group, and none of the selling security holders or their
affiliates has held any position or office or had any other material
relationship with us in the past three years.
Beneficial ownership is determined in accordance with the rules of the
Commission, and includes voting or investment power with respect to the
securities. To our knowledge, except as indicated by footnote, and subject to
community property laws where applicable, the persons named in the table below
have sole voting and investment power with respect to all shares of common stock
shown as beneficially owned by them. Except as indicated in the discussion of
contractual beneficial ownership limitations contained in the private placement
descriptions and footnotes following the table, shares of common stock
underlying derivative securities, if any, that currently are exercisable or
convertible or are scheduled to become exercisable or convertible for or into
shares of common stock within 60 days after the date of the table are deemed to
be outstanding in calculating the percentage ownership of each listed person or
group but are not deemed to be outstanding as to any other person or group.
Percentage of beneficial ownership is based on 37,330,958 shares of common stock
outstanding as of the date of the table. Shares shown as beneficially owned
after the offering assume that all shares being offered are sold.
The shares of common stock being offered under this prospectus may be
offered for sale from time to time during the period the registration statement
of which this prospectus is a part remains effective, by or for the accounts of
the selling security holders described below. Roth Capital Partners, LLC ("Roth
Capital") is an NASD-registered broker-dealer that received warrants as
compensation for services rendered as placement agent in the January 2005
private placement described below. Roth Capital has represented to us that it is
not acting as an underwriter in this offering, it received the warrants whose
underlying shares are offered under this prospectus in the ordinary course of
business, and at the time of such receipt, it had no agreements or
understandings, directly or indirectly, with any person to distribute the
warrants or underlying shares.
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SHARES OF SHARES OF
COMMON STOCK COMMON STOCK
BENEFICIALLY OWNED BENEFICIALLY OWNED
PRIOR TO OFFERING SHARES OF AFTER OFFERING
NAME OF ---------------------------- COMMON STOCK --------------------
BENEFICIAL OWNER NUMBER PERCENTAGE BEING OFFERED NUMBER PERCENTAGE
---------------------------------- -------------- ------------- ------------- -------- ------------
JLF Offshore Fund, Ltd............ 1,992,367 (1) 5.29% 1,823,750 (1) 168,617 *
JLF Partners I, LP................ 1,278,915 (2) 3.41% 1,172,500 (2) 106,415 *
Guggenheim Portfolio Company XXVIII. 453,382 (3) 1.21% 413,750 (3) 39,632 *
JLF Partners II, LP............... 98,336 (4) * 90,000 (4) 8,336 *
The Pinnacle Fund, L.P............ 3,125,000 (5) 8.24% 3,125,000 (5) -- --
Bonanza Master Fund Ltd........... 1,750,000 (6) 4.65% 1,750,000 (6) -- --
Roaring Fork Capital SBIC, L.P.... 1,706,250 (7) 4.54% 1,706,250 (7) -- --
Lagunitas Partners LP............. 1,125,000 (8) 3.00% 1,125,000 (8) -- --
Gruber & McBaine International.... 250,000 (9) * 250,000 (9) -- --
Jon D. Gruber & Linda W. Gruber
JTWROS.......................... 1,581,250 (10) 4.21% 206,250 (10) -- --
J. Patterson McBaine.............. 1,481,250 (11) 3.94% 106,250 (11) -- --
MicroCapital Fund LP.............. 1,080,000 (12) 2.88% 1,080,000 (12) -- --
MicroCapital Fund Ltd............. 607,500 (13) 1.62% 607,500 (13) -- --
Omicron Master Trust.............. 1,085,625 (14) 2.90% 1,085,625 (14) -- --
Stratford Partners, L.P........... 431,250 (15) 1.15% 431,250 (15) -- --
Select Contrarian Value Partners,
L.P............................. 829,107 (16) 2.22% 375,000 (16) 454,107 1.22%
Precept Capital Master Fund, G.P.. 281,250 (17) * 281,250 (17) -- --
Roth Capital Partners, LLC........ 650,310 (18) 1.71% 650,310 (18) -- --
Noel C. McDermott, Trustee of the
Noel C. McDermott Revocable Living
Trust dated December 18, 1995... 764,211 (19) 2.05% 764,211 (19) -- --
Warren P. Yost and Gail A. Yost,
Co-Trustees Under Declaration of
Trust dated March 9, 1988....... 599,381 (20) 1.60% 599,381 (20) -- --
Hayden Communications, Inc........ 75,000 (21) * 125,000 (22) -- --
Coffin Communications Group....... 35,000 (23) * 35,000 (23) -- --
George Farndell................... 314,748 (24) * 150,000 (24) 164,748 *
Steven Jacobus.................... 50,000 (25) * 50,000 (25) -- --
Jacques Moisset................... 120,000 (26) * 120,000 (26) -- --
Jason Oliva....................... 401,708 (27) * 200,500 (27) 201,208 *
Joseph Mirabella.................. 50,000 (28) * 50,000 (28) -- --
Placido Albanese.................. 15,000 (29) * 15,000 (29) -- --
-------------
* Less than 1.00%
(1) Includes 364,750 shares underlying a warrant. Power to vote or dispose of
the shares is held by Jeffrey L. Feinberg, as managing member of JLF
Asset Management, LLC. JLF Asset Management, LLC is investment manager of
JLF Offshore Fund, Ltd. and of JLF Partners I, LP, Guggenheim Portfolio
Company XXVIII and JLF Partners II, LP, three other selling security
holders. The address for Mr. Feinberg is c/o JLF Asset Management, LLC,
2775 Via de la Valle, Suite 204, Del Mar, CA 92014.
(2) Includes 234,500 shares underlying a warrant. Power to vote or dispose of
the shares is held by Jeffrey L. Feinberg, as managing member of JLF
Asset Management, LLC. See footnote (1) above for information regarding
JLF Asset Management, LLC.
83
(3) Includes 82,750 shares underlying a warrant. Power to vote or dispose of
the shares is held by Jeffrey L Feinberg, as managing member of JLF Asset
Management, LLC. See footnote (1) above for information regarding JLF
Asset Management, LLC.
(4) Includes 18,000 shares underlying a warrant. Power to vote or dispose of
the shares is held by Jeffrey L. Feinberg, as managing member of JLF
Asset Management, LLC. See footnote (1) above for information regarding
JLF Asset Management, LLC.
(5) Includes 625,000 shares underlying a warrant. Power to vote or dispose of
the shares is held by Barry M. Kitt, as sole member of Pinnacle Fund
Management, LLC, which entity is the general partner of Pinnacle
Advisers, L.P., which entity is the general partner of The Pinnacle Fund,
L.P. The address for Mr. Kitt is c/o The Pinnacle Fund, L.P., 4965
Preston Park, Blvd., Suite 240, Plano, TX 75093.
(6) Includes 350,000 shares underlying a warrant. Power to vote or dispose of
the shares is held by Bernay Box, as president of Bernay Box & Co., which
entity is the general partner of Bonanza Master Fund Ltd.
(7) Includes 341,250 shares underlying a warrant. Sole and shared power to
vote or dispose of the shares is held by each of Eugene McColley and
Sherman Muller, as managers of Roaring Fork Management, LLC, which entity
is the general partner of Roaring Fork Capital SBIC, L.P.
(8) Includes 225,000 shares underlying a warrant. Power to vote or dispose of
the shares is held by Jon D. Gruber and J. Patterson McBaine, as managers
of Gruber & McBaine Capital Management, which entity is the general
partner of Lagunitas Partners LP.
(9) Includes 50,000 shares underlying a warrant. Power to vote or dispose of
the shares is held by Jon D. Gruber and J. Patterson McBaine, as managers
of Gruber & McBaine Capital Management, which entity is the investment
advisor to Gruber & McBaine International.
(10) Includes 316,250 shares underlying a warrant held by Jon D. Gruber &
Linda W. Gruber JTWROS. Also includes aggregates of 1,100,000 outstanding
shares and 275,000 shares underlying warrants held by Lagunitas Partners,
LP and Gruber & McBaine International, two other selling security
holders.
(11) Includes 296,250 shares underlying a warrant. Also includes aggregates of
1,100,000 outstanding shares and 275,000 shares underlying warrants held
by Lagunitas Partners, LP and Gruber & McBaine International, two other
selling security holders.
(12) Includes 216,000 shares underlying a warrant. MicroCapital LLC is the
general partner and investment advisor to MicroCapital Fund LP and
MicroCapital Fund Ltd. Ian P. Ellis is the principal owner of
MicroCapital LLC and has sole responsibility for the selection,
acquisition and disposition of the portfolio securities by MicroCapital
LLC on behalf of its funds.
(13) Includes 121,500 shares underlying a warrant. MicroCapital LLC is the
general partner and investment advisor to MicroCapital Fund LP and
MicroCapital Fund Ltd. Ian P. Ellis is the principal owner of
MicroCapital LLC and has sole responsibility for the selection,
acquisition and disposition of the portfolio securities by MicroCapital
LLC on behalf of its funds.
(14) Includes 217,125 shares underlying a warrant. Omicron Capital, L.P., a
Delaware limited partnership (Omicron Capital), serves as investment
manager to Omicron Master Trust, a trust formed under the laws of Bermuda
(Omicron). Bruce Bernstein is the managing member of Omicron Capital.
Omicron Capital, Inc., a Delaware corporation (OCI), serves as general
partner of Omicron Capital, and Winchester Global Trust Company Limited
(Winchester) serves as the trustee of Omicron. By reason of such
relationships, Omicron Capital and OCI may be deemed to share dispositive
power over the shares of our common stock owned by Omicron, and
Winchester may be deemed to share voting and dispositive power over the
shares of our common stock owned by Omicron. Omicron Capital, OCI and
Winchester disclaim beneficial ownership of such shares of our common
stock. No other person has sole or shared voting or dispositive power
with respect to the shares of our common stock being offered by Omicron,
as those terms are used for purposes of Regulation 13D-G under the
Exchange Act. Omicron and Winchester are not "affiliates" of one another,
as that term is used for purposes of the Exchange Act, or of any other
person named in this prospectus as a selling security holder. No person
or "group" (as that term is used in Section 13(d) of the Exchange Act or
Regulation 13D-G) controls Omicron and Winchester.
84
(15) Includes 86,250 shares underlying a warrant. Power to vote or dispose of
the shares is shared by Mark Fain and Chad Comiteau, as managing
directors of Stratford Advisors LLC, which entity is the general partner
of Stratford Partners, L.P.
(16) Includes 75,000 shares underlying a warrant. Power to vote or dispose of
the shares is held by David W. Berry as principal of Kaizen Capital, LLC,
which entity is the general partner of Select Contrarian Value Partners,
L.P.
(17) Includes 56,250 shares underlying a warrant. Power to vote or dispose of
the shares is held by D. Blair Baker, as president of Precept Management,
LLC, which entity is the general partner of Precept Capital Management,
L.P., which entity is the agent of Precept Capital Master Fund, G.P.
(18) Represents 650,310 shares underlying a warrant. Power to vote or dispose
of the shares is held by Byron Roth, as Chief Executive Officer, and
Gordon J. Roth, as Chief Financial Officer, of Roth Capital.
(19) Includes 84,066 shares underlying a warrant. Sole power to vote or
dispose of the shares is held by Mr. McDermott as trustee. Mr. McDermott
was an officer and shareholder of Larus Corporation until its acquisition
by Emrise in July 2004.
(20) Includes 65,934 shares underlying a warrant. Mr. Yost was an officer and
shareholder of Larus Corporation until its acquisition by Emrise in July
2004.
(21) Represents 75,000 shares underlying warrants. Power to vote or dispose of
the shares is held by Matthew Hayden as president of Hayden
Communications, Inc. Hayden Communications, Inc. acts as an investor
relations consultant to Emrise.
(22) Represents 125,000 shares underlying warrants.
(23) Represents 35,000 shares underlying warrants. Power to vote or dispose of
the shares is held by William F. Coffin as Chief Executive Officer of
Coffin Communications Group. Coffin Communications Group is a former
investor relations consultant to Emrise.
(24) Includes 150,000 shares underlying a warrant and 103,181 shares held by
Mr. Farndell's spouse. Mr. Farndell is a former human resources
consultant to Emrise and is the brother-in-law of Carmine T. Oliva, who
is an executive officer and director of Emrise.
(25) Includes 50,000 shares underlying a warrant. Mr. Jacobus is a former
financial advisor to Emrise.
(26) Includes 120,000 shares underlying a warrant. Mr. Moisset is a former
employee of and former consultant to Emrise.
(27) Includes 200,500 shares underlying warrants. Jason Oliva is a former
financial advisor to Emrise and is the son of Carmine T. Oliva, who is an
executive officer and director of Emrise.
(28) Mr. Mirabella is a former consultant to Emrise.
(29) Mr. Albanese is a former financial advisor to Emrise.
85
PRIVATE PLACEMENTS THROUGH WHICH THE SELLING SECURITY HOLDERS OBTAINED
BENEFICIAL OWNERSHIP OF THE OFFERED SHARES
All of the shares of common stock being offered under this prospectus
were issued, or are issuable upon exercise of warrants that were issued, in the
below-described private placement transactions.
JANUARY 2005 PRIVATE PLACEMENT OF COMMON STOCK AND WARRANTS
On January 5, 2005, we issued to 17 accredited record holders in a
private offering an aggregate of 12,503,500 shares of our common stock at a
purchase price of $1.44 per share and five-year investor warrants to purchase up
to an additional 3,125,875 shares of our common stock at an exercise price of
$1.73 per share.
Roth Capital, an NASD-registered broker-dealer, acted as placement
agent in connection with the offering. We paid to Roth Capital cash placement
agent fees of approximately $936,500 and issued five-year placement agent
warrants to purchase up to an aggregate of 650,310 shares of our common stock in
connection with the offering. The closing date for the transactions contemplated
by the Securities Purchase Agreement was January 5, 2005.
We agreed to register for resale the shares of common stock issued to
investors and the shares of common stock issuable upon exercise of the investor
warrants and placement warrants. The registration obligations require, among
other things, that the registration statement of which this prospectus is a part
be declared effective no later than the 150th day following the closing date. If
we are unable to meet this obligation or are unable to maintain the
effectiveness of the registration in accordance with the requirements of the
Registration Rights Agreement, then we will be required to pay to each investor
liquidated damages equal to 1% of the amount paid by the investor for the common
shares still owned by the investor on the date of the default and 2% of the
amount paid by the investor for the common shares still owned by the investor on
each monthly anniversary of the date of the default that occurs prior to the
cure of the default. The maximum aggregate liquidated damages payable to any
investor will be equal to 10% of the aggregate amount paid by the investor for
common shares pursuant to the Securities Purchase Agreement.
The investor warrants and the placement warrants contain customary
anti-dilution provisions for stock splits, stock dividends and the like and
contain a net exercise cashless exercise feature that will permit the warrants
to be exercised for a net number of shares using the spread between the warrant
exercise price and the average of the closing sale prices for the five trading
days immediately prior to the exercise of the warrant as payment for a reduced
number of common shares. Use of the cashless exercise feature by the investors
is limited to times when a valid resale prospectus is not then available for use
by the investors.
The investor warrants and the placement warrants also contain a call
provision. The call provision generally provides that if, at any time after the
first anniversary of the issuance of the warrants, the volume weighted average
trading price of our common stock for each of 30 consecutive trading days
exceeds $3.46, a valid resale prospectus is available for the shares of common
stock underlying the warrants or the shares are eligible for resale without
volume restrictions pursuant to Rule 144(k) under the Securities Act, and we
have complied with our obligations under the warrant and related agreements,
then we may require the warrant holder to exercise the warrant in full (subject
to the 9.999% limitation described below) on the 30th day following written
notice to the warrant holder if the call eligibility criteria described above
continue to be met until that date.
86
In addition, the investor warrants and the placement warrants contain
provisions limiting the exercise or call of the warrants to the extent necessary
to insure that following the exercise or call, the total number of shares of
common stock then beneficially owned by the warrant holder and its affiliates
and others whose beneficial ownership would be aggregated with the holder's for
purposes of Section 13(d) of the Exchange Act does not exceed 9.999% of the
total number of then issued and outstanding shares of our common stock
(including for such purpose the shares of common stock issuable upon such
exercise or call). The 9.999% beneficial ownership limitation may not be waived.
However, the beneficial ownership limitation does not preclude a holder from
exercising a warrant and selling the shares underlying the warrant in stages
over time where each stage does not cause the holder and its affiliates to
beneficially own shares in excess of the limitation amount. As a result of the
beneficial ownership limitations, the numbers of shares shown in the table as
beneficially owned by certain of the selling security holders may have been
reduced as described in the footnotes to the table.
We have registered for resale under this prospectus the shares of
common stock issued to investors in the offering and the shares of common stock
underlying the investor warrants and the placement warrants. The Securities
Purchase Agreement, Registration Rights Agreement and placement agent
arrangements contain various indemnification provisions in connection with the
offering and registration of the shares and warrants. There are no material
relationships between us or our affiliates and any of the investors or placement
agents, except that each of The Pinnacle Fund, L.P., JLF Offshore Fund, Ltd.,
JLF Asset Management, LLC (which entity is investment manager of four of the
selling security holders, including JLF Offshore Fund, Ltd.) and Jeffrey L.
Feinberg (the managing member of JLF Asset Management, LLC), became a beneficial
owner of more than 5% of our outstanding common stock at the closing of the
offering.
LARUS CORPORATION ACQUISITION
As described elsewhere in this prospectus, we acquired the outstanding
capital stock of Larus Corporation in July 2004 from Noel C. McDermott, Trustee
of the Noel C. McDermott Revocable Living Trust dated December 18, 1995, and
Warren P. Yost and Gail A. Yost, Co-Trustees Under Declaration of Trust dated
March 9, 1988. The purchase price for the acquisition consisted of $1,000,000 in
cash, the issuance of 1,213,592 shares of our common stock, $887,500 in the form
of two short-term, zero interest promissory notes that have since been repaid,
$3,000,000 in the form of two subordinated secured promissory notes, and
warrants to purchase up to an aggregate of 150,000 shares of our stock at $1.30
per share. In addition, we assumed $245,000 in accounts payable and accrued
expenses and entered into an above-market real property lease with the sellers.
The warrants contain a net exercise cashless exercise feature that will permit
the warrants to be exercised for a net number of shares using the spread between
the warrant exercise price and the average of the last reported sale prices for
a share of our common stock on the OTC Bulletin Board for the five trading days
immediately prior to the exercise of the warrant as payment for a reduced number
of common shares. We granted the sellers piggyback and demand registration
rights for the shares we issued to them in the acquisition and for the shares
that are issuable upon exercise of the warrants issued in the acquisition and
have registered all of those shares for resale under this prospectus.
HAYDEN COMMUNICATIONS, INC. INVESTOR RELATIONS WARRANTS
In November 2004, we issued to Hayden Communications, Inc. warrants to
purchase up to 100,000 shares of common stock as partial consideration for
investor relations services. The warrants vest and become exercisable in three
installments. The warrants vested on November 3, 2004 as to 25,000 underlying
shares with an exercise price of $0.85 per share. The warrants vest on February
1, 2005 as to 25,000 underlying shares with an exercise price of $1.00 per
share, and vest on May 1, 2005 as to the remaining 50,000 underlying shares with
an exercise price of $1.15 per share. The warrants are exercisable for a period
of three years commencing on their respective vesting dates.
87
On January 24, 2005, we issued to Hayden Communications, Inc. a
fully-vested three-year warrant to purchase up to 25,000 shares of common stock
as additional consideration for investor relations services. The exercise price
of the warrant is $2.00 per share. All of the warrants issued to Hayden
Communications, Inc. contain a net exercise cashless exercise feature that will
permit the warrants to be exercised for a net number of shares using the spread
between the warrant exercise price and the average of the last bid and asked
prices reported on the last business day immediately prior to the exercise of
the warrant as payment for a reduced number of common shares. We have agreed to
register for resale and have included in this prospectus the 125,000 shares of
common stock underlying the warrants issued to Hayden Communications, Inc.
OTHER PRIVATE PLACEMENT TRANSACTIONS
In April 2001, we issued to Coffin Communications Group a five-year
warrant to purchase up to 35,000 shares of common stock at a per share exercise
price of $0.39 in consideration for investor relations services to be rendered.
We have included these underlying shares for resale under this prospectus.
In October 2001, we issued to Placido Albanese a three-year warrant to
purchase up to 15,000 shares of common stock at a per share exercise price of
$0.25 in consideration for financial advisory services rendered. Mr. Albanese
exercised this warrant, and we have included the 15,000 outstanding shares of
common stock for resale under this prospectus.
In October 2001, we issued to Joseph Mirabella a three-year warrant to
purchase up to 50,000 shares of common stock at a per share exercise price of
$0.31 in consideration for consulting services rendered. Mr. Mirabella
exercised this warrant, and we have included the 50,000 outstanding shares of
common stock for resale under this prospectus.
In September 2002, we issued to Jacques Moisset a three-year warrant to
purchase up to 120,000 shares of common stock at a per share exercise price of
$0.50 in consideration for post-retirement business services rendered. We have
included these underlying shares for resale under this prospectus.
In April 2003, we issued to George Farndell a three-year warrant to
purchase up to 150,000 shares of common stock at a per share exercise price of
$0.75 in consideration for human resources consulting services rendered. We have
included these underlying shares for resale under this prospectus.
In April 2003, we issued to each of Steven Jacobus and Jason Oliva a
three-year warrant to purchase up to 50,000 shares of common stock at a per
share exercise price of $0.75 in consideration for financial advisory services
rendered by each of them. We have included these underlying shares for resale
under this prospectus.
In April 2003, we issued to Steven Jacobus a three-year warrant to
purchase up to 50,000 shares of common stock at a per share exercise price of
$0.75 in consideration for financial advisory services rendered. We have
included these underlying shares for resale under this prospectus.
In April 2003, we issued to Jason Oliva three-year warrants to purchase
up to 100,000 shares of common stock at a per share exercise price of $0.75 and
up to 100,500 shares of common stock at a per share exercise price of $1.00 in
consideration for financial advisory services rendered. We have included these
underlying shares for resale under this prospectus.
88
PLAN OF DISTRIBUTION
The selling security holders and any of their donees, pledgees,
assignees and other successors-in-interest may, from time to time, sell any or
all of their shares of common stock being offered under this prospectus on any
stock exchange, market or trading facility on which the shares are traded, or in
private transactions. These sales, which may include block transactions, may be
at fixed or negotiated prices. The selling security holders may use any one or
more of the following methods when disposing of shares:
o ordinary brokerage transactions and transactions in which the
broker-dealer solicits purchasers;
o block trades in which the broker-dealer will attempt to sell
the shares as agent but may position and resell a portion of
the block as principal to facilitate the transaction;
o purchases by a broker-dealer as principal and resales by the
broker-dealer for its own account;
o an exchange distribution in accordance with the rules of the
applicable exchange;
o privately negotiated transactions;
o through the distribution of the shares by any selling security
holder to its partners, members or stockholders;
o broker-dealers may agree with the selling security holders to
sell a specified number of shares at a stipulated price per
share;
o one or more underwritten offerings on a firm commitment or
best efforts basis;
o a combination of any of these methods of sale; or
o any other method permitted by applicable law; provided,
however, that the selling security holders have agreed not to
engage in short sales involving the shares offered under this
prospectus.
The shares may also be sold under Rule 144 under the Securities Act, if
available, rather than under this prospectus. The selling security holders have
the sole and absolute discretion not to accept any purchase offer or make any
sale of shares if they deem the purchase price to be unsatisfactory at any
particular time.
The selling security holders may pledge their shares to their brokers
under the margin provisions of customer agreements. If a selling security holder
defaults on a margin loan, the broker may, from time to time, offer and sell the
pledged shares.
Broker-dealers engaged by the selling security holders may arrange for
other broker-dealers to participate in sales. Broker-dealers may receive
commissions or discounts from the selling security holders (or, if any
broker-dealer acts as agent for the purchaser of shares, from the purchaser) in
amounts to be negotiated, which commissions as to a particular broker or dealer
may be in excess of customary commissions to the extent permitted by applicable
law.
89
If sales of shares offered under this prospectus are made to
broker-dealers as principals, we would be required to file a post-effective
amendment to the registration statement of which this prospectus is a part. In
the post-effective amendment, we would be required to disclose the names of any
participating broker-dealers and the compensation arrangements relating to such
sales.
The selling security holders and any broker-dealers or agents that are
involved in selling the shares offered under this prospectus may be deemed to be
"underwriters" within the meaning of the Securities Act in connection with these
sales. Commissions received by these broker-dealers or agents and any profit on
the resale of the shares purchased by them may be deemed to be underwriting
commissions or discounts under the Securities Act. Any broker-dealers or agents
that are deemed to be underwriters may not sell shares offered under this
prospectus unless and until we set forth the names of the underwriters and the
material details of their underwriting arrangements in a supplement to this
prospectus or, if required, in a replacement prospectus included in a
post-effective amendment to the registration statement of which this prospectus
is a part.
The selling security holders may sell all or any part of the shares
offered under this prospectus through an underwriter. To our knowledge, no
selling security holder has entered into any agreement with a prospective
underwriter, and we cannot assure you as to whether any such agreement will be
entered into. If a selling security holder informs us that it has entered into
such an agreement or agreements, any material details will be set forth in a
supplement to this prospectus or, if required, in a replacement prospectus
included in a post-effective amendment to the registration statement of which
this prospectus is a part.
The selling security holders and any other persons participating in the
sale or distribution of the shares offered under this prospectus will be subject
to applicable provisions of the Exchange Act, and the rules and regulations
under that act, including Regulation M. These provisions may restrict activities
of, and limit the timing of purchases and sales of any of the shares by, the
selling security holders or any other person. Furthermore, under Regulation M,
persons engaged in a distribution of securities are prohibited from
simultaneously engaging in market making and other activities with respect to
those securities for a specified period of time prior to the commencement of
such distributions, subject to specified exceptions or exemptions. All of these
limitations may affect the marketability of the shares.
This prospectus does not cover the sale or other transfer of any of the
derivative securities whose underlying shares of common stock are being offered
for sale pursuant to this prospectus. If a selling security holder transfers
those derivative securities prior to conversion or exercise, then the transferee
of those derivative securities may not sell the underlying shares of common
stock under this prospectus unless we amend or supplement this prospectus to
cover such sales.
In addition, if any of the shares of common stock offered for sale
pursuant to this prospectus are transferred other than pursuant to a sale under
this prospectus, then subsequent holders could not use this prospectus until a
post-effective amendment or prospectus supplement is filed, naming such holders.
We offer no assurance as to whether any of the selling security holders will
sell all or any portion of the shares offered under this prospectus.
For the period a selling security holder holds a derivative security
whose underlying shares of common stock are being offered for sale pursuant to
this prospectus, the selling security holder has the opportunity to profit from
a rise in the market price of our common stock without assuming the risk of
ownership of the underlying shares of common stock. The terms on which we could
obtain additional capital during the period in which those derivative securities
remain outstanding may be adversely affected. The holders of derivative
securities are most likely to voluntarily convert or exercise their derivative
securities when the conversion or exercise price is less than the market price
for our common stock. However, we offer no assurance as to whether any of those
derivative securities will be converted or exercised.
90
We have agreed to pay all fees and expenses incident to the
registration of the shares being offered under this prospectus. However, each
selling security holder and purchaser is responsible for paying any discounts,
concessions and similar selling expenses they incur.
We and certain of the selling security holders have agreed to indemnify
one another against certain losses, claims, damages and liabilities arising in
connection with this prospectus, including liabilities under the Securities Act.
DESCRIPTION OF CAPITAL STOCK
Our authorized capital stock consists of 50,000,000 shares of common
stock, $0.0033 par value per share, and 10,000,000 shares of preferred stock,
$0.01 par value per share. As of January 24, 2005, there were 37,330,958 shares
of common stock issued and outstanding and no shares of preferred stock issued
and outstanding. The following description of our capital stock does not purport
to be complete and is subject to and qualified in its entirety by our
certificate of incorporation, our bylaws and the applicable provisions of
Delaware and California law.
COMMON STOCK
All outstanding shares of common stock are, and the common stock to be
issued upon exercise of warrants and resold by the selling security holders in
this offering will be, fully paid and nonassessable. The following summarizes
the rights of holders of our common stock:
o each holder of common stock is entitled to one vote per share
on all matters to be voted upon generally by the stockholders;
o subject to preferences that may apply to shares of preferred
stock outstanding, the holders of common stock are entitled to
receive lawful dividends as may be declared by our board of
directors, see "Dividend Policy";
o upon our liquidation, dissolution or winding up, the holders
of shares of common stock are entitled to receive a pro rata
portion of all our assets remaining for distribution after
satisfaction of all our liabilities and the payment of any
liquidation preference of any outstanding preferred stock;
o there are no redemption or sinking fund provisions applicable
to our common stock; and
o there are no preemptive or conversion rights applicable to our
common stock.
PREFERRED STOCK
Our board of directors is authorized to issue from time to time,
without stockholder authorization, in one or more designated series, any or all
of our authorized but unissued shares of preferred stock with any dividend,
redemption, conversion and exchange provision as may be provided in that
particular series.
91
The rights of the holders of our common stock will be subject to, and
may be adversely affected by, the rights of the holders of any preferred stock
that may be issued in the future. Issuance of a new series of preferred stock,
while providing desirable flexibility in connection with possible acquisitions
and other corporate purposes, could have the effect of entrenching our board of
directors and making it more difficult for a third-party to acquire, or
discourage a third-party from acquiring, a majority of our outstanding voting
stock. We have no present plans to issue any shares of or to designate any
series of preferred stock.
WARRANTS
At January 24, 2005, we had outstanding warrants to purchase 4,606,685
shares of our common stock at exercise prices ranging from $0.39 to $2.00.
OPTIONS
At January 24, 2005, we had outstanding options to purchase 2,133,256
shares of our common stock at exercise prices ranging from $0.20 to $3.44.
REGISTRATION RIGHTS
The holders of various shares of our common stock and warrants are
entitled to rights with respect to the registration of their shares under the
Securities Act. These registration rights are described in "Selling Security
Holders."
ANTI-TAKEOVER EFFECTS OF DELAWARE LAW AND OUR CERTIFICATE OF INCORPORATION AND
BYLAWS
Certain provisions of Delaware law, our certificate of incorporation
and our bylaws contain provisions that could have the effect of delaying,
deferring and discouraging another party from acquiring control of us. These
provisions, which are summarized below, are expected to discourage coercive
takeover practices and inadequate takeover bids. These provisions are also
designed to encourage persons seeking to acquire control of us to first
negotiate with our board of directors. We believe that the benefits of increased
protection of our potential ability to negotiate with an unfriendly or
unsolicited acquiror outweigh the disadvantages of discouraging a proposal to
acquire us because negotiation of these proposals could result in an improvement
of their terms.
CLASSIFIED BOARD
We have classified our board of directors into three classes of
staggered terms. Each class has a term of three years. At each annual meeting,
only those directors in one class are the subject of nomination and election. A
classified board of directors makes it more difficult for dissident stockholders
to wage a proxy fight to elect a majority of the directors.
UNDESIGNATED PREFERRED STOCK
The ability to authorize undesignated preferred stock makes it possible
for our board of directors to issue preferred stock with voting or other rights
or preferences that could impede the success of any attempt to acquire us. These
and other provisions may have the effect of deferring hostile takeovers or
delaying changes in control or management of Emrise.
REQUIREMENTS FOR ADVANCE NOTIFICATION OF STOCKHOLDER NOMINATIONS AND
PROPOSALS
Our bylaws establish advance notice procedures with respect to
stockholder proposals and the nomination of candidates for election as
directors, other than nominations made by or at the direction of the board of
directors or a committee of the board of directors. The bylaws do not give the
board of directors the power to approve or disapprove stockholder nominations of
92
candidates or proposals regarding business to be conducted at a special or
annual meeting of the stockholders. However, our bylaws may have the effect of
precluding the conduct of certain business at a meeting if the proper procedures
are not followed. These provisions may also discourage or deter a potential
acquiror from conducting a solicitation of proxies to elect the acquirer's own
slate of directors or otherwise attempting to obtain control of our company.
DELAWARE ANTI-TAKEOVER STATUTE
We are subject to the provisions of Section 203 of the Delaware General
Corporation Law regulating corporate takeovers. In general, Section 203
prohibits a publicly-held Delaware corporation from engaging, under certain
circumstances, in a business combination with an interested stockholder for a
period of three years following the date the person became an interested
stockholder unless:
o Prior to the date of the transaction, the board of directors
of the corporation approved either the business combination or
the transaction which resulted in the stockholder becoming an
interested stockholder.
o Upon completion of the transaction that resulted in the
stockholder becoming an interested stockholder, the
stockholder owned at least 85% of the voting stock of the
corporation outstanding at the time the transaction commenced,
excluding for purposes of determining the number of shares
outstanding (1) shares owned by persons who are directors and
also officers and (2) shares owned by employee stock plans in
which employee participants do not have the right to determine
confidentially whether shares held subject to the plan will be
tendered in a tender or exchange offer.
o On or subsequent to the date of the transaction, the business
combination is approved by the board and authorized at an
annual or special meeting of stockholders, and not by written
consent, by the affirmative vote of at least 66?% of the
outstanding voting stock which is not owned by the interested
stockholder.
Generally, a business combination includes a merger, asset or stock
sale, or other transaction resulting in a financial benefit to the interested
stockholder. An interested stockholder is a person who, together with affiliates
and associates, owns or, within three years prior to the determination of
interested stockholder status, did own 15% or more of a corporation's
outstanding voting securities. We expect the existence of its provision to have
an anti-takeover effect with respect to transactions our board of directors does
not approve in advance. We also anticipate that Section 203 may also discourage
attempts that might result in a premium over the market price for the shares of
common stock held by stockholders.
The provisions of Delaware law, our certificate of incorporation and
our bylaws could have the effect of discouraging others from attempting hostile
takeovers and, as a consequence, they may also inhibit temporary fluctuations in
the market price of our common stock that often result from actual or rumored
hostile takeover attempts. These provisions may also have the effect of
preventing changes in our management. It is possible that these provisions could
make it more difficult to accomplish transactions that stockholders may
otherwise deem to be in their best interests.
TRANSFER AGENT AND REGISTRAR
The stock transfer agent and registrar for our common stock is
Computershare Investor Services. Its telephone number is (303) 986-5400.
93
LEGAL MATTERS
The validity of the shares of common stock offered in this offering
will be passed upon for us by Rutan & Tucker, LLP, Costa Mesa, California.
EXPERTS
Grant Thornton LLP, independent registered public accounting firm, has
audited our consolidated balance sheets as of December 31, 2003 and 2002, and
related consolidated statements of operations, comprehensive income (loss),
stockholders' equity and cash flows for the years then ended, as set forth in
their report. Grant Thornton LLP has also audited our Schedule II for the years
ended December 31, 2003 and 2002. We have included our consolidated financial
statements and Schedule II in the prospectus and elsewhere in the registration
statement in reliance on Grant Thornton LLP's report, given on their authority
as experts in accounting and auditing.
BDO Seidman, LLP, independent registered public accounting firm, has
audited our consolidated statements of operations, comprehensive income,
stockholder's equity and cash flow for the year ended December 31, 2001, and the
information for the year ended December 31, 2001 in the consolidated financial
statement schedule, as set forth in their report. We have included our
consolidated financial statements (and schedule) in the prospectus and elsewhere
in the registration statement in reliance on BDO Seidman, LLP's report, given on
their authority as experts in accounting and auditing.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed a registration statement on Form S-1 with respect to the
common stock offered in this prospectus with the Commission in accordance with
the Securities Act, and the rules and regulations enacted under its authority.
This prospectus, which constitutes a part of the registration statement, does
not contain all of the information included in the registration statement and
its exhibits and schedules. Statements contained in this prospectus regarding
the contents of any document referred to in this prospectus are not necessarily
complete, and in each instance, we refer you to the full text of the document
which is filed as an exhibit to the registration statement. Each statement
concerning a document which is filed as an exhibit should be read along with the
entire document. For further information regarding us and the common stock
offered in this prospectus, we refer you to this registration statement and its
exhibits and schedules, which may be inspected without charge at the
Commission's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C.
20549. The Commission may be relocating the Public Reference Room in the near
future. Please call the SEC at 1-800-SEC-0330 for further information on the
Public Reference Room.
The Commission also maintains an Internet website that contains
reports, proxy and information statements, and other information regarding
issuers, such as us, that file electronically with the Commission . The
Commission's website address is http://www.sec.gov.
94
EMRISE CORPORATION AND SUBSIDIARIES
(FORMERLY MICROTEL INTERNATIONAL INC.)
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
Page
----
Financial Statements
--------------------
Condensed Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003 (Unaudited).............F-2
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2004
and 2003 (Unaudited).........................................................................................F-3
Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended
September 30, 2004 and 2003 (Unaudited)......................................................................F-4
Condensed Consolidated Statements of Stockholders' Equity for the Nine Months Ended September 30, 2004
(Unaudited)..................................................................................................F-5
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004.................F-6
Notes to Condensed Consolidated Financial Statements for the Nine Months Ended September 30, 2004 and
2003 (Unaudited).............................................................................................F-7
Report of Grant Thornton LLP, Independent Registered Public Accounting Firm.................................F-15
Report of BDO Seidman, LLP, Independent Registered Public Accounting Firm...................................F-16
Consolidated Balance Sheets as of December 31, 2003 and 2002................................................F-17
Consolidated Statements of Operations for the Years Ended December 31, 2003, 2002 and 2001..................F-18
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2003, 2002 and
2001........................................................................................................F-19
Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2003, 2002 and 2001........F-20
Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001..................F-21
Notes to Consolidated Financial Statements for the Years Ended December 31, 2003, 2002 and 2001.............F-23
Financial Statement Schedule
----------------------------
Consolidated Schedule II Valuation and Qualifying Accounts for the Years Ended December 31, 2003, 2002
and 2001....................................................................................................F-51
F-1
EMRISE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 2004 AND DECEMBER 31, 2003
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Sept.30, December 31,
2004 2003
------------- -------------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents $ 379 $ 1,174
Accounts receivable, net of allowance for doubtful
accounts of $141 and $161, respectively 5,381 5,393
Inventories 6,518 6,683
Deferred tax asset 153 108
Prepaid and other current assets 464 447
------------- -------------
Total current assets 12,895 13,805
Property, plant and equipment, net 691 322
Goodwill, net of accumulated amortization of $1,070
7,984 2,447
Other assets 502 595
------------- -------------
$ 22,072 $ 17,169
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable $ 2,435 $ 2,882
Current portion of long-term debt 869 316
Accounts payable 2,025 1,637
Income tax payable 239 --
Accrued expenses 2,728 3,274
------------- -------------
Total current liabilities 8,296 8,109
Long-term debt, less current portion 3,325 819
Other liabilities 909 325
------------- -------------
Total liabilities 12,530 9,253
------------- -------------
Stockholders' equity:
Preferred stock, authorized 10,000,000 shares;
Convertible Series B Preferred Stock, $0.01 par value;
issued and outstanding 0 shares and 1,000 shares,
respectively (aggregate liquidation preferences of $0 and
$4, respectively) -- 4
Common stock, $0.0033 par value. Authorized 50,000,000
shares; issued and outstanding 24,745,000 and 23,476,000,
respectively 81 77
Additional paid-in capital 26,700 25,613
Accumulated deficit (17,289) (17,886)
Accumulated other comprehensive income 50 108
------------- -------------
Total stockholders' equity 9,542 7,916
------------- -------------
$ 22,072 $ 17,169
============= =============
See accompanying notes to condensed consolidated financial statements.
F-2
EMRISE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
(in thousands, except per share amounts)
Net sales $ 7,469 $ 6,420 $ 20,093 $ 18,922
Cost of sales 4,239 3,705 11,217 11,237
--------- --------- --------- ---------
Gross profit 3,230 2,715 8,876 7,685
Operating expenses:
Selling, general and administrative 2,465 1,916 6,749 5,532
Engineering and product development 438 230 1,033 697
--------- --------- --------- ---------
Income from operations 327 569 1,094 1,456
Other expense:
Interest expense (115) (104) (305) (317)
Other income (expense) (28) 65 (64) 4
--------- --------- --------- ---------
Income before income taxes 184 530 725 1,143
Income tax expense 26 26 128 236
--------- --------- --------- ---------
Net income $ 158 $ 504 $ 597 $ 907
========= ========= ========= =========
Earnings per share:
Net income:
Basic $ 0.01 $ 0.02 $ 0.03 $ 0.04
========= ========= ========= =========
Diluted $ 0.01 $ 0.02 $ 0.02 $ 0.04
========= ========= ========= =========
See accompanying notes to condensed consolidated financial statements.
F-3
EMRISE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
2004 2003 2004 2003
------- ------- ------- ------
(in thousands)
Net income $ 158 $ 504 $ 597 $ 907
Other comprehensive income (loss):
Foreign currency translation adjustment 6 109 (58) 361
------- ------- ------- ------
Comprehensive income $ 164 $ 613 $ 539 $1,268
======= ======= ======= =======
See accompanying notes to condensed consolidated financial statements.
F-4
EMRISE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2004
(UNAUDITED)
(IN THOUSANDS)
Series B Accumulated
Convertible Other
Preferred Stock Common Stock Additional Accum- Comprehensive
----------------------- ---------------------- Paid-In ulated Income
Shares Amount Shares Amount Capital Deficit (Loss) Total
--------- --------- --------- --------- --------- --------- --------- ---------
Balance at
December 31,
2003 1 $ 4 23,476 $ 77 $ 25,613 $(17,886) $ 108 $ 7,916
Preferred Series
B conversions -- (3) 3 -- 3 -- -- --
Stock option
exercise -- -- 2 -- 1 -- -- 1
Foreign currency
translation
adjustment -- -- -- -- -- -- (58) (58)
Issuance of shares
for acquisition
of Larus -- -- 1,214 4 996 -- -- 1,000
Warrant exercise -- -- 50 -- 15 -- -- 15
Redemption of
Series B (1) (1) -- -- -- -- -- (1)
Value of warrants
issued for
acquisition of
Larus -- -- -- -- 72 -- -- 72
Net income for the
period -- -- -- -- -- 597 -- 597
--------- --------- --------- --------- --------- --------- --------- ---------
Balance at
September 30,
2004 0 $ 0 24,745 $ 81 $ 26,700 $(17,289) $ 50 $ 9,542
========= ========= ========= ========= ========= ========= ========= =========
See accompanying notes to condensed consolidated financial statements.
F-5
EMRISE CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
Nine Months Ended Sept. 30,
2004 2003
-------- --------
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 597 $ 907
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation and amortization 180 215
Provision for doubtful accounts 4 46
Provision for obsolete/slow moving inventory 496 628
Deferred taxes (45) (108)
Warrants issued for services -- 19
Changes in operating assets and liabilities, net of acquisition:
Accounts receivable 709 378
Inventories 323 182
Other assets 111 (174)
Accounts payable and accrued expenses (796) (1,035)
-------- --------
Cash provided by operating activities 1,579 1,058
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net purchases of property, plant and equipment (431) (42)
Cash received from sale of fixed assets -- 13
Cash collected on note receivable -- 12
Net cash paid for acquisition of Larus (1,492) --
-------- --------
Cash used in investing activities (1,923) (17)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in notes payable and long-term debt (388) (1,050)
Cash from exercise of warrant 15 --
-------- --------
Cash used in financing activities (373) (1,050)
-------- --------
Effect of exchange rate changes on cash (78) 360
-------- --------
Net increase (decrease) in cash and cash equivalents (795) 351
Cash and cash equivalents at beginning of period 1,174 254
-------- --------
Cash and cash equivalents at end of period $ 379 $ 605
======== ========
Cash paid for:
Income tax $ 427 $ 61
======== ========
Interest $ 256 $ 288
======== ========
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Issuance of common stock for Larus acquisition $ 1,000 --
Issuance of promissory note for Larus acquisition 3,000 --
Issuance of warrants for Larus acquisition 72 --
See accompanying notes to condensed consolidated financial statements.
F-6
EMRISE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
Emrise Corporation, formerly MicroTel International Inc. (the
"Company"), operates through four wholly-owned subsidiaries: CXR Telcom
Corporation ("CXR Telcom"), CXR Anderson Jacobson, formerly CXR, SA ("CXR-AJ"),
XET Corporation ("XET") and Larus Corporation ("Larus"). XET and its
subsidiaries design, develop, manufacture and market digital and rotary
switches, power supplies and subsystem assemblies. CXR Telcom and CXR-AJ design,
develop, manufacture and market network access and transmission products and
communications test equipment. Larus engages in the manufacturing and sale of
telecommunications products. The Company conducts its operations out of various
facilities in the United States, France, the United Kingdom and Japan and
organizes itself in two product line segments: electronic components and
communications equipment.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with the rules and regulations of the
Securities and Exchange Commission and therefore do not include all information
and footnotes necessary for a complete presentation of financial position,
results of operations and cash flows in conformity with accounting principles
generally accepted in the United States of America.
The unaudited condensed consolidated financial statements do, however,
reflect all adjustments, consisting of only normal recurring adjustments, which
are, in the opinion of management, necessary to state fairly the financial
position as of September 30, 2004 and December 31, 2003 and the results of
operations and cash flows for the related interim periods ended September 30,
2004 and 2003. However, these results are not necessarily indicative of results
for any other interim period or for the year. It is suggested that the
accompanying condensed consolidated financial statements be read in conjunction
with the Company's audited consolidated financial statements included in its
2003 annual report on Form 10-K.
Stock-Based Compensation
The Company applies Accounting Principles Bulletin ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees" and related interpretations in
accounting for its employee stock-based compensation plans. Accordingly, no
compensation cost is recognized for its employee stock option plans unless the
exercise price of options granted is less than fair market value on the date of
grant. The Company has adopted the disclosure provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation" and SFAS No. 148 "Accounting for Stock-Based
Compensation-Transition and Disclosure."
The following table sets forth the net income, net income available for
common stockholders and earnings per share amounts for the periods presented as
if the Company had elected the fair value-based method of accounting for stock
options for all periods presented:
F-7
EMRISE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- ------------------------------
2004 2003 2004 2003
------------ ------------ ------------ -------------
Net income:
As reported $ 158,000 $ 504,000 $ 597,000 $ 907,000
Add: Stock-based compensation expense
included in reported net income, net
of related tax effect -- -- -- --
Deduct: Stock-based compensation
expense determined under the fair
value-based method (39,000) (10,000) (87,000) (34,000)
------------ ------------ ------------ -------------
Pro forma $ 119,000 $ 494,000 $ 510,000 $ 873,000
============ ============ ============ =============
Basic earnings per share:
As reported $ 0.01 0.02 $ 0.03 $ 0.04
Add: Stock-based compensation expense
included in reported net income, net
of related tax effect -- -- -- --
Deduct: Stock-based compensation
expense determined under the fair
value-based method (0.01) -- (0.01) --
Pro forma $ 0.00 $ 0.02 $ 0.02 $ 0.04
Diluted earnings per share:
As reported $ 0.01 $ 0.02 $ 0.02 $ 0.04
------------ ------------ ------------ -------------
Add: Stock-based compensation expense
included in reported net income, net
of related tax effect -- -- -- --
Deduct: Stock-based compensation
expensed determined under the fair
value-based method (0.01) -- -- --
------------ ------------ ------------ -------------
Pro forma $ 0.00 $ 0.02 $ 0.02 $ 0.04
The above calculations include the effects of all grants in the periods
presented. Because options often vest over several years and additional awards
are made each year, the results shown above may not be representative of the
effects on net income or loss in future periods. The calculations were based on
a Black-Scholes pricing model with the following assumptions: no dividend yield;
expected volatility of 92% to 107%; risk-free interest rate of 3%-4.25%;
expected lives of 7 years.
F-8
EMRISE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
(2) EARNINGS PER SHARE
The following table illustrates the computation of basic and diluted
earnings per share:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
2004 2003 2004 2003
-------- -------- -------- --------
(in thousands, except per share amounts)
NUMERATOR:
Net income $ 158 $ 504 $ 597 $ 907
Less: accretion of the excess of the
redemption value over the
carrying value of redeemable
preferred stock -- -- -- 5
-------- -------- -------- --------
Income attributable to common
stockholders $ 158 $ 504 $ 597 $ 902
======== ======== ======== ========
DENOMINATOR:
Weighted average number of common
shares outstanding during
the period 24,538 23,428 23,833 22,280
Incremental shares from assumed
conversions of warrants,
options and preferred stock 556 470 766 1,324
-------- -------- -------- --------
Adjusted weighted average number of
outstanding shares 25,094 23,898 24,599 23,604
======== ======== ======== ========
Basic earnings per share $ 0.01 $ 0.02 $ 0.03 $ 0.04
======== ======== ======== ========
Diluted earnings per share $ 0.01 $ 0.02 $ 0.02 $ 0.04
======== ======== ======== ========
F-9
EMRISE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
The following options and warrants were excluded from the computation
of diluted earnings per share as a result of the exercise prices exceeding the
average market prices of the underlying shares of common stock (in thousands,
except per share amounts):
Three Months Ended Sept. 30,
--------------------------------
2004 2003
-------------- --------------
Options and warrants to purchase shares of common stock 1,668 1,325
-------------- --------------
Exercise prices per share $0.75 - $3.44 $0.35 - $3.44
-------------- --------------
Nine Months Ended
September 30,
-------------------------------
2004 2003
-------------- --------------
Options and warrants to purchase shares of common stock 1,091 978
-------------- --------------
Exercise prices per share $0.75 - $3.44 $0.35 - $3.44
-------------- --------------
(3) INVENTORIES
Inventories consisted of the following (in thousands):
September 30, December 31,
2004 2003
------------ ------------
Raw materials $ 3,371 $ 3,230
Work-in-process 1,240 1,963
Finished goods 1,907 1,490
------------ ------------
$ 6,518 $ 6,683
============ ============
(4) REPORTABLE SEGMENTS
The Company has two reportable segments: electronic components and
communications equipment. The electronic components segment operates in the
United States, European and Asian markets and designs, manufactures and markets
digital and rotary switches, electronic power supplies and subsystem assemblies.
The communications equipment segment also operates in the United States,
European and Asian markets and designs, manufactures and distributes network
access and transmission products, communications test instruments and
communication timing and synchronization products.
The accounting policies of the segments are the same as those described
in the summary of significant accounting policies. The Company evaluates
performance based upon profit or loss from operations before income taxes,
exclusive of nonrecurring gains and losses. The Company accounts for
intersegment sales at prices negotiated between the individual segments.
The Company's reportable segments are comprised of operating entities
offering the same or similar products to similar customers. Each segment is
managed separately because each business has different customers and different
design and manufacturing and marketing strategies.
There were no differences in the basis of segmentation or in the basis
of measurement of segment profit or loss from the amounts disclosed in the
Company's audited consolidated financial statements included in its 2003 annual
report on Form 10-K except for the inclusion of Larus sales in the
communications equipment segment in the third quarter of 2004. Selected
financial data for each of the Company's operating segments is shown below (in
thousands):
F-10
EMRISE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
Sept. 30, 2004 Sept. 30, 2003 Sept. 30, 2004 Sept. 30, 2003
-------------- -------------- ---------------- ----------------
Sales to external customers:
Electronic Components $ 3,843 $ 4,402 $ 11,703 $ 12,251
Communications Equipment 3,626 2,018 8,390 6,671
-------------- -------------- ---------------- ----------------
$ 7,469 $ 6,420 $ 20,093 $ 18,922
============== ============== ================ ================
Segment pretax income:
Electronic Components $ 632 $ 1,069 $ 2,228 $ 2,729
Communications Equipment 75 67 206 34
-------------- -------------- ---------------- ----------------
$ 707 $ 1,136 $ 2,434 $ 2,763
============== ============== ================ ================
Sept. 30, 2004 December 31, 2003
---------------- ----------------
Segment assets:
Electronic Components $ 7,879 $ 9,466
Communications Equipment 14,000 6,969
---------------- ----------------
$ 21,879 $ 16,435
================ ================
The following is a reconciliation of the reportable segment income and
assets to the Company's consolidated totals (in thousands):
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
Sept. 30, 2004 Sept. 30, 2003 Sept. 30, 2004 Sept. 30, 2003
-------------- -------------- ---------------- ----------------
Total income for reportable
segments $ 707 $ 1,136 $ 2,434 $ 2,763
Unallocated amounts:
Unallocated general
corporate expenses 523 606 1,709 1,620
-------------- -------------- ---------------- ----------------
Consolidated income before
income taxes $ 184 $ 530 $ 725 $ 1,143
============== ============== ================ ================
F-11
EMRISE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
Sept. 30, December 31,
2004 2003
------------ ------------
Assets
Total assets for reportable segments $ 21,879 $ 16,437
Other assets 193 732
------------ ------------
Total consolidated assets $ 22,072 $ 17,169
============ ============
(5) NEW ACCOUNTING PRONOUNCEMENTS
New accounting pronouncements are discussed under the heading "Impacts
of New Accounting Pronouncements" in Item 2 of Part I of this report.
(6) INCOME TAXES
The effective tax rate for the three- and nine-month periods ended
September 30, 2004 is different than the 34% United States statutory rate
primarily because the Company has net operating loss carryforwards that it used
to reduce current United States taxes. In addition, the Company recorded a
$45,000 income tax benefit in the third quarter of 2004 by reversing a portion
of its valuation allowance due to the expectation of realizing a benefit from
the net operating loss carryforwards. In addition, the Company recorded a tax
expense for foreign taxes, as the Company has no foreign net operating loss
carryforwards to apply to foreign taxes.
(7) CREDIT FACILITIES
On June 1, 2004, two of the Company's subsidiaries, XET Corporation and
CXR Telcom Corporation, together with the Company acting as guarantor, obtained
a credit facility from Wells Fargo Bank, N.A. for the Company's domestic
operations. This facility is effective through July 1, 2005 and replaced the
previous credit facility the Company had with Wells Fargo Business Credit, Inc.
No prepayment penalty was due because the prior loan contract excluded from
prepayment penalties loans replaced with new credit facilities from Wells Fargo
Bank, N.A. Also, the new credit facility has no minimum interest but is subject
to an unused commitment fee equal to 0.25% per annum, payable quarterly based on
the average daily unused amount of the line of credit described in the following
paragraph.
The new credit facility provides a $3,000,000 revolving line of credit
secured by accounts receivable, other rights to payment and general intangibles,
inventories and equipment. Borrowings do not need to be supported by specific
receivables or inventory balances unless aggregate borrowings under the line of
credit and the term loan described in the following paragraph exceed $2,000,000
for 30 consecutive days (a "conversion event"). If a conversion event occurs,
the line of credit will convert into a formula-based line of credit until the
borrowings are equal to or less than $2,000,000 for 30 consecutive days. The
formula generally provides that outstanding borrowings under the line of credit
may not exceed an aggregate of 80% of eligible accounts receivable, plus 15% of
the value of eligible raw material inventory, plus 30% of the value of eligible
finished goods inventory. The interest rate is variable and is adjusted monthly
based on the prime rate plus 0.5%. The prime rate at September 30, 2004 was
4.75%.
The new credit facility also provides a term loan of $150,000 secured
by equipment, amortizable over 36 months at a variable rate equal to the prime
rate plus 1.5%. In addition, Wells Fargo Bank, N.A. has provided the Company
with $300,000 of credit available for the purchase of new capital equipment when
needed, of which a balance of $60,000 was outstanding at September 30, 2004.
F-12
EMRISE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
As of September 30, 2004, the Company had a balance owing under the
revolving credit line of $1,567,000, and the Company had $433,000 of
availability on the non-formula based portion of the credit line. The credit
facility is subject to the following financial covenants: debt service; annual
profitability; debt-to-tangible net worth; current ratio; and minimum tangible
net worth. As of September 30, 2004, the Company was not in compliance with
three of those covenants: debt-to-tangible net worth; current ratio; and minimum
tangible net worth. The Company obtained a waiver of non-compliance for those
covenants as of September 30, 2004. The Company is currently in discussion with
Wells Fargo Bank, N.A. to amend the existing financial covenants effective as of
the next measurement date of December 31, 2004. Management believes that the
amendments to the financial covenants will be completed in the fourth quarter of
2004 and that the Company will be able to comply with the revised covenants over
the next twelve months.
As of September 30, 2004, the Company's foreign subsidiaries had credit
facilities, including lines of credit and term loans, with Venture Finance PLC,
a subsidiary of the global Dutch ABN AMRO Holdings, N.V. financial institution,
in England, IFN Finance, a subsidiary of ABN AMRO Holdings, N.V., Banc National
de Paris, Societe Generale in France and Sogelease and Johnan Shinkin Bank in
Japan. At September 30, 2004, the balances outstanding under the Company's
United Kingdom, France and Japan credit facilities were $774,000, $688,000 and
$59,000, respectively.
On July 13, 2004, the Company issued two promissory notes to the former
shareholders of Larus totaling $3,000,000 in addition to paying cash and issuing
shares of common stock (see Note 8), in exchange for 100% of the capital stock
of Larus. These notes are subordinated to the Company's bank debt and are
payable in 72 monthly equal payments of principal totaling $41,667 per month
plus interest at the monthly LIBOR rate plus 5% with a maximum interest rate of
7% during the first two years of the term of the notes, 8% during the third and
fourth years and 9% thereafter. During September 2004, the LIBOR rate was 1.84%.
The total balance on these promissory notes as of September 30, 2004 was
$2,875,000.
(8) ACQUISITION
Pursuant to the terms of a Stock Purchase Agreement executed on July
13, 2004, the Company acquired all of the issued and outstanding common stock of
Larus. Larus is based in San Jose, California and engages in the manufacturing
and sale of telecommunications products. Larus has one wholly-owned subsidiary,
Vista Labs, Incorporated ("Vista"), which provides engineering services to
Larus. The Company acquired all of the assets and liabilities of Larus in this
transaction, including the intellectual property, cash, accounts receivable and
inventories owned by each of Larus and Vista.
The purchase price for the acquisition consisted of $1,000,000 in cash,
the issuance of 1,213,592 shares of the Company's common stock, $887,500 in the
form of two short-term, zero interest promissory notes that have since been
repaid, $3,000,000 in the form of two subordinated secured promissory notes, and
warrants to purchase up to an aggregate of 150,000 shares of the Company's
common stock at $1.30 per share. In addition, the Company assumed $245,000 in
accounts payable and accrued expenses and entered into an above-market real
property lease with the sellers. This lease represents an obligation that
exceeds the fair market value by approximately $756,000 and is part of the
acquisition purchase price. The cash portion of the acquisition purchase price
was funded with proceeds from the Company's credit facility with Wells Fargo
Bank, N.A. and cash on-hand.
F-13
EMRISE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
SEPTEMBER 30, 2004 AND 2003
(UNAUDITED)
The following table summarizes the unaudited assets acquired and
liabilities assumed in connection with this acquisition:
Amount
in Thousands
------------
Current assets.......................................... $ 2,488
Property, plant and equipment........................... 90
Goodwill 5,535
------------
Total assets acquired................................... 8,113
Current liabilities..................................... (685)
Other liabilities....................................... (132)
------------
Total liabilities assumed............................... (817)
------------
Net assets acquired..................................... $ 7,296
============
The following table summarizes, on an unaudited pro forma basis, the
combined results of operations of the Company and Larus, as though the
acquisition occurred as of January 1, 2003. The pro forma amounts give effect to
appropriate adjustments for interest expense and income taxes. The pro forma
amounts presented are not necessarily indicative of future operating results (in
thousands, except per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ --------------------------
2004 2003 2004 2003
---------- ---------- ----------- -----------
Revenues 7,469 7,893 22,718 23,234
Net income 158 761 869 1,639
Earnings per share of common stock:
Basic $ 0.01 $ 0.03 $ 0.04 $ 0.07
========== ========== =========== ===========
Diluted $ 0.01 $ 0.03 $ 0.04 $ 0.07
========== ========== =========== ===========
(9) SUBSEQUENT EVENTS
In November 2004, the Company issued to Hayden Communications, Inc.
warrants to purchase up to 100,000 shares of common stock as partial
consideration for investor relations services. The warrants vest and become
exercisable in three installments. The warrants vested on November 3, 2004 as to
25,000 underlying shares with an exercise price of $0.85 per share. The warrants
vest on February 1, 2005 as to 25,000 underlying shares with an exercise price
of $1.00 per share, and vest on May 1, 2005 as to the remaining 50,000
underlying shares with an exercise price of $1.15 per share. The warrants are
exercisable for a period of three years commencing on their respective vesting
dates.
On January 5, 2005, the Company issued to 17 accredited record holders
in a private offering an aggregate of 12,503,500 shares of its common stock at a
purchase price of $1.44 per share and five-year investor warrants to purchase up
to an additional 3,125,875 shares of its common stock at an exercise price of
$1.73 per share. Roth Capital, an NASD-registered broker-dealer, acted as
placement agent in connection with the offering. The Company paid to Roth
Capital cash placement agent fees of approximately $936,500 and issued five-year
placement agent warrants to purchase up to an aggregate of 650,310 shares of its
common stock in connection with the offering.
On January 24, 2005, the Company issued to Hayden Communications, Inc.
a fully-vested three-year warrant to purchase up to 25,000 shares of common
stock as additional consideration for investor relations services. The exercise
price of the warrant is $2.00 per share. All of the warrants issued to Hayden
Communications, Inc. contain a net exercise cashless exercise feature that will
permit the warrants to be exercised for a net number of shares using the spread
between the warrant exercise price and the average of the last bid and asked
prices reported on the last business day immediately prior to the exercise of
the warrant as payment for a reduced number of common shares. The Company has
agreed to register for resale the 125,000 shares of common stock underlying the
warrants issued to Hayden Communications, Inc.
F-14
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
and Shareholders of Emrise Corporation
We have audited the accompanying consolidated balance sheets of Emrise
Corporation (formerly MicroTel International Inc., a Delaware corporation) as
of December 31, 2003 and 2002, and the related consolidated statements of
operations, comprehensive income (loss), stockholders' equity, and cash flows
for each of the two years in the period ended December 31, 2003. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Emrise Corporation
as of December 31, 2003 and 2002, and the results of its operations and its cash
flows for each of the two years in the period ended December 31, 2003 in
conformity with accounting principles generally accepted in the United States of
America.
Our audits were conducted for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The consolidated Schedule II
for the years ended December 31, 2003 and 2002 are presented for purposes of
additional analysis and are not a required part of the basic consolidated
financial statements. These schedules have been subjected to the auditing
procedures applied in the audits of the basic consolidated financial statements
and, in our opinion, are fairly stated in all material respects in relation to
the basic consolidated financial statements taken as a whole.
/S/ GRANT THORNTON LLP
-----------------------
Los Angeles, California
March 5, 2004
F-15
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
MicroTel International, Inc.
Rancho Cucamonga, California
We have audited the accompanying consolidated statements of operations,
comprehensive income, stockholders' equity and cash flows of MicroTel
International, Inc. for the year ended December 31, 2001. We have also audited
the information for the year ended December 31, 2001 in the consolidated
financial statement schedule listed in the accompanying index. These
consolidated financial statements and the consolidated financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements and the
consolidated financial statement schedule based on our audit.
We conducted our audit in accordance with auditing standards of the
Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements and the financial statement schedule are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements and the
financial statement schedule. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall presentation of the financial statements and the
financial statement schedule. We believe that our audit provides a reasonable
basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the results of operations and cash
flows of MicroTel International, Inc. for the year ended December 31, 2001 in
conformity with accounting principles generally accepted in the United States of
America. Also, in our opinion, the consolidated financial statement schedule
referred to above presents fairly, in all material respects, the information set
forth therein.
BDO SEIDMAN, LLP
Costa Mesa, California
February 25, 2002
F-16
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2003 AND 2002
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
ASSETS (Notes 5 and 6) 2003 2002
--------- ---------
Current assets:
Cash and cash equivalents $ 1,174 $ 254
Accounts receivable, net of allowance for doubtful accounts
of $161 and $130, respectively 5,393 5,356
Inventories (Note 2) 6,683 7,505
Prepaid and other current assets 555 343
--------- ---------
Total current assets 13,805 13,458
Property, plant and equipment, net (Note 3) 322 588
Goodwill, net of accumulated amortization of $1,070 and $1,050 in 2003
and 2002, respectively 2,447 2,346
Other assets 595 394
--------- ---------
$ 17,169 $ 16,786
========= =========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable (Note 5) $ 2,882 $ 3,475
Current portion of long-term debt (Note 6) 316 318
Accounts payable 1,637 2,439
Accrued expenses 3,274 3,265
--------- ---------
Total current liabilities 8,109 9,497
Long-term debt, less current portion (Note 6) 819 927
Other liabilities 325 348
--------- ---------
Total liabilities $ 9,253 $ 10,772
Commitments and contingences (Note 11)
Convertible redeemable Series A Preferred Stock, $10,000 unit value. Authorized
200 shares; issued and outstanding 0 shares and 25 shares in 2003 and 2002,
respectively (aggregate liquidation preferences of $0 and $250,
respectively) (Note 7) -- 282
Stockholders' equity (Notes 7, 8 and 11):
Preferred stock, authorized 10,000,000 shares;
Convertible Series B Preferred Stock, $0.01 par value, issued and
outstanding 1,000 shares and 64,000 shares in 2003 and 2002, respectively
(aggregate liquidation preference of $4 and $410 in 2003
and 2002, respectively) 4 400
Common stock, $0.0033 par value. Authorized 50,000,000 shares; issued and
outstanding 23,476,000 and 21,535,000 shares in 2003 and 2002, respectively 77 71
Additional paid-in capital 25,613 24,900
Accumulated deficit (17,886) (19,042)
Accumulated other comprehensive income (loss) 108 (597)
--------- ---------
Total stockholders' equity 7,916 5,732
--------- ---------
$ 17,169 $ 16,786
========= =========
See accompanying notes to condensed consolidated financial statements.
F-17
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2003 2002 2001
--------- --------- ---------
Net sales (Note 12) $ 25,519 $ 22,664 $ 27,423
Cost of sales 14,835 14,147 15,456
--------- --------- ---------
Gross profit 10,684 8,517 11,967
Operating expenses:
Selling, general and administrative 7,812 7,731 10,129
Engineering and product development 951 1,015 1,076
--------- --------- ---------
Income (loss) from operations 1,921 (229) 762
Other income (expense):
Interest expense (416) (441) (396)
Other, net (58) 80 (18)
--------- --------- ---------
Income (loss) from continuing operations before income
taxes 1,447 (590) 348
Income tax expense (benefit) (Note 9) 286 (20) 77
--------- --------- ---------
Income (loss) from continuing operations 1,161 (570) 271
--------- --------- ---------
Income (loss) from discontinued operations (Note 13) -- -- 56
--------- --------- ---------
Net income (loss) $ 1,161 $ (570) $ 327
========= ========= =========
Basic earnings (loss) per share from continuing
operations $ 0.05 $ (0.03) $ 0.01
========= ========= =========
Diluted earnings (loss) per share from continuing
operations $ 0.05 $ (0.03) $ 0.01
========= ========= =========
Basic earnings (loss) per share from discontinued operations $ -- $ -- $ 0.00
========= ========= =========
Diluted earnings (loss) per share from discontinued operations $ -- $ -- $ 0.00
========= ========= =========
Basic earnings (loss) per share (Note 10) $ 0.05 $ (0.03) $ 0.02
========= ========= =========
Diluted earnings (loss) per share (Note 10) $ 0.05 $ (0.03) $ 0.01
========= ========= =========
See accompanying notes to condensed consolidated financial statements.
F-18
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(IN THOUSANDS)
2003 2002 2001
------- ------- -------
Net income (loss) $1,161 $ (570) $ 327
Other comprehensive income (loss):
Foreign currency translation adjustment 705 446 (312)
------- ------- -------
Comprehensive Income (loss) $1,866 $ (124) $ 15
======= ======= =======
See accompanying notes to condensed consolidated financial statements.
F-19
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(IN THOUSANDS)
Series B Accumulated
Convertible Other
Preferred Stock Common Stock Additional Comprehensive
------------------------------------------------ Paid-in Accumulated Income
Shares Amount Shares Amount Capital Deficit (Loss) Total
------- --------- --------- --------- --------- --------- --------- ---------
Balance at
December 31, 2000 150 938 20,570 68 24,307 (18,775) (731) 5,807
Warrants issued
for services -- -- -- -- 21 -- -- 21
Stock issued
for services -- -- 100 -- 30 -- -- 30
Stock issued under
stock purchase plan -- -- 1 -- -- -- -- --
Foreign currency
translation
adjustment -- -- -- -- -- -- (312) (312)
Accretion of
redeemable
preferred stock -- -- -- -- -- (11) -- (11)
Net income -- -- -- -- -- 327 -- 327
------- --------- --------- --------- --------- --------- --------- ---------
Balance at
December 31, 2001 150 938 20,671 68 24,358 (18,459) (1,043) 5,862
Preferred Series
B conversions (86) (538) 864 3 535 -- -- --
Accretion of
redeemable
preferred stock -- -- -- -- -- (13) -- (13)
Warrants issued
for services -- -- -- -- 6 -- -- 6
Common stock
issued for
services -- -- -- -- 1 -- -- 1
Foreign currency
translation
adjustment -- -- -- -- -- -- 446 446
Net loss -- -- -- -- -- (570) -- (570)
------- --------- --------- --------- --------- --------- --------- ---------
Balance at
December 31, 2002 64 $ 400 21,535 $ 71 $ 24,900 $(19,042) $ (597) $ 5,732
Preferred Series
A conversions -- -- 1,263 4 283 -- -- 287
Preferred Series
B conversions (63) (396) 635 2 395 (1) -- --
Foreign currency
translation
adjustment -- -- -- -- -- -- 705 705
Accretion of
redeemable
preferred stock -- -- -- -- -- (4) -- (4)
Warrants issued
for services -- -- -- -- 19 -- -- 19
Exercise of
warrants and
options -- -- 43 -- 16 -- -- 16
Net income -- -- -- -- -- 1,161 -- 1,161
------- --------- --------- --------- --------- --------- --------- ---------
Balance at
December 31, 2003 1 $ 4 23,476 $ 77 $ 25,613 $(17,886) $ 108 $ 7,916
======= ========= ========= ========= ========= ========= ========= =========
See accompanying notes to condensed consolidated financial statements.
F-20
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(IN THOUSANDS)
2003 2002 2001
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 1,161 $ (570) $ 327
Adjustments to reconcile net income (loss) to cash provided by
(used in) operating activities:
Depreciation and amortization 249 349 345
Amortization of intangible assets -- -- 370
Provision for doubtful accounts 61 118 216
Provision for inventory obsolescence 924 438 659
Gain on sale of fixed assets 1 (9) --
Stock and warrants issued for services 19 7 51
Net change in operating assets of discontinued operations -- -- (15)
Changes in operating assets and liabilities net of businesses acquired:
Accounts receivable (106) 22 1,609
Inventories (113) (657) (1,755)
Prepaids and other assets (341) 219 458
Accounts payable (802) 114 (1,439)
Accrued expenses and other liabilities (14) (688) (926)
-------- -------- --------
Cash provided by (used in) operating activities 1,039 (657) (100)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net purchases of property, plant and equipment (63) (193) (120)
Cash received from sale of fixed assets 13 -- --
Cash collected on notes receivable 12 17 82
-------- -------- --------
Cash used in investing activities (38) (176) (38)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) of notes payable (703) (206) (34)
Net proceeds of long-term debt -- -- 392
Cash from warrant/option exercise 16 -- --
-------- -------- --------
Cash provided by (used in) financing activities (687) (206) 358
-------- -------- --------
Effect of exchange rate changes on cash 606 689 (372)
Net increase (decrease) in cash and cash equivalents 920 (350) (152)
Cash and cash equivalents at beginning of year 254 604 756
-------- -------- --------
Cash and cash equivalents at end of year $ 1,174 $ 254 $ 604
======== ======== ========
See accompanying notes to condensed consolidated financial statements.
F-21
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(IN THOUSANDS)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: 2003 2002 2001
----- ----- -----
Cash paid during the year for:
Interest $382 $361 $400
===== ===== =====
Income taxes $ 81 $ 95 $ 45
===== ===== =====
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING
ACTIVITIES:
===== ===== =====
Equipment acquired under capital lease $ -- $143 $150
===== ===== =====
Common stock issued upon conversion of redeemable preferred stock $287 $ -- $ --
===== ===== =====
Accretion of redeemable preferred stock $ 4 $ 13 $ 11
===== ===== =====
See accompanying notes to condensed consolidated financial statements.
F-22
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
MicroTel International Inc. (the "Company") operates through three
wholly-owned subsidiaries: CXR Telcom Corporation ("CXR Telcom"), CXR Anderson
Jacobson, formerly CXR, SA ("CXR-AJ") and XET Corporation ("XET"). XET and its
subsidiaries design, develop, manufacture and market digital and rotary
switches, power supplies and subsystem assemblies. CXR Telcom and CXR-AJ design,
develop, manufacture and market network access and transmission products and
communications test equipment. The Company conducts its operations out of
various facilities in the U.S., France, England and Japan and organizes itself
in two product line segments: electronic components and communications
equipment.
In October 2000, the Company discontinued its circuits segment
operations (see Note 13). At that time, the circuits segment operations
consisted of XCEL Etch Tek, a wholly-owned subsidiary, and XCEL Circuits
Division ("XCD"), a division of XET. XCEL Etch Tek was offered for sale and sold
in November 2000. XCD, predominantly a captive supplier of printed circuit
boards to the electronic components segment, has been retained and is now
included in the electronic components segment. Accordingly, all current and
prior financial information related to the circuits segment operations has been
presented as discontinued operations in the accompanying consolidated financial
statements.
BASIS OF PRESENTATION
The consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
and include the accounts of the Company and each of its subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
REVENUE RECOGNITION
Revenues are recorded when products are shipped if shipped FOB shipping
point or when received by the customer if shipped FOB destination.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of all highly liquid investments with
an original maturity of three months or less when purchased. As of December 31,
2003, cash in foreign accounts was $535,000.
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out) or
market (net realizable value).
F-23
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost, less accumulated
depreciation and amortization. Depreciation and amortization are computed
principally using the straight-line method over the useful lives of the assets
(or lease term, if shorter) as follows:
Buildings 50 years
Machinery, equipment and fixtures 3-7 years
Leasehold improvements 5 years
Maintenance and repairs are expensed as incurred, while renewals and
betterments are capitalized.
LONG-LIVED ASSETS
The Company reviews the carrying amount of its long-lived assets for
possible impairment whenever events or changes in circumstances indicate that
the carrying amount of the assets may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to future undiscounted net cash flows expected to be generated by the
asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets. Assets to be disposed of are reported at
the lower of the carrying amount or fair value less costs to sell.
DEBT ISSUANCE COSTS
The costs related to the issuance of debt are, and the costs related to
the issuance of the redeemable preferred stock were, capitalized and amortized
over the life of the instruments.
PRODUCT WARRANTY LIABILITIES
Estimated warranty costs are based on actual warranty costs as a
percentage of sales and a liability is recorded and reviewed in order to reflect
current activity. The Company's electronic components carry a one-year limited
parts and labor warranty, and the Company's communications equipment products
carry a two-year limited parts and labor warranty. The Company's communications
equipment products may be returned within 30 days of purchase if a new order is
received, and the new order will be credited with 80% of the selling price of
the returned item. Products returned under warranty typically are tested and
repaired or replaced at the Company's option. Historically, the Company has not
experienced significant warranty costs or returns. During the fourth quarter of
2001, the Company performed a study of its warranty costs incurred over the
previous two years. Based on the study, the Company determined that it was
over-accrued and, accordingly, reduced its warranty accrual by approximately
$85,000, which amount is included in cost of sales in the accompanying 2001
consolidated statement of operations.
The Company records a liability for an estimate of costs that it
expects to incur under its basic limited warranties when product revenue is
recognized. Factors affecting the Company's warranty liability include the
number of units sold, historical and anticipated rates of claim, and costs per
claim. The Company periodically assesses the adequacy of its warranty liability
accrual based on changes in these factors.
F-24
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
The changes in the Company's product warranty liability during 2003 and
2002 were as follows:
Year Ended December 31,
2003 2002
--------- ---------
Liability, beginning of year $ 32,000 $ 32,000
Expense for new warranties issued 14,000 32,000
Expense related to accrual revision for prior year warranties -- --
Warranty claims (14,000) (32,000)
--------- ---------
Liability, end of year $ 32,000 $ 32,000
========= =========
INCOME TAXES
The Company uses the liability method of accounting for income taxes in
accordance with Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes." Deferred income taxes are recognized based on the differences
between financial statement and income tax bases of assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected
to reverse. Valuation allowances are established, when necessary, to reduce
deferred tax assets to the amount expected to be realized. The provision for
income taxes represents the tax payable for the year and the change during the
year in deferred tax assets and liabilities.
STOCK-BASED COMPENSATION
The Company applies Accounting Principles Bulletin ("APB") Opinion No.
25, "Accounting for Stock Issued to Employees" and related interpretations in
accounting for its employee stock-based compensation plans. Accordingly, no
compensation cost is recognized for its employee stock option plans unless the
exercise price of options granted is less than fair market value on the date of
grant. The Company has adopted the disclosure provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation."
The following table sets forth the net income (loss), net income (loss)
available for common stockholders and earnings (loss) per share amounts for the
periods presented as if the Company had elected the fair value method of
accounting for stock options:
F-25
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
2003 2002 2001
---------- -------- --------
NET INCOME (LOSS)
As reported $ 1,161 $ (570) $ 327
Pro forma $ 1,116 $ (590) $ 211
NET INCOME (LOSS) AVAILABLE FOR
COMMON STOCKHOLDERS (LESS
ACCRETION OF PREFERRED STOCK)
As reported $ 1,157 $ (583) $ 316
Pro forma $ 1,112 $ (603) $ 200
BASIC EARNINGS (LOSS) PER SHARE
As reported $ 0.05 $ (0.03) $ 0.02
Pro forma $ 0.05 $ (0.03) $ 0.01
DILUTED EARNINGS (LOSS) PER SHARE
As reported $ 0.05 $ (0.03) $ 0.01
Pro forma $ 0.05 $ (0.03) $ 0.01
The above calculations include the effects of all grants in the years
presented. Because options often vest over several years and additional awards
are made each year, the results shown above may not be representative of the
effects on net income (loss) in future years. The additional stock based
employee compensation expense determined under the fair value method totaled
$45, $20 and $110 in 2003, 2002 and 2001, respectively.
EARNINGS (LOSS) PER SHARE
Earnings (loss) per share is calculated according to Statement of
Financial Accounting Standards No. 128, "Earnings Per Share." Basic earnings
(loss) per share includes no dilution and is computed by dividing net income
(loss) available to common stockholders by the weighted average number of shares
outstanding during the year. Diluted earnings (loss) per share reflects the
potential dilution of securities that could share in the earnings of the
Company.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures about
Fair Value of Financial Instruments" requires all entities to disclose the fair
value of financial instruments, both assets and liabilities recognized and not
recognized on the balance sheet, for which it is practicable to estimate fair
value. This statement defines fair value of a financial instrument as the amount
at which the instrument could be exchanged in a current transaction between
willing parties. As of December 31, 2003 and 2002, the fair value of all
financial instruments approximated carrying value.
The carrying amount of cash and cash equivalents, accounts receivable,
accounts payable and accrued expenses are reasonable estimates of their fair
value because of the short maturity of these items. The Company believes the
carrying amounts of its notes payable and long-term debt approximate fair value
because the interest rates on these instruments are subject to change with, or
approximate, market interest rates.
F-26
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. In the fourth quarter of 2001, the Company finalized a sales tax
audit, resulting in a final tax assessment at a lower amount than had been
accrued for at December 31, 2000. The Company reversed the over-accrual in the
amount of approximately $78,000 in the fourth quarter of 2001, which amount is
included in selling, general and administrative expenses in the accompanying
2001 consolidated statement of operations.
CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially expose the Company to
concentration of credit risk, consist primarily of cash and accounts receivable.
The Company places its cash with high quality financial institutions. At times,
cash balances may be in excess of the amounts insured by the Federal Deposit
Insurance Corporation.
The Company's accounts receivable result from sales to a broad customer
base. The Company extends credit to its customers based upon an evaluation of
the customer's financial condition and credit history and generally does not
require collateral. Accounts receivable are generally due within 30 days in the
Company's U.S. operations and are stated net of allowance for doubtful accounts.
Accounts outstanding for longer than the contractual payment terms are
considered past due. Provisions for uncollectible accounts are made based on the
Company's specific assessment of the collectibility of all past due accounts.
Credit losses are provided for in the financial statements and consistently have
been within management's expectations. Sales to various BAE Systems companies in
the U.S. and Europe represented approximately 13% and 14% of the Company's total
net revenues during 2003 and 2002, respectively.
FOREIGN CURRENCY TRANSLATION
The accounts of foreign subsidiaries have been translated using the
local currency as the functional currency. Accordingly, foreign currency
denominated assets and liabilities have been translated to U.S. dollars at the
current rate of exchange on the balance sheet date. The effects of translation
are recorded as a separate component of stockholders' equity in accumulated
other comprehensive income (loss). Exchange gains and losses arising from
transactions denominated in foreign currencies are translated at average
exchange rates and included in operations. Such amounts are not material to the
accompanying consolidated financial statements.
F-27
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
RECLASSIFICATIONS
Certain reclassifications have been made to the prior years' financial
statements to be consistent with the 2003 presentation.
(2) INVENTORIES
Inventories are summarized as follows:
2003 2002
----------- -----------
Raw materials $3,230,000 $2,904,000
Work-in-process $1,963,000 2,988,000
Finished goods $1,490,000 1,613,000
----------- -----------
$6,683,000 $7,505,000
=========== ===========
Included in the amounts above are allowances for inventory obsolescence
of $1,692,000 and $1,497,000 at December 31, 2003 and 2002, respectively.
Allowances for inventory obsolescence are recorded as necessary to reduce
obsolete inventory to estimated net realizable value or to specifically reserve
for obsolete inventory that the Company intends to dispose of. The inventory
items identified for disposal at each year end are generally discarded during
the following year.
(3) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following:
2003 2002
------------ ------------
Land and buildings $ 365,000 $ 309,000
Machinery, equipment and fixtures $ 3,591,000 $ 3,717,000
Leasehold improvements $ 435,000 $ 450,000
------------ ------------
$ 4,391,000 $ 4,476,000
Accumulated depreciation $(4,069,000) $(3,888,000)
------------ ------------
$ 322,000 $ 588,000
============ ============
F-28
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(4) GOODWILL AMORTIZATION AND IMPAIRMENT TESTING
The Company initially applied Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142") on
January 1, 2002. SFAS No. 142 provides for impairment testing of goodwill
carrying values and disallows the amortization of goodwill. In applying SFAS No.
142, the Company performed the transitional reassessment and impairment tests
required as of January 1, 2002 and determined that goodwill had indefinite
useful lives and that there was no impairment of these assets. At the time of
adoption, the Company had $1,060,000 of accumulated amortization of goodwill.
The Company performed its annual required tests of impairment as of December 31,
2003 and 2002. The following table includes a reversal of the Company's goodwill
amortization expenses for 2001 so that 2001 can be compared with 2003 and 2002,
during which years the Company had no goodwill amortization expense in
accordance with SFAS No. 142.
Year Ended December 31,
2003 2002 2001
-------------- ------------ ------------
Reported net income (loss) from continuing
operations $ 1,161,000 $ (570,000) $ 271,000
Add back: goodwill amortization -- -- 370,000
-------------- ------------ ------------
Adjusted net income (loss) excluding
amortization of goodwill $ 1,161,000 $ (570,000) $ 641,000
============== ============ ============
Income (loss) from discontinued operations -- -- 56,000
Pro forma net income (loss) $ 1,161,000 $ (570,000) $ 697,000
============== ============ ============
Earnings (loss) per share:
Basic
Reported net income (loss) from continuing
operations $ 0.05 $ (0.03) $ 0.01
Add back: goodwill amortization $ -- $ -- $ 0.02
Adjusted net income (loss) excluding
amortization of goodwill $ 0.05 $ (0.03) $ 0.03
============== ============ ============
Income (loss) from discontinued operations -- -- --
Net income (loss) $ 0.05 $ (0.03) $ 0.03
============== ============ ============
Diluted
Reported net income (loss) from continuing
operations $ 0.05 $ (0.03) $ 0.01
Add back: goodwill amortization -- -- 0.02
Adjusted net income (loss) excluding
amortization of goodwill $ 0.05 $ (0.03) $ 0.03
============== ============ ============
Income (loss) from discontinued operations -- -- --
Pro forma net income (loss) $ 0.05 $ (0.03) $ 0.03
============== ============ ============
F-29
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(5) NOTES PAYABLE
A summary of notes payable is as follows:
2003 2002
----------- -----------
Line of credit with a U.S. commercial lender $1,077,000 $1,070,000
Lines of credit with foreign banks 1,805,000 2,405,000
----------- -----------
$2,882,000 $3,475,000
=========== ===========
In April 2002, the maturity date of the facility with Wells Fargo
Business Credit, Inc. was extended by two years to August 16, 2005. Since April
17, 2002, the facility has provided for a revolving loan of up to $3,000,000
secured by the Company's inventory and accounts receivable and a term loan in
the amount of $687,000 secured by the Company's machinery and equipment. On
December 31, 2003, the interest rate was the prime rate (then 4.0%) plus 1%
subject to a minimum interest charge of $13,500 per month. Due to the minimum
interest charge, the effective interest rate the Company paid for this credit
facility during 2003 was 20.3%. The balance outstanding at December 31, 2003 was
$1,077,000 on the revolving loan and $114,000 on the term loan, and $238,000 of
additional borrowings were available under the revolving loan. The credit
facility contains restrictive financial covenants that are set by mutual
agreement each year. At December 31, 2003, the Company was in compliance with
the covenants.
The Company's U.K. subsidiary, XPS, obtained a credit facility with
Venture Finance PLC, a subsidiary of the global Dutch ABN AMRO Holdings, N.V.
financial institution which new facility replaced a Lloyds Bank facility as of
November 12, 2002 and expires on November 12, 2005. Using the exchange rate in
effect at December 31, 2003 for the conversion of British pounds into United
States dollars, the new facility is for a maximum of $2,685,000 and includes a
$627,000 unsecured cash flow loan, a $143,000 term loan secured by XPS' fixed
assets and the remainder of the loan is secured by XPS' accounts receivable and
inventory. The interest rate is the base rate of Venture Finance PLC (3.75% at
December 31, 2003) plus 2%, and is subject to a minimum rate of 4% per annum.
There are no financial performance covenants applicable to this credit facility.
On April 8, 2003, CXR-AJ obtained a credit facility from IFN Finance, a
subsidiary of ABN AMRO Holdings N.V. The new credit line is for a maximum of
$1,516,000, based on the exchange rate in effect at December 31, 2003 for the
conversion of euros into United States dollars. The IFN Finance facility
replaced several smaller credit lines. The IFN Finance facility is secured by
CXR-AJ's accounts receivable and carries an annual interest rate of 1.6
percentage points above the French "T4M" rate. The French T4M rate was 2.6% as
of December 31, 2003. Funds that become available under the new IFN Finance
credit line as new accounts receivables develop have been used to retire the
prior existing CXR-AJ credit facilities. CXR-AJ currently also has term loan
balances with Banc Nacional de Paris and Sogelease with aggregate balances
totaling $80,000 as of December 31, 2003.
XCEL Japan Ltd. ("XJL") obtained a term loan on November 29, 2002 from
Johnan Shinkin Bank. The loan is amortized over five years and carries a fixed
annual interest rate of 3.25%. The balance of the loan on December 31, 2003 was
$73,000 using the exchange rate in effect at December 31, 2003 for conversion of
Japanese yen into United States dollars.
F-30
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
The Company cannot offer assurance that the various lenders to the
Company's U.K. and/or French subsidiaries will not seek immediate payment of all
amounts owed by them under their respective credit facilities or seek to
terminate any of the existing credit facilities. Similarly, the Company cannot
offer assurance that if either of these events were to occur, the Company would
be successful in obtaining the required replacement financing for its operations
in the U.K. and/or France or, if the Company were able to obtain such financing,
that the financing would occur on a timely basis, would be on acceptable terms
and would be sufficient to allow the Company to maintain its business operations
in the U.K. and/or France. Accordingly, any of these actions on the part of the
lenders to the Company's U.K. and/or French subsidiaries could adversely impact
the Company's results of operations and cash flows.
(6) LONG-TERM DEBT
A summary of long-term debt follows:
2003 2002
------------ ------------
Term notes payable to commercial lender (a) $ 114,000 $ 95,000
Term notes payable to foreign banks (b) 871,000 901,000
Capitalized lease obligations (c) 150,000 249,000
------------ ------------
1,135,000 1,245,000
Current portion (316,000) (318,000)
------------ ------------
$ 819,000 $ 927,000
============ ============
-------------
(a) Two term notes payable to Wells Fargo Business Credit, Inc. bearing
interest at the lender's prime rate (4.0% at December 31, 2003) plus 1%,
subject to a minimum interest charge of $13,500 per month. The term notes
payable are subject to the same provisions and covenants as the credit
facility discussed in Note 5. The notes are collateralized by machinery and
equipment and are payable in total monthly principal installments plus
interest through the final maturity date of August 16, 2005.
(b) The Company has agreements with several foreign banks that include term
borrowings that mature at various dates through 2007. Interest rates on the
borrowings bear interest at rates ranging from 2.9% to 6.5% and are payable
in monthly installments.
(c) Capital lease agreements are calculated using interest rates appropriate at
the inception of the lease and range from 6% to 16%. Lease liabilities are
amortized over the lease term using the effective interest method. The
leases all contain bargain purchase options and expire at dates through
2004.
F-31
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Principal maturities related to long-term debt as of December 31, 2003
are as follows:
Year Ending December 31, Amount
------------------------ ---------
2004 $ 316,000
2005 $ 780,000
2006 $ 22,000
2007 $ 17,000
2008 $ --
(7) REDEEMABLE PREFERRED STOCK
CONVERTIBLE REDEEMABLE PREFERRED STOCK
In June 1998, the Company sold 50 shares of convertible redeemable
Series A Preferred Stock (the "Series A Shares") at $10,000 per share to one
institutional investor. In July 1998, the Company sold an additional 150 Series
A Shares at the same per share price to two other institutional investors.
Included with the sale of such Series A Shares were warrants to purchase a total
of 1,000,000 shares of the Company's common stock exercisable at $1.25 per share
that expired May 22, 2001. The estimated fair value of these warrants (based
upon a Black-Scholes pricing model with the following assumptions: no dividend
yield; expected volatility of 28%; risk-free interest rate of 5.1%; and an
expected life of 3 years) totaled $163,000 and reduced the convertible
redeemable preferred stock balance as of the date of issuance.
The Company received net proceeds totaling approximately $1,843,000
after deduction of commissions and transaction-related expenses. Under the
original certificate of designation, the Series A Shares were convertible into
common stock of the Company at the option of the holder thereof at any time
after the ninetieth (90th) day of issuance thereof at the conversion price per
share of Series A Shares equal to $10,000 divided by the lesser of (x) $1.26 and
(y) One Hundred Percent (100%) of the arithmetic average of the three lowest
closing bid prices over the forty (40) trading days prior to the exercise date
of any such conversion. Also under the original certificate of designation, no
more than 20% of the aggregate number of Series A Shares originally purchased
and owned by any single entity could be converted in any thirty (30) day period
after the ninetieth (90th) day from issuance. In the event of any liquidation,
dissolution or winding up of the Company, the holders of shares of Series A
Shares are entitled to receive, prior and in preference to any distribution of
any assets of the Company to the holders of the Company's common stock, an
amount per share equal to $10,000 for each outstanding Series A Share. Any
unconverted Series A Shares were redeemable at the option of the Company for
cash at a per share price equal to $11,500 per Series A Share, and any Series A
Shares that remained outstanding as of May 22, 2003 were subject to mandatory
redemption by the Company at the same per-share redemption price. The excess of
the redeemable value over the carrying value was accreted by periodic charges to
retained earnings over the original life of the issue.
In November 1998, the holders of the Series A Shares agreed to revise
the certificate of designations relating to the Series A Shares to provide that:
(i) the conversion price would be fixed at $10,000 divided by $0.50 for so long
as the Company's common stock continued to be traded on the Nasdaq SmallCap
Market and the Company did not conduct a reverse split of its outstanding common
stock; and (ii) the Company would not exercise its redemption rights for the
outstanding shares of the Series A Shares for six months. The agreement also
provided that the existing restriction on the right of each holder of the Series
F-32
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
A Shares to convert more than 20% of the aggregate number of shares of the
Series A Shares originally purchased by such holder in any 30-day period would
be eliminated. Also, the agreement provided that the Company would replace the
existing warrants, which warrants had an exercise price of $1.25 per share, with
warrants that had an exercise price of $0.75 per share.
The Company inadvertently failed to obtain the required approval of the
Company's common stockholders and to file an amended certificate of designations
to effectuate the amendments to the certificate of designations that were
contained in the November 1998 agreement. However, between November 18, 1998 and
March 26, 1999, the holders of the Series A Shares converted shares of the
Series A Shares into shares of common stock at the rate of 20,000 shares of
common stock per share of the Series A Shares, as agreed to in the November 1998
agreement. Use of the $10,000 divided by $0.50 conversion price in four of the
conversions resulted in the stockholders receiving an aggregate of 46,437 more
shares of common stock than they would have received under the original
conversion price formula that was contained in the certificate of designations.
The Company has determined, however, that the excess shares were in fact validly
issued under Delaware law.
In May 1999, the Company's common stock was delisted from the Nasdaq
SmallCap Market due to a failure to meet Nasdaq's minimum closing bid price
listing requirement, and the Company's common stock began trading on the OTC
Bulletin Board (see Note 8). Based upon the terms of the November 1998
agreement, the conversion price of the Series A Shares reverted back to the
floating conversion price shown in the certificate of designations, which
conversion price was $10,000 divided by the lesser of $1.26 and 100% of the
arithmetic average of the three lowest closing bid prices over the 40 trading
days prior to a conversion.
In December 1999, two institutional investors sold all of their
outstanding Series A Shares and the prorated portion of warrants applicable to
the then outstanding Series A Shares. The purchasers of such Series A Shares and
prorated warrants included an executive officer of the Company and certain
related parties. Also in December 1999, the holders of the 59.5 outstanding
shares of the Series A Shares agreed to modify the conversion ratio to a fixed
factor of $10,000 divided by $0.1979, or 50,530 shares of common stock per
Series A Share, in exchange for a reduction in the exercise price of the
warrants to $0.25 per share and an extension of the expiration date of the
warrants to December 2002. In the event a holder of the Series A Shares had
converted its Series A Shares to common stock immediately before the December
1999 agreement, each Series A Share would have been converted into approximately
52,632 shares of common stock at a per share conversion price of $10,000 divided
by $0.19, based on the original conversion ratio. In connection with the
repricing of the warrants, the Company recognized $91,000 of non-cash expense in
1999. This expense represents the excess of the fair value of the warrants after
repricing over the value of the warrants immediately before the repricing. The
estimated fair values of the old and revised warrants was calculated using a
Black-Scholes pricing model with the following assumptions: no dividend yield;
expected volatility of 81%; a risk free interest rate of 6%; and an expected
life of 1.5 and 3 years, respectively.
The Company filed an amended certificate of designation with the
Delaware Secretary of State to give effect to the December 1999 agreements by
fixing the conversion price of the Series A Shares at $10,000 divided by
$0.1979. However, because the Company inadvertently failed to obtain approval of
the Company's common stockholders for the amendment to the certificate of
designation, the amendment was invalid under the Delaware General Corporation
Law. However, in June 2000, a holder of Series A Shares converted 34.5 shares of
F-33
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
the Series A Shares into 1,743,285 shares of common stock based upon the $10,000
divided by $0.1979 per share conversion price that the Company and the holders
of the Series A Shares believed to be in effect. This conversion resulted in the
issuance of 1,048,654 more shares of common stock than would otherwise have been
issued upon conversion of the 34.5 shares of the Series A Shares under the
certificate of designations that was then in effect. The Company has determined,
however, that the excess shares were in fact validly issued under Delaware law.
In November 2000, the Company realized that the modifications to the
conversion price of the Series A Shares were invalid because the Company had
inadvertently failed to obtain common stockholder approval for the modifications
to the certificate of designations and had also inadvertently failed to file an
amendment reflecting the November 1998 modifications. The Company's board of
directors distributed proxy materials requesting that holders of the Company's
common stock and the Series A Shares approve an amendment to the certificate of
designations that provided for a fixed conversion price of $10,000 divided by
$0.1979 and an amendment to the certificate of incorporation that increased the
authorized shares of common stock from 25,000,000 to 50,000,000. The amendments
were approved at a special meeting of stockholders that was held on January 16,
2001. The Company filed the amendments with the Delaware Secretary of State on
January 22, 2001, so that after that date, each outstanding Series A Share was
convertible into 50,530 shares of common stock. As of December 31, 2003, there
were no Series A Shares outstanding.
The following table reflects the convertible redeemable preferred stock
activity:
Number
of Shares Amount
--------- ---------
Balance at December 31, 2000 25.0 $259,000
Conversion to common stock -- --
Accretion of preferred stock -- 11,000
---------------------------- --------- ---------
Balance at December 31, 2001 25.0 270,000
Conversion to common stock -- --
Accretion of preferred stock -- 12,000
---------------------------- --------- ---------
Balance at December 31, 2002 25.0 282,000
Accretion of preferred stock -- 5,000
---------------------------- --------- ---------
Conversion to common stock (25.0) (287,000)
Balance at December 31, 2003 -- $ --
========= =========
(8) STOCKHOLDERS' EQUITY
STOCK OPTIONS AND WARRANTS
The Company has four stock option plans:
o Employee Stock and Stock Option Plan, effective July 1, 1994,
providing for non-qualified stock options as well as
restricted and non-restricted stock awards to both employees
and outside consultants. Up to 520,000 shares were authorized
for issuance under this plan. Terms of related grants under
the plan are at the discretion of the board of directors. The
board of directors does not intend to issue any additional
options or make any additional stock grants under this plan.
F-34
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
o 1993 Stock Option Plan, providing for the grant of up to
300,000 incentive and non-qualified stock options to purchase
stock at not less than the current market value on the date of
grant. Options granted under this plan vest ratably over three
years and expire 10 years after date of grant. The board of
directors does not intend to issue any additional options
under this plan.
o The MicroTel International Inc. 1997 Stock Incentive Plan (the
"1997 Plan") provides that options granted may be either
qualified or nonqualified stock options and are required to be
granted at fair market value on the date of grant. Subject to
termination of employment, options may expire up to ten years
from the date of grant and are nontransferable other than in
the event of death, disability or certain other transfers that
the committee of the board of directors administering the 1997
Plan may permit. Up to 1,600,000 stock options were authorized
to be granted under the 1997 Plan. All outstanding options of
former optionholders under the XET 1987 Employee Stock Option
Plan were converted to options under the 1997 Plan as of the
date of the merger between the Company and XET at the exchange
rate of 1.451478. The board of directors does not intend to
issue any additional options under this plan.
o The 2000 Stock Option Plan was adopted by the board of
directors in November 2000 and approved by the stockholders on
January 16, 2001. The board of directors adopted the Amended
and Restated 2000 Stock Option Plan ("2000 Plan") effective as
of August 3, 2001. Under the 2000 Plan, options granted may be
either incentive or nonqualified options. Incentive options
must have an exercise price of not less than the fair market
value of a share of common stock on the date of grant.
Nonqualified options must have an exercise price of not less
than 85% of the fair market value of a share of common stock
on the date of grant. Up to 2,000,000 options may be granted
under the 2000 Plan. No option may be exercised more than ten
years after the date of grant.
The Company accounts for stock-based compensation under the "intrinsic
value" method. Under this method, no compensation expense is recorded for these
plans and arrangements for current employees whose grants provide for exercise
prices at or above the market price on the date of grant. Compensation or other
expense is recorded based on intrinsic value (excess of market price over
exercise price on date of grant) for employees, and fair value of the option
awards for others.
F-35
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
The following table shows activity in the outstanding options for the
years ended December 31, 2003, 2002 and 2001:
Weighted Weighted Weighted
Average Average Average
2003 Exercise 2002 Exercise 2001 Exercise
Shares Price Shares Price Shares Price
---------- -------- ---------- -------- ---------- --------
Outstanding at beginning of year 1,432,000 $1.11 1,718,000 $1.34 1,454,000 $1.34
Granted 344,000 $0.35 50,000 0.32 345,000 0.41
Exercised (28,000) $0.24 -- -- -- --
Forfeited (19,000) $2.21 (336,000) 1.37 (81,000) 0.64
---------- -------- ---------- -------- ---------- --------
Outstanding at end of year 1,729,000 $0.96 1,432,000 $1.11 1,718,000 $1.18
========== ======== ========== ======== ========== ========
The following table summarizes information with respect to stock
options at December 31, 2003:
Options Outstanding Options Exercisable
------------------- -------------------
Number Weighted Average Number
Range of Outstanding Remaining Weighted Exercisable Weighted
Exercise December 31, Contractual Life Average December 31, Average
Price 2003 (Years) Price 2003 Price
-------------- ----------- ---------------- -------- ---------- ---------
$0.20 to $1.00 1,036,000 7.23 $0.36 839,000 $0.36
$1.01 to $2.00 676,000 1.43 1.83 676,000 1.83
$3.01 to $4.00 17,000 2.33 3.23 17,000 3.23
----------- ---------------- -------- ---------- ---------
$0.20 to $4.00 1,729,000 4.91 $0.96 1,532,000 $1.04
=========== ================ ======== ========== =========
The fair value of options granted during 2003 was $42,000, at a
weighted average value of $0.12 per share. The fair values of options granted
during 2002 and 2001 were $13,000 and $115,000, respectively, at weighted
average values of $0.26 and $0.41 per share, respectively.
If the Company had instead elected the fair value method of accounting
for stock-based compensation, compensation cost would be accrued at the
estimated fair value of all stock option grants over the service period,
regardless of later changes in stock prices and price volatility. The fair value
at date of grant for options granted in 2003, 2002 and 2001 has been estimated
based on a Black-Scholes pricing model with the following assumptions: no
dividend yield; expected volatility of 92% in 2003, 92% in 2002 and 89% to 95%
in 2001; risk-free interest rate of 2.0% to 3.0%; and average expected lives of
approximately seven to ten years.
F-36
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
The board of directors has also authorized the issuance of common stock
purchase warrants to certain officers, directors, stockholders, key employees
and other parties as follows:
Warrant Price
Number ---------------------------------
of Shares Per Share Total
----------- --------------- ------------
Balance outstanding at December 31, 2000 2,172,000 $0.25 to $2.50 1,703,000
Warrants issued 100,000 $0.25 to $0.39 33,000
Warrants expired/forfeited (300,000) $1.00 to $1.25 (362,000)
----------- --------------- ------------
Balance outstanding at December 31, 2001 1,972,000 $0.25 to $2.50 $1,374,000
Warrants issued 120,000 $0.50 60,000
Warrants expired/forfeited (1,688,000) $0.25 to $1.73 $(1,161,000)
----------- --------------- ------------
Balance outstanding at December 31, 2002 404,000 $0.25 to $2.50 $ 273,000
Warrants issued 401,000 $0.75 to $1.00 325,000
Warrants expired/forfeited (138,000) $0.66 (91,000)
Warrants exercised (14,000) $0.66 (9,000)
----------- --------------- ------------
Balance outstanding at December 31, 2003 653,000 $0.25 to $2.50 $ 498,000
----------- --------------- ------------
During 2003, the Company issued warrants to purchase up to 300,000
shares of common stock at the exercise price of $0.75 and 100,500 shares at the
exercise price of $1.00. The Company issued the warrants for services rendered
or to be rendered. The estimated value of the warrants was $19,000 and was
calculated using the Black-Scholes pricing model with the following assumptions:
risk-free interest rate of 1.6%, expected lives of 3 years, no dividend yield
and an expected volatility of 84.8%.
During 2002, the Company issued warrants to purchase up to 120,000
shares of common stock at an exercise price of $0.50 per share. The Company
issued the warrants to a former executive of the Company as compensation for
services rendered. The estimated value of the warrants was $7,000 and was
calculated using the Black-Scholes pricing model with the following assumptions:
no dividend yield; expected volatility of 92%; a risk-free interest rate of
3.75%; and a contractual life of 3 years. Also, during 2002 the Company issued
5,000 shares of common stock in consideration for services rendered. The stock
was valued at $1,000 on the date of issuance and, accordingly, the Company
recorded a $1,000 expense.
During 2001, the Company issued warrants to purchase up to 35,000,
50,000 and 15,000 shares of common stock at exercise prices of $0.39, $0.31 and
$0.25, respectively. The Company issued the warrants as compensation for
services rendered. The estimated value of the warrants was $21,000 and was
calculated using the Black-Scholes pricing model with the following assumptions:
no dividend yield; expected volatility of 91% to 94%; a risk-free interest rate
of 3.1% to 5%; and expected lives of 3 to 5 years. Also during 2001, the Company
issued 100,000 shares of common stock in consideration for investor relations
services. The stock was valued at $30,000 on the date of issuance and,
accordingly, the Company recorded a $30,000 expense.
The Company had an Employee Stock Purchase Plan at its CXR Telcom
subsidiary allowing eligible subsidiary employees to purchase shares of the
Company's common stock at 85% of market value. During 2001, an aggregate of 900
shares were issued pursuant to the plan. The Company terminated this plan
effective as of July 1, 2001.
F-37
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
As of December 31, 2003, the Company was authorized to issue 50,000,000
shares of common stock. As of that date, the Company had 23,476,163 shares of
common stock outstanding and 2,386,761 shares of common stock that could become
issuable pursuant to the exercise of outstanding stock options and warrants and
the conversion of convertible preferred stock.
DIVIDENDS
No dividends on the Company's common stock have been paid to date. The
Company's line of credit with Wells Fargo Business Credit, Inc. prohibits the
payment of cash dividends on the Company's common stock. The Company currently
intends to retain future earnings to fund the development and growth of its
business and, therefore, does not anticipate paying cash dividends on its common
stock within the foreseeable future. Any future payment of dividends on the
Company's common stock will be determined by the Company's board of directors
and will depend on the Company's financial condition, results of operations,
contractual obligations and other factors deemed relevant by the Company's board
of directors.
(9) INCOME TAXES
The Company files a consolidated U.S. federal income tax return. This
return includes all domestic companies 80% or more owned by the Company. State
tax returns are filed on a consolidated, combined or separate basis depending on
the applicable laws relating to the Company and its domestic subsidiaries.
Income (loss) from continuing operations before income taxes was taxed
under the following jurisdictions:
2003 2002 2001
------------ ------------ ------------
Domestic $ 961,000 $ 497,000 $ 718,000
Foreign 486,000 (1,087,000) (370,000)
------------ ------------ ------------
Total $ 1,447,000 $ (590,000) $ 348,000
============ ============ ============
F-38
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Income tax expense (benefit) consists of the following:
2003 2002 2001
---------- ---------- ----------
Current
Federal $ (12,000) $ -- $ 5,000
State 55,000 18,000 5,000
Foreign 351,000 (38,000) 67,000
---------- ---------- ----------
Total Current $ 394,000 $ (20,000) $ 77,000
========== ========== ==========
Deferred
Federal $ (94,000) $ -- $ --
State (14,000) -- --
Foreign -- -- --
---------- ---------- ----------
Total Deferred $(108,000) $ -- $ --
Total
Federal $(106,000) $ -- $ 5,000
State 41,000 18,000 5,000
Foreign 351,000 (38,000) 67,000
---------- ---------- ----------
Total $ 286,000 $ (20,000) $ 77,000
========== ========== ==========
Income tax expense (benefit) differs from the amount obtained by
applying the statutory federal income tax rate of 34% to income (loss) from
continuing operations before income taxes as follows:
2003 2002 2001
---------- ---------- ----------
Tax (tax benefit) at U.S. federal statutory rate $ 492,000 $(200,000) $ 118,000
State taxes, net of federal income tax benefit 43,000 (34,000) 5,000
Foreign income taxes (63,000) (38,000) 67,000
Change in valuation allowances (182,000) 258,000 --
Permanent differences 12,000 11,000 54,000
Utilization of net operating losses -- -- (167,000)
Other (16,000) (17,000) --
---------- ---------- ----------
$ 286,000 $ (20,000) $ 77,000
========== ========== ==========
F-39
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax assets and liabilities are as follows:
2003 2002
------------- -------------
Deferred tax assets:
Fixed assets depreciation $ 269,000 $ 250,000
Allowance for doubtful accounts 10,000 3,000
Inventory reserves and uniform capitalization 206,000 279,000
Other accrued liabilities 112,000 216,000
Deferred compensation 110,000 144,000
Research credit carryforwards -- 224,000
Alternative Minimum Tax credit carryforwards 142,000 135,000
Capital loss carryforwards 136,000 --
Net operating loss carryforwards 12,315,000 12,123,000
------------- -------------
Total deferred tax assets 13,300,000 13,374,000
Valuation allowance for deferred tax assets (13,192,000) (13,374,000)
------------- -------------
Net deferred tax assets $ 108,000 $ --
============= =============
Net deferred tax assets of $108,000 are included in prepaid and other
current assets as of December 31, 2003. As of December 31, 2003, the Company had
federal net operating loss carryforwards of approximately $36,056,000 which
expire at various dates through 2022, and state net operating loss carryforwards
of approximately $1,272,000, which expire at various dates through 2012. At
December 31, 2002, the Company had recorded a 100% valuation allowance on the
net deferred tax asset because of uncertainty regarding its realization. The
ultimate realization of the deferred tax asset is dependant upon the generation
of future taxable income during the periods in which those temporary differences
become deductible. Management considers projected future taxable income and tax
planning strategies in making this assessment. For the year ended December 31,
2003, management recorded a reduction in its valuation allowance of $108,000
based on the domestic income in 2003 and projections for future taxable income
over periods that the deferred assets are deductible. Management believes that
it is more likely than not that the Company will realize the benefits of these
deductible differences. The amount of the deferred tax assets considered
realizable, however, could materially change in the near future if estimates of
future taxable income during the carryforward period are changed.
As a result of the merger in 1997 of the privately held XET with a
wholly-owned, newly formed subsidiary of the Company, with XET as the surviving
subsidiary, the Company experienced a more than 50% ownership change for federal
income tax purposes. As a result, an annual limitation will be placed upon the
Company's ability to realize the benefit of most of its net operating loss and
credit carryforwards. The amount of this annual limitation, as well as the
impact of the application of other possible limitations under the consolidated
return regulations, has not been definitively determined at this time.
Management believes sufficient uncertainty exists regarding the realizability of
the deferred tax asset items and that a valuation allowance, substantially equal
to the net deferred tax asset amount, is required.
F-40
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(10) EARNINGS (LOSS) PER SHARE
The following table illustrates the computation of basic and diluted
earnings (loss) per share (in thousands, except per share amounts):
2003 2002 2001
------------- ------------- -------------
NUMERATOR:
Net income (loss) $ 1,161,000 $ (570,000) $ 327,000
Less: accretion of the excess of the redemption value over
the carrying value of redeemable preferred stock (4,000) (13,000) (11,000)
------------- ------------- -------------
Income (loss) attributable to common stockholders $ 1,157,000 $ (583,000) $ 316,000
============= ============= =============
DENOMINATOR:
Weighted average number of common shares outstanding during the
period - basic 22,567,000 21,208,000 20,594,000
Incremental shares from assumed conversions of warrants,
options and preferred stock 1,244,000 -- 3,188,000
------------- ------------- -------------
Adjusted weighted average shares - diluted 23,811,000 21,208,000 23,782,000
------------- ------------- -------------
Basic earnings (loss) per share $ 0.05 $ (0.03) $ 0.02
============= ============= =============
Diluted earnings (loss) per share $ 0.05 $ (0.03) $ 0.01
============= ============= =============
The following table shows the common stock equivalents that were
outstanding as of December 31, 2003 and 2002 but were not included in the
computation of diluted earnings (loss) per share because the options' or
warrants' exercise price was greater than the average market price of the common
shares and, therefore, the effect would be anti-dilutive:
Number Exercise Price
of Shares Per Share
--------- --------------
Anti-dilutive common stock options:
As of December 31, 2003 693,000 $1.13 to $3.44
As of December 31, 2002 1,432,000 $0.20 to $3.44
Anti-dilutive common stock warrants:
As of December 31, 2003 32,000 $2.50
As of December 31, 2002 404,000 $0.25 to $2.50
The computation of diluted loss per share for 2002 excludes the effect
of incremental common shares attributable to the exercise of outstanding common
stock options and warrants because their effect was anti-dilutive due to losses
incurred by the Company. See summary of outstanding stock options and warrants
in Note 8.
F-41
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(11) COMMITMENTS AND CONTINGENCIES
LEASES
The Company conducts most of its operations from leased facilities
under operating leases that expire at various dates through 2013. The leases
generally require the Company to pay all maintenance, insurance and property tax
costs and contain provisions for rent increases. Total rent expense, net of
sublease income, for 2003, 2002 and 2001 was approximately $909,000, $1,097,000
and $1,091,000, respectively.
The future minimum rental payments required under operating leases that
have initial or remaining noncancelable lease terms in excess of one year are as
follows:
Year Ending December 31, Amount
------------------------ -------------
2004 $ 718,000
2005 497,000
2006 425,000
2007 404,000
2008 and thereafter 585,000
-------------
$ 2,629,000
=============
LITIGATION
The Company is not currently a party to any material legal proceedings.
However, the Company and its subsidiaries are, from time to time, involved in
legal proceedings, claims and litigation arising in the ordinary course of
business. While the amounts claimed may be substantial, the ultimate liability
cannot presently be determined because of considerable uncertainties that exist.
Therefore, it is possible the outcome of such legal proceedings, claims and
litigation could have a material effect on quarterly or annual operating results
or cash flows when resolved in a future period. However, based on facts
currently available, management believes such matters will not have a material
adverse effect on the Company's consolidated financial position, results of
operations or cash flows.
EMPLOYEE BENEFIT PLANS
Effective October 1, 1998, the Company instituted a defined
contribution plan ("401(k) Plan") covering the majority of its U.S. domestic
employees. Participants may make voluntary pretax contributions to such plans up
to the limit as permitted by law. Annual contributions to any plan by the
Company is discretionary. The Company made contributions of $20,000, $22,000 and
$16,000 to the 401(k) Plan for the years ended December 31, 2003, 2002 and 2001,
respectively.
F-42
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
EXECUTIVE MANAGEMENT
Effective January 1, 2001, the Company and Carmine T. Oliva, its Chief
Executive Officer, entered into a new employment agreement that provides for an
annual base salary of $250,000, with annual merit increases, an initial term of
five years, two renewal periods of two years each, and severance pay of at least
three years' salary during the initial period or at least two years' salary
during a renewal period.
Effective July 2, 2001, the Company and Randolph D. Foote, its Senior
Vice President and Chief Financial Officer, entered into an employment agreement
that provides for an initial annual salary of $130,000, an initial term of three
years, two renewal periods of one year each, and severance pay of at least one
years' salary.
Effective July 2, 2001, the Company and Graham Jefferies, Managing
Director of XCEL Corporation Ltd. and Executive Vice President and Chief
Operating Officer of the Company's Telecommunications Group, entered into an
employment agreement that provides for an initial annual salary of 100,000
British pounds (approximately $141,000 at the then current exchange rates), an
initial term of three years, two renewal periods of one year each, and severance
pay of at least one years' salary.
(12) SEGMENT AND MAJOR CUSTOMER INFORMATION
The Company has two reportable segments: electronic components and
communications equipment. The electronic components segment operates in the
U.S., European and Asian markets and designs, manufactures and markets digital
switches and power supplies. The communications equipment segment operates
principally in the U.S. and European markets and designs, manufactures and
distributes voice and data transmission and networking equipment and
communications test instruments.
In October 2000, the Company decided to discontinue its circuits
segment operations. At that time the circuits segment operations consisted of
XCEL Etch Tek, a wholly-owned subsidiary, and XCEL Circuits Division ("XCD"), a
division of XET Corporation, a wholly-owned subsidiary of the Company. XCEL Etch
Tek was offered for sale. XCD is essentially a captive supplier of printed
circuit boards to the electronic components segment with total sales to external
customers of $153,000, $160,000 and $127,000 for the years ended December 31,
2003, 2002 and 2001, respectively. XCD has been retained and is now included in
the electronic components segment. Accordingly, all current and prior financial
information related to the circuits segment operations have been presented as
discontinued operations in the accompanying consolidated financial statements,
with the exception of XCD which has been included in the current and prior
financial information related to the electronic components segment in the
accompanying consolidated financial statements.
The accounting policies of the segments are the same as those described
in the summary of significant accounting policies. The Company evaluates
performance based upon profit or loss from operations before income taxes
exclusive of nonrecurring gains and losses. The Company accounts for
intersegment sales at prices negotiated between the individual segments.
F-43
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
The Company's reportable segments are comprised of operating entities
offering the same or similar products to similar customers. Each segment is
managed separately because each business has different customers and different
design and manufacturing and marketing strategies. Selected financial data for
each of the Company's operating segments is shown below.
2003 2002 2001
------------- ------------- -------------
SALES TO EXTERNAL CUSTOMERS:
Electronic Components $ 16,168,000 $ 13,390,000 $ 12,646,000
Communications Equipment 9,351,000 9,274,000 14,777,000
------------- ------------- -------------
$ 25,519,000 $ 22,664,000 $ 27,423,000
============= ============= =============
INTEREST EXPENSE:
Electronic Components $ 247,000 $ 259,000 $ 228,000
Communications Equipment 162,000 168,000 158,000
------------- ------------- -------------
$ 409,000 $ 427,000 $ 386,000
============= ============= =============
DEPRECIATION AND AMORTIZATION:
Electronic Components $ 72,000 $ 93,000 $ 279,000
Communications Equipment 65,000 177,000 322,000
------------- ------------- -------------
$ 137,000 $ 270,000 $ 601,000
============= ============= =============
SEGMENT PROFITS (LOSSES):
Electronic Components $ 3,590,000 $ 2,452,000 $ 2,882,000
Communications Equipment 74,000 (1,257,000) 450,000
------------- ------------- -------------
$ 3,664,000 $ 1,195,000 $ 3,332,000
============= ============= =============
SEGMENT ASSETS:
Electronic Components $ 9,466,000 $ 9,445,000 $ 9,060,000
Communications Equipment 6,969,000 6,773,000 8,317,000
------------- ------------- -------------
$ 16,435,000 $ 16,218,000 $ 17,377,000
============= ============= =============
F-44
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
The following is a reconciliation of the reportable segment revenues,
profit or loss and assets to the Company's consolidated totals.
2003 2002 2001
------------- ------------- -------------
Net sales
---------
Total sales for reportable segments $ 25,519,000 $ 22,664,000 $ 27,423,000
Elimination of intersegment sales -- -- --
------------- ------------- -------------
Total consolidated revenues $ 25,519,000 $ 22,664,000 $ 27,423,000
============= ============= =============
Profit (loss) from continuing operations
----------------------------------------
before income taxes
-------------------
Total profit (loss) for reportable segments $ 3,656,000 $ 1,195,000 $ 3,332,000
Unallocated amounts:
General corporate expenses (2,209,000) (1,785,000) (2,984,000)
------------- ------------- -------------
Consolidated income (loss) from continuing operations before
income taxes $ 1,447,000 $ (590,000) $ 348,000
============= ============= =============
Assets
------
Total assets for reportable segments $ 16,437,000 $ 16,218,000 $ 17,377,000
Other assets 732,000 568,000 311,000
------------- ------------- -------------
Total consolidated assets $ 17,169,000 $ 16,786,000 $ 17,688,000
============= ============= =============
Interest expense
----------------
Interest expense for reportable segments $ 409,000 $ 427,000 $ 386,000
Other interest expense 7,000 14,000 10,000
------------- ------------- -------------
Total interest expense $ 416,000 $ 441,000 $ 396,000
============= ============= =============
Depreciation and amortization
-----------------------------
Depreciation and amortization expense
for reportable segments $ 137,000 $ 270,000 $ 601,000
Other depreciation and amortization expense 64,000 79,000 114,000
------------- ------------- -------------
Total depreciation and amortization $ 201,000 $ 349,000 $ 715,000
============= ============= =============
F-45
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
A summary of the Company's net sales and identifiable assets by
geographical area follows:
2003 2002 2001
----------- ----------- -----------
Net sales:
----------
United States $ 7,971,000 $ 8,598,000 $12,461,000
Japan 838,000 768,000 1,085,000
France 6,627,000 5,854,000 7,848,000
United Kingdom 10,083,000 7,444,000 6,029,000
----------- ----------- -----------
$25,519,000 $22,664,000 $27,423,000
============ ============ ============
Long-lived assets:
------------------
United States $ 117,000 $ 399,000 $ 422,000
Japan 16,000 15,000 14,000
France 107,000 177,000 186,000
United Kingdom 82,000 97,000 136,000
----------- ----------- -----------
$ 322,000 $ 688,000 $ 758,000
============ ============ ============
Sales and purchases between geographic areas have been accounted for on
the basis of prices set between the geographic areas, generally at cost plus 5%.
Identifiable assets by geographic area are those assets that are used in the
Company's operations in each location. Net sales by geographic area have been
determined based upon the country from which the product was shipped.
One customer in the electronic components segment accounted for 10% or
more of net sales during 2003, 2002 and 2001.
(13) DISCONTINUED OPERATIONS
In October 2000, the Company decided to discontinue its circuits
segment operations. At that time, the circuits segment operations consisted of
XCEL Etch Tek, a wholly-owned subsidiary and XCD, a division of XET Corporation,
a wholly-owned subsidiary of the Company. During 1998 and 1999, the Company sold
substantially all of the assets of two other circuits operations, HyComp and
XCEL Arnold Circuits. XCD is essentially a captive supplier of printed circuit
boards to the electronic components segment with total sales to external
customers of $153,000, $160,000 and $127,000 for the years ended December 31,
2003, 2002 and 2001, respectively. XCD has been retained and is now included in
the electronics components segment. Accordingly, all current and prior financial
information related to the circuits segment operations (XCEL Etch Tek, HyComp
and XCEL Arnold) has been presented as discontinued operations in the
accompanying consolidated financial statements.
Summarized results of operations for the discontinued operations for
2003, 2002 and 2001 are as follows:
2003 2002 2001
--------- --------- --------
Net sales $ -- $ -- $ --
========= ========= ========
Operating income (loss) $ -- $ -- $56,000
========= ========= ========
Gain (loss) on sale of discontinued operations $ -- $ -- $ --
========= ========= ========
F-46
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
There were no assets and liabilities as of December 31, 2003, 2002 and
2001 relating to the circuits segment.
(14) NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities"
("SFAS 146"). SFAS No. 146 addresses accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred
in a Restructuring)." SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized and measured
initially at fair value when the liability is incurred. SFAS No. 146 is
effective for exit or disposal activities that are initiated after December 31,
2002, with early application encouraged. The Company does not expect the
adoption of this statement to have a material effect on the Company's financial
statements.
In November 2002, the FASB issued FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, including
Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 requires a
guarantor to recognize a liability, at the inception of the guarantee, for the
fair value of obligations it has undertaken in issuing the guarantee and also to
include more detailed disclosures with respect to guarantees. FIN 45 is
effective for guarantees issued or modified after December 31, 2002 and requires
the additional disclosures for interim or annual periods ended after December
15, 2002. The initial recognition and measurement provisions of FIN 45 did not
have a material impact on the Company's results of operations or financial
position.
In November 2002, the EITF reached a consensus on Issue No. 00-21,
Accounting for Revenue Arrangements with Multiple Deliverables. This Issue
provides guidance on when and how to separate elements of an arrangement that
may involve the delivery or performance of multiple products, services and
rights to use assets into separate units of accounting. The guidance in the
consensus is effective for revenue arrangements entered into in fiscal periods,
interim or annual, beginning after June 15, 2003. The Company adopted Issue No.
00-21 on July 1, 2003. The adoption of Issue No. 00-21 did not have a material
impact to the Company's consolidated financial position, results of operations,
or cash flows.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure-An Amendment of SFAS 123"
("SFAS No. 148"). This statement amends SFAS No. 123 to provide alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this statement
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The Company has chosen to continue to account for
stock-based compensation using the intrinsic value method prescribed in APB
Opinion No. 25 and related interpretations. Accordingly, compensation expense
for stock options is measured as the excess, if any, of the estimate of the
market value of the Company's stock at the date of the grant over the amount an
employee must pay to acquire the stock. The Company has adopted the annual
disclosure provisions of SFAS No. 148 in its financial reports for the year
ended December 31, 2002 and adopted the interim disclosure provisions for its
financial reports beginning with the quarter ending March 31, 2003. Because the
adoption of this standard involves disclosures only, the adoption did not have a
material impact on the Company's results of operations, financial position or
liquidity.
F-47
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
In January 2003, the FASB FIN 46, "Consolidation of Variable Interest
Entities - An interpretation of ARB No. 51" ("FIN 46"). FIN 46 requires that if
an entity has a controlling financial interest in a variable interest entity,
the assets, liabilities and results of activities of the variable interest
entity should be included in the consolidated financial statements of the
entity. FIN 46 requires that its provisions are effective immediately for all
arrangements entered into after January 31, 2003. For arrangements entered into
prior to January 31, 2003, the FIN 46 provisions were required to be adopted at
the beginning of the first interim or annual period beginning after June 15,
2003. The provisions of FIN 46 have not had a material impact on the Company's
results of operations or financial position.
In May 2003, the FASB issued Statement No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS 150"). This statement establishes standards for how an issuer classifies
and measures in its statement of financial position certain financial
instruments with characteristics of both liabilities and equity. In accordance
with the standard, financial instruments that embody obligations for the issuer
are required to be classified as liabilities. SFAS No. 150 is effective for all
financial instruments created or modified after May 31, 2003, and otherwise
shall be effective at the beginning of the first interim period beginning after
June 15, 2003. The adoption of SFAS No. 150 is not expected to have a material
effect on the Company's financial condition or results of operations.
In November 2003, the EITF reached a consensus on Issue No. 03-1, "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments." EITF Issue No. 03-1 provides guidance on other-than-temporary
impairment and its application to debt and equity investments. The requirements
apply to investments in debt and marketable equity securities that are accounted
for under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." The provisions of Issue No. 03-1 are effective for annual periods
ending after December 15, 2003. The adoption of this Statement is not expected
to have a material effect on the Company's financial condition or results of
operations.
In December 2003, the FASB issued SFAS No. 132 (revised 2003),
"Employers' Disclosures about Pensions and Other Postretirement Benefits," an
amendment of SFAS No. 87, 88 and 106, and a revision of SFAS No. 132. The
statement is effective for fiscal years and interim periods ending after
December 15, 2003. This Statement revises employers' disclosures about pension
plans and other postretirement benefit plans. It does not change the measurement
or recognition of those plans required by SFAS No. 87, 88 and 106. The new rules
require additional disclosures about the assets, obligations, cash flows, and
net periodic benefit cost of defined benefit pension plans and other
postretirement benefit plans. The adoption of this Statement is not expected to
have a material effect on the Company's financial condition or results of
operations.
In December 2003, the FASB issued FASB Staff Position No. FAS 106-1
(FSP 106-1), "Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003." The guidance is
effective for initial interim or annual fiscal periods ending after December 7,
2003. FSP 106-1 permits employers that sponsor postretirement benefit plans
F-48
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(plan sponsors) that provide prescription drug benefits to retirees to make a
one-time election to defer accounting for any effects of the Medicare
Prescription Drug, Improvement, and Modernization Act of 2003 (the "Act").
Without FSP 106-1, plan sponsors would be required under SFAS No. 106 to account
for the effects of the Act in the fiscal period that includes December 8, 2003,
the date the President signed the Act into law. The adoption of this Statement
is not expected to have a material effect on the Company's financial condition
or results of operations.
In December 2003 the SEC issued Staff Accounting Bulletin (SAB) No.
104, Revenue Recognition. SAB 104 codifies, revises and rescinds certain
sections of SAB No. 101 in order to make this interpretive guidance consistent
with current authoritative accounting and auditing guidance and SEC rules and
regulations. Accordingly, there is no impact to our results of operations,
financial position or cash flows as a result of the issuance of SAB No. 104.
In December 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46R, Consolidation of Variable Interest Entities (FIN 46R).
FIN 46R requires the application of either FIN 46 or FIN 46R by Public Entities
to all Special Purpose Entities ("SPEs") created prior to February 1, 2003 as of
December 31, 2003 for calendar year-end companies. FIN 46R is applicable to all
non-SPEs created prior to February 1, 2003 at the end of the first interim or
annual period ending after March 15, 2004. For all entities created subsequent
to January 31, 2003, Public Entities were required to apply the provisions of
FIN 46. The adoption of FIN 46 did not have a material impact to our
consolidated financial position, results of operations or cash flows. The
adoption of FIN 46R for SPEs did not have an impact to our consolidated
financial position, results of operations or cash flows, and we do not believe
the adoption of FIN 46R for non-SPEs will have a material impact to our
consolidated financial position, results of operations or cash flows.
F-49
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(15) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the quarterly operations for the years
ended December 31, 2003 and 2002 (in thousands, except for per share data).
2003 Mar. 31 June 30 Sept. 30 Dec. 31
-------------------------------------------- -------- -------- --------- --------
Net Sales $ 5,668 $ 6,824 $ 6,420 $ 6,597
Gross Profit 2,141 2,829 2,715 2,999
Net income (loss) 44 359 504 254
Income (loss) available to common shareholder 42 357 504 254
Earnings (loss) per share:
Basic -- 0.02 0.02 0.01
Diluted -- 0.02 0.02 0.01
2002 Mar. 31 June 30 Sept. 30 Dec. 31
-------------------------------------------- -------- -------- --------- --------
Net Sales $ 4,820 $ 6,118 $ 5,764 $ 5,962
Gross Profit 1,529 2,510 2,084 2,394
Net income (loss) (699) 255 (330) 204
Income (loss) available to common shareholder (702) 252 (333) 201
Earnings (loss) per share:
Basic (0.03) 0.01 (0.02) 0.01
Diluted (0.03) 0.01 (0.02) 0.01
F-50
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Additions
Balance at Charged to Deductions
Beginning of Costs and Write-offs of Balance at
Description Year Expenses Accounts End of Year
--------------------------------- ----------- ----------- ----------- -----------
Allowance for doubtful accounts:
Year ended December 31, 2003 $ 130,000 $ 61,000 $ (30,000) $ 161,000
Year ended December 31, 2002 226,000 118,000 (214,000) 130,000
Year ended December 31, 2001 111,000 216,000 (101,000) 226,000
=========== =========== =========== ===========
Allowance for inventory obsolescence:
Year ended December 31, 2003 $1,497,000 $ 924,000 $ (729,000) $1,692,000
Year ended December 31, 2002 1,152,000 438,000 (93,000) 1,497,000
Year ended December 31, 2001 1,169,000 659,000 (676,000) 1,152,000
=========== =========== =========== ===========
F-51
EMRISE CORPORATION
PROSPECTUS
, 2005
WE HAVE NOT AUTHORIZED ANY DEALER, SALESMAN OR OTHER PERSON TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS AND ANY ACCOMPANYING SUPPLEMENT TO THIS PROSPECTUS. YOU MUST NOT RELY
UPON ANY INFORMATION OR REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS OR ANY
ACCOMPANYING PROSPECTUS SUPPLEMENT. THIS PROSPECTUS AND ANY ACCOMPANYING
SUPPLEMENT TO THIS PROSPECTUS DO NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE REGISTERED
SECURITIES TO WHICH THEY RELATE, NOR DO THIS PROSPECTUS AND ANY ACCOMPANYING
SUPPLEMENT TO THIS PROSPECTUS CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF
AN OFFER TO BUY SECURITIES IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS
UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION IN SUCH JURISDICTION. THE
INFORMATION CONTAINED IN THIS PROSPECTUS AND ANY ACCOMPANYING SUPPLEMENT TO THIS
PROSPECTUS IS ACCURATE AS OF THE DATES ON THEIR COVERS. WHEN WE DELIVER THIS
PROSPECTUS OR A SUPPLEMENT OR MAKE A SALE PURSUANT TO THIS PROSPECTUS OR A
SUPPLEMENT, WE ARE NOT IMPLYING THAT THE INFORMATION IS CURRENT AS OF THE DATE
OF THE DELIVERY OR SALE.
PART II
PART II: INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth all expenses to be paid by the
registrant in connection with this offering. All amounts shown are estimates
except for the SEC registration fee.
SEC registration fee $3,224.89
Legal fees and expenses $ *
Accounting fees and expenses $ *
Printing expenses $ *
Blue sky fees and expenses $ *
Transfer agent and registrar fees and expenses $ *
Miscellaneous $ *
---------
Total $ *
=========
---------------------
* To be completed by amendment
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law authorizes a court
to award, or a corporation's board of directors to grant, indemnity to officers,
directors and other corporate agents in terms sufficiently broad to permit
indemnification under certain circumstances and subject to certain limitations,
such as if such person acted in good faith and in a manner such person
reasonably believed to be in or not opposed to the best interests of the
registrant, and with respect to any criminal proceeding, had no reasonable cause
to believe such person's conduct was unlawful.
As permitted to Section 145 of the Delaware General Corporation Law,
the registrant's amended and restated certificate of incorporation includes a
provision that eliminates the personal liability of its directors of monetary
damages for breach of their fiduciary duty as directors.
In addition, as permitted by Section 145 of the Delaware General
Corporation Law, the bylaws of the registrant provide that:
o The registrant shall indemnify its directors and officers for
serving the registrant in those capacities or for serving
other business enterprises at the registrant's request, to the
fullest extent permitted by Delaware law.
o The registrant may, in its discretion, indemnify employees and
agents in those circumstances where indemnification is not
required by law.
o The registrant is required to advance expenses, as incurred,
to its directors and officers in connection with defending a
proceeding, except that such director or officer shall
undertake to repay such advance if it is ultimately determined
that such person is not entitled to indemnification.
II-1
o The rights conferred in the bylaws are not exclusive, and the
registrant is authorized to enter into indemnification
agreements with its directors, officers, employees and agents
and to obtain insurance to indemnify such persons.
o The Registrant may not retroactively amend the bylaw
provisions to reduce its indemnification obligations to
directors, officers, employees and agents.
The registrant's policy is to enter into separate indemnification
agreements with each of its directors and officers that provide the maximum
indemnity allowed to directors and officers by Section 145 of the Delaware
General Corporation Law and which allow for additional procedural protections.
The registrant also maintains directors' and officers' insurance to insure those
persons against various liabilities.
Registration rights agreements between the registrant and various
investors provide for cross-indemnification in connection with registration of
the registration's common stock on behalf of those investors.
These indemnification provisions and the indemnification agreements
entered into between the registrant and its officers and directors may be
sufficiently broad to permit indemnification of the registrant's officers and
directors for liabilities (including reimbursement of expenses incurred) arising
under the Securities Act.
Reference is made to the following documents filed as exhibits to this
registration statement regarding relevant indemnification provisions described
above and elsewhere herein.
EXHIBIT
DOCUMENT NUMBER
-------- ------
Restated Certificate of Incorporation 3.01
Amended and Restated Bylaws 3.02
Form of Indemnification Agreement 10.40
Registration Rights Agreements 4.2 and 4.5
II-2
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
In March 2002, the registrant issued an aggregate of 39,628 shares of
common stock upon conversion of 3,962.8 shares of Series B Preferred Stock held
by two individuals.
In April and May 2002, the registrant issued an aggregate of 756,742
shares of common stock upon conversion of 75,674.2 shares of Series B Preferred
Stock held by four individuals and three entities.
In July 2002, the registrant issued an aggregate of 46,293 shares of
common stock upon conversion of 4,629.3 shares of Series B Preferred Stock held
by one entity.
In September 2002, the registrant issued to a former employee for
advice and consultation services valued at $6,000, three-year warrants to
acquire 120,000 shares of our common stock at an exercise price of $0.50 per
share.
In November 2002, the registrant issued 5,000 shares of common stock
with an aggregate value of $1,000 to a former employee for services rendered.
In December 2002, the registrant issued an aggregate of 16,759 shares
of common stock to two holders of Series B Preferred Stock upon conversion of
1,675.9 shares of Series B Preferred Stock.
In March 2003, the registrant issued 41,663 shares of common stock to
one investor upon conversion of 4,166.3 shares of Series B Preferred Stock.
In April 2003, the registrant issued to two individuals three-year
warrants to purchase up to 150,000 shares of common stock at a per share
exercise price of $0.75 and up to 100,500 shares of common stock at a per share
exercise price of $1.00 in consideration for financial advisory services
rendered.
In May and June 2003, the registrant issued an aggregate of 587,286
shares of common stock to five investors upon conversion of 58,728.6 shares of
Series B Preferred Stock.
In May and June 2003, the registrant issued an aggregate of 1,263,250
shares of common stock to four investors upon conversion of 25 shares of Series
A Preferred Stock.
In September 2003, the registrant issued an aggregate of 5,926 shares
of common stock to two investors upon conversion of 52.6 shares of Series B
Preferred Stock.
In January 2004, the registrant issued 3,703 shares of common stock to
an investor upon conversion of shares of Series B Convertible Preferred Stock.
On July 13, 2004, the registrant issued 1,213,592 shares of common
stock and warrants to purchase up to an aggregate of 150,000 shares of common
stock at $1.30 per share to two trusts as part of the purchase price for the
acquisition of Larus Corporation pursuant to a Stock Purchase Agreement.
On November 3, 2004, the registrant issued to one entity warrants to
purchase an aggregate of 100,000 shares of common stock at exercise prices
ranging from $0.85 to $1.15 per share as partial consideration for investor
relations services.
On January 24, 2005, the registrant issued to this same entity
additional warrants to purchase 25,000 shares of common stock at an exercise
price of $2.00 per share, again as partial consideration for investor relations
services.
In January 2005, the registrant issued 12,503,500 shares of common
stock at a purchase price of $1.44 per share and five-year investor warrants to
purchase up to an additional 3,125,875 shares of common stock at an exercise
price of $1.73 per share in a private offering to 17 record holders pursuant to
a Securities Purchase Agreement. The registrant also entered into a Registration
Rights Agreement in which it agreed to register for resale the shares of common
stock issued to investors and the shares of common stock issuable upon exercise
of the investor warrants and placement warrants. Additionally, the registrant
agreed to pay cash placement agent fees of approximately $936,500 and issued a
five-year placement agent warrant to purchase up to 650,310 shares of common
stock at an exercise price of $1.73 per share.
The issuances of our securities described above were made in reliance
upon the exemption from registration available under Section 4(2) of the
Securities Act, among others, as transactions not involving a public offering.
This exemption was claimed on the basis that these transactions did not involve
any public offering and the purchasers in each offering were accredited or
sophisticated and had sufficient access to the kind of information registration
would provide. In each case, appropriate investment representations were
obtained and stock certificates were issued with restrictive legends.
II-3
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS.
The following exhibits are included or incorporated herein by
reference:
EXHIBIT
NUMBER DESCRIPTION
------ -----------
2.1 Stock Purchase Agreement dated July 13, 2004 between MicroTel
International Inc.; Noel C. McDermott; Warren P. Yost; Noel C.
McDermott, as Trustee of the Noel C. McDermott Revocable Living
Trust dated December 19, 1995; and Warren P. Yost and Gail A.
Yost, as Co-Trustees Under Declaration of Trust dated March 9,
1988 (1)
3.1 Restated Certificate of Incorporation of Emrise Corporation filed
with the Secretary of State of Delaware on December 8, 2004 (2)
3.2 Amended and Restated Bylaws adopted by the Board of Directors of
the Corporation on September 1, 2004 (3)
4.1 Securities Purchase Agreement dated December 29, 2004 among Emrise
Corporation and the investors listed on an attachment thereto (4)
4.2 Registration Rights Agreement dated December 29, 2004 among Emrise
Corporation and the investors who are parties to the Securities
Purchase Agreement listed as Exhibit 4.1 (4)
4.3 Form of Investor Warrant issued by Emrise Corporation to the
investors who are parties to the Securities Purchase Agreement
listed as Exhibit 4.1 (4)
4.4 Form of Placement Warrant issued by Emrise Corporation to Roth
Capital Partners, LLC covering 650,310 shares of common stock (4)
4.5 Registration Rights Agreement dated July 13, 2004 among the
Registrant and Noel C. McDermott, as Trustee of the Noel C.
McDermott Revocable Living Trust dated December 19, 1995, and
Warren P. Yost and Gail A. Yost, as Co-Trustees Under Declaration
of Trust dated March 9, 1988 (5)
4.6 Form of Common Stock Purchase Warrant dated July 13, 2004 issued
by the Registrant to: (a) Noel C. McDermott, as Trustee of the
Noel C. McDermott Revocable Living Trust dated December 19, 1995
(84,066 shares); and (b) Warren P. Yost and Gail A. Yost, as
Co-Trustees Under Declaration of Trust dated March 9, 1988 (65,934
shares) (5)
4.7 Common Stock Purchase Warrant dated November 3, 2004 issued by the
Registrant to Hayden Communications, Inc. (100,000 shares) (5)
4.8 Common Stock Purchase Warrant dated January 24, 2005 issued by the
Registrant to Hayden Communications, Inc. (25,000 shares) (5)
4.9 Common Stock Purchase Warrant dated April 3, 2001 issued by the
Registrant to Coffin Communications Group (35,000 shares) (5)
4.10 Common Stock Purchase Warrant dated September 25, 2002 issued by
the Registrant to Jacques Moisset (120,000 shares) (5)
II-4
EXHIBIT
NUMBER DESCRIPTION
------ -----------
4.11 Form of Common Stock Purchase Warrant dated April 2, 2003 issued
by the Registrant to: (a) Jason Oliva (100,000 shares at $0.75 per
share); (b) Jason Oliva (100,500 shares at $1.00 per share); and
(c) Steven Jacobus (50,000 shares at $0.75 per share) (5)
5.1 Opinion of Rutan & Tucker, LLP (5)
10.1 1993 Stock Option Plan (#) (6)
10.2 Employee Stock and Stock Option Plan (#) (7)
10.3 1997 Stock Incentive Plan (#) (8)
10.4 Amended and Restated 2000 Stock Option Plan (#) (9)
10.5 Form of Incentive Stock Option Agreement Under Amended and
Restated 2000 Stock Option Plan (#) (5)
10.6 Form of Non-Qualified Stock Option Agreement Under Amended and
Restated 2000 Stock Option Plan (#) (5)
10.7 Credit Facility Letter Agreement dated June 1, 2004 between Wells
Fargo Bank, N.A., XET Corporation and CXR Telcom Corporation (10)
10.8 Revolving Line of Credit Note dated June 1, 2004 in the principal
amount of up to $3,000,000 made by XET Corporation and CXR Telcom
Corporation in favor of Wells Fargo Bank, N.A. (10)
10.9 Term Note dated June 1, 2004 in the principal amount of $150,000
made by XET Corporation and CXR Telcom Corporation in favor of
Wells Fargo Bank, N.A. (10)
10.10 Continuing Guaranty made by XET Corporation and CXR Telcom
Corporation in favor of Wells Fargo Bank, N.A. (10)
10.11 Security Agreement Equipment made by XET Corporation in favor of
Wells Fargo Bank, N.A. (10)
10.12 Security Agreement Equipment made by CXR Telcom Corporation in
favor of Wells Fargo Bank, N.A. (10)
10.13 Continuing Security Agreement Rights to Payment and Inventory made
by XET Corporation in favor of Wells Fargo Bank, N.A. (10)
10.14 Continuing Security Agreement Rights to Payment and Inventory made
by CXR Telcom Corporation in favor of Wells Fargo Bank, N.A. (10)
10.15 Deed of Guarantee and Indemnity dated November 12, 2002 made by
MicroTel International Inc., XCEL Corporation Limited, Belix Power
Conversion Limited and Belix Wound Components Limited in favor of
Venture Finance PLC (11)
10.16 Advantage Facility dated November 12, 2002 between XCEL Power
Systems Limited and Venture Finance PLC (11)
II-5
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.17 Cashflow Loan Agreement dated November 12, 2002 between XCEL Power
Systems Limited and Venture Finance PLC (11)
10.18 Term Loan Agreement dated November 12, 2002 between XCEL Power
Systems Limited and Venture Finance PLC (11)
10.19 Deed of Subordination dated November 12, 2002 between Venture
Finance PLC, MicroTel International Inc. and XCEL Corporation
Limited (11)
10.20 Agreement for the Purchase of Debts dated November 12, 2002
between XCEL Power Systems Limited and Venture Finance PLC (11)
10.21 Letter Agreement dated October 23, 2002 between XCEL Power Systems
Limited and Venture Finance PLC regarding Amendments to Agreement
for the Purchase of Debts (11)
10.22 Credit Facility Agreement dated April 8, 2003, between IFN Finance
and CXR, S.A.S. (11)
10.23 English Summary of Credit Facility Agreement dated April 8, 2003
between IFN Finance and CXR, S.A.S. (12)
10.24 Subordinated Secured Promissory Note dated July 13, 2004 in the
principal amount of $1,681,318.68 made by MicroTel International
Inc. in favor of Noel C. McDermott Revocable Living Trust dated
December 19, 1995 (10)
10.25 Subordinated Secured Promissory Note dated July 13, 2004 in the
principal amount of $1,318,681.32 made by MicroTel International
Inc. in favor of Warren P. Yost and Gail A. Yost, as Co-Trustees
Under Declaration of Trust dated March 9, 1988 (10)
10.26 Pledge and Security Agreement dated July 13, 2004 between MicroTel
International Inc.; Noel C. McDermott, as Collateral Agent; Noel
C. McDermott, as Trustee of the Noel C. McDermott Revocable Living
Trust dated December 19, 1995; and Warren P. Yost and Gail A.
Yost, as Co-Trustees Under Declaration of Trust dated March 9,
1988 (10)
10.27 Intercreditor Agreement dated July 13, 2004 between MicroTel
International Inc.; Noel C. McDermott, as Trustee of the Noel C.
McDermott Revocable Living Trust dated December 19, 1995; and
Warren P. Yost and Gail A. Yost, as Co-Trustees Under Declaration
of Trust dated March 9, 1988 (10)
10.28 Continuing Guarantee dated July 13, 2004 made by Larus Corporation
in favor of Noel C. McDermott, as Trustee of the Noel C. McDermott
Revocable Living Trust dated December 19, 1995, and Warren P. Yost
and Gail A. Yost, as Co-Trustees Under Declaration of Trust dated
March 9, 1988 (10)
10.29 Continuing Guarantee dated July 13, 2004 made by Vista Labs
Incorporated in favor of Noel C. McDermott, as Trustee of the Noel
C. McDermott Revocable Living Trust dated December 19, 1995, and
Warren P. Yost and Gail A. Yost, as Co-Trustees Under Declaration
of Trust dated March 9, 1988 (10)
II-6
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.30 Continuing Guarantee dated July 13, 2004 made by CXR Telcom in
favor of Noel C. McDermott, as Trustee of the Noel C. McDermott
Revocable Living Trust dated December 19, 1995, and Warren P. Yost
and Gail A. Yost, as Co-Trustees Under Declaration of Trust dated
March 9, 1988 (10)
10.31 Security Agreement dated July 13, 2004 made by Larus Corporation
in favor of Noel C. McDermott, as Trustee of the Noel C. McDermott
Revocable Living Trust dated December 19, 1995, and Warren P. Yost
and Gail A. Yost, as Co-Trustees Under Declaration of Trust dated
March 9, 1988 (10)
10.32 Security Agreement dated July 13, 2004 made by Vista Labs
Incorporated in favor of Noel C. McDermott, as Trustee of the Noel
C. McDermott Revocable Living Trust dated December 19, 1995, and
Warren P. Yost and Gail A. Yost, as Co-Trustees Under Declaration
of Trust dated March 9, 1988 (10)
10.33 Security Agreement dated July 13, 2004 made by CXR Telcom in favor
of Noel C. McDermott, as Trustee of the Noel C. McDermott
Revocable Living Trust dated December 19, 1995, and Warren P. Yost
and Gail A. Yost, as Co-Trustees Under Declaration of Trust dated
March 9, 1988 (10)
10.34 Lease agreement between the Registrant and Property Reserve Inc.
dated September 16, 1999 (13)
10.35 Lease agreement between XET, Inc. and Rancho Cucamonga Development
dated August 30, 1999 (13)
10.36 Commercial Lease dated July 13, 2004 between MicroTel
International Inc., as Tenant, and Noel C. McDermott and Warren P.
Yost, as Landlord, for the premises located at 894 Faulstich
Court, San Jose, California (10)
10.37 Employment Agreement dated as of January 1, 2001 between the
Registrant and Carmine T. Oliva (#) (14)
10.38 Employment Agreement dated as of July 2, 2001 between the
Registrant and Randolph D. Foote (#) (9)
10.39 Employment Agreement dated as of January 1, 2001 between the
Registrant and Graham Jefferies (#) (9)
II-7
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.40 Form of Executive Officer and Director Indemnification Agreement
entered into between the Registrant and each of Carmine T. Oliva,
Robert B. Runyon, Laurence P. Finnegan, Jr., Otis W. Baskin,
Randolph D. Foote and Graham Jefferies (2)
10.41 Description of Retirement Account Matching Contributions (#) (5)
21 Subsidiaries of the Registrant (5)
23.1 Consent of Grant Thornton LLP, Independent Registered Public
Accounting Firm*
23.2 Consent of BDO Seidman, LLP, Independent Registered Public
Accounting Firm*
23.3 Consent of Rutan & Tucker, LLP (contained in Exhibit 5.1) (5)
24 Power of Attorney (contained on the signature page to this
registration statement)
---------------
* Filed herewith.
(#) Management contract or compensatory plan, contract or arrangement
required to be filed as an exhibit.
(1) Filed as an exhibit to the Registrant's current report on Form 8-K for
July 13, 2004 and incorporated herein by reference.
(2) Filed as an exhibit to the Registrant's current report on Form 8-K for
December 8, 2004 and incorporated herein by reference.
(3) Filed as Appendix G to the Registrant's definitive proxy statement for
the Registrant's 2004 annual meeting of stockholders and incorporated
herein by reference.
(4) Filed as an exhibit to the Registrant's Form 8-K for December 29, 2004
and incorporated herein by reference.
(5) To be filed by amendment.
(6) Filed as an exhibit to the Registrant's annual report on Form 10-K for
the year ended December 31, 2000 and incorporated herein by reference.
(7) Filed as an exhibit to the Registrant's definitive proxy statement for
the Registrant's annual meeting of stockholders held June 11, 1998 and
incorporated herein by reference.
(8) Filed as an exhibit to the Registrant's definitive proxy statement for
the special meeting of stockholders held January 16, 2001 and
incorporated herein by reference.
(9) Filed as an exhibit to the Registrant's quarterly report on Form 10-Q for
September 30, 2001 and incorporated herein by reference.
(10) Filed as an exhibit to the Registrant's quarterly report on Form 10-Q for
June 30, 2004 and incorporated herein by reference.
II-8
(11) Filed as an exhibit to the Registrant's quarterly report on Form 10-Q for
June 30, 2003 and incorporated herein by reference.
(12) Filed as an exhibit to Amendment No. 1 to the Registrant's quarterly
report on Form 10-Q for June 30, 2003 and incorporated herein by
reference.
(13) Filed as an exhibit to the Registrant's registration statement on Form
S-8 (Registration Statement No. 333-29925) and incorporated herein by
reference.
(14) Filed as an exhibit to the initial filing of the Registrant's
registration statement on Form S-1 (Registration Statement No. 333-63024)
and incorporated herein by reference.
(b) FINANCIAL STATEMENT SCHEDULES
The following financial statement schedule required to be filed by Item
16(b) is contained on page F-51 of this registration statement:
Consolidated Schedule II Valuation and Qualifying Accounts for the
Years Ended December 31, 2003, 2002 and 2001
All other schedules have been omitted because they are either
inapplicable or the required information has been given in the consolidated
financial statements or notes thereto.
II-9
ITEM 17. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of
the Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising
after the effective date of the registration statement (or the most
recent post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than a 20 percent change
in the maximum aggregate offering price set forth in the "Calculation
of Registration fee" table in the effective registration statement; and
(iii) To include any material information with respect to the
plan of distribution not previously disclosed in the registration
statement or any material change to such information in the
registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed to be
a new registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bone
fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the termination of
the offering.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in the form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this registration
statement as of the time it was declared effective.
(2) For purposes of determining any liability under the Securities Act,
each post-effective amendment that contains a form of prospectus shall be deemed
to be a new registration statement relating to the securities offered therein,
and the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
registrant pursuant to the provisions described in Item 14 hereof, or otherwise,
the registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Securities Act, and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the registrant of expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful defense of any action,
suit or proceeding) is asserted by such director, officer or controlling person
in connection with the securities being registered, the registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question of whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
II-10
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
registrant has duly caused this registration statement on Form S-1 to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Rancho Cucamonga, State of California on January 28, 2005.
EMRISE CORPORATION
By: /S/ CARMINE T. OLIVA
----------------------------------
Carmine T. Oliva
Chairman of the Board, President
and Chief Executive Officer
POWER OF ATTORNEY
Each of the officers and directors of Emrise Corporation whose
signature appears below hereby constitutes and appoints Carmine T. Oliva and
Randolph D. Foote his true and lawful attorneys and agents, with full power of
substitution, and with power to act alone, to sign on behalf of the undersigned
any amendment or amendments to this Registration Statement on Form S-1
(including post-effective amendments) and any and all new registration
statements filed pursuant to Rule 462 under the Securities Act of 1933, as
amended, and to perform any acts necessary to file such amendments or
registration statements, with exhibits thereto and other documents in connection
therewith, and each of the undersigned does hereby ratify and confirm his
signature as it may be signed by his said attorneys and agents to any and all
such documents and all that said attorneys and agents, or their substitutes,
shall do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this registration statement has been signed by the following persons in the
capacities and on the dates indicated.
NAME TITLE DATE
---- ----- ----
/S/ CARMINE T. OLIVA Chairman of the Board, President, January 28, 2005
----------------------------- Chief Executive Officer (principal
Carmine T. Oliva executive officer) and Director
/S/ RANDOLPH D. FOOTE Chief Financial Officer January 28, 2005
----------------------------- (principal accounting and
Randolph D. Foote financial officer),
Senior Vice President and
Secretary
/S/ ROBERT B. RUNYON Director January 28, 2005
-----------------------------
Robert B. Runyon
/S/ LAURENCE P. FINNEGAN, JR. Director January 28, 2005
-----------------------------
Laurence P. Finnegan, Jr.
/S/ OTIS W. BASKIN Director January 28, 2005
-----------------------------
Otis W. Baskin
II-11
INDEX TO EXHIBITS ATTACHED TO THIS FORM S-1
Exhibit
Number Description
------ -----------
23.1 Consent of Grant Thornton LLP, Independent Registered Public
Accounting Firm
23.2 Consent of BDO Seidman, LLP, Independent Registered Public
Accounting Firm