| Emrise CORP Item 1A Risk Factors |
| 22 ITEM 1A RISK FACTORS RISK FACTORS THE FOLLOWING SUMMARIZES MATERIAL RISKS THAT INVESTORS SHOULD CAREFULLY CONSIDER BEFORE DECIDING TO BUY OR MAINTAIN AN INVESTMENT IN OUR COMMON STOCK ANY OF THE FOLLOWING RISKS, IF THEY ACTUALLY OCCUR, WOULD LIKELY HARM OUR BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS AS A RESULT, THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, AND INVESTORS COULD LOSE THE MONEY THEY PAID TO BUY OUR COMMON STOCK OUR LACK OF LONG-TERM PURCHASE ORDERS OR COMMITMENTS MAY ADVERSELY AFFECT OUR BUSINESS IF DEMAND IS REDUCED During 2005, the sale of electronic components accounted for approximately 62dtta6prca of our total net sales, and the sale of communications equipment and related services accounted for approximately 37dtta4prca of our total net sales |
| In many cases we have long-term contracts with our electronic components and communications equipment customers that cover the general terms and conditions of our relationships with them but that do not include long-term purchase orders or commitments |
| Rather, our customers issue purchase orders requesting the quantities of communications equipment they desire to purchase from us, and if we are able and willing to fill those orders, then we fill them under the terms of the contracts |
| Accordingly, we cannot rely on long-term purchase orders or commitments to protect us from the negative financial effects of reduced demand for our products that could result from a general economic downturn, from changes in the electronic components and communications equipment industries, including the entry of new competitors into the market, from the introduction by others of new or improved technology, from an unanticipated shift in the needs of our customers, or from other causes |
| THE UNPREDICTABILITY OF OUR QUARTERLY OPERATING RESULTS MAY CAUSE THE PRICE OF OUR COMMON STOCK TO FLUCTUATE OR DECLINE Our quarterly operating results have varied significantly in the past and will likely continue to do so in the future due to a variety of factors, many of which are beyond our control |
| Our operating results from our communications segment tend to be less stable and predictable than our operating results from our electronic components segment |
| 22 The cyclical nature of the telecommunications business due to the budgetary cycle of RBOCs has had and will continue to have for the foreseeable future an effect on our quarterly operating results |
| RBOCs generally obtain approval for their annual budgets during the first quarter of each calendar year |
| If an RBOCapstas annual budget is not approved early in the calendar year or is insufficient to cover its desired purchases for the entire calendar year, we are unable to sell products to the RBOC during the period of the delay or shortfall |
| Our electronic components sales are often made in conjunction with military contracts |
| The timing of required deliveries under these contracts can be delayed based on issues related to the overall military contract, which can cause delays in our shipment schedules and revenue recognition |
| Quarter to quarter fluctuations may also result from the uneven pace of technological innovation, the development of products responding to these technological innovations by us and our competitors, our customers &apos acceptance of these products and innovations, the varied degree of price, product and technological competition and our customers &apos and competitors &apos responses to these changes |
| Due to these factors and other factors, including changes in general economic conditions, we believe that period-to-period comparisons of our operating results will not necessarily be meaningful in predicting future performance |
| If our operating results do not meet the expectations of investors, our stock price may fluctuate or decline |
| MANY OF OUR COMPETITORS HAVE GREATER RESOURCES THAN US IN ORDER TO COMPETE SUCCESSFULLY, WE MUST KEEP PACE WITH OUR COMPETITORS IN ANTICIPATING AND RESPONDING TO THE RAPID CHANGES INVOLVING THE ELECTRONIC COMPONENTS AND COMMUNICATIONS EQUIPMENT INDUSTRIES Our future success will depend upon our ability to enhance our current products and services and to develop and introduce new products and services that keep pace with technological developments, respond to the growth in the electronic components and communications equipment markets in which we compete, encompass evolving customer requirements, provide a broad range of products and achieve market acceptance of our products |
| Many of our existing and potential competitors have larger technical staffs, more established and larger marketing and sales organizations and significantly greater financial resources than we do |
| Our lack of resources relative to our competitors may cause us to fail to anticipate or respond adequately to technological developments and customer requirements or to experience significant delays in developing or introducing new products and services |
| These failures or delays could reduce our competitiveness, revenues, profit margins or market share |
| WE RELY HEAVILY ON OUR MANAGEMENT, AND THE LOSS OF THEIR SERVICES COULD ADVERSELY AFFECT OUR BUSINESS Our success is highly dependent upon the continued services of key members of our management, including Carmine T Oliva, our Chairman of the Board, President and Chief Executive Officer, Graham Jefferies, our Executive Vice President and Chief Operating Officer, and Randolph Foote, our Senior Vice President, Chief Financial Officer and Secretary |
| Oliva co-founded EMRISE Electronics and has developed personal contacts and other skills that we rely upon in connection with our financing, acquisition and general business strategies |
| Jefferies is a long-time employee of EMRISE who we have relied upon in connection with our United Kingdom acquisitions and who fulfills significant operational responsibilities in connection with our foreign and domestic operations |
| Footeapstas skills in financial reporting, accounting and tax matters in addition to his skills in the analysis of potential acquisitions and general corporate administration |
| Consequently, the loss of Mr |
| Jefferies, Mr |
| Foote or one or more other key members of management could adversely affect us |
| Although we have entered into employment agreements with each of our executive officers, those agreements are of limited duration and are subject to early termination by the officers under some circumstances |
| We maintain key-man life insurance on Mr |
| Oliva and Mr |
| However, we cannot assure you that we will be able to maintain this insurance in effect or that the coverage will be sufficient to compensate us for the loss of the services of Mr |
| Oliva or Mr |
| 23 IF WE ARE UNABLE TO SUCCESSFULLY IDENTIFY OR MAKE STRATEGIC ACQUISITIONS, OUR LONG-TERM COMPETITIVE POSITIONING MAY SUFFER Our business strategy includes growth through acquisitions that we believe will improve our competitive capabilities or provide additional market penetration or business opportunities in areas that are consistent with our business plan |
| Identifying and pursuing strategic acquisitions and integrating acquired products and businesses requires a significant amount of management time and skill |
| Acquisitions may also require us to expend a substantial amount of cash or other resources, not only as a result of the direct expenses involved in the acquisition transaction, but also as a result of ongoing research and development activities that may be required to maintain or enhance the long-term competitiveness of acquired products, particularly those products marketed to the rapidly evolving telecommunications industry |
| If we are unable to make strategic acquisitions due to our inability to identify appropriate targets, or to manage the difficulties or costs involved in the acquisitions, our long-term competitive positioning may suffer |
| IF WE ARE UNABLE TO FULFILL BACKLOG ORDERS DUE TO CIRCUMSTANCES INVOLVING US OR ONE OR MORE OF OUR SUPPLIERS OR CUSTOMERS, OUR ANTICIPATED RESULTS OF OPERATIONS WILL SUFFER As of December 31, 2005, we had dlra22cmam150cmam000 in backlog orders for our products |
| Backlog orders represent revenue that we anticipate recognizing in the future, as evidenced by purchase orders and other purchase commitments received from customers, but on which work has not yet been initiated or with respect to which work is currently in progress |
| Our backlog orders are due in large part to the long lead-times associated with our electronic components products, which products generally are custom built to order |
| We cannot assure you that we will be successful in fulfilling orders and commitments in a timely manner or that we will ultimately recognize as revenue the amounts reflected as backlog |
| Factors that could affect our ability to fulfill backlog orders include difficulty we may experience in obtaining components from suppliers, whether due to obsolescence, production difficulties on the part of suppliers or other causes, or customer-induced delays and product holds |
| Our anticipated results of operations will suffer to the extent we are unable to fulfill backlog orders within the timeframes we establish, particularly if delays in fulfilling backlog orders cause our customers to reduce or cancel their orders |
| IF OUR PRODUCTS FAIL TO COMPLY WITH EVOLVING GOVERNMENT AND INDUSTRY STANDARDS AND REGULATIONS, WE MAY HAVE DIFFICULTY SELLING OUR PRODUCTS We design our products to comply with a significant number of industry standards and regulations, some of which are evolving as new technologies are deployed |
| In the United States, our communications equipment products must comply with various regulations defined by the FCC and Underwriters Laboratories as well as industry standards established by Telcordia Technologies, Inc |
| and the American National Standards Institute |
| Internationally, our communications equipment products must comply with standards established by the European Committee for Electrotechnical Standardization, the European Committee for Standardization, the European Telecommunications Standards Institute, telecommunications authorities in various countries as well as with recommendations of the International Telecommunications Union |
| The failure of our products to comply, or delays in compliance, with the various existing and evolving standards could negatively affect our ability to sell our products |
| 24 OUR BUSINESS COULD SUFFER IF WE ARE UNABLE TO OBTAIN COMPONENTS OF OUR PRODUCTS FROM OUTSIDE SUPPLIERS The major components of our products include circuit boards, microprocessors, chipsets and memory components |
| Most of these components are available from multiple sources |
| However, we currently obtain some components used in our products from single or limited sources |
| Some modem chipsets used in our data communications equipment products have been in short supply and are frequently on allocation by semiconductor manufacturers |
| We have, from time to time, experienced difficulty in obtaining some components |
| We do not have guaranteed supply arrangements with any of our suppliers, and there can be no assurance that our suppliers will continue to meet our requirements |
| Further, disruption in transportation services as a result of enhanced security measures in response to terrorism threats or attacks may cause some increases in costs and timing for both our receipt of components and shipment of products to our customers |
| If our existing suppliers are unable to meet our requirements, we could be required to alter product designs to use alternative components or, if alterations are not feasible, we could be required to eliminate products from our product line |
| Shortages of components could not only limit our product line and production capacity but also could result in higher costs due to the higher costs of components in short supply or the need to use higher cost substitute components |
| Significant increases in the prices of components could adversely affect our results of operations because our products compete on price and, therefore, we may not be able to adjust product pricing to reflect the increases in component costs |
| Also, an extended interruption in the supply of components or a reduction in their quality or reliability would adversely affect our financial condition and results of operations by impairing our ability to timely deliver quality products to our customers |
| Delays in deliveries due to shortages of components or other factors may result in cancellation by our customers of all or part of their orders |
| Although customers who purchase from us products, such as many of our digital switches and all of our custom power supplies, that are not readily available from other sources would be less likely than other customers of ours to cancel their orders due to production delays, we cannot assure you that cancellations would not occur |
| FINANCIAL STATEMENTS OF OUR FOREIGN SUBSIDIARIES ARE PREPARED USING THE RELEVANT FOREIGN CURRENCY THAT MUST BE CONVERTED INTO UNITED STATES DOLLARS FOR INCLUSION IN OUR CONSOLIDATED FINANCIAL STATEMENTS AS A RESULT, EXCHANGE RATE FLUCTUATIONS MAY ADVERSELY AFFECT OUR REPORTED RESULTS OF OPERATIONS We have established and acquired international subsidiaries that prepare their balance sheets in the relevant foreign currency |
| In order to be included in our consolidated financial statements, these balance sheets are converted, at the then current exchange rate, into United States dollars, and the statements of operations are converted using weighted average exchange rates for the applicable period |
| Accordingly, fluctuations of the foreign currencies relative to the United States dollar could affect our consolidated financial statements |
| Our exposure to fluctuations in currency exchange rates has increased as a result of the growth of our international subsidiaries |
| Sales of our products and services to customers located outside of the United States accounted for approximately 49dtta7prca of our net sales for 2005 |
| We use derivatives to manage foreign currency rate risk |
| Our ultimate realized gain or loss with respect to currency fluctuations will depend on the currency exchange rates and other factors in effect as the contracts mature |
| Net foreign exchange transaction gains included in other income and expense in our consolidated statements of operations totaled dlra123cmam000 for 2005 |
| 25 BECAUSE WE BELIEVE THAT PROPRIETARY RIGHTS ARE MATERIAL TO OUR SUCCESS, MISAPPROPRIATION OF THESE RIGHTS COULD ADVERSELY AFFECT OUR FINANCIAL CONDITION Our future success will be highly dependent on proprietary technology, particularly in our communications equipment business |
| However, we do not hold any patents and we currently rely on a combination of contractual rights, copyrights, trademarks and trade secrets to protect our proprietary rights |
| Our management believes that because of the rapid pace of technological change in the industries in which we operate, the legal intellectual property protection for our products is a less significant factor in our success than the knowledge, abilities and experience of our employees, the frequency of our product enhancements, the effectiveness of our marketing activities and the timeliness and quality of our support services |
| Consequently, we rely to a great extent on trade secret protection for much of our technology |
| However, there can be no assurance that our means of protecting our proprietary rights will be adequate or that our competitors or customers will not independently develop comparable or superior technologies or obtain unauthorized access to our proprietary technology |
| Our financial condition would be adversely affected if we were to lose our competitive position due to our inability to adequately protect our proprietary rights as our technology evolves |
| OUR COMMON STOCK PRICE HAS BEEN VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES FOR INVESTORS PURCHASING SHARES OF OUR COMMON STOCK AND IN LITIGATION AGAINST US The market prices of securities of technology-based companies currently are highly volatile |
| The market price of our common stock has fluctuated significantly in the past |
| In fact, during 2005, the high and low closing sale prices of a share of our common stock were dlra2dtta34 and dlra0dtta91, respectively |
| Between January 1, 2006 and March 23, 2006, the high and low closing sale prices of a share of our common stock were dlra1dtta46 and dlra1dtta15, respectively |
| The market price of our common stock may continue to fluctuate in response to the following factors, many of which are beyond our control: o changes in market valuations of similar companies and stock market price and volume fluctuations generally; o economic conditions specific to the electronic components or communications equipment industries; o announcements by us or our competitors of new or enhanced products, technologies or services or significant contracts, acquisitions, strategic relationships, joint ventures or capital commitments; o delays in our introduction of new products or technological innovations or problems in the functioning of these new products or innovations; o third parties &apos infringement of our intellectual property rights; o changes in our pricing policies or the pricing policies of our competitors; o foreign currency translations gains or losses; o regulatory developments; o fluctuations in our quarterly or annual operating results; o additions or departures of key personnel; and 26 o future sales of our common stock or other securities |
| The price at which you purchase shares of common stock may not be indicative of the price of our stock that will prevail in the trading market |
| You may be unable to sell your shares of common stock at or above your purchase price, which may result in substantial losses to you |
| Moreover, in the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities |
| We may in the future be the target of similar litigation |
| Securities litigation could result in substantial costs and divert managementapstas attention and resources |
| FUTURE SALES OF SHARES OF OUR COMMON STOCK BY OUR STOCKHOLDERS COULD CAUSE OUR STOCK PRICE TO DECLINE We cannot predict the effect, if any, that market sales of shares of our common stock or the availability of shares of common stock for sale will have on the market price prevailing from time to time |
| As of March 24, 2006, we had outstanding 37cmam911cmam750 shares of common stock and options and warrants to purchase an aggregate of 6cmam258cmam433 shares of common stock |
| A substantial number of these outstanding shares of common stock and shares of common stock underlying the options and warrants are registered for issuance or public resale under existing registration statements |
| Sales of shares of our common stock in the public market, or the perception that those sales may occur, could cause the trading price of our common stock to decrease or to be lower than it might be in the absence of those shares or perceptions |