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EX-31.2 - EX-31.2 - RAE SYSTEMS INC | f59213exv31w2.htm |
EX-32.2 - EX-32.2 - RAE SYSTEMS INC | f59213exv32w2.htm |
EX-32.1 - EX-32.1 - RAE SYSTEMS INC | f59213exv32w1.htm |
EX-31.1 - EX-31.1 - RAE SYSTEMS INC | f59213exv31w1.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2011
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 001-31783
RAE SYSTEMS INC.
(Exact name of registrant as specified in its charter)
Delaware | 77-0280662 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification No.) | |
3775 North First Street | ||
San Jose, California | 95134 | |
(Address of principal executive offices) | (Zip Code) |
408-952-8200
(Registrants telephone number, including area code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files). Yes
o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer o | Non-accelerated filer þ (Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuers classes of common stock, as
of the latest practicable date.
Class | Outstanding at April 30, 2011 | ||||
Common stock, $0.001 par value per share | 59,512,064 shares | ||||
INDEX
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Table of Contents
PART I. Financial Information
Item 1. Financial Statements
RAE Systems Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share and par value data)
(unaudited)
Condensed Consolidated Balance Sheets
(in thousands, except share and par value data)
(unaudited)
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 13,380 | $ | 16,296 | ||||
Restricted cash |
| 2,000 | ||||||
Trade notes receivable |
2,117 | 2,018 | ||||||
Accounts receivable, net of allowances of $3,821 and $3,539, respectively |
14,793 | 14,286 | ||||||
Accounts receivable from affiliate |
187 | 200 | ||||||
Inventories |
13,320 | 11,546 | ||||||
Prepaid expenses and other current assets |
5,522 | 4,557 | ||||||
Income taxes receivable |
133 | 130 | ||||||
Current assets of discontinued operation |
| 6,093 | ||||||
Total current assets |
49,452 | 57,126 | ||||||
Property and equipment, net |
12,251 | 10,730 | ||||||
Intangible assets, net |
110 | 196 | ||||||
Investments in unconsolidated affiliates |
139 | 184 | ||||||
Other assets |
396 | 393 | ||||||
Noncurrent assets of discontinued operation |
| 3,478 | ||||||
Total assets |
$ | 62,348 | $ | 72,107 | ||||
LIABILITIES AND EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 7,308 | $ | 5,475 | ||||
Accounts payable to affiliate |
13 | 25 | ||||||
Bank debt, current |
1,810 | 1,814 | ||||||
Accrued liabilities |
9,878 | 11,957 | ||||||
Notes payable to related parties, current |
286 | 278 | ||||||
Income taxes payable |
428 | 128 | ||||||
Deferred revenue, current |
586 | 557 | ||||||
Current liabilities of discontinued operation |
| 5,790 | ||||||
Total current liabilities |
20,309 | 26,024 | ||||||
Deferred revenue, non-current |
796 | 776 | ||||||
Deferred tax liabilities, non-current |
143 | 141 | ||||||
Deferred gain on sale of real estate, non-current |
3,650 | 3,809 | ||||||
Other long-term liabilities |
1,527 | 1,491 | ||||||
Noncurrent liabilities of discontinued operation |
| 182 | ||||||
Total liabilities |
26,425 | 32,423 | ||||||
COMMITMENTS AND CONTINGENCIES (NOTE 6) |
||||||||
EQUITY: |
||||||||
Common stock, $0.001 par value, 200,000,000 shares authorized; 59,512,064 and 59,512,064 shares
issued and outstanding as of March 31, 2011 and December 31, 2010, respectively |
59 | 59 | ||||||
Additional paid-in capital |
65,238 | 65,041 | ||||||
Accumulated other comprehensive income |
6,693 | 7,786 | ||||||
Accumulated deficit |
(36,735 | ) | (34,311 | ) | ||||
Total RAE Systems Inc. shareholders equity |
35,255 | 38,575 | ||||||
Noncontrolling interest |
668 | 1,109 | ||||||
Total equity |
35,923 | 39,684 | ||||||
Total liabilities and equity |
$ | 62,348 | $ | 72,107 | ||||
. |
See accompanying notes to condensed consolidated financial statements.
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Table of Contents
RAE Systems Inc.
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
Three Months Ended | ||||||||
March 31, | ||||||||
2011 | 2010 | |||||||
Net sales |
$ | 22,447 | $ | 16,855 | ||||
Cost of sales |
8,772 | 7,359 | ||||||
Gross profit |
13,675 | 9,496 | ||||||
Operating expenses: |
||||||||
Sales and marketing |
5,089 | 4,173 | ||||||
Research and development |
1,761 | 1,579 | ||||||
General and administrative |
8,961 | 3,826 | ||||||
Total operating expenses |
15,811 | 9,578 | ||||||
Operating loss from continuing operations |
(2,136 | ) | (82 | ) | ||||
Other income (expense): |
||||||||
Interest income |
4 | 23 | ||||||
Interest expense |
(26 | ) | (21 | ) | ||||
Other, net |
(76 | ) | 46 | |||||
Equity in loss of unconsolidated affiliate |
(46 | ) | (51 | ) | ||||
Loss from continuing operations before income taxes |
(2,280 | ) | (85 | ) | ||||
Income tax expense |
(585 | ) | (129 | ) | ||||
Loss from continuing operations |
(2,865 | ) | (214 | ) | ||||
Loss from discontinued operations, net of tax |
| (194 | ) | |||||
Net loss |
(2,865 | ) | (408 | ) | ||||
Net (income) loss attributable to the noncontrolling interest, continuing operations |
(39 | ) | 12 | |||||
Net loss attributable to the noncontrolling interest,
discontinued operations |
| 32 | ||||||
Net (income) loss attributable to the noncontrolling interest |
(39 | ) | 44 | |||||
Net loss attributable to RAE Systems Inc. |
$ | (2,904 | ) | $ | (364 | ) | ||
Earnings per common share basic and diluted: |
||||||||
Continuing operations |
$ | (0.05 | ) | $ | (0.01 | ) | ||
Discontinued operations |
| | ||||||
Net loss per share basic and diluted |
$ | (0.05 | ) | $ | (0.01 | ) | ||
Weighted-average common shares outstanding basic and diluted |
59,512 | 59,405 | ||||||
See accompanying notes to condensed consolidated financial statements.
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Table of Contents
RAE Systems Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
Three Months Ended March 30, | ||||||||
2011 | 2010 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES: |
||||||||
Net loss |
$ | (2,865 | ) | $ | (408 | ) | ||
Loss from discontinued operations |
| (194 | ) | |||||
Loss from continuing operations |
(2,865 | ) | (214 | ) | ||||
Adjustments to reconcile net loss to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
387 | 454 | ||||||
Gain on disposal of property and equipment |
(158 | ) | (144 | ) | ||||
Stock based compensation expense |
197 | 354 | ||||||
Equity in loss of unconsolidated affiliate |
46 | 51 | ||||||
Amortization of discount on notes payable to related parties |
1 | 3 | ||||||
Changes in operating assets and liabilities: |
||||||||
Accounts receivable |
(270 | ) | 1,366 | |||||
Accounts receivable from affiliate |
14 | 86 | ||||||
Trade notes receivable |
(71 | ) | 135 | |||||
Inventories |
(1,549 | ) | (329 | ) | ||||
Prepaid expenses and other current assets |
950 | 331 | ||||||
Other assets |
7 | 120 | ||||||
Accounts payable |
1,760 | (703 | ) | |||||
Accounts payable to affiliate |
(12 | ) | (46 | ) | ||||
Accrued liabilities |
(2,470 | ) | (549 | ) | ||||
Income taxes payable |
323 | 5 | ||||||
Deferred revenue |
49 | (172 | ) | |||||
Other liabilities |
16 | 59 | ||||||
Net cash (used in) provided by operating activities of continuing operations |
(3,645 | ) | 807 | |||||
Net cash used in operating activities of discontinued operations |
| (738 | ) | |||||
Net cash (used in) provided by operating activities |
(3,645 | ) | 69 | |||||
CASH FLOWS FROM INVESTING ACTIVITIES: |
||||||||
Changes in restricted cash |
2,000 | | ||||||
Acquisition of property and equipment |
(1,379 | ) | (235 | ) | ||||
Proceeds from sale of net assets |
| 16 | ||||||
Net cash provided by (used in) investing activities of continuing operations |
621 | (219 | ) | |||||
Net cash provided by investing activities of discontinued operations |
| 86 | ||||||
Net cash provided by (used in) investing activities |
621 | (133 | ) | |||||
CASH FLOWS FROM FINANCING ACTIVITIES: |
||||||||
Repayments of bank loans |
(2 | ) | | |||||
Payments on notes payable to related parties |
| (4 | ) | |||||
Net cash used in financing activities |
(2 | ) | (4 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents |
76 | (109 | ) | |||||
Decrease in cash and cash equivalents |
(2,950 | ) | (177 | ) | ||||
Cash and cash equivalents at beginning of period |
16,330 | 18,528 | ||||||
Cash and cash equivalents at end of period |
13,380 | 18,351 | ||||||
Less cash and cash equivalents of discontinued operations at end of period |
| 783 | ||||||
Cash and cash equivalents of continuing operations at end of period |
$ | 13,380 | $ | 17,568 | ||||
Supplemental disclosure of cash flow information: |
||||||||
Cash paid for taxes, net |
$ | 198 | $ | 59 | ||||
Cash paid for interest by continuing operations, net of amounts capitalized |
22 | 60 | ||||||
Cash paid for interest by discontinued operation |
| 30 | ||||||
Non-cash investing and financing activities: |
||||||||
Unpaid property and equipment of continuing operations |
346 | 161 | ||||||
Unpaid property and equipment of discontinued operations |
| 25 |
See accompanying notes to condensed consolidated financial statements.
5
Table of Contents
Notes to Condensed Consolidated Financial Statements
(unaudited)
(unaudited)
Note 1. Summary of Significant Accounting Policies
The Company
Founded in 1991, RAE Systems Inc. (the Company or RAE Systems), a Delaware company,
develops and manufactures rapidly-deployable, multi-sensor chemical and radiation detection
monitors and networks for oil and gas, hazardous material management, industrial safety, civil
defense and environmental remediation applications. The Companys products are based on proprietary
sensor technology, and include personal, breathing zone, portable, wireless and fixed chemical
detection monitors and radiation detectors.
As a result of an independent investigation conducted by the Audit Committee of the Board of
Directors during fiscal year 2008, the Company made a voluntary disclosure to the United States
Department of Justice (DOJ) and the United States Securities and Exchange Commission (SEC) that
the Company may have violated the United States Foreign Corrupt Practices Act (FCPA). The Company
cooperated with the DOJ and the SEC in connection with their review of the matter. In December
2010, the Company settled all outstanding issues with regard to this matter in separate agreements
with the DOJ and the SEC. Pursuant to these agreements; the Company paid a $1.7 million criminal
penalty to the DOJ and $1.3 million in restitution and interest to the SEC. The Company also agreed
to advise the DOJ and the SEC periodically until December 2013 on its ongoing efforts to ensure
continued compliance with the FCPA.
In April 2011, the SEC inquired whether the Company had adopted a sales program in China
whereby customers are awarded points based on the level of their purchases of RAE products, which
points they may later redeem for gifts, and if such a program was adopted, whether it complies with
the FCPA. The Company conducted a review in response to the SECs inquiry and has concluded that no
such program had been adopted in China.
Definitive Acquisition Agreement with Vector Capital
On September 19, 2010, the Company signed a definitive agreement to be acquired by an
affiliate of Battery Ventures (the Battery Merger Agreement) for $1.60 in cash per share (other
than certain shares held by our founders, Robert Chen, Peter Hsi and affiliated entities).
Subsequently, on January 12, 2011, the Company received an offer from an affiliate of Vector
Capital to acquire the outstanding shares of our common stock for $1.75 per share in cash (other
than certain shares held by Robert Chen, Peter Hsi and affiliated entities). The Company
terminated the Battery Merger Agreement on January 18, 2011, paid a termination fee of $3.39
million to Battery Ventures in accordance with the terms of the Battery Merger Agreement, and
signed a Merger Agreement with the affiliate of Vector Capital (the Vector Merger
Agreement) on the terms described above. On April 2, 2011, we received an offer from an
affiliate of Battery Ventures to acquire all of our outstanding capital stock for $1.90 per share in
cash, and on April 3, 2011, we entered into an amendment to the Vector Merger Agreement
increasing the per share cash price to be paid for the outstanding shares of our common stock (other than certain shares held by Robert Chen, Peter Hsi and affiliated entities) to $1.88. This
transaction is subject to customary closing conditions, including the approval of RAE Systems
shareholders.
In connection with the acquisition agreements, eleven lawsuits have been filed against the
Company and members of its Board of Directors. These suits were filed in State Courts in
California and Delaware and in the Federal District Court in California. In summary, the suits
allege violations of federal securities laws and that the individual defendants breached their
fiduciary duties by conducting an unfair sales process and agreeing to an unfair price, are
receiving improper personal benefits, and were aided and abetted by the other defendants. The
Company believes the claims in these lawsuits are without merit and intends to vigorously
defend against them. However, there can be no assurances as to the outcome of the litigation. See
Note 6. Commitments and Contingencies for more detail.
Basis of Presentation
The financial information presented in this Form 10-Q is unaudited and is not necessarily
indicative of the future consolidated financial position, results of operations or cash flows of
RAE Systems. The unaudited condensed consolidated financial statements contained in this Form 10-Q
have been prepared on the same basis as the annual consolidated financial statements and, in the
opinion of management, reflect all adjustments, which include only
normal recurring adjustments, necessary to present fairly the Companys financial position at
the date of the interim balance sheets, and its results of operations and cash flows for the stated
periods, in conformity with the accounting principles generally accepted in the United States of
America. The consolidated balances at December
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31, 2010, were derived from the audited consolidated
financial statements included in the Companys Annual Report (Annual Report) on Form 10-K for the
year ended December 31, 2010. The condensed consolidated financial statements included in this
report should be read in conjunction with the audited consolidated financial statements for the
year ended December 31, 2010, included in the Annual Report.
Principles of Consolidation
The condensed consolidated financial statements include the Company and its subsidiaries. All
intercompany balances and transactions have been eliminated. The ownership of other interest
holders of consolidated subsidiaries is reflected as noncontrolling interest.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting
principles in the United States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities, disclosures of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. The Company bases its estimates on historical experience and
on various other assumptions that are believed to be reasonable based on available information.
Actual results may differ materially from these estimates and assumptions.
Revenue Recognition
The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has
occurred, the fee is fixed or determinable, and collectability is reasonably assured. A provision
for estimated product returns is established at the time of sale based upon historical return rates
adjusted for current economic conditions. Historically, the Company has experienced an
insignificant amount of sales returns. The Company generally recognizes revenue upon shipment to
its distributors in accordance with standard contract terms that pass title of all goods upon
delivery to a common carrier (Free on board, FOB) and provides for sales returns under standard
product warranty provisions. For non-standard contract terms where title to goods passes upon
delivery to the customer (FOB destination), revenue is recognized after the Company has established
proof of delivery. Revenue related to services performed under the Companys extended warranty
program is recognized as earned based upon contract terms, generally ratably over the term of
service. The Company records project installation work in Asia using the percentage-of-completion
method. Net sales also include amounts billed to customers for shipping and handling. The Companys
shipping costs are included in cost of sales. Net sales does not include sales tax.
Effective January 1, 2011, when a sales arrangement contains multiple elements, the Company
allocates revenue to all deliverables based on their relative selling prices. Under this approach,
the selling price of a deliverable is determined by using a selling price hierarchy which requires
the use of Vendor Specific Objective Evidence (VSOE) of fair value if available, third party
evidence (TPE) if VSOE is not available, or best estimated selling price (BESP) if neither VSOE
nor TPE is available. The Companys sales arrangements typically contain multiple elements when
products and services are sold together. The adoption of this accounting standard did not impact
the Companys condensed consolidated financial statements.
Stock-Based Compensation Expense
The fair value of each option award is estimated on the date of grant using the
Black-Scholes-Merton valuation method. Accordingly, stock-based compensation cost is measured at
grant date based on the fair value of the award and recognized in expense over the requisite
service, which is generally the vesting period.
The impact on the Companys results from operations of recording stock-based compensation by
function for the three months ended March 31, 2011 and 2010 was as follows:
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Three Months Ended | ||||||||
March 31, | ||||||||
(in thousands) | 2011 | 2010 | ||||||
Cost of sales |
$ | 23 | $ | 23 | ||||
Sales and marketing |
22 | 33 | ||||||
Research and development |
28 | 36 | ||||||
General and administrative |
124 | 262 | ||||||
Total |
$ | 197 | $ | 354 | ||||
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The following is a summary of options (in thousands, except weighted-average exercise price):
Options Outstanding | ||||||||
Number | Weighted-Average | |||||||
of Shares | Exercise Price | |||||||
Balance as of January 1, 2011 |
5,266 | $ | 1.99 | |||||
Granted |
| |||||||
Exercised |
| |||||||
Canceled |
| |||||||
Balance as of March 31, 2011 |
5,266 | 1.99 | ||||||
The fair value of the Companys stock options granted to employees for the three months ended
March 31, 2010 was estimated using the following weighted-average assumptions:
Three | ||||
Months | ||||
Ended | ||||
March 31, | ||||
2010 | ||||
Expected volatility |
110 | % | ||
Expected dividend yield |
0 | % | ||
Risk-free interest rate |
2.8 | % | ||
Expected term in years |
6.0 | |||
Weighted-average grant date fair value |
$ | 0.71 |
No stock options were granted in the three months ended March 31, 2011.
Stock Option Plans
In June 2007, the shareholders of RAE Systems approved the Companys 2007 Equity Incentive
Plan (the 2007 Plan) at the annual meeting of shareholders. The 2007 Plan replaced the Companys
2002 Stock Option Plan (the 2002 Plan). A total of 4,000,000 shares of the Companys common stock
are authorized for issuance under the 2007 Plan. The maximum number of shares that may be issued
under the 2007 plan will be increased from time to time by shares subject to options granted under
the 2002 Plan that expire or are terminated and by shares acquired under the 2002 Plan that are
forfeited or repurchased by the Company for the option holders purchase price. However, no more
than 1,500,000 additional shares may be authorized for issuance under the 2007 Plan as a result of
these adjustments.
As of March 31, 2011, the Company has reserved 90,666 shares of common stock for issuance
under its 1993 Stock Option Plan, 1,986,188 shares under the 2002 Plan and 3,189,167 shares under
the 2007 Plan. As of March 31, 2011, 1,264,541 shares have been added to the balance available for
grant under the 2007 Plan as a result of grants cancelled under the 2002 Plan and 1,919,124 shares
of common stock remain available for future grants under the 2007 Plan.
Non-Plan Stock Options
In 2002, the Company granted certain of its directors non-plan options to purchase 400,000
shares of common stock at a weighted-average exercise price of $0.99 per share. The options vested
25% after one year with the remainder vesting pro-rata monthly over the following three years. From
2002 to 2006, the Company issued 300,000 shares of common stock due to the exercise of such
options. There have been no further grants, exercises or cancellations through March 31, 2011. As
such, non-plan stock options outstanding at March 31, 2011 and December 31, 2010, respectively,
totaled 100,000 at a weighted-average exercise price of $1.06. The vested options are exercisable
over ten years from the date of grant. There was no stock-based compensation expense recorded
during
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the three month periods ended March 31, 2011 and 2010, respectively, and no stock-based
compensation expense remains to be recorded related to non-plan options.
Non-Plan Restricted Stock
In August 2006, the Company granted 536,000 shares of restricted stock to four individuals at
a weighted-average grant date fair value of $2.81 per share as an inducement to join the Company.
Twenty five percent of this restricted stock or 134,000 shares vested in July 2007 with the
remainder vesting pro-rata quarterly over the following three years subject to accelerated vesting
in certain circumstances.
The fair market value of the Companys common shares on the date the awards were granted
represents unrecognized stock-based compensation which was amortized ratably over the vesting
period of the underlying stock awards. Vesting was completed during the third quarter of 2010. As
such, no unvested restricted stock remained outstanding at March 31, 2011 and December 31, 2010,
respectively. As of March 31, 2011, no stock-based compensation expense related to restricted stock
awards remained to be recorded and none was recorded for the quarter then ended.
Earnings Per Share
Basic earnings per common share includes no dilution and is computed by dividing net income or
loss available to common shareholders by the weighted-average number of common shares outstanding
for the period. Diluted earnings per common share reflects the potential dilution of common stock
equivalents, such as options and warrants, to the extent the impact is dilutive. As the Company
incurred a net loss for the three months ended March 31, 2011 and March 31, 2010, the effect of
potentially dilutive securities on diluted net loss per share computations was anti-dilutive for
these periods.
The number of anti-dilutive shares excluded from the diluted earnings per common share
calculations for the three months ended March 31, 2011 and March 31, 2010 was 5,366,021 and
5,530,171, respectively.
Segment Reporting
FASB Accounting Standards Codification (ASC) Topic 280, Segment Reporting, establishes
standards for public business enterprises to report information about operating segments in their
annual financial statements and requires that those enterprises report selected information about
operating segments in subsequent interim financial reports issued to shareholders. It also
established standards for related disclosure about products and services, geographic areas, and
major customers. Operating segments are components of an enterprise, which are evaluated regularly
by the chief operating decision-makers in deciding how to allocate and assess resources and
performance. The Companys chief operating decision-makers are the Chief Executive Officer and the
Chief Financial Officer. Although the Companys operating segments consist of entities
geographically based in the Americas, Asia and Europe, the Company operates in a single reportable
segment worldwide in the sale of portable and wireless chemical and radiation detection products
and related services.
Variable Interest Entities
S.A.R.L RAE France (RAE France) is the exclusive distributor of RAE Systems products in
France. RAE Systems owns 49% of RAE Frances common stock and is the distributors largest
shareholder. Although the operations of RAE France generally are independent of RAE Systems,
through governance rights, the Company may direct RAE Frances business strategies. The Company has
identified RAE France as a variable interest entity with
RAE Systems as the primary beneficiary since inception in the fourth quarter of 2004.
Accordingly, the Company has consolidated RAE France since December 2004.
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RAE France had total sales of $948,000 and $724,000 in the three months ended March 31, 2011
and 2010, respectively. The carrying amounts of the major classes of RAE France assets and
liabilities included in the Companys Condensed Consolidated Balance Sheets were as follows:
March 31, | December 31, | |||||||
(in thousands) | 2011 | 2010 | ||||||
Cash and cash equivalents |
$ | 160 | $ | 194 | ||||
Accounts receivable |
675 | 584 | ||||||
Inventories |
365 | 209 | ||||||
Prepaid expenses and other current assets |
127 | 119 | ||||||
Total current assets |
1,327 | 1,106 | ||||||
Other non-current assets |
34 | 40 | ||||||
Total assets |
$ | 1,361 | $ | 1,146 | ||||
Accounts payable |
$ | 16 | $ | 25 | ||||
Accrued liabilities |
369 | 339 | ||||||
Total current liabilities |
$ | 385 | $ | 364 | ||||
There were no restrictions or other special conditions on the assets or liabilities of RAE
France.
Recent Accounting Pronouncements
In October 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards
Update (ASU) 2009-13, Multiple-Deliverable Revenue Arrangements, (amendments to FASB Accounting
Standards Codification (ASC) Topic 605, Revenue Recognition) (ASU 2009-13) and ASU 2009-14,
Certain Arrangements That Include Software Elements, (amendments to FASB ASC Topic 985, Software)
(ASU 2009-14). ASU 2009-13 requires entities to allocate revenue in an arrangement using
estimated selling prices of the delivered goods and services based on a selling price hierarchy.
The amendments eliminate the residual method of revenue allocation and require revenue to be
allocated using the relative selling price method. ASU 2009-14 removes tangible products from the
scope of software revenue guidance and provides guidance on determining whether software
deliverables in an arrangement that includes a tangible product are covered by the scope of the
software revenue guidance. ASU 2009-13 and ASU 2009-14 should be applied on a prospective basis for
revenue arrangements entered into or materially modified in fiscal years beginning on or after June
15, 2010, with early adoption permitted. The adoption of this guidance did not impact the Companys condensed consolidated financial statements.
In January 2010, the FASB issued guidance to amend the disclosure requirements related to
recurring and nonrecurring fair value measurements. The guidance requires new disclosures on the
transfers of assets and liabilities between Level 1 (quoted prices in active market for identical
assets or liabilities) and Level 2 (significant other observable inputs) of the fair value
measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the
guidance requires a roll forward of activities on purchases, sales, issuance, and settlements of
the assets and liabilities measured using significant unobservable inputs (Level 3 fair value
measurements). The guidance became effective for entities with a reporting period beginning January
1, 2010, except for the disclosure on the roll forward activities for Level 3 fair value
measurements, which became effective for the reporting period beginning January 1, 2011. The
adoption of these changes had no material impact on the Companys condensed consolidated financial
statements.
In December 2010, the FASB issued ASU 2010-29, Disclosure of Supplementary Pro Forma
Information for Business Combinations (amendments to FASB ASC Topic 805, Business Combinations).
The guidance in ASU 2010-29 provides amendments to clarify the acquisition date which should be
used for reporting the pro forma financial information disclosures in Topic 805 when comparative
financial statements are presented. The amendments also improve the usefulness of the pro forma
revenue and earnings disclosures by requiring a
description of the nature and amount of material, nonrecurring pro forma adjustments directly
attributable to the business combination(s). The amendments in this update are effective
prospectively for business combinations for which the acquisition date is on or after the beginning
of the first annual reporting period beginning on or after December 15, 2010. Early adoption is
permitted. The adoption of this guidance did not have a material impact on the Companys condensed
consolidated financial statements.
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In December, 2010, the FASB issued ASU 2010-28, When to Perform Step 2 of the Goodwill
Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (amendments to FASB ASC
Topic 350, Intangibles Goodwill and Other). The objective of this ASU is to address diversity in
practice in the application of goodwill impairment testing by entities with reporting units with
zero or negative carrying amounts, eliminating an entitys ability to assert that a reporting unit
is not required to perform Step 2 because the carrying amount of the reporting unit is zero or
negative despite the existence of qualitative factors that indicate the goodwill is more likely
than not impaired. This ASU is effective for interim periods after January 1, 2011. The adoption of
this ASU did not have a material impact on the Companys condensed consolidated financial
statements.
Note 2. Discontinued Operation
On December 22, 2010, the Board of Directors approved managements plan to pursue the sale of
the Companys 70% interest in RAE Coal Mine Safety Instruments (Fushun) Co., Ltd. (RAE Fushun), a
Sino-Foreign joint venture in China. RAE Fushun had not met the Companys revenue and earnings
expectations, and the joint venture was not well positioned to capitalize on the Companys future
strategies. On January 12, 2011, the Company signed a definitive agreement to sell its 70% interest
to the Shenyang Research Institute of China Coal Research Institute (Shenyang Institute), a
state-owned enterprise, for zero proceeds. However, under the terms of the agreement the Shenyang
Institute assumed all documented joint venture liabilities and agreed to pay approximately RMB
12.25 million (or approximately $1.87 million) intercompany balances owed to RAE Shanghai and RAE
Beijing for products and services previously provided to the joint venture. As of April 30, 2011,
Shenyang Institute had made scheduled payments to RAE Systems totaling RMB 8 million (or
approximately $1.2 million). The Company expects to receive RMB 2 million (or approximately $0.3
million) monthly until paid in full. As of March 31, 2011 the remaining total balance owed to RAE
Shanghai and RAE Beijing was $0.9 million which is included in Prepaid expenses and other current
assets in the Companys Condensed Consolidated Balance Sheets.
The purchase agreement between RAE Systems and Shenyang Institute is subject to customary
closing conditions in China, which includes obtaining certain government approvals. The Company and
Shenyang Institute anticipate receiving all of the necessary approvals and effecting the final
transfer of shares within six months from signing the definitive agreement. In addition to assuming
the entitys liabilities, the purchase agreement required Shenyang Institute to begin funding the
operations of the surviving company as of signature date. Therefore, RAE Systems provided Shenyang
Institute with complete operating control of RAE Fushun on January 12, 2011, and RAE Systems
subsequently has not been involved in the day-to-day management or operating activities of RAE
Fushun. The Company still retains its 70% ownership in the entity until such time as regulatory
approvals are obtained; however, the Company has not provided nor does it anticipate providing any
financial support or management support to the entity during the closing process. Management
believes the activities from January 1 to January 12, 2011 are not material and no additional gain
or loss on discontinued operations was incurred or recorded. In addition, since January 12, 2011,
the Company has had no representation on the entitys Board of Directors.
Prior to January 12, 2011, RAE Systems consolidated RAE Fushun in its financial statements
based on its controlling financial interest. However, the Company believes that execution of the
definitive agreement on January 12, 2011 constituted a reconsideration event under ASC Topic 810,
Consolidation, requiring the Company to assess whether RAE Fushun meets the definition of a
Variable Interest Entity (VIE) and whether RAE Systems is the primary beneficiary of RAE Fushun.
Effective upon signing the agreement, Shenyang Institute superseded the Company as RAE Fushuns
controlling manager. Subsequently, Shenyang Institute has had the sole ability to establish RAE
Fushuns business strategies and to manage the entitys day-to-day operations. Shenyang Institute
also assumed the obligation to absorb RAE Fushuns gains and losses, if any, by virtue of its
contractual obligation to fund the entitys ongoing operations. In the event that the necessary
government approvals required in China were not obtained, that the capital contributions made by
Shenyang Institute would not be refundable. At the same time, upon receipt of final government
approvals, Shenyang Institute will be entitled to the benefits of RAE Fushuns operations from the
date of the purchase agreement. As the equity holders of RAE Fushun are protected from
ongoing variability in the operations of the entity, RAE Fushun is deemed to be a VIE with
Shenyang Institute being the primary beneficiary as of January 12, 2011. Consequently, RAE Systems
deconsolidated RAE Fushun from its financial statements as of the same date and no gain or loss was
recorded upon deconsolidation.
The financial results of RAE Fushun are reported as discontinued operations in
accordance with ASC Subtopic 205-20, Discontinued Operations. The financial results included in
discontinued operations were as follows:
Three | ||||
Months | ||||
Ended | ||||
March 31, | ||||
(in thousands) | 2010 | |||
Net sales |
$ | 1,940 | ||
Loss from discontinued operations before income taxes |
(194 | ) | ||
Income tax benefit |
| |||
Loss from discontinued operations |
(194 | ) | ||
Net loss attributable to the noncontrolling interest |
32 | |||
Net loss from discontinued operations attributable to RAE Systems Inc. |
$ | (162 | ) | |
Management believes the activities from January 1 to January 12, 2011 were not
material and no additional gain or loss on discontinued operations was incurred or recorded.
Prior to deconsolidation, the carrying amounts of the major classes of assets and liabilities
included as part of the disposal group were as follows:
December 31, | ||||
(in thousands) | 2010 | |||
Cash & cash equivalents |
$ | 34 | ||
Restricted cash |
151 | |||
Trade notes receivable |
106 | |||
Accounts receivable, net of allowances of $3,591 and $2,705, respectively |
2,533 | |||
Inventories |
2,551 | |||
Prepaid expenses and other current assets |
718 | |||
Total current assets |
6,093 | |||
Property and equipment, net |
3,478 | |||
Total assets |
$ | 9,571 | ||
Accounts payable |
$ | 1,122 | ||
Bank line of credit |
1,512 | |||
Accrued liabilities |
3,156 | |||
Total current liabilities |
5,790 | |||
Other long-term liabilities |
182 | |||
Total liabilities |
$ | 5,972 | ||
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Note 3. Composition of Certain Financial Statement Items
Inventories
Inventories are stated at the lower of standard cost, which approximates actual cost computed
on a first-in, first-out basis, or market and include material, labor and manufacturing overhead
costs. The components of inventories were as follows:
March 31, | December 31, | |||||||
(in thousands) | 2011 | 2010 | ||||||
Raw materials |
$ | 7,363 | $ | 6,770 | ||||
Work-in-progress |
3,453 | 2,396 | ||||||
Finished goods |
2,504 | 2,380 | ||||||
Total inventories |
$ | 13,320 | $ | 11,546 | ||||
Prepaid expenses and other current assets
March 31, | December 31, | |||||||
(in thousands) | 2011 | 2010 | ||||||
Supplier advances and deposits |
$ | 609 | $ | 971 | ||||
Accounts receivable from employees |
434 | 368 | ||||||
Prepaid insurance |
156 | 269 | ||||||
Deferred tax assets, current |
1,612 | 1,595 | ||||||
Other current assets |
2,711 | 1,354 | ||||||
Total prepaid expenses and
other current assets |
$ | 5,522 | $ | 4,557 | ||||
Property and equipment, net
March 31, | December 31, | |||||||
(in thousands) | 2011 | 2010 | ||||||
Buildings and improvements |
$ | 6,466 | $ | 6,404 | ||||
Equipment |
4,595 | 4,489 | ||||||
Computer equipment |
5,042 | 5,003 | ||||||
Automobiles |
498 | 488 | ||||||
Furniture and fixtures |
410 | 408 | ||||||
Construction in progress |
7,178 | 5,478 | ||||||
24,189 | 22,270 | |||||||
Less: Accumulated depreciation |
(11,938 | ) | (11,540 | ) | ||||
Total property and equipment, net |
$ | 12,251 | $ | 10,730 | ||||
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Intangible assets, net
March 31, 2011 | December 31, 2010 | ||||||||||||||||||||||||||
Gross | Net | Gross | Net | ||||||||||||||||||||||||
Carrying | Accumulated | Carrying | Carrying | Accumulated | Carrying | ||||||||||||||||||||||
(in thousands) | Amount | Amortization | Amount | Amount | Amortization | Amount | |||||||||||||||||||||
Customer list |
$ | 1,748 | $ | (1,748 | ) | $ | | $ | 1,730 | $ | (1,693 | ) | $ | 37 | |||||||||||||
Trade name |
1,415 | (1,305 | ) | 110 | 1,402 | (1,243 | ) | 159 | |||||||||||||||||||
Total |
$ | 3,163 | $ | (3,053 | ) | $ | 110 | $ | 3,132 | $ | (2,936 | ) | $ | 196 | |||||||||||||
Amortization expense associated with intangible assets was $86,000 and $89,000 for the three
months ended March 31, 2011 and 2010, respectively. Based on the carrying amount of intangible
assets as of March 31, 2011 and assuming no future impairment of the underlying assets, the
estimated future amortization is as follows (in thousands):
Years Ended December 31, | ||||
Remainder of 2011 |
$ | 55 | ||
2012 |
37 | |||
2013 |
18 | |||
Thereafter |
| |||
Total amortization |
$ | 110 | ||
Accrued liabilities
March 31, | December 31, | |||||||
(in thousands) | 2011 | 2010 | ||||||
Compensation and related benefits |
$ | 2,532 | $ | 4,249 | ||||
Accrued commissions |
1,107 | 938 | ||||||
Accrued FCPA settlement (see Note 1) |
| 1,700 | ||||||
Accrued construction in progress |
759 | | ||||||
Accrued professional fees |
2,103 | 1,014 | ||||||
Customer deposits |
660 | 730 | ||||||
Other |
2,717 | 3,326 | ||||||
Total accrued liabilities |
$ | 9,878 | $ | 11,957 | ||||
Note 4. Income Tax
The Company estimates its annual effective tax rate for the year and applies that rate to the
year to date profit before tax to determine the quarterly and year to date tax expense. Certain
loss entities are excluded from the calculation of annual estimated effective tax rate if the
Company anticipates that it will not be able to recognize a benefit from those loss entities at
year end. Certain expenses are accounted for as discrete to the quarter and excluded from the
estimated annual effective tax rate.
The effective tax rate after discrete items for the three months ended March 31, 2011, was 26%
of pretax loss, compared to 152% of pretax loss for the same period in 2010. The tax rate for the
first quarter of 2011 differed from the U.S. statutory rate primarily due to the tax effect of
foreign earnings taxed at lower rates, losses not benefited, nondeductible stock compensation
expenses, nondeductible costs related to the acquisition transaction, and discrete true-up
adjustments applicable to 2010.
The effective tax rate is highly dependent upon the geographic distribution of the Companys
worldwide earnings or loss, tax regulations in each geographic region, the availability of tax
credits and carryforwards, and the effectiveness of the Companys tax
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planning strategies. The
Company regularly monitors the assumptions used in estimating its annual effective tax rate and
adjusts its estimates accordingly. If actual results differ from its estimates, future income tax
expense could be materially affected.
The Companys valuation allowance was determined in accordance with the existing authoritative
guidance, which requires an assessment of both positive and negative evidence when determining
whether it is more likely than not that deferred tax assets are recoverable, with such assessment
being required on a jurisdiction by jurisdiction basis. Management believes that sufficient
uncertainty exists with regard to the realizability of the Companys tax assets such that a
valuation allowance is necessary. Factors considered in providing a valuation allowance include the
lack of a significant history of consistent profits, the potential impact of historical losses or
the Companys ability to sustain or grow revenues and earnings in the future, and the length of
carryback and carryforward periods.
At December 31, 2010, the Company concluded it was appropriate to have a full valuation
allowance for its deferred tax assets in certain jurisdictions. The Company continued to maintain a
full valuation allowance for these jurisdictions as of March 31, 2011. The Company expects to
provide a full valuation allowance on future tax benefits until it can sustain a level of
profitability that demonstrates its ability to utilize these assets. The amount of the deferred tax
asset valuation allowance, however, could be reduced in future periods to the extent that future
taxable income is realized.
Note 5. Comprehensive Loss
The components of comprehensive loss were as follows:
Three Months Ended | ||||||||
March 31, | ||||||||
(in thousands) | 2011 | 2010 | ||||||
Net loss |
$ | (2,865 | ) | $ | (408 | ) | ||
Other comprehensive income: |
||||||||
Change in foreign currency translation |
(1,093 | ) | (295 | ) | ||||
Comprehensive loss |
(3,958 | ) | (703 | ) | ||||
Comprehensive (income) loss attributable to the
noncontrolling interest |
(39 | ) | 44 | |||||
Comprehensive loss attributable to RAE Systems Inc. |
$ | (3,997 | ) | $ | (659 | ) | ||
Note 6. Commitments and Contingencies
Legal Proceedings
On January 2, 2011, Kuldip Shodhan, Polygon USA, and Polygon Agency Pvt. Ltd. (collectively,
Polygon) commenced an arbitration action before the International Centre for Dispute Resolution
division of the American Arbitration Association against the Company, ICDR Case No. 50 117 T 005
11, alleging causes of action for breach of a Sales Representative Agreement between Polygon and
RAE-KLH (Beijing) Co., Limited, a subsidiary of the Company, and seeking damages incurred by
Polygon resulting from the alleged breach. The dispute was submitted to mediation prior to
commencement of formal arbitration proceedings, and Polygon and representatives of the Company
agreed to a settlement pursuant to which the Company would pay to Polygon the sum of $260,000 in
return for a complete release of all claims. This proposed settlement remains subject to the
approval of the Companys management as well as Vector Capital (see Note 1 of Notes to Condensed
Consolidated Financial Statements). The Company has accrued the settlement amount of $260,000 in
its financial statements as of March 31, 2011.
Shareholder Lawsuits
The California State Court Actions:
On September 20, 2010, a putative class action suit, entitled Foley v. RAE Systems Inc., et
al., No. 110CV182985, was filed in the Superior Court of California, County of Santa Clara, against
the Company, members of its Board of Directors, the Companys Chief Financial Officer, and entities
affiliated with Battery Ventures. The suit alleges in summary that, in connection with a proposed
acquisition of the Company by an affiliate of Battery Ventures, the individual defendants breached
their fiduciary duties by conducting an unfair sale process and agreeing to an unfair price, would
purportedly receive improper personal benefits in connection with the
15
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proposed acquisition, and
were aided and abetted by the other defendants. Plaintiff seeks, among other things, a declaration
that the suit can be maintained as a class action, an injunction against the proposed merger,
rescission of the Merger Agreement, a directive that the defendants exercise their fiduciary duties
to implement a process to secure the best possible consideration for stockholders, imposition of a
constructive trust on allegedly improper benefits, and fees and costs. Four other lawsuits making
similar allegations have also been filed in the Superior Court of the State of California, County
of Santa Clara against the Company, its Board of Directors and Battery Ventures or its affiliates:
Angles v. RAE Systems Inc., et al., No. 110CV183606; Greenbaum v. Chen, et al., No. 110CV183814; AC
Photonics, Inc. v. RAE Systems Inc., et al., No. 110CV183942; and Mann v. RAE Systems Inc., et al.,
No. 110CV183960. On October 28, 2010 the California court consolidated all five California actions
under the caption In re RAE Systems, Inc. Shareholder Litigation, Lead Case No. 110CV182985. On
December 15, 2010, plaintiffs Mann and Angles filed an amended complaint continuing to set forth
the claims set forth above and including additional disclosure claims based on allegations that the
Companys proxy filings contain materially false statements and fail to disclose material facts
regarding, among other things, the Special Committee, the holders of the Rollover Shares, the
process and events leading up to the proposed acquisition, the FCPA investigation, communications
with Battery Ventures and other potential bidders, and the work performed by UBS and data
underlying its analyses. On December 17, 2010, the California court issued an order staying all
proceedings in California state court in favor of litigation pending in Delaware.
The Delaware Chancery Court Actions:
In addition to the California state court actions, four putative class action suits with
similar allegations have been filed in Delaware Chancery Court: Nelson v. RAE Systems Inc., et al.,
C.A. No. 5848-VCS; Venton v. RAE Systems Inc., et al., C.A. No. 5854-VCS; Quintanilla v. RAE
Systems Inc., et al., C.A. No. 5872; Villeneuve v. RAE Systems Inc., et al., C.A. No. 5877. The
Delaware actions have been consolidated under the caption In re RAE Systems, Inc. Shareholder
Litigation, Consolidated C.A. No. 5848-VCS, and plaintiffs filed a Verified Consolidated Amended
Class Action Complaint on or about October 28, 2010. In this pleading, plaintiffs continued to
assert the claims set forth above, and in addition they alleged that the Companys Preliminary
Proxy Statement, filed with the SEC on October 21, 2010, contained materially false statements or
failed to disclose material facts regarding, among other things, the Special Committee, the holders
of the Rollover Shares, the process and events leading up to the proposed acquisition, the FCPA
investigation, communications with Battery Ventures and other potential bidders, and the work
performed by UBS and data underlying its analyses. Plaintiffs requested various forms of injunctive
relief, as well as money damages allegedly suffered or to be suffered by the putative class. On
December 17, 2010, two of the plaintiffs from the stayed California action (Mann and Angles) also
filed a complaint in Delaware Chancery Court making essentially the same allegations as in their
amended California complaint described above. Plaintiffs Mann and Angles subsequently voluntarily
dismissed their Delaware complaint.
On February 24, 2011, the remaining Delaware plaintiffs filed a motion requesting leave to
file a Supplemental and Amended Verified Class Action Complaint. The Delaware Chancery Court
granted plaintiffs leave to amend their complaint on March 2, 2011. The Supplemental Amended
Verified Class Action Complaint asserts claims against the Company, members of its Board of
Directors, and entities affiliated with Vector Capital, and alleges in summary that, in connection
with the proposed acquisition of the Company by an affiliate of Vector Capital, the individual
defendants breached their fiduciary duties by conducting an unfair sale process and agreeing to an
unfair price, are purportedly receiving improper personal benefits, and were aided and abetted by
the other defendants. The complaint also alleges that the Companys Preliminary Proxy Statement,
filed with the SEC on February 22, 2011, contains materially false statements or fails to disclose
material facts regarding, among other things, the Special Committee, the holders of the Rollover
Shares, the process and events leading up to the proposed acquisition, the work performed by UBS
and data underlying its analyses, and communications with Battery Ventures, Vector Capital, and
other potential bidders. Plaintiffs request various forms of injunctive relief, as well as money
damages allegedly suffered or to be suffered by the putative class. On March 7, 2011, the Delaware
plaintiffs filed a motion seeking to preliminarily enjoin the proposed acquisition of the Company
by an affiliate of Vector Capital. On April 4, 2011, the Delaware Chancery Court held a conference
regarding the Delaware plaintiffs motion for preliminary injunction. Following that conference,
the Company postponed the shareholder vote on the proposed acquisition.
The Federal Court Actions:
Two other actions have been filed in the United States District Court for the Northern
District of California against the Company, members of its Board of Directors, the Companys Chief
Financial Officer, and/or Battery Ventures, Rudy Merger Sub Corp. and Rudy Acquisition Corp. Those
actions are entitled LaPlante v. RAE Systems Inc., et al., No. CV104944 and Mabry v. Chen, et al.,
No. CV 10-5328. They make allegations similar to the other lawsuits, and add claims for alleged
violation of the federal securities laws in connection with the preparation of the proxy statement
filed by the Company in connection with a proposed acquisition by affiliates of Battery Ventures.
On January 10, 2011, the federal court issued an order pursuant to a stipulation of the parties
staying proceedings in
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the LaPlante action in favor of litigation pending in Delaware. A similar
order was entered by the federal court in the Mabry action on January 21, 2011, pursuant to
stipulation of the parties.
The Company believes that the claims in the above shareholder lawsuits are without merit and
intends to vigorously defend against them. However, there can be no assurances as to the outcome of
the litigation. The Company is in the process of assessing these matters and is consulting with its
external legal counsel and technical experts. The amount of loss related to these matters is not
estimable at this time. Accordingly, the Company has not accrued an amount of the loss related to
these matters.
Leases
The Company and its subsidiaries lease certain manufacturing, warehousing and other facilities
under operating leases. The leases generally provide for the lessee to pay taxes, maintenance,
insurance and certain other operating costs of the leased property. Total rent expense for the
three months ended March 31, 2011 and 2010, was $345,000 and $340,000, respectively. Future minimum
annual payments under non-cancellable leases were as follows as of March 31, 2011 (in thousands):
Years Ended December 31, | Operating | |||
Remainder of 2011 |
$ | 1,259 | ||
2012 |
1,507 | |||
2013 |
1,419 | |||
2014 |
1,309 | |||
2015 |
1,140 | |||
Thereafter |
2,350 | |||
Total minimum payments |
$ | 8,984 | ||
In December 2008, the Company invested approximately $1.2 million for land use rights in
Shanghai, China to construct a new manufacturing, engineering and administrative facility.
Construction began during the first quarter of 2010. The estimated cost to complete this project is
approximately $1.8 million with the work scheduled to be completed during the first half of 2011.
Upon completion of construction, the Company intends to vacate its existing leased facility in
Shanghai. Based on discussions with Shanghai government officials, the landlord of the existing
Company facility, the Company believes it will be able to terminate the lease without penalty.
However, no assurance can be given at this time that the Company will not be subject to a lease
termination penalty.
During the three months ended March 31, 2011 and 2010, zero and $51,000, respectively, of
interest expense was capitalized for construction of the Companys new facility in Shanghai.
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Guarantees
The Company is permitted under Delaware law and required under RAE Systems Certificate of
Incorporation and Bylaws to indemnify its officers and directors for certain events or occurrences,
subject to certain limits, while the officer is or was serving at the Companys request in such
capacity. The term of the indemnification period is for the officers or directors lifetime. The
maximum amount of potential future indemnification is unlimited; however, the Company has a
Director and Officer Insurance Policy that limits its exposure and enables it to recover a portion
of any future amounts paid. To date the Company has not incurred any losses under these agreements.
The Company typically agrees to indemnify its customers for any expenses or liability
resulting from claimed infringements of patents, trademarks or copyrights of third parties. The
terms of these indemnification agreements are generally perpetual any time after execution of the
agreement. The maximum amount of potential future indemnification is unlimited. To date, the
Company has not paid any amounts to settle claims or defend lawsuits.
Note 7. Warranty Reserves
The Company sells the majority of its products with a 12 to 24 month repair or replacement
warranty from the date of shipment. The Company provides an accrual for estimated future warranty
costs based upon the historical relationship of warranty costs to sales. The estimated future
warranty obligations related to product sales are recorded in the period in which the related
revenue is recognized under Accrued liabilities on the Condensed Consolidated Balance Sheets. The
following is a summary of the changes in these liabilities during the three months ended March 31,
2011 and 2010, respectively:
Three Months Ended | ||||||||
March 31, | ||||||||
(in thousands) | 2011 | 2010 | ||||||
Warranty reserve at beginning of period |
$ | 976 | $ | 695 | ||||
Provision for warranty |
165 | 215 | ||||||
Utilization of reserve |
(278 | ) | (229 | ) | ||||
Foreign currency translation effects |
9 | (5 | ) | |||||
Warranty reserve at end of period |
$ | 872 | $ | 676 | ||||
Note 8. Bank Debt
In the United States, the Company had a $10.0 million revolving credit agreement as of
December 31, 2010. On March 28, 2011, the credit facility maturity date was extended to the earlier
of June 15, 2011 or consummation of a merger with Vector Capital. (Refer to Note 1. Summary of
Significant Accounting Policies for details of the Merger Agreement). Available credit is based on
a percentage of specific qualifying assets and the total facility is collateralized by a blanket
security interest in the Companys assets in the United States. The Company is required to comply
with certain reporting and financial requirements in addition to the ongoing requirement to submit
quarterly financial statements. Interest accrues at the floating prime bank lending rate plus 100
basis points subject to a minimum total rate of 5%. In addition, the Company pays 30 basis points
annually of the average unused portion of the facility. Through December 31, 2010, the Company was
required to maintain a compensating balance of at least $2.0 million at all times. The compensating
balance was included in Restricted cash on the Condensed Consolidated Balance Sheets. The
compensating balance requirement was released in January 2011. As of March 31, 2011 and December
31, 2010, $1.8 million was outstanding against the revolving credit agreement and interest was
accruing at 5% per annum.
The carrying amount reported in the Condensed Consolidated Balance Sheets approximates fair value due to the short-term maturity
of the credit facility.
Financial covenants under the revolving credit agreement require the Company to maintain
specified minimum quarterly earnings before interest, depreciation, amortization, income tax and
non-cash stock compensation expenses. As a result of the impairment
expense incurred to discontinue operations in Fushun, China, the Company was in default of the
trailing two-quarter minimum earnings requirement for the period ended December 31, 2010. However,
the lender issued a waiver for the non compliance. The Company was in compliance with the loan
covenants as of March 31, 2011.
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On March 28, 2011, the Company amended the credit facility to allow borrowings of up to $2
million on a non-formula basis. Interest on non-formula advances accrues at the floating prime bank
lending rate plus 400 basis points subject to a minimum total rate of 8%. No non-formula loan
balances were outstanding as of March 31, 2011.
Note 9. Related Party Transactions
The Company accounts for its 40% ownership in Renex Technologies Ltd. (Renex), a Hong Kong
company following the equity method. The Companys total investment in Renex at March 31, 2011 and
December 31, 2010 was $119,000 and $166,000, respectively. The Company recorded losses of $46,000
and $51,000 on its equity interest in Renex for the three months ended March 31, 2011 and 2010,
respectively.
In conjunction with the Companys investment in RAE Beijing, unsecured notes payable were
established for the previous RAE Beijing shareholders as part of the purchase price agreement in
July 2006. Although these notes bear a stated interest rate of 3% per annum, the notes were
discounted using a market interest rate of 6.48%. As of March 31, 2011 and December 31, 2010,
$286,000 and $278,000, respectively, was included in current notes payable to related parties in
the Companys Condensed Consolidated Balance Sheets. The final scheduled payment of principal and
accrued interest under the notes at maturity in July 2011.
In addition to its 40% ownership in Renex, the Company has investments in three distributors
of RAE Systems products, RAE Australia, RAE Benelux and RAE Spain. The Company owns 19%, 10% and
19% of RAE Australia, RAE Benelux and RAE Spain, respectively. These investments are accounted for
under the cost method.
Transactions and balances with the Companys related parties were as follows (in thousands):
Three Months Ended | ||||||||
March 31, | ||||||||
(in thousands) | 2011 | 2010 | ||||||
Sales: |
||||||||
Renex |
$ | 57 | $ | 95 | ||||
RAE Australia |
224 | 335 | ||||||
RAE Benelux |
1,822 | 517 | ||||||
RAE Spain |
182 | 80 | ||||||
$ | 2,285 | $ | 1,027 | |||||
Purchases: |
||||||||
Renex |
$ | 74 | $ | 74 |
March 31, | December 31, | |||||||
2011 | 2010 | |||||||
Accounts receivable: |
||||||||
Renex |
$ | 187 | $ | 200 | ||||
RAE Australia |
180 | 131 | ||||||
RAE Benelux |
664 | 268 | ||||||
RAE Spain |
143 | 123 | ||||||
$ | 1,174 | $ | 722 | |||||
Accounts payable: |
||||||||
Renex |
$ | 13 | $ | 25 |
The Companys Director of Information Systems, Lien Chen, is the wife of our Chief Executive
Officer, Robert Chen. Ms. Chen was paid a salary of $29,000 and $31,000 for the three months ended
March 31, 2011 and 2010, respectively. Ms. Chen also receives standard employee benefits offered to
all other full-time U.S. employees. Ms. Chen does not report to Robert Chen and compensation
decisions regarding Ms. Chen are performed in the same manner as other U.S. employees, with Robert
Chen the final approval signatory on compensation recommendations.
Note 10. Fair Value Measurements
The Company uses the following methods and assumptions in estimating the fair value of assets
and liabilities:
Cash and cash equivalents and restricted cash: The carrying amounts reported in the Condensed
Consolidated Balance Sheets approximate fair value due to the short-term maturity of these
instruments.
Notes payable to related parties: The fair value was determined by discounting these notes
payable with below market interest rates at an interest rate commensurate with commercial borrowing
rates available to the Company in China.
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Intangible assets, net: The fair value is evaluated whenever events or changes in
circumstances indicate that the carrying value of the asset may not be recoverable.
The existing authoritative guidance requires that assets and liabilities carried at fair value
be classified and disclosed in one of the following three categories:
Level 1: Quoted market prices in active markets for identical assets or liabilities.
Level 2: Observable market based inputs or unobservable inputs that are corroborated by market
data.
Level 3: Unobservable inputs that are not corroborated by market data.
Note 11. Shareholders Equity
The following table is a summary of the changes in equity:
Three Months Ended March 31, | Three Months Ended March 31, | ||||||||||||||||||||||||||
2011 | 2010 | ||||||||||||||||||||||||||
RAE Systems | RAE Systems | ||||||||||||||||||||||||||
Shareholders | Noncontrolling | Total | Shareholders | Noncontrolling | Total | ||||||||||||||||||||||
(in thousands) | Equity | Interest | Equity | Equity | Interest | Equity | |||||||||||||||||||||
Equity, Beginning of Period |
$ | 38,575 | $ | 1,109 | $ | 39,684 | $ | 39,029 | $ | 4,526 | $ | 43,555 | |||||||||||||||
Net loss |
(2,904 | ) | 39 | (2,865 | ) | (364 | ) | (44 | ) | (408 | ) | ||||||||||||||||
Translation adjustments |
(1,093 | ) | | (1,093 | ) | (295 | ) | | (295 | ) | |||||||||||||||||
Comprehensive loss |
(3,997 | ) | 39 | (3,958 | ) | (659 | ) | (44 | ) | (703 | ) | ||||||||||||||||
Impact to noncontrolling interest on deconsolidation of discontinued operations |
480 | (480 | ) | | | | | ||||||||||||||||||||
Stock-based compensation expense |
197 | | 197 | 354 | | 354 | |||||||||||||||||||||
Equity, End of Period |
$ | 35,255 | $ | 668 | $ | 35,923 | $ | 38,724 | $ | 4,482 | $ | 43,206 | |||||||||||||||
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
The following Managements Discussion and Analysis of Financial Condition and Results of
Operations contains forward-looking statements. In some cases, readers can identify forward-looking
statements by terminology such as may, will, should, could, expects, plans,
anticipates, believes, estimates, predicts, potential, or continue. These statements
involve known and unknown risks, uncertainties and other factors that may cause our actual results,
performance or achievements to be materially different from those stated herein. Although
management believes that the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, performance, or achievements. For further
information, refer to the sections entitled Risk Factors in Part II Item 1A of this Form 10-Q.
The following discussion should be read in conjunction with the condensed consolidated financial
statements and the notes thereto included elsewhere in this Form 10-Q.
Overview
We are a leader in delivering innovative sensor solutions to serve industrial, energy,
environmental and government safety markets worldwide. In addition, we offer a full line of
portable single and multi-sensor chemical and radiation detection products. The market for our
products has evolved from being strictly focused on environmental and industrial monitoring to now
encompassing the public safety and energy markets. We have expanded our presence to include the
broader global energy exploration and refining safety equipment market.
In 2006, we made two significant business investments in China. First in July 2006, we
increased our ownership in RAE Beijing to 96%. RAE Beijing produces, sells and distributes safety
and security solutions for the chemical, oil and gas, metals and energy sectors in China. In
December 2006 we formed RAE Fushun to serve the coal mine safety market in China. This joint
venture was 30% owned by Fushun Anyi and 70% owned by RAE Systems. On January 12, 2011, we entered
into a definitive agreement to sell our 70 percent ownership of RAE Fushun to the Shenyang Research
Institute of China Coal Research Institute. The agreement is expected to close within 180 days of
signing the definitive agreement and is subject to customary closing conditions. In China, our
focus is on growing the environmental protection market and the industrial sector, including oil
and gas, petro-chemicals, steel, and telecommunications.
We offer a complete line of products to meet the requirements of the various global markets
that we serve. Products range from breathing zone single sensor products for specific toxic
chemicals (ToxiRAE 3) to belt worn multi-gas monitors (QRAE 2) to handheld instruments (MiniRAE
3000, ppbRAE 3000 and UltraRAE) to measure total and specific volatile organic compounds, to
wireless monitors for industrial and public safety applications (AreaRAE Steel and MeshGuard).
We have expanded our wireless product offering with the introduction of MeshGuard, a
single-gas, mesh radio-based monitor designed to replace single-gas fixed monitors in industrial
environments that include steel mills, oil and gas exploration and chemical processing. We continue
to improve our product offerings through advances in sensors and wireless networking technologies,
including the RAELink 3, a wireless modem with integrated GPS and Bluetooth radio technologies that
provides a data bridge for our products, and complementary products such as chemical warfare agents
and particle counters. We updated several of our fixed gas monitors to meet the needs of the China
market. We received an additional sensor patent for a new gamma radiation detector/dosimeter, and
this was deployed in our GammaRAE II R product.
In all of our markets we will continue to explore and develop strategic value added
partnerships, to leverage our product and market expertise.
Recent Developments
During 2009 we focused on the energy sector, public safety, global confined space entry,
worker safety regulation, and the health exposure gas detection markets. With our ToxiRAE 3, QRAE
II, MiniRAE 3000, UltraRAE 3000, AreaRAE Steel and MeshGuard we offer a full suite of portable gas
detection solutions for the oil production market. In addition, the MultiRAE Plus continues to be
purchased by the U.S. military for aviation safety in the handling and detection of highly toxic
and flammable jet fuel.
In 2010, we enhanced the wireless sensor capability of our MeshGuard platform, with the
addition of fixed system and wireless controllers, two additional toxic gas sensors and other
accessories. RAE Systems products were key in providing public venue security at the National
Football League Super Bowl, the National Basketball Association All Star Game as well as the
Vancouver Winter Olympics. Our Americas operations focused on government contracts, first
responders, and industrial safety applications, particularly in
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the energy sector. Our China
operation continues to sell to state run steel mills, energy markets, including downstream oil
processing, petrochemicals and electric utilities. Our Europe, Middle East, and Asia Pacific region
generate sales primarily from the Middle East and Asia Pacific oil producers. All of our sales
regions are driving adoption of our wireless sensor solutions for applications in both safety and
security. Our global markets continue to be impacted by the effects of the 2009 global recession.
In each of our markets we will continue to explore and develop strategic value added partnerships,
to leverage our product and market expertise. In the first quarter of 2011, RAE Systems products
again provided public venue security at the National Football League Super Bowl.
We are deemphasizing the lower gross margin Fire and Security integrated project installation
business in China and have refocused our attention in China on the markets and the products sold
and produced by the Company on a global basis, and the fixed sensor systems sold by the Companys
operations in Beijing, China.
In December 2010, we settled all outstanding issues with regard to the ongoing investigation
of violation of the FCPA. We signed separate agreements with the DOJ and the SEC. Pursuant to
these agreements; we paid a $1.7 million criminal penalty to the DOJ and $1.3 million in
restitution and interest to the SEC. We also agreed to advise the DOJ and the SEC periodically
until December 2013 on our ongoing efforts to ensure continued compliance with the FCPA.
In the course of telephonic discussions between April 15 and 19, 2011, outside counsel for the
Company was asked by the SEC whether RAE China had adopted a sales program whereby customers are
awarded points based on the level of their purchases of RAE products, which points they may later
redeem for gifts such as iPads or cameras, and if such a program was adopted, whether it complies
with the FCPA. We have conducted a review in response to the SECs inquiry and have concluded that
RAE China has not adopted any such program. We intend to provide our conclusions to the SEC and the
DOJ.
During the quarter ended March 31, 2011, we enhanced our wireless product offering with the
release of ToxiRAE Pro wireless single-gas monitors. The ToxiRAE Pro family extends the wireless
capabilities of our products to the personnel operating in the hazardous area. We also released
DoseRAE 2, an alarming personal radiation detector that provides real-time monitoring of personal
dose and dose rate. The DoseRAE2 was designed for workers at nuclear power plants, research
facilities, hospitals and industrial locations, such as oil exploration and imaging technology.
Definitive Acquisition Agreement with Battery Ventures
On September 19, 2010, the Company signed a definitive agreement to be acquired by an
affiliate of Battery Ventures (the Battery Merger Agreement) for $1.60 in cash per share (other
than certain shares held by our founders, Robert Chen, Peter Hsi and affiliated entities).
Subsequently, on January 12, 2011, the Company received an offer from an affiliate of Vector
Capital to acquire the outstanding shares of our common stock for $1.75 per share in cash (other
than certain shares held by Robert Chen, Peter Hsi and affiliated entities). The Company
terminated the Battery Merger Agreement on January 18, 2011, paid a termination fee of $3.39
million to Battery Ventures in accordance with the terms of the Battery Merger Agreement, and
signed a Merger Agreement with the affiliate of Vector Capital (the Vector Merger
Agreement) on the terms described above. On April 2, 2011, we received an offer from an
affiliate of Battery Ventures to acquire all of our outstanding capital stock for $1.90 per share in
cash, and on April 3, 2011, we entered into an amendment to the Vector Merger Agreement
increasing the per share cash price to be paid for the outstanding shares of our common stock (other than certain shares held by Robert Chen, Peter Hsi and affiliated entities) to $1.88. This
transaction is subject to customary closing conditions, including the approval of RAE Systems
shareholders.
In connection with the acquisition agreements, eleven lawsuits have been filed against the
Company and members of its Board of Directors. These suits were filed in State Courts in
California and Delaware and in the Federal District Court in California. In summary, the suits
allege violations of federal securities laws and that the individual defendants breached their
fiduciary duties by conducting an unfair sales process and agreeing to an unfair price, are
receiving improper personal benefits, and were aided and abetted by the other defendants. The
Company believes the claims in these lawsuits are without merit and intends to vigorously
defend against them. However, there can be no assurances as to the outcome of the litigation. See
Note 6. Commitments and Contingencies for more detail.
Critical Accounting Policies
We believe the following critical accounting policies affect our more significant judgments or
estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred,
the fee is fixed or determinable, and collectability is reasonably assured. A provision for
estimated product returns is established at the time of sale based upon historical return rates
adjusted for current economic conditions. Historically, we have experienced an insignificant amount
of sales returns. We generally recognize revenue upon shipment to our distributors in accordance
with standard contract terms that pass title of all goods upon delivery to a common carrier (FOB
factory) and provide for sales returns under standard product warranty provisions. For non-standard
contract terms, where title to goods passes upon delivery to the customer (FOB destination),
revenue is recognized after we have established proof of delivery. Revenue related to services
performed under our extended warranty program is recognized as earned based upon contract terms,
generally ratably over the term of service. We record project installation work in Asia using the
percentage-of-completion method. Net sales also include amounts billed to customers for shipping
and handling. Our shipping costs are included in cost of sales. Net sales do not include sales tax.
Effective January 1, 2011, when a sales arrangement contains multiple elements, we allocate
revenue to all deliverables based on their relative selling prices. Under this approach, the
selling price of a deliverable is determined by using a selling price hierarchy which requires the
use of Vendor Specific Objective Evidence (VSOE) of fair value if available, third party evidence
(TPE) if VSOE is not available, or best estimated selling price (BESP) if neither VSOE nor TPE
is available. Our sales arrangements typically contain multiple elements when products and services
are sold together. The adoption of this accounting standard did not impact our condensed
consolidated financial statements.
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Accounts Receivable, Trade Notes Receivable and Allowance for Doubtful Accounts
We grant credit to our customers after undertaking an investigation of credit risk for
significant amounts. An allowance for doubtful accounts is provided for estimated credit losses at
a level deemed appropriate to adequately provide for known and inherent risks related to such
amounts. The allowance is based on reviews of loss, adjustments history, current economic
conditions and other factors that deserve recognition in estimating potential losses. We generally
do not require collateral for sales on credit. While management uses the best information available
in making our determination, the ultimate recovery of recorded accounts receivable is also
dependent upon future economic and other conditions that may be beyond managements control. If
there was a deterioration of a major customers credit-worthiness or if actual defaults were higher
than what have been experienced historically, additional allowances would be required.
We are not able to predict changes in the financial stability of our customers. Any material
change in the financial status of any one or a group of customers could have a material adverse
effect on our results of operations and financial condition.
Trade notes receivable are presented to us from some of our customers in China as a payment
against the outstanding trade receivables. These notes receivable are bank guarantee promissory
notes which are non-interest bearing and generally mature within six months.
Inventories
Inventories are stated at the lower of standard cost, which approximates actual cost computed
on a first-in, first-out basis, or market and include material, labor and manufacturing overhead
costs. We are exposed to a number of economic and market factors that could result in portions of
our inventory becoming either obsolete or in excess of anticipated usage, or saleable only for
amounts that are less than their carrying amounts. These factors include, but are not limited to,
technological changes in the market, competitive pressures in products and prices, and the
availability of key components from our suppliers. We write-down inventory when
conditions exist that suggest our inventory may be in excess of anticipated demand, based upon
assumptions about future demand for our products and market conditions, or the inventory is
obsolete. When recorded, write-downs are intended to reduce the carrying value of the inventory to its
net realizable value. If actual demand for specified products deteriorates, or market conditions
are less favorable than those projected, additional write-downs may be required.
Long-Lived Assets
We test the recoverability of long-lived assets with finite lives periodically and whenever
events or changes in circumstances indicate that the carrying amount of an asset may not be
recoverable. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of
the undiscounted cash flows expected to result from the use and eventual disposition of the asset.
If the carrying amount of a long-lived asset is deemed not recoverable, an impairment loss is
recognized for the difference between the carrying amount of the asset and its fair value,
generally the present value of estimated future cash flows or an assets appraised value.
Share-Based Payments
We recognize in our statement of operations all share-based payments, including grants of
stock options, based on their grant date fair value after adjusting fair value to reflect only
those shares outstanding that are actually expected to vest. We estimate the fair value of each
share-based payment on the date of grant using the Black-Scholes-Merton valuation method. The
Black-Scholes-Merton method requires certain assumptions about the expected life of the option and
the volatility of the market price over the life of the option. The Company estimates these
assumptions based on the Companys historical experience of employee exercises and the historical
market price of the Companys stock.
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Income Taxes
We are subject to income taxes in the United States and numerous foreign jurisdictions.
Significant judgment is required in evaluating our tax positions and determining our provision for
income taxes.
Our effective tax rates differs from statutory rates primarily due to foreign earnings taxed
at lower rates, losses not benefited, non-deductible share-based compensation expenses,
nondeductible transaction costs, and provision changes for uncertain tax positions. Our future
effective tax rates could be adversely affected by earnings being lower than anticipated in
countries where we have lower statutory rates and higher than anticipated in countries where we
have higher statutory rates, by changes in the valuation of our deferred tax assets or liabilities,
or by changes in tax laws, regulations, accounting principles, or interpretations thereof. We
regularly assess the likelihood of adverse outcomes resulting from tax examinations to determine
the adequacy of our provision for income taxes.
Significant judgment is also required in determining any valuation allowance recorded against
deferred tax assets. In assessing the need for a valuation allowance, we consider all available
evidence including past operating results, estimates of future taxable income, and the feasibility
of tax planning strategies. In the event that we change our determination as to the amount of
deferred tax assets that can be realized, we will adjust our valuation allowance with a
corresponding impact to the provision for income taxes in the period in which such determination is
made.
Recent Accounting Pronouncements
In October 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards
Update (ASU) 2009-13, Multiple-Deliverable Revenue Arrangements, (amendments to FASB Accounting
Standards Codification (ASC) Topic 605, Revenue Recognition) (ASU 2009-13) and ASU 2009-14,
Certain Arrangements That Include Software Elements, (amendments to FASB ASC Topic 985, Software)
(ASU 2009-14). ASU 2009-13 requires entities to allocate revenue in an arrangement using
estimated selling prices of the delivered goods and services based on a selling price hierarchy.
The amendments eliminate the residual method of revenue allocation and require revenue to be
allocated using the relative selling price method. ASU 2009-14 removes tangible products from the
scope of software revenue guidance and provides guidance on determining whether software
deliverables in an arrangement that includes a tangible product are covered by the scope of the
software revenue guidance. ASU 2009-13 and ASU 2009-14 should be applied on a prospective basis for
revenue arrangements entered into or materially modified in fiscal years beginning on or after June
15, 2010, with early adoption permitted. The adoption of this guidance did not impact our consolidated financial statements.
In January 2010, the FASB issued guidance to amend the disclosure requirements related to
recurring and nonrecurring fair value measurements. The guidance requires new disclosures on the
transfers of assets and liabilities between Level 1 (quoted prices in active market for identical
assets or liabilities) and Level 2 (significant other observable inputs) of the fair value
measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the
guidance requires a roll forward of activities on purchases, sales, issuance, and settlements of
the assets and liabilities measured using significant unobservable inputs (Level 3 fair value
measurements). The guidance became effective for entities with a reporting period beginning January
1, 2010, except for the disclosure on the roll forward activities for Level 3 fair value
measurements, which became effective for the reporting period beginning January 1, 2011. The
adoption of these changes had no material impact on our consolidated financial statements.
In December 2010, the FASB issued ASU 2010-29, Disclosure of Supplementary Pro Forma
Information for Business Combinations (amendments to FASB ASC Topic 805, Business Combinations).
The guidance in ASU 2010-29 provides amendments to clarify the acquisition date which should be
used for reporting the pro forma financial information disclosures in Topic 805 when comparative
financial statements are presented. The amendments also improve the usefulness of the pro forma
revenue and earnings disclosures by requiring a description of the nature and amount of material,
nonrecurring pro forma adjustments directly attributable to the business combination(s). The
amendments in this update are effective prospectively for business combinations for which the
acquisition date is on or after the beginning of the first annual reporting period beginning on or
after December 15, 2010. Early adoption is permitted. The adoption of this guidance did not have a
material impact on our consolidated financial statements.
In December, 2010, the FASB issued ASU 2010-28, When to Perform Step 2 of the Goodwill
Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (amendments to FASB ASC
Topic 350, Intangibles Goodwill and Other). The objective of this ASU is to address diversity in
practice in the application of goodwill impairment testing by entities with reporting units with
zero or negative carrying amounts, eliminating an entitys ability to assert that a reporting unit
is not required to perform Step 2 because the
carrying amount of the reporting unit is zero or negative despite the existence of qualitative
factors that indicate the goodwill is more likely than not impaired. This ASU is effective for
interim periods after January 1, 2011. The adoption of this ASU did not have a material impact on
our consolidated financial statements.
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Results of Operations
Net Sales
Three Months Ended | ||||||||||||||||
March 31, | Percentage | |||||||||||||||
(in thousands) | 2011 | 2010 | Change | Change | ||||||||||||
Net sales |
$ | 22,447 | $ | 16,855 | $ | 5,592 | 33 | % |
Net sales for the quarter ended March 31, 2011, increased by $5.6 million or 33% compared with
the quarter ended March 31, 2010. Sales increased $2.7 million or 33% in Americas and $2.2 million
or 60% in Europe and the Middle East and $0.7 million or 14% in Asia. The increase in the Americas
was primarily due to increased U.S. military revenue of $0.9 million, increased Canadian oil and
gas revenue of $0.8 million and increased U.S. oil and gas and environmental safety revenue of $0.6
million. The increase in Europe and the Middle East of $2.2 million was primarily due to increased
revenue for oil and gas and industrial safety of $1.3 million, and environmental safety and hazmat
revenue of $0.9 million. The increase in Asia of approximately $0.7 million was primarily the
result of increased sales in the industrial safety and hazmat markets.
Cost of Sales & Gross Margin
Three Months Ended | ||||||||||||||||
March 31, | Percentage | |||||||||||||||
(in thousands) | 2011 | 2010 | Change | Change | ||||||||||||
Cost of sales |
$ | 8,772 | $ | 7,359 | $ | 1,413 | 19 | % | ||||||||
Gross profit |
$ | 13,675 | $ | 9,496 | $ | 4,179 | 44 | % | ||||||||
Gross margin |
61 | % | 56 | % |
Cost of sales for the quarter ended March 31, 2011, increased by $1.4 million or 19% compared
with the quarter ended March 31, 2010. Approximately $2.4 million of the increase in cost of sales
was due to increased sales volume, which was partially offset by efficiencies gained by moving
China fixed system production to our global manufacturing center in Shanghai and improved overhead
absorption due to higher production volume in Shanghai. The improved gross margin of 61% for the
quarter ended March 31, 2011, was primarily the result of the year-over-year increase in sales of
the higher margin products in the Americas and Europe.
Sales and Marketing Expense
Three Months Ended | ||||||||||||||||
March 31, | Percentage | |||||||||||||||
(in thousands) | 2011 | 2010 | Change | Change | ||||||||||||
Sales and marketing |
$ | 5,089 | $ | 4,173 | $ | 916 | 22 | % | ||||||||
Percentage of net sales |
23 | % | 25 | % |
Sales and marketing expenses increased by $0.9 million or 22% for the quarter ended March 31,
2011, compared with the quarter ended March 31, 2010. The increase was primarily due to management
bonuses and higher sales commissions of approximately $0.5 million, and additional spending on our
web services, key trade shows and demo equipment of approximately $0.3 million.
Research and Development Expense
Three Months Ended | ||||||||||||||||
March 31, | Percentage | |||||||||||||||
(in thousands) | 2011 | 2010 | Change | Change | ||||||||||||
Research and development |
$ | 1,761 | $ | 1,579 | $ | 182 | 12 | % | ||||||||
Percentage of net sales |
8 | % | 9 | % |
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Research and development expenses increased by approximately $0.2 million or 12% for the
quarter ended March 31, 2011, compared with the quarter ended March 31, 2010. The increase was
primarily due to increased headcount, increased salaries at the RAE Engineering Center in Shanghai,
China and project expenses to support new product development programs.
General and Administrative Expense
Three Months Ended | ||||||||||||||||
March 31, | Percentage | |||||||||||||||
(in thousands) | 2011 | 2010 | Change | Change | ||||||||||||
General and administrative |
$ | 8,961 | $ | 3,826 | $ | 5,135 | 134 | % | ||||||||
Percentage of net sales |
40 | % | 23 | % |
General and administrative expenses increased by $5.0 million or 131% for the quarter ended
March 31, 2011, compared with the quarter ended March 31, 2010. The increase was primarily due to
increased legal expense of $1.7 million related to the Companys going private transaction and
payment of a termination fee of $3.4 million to Battery Ventures, in accordance with the terms of
the Battery Merger Agreement.
Other Income (Expense)
Three Months Ended | ||||||||||||||||
March 31, | Percentage | |||||||||||||||
(in thousands) | 2011 | 2010 | Change | Change | ||||||||||||
Interest income |
$ | 4 | $ | 23 | $ | (19 | ) | -83 | % | |||||||
Interest expense |
(26 | ) | (21 | ) | (5 | ) | -24 | % | ||||||||
Other, net |
(76 | ) | 46 | (122 | ) | 265 | % | |||||||||
Equity in loss of unconsolidated affiliate |
(46 | ) | (51 | ) | 5 | -10 | % | |||||||||
Total other income (expense) |
$ | (144 | ) | $ | (3 | ) | $ | (141 | ) | -4700 | % | |||||
For the quarter ended March 31, 2011, total other expense increased by approximately $141,000
compared with the quarter ended March 31, 2010. The change was primarily the result of foreign
exchange losses in Asia and Europe.
Income Tax Benefit (Expense)
Three Months Ended | ||||||||||||||||
March 31, | Percentage | |||||||||||||||
(in thousands) | 2011 | 2010 | Change | Change | ||||||||||||
Income tax expense |
$ | (585 | ) | $ | (129 | ) | $ | (456 | ) | 353 | % | |||||
Effective tax rate |
-26 | % | -152 | % |
Income tax expense for the three months ended March 31, 2011, was $585,000 compared to
$129,000 for the three months ended March 31, 2010. At December 31, 2010 and March 31, 2011,
respectively, we concluded it was appropriate to have a full valuation
allowance for our net deferred tax assets in some jurisdictions. The interim income tax
expense was calculated based on the estimated annual effective tax rate for the Company. The tax
rate for the first quarter of fiscal year 2011 differed from the U.S. statutory rate primarily due
to foreign earnings taxed at lower rates, losses not benefited, nondeductible stock compensation
expense, nondeductible costs related to the acquisition transaction, and additional provisions for
uncertain tax positions applicable to fiscal year 2011. Included in tax expense for the three
months ended March 31, 2011, were discrete tax expense items of $26,000 related to the accrual of
interest on various uncertain tax benefits, U.S. federal, state and local taxes of $39,000, and
prior years true-ups of $125,000.
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Net (Income) Loss Attributable to the Noncontrolling Interest
Three Months Ended | ||||||||||||||||
March 31, | Percentage | |||||||||||||||
(in thousands) | 2011 | 2010 | Change | Change | ||||||||||||
Net (income) loss attributable to the
noncontrolling interest |
$ | (39 | ) | $ | 12 | $ | (51 | ) | -425 | % |
For the quarter ended March 31, 2011, the noncontrolling interest in continuing operations of
consolidated subsidiaries increased approximately $51,000 compared with the quarter ended March 31,
2010. The increase was primarily due to the income generated at RAE Beijing compared to a loss in
the quarter ended March 31, 2010 and higher income generated at RAE France compared with the
quarter ended March 31, 2010. The noncontrolling ownership was 4% of RAE Beijing and 51% of RAE
France.
Loss From Discontinued Operations
Three Months Ended | ||||||||||||||||
March 31, | Percentage | |||||||||||||||
(in thousands) | 2011 | 2010 | Change | Change | ||||||||||||
Loss from discontinued operations
before income taxes |
$ | | $ | (194 | ) | $ | 194 | -100 | % | |||||||
Income tax benefit |
| | | 0 | % | |||||||||||
Loss from discontinued operations, net of tax |
| (194 | ) | 194 | -100 | % | ||||||||||
Net loss attributable to the noncontrolling
interest, discontinued operations |
| 32 | (32 | ) | 0 | % | ||||||||||
Loss from discontinued operations
attributable to RAE Systems Inc. |
$ | | $ | (162 | ) | $ | 162 | -100 | % | |||||||
On December 22, 2010, the Board of Directors approved managements plan to pursue the sale of
the Companys 70% interest in RAE Coal Mine Safety Instruments (Fushun) Co., Ltd. (RAE Fushun), a
Sino-Foreign joint venture in China. RAE Fushun had not met the Companys revenue and earnings
expectations, and the joint venture was not well positioned to capitalize on the Companys future
strategies. On January 12, 2011, we signed a definitive agreement to sell our 70% interest to the
Shenyang Research Institute of China Coal Research Institute (Shenyang Institute), a state-owned
enterprise, for zero proceeds.
The purchase agreement between RAE Systems and Shenyang Institute is subject to customary
closing conditions in China, which includes obtaining certain government approvals. The Company and
Shenyang Institute anticipate receiving all of the necessary approvals and effecting the final
transfer of shares within six months from signing the definitive agreement. In addition to assuming
the entitys liabilities, the purchase agreement required Shenyang Institute to begin funding the
operations of the surviving company as of signature date. Therefore, we provided Shenyang Institute
with complete operating control of RAE Fushun on January 12, 2011, and we subsequently have not
been involved in the day-to-day management or operating activities of RAE Fushun. The Company still
retains its 70% ownership in the entity until such time as regulatory approvals are obtained;
however, we have not provided nor do we anticipate providing any financial support or management
support to the entity during the closing process. We believe our activities from January 1 to
January 12, 2011 are not material and no additional gain or loss on discontinued operations was
incurred or recorded. In addition, since January 12, 2011, we have had no representation on the
entitys Board of Directors.
Prior to January 12, 2011, we consolidated RAE Fushun in our financial statements based on our
controlling financial interest. However, we believe that execution of the definitive agreement on
January 12, 2011 constituted a reconsideration event under ASC Topic 810, Consolidation,
requiring us to assess whether RAE Fushun meets the definition of a Variable Interest Entity
(VIE) and whether RAE Systems is the primary beneficiary of RAE Fushun. Effective upon signing
the agreement, Shenyang Institute superseded the Company as RAE Fushuns controlling manager.
Subsequently, Shenyang Institute has had the sole ability to establish RAE
Fushuns business strategies and to manage the entitys day-to-day operations. Shenyang
Institute also assumed the obligation to absorb RAE Fushuns gains and losses, if any, by virtue of
its contractual obligation to fund the entitys ongoing operations. In the event that the necessary
government approvals required in China are not obtained, the capital contributions made by
Shenyang Institute would not be
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refundable. At the same time, upon receipt of final government
approvals, Shenyang Institute will be entitled to the benefits of RAE Fushuns operations from the
date of the purchase agreement. As the equity holders of RAE Fushun are protected from ongoing
variability in the operations of the entity, RAE Fushun is deemed to be a VIE with Shenyang
Institute being the primary beneficiary as of January 12, 2011. Consequently, we deconsolidated RAE
Fushun from our financial statements as of the same date and no gain or loss was recorded upon
deconsolidation.
Liquidity and Capital Resources
To date, we have financed our operations primarily through operating revenues, proceeds from
the issuance of equity securities and short-term bank borrowings. In 2007, we also sold and leased
back our corporate headquarters in San Jose, California. As of March 31, 2011, we had $13.4 million
in cash and cash equivalents compared with $16.3 million on December 31, 2010.
At March 31, 2011, we had $29.1 million in working capital (current assets less current
liabilities) and a current ratio (ratio of current assets to current liabilities) of 2.4 to 1.0
compared to $31.1 million of working capital and a current ratio of 2.2 to 1.0 at December 31,
2010.
In the United States, we have a $10.0 million revolving credit agreement. On March 28, 2011,
the credit facility maturity date was extended to the earlier of June 15, 2011 or consummation of a
merger with Vector Capital. (Refer to Note 1. Summary of Significant Accounting Policies for
details of the Merger Agreement). Available credit is based on a percentage of specific qualifying
assets and the total facility is collateralized by a blanket security interest over our assets in
the United States. We are required to comply with certain reporting and financial requirements in
addition to the ongoing requirement to submit quarterly financial statements. Interest accrues at
the floating prime bank lending rate plus 100 basis points subject to a minimum total rate of 5%.
In addition, we pay 30 basis points annually of the average unused portion of the facility. Through
December 31, 2010, we were required to maintain a compensating balance of at least $2 million at
all times. The compensating balance was included in Restricted cash on the Condensed Consolidated
Balance Sheets. The compensating balance requirement was released in January 2011. As of March 31,
2011 and December 31, 2010, $1.8 million was outstanding against the revolving credit agreement in
the United States and interest was accruing at 5% per annum.
Financial covenants under the revolving credit agreement require us to maintain specified
minimum quarterly earnings before interest, depreciation, amortization, income tax and non-cash
stock compensation expenses As a result of the impairment expense incurred to discontinue
operations in Fushun, China, we were in default of the trailing two-quarter minimum earnings
requirement for the period ended December 31, 2010. However, the lender issued a waiver for the non
compliance. We were in compliance with the loan covenants as of March 31, 2011.
On March 28, 2011, we amended the credit facility to allow borrowings of up to $2 million on a
non-formula basis. Interest on non-formula advances accrues at the floating prime bank lending rate
plus 400 basis points subject to a minimum total rate of 8%. No non-formula loan balances were
outstanding as of March 31, 2011.
In China as of March 31, 2011 and December 31, 2010, we did not have credit facilities in
place. At this time, we believe the cash balances in China are sufficient to fund operation and
capital requirements; however, we may seek a new financing facility in the future.
Our Condensed Consolidated Statements of Cash Flows may be summarized as follows:
Three Months Ended | ||||||||
March 31, | ||||||||
(in thousands) | 2011 | 2010 | ||||||
Net cash provided by (used in): |
||||||||
Operating activities |
$ | (3,645 | ) | $ | 69 | |||
Investing activities |
621 | (133 | ) | |||||
Financing activities |
(2 | ) | (4 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents |
76 | (109 | ) | |||||
Net (decrease) increase in cash and cash equivalents |
$ | (2,950 | ) | $ | (177 | ) | ||
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Operating Activities
For the three months ended March 31, 2011, net cash used in operating activities of $3.6
million was attributable to the following factors:
| Our net loss of $2.9 million (including the portion attributable to the noncontrolling interest) was partially offset by non-cash charges of $0.5 million. Our principal non-cash expenses were $0.4 million depreciation and amortization and $0.2 million stock-based compensation. These non-cash expenses were partially offset by a $0.1 million deferred gain on the disposal of property and equipment. | ||
| The net change in operating assets and liabilities which consumed cash of $1.2 million. Cash was applied to increase inventories and accounts receivable by $1.5 million and $0.3 million, respectively and to reduce accrued expenses by $2.5 million. Cash was contributed by increases in accounts payable and income taxes payable of $1.8 million and $0.3 million, respectively, and reductions in prepaid expenses and other current assets totaling $1.0 million. |
For the three months ended March 31, 2010, net cash provided by operating activities of $0.1
million, with $0.8 million from continuing operations and ($0.7) million from discontinued
operations, was attributable to the following factors:
| Cash flow decreased due to the net loss from continuing operations of $0.2 million (including the portion attributable to the noncontrolling interest). However, because the net loss includes non-cash charges totaling $0.7 million, the net increase to cash was $0.5 million. Our principal non-cash expenses were as follows: $0.4 million depreciation and amortization and $0.4 million stock-based compensation. These non-cash expenses were partially offset by $0.1 million in deferred gains on the disposal of property and equipment. | ||
| The net change in operating assets and liabilities generated cash of $0.3 million. Cash was primarily provided by decreases in accounts receivable, prepaid and other assets, notes receivable, other assets and accounts receivable from affiliate of $1.4 million, $0.3 million, $0.1 million, $0.1 million and $0.1 million respectively. Cash was applied to reduce accounts payable and accrued expenses by $0.7 million and $0.5 million, respectively. Cash was further used to increase inventories and deferred revenue by $0.3 million and 0.2 million respectively. |
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Investing Activities
Net cash provided by investing activities during the three months ended March 31, 2011, was
$0.6 million compared with $0.2 million used for the three months ended March 31, 2010. Cash used
during the first three months of 2011 of $1.4 million consisted of ongoing construction costs for
our new facility in Shanghai. These construction costs were offset by the release of restricted
cash related to our revolving bank line of credit in the United States. Cash used during the first
three months of 2010 primarily consisted of equipment purchases to support our manufacturing
operations.
In December 2008, we purchased the land use rights for 50 years to 5 acres of land in Shanghai
to construct a new manufacturing, engineering and administrative facility, which is intended to
replace our existing, leased Shanghai facility. Construction began during the first quarter of
2010. The estimated cost to complete this project is approximately $1.7 million with the work
scheduled to be completed in the first half of 2011. Upon completion of construction, we intend to
vacate our existing leased facility in Shanghai. Based on discussions with Shanghai government
officials, the landlord of the existing Company facility, we believe we will be able to terminate
the lease without penalty. However, no assurance can be given at this time that we will not be
subject to lease a termination penalty.
Financing activities
The final scheduled principal payment of approximately $0.3 million on the notes payable to
related parties for the acquisition of RAE Beijing is due in July 2011.
We believe our existing balances of cash and cash equivalents, together with cash generated
from product sales, will be sufficient to meet our cash needs for working capital, debt service and
capital expenditures for at least the next twelve months. Our future capital requirements will
depend on many factors that are difficult to predict, including the size, timing and structure of
any future acquisitions, future capital investments, and future results of operations. Any future
financing we may require may be unavailable on favorable terms, if at all. Any difficulty in
obtaining additional financial resources could force us to curtail our operations, or could prevent
us from pursuing our growth strategy. Any future funding may dilute the ownership of our
stockholders.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
The following discussion analyzes our disclosure of market risk related to concentration of
credit risk, changes in interest rates and foreign currency exchange rates.
Concentration of Credit Risk
Currently, we have cash and cash equivalents as well as restricted cash on deposit with major
financial institutions in the countries where we conduct business. Our deposits may exceed the
amount of insurance available to cover such deposits. To date, we have not experienced any
financial losses on these deposits. Management regularly reviews our deposit balances and the
credit worthiness of the financial institutions which hold our deposits.
Interest Rate Risk
As of March 31, 2011, we had cash and cash equivalents of $13.4 million. The Company had no
other significant interest bearing assets. Over time, changes to interest rates may reduce or
increase our interest income, but the impact on our net income (loss) or the fair value of our
interest bearing assets is not expected to be significant.
Our borrowings in China have generally been at fixed interest rates or at rates fixed for 12
months, and no adjustable rate debt was outstanding there as of March 31, 2011. The outstanding
balance under our line of credit in the United States bears interest at the floating prime bank
lending rate plus 100 basis points subject to a minimum total rate of 5%. As the prime rate on
March 31, 2011, was 3.25%, our cost of funds in the United States will not increase until the prime
rate rises by more than 75 basis points. On an outstanding balance of $1.8 million, the loan
balance in the United States on March 31, 2011, annual interest expense would increase by $1,800
for each basis point thereafter.
Foreign Currency Exchange Rate Risk
For the three months ended March 31, 2011, a substantial portion of our Asia revenue (25%) was
denominated in RMB. Revenue denominated in U.S. dollars is generated primarily from operations in
the Americas (49%), and revenue from our European operations (26%) is primarily denominated in
Euros. We manufacture a majority of our products at our manufacturing facility in Shanghai, China.
Our strategy has been and will continue to be to increase our overseas manufacturing and
research and development activities to capitalize on lower cost capacity and efficiencies in
supply-chain management. Additionally, in 2004 and 2006, we made a strategic investment with the
acquisition of 96% interest in RAE Beijing, a Beijing-based manufacturer and distributor of
environmental safety and security equipment. There has been continued speculation in the financial
press that Chinas currency, the RMB, will be subject to a further market adjustment relative to
the U.S. dollar and other currencies. If, for example, there was a hypothetical 10% change in the
RMB relative to the U.S. dollar, the effect on our net income would have been approximately $0.2
million for the three months ended March 31, 2011. From January 1 through March 31, 2011, the RMB
appreciated RMB 0.06 or 0.9% measured against the U.S. dollar.
If the currencies in all other countries in Europe and Asia where we have operations were to
change in unison with the RMB by a hypothetical 10% relative to the U.S. dollar, the effect on our
net income would have been approximately $(0.3) million for the three months ended March 31, 2011.
The difference of $0.5 million is attributable to the impact of foreign currencies outside of
China, principally the Euro. From January 1 through March 31, 2011, the Euro appreciated $0.08 or
6.4% measured against the U.S. dollar.
To the extent that we have international sales denominated in U.S. dollars, any fluctuation in
the value of the U.S. dollar relative to foreign currencies could affect our competitive position
in the international markets. Although we continue to monitor our exposure to currency fluctuations
and, when appropriate, may use financial hedging techniques in the future to minimize the effect of
these fluctuations, we cannot be certain that exchange rate fluctuations will not adversely affect
our financial results in the future.
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Item 4. Controls and Procedures
Evaluation of Effectiveness of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief
Executive Officer and our Chief Financial Officer, the Company evaluated the effectiveness of its
disclosure controls and procedures, as such term is defined under Rule 13a-15(e) and 15d-15(e)
promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act). The
evaluation considered the procedures designed to ensure that information required to be disclosed
by us in the reports filed or submitted by the Company under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the SECs rules and forms
and communicated to our management as appropriate to allow timely decisions regarding required
disclosure. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer
concluded that our disclosure controls and procedures were not
effective as of March 31, 2011 as a result of the material
weakness related to the Fushun operations discussed below.
Impact of 2011 Changes to Management and Operational Involvement in RAE Fushun
As of January 12, 2011, management entered into a definitive agreement to sell our 70 percent
ownership of RAE Fushun to the Shenyang Research Institute of China Coal Research Institute. At
that time, RAE Systems and RAE Fushun management allowed Shenyang Research Institute to begin
managing and operating the entity without the involvement of RAE Systems or RAE Fushun management.
As a result, from January 12, 2011, RAE Systems has had no day-to-day management or operating
involvement in RAE Fushun and therefore no control oversight over the entitys financial
information. Accordingly, management believes that a material weakness in internal control over
financial reporting related to this matter existed as of March 31, 2011.
There were no changes in our internal control over financial reporting during the quarter
ended March 31, 2011, that have materially affected, or are reasonably likely to materially affect
our internal control over financial reporting except for the material
weakness discussed above.
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PART II. Other Information
Item 1. Legal Proceedings
Legal Proceedings
On January 2, 2011, Kuldip Shodhan, Polygon USA, and Polygon Agency Pvt. Ltd. (collectively,
Polygon) commenced an arbitration action before the International Centre for Dispute Resolution
division of the American Arbitration Association against the Company, ICDR Case No. 50 117 T 005
11, alleging causes of action for breach of a Sales Representative Agreement between Polygon and
RAE-KLH (Beijing) Co., Limited, a subsidiary of the Company, and seeking damages incurred by
Polygon resulting from the alleged breach. The dispute was submitted to mediation prior to
commencement of formal arbitration proceedings, and Polygon and representatives of the Company
agreed to a settlement pursuant to which the Company would pay to Polygon the sum of $260,000 in
return for a complete release of all claims. This proposed settlement remains subject to the
approval of the Companys management as well as Vector Capital (see Note 1 of Notes to Condensed
Consolidated Financial Statements). The Company has accrued the settlement amount of $260,000 in
its financial statements as of March 31, 2011.
Shareholder lawsuits
The California State Court Actions:
On September 20, 2010, a putative class action suit, entitled Foley v. RAE Systems Inc., et
al., No. 110CV182985, was filed in the Superior Court of California, County of Santa Clara, against
the Company, members of its Board of Directors, the Companys Chief Financial Officer, and entities
affiliated with Battery Ventures. The suit alleges in summary that, in connection with a proposed
acquisition of the Company by an affiliate of Battery Ventures, the individual defendants breached
their fiduciary duties by conducting an unfair sale process and agreeing to an unfair price, would
purportedly receive improper personal benefits in connection with the proposed acquisition, and
were aided and abetted by the other defendants. Plaintiff seeks, among other things, a declaration
that the suit can be maintained as a class action, an injunction against the proposed merger,
rescission of the Merger Agreement, a directive that the defendants exercise their fiduciary duties
to implement a process to secure the best possible consideration for stockholders, imposition of a
constructive trust on allegedly improper benefits, and fees and costs. Four other lawsuits making
similar allegations have also been filed in the Superior Court of the State of California, County
of Santa Clara against the Company, its Board of Directors and Battery Ventures or its affiliates:
Angles v. RAE Systems Inc., et al., No. 110CV183606; Greenbaum v. Chen, et al., No. 110CV183814; AC
Photonics, Inc. v. RAE Systems Inc., et al., No. 110CV183942; and Mann v. RAE Systems Inc., et al.,
No. 110CV183960. On October 28, 2010 the California court consolidated all five California actions
under the caption In re RAE Systems, Inc. Shareholder Litigation, Lead Case No. 110CV182985. On
December 15, 2010, plaintiffs Mann and Angles filed an amended complaint continuing to set forth
the claims set forth above and including additional disclosure claims based on allegations that the
Companys proxy filings contain materially false statements and fail to disclose material facts
regarding, among other things, the Special Committee, the holders of the Rollover Shares, the
process and events leading up to the proposed acquisition, the FCPA investigation, communications
with Battery Ventures and other potential bidders, and the work performed by UBS and data
underlying its analyses. On December 17, 2010, the California court issued an order staying all
proceedings in California state court in favor of litigation pending in Delaware.
The Delaware Chancery Court Actions:
In addition to the California state court actions, four putative class action suits with
similar allegations have been filed in Delaware Chancery Court: Nelson v. RAE Systems Inc., et al.,
C.A. No. 5848-VCS; Venton v. RAE Systems Inc., et al., C.A. No. 5854-VCS; Quintanilla v. RAE
Systems Inc., et al. , C.A. No. 5872; Villeneuve v. RAE Systems Inc., et al. , C.A. No. 5877. The
Delaware actions have been consolidated under the caption In re RAE Systems, Inc. Shareholder
Litigation, Consolidated C.A. No. 5848-VCS, and plaintiffs filed a Verified Consolidated Amended
Class Action Complaint on or about October 28, 2010. In this pleading, plaintiffs continued to
assert the claims set forth above, and in addition they alleged that the Companys Preliminary
Proxy Statement, filed with the SEC on October 21, 2010, contained materially false statements or
failed to disclose material facts regarding, among other things, the Special Committee, the holders
of the Rollover Shares, the process and events leading up to the proposed acquisition, the FCPA
investigation, communications with Battery Ventures and other potential bidders, and the work
performed by UBS and data underlying its analyses. Plaintiffs requested various forms of injunctive
relief, as well as money damages allegedly suffered or to be suffered by the putative class. On
December 17, 2010, two of the plaintiffs from the stayed California action (Mann and Angles) also
filed a complaint in Delaware Chancery Court making essentially the same allegations as in their
amended California complaint described above.
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Plaintiffs Mann and Angles subsequently voluntarily dismissed their Delaware complaint.
On February 24, 2011, the remaining Delaware plaintiffs filed a motion requesting leave to
file a Supplemental and Amended Verified Class Action Complaint. The Delaware Chancery Court
granted plaintiffs leave to amend their complaint on March 2, 2011. The Supplemental Amended
Verified Class Action Complaint asserts claims against the Company, members of its Board of
Directors, and entities affiliated with Vector Capital, and alleges in summary that, in connection
with the proposed acquisition of the Company by an affiliate of Vector Capital, the individual
defendants breached their fiduciary duties by conducting an unfair sale process and agreeing to an
unfair price, are purportedly receiving improper personal benefits, and were aided and abetted by
the other defendants. The complaint also alleges that the Companys Preliminary Proxy Statement,
filed with the SEC on February 22, 2011, contains materially false statements or fails to disclose
material facts regarding, among other things, the Special Committee, the holders of the Rollover
Shares, the process and events leading up to the proposed acquisition, the work performed by UBS
and data underlying its analyses, and communications with Battery Ventures, Vector Capital, and
other potential bidders. Plaintiffs request various forms of injunctive relief, as well as money
damages allegedly suffered or to be suffered by the putative class. On March 7, 2011, the Delaware
plaintiffs filed a motion seeking to preliminarily enjoin the proposed acquisition of the Company
by an affiliate of Vector Capital. On April 4, 2011, the Delaware Chancery Court held a conference
regarding the Delaware plaintiffs motion for preliminary injunction. Following that conference,
the Company postponed the shareholder vote on the proposed acquisition.
The Federal Court Actions:
Two other actions have been filed in the United States District Court for the Northern
District of California against the Company, members of its Board of Directors, the Companys Chief
Financial Officer, and/or Battery Ventures, Rudy Merger Sub Corp. and Rudy Acquisition Corp. Those
actions are entitled LaPlante v. RAE Systems Inc., et al., No. CV104944 and Mabry v. Chen, et al.,
No. CV 10-5328. They make allegations similar to the other lawsuits, and add claims for alleged
violation of the federal securities laws in connection with the preparation of the proxy statement
filed by the Company in connection with a proposed acquisition by affiliates of Battery Ventures.
On January 10, 2011, the federal court issued an order pursuant to a stipulation of the parties
staying proceedings in the LaPlante action in favor of litigation pending in Delaware. A similar
order was entered by the federal court in the Mabry action on January 21, 2011, pursuant to
stipulation of the parties.
The Company believes that the claims in the above shareholder lawsuits are without merit and
intends to vigorously defend against them. However, there can be no assurances as to the outcome of
the litigation. The Company is in the process of assessing these matters and is consulting with its
external legal counsel and technical experts. The amount of loss related to these matters is not
estimable at this time. Accordingly, the Company has not accrued an amount of the loss related to
these matters.
Item 1A. Risk Factors
You should carefully consider the risks described below before making a decision regarding an
investment in our common stock. If any of the following risks actually occur, our business could be
harmed, the trading price of our common stock could decline and you may lose all or part of your
investment. You should also refer to the other information contained in this report, including our
financial statements and the related notes.
Although we have settled outstanding issued related to our possible violations of the Foreign
Corrupt Practices Act, we still face risks of non-compliance with the FCPA going forward.
During fiscal year 2008, our internal audit department identified certain payments and gifts
made by certain personnel in our China operations that may have violated the FCPA. Following this
discovery, the Audit Committee of our Board of Directors initiated an independent investigation. We
made a voluntary disclosure to the DOJ and the SEC regarding the results of our investigation. We
also implemented additional policies and controls with respect to compliance with the FCPA. The
FCPA and related statutes and regulations provide for potential monetary penalties, criminal
sanctions and in some cases debarment from doing business with the U.S. federal government in
connection with FCPA violations. We cooperated with the DOJ and the SEC in connection with their
review of the matter, and recorded an accrual of $3.5 million in the third quarter of 2009 relating
to the potential settlement of this matter. In December 2010, we settled all outstanding issues
with regard to this matter pursuant to separate agreements with the DOJ and the SEC, under which we
have paid a $1.7 million criminal penalty to the DOJ and about $1.15 million in restitution plus
$0.1 million in interest to the SEC. We also agreed to advise the DOJ and the SEC periodically
until December 2013 as to our ongoing efforts to ensure continued compliance with the FCPA.
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In the course of telephonic discussions between April 15 and 19, 2011, outside counsel for the
Company was asked by the SEC whether RAE China had adopted a sales program whereby customers are
awarded points based on the level of their purchases of RAE products, which points they may later
redeem for gifts such as iPads or cameras, and if such a program was adopted, whether it complies
with the FCPA. We have conducted a review in response to the SECs inquiry and have concluded that
RAE China has not adopted any such program. We intend to provide our conclusions to the SEC and the
DOJ.
Economic conditions could materially adversely affect our business.
The financial turmoil that first arose in the fall of 2008 has resulted in a tightening in the
credit markets and a low level of liquidity in many financial markets. There could be a number of
follow-on effects from the credit crisis on our business, including the insolvency of key suppliers
or their inability to obtain credit to finance manufacturing of their products, resulting in
product delays; inability of customers, including channel partners, to obtain credit to finance
purchases of our products; and/or customer, including channel partner, insolvencies. Our operations
and performance depend significantly on worldwide economic conditions. Uncertainty about current
global economic conditions poses a risk as businesses and governments may postpone spending in
response to tighter credit and/or negative financial news, which could have a material negative
effect on demand for our products. Our operating results could also be adversely affected if the
U.S. dollar strengthens against various foreign currencies.
Political events, war, terrorism, natural disasters, and other circumstances could materially
adversely affect us.
War, terrorism, geopolitical uncertainties, and other business interruptions have caused and
could cause damage or disruption to international commerce and the global economy, and thus could
have a strong negative effect on us and our suppliers, logistics providers, manufacturing vendors,
and customers, including channel partners. Our business operations are potentially subject to
interruption by natural disasters, fire, power shortages, terrorist attacks and other hostile acts,
and other events beyond our control. Such events could decrease demand for our products, make it
difficult or impossible for us to make and deliver products to our customers, including channel
partners, or to receive components from our suppliers, and create delays and inefficiencies in our
supply chain.
Our future revenues are unpredictable, our operating results are likely to fluctuate from
quarter-to-quarter, and if we fail to meet the expectations of securities analysts or investors,
our stock price could decline significantly.
Our quarterly and annual operating results have fluctuated in the past and are likely to
fluctuate significantly in the future due to a variety of factors, some of which are outside of our
control. Accordingly, we believe that period-to-period comparisons of our results of operations are
not meaningful and should not be relied upon as indications of future performance. Some of the
factors that could cause our quarterly or annual operating results to fluctuate include significant
shortfalls in revenue relative to our planned expenditures, changes in budget allocations by the
federal government for homeland security purposes, changes in world-wide energy production and
refining, market acceptance of our products, ongoing product development and production,
competitive pressures and customer retention. It is likely that in some future quarters our
operating results may fall below the expectations of investors. In this event, the trading price of
our common stock could significantly decline.
We may have difficulty achieving and sustaining profitability and may experience additional
losses in the future. If we continue to report losses or are marginally profitable, the financial
impact of future events may be magnified and may lead to a disproportionate impact on the trading
price of our stock.
We reported a net loss of $2.9 million for the three months ended March 31, 2011 and we
recorded net losses of $2.6 million, $5.8 million and $7.2 million for 2010, 2009 and 2008,
respectively. In order to improve our profitability, we will need to continue to generate new sales
while controlling our costs. As we plan on continuing the growth of our business while implementing
cost control measures, we may not be able to successfully generate enough revenues to sustain
profitability. Any failure to increase our revenues and control costs as we pursue our planned
growth would harm our profitability and would likely result in a negative effect on the market
price of our stock. Our financial results have historically bordered at or near profitability, and
if we continue to perform at this level, the financial impact may be magnified and we may
experience a disproportionate impact on our trading price as a result. If we again incur losses in
the future, any particular financial event could result in a relatively large change in our
financial results that could be the difference between us having a profit or a loss for a
particular quarter in which it occurs.
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We may require additional capital in the future, which may not be available or may be available
only on unfavorable terms.
Our future capital requirements depend on many factors, including potential future
acquisitions and our ability to generate revenue and control costs. Should we have the need to
raise additional capital, we might not be able to do so at all or on favorable terms. In the case
of any future equity financings, dilution to our shareholders could result and, in any case, such
securities may have rights, preferences and privileges that are senior to those of our common
stock. If we are unable to obtain needed capital on favorable terms, or at all, our business and
results of operations could be harmed and our liquidity could be adversely affected.
The market for gas and radiation detection monitoring devices is highly competitive, and if we
cannot compete effectively, our business may be harmed.
The market for gas and radiation detection monitoring devices is highly competitive.
Competitors in the gas and radiation monitoring industry differentiate themselves on the basis of
their technology, quality of product and service offerings, cost and time to market. Our primary
competitors in the gas detection market include Industrial Scientific Corporation, Mine Safety
Appliances Company, Honeywell, Ion Science, Draeger Safety Inc., Gastec Corporation and Sperian
Protection. Our competitors in the radiation market include Canberra, Exporanium, ICx, MGP
Polimaster Ltd., Santa Barbara Systems, Smiths Detection, ThermoFisher and TSA Limited. Several of
our competitors such as Mine Safety Appliances Company, Draeger Safety Inc. and Smiths have longer
operating histories, larger customer bases, greater brand recognition and significantly greater
financial and marketing resources than we do. In addition, some of our competitors may be able to:
| devote greater resources to marketing and promotional campaigns; | ||
| adopt more aggressive pricing policies; or | ||
| devote more resources to technology and systems development. |
In light of these factors, we may be unable to compete successfully.
We may not be successful in the development or introduction of new products and services in a
timely and effective manner and, consequently, we may not be able to remain competitive and the
results of operations may suffer.
Our revenue growth is dependent on the timely introduction of new products to market. We may
be unsuccessful in identifying new product and service opportunities or in developing or marketing
new products and services in a timely or cost-effective manner. In developing new products, we may
be required to make significant investments before we can determine the commercial viability of the
new product. If we fail to accurately foresee our customers needs and future activities, we may
invest heavily in research and development of products that do not lead to significant sales.
We have expanded our current business of providing gas detection instruments to include
radiation detection and wireless systems for local and remote security monitoring. While we
perceive a large market for such products, the radiation detection and wireless systems markets are
still evolving, and we have little basis to assess the demand for these products and services or to
evaluate whether our products and services will be accepted by the market. If our radiation
detection products and wireless products and services do not gain broad market acceptance or if we
do not continue to maintain the necessary technology, our business and results of operations will
be harmed.
In addition, compliance with safety regulations, specifically the need to obtain regulatory
approvals in certain jurisdictions, could delay the introduction of new products by us. As a
result, we may experience delays in realizing revenues from our new products.
The securities laws and regulations have and are likely to continue to have a significant effect
on our costs.
The Sarbanes-Oxley Act of 2002 (the Act) and the rules promulgated by the SEC and the New
York Stock Exchange in relation thereto require significant legal, financial and accounting
compliance costs, and we expect these costs to continue indefinitely.
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In the event we are unable to satisfy regulatory requirements relating to internal control over
financial reporting or, if these controls are not effective, our business and financial results
may suffer.
In designing and evaluating our internal control over financial reporting, we recognize that
any internal control or procedure, no matter how well designed and operated, can provide only
reasonable assurance of achieving desired control objectives. For example, a companys operations
may change over time as the result of new or discontinued lines of business and management must
periodically modify a companys internal controls and procedures to timely match these changes in
its business. In addition, management is required to apply its judgment in evaluating the
cost-benefit relationship of possible controls and procedures and company personnel are required to
use judgment in their application. While we continue to improve upon our internal control over
financial reporting, so that it can provide reasonable assurance of achieving its control
objectives, no system of internal controls can be designed to provide absolute assurance of
effectiveness.
Material weaknesses in internal control over financial reporting may materially impact our
reported financial results and the market price of our stock could significantly decline.
Additionally, adverse publicity related to a material failure of internal control over financial
reporting could have a negative impact on our reputation and business.
We are subject to risks and uncertainties of the government marketplace, including the risk that
the government may not fund projects that our products are designed to address and that certain
terms of our contracts with government agencies may subject us to adverse government actions or
penalties.
Some of our customers, such as first responders, rely to some extent on government grants to
purchase our products. Decisions on what types of projects are to be funded by local, state and
federal government agencies may have a material impact on our business. The Federal budget for the
Department of Homeland Security, which we refer to as Homeland Security herein, is a source for
funding for many of our customers either directly or through grants to state and local agencies.
However, if the government does not fund projects that our products are designed to address, or
funds such projects at levels lower than we expect, our business and results of operations will be
harmed.
From time-to-time we enter into government contracts that contain provisions which subject us
to laws and regulations that provide government clients with rights and remedies not typically
found in commercial contracts. For example, a portion of our federal contracting has been done
through our distributors who are on the Federal Supply Schedules from the United States General
Services Administration (GSA). GSA Schedule contracts which we may enter into often include a
clause known as the Price Reductions clause; the terms of that clause are similar but not
identical to a most favored customer clause in commercial contracts. Under that clause, we may
agree that the prices to the government under the GSA Schedules contract will maintain a constant
relationship to the prices charged to certain commercial customers, i.e., when prices to those
benchmark customers drop, our prices on our GSA Schedules contract must be adjusted accordingly.
Although when we are party to these contracts we undertake extensive efforts to comply with the
Price Reductions clause, it is possible that we may have an unreported discount offered to a Basis
of Award customer and may have failed to honor the obligations of the Price Reductions clause. If
that occurs, we could, under certain circumstances, be subject to an audit, an action in fraud, or
other adverse government actions or penalties.
We may not be successful in promoting and developing our brand, which could prevent us from
remaining competitive.
We believe that our future success will depend on our ability to maintain and strengthen the
RAE Systems brand, which will depend, in turn, largely on the success of our marketing efforts and
ability to provide our customers with high-quality products. If we fail to successfully promote and
maintain our brand, or incur excessive expenses in attempting to promote and maintain our brand,
our business will be harmed.
We may face risks from our substantial international operations and sales.
We have significant operations in foreign countries, including manufacturing facilities, sales
personnel and customer support operations. For the years ended December 31, 2010 and 2009,
approximately 28% and 34% of our revenues, respectively, were from sales to customers located in
Asia and approximately 18% and 19% of our revenues, respectively, were from sales to customers
located in Europe. We have manufacturing facilities in China and in the United States. A
significant portion of our products and components are manufactured at our facility in Shanghai,
China.
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Our international operations are subject to economic and other risks inherent in doing
business in foreign countries, including the following:
| difficulties with staffing and managing international operations; | ||
| transportation and supply chain disruptions and increased transportation expense as a result of epidemics, terrorist activity, acts of war or hostility, natural disasters, increased security and less developed infrastructure; | ||
| economic slowdown and/or downturn in foreign markets; | ||
| international currency fluctuations; | ||
| political and economic uncertainty caused by epidemics, terrorism or acts of war or hostility; | ||
| legislative and regulatory responses to terrorist activity such as increased restrictions on cross-border movement of products and technology; | ||
| legislative, regulatory, police, or civil responses to epidemics or other outbreaks of infectious diseases such as quarantines, factory closures, or increased restrictions on transportation or travel; | ||
| increased costs and complexities associated with complying with Section 404 of the Sarbanes-Oxley Act of 2002; | ||
| general strikes or other disruptions in working conditions; | ||
| labor shortages; | ||
| political instability; | ||
| changes in tariffs; | ||
| generally longer periods to collect receivables; | ||
| unexpected legislative or regulatory requirements; | ||
| reduced protection for intellectual property rights in some countries; | ||
| significant unexpected duties or taxes or other adverse tax consequences; | ||
| difficulty in obtaining export licenses and other trade barriers; and | ||
| ability to obtain credit and access to capital issues faced by our international customers. |
The specific economic conditions in each country will impact our future international sales.
For example, approximately half of our recognized revenue has been denominated in U.S. dollars.
Significant downward fluctuations in currency exchange rates against the U.S. dollar could result
in higher product prices and/or declining margins and increased manufacturing costs. If we do not
effectively manage the risks associated with international operations and sales, our business,
financial condition and operating results could suffer.
Like other companies operating or selling internationally, we are subject to the FCPA and
other laws which prohibit improper payments or offers of payments to foreign governments and their
officials and political parties by U.S. and other business entities for the purpose of obtaining or
retaining business. We make sales in countries known to experience corruption. Our sales activities
in such countries create the risk of unauthorized payments or offers of payments by one of our
employees, consultants, sales agents or distributors which could be in violation of various laws
including the FCPA, even though such parties are not always subject to our control. We have
implemented new policies and procedures to prevent losses from such practices and to discourage
such practices by our employees, consultants, sales agents and distributors and are continuing our
efforts to improve such policies and procedures. Among
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other things, we have established on-going training programs for our employees to ensure that
they are aware of their responsibilities under the FCPA and similar laws. However, our existing
safeguards and any improvements may prove to be less than effective and our employees, consultants,
sales agents or distributors may engage in conduct for which we might be held responsible.
Violations of the FCPA may result in severe criminal or civil sanctions, and we may be subject to
other liabilities, which could negatively affect our business, financial condition and results of
operations.
The loss of Normal Trade Relation status for China, changes in current tariff structures or
adoption of other trade policies adverse to China could have an adverse effect on our business.
Our ability to import products from China at current tariff levels could be materially and
adversely affected if the normal trade relations (NTR, formerly most favored nation) status
the United States government has granted to China for trade and tariff purposes is terminated. As a
result of its NTR status, China receives the same favorable tariff treatment that the United States
extends to its other normal trading partners. Chinas NTR status, coupled with its membership in
the World Trade Organization, could eventually reduce barriers to manufacturing products in and
exporting products from China. However, we cannot provide any assurance that Chinas membership in
the World Trade Organization or NTR status will not change. As a result of opposition to certain
policies of the Chinese government and Chinas growing trade surpluses with the United States,
there has been, and in the future may be, opposition to NTR status for China. Also, the imposition
of trade sanctions by the United States or the European Union against a class of products imported
by us from, or the loss of NTR status with, China, could significantly increase our cost of
products imported into the United States or Europe and harm our business. For example, in September
2009, the U.S. government imposed new tariffs on tires imported from China. Retaliatory actions by
China could be harmful to our business. Because of the importance of our international sales and
international sourcing of manufacturing to our business, our financial condition and results of
operations could be significantly and adversely affected if any of the risks described above were
to occur.
The government of China may change or even reverse its policies of promoting private industry and
foreign investment, in which case our assets and operations may be at risk.
We currently manufacture and sell a significant portion of our components and products in
China. Our existing and planned operations in China are subject to the general risks of doing
business internationally and the specific risks related to the business, economic and political
conditions in China, which include the possibility that the central government of China will change
or even reverse its policies of promoting private industry and foreign investment in China. Many of
the current reforms which support private business in China are unprecedented or experimental.
Other political, economic and social factors, such as political changes, changes in the rates of
economic growth, unemployment or inflation, or in the disparities of per capita wealth among
citizens of China and between regions within China, could also lead to further readjustment of the
governments reform measures. It is not possible to predict whether the Chinese government will
continue to be as supportive of private business in China, nor is it possible to predict how future
reforms will affect our business.
Any failure to adequately protect and enforce our intellectual property rights could harm our
business.
We regard our intellectual property as critical to our success. We rely on a combination of
patent, trademark, copyright, trade secret laws and non-disclosure agreements and confidentiality
procedures to protect our proprietary rights. Notwithstanding these laws, we may be unsuccessful in
protecting our intellectual property rights or in obtaining patents or registered trademarks for
which we apply. Although processes are in place to protect our intellectual property rights, we
cannot guarantee that these procedures are adequate to prevent misappropriation of our current
technology or that our competitors will not develop technology that is similar to our own.
While there is no single patent or license to technology of material significance to the
Company, our ability to compete is affected by our ability to protect our intellectual property
rights in general. For example, we have a collection of patents related to our photoionization
detector technology, the first of which expires in 2012, and our ability to compete may be affected
by any competing similar or new technology. In addition, if we lose the licensing rights to a
patented or other proprietary technology, we may need to stop selling products incorporating that
technology and possibly other products, redesign our products or lose a competitive advantage. We
cannot ensure that our future patent applications will be approved or that our current patents will
not be challenged by third parties. Furthermore, we cannot ensure that, if challenged, our patents
will be found to be valid and enforceable. Any litigation relating to our intellectual property
rights could, regardless of the outcome, have a material adverse impact on our business and results
of operations.
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We may face intellectual property infringement claims that might be costly to resolve and affect
our results of operations.
In connection with the enforcement of our own intellectual property rights, the acquisition of
third-party intellectual property rights or disputes relating to the validity or alleged
infringement of third-party rights, including patent rights, we have been and may in the future be
subject to claims, negotiations or complex, protracted litigation. Intellectual property disputes
and litigation are typically very costly and can be disruptive to our business operations by
diverting the attention and energies of management and key technical personnel. Although we have
successfully defended or resolved past litigation and disputes, we may not prevail in any ongoing
or future litigation and disputes. We may incur significant costs in acquiring the necessary third
party intellectual property rights for use in our products. Third party intellectual property
disputes could subject us to significant liabilities, require us to enter into royalty and
licensing arrangements on less favorable terms, prevent us from manufacturing or licensing certain
of our products, cause severe disruptions to our operations or the markets in which we compete, or
require us to satisfy indemnification commitments with our customers including contractual
provisions under various license arrangements, any one of which could seriously harm our business.
Some of our products may be subject to product liability claims which could be costly to resolve
and affect our results of operations.
There can be no assurance that we will not be subject to third-party claims in connection with
our products or that any indemnification or insurance available to us will be adequate to protect
us from liability. A product liability claim, product recall or other claim, as well as any claims
for uninsured liabilities or in excess of insured liabilities, could have a material adverse effect
on our business and results of operations.
We sell a majority of our products through distributors, and if our distributors stop selling our
products, our revenues would suffer.
We distribute our products in the Americas, Europe, Asia Pacific and the Middle East primarily
through distributors. We are dependent upon these distributors to sell our products and to assist
us in promoting and creating a demand for our products. Distributors are an important sales channel
for our future growth. If one or more of our distributors were to experience financial difficulties
or become unwilling to promote and sell our products for any reason, including any refusal to renew
their commitment as our distributor, we might not be able to replace such lost revenue, and our
business and results of operations could be materially harmed.
Because we purchase a significant portion of our component parts from a limited number of third
party suppliers, we are subject to the risk that we may be unable to acquire quality components
in a timely manner, which could result in delays of product shipments and damage our business and
operating results.
We currently purchase component parts used in the manufacture of our products from a limited
number of third party suppliers. We depend on these suppliers to meet our needs for various
sensors, microprocessors and other material components. Moreover, we depend on the quality of the
products supplied to us over which we have limited control. Should we encounter shortages and
delays in obtaining components, we might not be able to supply products in a timely manner due to a
lack of components, and our business could be adversely affected.
Future acquisitions that we undertake could be difficult to integrate, disrupt our business,
dilute shareholder value or harm our results of operations.
In the last several years, we increased our ownership of RAE Beijing to 96%, acquired Aegison
Corporation and Tianjin Securay Technology Co., Ltd. and formed RAE Fushun, of which we held 70%
ownership. In August 2007, we determined to discontinue the Aegison and Securay businesses. On
January 12, 2011, we entered into a definitive agreement to sell our 70% ownership of RAE Fushun to
the Shenyang Research Institute of China Coal Research Institute. The agreement is expected to
close within 180 days of signing the definitive agreement and is subject to customary closing
conditions. We may acquire or make additional investments in complementary businesses,
technologies, services or products if appropriate opportunities arise. The process of integrating
any acquired business, technology, service or product into our business and operations may result
in unforeseen operating difficulties and expenditures. Integration of an acquired company also may
consume much of our managements time and attention that would otherwise be available for ongoing
development of our business. Moreover, the anticipated benefits of any acquisition may not be
realized. Future acquisitions could result in dilutive issuances of equity securities or the
incurrence of debt or contingent liabilities, any of which could harm our business.
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Our ownership interest in Renex will cause us to incur losses that we would not otherwise
incur.
We currently own approximately 40% of Renex, a wireless systems company. We are required to
incorporate our share of its expenses as losses in our Consolidated Statements of Operations. If
Renex does not begin to generate revenues at the level we anticipate or otherwise incurs greater
losses, we could incur greater losses than we anticipate and our results of operations will suffer.
Our business could suffer if we lose the services of any of our executive officers.
Our future success depends to a significant extent on the continued service of our executive
officers. We have no formal employment agreements with any of our executives other than the initial
offer letter, if applicable. The loss of the services of any of our executive officers could harm
our business. We do not have key person life insurance on any of our personnel.
Our officers and directors beneficially own approximately 31% of our common stock and,
accordingly, may exert substantial influence over the Company.
Our executive officers and directors, in the aggregate, beneficially own approximately 31% of
our common stock as of March 31, 2011. These stockholders acting together have the ability to
substantially influence all matters requiring approval by our stockholders. These matters include
the election and removal of the directors, amendment of our certificate of incorporation, and any
merger, consolidation or sale of all or substantially all of our assets. In addition, they may
dictate the management of our business and affairs. Furthermore, this concentration of ownership
could have the effect of delaying, deferring or preventing a change in control, or impeding a
merger or consolidation, takeover or other business combination and may substantially reduce the
marketability of our common stock.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Reserved
Item 5. Other Information
None
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Item 6. Exhibits
The following is a list of exhibits filed as part of this Report on Form 10-Q.
Exhibit | ||
Number | Description of Document | |
31.1
|
Certification of Robert I. Chen, President, Chief Executive Officer and Chairman of the Board of the Registrant, furnished pursuant to Rule 13a-14(a) adopted under the Securities Exchange Act of 1934, as amended, and Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2
|
Certification of Randall Gausman, Vice President and Chief Financial Officer of the Registrant, furnished pursuant to Rule 13a-14(a) adopted under the Securities Exchange Act of 1934, as amended, and Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1
|
Certification of Robert I. Chen, President, Chief Executive Officer and Chairman of the Registrant, furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2
|
Certification of Randall Gausman, Vice President and Chief Financial Officer of the Registrant, furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
May 16, 2011
RAE SYSTEMS INC. |
||||
By: | /s/ Randall Gausman | |||
Randall Gausman | ||||
Vice President and Chief Financial Officer |
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Exhibit Index
Exhibit | ||
Number | Description of Document | |
31.1
|
Certification of Robert I. Chen, President, Chief Executive Officer and Chairman of the Board of the Registrant, furnished pursuant to Rule 13a-14(a) adopted under the Securities Exchange Act of 1934, as amended, and Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2
|
Certification of Randall Gausman, Vice President and Chief Financial Officer of the Registrant, furnished pursuant to Rule 13a-14(a) adopted under the Securities Exchange Act of 1934, as amended, and Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1
|
Certification of Robert I. Chen, President, Chief Executive Officer and Chairman of the Registrant, furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
32.2
|
Certification of Randall Gausman, Vice President and Chief Financial Officer of the Registrant, furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
44