UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended March 31, 2010
OR
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o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period from ____________ to ____________
Commission file number: 001-31783
RAE SYSTEMS INC.
(Exact name of registrant as specified in its charter)
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Delaware
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77-0280662
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(State or other jurisdiction of
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(I.R.S. Employer
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incorporation or organization)
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Identification No.)
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3775 North First Street
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San Jose, California
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95134
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(Address of principal executive offices)
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(Zip Code)
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408-952-8200
(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):
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Large accelerated filer
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Accelerated filer
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Non-accelerated filer
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(Do not check if a smaller reporting company)
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Smaller reporting company
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes
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No
þ
Indicate the number of shares outstanding of each of the issuers classes of common stock, as
of the latest practicable date.
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Class
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Outstanding at April 30, 2010
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Common stock, $0.001 par value per share
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59,438,328 shares
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PART I. Financial Information
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Item 1.
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Financial Statements
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RAE Systems Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share and par value data)
(unaudited)
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March 31,
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December 31,
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2010
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2009
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ASSETS
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Current assets:
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Cash and cash equivalents
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$
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18,351
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$
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18,528
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Restricted cash
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2,146
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2,146
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Trade notes receivable
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1,998
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2,039
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Accounts receivable, net of allowances of $5,413 and $5,380, respectively
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17,762
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19,428
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Accounts receivable from affiliate
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235
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322
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Inventories
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12,325
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12,068
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Prepaid expenses and other current assets
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3,778
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3,983
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Income taxes receivable
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659
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659
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Total current assets
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57,254
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59,173
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Property and equipment, net
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16,022
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15,590
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Intangible assets, net
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2,202
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2,428
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Investments in unconsolidated affiliates
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306
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358
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Other assets
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552
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1,325
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Total assets
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$
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76,336
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$
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78,874
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LIABILITIES AND SHAREHOLDERS EQUITY
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Current liabilities:
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Accounts payable
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$
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5,842
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$
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6,454
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Accounts payable to affiliate
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47
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92
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Bank lines of credit
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4,020
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4,026
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Accrued liabilities
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14,388
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15,753
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Notes payable to related parties, current
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380
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370
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Income taxes payable
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310
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199
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Deferred revenue, current
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492
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603
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Total current liabilities
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25,479
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27,497
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Deferred revenue, non-current
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554
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615
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Deferred tax liabilities, non-current
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156
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156
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Long-term debt
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1,463
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1,463
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Deferred gain on sale of real estate, non-current
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4,285
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4,444
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Other long-term liabilities
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832
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781
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Notes payable to related parties, non-current
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361
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363
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Total liabilities
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33,130
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35,319
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COMMITMENTS AND CONTINGENCIES (NOTE 5)
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SHAREHOLDERS EQUITY:
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Common
stock, $0.001 par value, 200,000,000 shares authorized; 59,438,328 and 59,438,328 shares issued and outstanding, respectively
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59
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59
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Additional paid-in capital
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64,186
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63,832
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Accumulated other comprehensive income
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6,549
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6,844
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Accumulated deficit
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(32,070
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)
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(31,706
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)
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Total RAE Systems Inc. shareholders equity
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38,724
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39,029
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Noncontrolling interest
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4,482
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4,526
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Total shareholders equity
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43,206
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43,555
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Total liabilities and shareholders equity
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$
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76,336
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$
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78,874
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See accompanying notes to condensed consolidated financial statements.
3
RAE Systems Inc.
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
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Three Months Ended
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March 31,
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2010
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2009
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Net sales
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$
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18,795
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$
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19,113
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Cost of sales
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8,606
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9,783
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Gross profit
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10,189
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9,330
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Operating expenses:
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Sales and marketing
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4,658
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4,382
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Research and development
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1,687
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1,595
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General and administrative
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4,098
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4,413
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Total operating expenses
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10,443
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10,390
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Operating loss
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(254
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)
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(1,060
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)
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Other income (expense):
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Interest income
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23
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9
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Interest expense
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(51
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(145
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Other, net
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54
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(61
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Equity in loss of unconsolidated affiliate
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(51
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(67
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)
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Loss before income taxes
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(279
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)
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(1,324
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)
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Income tax (expense) benefit
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(129
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)
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41
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Net loss
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(408
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)
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(1,283
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)
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Net loss attributable to the noncontrolling interest
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44
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295
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Net loss attributable to RAE Systems Inc.
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$
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(364
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$
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(988
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Net loss per share-basic and diluted
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$
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(0.01
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$
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(0.02
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)
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Weighted- average common shares outstanding-basic and diluted
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59,405
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59,343
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See accompanying notes to condensed consolidated financial statements.
4
RAE Systems Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
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Three Months Ended March 31,
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2010
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2009
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CASH FLOWS FROM OPERATING ACTIVITIES:
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Net loss
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$
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(408
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)
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$
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(1,283
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)
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Adjustments to reconcile net loss to net cash provided by operating activities:
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Depreciation and amortization
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714
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896
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Gain on disposal of property and equipment
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(144
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)
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(158
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Stock based compensation expense
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354
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364
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Equity in loss of unconsolidated affiliate
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51
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67
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Deferred income taxes
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(83
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)
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Amortization of discount on notes payable to related parties
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3
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13
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Changes in operating assets and liabilities:
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Accounts receivable
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1,544
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2,797
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Accounts receivable from affiliate
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86
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(41
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)
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Trade notes receivable
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36
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(75
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)
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Inventories
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(333
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)
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1,399
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Prepaid expenses and other current assets
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188
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645
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Income taxes receivable
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(84
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)
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Other assets
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120
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94
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Accounts payable
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(628
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)
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(830
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)
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Accounts payable to affiliate
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(46
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)
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(175
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)
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Accrued liabilities
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(1,471
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)
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(1,794
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)
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Income taxes payable
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116
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33
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Deferred revenue
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(172
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)
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(123
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)
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Other liabilities
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59
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(79
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)
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Net cash provided by operating activities
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69
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1,583
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CASH FLOWS FROM INVESTING ACTIVITIES:
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Acquisition of property and equipment
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(133
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)
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(1,782
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)
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Net cash
used in investing activities
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(133
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)
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(1,782
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)
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CASH FLOWS FROM FINANCING ACTIVITIES:
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Proceeds from bank loans
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1,167
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Payments on notes payable to related parties
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(4
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)
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(988
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)
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Net cash (used in) provided by financing activities
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(4
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)
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179
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Effect of exchange rate changes on cash and cash equivalents
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(109
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)
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(122
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)
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Increase (decrease) in cash and cash equivalents
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(177
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)
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(142
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)
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Cash and cash equivalents at beginning of period
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18,528
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14,845
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Cash and cash equivalents at end of period
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$
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18,351
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$
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14,703
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Supplemental disclosure of cash flow information:
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Cash paid for interest
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$
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90
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$
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278
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Cash paid for taxes, net
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59
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194
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|
Non-cash investing and financing activities:
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Unpaid property and equipment
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186
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See accompanying notes to condensed consolidated financial statements.
5
Notes to Condensed Consolidated Financial Statements
(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 United States Foreign Corrupt Practices Act (FCPA). The Company is
cooperating with the DOJ and the SEC in connection with their review of the matter and is actively
engaged in settlement discussions. Although no assurances can be given as to whether the matter
will settle or the amount of any settlement, the Company accrued $3.5 million in the third quarter
of 2009 for the potential settlement of this matter.
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, results of operations and its 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 31, 2009, 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, 2009.
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,
2009, 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
6
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. Revenues related to services performed under the
Companys extended warranty program are 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.
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 continuing operations of recording stock-based
compensation by function for the three months ended March 31, 2010 and 2009 was as follows:
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|
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Three Months Ended
|
|
|
|
March 31,
|
|
(in thousands)
|
|
2010
|
|
|
2009
|
|
Cost of sales
|
|
$
|
23
|
|
|
$
|
15
|
|
Sales and marketing
|
|
|
33
|
|
|
|
18
|
|
Research and development
|
|
|
36
|
|
|
|
80
|
|
General and administrative
|
|
|
262
|
|
|
|
251
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
354
|
|
|
$
|
364
|
|
|
|
|
|
|
|
|
The following is a summary of options (
in thousands, except weighted-average exercise
price
):
|
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|
|
|
|
|
|
|
|
|
Options Outstanding
|
|
|
Number
|
|
Weighted- Average
|
|
|
of Shares
|
|
Exercise Price
|
Balance as of January 1, 2010
|
|
|
5,393
|
|
|
$
|
1.97
|
|
Granted
|
|
|
10
|
|
|
|
0.85
|
|
Exercised
|
|
|
|
|
|
|
|
|
Canceled
|
|
|
(4
|
)
|
|
|
0.66
|
|
|
|
|
|
|
|
|
|
|
Balance as of March 31, 2010
|
|
|
5,399
|
|
|
|
1.97
|
|
|
|
|
|
|
|
|
|
|
7
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
|
|
$
|
0.85
|
|
No stock options or restricted stock were granted in the three months ended March 31, 2009.
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, 2010, the Company has reserved 120,877 shares of common stock for issuance
under its 1993 Stock Option Plan, 2,078,877 shares under the 2002 Plan and 3,199,167 shares under
the 2007 Plan. As of March 31, 2010, 1,254,541 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 1,905,374 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 restricted 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, 2010.
As such, total outstanding non-plan stock options at March 31, 2010 were 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 the three month
periods ended March 31, 2010 and 2009, respectively, and no stock-based compensation expense
remains to be recorded related to these options.
Non-Plan Restricted Stock
In August 2006, the Company granted 536,000 shares of restricted stock to four individuals 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 quarterly over the following three years subject to
accelerated vesting in certain circumstances.
The fair market value of the Companys common shares on the dates the awards were granted
represents unrecognized stock-based compensation which is being amortized on a straight-line basis
over the vesting period of the underlying stock awards. As of March 31, 2010, $49,000 of estimated
stock-based compensation expense related to restricted stock awards remains to be recorded. That
cost is expected to be recorded during the second quarter of 2010.
8
The following is a summary of activity for the non-plan stock awards (
in thousands, except per
share amounts
):
|
|
|
|
|
|
|
|
|
|
|
Restricted Stock Awards
|
|
|
|
|
|
|
Weighted- Average
|
|
|
Number
|
|
Grant Date
|
|
|
of Shares
|
|
Fair Value
|
Unvested as of January 1, 2010
|
|
|
47
|
|
|
$
|
2.81
|
|
Granted
|
|
|
|
|
|
|
|
|
Vested
|
|
|
(16
|
)
|
|
|
2..81
|
|
Forfeited
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unvested as of March 31, 2010
|
|
|
31
|
|
|
|
2..81
|
|
|
|
|
|
|
|
|
|
|
Net Loss Per Share
Basic loss per share includes no dilution and is computed by dividing
net loss attributable to RAE Systems 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 net losses for
the quarters ended March 31, 2010 and 2009, the effect of potentially dilutive securities on
diluted net loss per share computations was anti-dilutive. The weighted-average number of
anti-dilutive shares excluded from the diluted net loss per common share calculation for the three
months ended March 31, 2010 and 2009 was 5,453,586 and 4,363,023, 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 reporting
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.
9
RAE France had total sales of $724,000 and $632,000 in the three months ended March 31, 2010
and 2009, respectively. The carrying amounts of the major classes of assets and liabilities
included in the Companys Condensed Consolidated Balance Sheets were as follows:
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
(m thousands)
|
|
2010
|
|
|
2009
|
|
Cash and cash equivalents
|
|
$
|
183
|
|
|
$
|
299
|
|
Accounts receivable
|
|
|
604
|
|
|
|
438
|
|
Inventories
|
|
|
206
|
|
|
|
198
|
|
Prepaid expenses and other current assets
|
|
|
121
|
|
|
|
142
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
1,114
|
|
|
|
1,077
|
|
Other non-current assets
|
|
|
64
|
|
|
|
77
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,178
|
|
|
$
|
1,154
|
|
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
20
|
|
|
$
|
24
|
|
Accrued liabilities
|
|
|
315
|
|
|
|
330
|
|
Income taxes payable
|
|
|
8
|
|
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
$
|
343
|
|
|
$
|
354
|
|
|
|
|
|
|
|
|
There were no restrictions or other special conditions on the assets or liabilities of
RAE France.
Recent Accounting Pronouncements
In June 2009, the FASB issued authoritative guidance for determining whether an entity is a
variable interest entity (VIE) and requires an enterprise to perform an analysis to determine
whether the enterprises variable interest or interests give it a controlling financial interest in
a VIE. Under this guidance, an enterprise has a controlling financial interest when it has a) the
power to direct the activities of a VIE that most significantly impact the entitys economic
performance and b) the obligation to absorb losses of the entity or the right to receive benefits
from the entity that could potentially be significant to the VIE. The guidance also requires an
enterprise to assess whether it has an implicit financial responsibility to ensure that a VIE
operates as designed when determining whether it has power to direct the activities of the VIE that
most significantly impact the entitys economic performance. The guidance became effective for the
Company on January 1, 2010, and requires ongoing assessments of whether an enterprise is the primary
beneficiary of a VIE as well as certain enhanced disclosures. The Company evaluated its investments
and concluded it does not have any additional variable interests which give it controlling
financial interest in a VIE; therefore, the adoption of this new standard did not have a material
impact on its financial statements.
In October 2009, the FASB issued authoritative guidance on revenue recognition that will
become effective for the Company beginning January 1, 2011, with earlier adoption permitted. Under
the new guidance on arrangements that include software elements, tangible products that have
software components that are essential to the functionality of the tangible product will no longer
be within the scope of the software revenue recognition guidance, and software-enabled products
will now be subject to other relevant revenue recognition guidance. Additionally, the FASB issued
authoritative guidance on revenue arrangements with multiple deliverables that are outside the
scope of the software revenue recognition guidance. Under the new guidance, when vendor specific
objective or third party evidence for deliverables in an arrangement cannot be determined, a best
estimate of the selling price is required to separate deliverables and allocate arrangement
consideration using the relative selling price method. The new guidance includes new disclosure
requirements on how the application of the relative selling price method affects the timing and
amount of revenue recognition. The Company is currently assessing the potential effect, if any, on
its financial statements.
In January 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-06, Fair
Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value
Instruments. ASU No. 2010-06 amends ASC 820 to require additional disclosures regarding fair value
measurements. Specifically, the ASU requires entities to disclose the amounts and reasons for
significant transfers between Level 1 and Level 2 of the fair value hierarchy, to disclose reasons
for any transfers in or out of Level 3 and to separately disclose information in the reconciliation
of recurring Level 3 measurements about purchases, sales, issuances and settlements. In addition,
the ASU amends ASC 820 to clarify certain existing disclosure requirements. Except for the
requirement to disclose information about purchases, sales, issuances and settlements in the
reconciliation of recurring Level 3 measurements separately, the amendments to ASC 820 made by ASU
No. 2010-06 are effective for interim and annual reporting periods beginning after December 15,
2009. The adoption of these provisions of ASU No. 2010-06 did not have a material impact on the
Companys condensed consolidated financial statements. The requirement to separately disclose purchases, sales,
issuances and settlements of recurring Level 3 measurements is effective for interim and annual
reporting periods beginning after December 15, 2010. The Company does not expect the adoption of
the remaining provisions of this ASU to have a material impact on the Companys condensed consolidated
financial statements.
10
Note 2. 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)
|
|
2010
|
|
|
2009
|
|
Raw materials
|
|
$
|
5,754
|
|
|
$
|
5,655
|
|
Work-in-progress
|
|
|
2,550
|
|
|
|
2,557
|
|
Finished goods
|
|
|
4,021
|
|
|
|
3,856
|
|
|
|
|
|
|
|
|
Total inventories
|
|
$
|
12,325
|
|
|
$
|
12,068
|
|
|
|
|
|
|
|
|
Prepaid expenses and other current assets
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
(in thousands)
|
|
2010
|
|
|
2009
|
|
Supplier advances and deposits
|
|
$
|
592
|
|
|
$
|
1,330
|
|
Accounts receivable from employees
|
|
|
78
|
|
|
|
81
|
|
Prepaid insurance
|
|
|
162
|
|
|
|
275
|
|
Deferred tax assets, current
|
|
|
934
|
|
|
|
934
|
|
Other current assets
|
|
|
2,012
|
|
|
|
1,363
|
|
|
|
|
|
|
|
|
Total prepaid expenses and other current assets
|
|
$
|
3,778
|
|
|
$
|
3,983
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
(in thousands)
|
|
2010
|
|
|
2009
|
|
Buildings and improvements
|
|
$
|
11,944
|
|
|
$
|
11,945
|
|
Equipment
|
|
|
4,965
|
|
|
|
4,788
|
|
Computer equipment
|
|
|
4,928
|
|
|
|
4,996
|
|
Automobiles
|
|
|
1,293
|
|
|
|
1,385
|
|
Furniture and fixtures
|
|
|
442
|
|
|
|
444
|
|
Construction in progress
|
|
|
4,340
|
|
|
|
3,468
|
|
|
|
|
|
|
|
|
|
|
|
27,912
|
|
|
|
27,026
|
|
Less: Accumulated depreciation
|
|
|
(11,890
|
)
|
|
|
(11,436
|
)
|
|
|
|
|
|
|
|
Total property and equipment, net
|
|
$
|
16,022
|
|
|
$
|
15,590
|
|
|
|
|
|
|
|
|
11
Intangible assets, net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2010
|
|
|
December 31, 2009
|
|
|
|
Gross
|
|
|
|
|
|
|
Net
|
|
|
Gross
|
|
|
|
|
|
|
Net
|
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
Carrying
|
|
|
Carrying
|
|
|
Accumulated
|
|
|
Carrying
|
|
(in thousands)
|
|
Amount
|
|
|
Amortization
|
|
|
Amount
|
|
|
Amount
|
|
|
Amortization
|
|
|
Amount
|
|
Customer list
|
|
$
|
5,453
|
|
|
$
|
(3,551
|
)
|
|
$
|
1,902
|
|
|
$
|
5,456
|
|
|
$
|
(3,376
|
)
|
|
$
|
2,080
|
|
Trade name
|
|
|
1,356
|
|
|
|
(1,056
|
)
|
|
|
300
|
|
|
|
1,356
|
|
|
|
(1,008
|
)
|
|
|
348
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
6,809
|
|
|
$
|
(4,607
|
)
|
|
$
|
2,202
|
|
|
$
|
6,812
|
|
|
$
|
(4,384
|
)
|
|
$
|
2,428
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization expense associated with intangible assets was $226,000 and $253,000 for the
three months ended March 31, 2010 and 2009, respectively. Based on the carrying amount of
intangible assets as of March 31, 2010, and assuming no future impairment of the underlying assets,
the estimated future amortization is as follows
(in thousands
):
|
|
|
|
|
Years Ended December 31,
|
|
|
|
|
Remainder of 2010
|
|
$
|
678
|
|
2011
|
|
|
638
|
|
2012
|
|
|
372
|
|
2013
|
|
|
281
|
|
2014
|
|
|
161
|
|
Thereafter
|
|
|
72
|
|
|
|
|
|
Total amortization
|
|
$
|
2,202
|
|
|
|
|
|
Accrued liabilities
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
(in thousands)
|
|
2010
|
|
|
2009
|
|
Compensation and related benefits
|
|
$
|
2,567
|
|
|
$
|
3,764
|
|
Accrued commissions
|
|
|
2,024
|
|
|
|
1,265
|
|
Accrued FCPA settlement (see Note 5)
|
|
|
3,500
|
|
|
|
3,500
|
|
Accrued professional fees
|
|
|
751
|
|
|
|
426
|
|
Customer deposits
|
|
|
836
|
|
|
|
941
|
|
Other
|
|
|
4,710
|
|
|
|
5,857
|
|
|
|
|
|
|
|
|
Total accrued liabilities
|
|
$
|
14,388
|
|
|
$
|
15,753
|
|
|
|
|
|
|
|
|
Note 3. Income Tax
The Company estimates its annual effective tax rate for the year and applies that rate to the
quarter 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 before discrete items for the three months ended March 31, 2010, was
46% of pretax loss, compared to (3)% benefit of pretax loss in the same period in 2009.
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 its tax 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.
12
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 some 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 current belief of continued weakness in the overall
market for the Companys products thereby potentially impacting the Companys ability to sustain or
grow revenues and earnings, and the length of carryback and carryforward periods.
At December 31, 2009, 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, 2010. During fiscal 2009, the
Company concluded that the operating results of one of its Chinese subsidiaries had declined and
that it was appropriate to put a full valuation allowance on the related deferred tax asset. 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 4. Comprehensive Loss
The components of comprehensive loss were as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
(in thousands)
|
|
2010
|
|
|
2009
|
|
Net loss
|
|
$
|
(408
|
)
|
|
$
|
(1,283
|
)
|
Other comprehensive income:
|
|
|
|
|
|
|
|
|
Change in foreign currency translation
|
|
|
(295
|
)
|
|
|
(144
|
)
|
|
|
|
|
|
|
|
Comprehensive loss
|
|
|
(703
|
)
|
|
|
(1,427
|
)
|
Comprehensive loss attributable to the noncontrolling interest
|
|
|
44
|
|
|
|
295
|
|
|
|
|
|
|
|
|
Comprehensive loss attributable to RAE Systems Inc.
|
|
$
|
(659
|
)
|
|
$
|
(1,132
|
)
|
|
|
|
|
|
|
|
Note 5. Commitments and Contingencies
Regulatory Compliance
During fiscal year 2008, the Companys internal audit department identified certain payments
and gifts made by certain personnel in the Companys operations in the Peoples Republic of China
(China) that may have violated the United States Foreign Corrupt Practices Act (FCPA).
Following this discovery, the Audit Committee of the Board of Directors initiated an independent
investigation. The Company has made a voluntary disclosure to the United States Department of
Justice (DOJ) and the United States Securities and Exchange Commission (SEC) regarding the results
of its investigation. The Company has 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 violations. The Company is cooperating with the
DOJ and the SEC in connection with their review of the matter and is actively engaged in settlement
discussions. Although no assurances can be given as to whether the matter will settle or the amount
of any settlement, the Company booked an accrual of $3.5 million in the third quarter of 2009
relating to the potential settlement of this matter. The timing and final outcome of this or any
future government investigation cannot be predicted with certainty and any indictment, conviction
or material fine, debarment or settlement arising out of these investigations could have a material
adverse affect on the Companys business, financial condition, results of operation and future
prospects.
13
Polimaster Ltd. et al. v. RAE Systems Inc., United States District Court for the Northern District
of California, Case No. 05-CV-01887-JF, United States Court of Appeals for the Ninth Circuit, No.
08-15708 and 09-15369
Polimaster Ltd. and Na&Se Trading Company, Ltd. (Polimaster) filed a complaint against the
Company on May 9, 2005, in the United States District Court for the Northern District of California
in a case titled Polimaster Ltd., et al. v. RAE Systems Inc. (Case No. 05-CV-01887-JF). The
complaint alleges, among other things, that the Company breached its contract with Polimaster and
infringed upon Polimasters intellectual property rights. The dispute was subject to a contractual
arbitration agreement, although the federal court retained jurisdiction over the matter pending
completion of the arbitration. The arbitration was conducted in the spring of 2007.
In September 2007, a Final Award was issued in the arbitration. The arbitrator ruled that
Polimaster failed to prove its claims and was not entitled to any relief; that the Company had
proven its counterclaims and was awarded damages of approximately $2.4 million; and that as the
prevailing party, the Company was entitled to recover costs in the amount of $46,000. On October 5,
2007, RAE Systems filed a motion to confirm the Final Award. On October 17, 2007, Polimaster filed
an opposition to RAE Systems motion to confirm the Final Award and filed its own motion to vacate
the Final Award. Both motions were heard on December 7, 2007, and the district court confirmed the
Final Award in an order dated February 25, 2008. Polimaster appealed from the district courts
order confirming the arbitration award in Polimaster Ltd. et al. v. RAE Systems Inc., No. 08-15708.
The appeal is currently pending in the United States Court of Appeals for the Ninth Circuit.
Briefing on the appeal has been completed by both sides and the appeal was argued and submitted to
the Ninth Circuit for decision on January 15, 2010.
When the district court confirmed the Final Award in favor of RAE Systems it did not enter
judgment, an omission the district court described as a non-substantive clerical error. On
September 9, 2008, the court of appeal granted leave for the district court to correct this
clerical error. On January 23, 2009, the district court entered judgment in favor of RAE Systems
and against Polimaster, and included in the judgment post-arbitration/pre-judgment interest and
post-judgment interest. Polimaster has appealed the inclusion of these two interest components in
the judgment, in Polimaster Ltd. et al. v. RAE Systems Inc., No. 09-15369, and briefing on the
appeal has been completed by both sides and the appeal was argued and submitted to the Ninth
Circuit for decision on January 15, 2010.
On May 14, 2009, Polimaster and RAE Systems entered a First Amended And Restated Stipulation
And Order Re Stay Of Execution Of Judgment In Favor Of RAE Systems Inc. (the stipulation),
pursuant to which Polimaster wire transferred $1.4 million to the client trust account of RAE
Systems counsel McLeod, Witham & Flynn LLP, and agreed to wire transfer an additional $116,224.25
per month until the entire amount deposited equals the amount of the judgment (approximately $2.8
million) plus accrued interest at the judgment rate of 0.43 percent per annum. Pursuant to the
stipulation, the amounts transferred by Polimaster are being maintained in the client trust account
of McLeod, Witham & Flynn LLP, and shall not be distributed to RAE Systems or Polimaster, until the
Ninth Circuit has ruled on Polimasters appeal (Nos. 08-15708 and 09-15369). McLeod, Witham & Flynn
LLP shall release the funds in the account to RAE Systems and/or Polimaster within seven days of
the Ninth Circuits final ruling on the appeal, in accordance with the Ninth Circuits decision.
Polimaster is currently in compliance with the payment schedule provided in the stipulation. If RAE
Systems is successful on appeal, it is expected that the Company would receive approximately $1.9
million, net of attorneys fees and expenses. The timing of a final ruling on the appeal is not
currently determinable.
14
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, 2010 and 2009, was $347,000 and $375,000, respectively. Future minimum
annual payments under non-cancellable leases were as follows as of March 31, 2010
(in thousands)
:
|
|
|
|
|
Years Ended December 31,
|
|
Operating
|
|
Remainder of 2010
|
|
$
|
1,319
|
|
2011
|
|
|
1,465
|
|
2012
|
|
|
1,345
|
|
2013
|
|
|
1,331
|
|
2014
|
|
|
1,299
|
|
Thereafter
|
|
|
3,488
|
|
|
|
|
|
Total minimum payments
|
|
$
|
10,247
|
|
|
|
|
|
In December 2004, the Company moved into its current corporate headquarters in San Jose,
California and abandoned a leased facility in Sunnyvale, California. During the second quarter of
2005, the Company accrued a restructuring reserve of approximately $2.0 million for the remaining
lease term of the former headquarters in Sunnyvale. The discount rate used was 4.85% and the
liability was not reduced for any anticipated future sublease income. In March 2007, due to
improved conditions for office rentals, the Company revised the estimated loss on abandonment of
the lease and reduced the operating expense by $595,000. During the second quarter of 2007, a
sublease was executed with rental income commencing in June 2007. Both the master lease and the
sublease expired in October 2009. Rent payments for the three months ended March 31, 2010 and 2009,
were zero and $132,000, respectively, for the Sunnyvale building with sublease income of zero and
$44,000 for the three months ended March 31, 2010 and 2009, respectively.
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 $5.3 million with the work scheduled to be completed during the first quarter 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 quarter ended March 31, 2010, $51,000 of interest expense was capitalized for
construction of the Companys new facility in Shanghai.
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.
15
Note 6. 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,
2010 and 2009, respectively:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
(in thousands)
|
|
2010
|
|
|
2009
|
|
Warranty reserve at beginning of period
|
|
$
|
926
|
|
|
$
|
707
|
|
Provision for warranty
|
|
|
129
|
|
|
|
360
|
|
Utilization of reserve
|
|
|
(258
|
)
|
|
|
(327
|
)
|
Foreign currency translation effects
|
|
|
(5
|
)
|
|
|
(5
|
)
|
|
|
|
|
|
|
|
Warranty reserve at end of period
|
|
$
|
792
|
|
|
$
|
735
|
|
|
|
|
|
|
|
|
Note 7. Bank Debt
The Company maintains credit facilities to support its operations in the United States and
China.
In the United States, the Company had a $10.0 million revolving credit agreement as of
December 31, 2009. This credit facility is renewed annually and, on April 26, 2010, was renewed to
expire on April 25, 2011. 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 and is required to maintain a compensating balance of at least $2.0 million
at all times. The compensating balance is included in Restricted cash on the Condensed Consolidated
Balance Sheets. As of March 31, 2010 and December 31, 2009, $1.8 million was outstanding against
the revolving credit agreement.
Financial covenants under the revolving credit agreement 1) require the Company to maintain
specified trailing two-quarter minimum earnings before interest, depreciation, amortization and
non-cash stock compensation expenses and 2) limits the size of potential monetary penalties under
the FCPA to $3.5 million. The Company was in compliance with these covenants as of March 31, 2010.
16
In China, the Company generally maintains one or more unsecured revolving lines of credit to
provide working capital. Borrowings under these credit facilities are generally at the current
market rate for fixed rate loans of the amount and duration requested, up to one year. The maturity
dates of such fixed rate loans may extend beyond the renewal date of the line of credit
arrangement, which governs the advance of new loans. The availability of new loans under the
Companys current line of credit will expire for annual renewal on September 20, 2010. The
following table presents the Companys total lines of credit in China for working capital and
balances drawn against each as of March 31, 2010 and December 31, 2009
(in millions)
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Chinese Renminbi
|
|
U.S. Dollars
|
|
|
|
|
|
|
|
|
Amount
|
|
Total
|
|
|
|
|
|
Amount
|
|
Total
|
|
|
|
|
Amount
|
|
Available
|
|
Line
|
|
Amount
|
|
Available
|
|
Line
|
|
Interest
|
|
|
Oustanding
|
|
for Use
|
|
of Credit
|
|
Oustanding
|
|
for Use
|
|
of Credit
|
|
Rate
|
March 31, 2010:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Due October 12, 2010
|
|
|
15.0
|
|
|
|
5.0
|
|
|
|
20.0
|
|
|
|
2.2
|
|
|
|
0.7
|
|
|
|
2.9
|
|
|
|
5.04
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15.0
|
|
|
|
5.0
|
|
|
|
20.0
|
|
|
|
2.2
|
|
|
|
0.7
|
|
|
|
2.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Due October 12, 2010
|
|
|
15.0
|
|
|
|
5.0
|
|
|
|
20.0
|
|
|
|
2.2
|
|
|
|
0.7
|
|
|
|
29
|
|
|
|
5.04
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15.0
|
|
|
|
5.0
|
|
|
|
20.0
|
|
|
|
2.2
|
|
|
|
0.7
|
|
|
|
29
|
|
|
|
|
|
Term Loan
On November 9, 2009,
RAE Fushun, the Companys 70% owned subsidiary in Fushun, China, borrowed RMB 10.0 million, or approximately $1.5
million, to provide working capital for its operations. The loan is
due on April 26, 2011 and bears interest at a fixed rate of 8.1% for 12 months. The interest rate
will be reset once in November 2010 at 1.5 times the Peoples Bank of China benchmark rate. Loan
repayment is guaranteed by an unrelated third party, to whom RAE Fushun has granted a lien which
includes the wholly owned plant and associated land rights. As a condition of the loan, the lending
bank required a deposit of approximately $0.1 million from the guarantor. This deposit was funded
by RAE Fushun from the loan proceeds and is included in Restricted Cash on the Consolidated Balance
Sheets.
Note 8. 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, 2010 and
December 31, 2009 was $288,000 and $339,000, respectively. The Company recorded losses of $51,000
and $67,000 on its equity interest in Renex for the three months ended March 31, 2010 and 2009,
respectively.
In conjunction with the 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. As
of March 31, 2010 and December 31, 2009, $380,000 and $370,000, respectively, was included in
current notes payable to related parties in the Companys Condensed Consolidated Balance Sheets and
$361,000 and $363,000, respectively, was included in long term notes payable to related parties.
The remaining scheduled annual payments of principal and accrued interest under these notes from
2010 through maturity in 2011 are $380,000 and $361,000, respectively.
In conjunction with the investment in RAE Beijing in July 2006, 11.0 million shares of
RAE Beijing preferred stock were issued to four shareholders of RAE Beijing. In accordance with the
authoritative accounting guidance, these preferred shares were classified as liabilities and were
recorded as notes payable to related parties. Although these preferred shares bear a dividend yield
rate of 3% per annum, the notes payable were discounted using a market interest rate of 6.48%.
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.
17
The Liaoning Coal Industry Group, Ltd. (Liaoning Group) owns a 30% interest in RAE Fushun
and, on occasion, has also been a supplier to RAE Fushun.
Transactions and balances with the Companys related parties were as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31,
|
|
(in thousands)
|
|
2010
|
|
|
2009
|
|
Sales:
|
|
|
|
|
|
|
|
|
Renex
|
|
$
|
95
|
|
|
$
|
105
|
|
RAE Australia
|
|
|
335
|
|
|
|
|
|
RAE Benelux
|
|
|
517
|
|
|
|
459
|
|
RAE Spain
|
|
|
80
|
|
|
|
50
|
|
|
|
|
|
|
|
|
|
|
$
|
1,027
|
|
|
$
|
614
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases:
|
|
|
|
|
|
|
|
|
Liaoning Group
|
|
$
|
|
|
|
$
|
|
|
Renex
|
|
|
74
|
|
|
|
47
|
|
|
|
|
|
|
|
|
|
|
$
|
74
|
|
|
$
|
47
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2010
|
|
|
2009
|
|
Accounts receivable:
|
|
|
|
|
|
|
|
|
Renex
|
|
$
|
235
|
|
|
$
|
322
|
|
RAE Australia
|
|
|
154
|
|
|
|
59
|
|
RAE Benelux
|
|
|
195
|
|
|
|
253
|
|
RAE Spain
|
|
|
99
|
|
|
|
119
|
|
|
|
|
|
|
|
|
|
|
$
|
683
|
|
|
$
|
753
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable:
|
|
|
|
|
|
|
|
|
Liaoning Group
|
|
$
|
|
|
|
$
|
14
|
|
Renex
|
|
|
47
|
|
|
|
92
|
|
|
|
|
|
|
|
|
|
|
$
|
47
|
|
|
$
|
106
|
|
|
|
|
|
|
|
|
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 $31,000 and $30,000 for the three
months ended March 31, 2010 and 2009, 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 9. 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.
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.
18
The carrying amounts and fair values of the Companys financial assets and liabilities were as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2010
|
|
December 31, 2009
|
|
|
|
|
|
|
Carrying
|
|
|
|
|
|
Carrying
|
|
|
|
|
Category
|
|
Amounts
|
|
Fair Value
|
|
Amounts
|
|
Fair Value
|
|
|
(In thousands)
|
Cash and cash equivalents
|
|
Level 1
|
|
$
|
18,351
|
|
|
$
|
18,351
|
|
|
$
|
18,528
|
|
|
$
|
18,528
|
|
Restricted cash
|
|
Level 1
|
|
|
2,146
|
|
|
|
2,146
|
|
|
|
2,145
|
|
|
|
2,146
|
|
Notes payable to
related parties
|
|
Level 2
|
|
|
741
|
|
|
|
741
|
|
|
|
733
|
|
|
|
733
|
|
Note 10. Shareholders Equity
The following table is a summary of the changes in equity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
Three Months Ended March 31,
|
|
|
|
2010
|
|
|
2009
|
|
|
|
RAE Systems
|
|
|
|
|
|
|
|
|
|
|
RAE Systems
|
|
|
|
|
|
|
|
|
|
Shareholders
|
|
|
Noncontrolling
|
|
|
Total
|
|
|
Shareholders
|
|
|
Noncontrolling
|
|
|
Total
|
|
(in thousands)
|
|
Equity
|
|
|
Interest
|
|
|
Equity
|
|
|
Equity
|
|
|
Interest
|
|
|
Equity
|
|
Equity, Beginning of Period
|
|
$
|
39,029
|
|
|
$
|
4,526
|
|
|
$
|
43,555
|
|
|
$
|
43,216
|
|
|
$
|
5,481
|
|
|
$
|
48,697
|
|
Net loss
|
|
|
(364
|
)
|
|
|
(44
|
)
|
|
|
(408
|
)
|
|
|
(988
|
)
|
|
|
(295
|
)
|
|
|
(1,283
|
)
|
Translation adjustments
|
|
|
(295
|
)
|
|
|
|
|
|
|
(295
|
)
|
|
|
(144
|
)
|
|
|
|
|
|
|
(144
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive (loss) income
|
|
|
(659
|
)
|
|
|
(44
|
)
|
|
|
(703
|
)
|
|
|
(1,132
|
)
|
|
|
(295
|
)
|
|
|
(1,427
|
)
|
Stock-based compensation expense
|
|
|
354
|
|
|
|
|
|
|
|
354
|
|
|
|
364
|
|
|
|
|
|
|
|
364
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity, End of Period
|
|
$
|
38,724
|
|
|
$
|
4,482
|
|
|
$
|
43,206
|
|
|
$
|
42,448
|
|
|
$
|
5,186
|
|
|
$
|
47,634
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
19
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. With the formation of RAE
Fushun, we are serving the coal mine safety equipment market in China.
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. Second,
in December 2006, we formed RAE Fushun, a joint venture with Fushun Anyi, a former state owned
company serving the coal mine safety market. This joint venture was formed to capitalize on Chinas
growing reliance on coal based energy. RAE Fushun manufactures and sells coal mine safety
equipment. RAE Systems owns 70% of the joint venture.
In China, our focus is on growing the environmental protection market and the industrial
sector, including oil and gas, petro-chemicals, steel, telecommunications and coal mining. A major
priority will be to introduce new products for the coal mine safety market through RAE Fushun. We
believe this market will provide us a number of new business opportunities, as China continues to
modernize its coal mining industry.
We offer a complete line of products to meet the requirements of the various markets 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).
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 technology 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
In 2008, we introduced eight new products. We now offer a complete line of products to serve
the personnel safety, regulated worker safety and detection needs of the global energy market.
Products range from breathing zone single sensor products for specific toxic chemicals (ToxiRAE 3
and AutoRAE Lite Calibration Station) to belt worn multi-gas monitors (QRAE II with AutoRAE Lite
Calibration Station, and MultiRAE Plus) to handheld instruments (MiniRAE 3000, MiniRAE Lite, ppbRAE
3000 and UltraRAE) to measure total and specific volatile organic compounds, to wireless monitors
for wireless industrial and public safety applications
20
(AreaRAE Steel, RAELink3 and MeshGuard) as
well as fixed monitors (RAEGuard, RAEGuard-S, RAEGuard PID and FMC Series Controllers) for
deployment in factory or safety process management.
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 the first quarter of 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 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.
The Company remains actively engaged in discussions with the Department of Justice and the
Securities and Exchange Commission to settle the outstanding joint investigation into the Companys
alleged violations of the FCPA.
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.
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, history of adjustments, 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.
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 nine months.
21
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 have established inventory reserves when
conditions exist that suggest that our inventory may be in excess of anticipated demand or is
obsolete based upon assumptions about future demand for our products and market conditions. When
recorded, reserves 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 reserves may be required.
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.
Business Combinations
In accordance with business combination accounting standards, we allocate the purchase price
of acquired companies to the tangible and intangible assets acquired and liabilities assumed based
on their estimated fair values at the date of acquisition. We typically engage third-party
appraisal firms to assist management in determining the fair values of certain assets acquired and
liabilities assumed. Such a valuation requires management to make significant estimates and
assumptions, especially with respect to intangible assets and goodwill.
Management makes estimates of fair value based upon assumptions believed to be reasonable.
Fair value estimates are based on historical experience and information obtained from the
management of the acquired companies and the estimates are inherently uncertain. Critical estimates
in valuing certain of the intangible assets include, but are not limited to: discount rates; future
expected cash flows from maintenance agreements, customer contracts, acquired developed
technologies and pending patents; expected costs to develop the in-process research and development
into commercially viable products and estimating cash flows from these projects when completed; the
acquired companys brand awareness and market position; and assumptions about the period of time an
acquired brand will continue to be used in the combined companys product portfolio. Unanticipated
events and circumstances may occur which may affect the accuracy or validity of such assumptions,
estimates or actual results.
Income Taxes
We are subject to income taxes in both 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 differ from statutory rates primarily due to foreign earnings taxed at
lower rates, losses not benefited, non-deductible share-based compensation deductions 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.
22
Recent Accounting Pronouncements
In June 2009, the FASB issued authoritative guidance for determining whether an entity is a
variable interest entity (VIE) and requires an enterprise to perform an analysis to determine
whether the enterprises variable interest or interests give it a controlling financial interest in
a VIE. Under this guidance, an enterprise has a controlling financial interest when it has a) the
power to direct the activities of a VIE that most significantly impact the entitys economic
performance and b) the obligation to absorb losses of the entity or the right to receive benefits
from the entity that could potentially be significant to the VIE. The guidance also requires an
enterprise to assess whether it has an implicit financial responsibility to ensure that a VIE
operates as designed when determining whether it has power to direct the activities of the VIE that
most significantly impact the entitys economic performance. The guidance became effective January
1, 2010, and requires ongoing assessments of whether an enterprise is the primary beneficiary of a
VIE as well as certain enhanced disclosures. We evaluated our investments and concluded that we do
not have any additional variable interests which give us a controlling financial interest in a VIE;
therefore, the adoption of this new standard did not have a material impact on our financial
statements.
In October 2009, the FASB issued authoritative guidance on revenue recognition that will
become effective for the Company beginning January 1, 2011, with earlier adoption permitted. Under
the new guidance on arrangements that include software elements, tangible products that have
software components that are essential to the functionality of the tangible product will no longer
be within the scope of the software revenue recognition guidance, and software-enabled products
will now be subject to other relevant revenue recognition guidance. Additionally, the FASB issued
authoritative guidance on revenue arrangements with multiple deliverables that are outside the
scope of the software revenue recognition guidance. Under the new guidance, when vendor specific
objective or third party evidence for deliverables in an arrangement cannot be determined, a best
estimate of the selling price is required to separate deliverables and allocate arrangement
consideration using the relative selling price method. The new guidance includes new disclosure
requirements on how the application of the relative selling price method affects the timing and
amount of revenue recognition. The Company is currently assessing the potential effect, if any, on
its financial statements.
In January 2010, the FASB issued Accounting Standards Update (ASU) No. 2010-06, Fair Value
Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Instruments. ASU
No. 2010-06 amends ASC 820 to require additional disclosures regarding fair value measurements.
Specifically, the ASU requires entities to disclose the amounts and reasons for significant
transfers between Level 1 and Level 2 of the fair value hierarchy, to disclose reasons for any
transfers in or out of Level 3 and to separately disclose information in the reconciliation of
recurring Level 3 measurements about purchases, sales, issuances and settlements. In addition, the
ASU amends ASC 820 to clarify certain existing disclosure requirements. Except for the
requirement to disclose information about purchases, sales, issuances and settlements in the
reconciliation of recurring Level 3 measurements separately, the amendments to ASC 820 made by ASU
No. 2010-06 are effective for interim and annual reporting periods beginning after December 15,
2009. The adoption of these provisions of ASU No. 2010-06 did not have a material impact on
our condensed consolidated financial statements. The requirement to separately disclose purchases,
sales, issuances and settlements of recurring Level 3 measurements is effective for interim and
annual reporting periods beginning after December 15, 2010. We do not expect the
adoption of the remaining provisions of this ASU to have a material impact on our
consolidated financial statements.
Results of Operations
Net Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
Percentage
|
(in thousands)
|
|
2010
|
|
2009
|
|
Change
|
|
Change
|
Net sales
|
|
$
|
18,795
|
|
|
$
|
19,113
|
|
|
$
|
(318
|
)
|
|
|
-2
|
%
|
Net sales for the quarter ended March 31, 2010, decreased by $0.3 million or 2% compared with
the quarter ended March 31, 2009. Sales increased $0.2 million or 3% in Americas, which was offset
by a decrease of 0.5 million or 7% in Asia. Sales in Europe and the Middle-East were flat during
the quarter ended March 31, 2010, compared with the quarter ended March 31, 2009.
23
Cost of Sales & Gross Margin
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
Percentage
|
(in thousands)
|
|
2010
|
|
2009
|
|
Change
|
|
Change
|
Cost of sales
|
|
$
|
8,606
|
|
|
$
|
9,783
|
|
|
$
|
(1,177
|
)
|
|
|
-12
|
%
|
Gross profit
|
|
$
|
10,189
|
|
|
$
|
9,330
|
|
|
$
|
859
|
|
|
|
9
|
%
|
Gross margin
|
|
|
54
|
%
|
|
|
49
|
%
|
|
|
|
|
|
|
|
|
Cost of sales for the quarter ended March 31, 2010, decreased by $1.2 million or 12% compared
with the quarter ended March 31, 2009, primarily due to product mix changes. Gross profit for the
quarter ended March 31, 2010, increased by $0.9 million or 9% compared with the quarter ended March
31, 2009, due to a favorable product mix improvement, that included an increase in sales of
multi-gas products, sensors and accessories, and the sale of Digital Mine Safety systems sold by
the Companys Fushun, China operations.
Additionally, inventory adjustments, during the quarter ended March 31, 2010, compared
with the quarter ended March 31, 2009, were approximately $0.5 million lower. The
adjustments consisted primarily of additional provisions during the quarter ended March
31, 2009, for inventory obsolescence and anticipated warranty obligations.
Sales and Marketing Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
Percentage
|
(in thousands)
|
|
2010
|
|
2009
|
|
Change
|
|
Change
|
Sales and marketing
|
|
$
|
4,658
|
|
|
$
|
4,382
|
|
|
$
|
276
|
|
|
|
6
|
%
|
Percentage of net sales
|
|
|
25
|
%
|
|
|
23
|
%
|
|
|
|
|
|
|
|
|
Sales and marketing expenses increased by $0.3 million or 6% for the quarter ended March
31, 2010, compared with the quarter ended March 31, 2009. The increase in expense was due to
marketing activities to improve sales management information and web service capabilities.
Research and Development Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
Percentage
|
(in thousands)
|
|
2010
|
|
2009
|
|
Change
|
|
Change
|
Research and development
|
|
$
|
1,687
|
|
|
$
|
1,595
|
|
|
$
|
92
|
|
|
|
6
|
%
|
Percentage of net sales
|
|
|
9
|
%
|
|
|
8
|
%
|
|
|
|
|
|
|
|
|
Research and development expenses increased by approximately $0.1 million or 6% during
the quarter ended March 31, 2010, compared with the quarter ended March 31, 2009. The increase was
primarily due to engineering investments in the Digital Mine safety products being sold in China.
General and Administrative Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
Percentage
|
(in thousands)
|
|
2010
|
|
2009
|
|
Change
|
|
Change
|
General and administrative
|
|
$
|
4,098
|
|
|
$
|
4,413
|
|
|
$
|
(315
|
)
|
|
|
-7
|
%
|
Percentage of net sales
|
|
|
22
|
%
|
|
|
23
|
%
|
|
|
|
|
|
|
|
|
General and administrative expenses decreased by $0.3 million or 7% in the quarter ended
March 31, 2010, compared with the quarter ended March 31, 2009. The decrease was primarily due to
the collection of accounts receivable that had been previously written off as bad debt in March 31,
2009.
24
Other Income (Expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
|
Percentage
|
|
(in thousands)
|
|
2010
|
|
|
2009
|
|
|
Change
|
|
|
Change
|
|
Interest income
|
|
$
|
23
|
|
|
$
|
9
|
|
|
$
|
14
|
|
|
|
156
|
%
|
Interest expense
|
|
|
(51
|
)
|
|
|
(145
|
)
|
|
|
94
|
|
|
|
65
|
%
|
Other, net
|
|
|
54
|
|
|
|
(61
|
)
|
|
|
115
|
|
|
|
189
|
%
|
Equity in loss of unconsolidated affiliate
|
|
|
(51
|
)
|
|
|
(67
|
)
|
|
|
16
|
|
|
|
-24
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other income (expense)
|
|
$
|
(25
|
)
|
|
$
|
(264
|
)
|
|
$
|
239
|
|
|
|
91
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the quarter ended March 31, 2010, Total other (expense) decreased by $0.2 million or
91% compared with the quarter ended March 31, 2009. The change was primarily due to lower interest
expense related amounts due to the notes to the former shareholders of RAE Beijing, interest
expense capitalized related to the construction in progress on the Companys facility in Shanghai,
China and the result of foreign exchange gains in Asia and Europe.
Income Tax Benefit (Expense)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
Percentage
|
(in thousands)
|
|
2010
|
|
2009
|
|
Change
|
|
Change
|
Income tax benefit (expense)
|
|
$
|
(129
|
)
|
|
$
|
41
|
|
|
$
|
(170
|
)
|
|
|
-415
|
%
|
Effective tax rate
|
|
|
46
|
%
|
|
|
-3
|
%
|
|
|
|
|
|
|
|
|
Income tax expense after discrete items for the three months ended March 31, 2010, was
$129,000 compared to an income tax benefit of $41,000 for the three months ended March 31, 2009. At
December 31, 2009 and March 31, 2010, 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 2010 differed from the U.S. statutory rate primarily due
to foreign earnings taxed at lower rates, losses not benefited, nondeductible stock compensation
deductions and additional provisions for uncertain tax positions applicable to fiscal year 2010.
Included in the tax expense for the three months ended March 31, 2010, were discrete tax expense
items of $15,000 related to the accrual of interest related to various uncertain tax benefits,
state and local taxes of $9,000, and prior years true-ups of ($62,000).
Net Loss Attributable to the Noncontrolling Interest
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
|
|
|
Percentage
|
(in thousands)
|
|
2010
|
|
2009
|
|
Change
|
|
Change
|
Net loss (income) attributable to the noncontrolling interest
|
|
$
|
44
|
|
|
$
|
295
|
|
|
$
|
(251
|
)
|
|
|
-85
|
%
|
For the quarter ended March 31, 2010, the noncontrolling interest in the operating loss
of consolidated subsidiaries decreased approximately $251,000 from a loss of $295,000 for the
quarter ended March 31, 2009. The decrease was primarily due to the losses incurred in RAE Fushun,
being lower during the quarter ended March 31, 2010, compared
with losses incurred in RAE Fushun
during the quarter ended March 31, 2009. The noncontrolling ownership was 4% of RAE Beijing, 30% of
RAE Fushun and 51% of RAE France.
25
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, 2010, we had $18.4 million
in cash and cash equivalents compared with $18.5 million on December 31, 2009.
At March 31, 2010, we had $31.8 million in working capital (current assets less current
liabilities) and a current ratio (ratio of current assets to current liabilities) of 2.2 to 1.0
compared to $31.7 million of working capital and a current ratio of 2.2 to 1.0 at December 31,
2009.
In the United States, we have a $10.0 million revolving credit agreement. This credit facility
is renewed annually and, on April 26, 2010, was renewed to expire on April 25, 2011. 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. We must also maintain a compensating balance with the
lending bank of at least $2.0 million at all times, which is included in Restricted cash on the
Condensed Consolidated Balance Sheets. As of March 31, 2010 and December 31, 2009, $1.8 million was
outstanding against the revolving credit agreement in the United States.
Financial covenants under the revolving credit agreement 1) require us to maintain specified
trailing two-quarter minimum earnings before interest, depreciation, amortization and non-cash
stock compensation expenses and 2) limits the size of potential monetary penalties under the FCPA
to $3.5 million. We were in compliance with these covenants as of March 31, 2010.
In China as of March 31, 2010 and December 31, 2010, we had an unsecured revolving line of
credit in the amount of RMB 20.0 million or approximately $2.9 million. Borrowings under this line
of credit are available to provide working capital and are generally at the current market rate for
fixed rate loans of the amount and duration requested, up to one year. The revolving line of credit
is renewed annually. As of March 31, 2010 and December 31, 2009, RMB 15.0 million, or approximately
$2.2 million, was outstanding against the revolving line of credit in China.
In November 2009, we borrowed RMB 10.0 million, or approximately $1.5 million, for a term of
18 months to provide working capital for our 70% owned subsidiary in Fushun, China (RAE Fushun).
Loan repayment is guaranteed by an unrelated third party, to whom RAE Fushun granted a lien over
its wholly owned plant and associated land rights. As a condition of the loan, the lending bank
required a deposit of approximately $0.1 million from the guarantor. This deposit was funded by RAE
Fushun from the loan proceeds and is included in Restricted cash on the Condensed Consolidated
Balance Sheets.
Our Condensed Consolidated Statements of Cash Flows may be summarized as follows:
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Three Months Ended
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March 31,
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(in thousands)
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2010
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2009
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Net cash provided by (used in):
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Operating activities
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$
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69
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$
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1,583
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Investing activities
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(133
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)
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(1,782
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)
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Financing activities
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(4
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)
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179
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Effect of exchange rate changes on cash and cash equivalents
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(109
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)
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(122
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)
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Net increase (decrease) in cash and cash equivalents
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$
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(177
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)
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$
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(142
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)
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Operating Activities
For the quarter ended March 31, 2010, net cash provided by operating activities of $0.1
million was attributable to the following factors:
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Cash flow decreased due to the net loss of $0.4 million (including the portion
attributable to the noncontrolling interest). However, because the net loss includes
non-cash charges totaling $1 million, the net increase to cash was $0.6 million. Our
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26
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principal non-cash expenses were as follows: $0.7 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.
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The net change in operating assets and liabilities which consumed cash flow of $0.5
million. Cash was primarily provided by a reduction of $1.5 million in trade accounts
receivable. Cash was applied to reduce trade accounts payable and accrued expenses by
$0.6 million and $1.4 million respectively.
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For the three months ended March 31, 2009, net cash provided by operating activities of $1.6
million was due to the following:
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Cash decreased due to the net loss of $1.3 million (including the portion
attributable to the noncontrolling interest), which included non-cash charges totaling
$1.1 million. Our principal non-cash expenses were as follows: $0.9 million depreciation
and amortization and $0.4 million stock-based compensation. These non-cash expenses were
partially offset by $0.2 million in gains on disposal of property and equipment.
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The net change in operating assets and liabilities which generated cash of $1.8
million. Cash was primarily provided by managed reductions of $2.8 million, $1.4 million
and $0.7 million in accounts receivable, inventories and prepaid expenses, respectively.
At the same time, cash was applied to reduce accrued liabilities, accounts payable and
accounts payable to affiliates by $1.8 million, $0.8 million and $0.2 million,
respectively. Cash flow also decreased by $0.1 million due to a decline in deferred
revenues. The net change in various other operating accounts used additional cash flow
of $0.2 million during the period.
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Investing Activities
Net cash used in investing activities during the three months ended March 31, 2010, was $0.1
million compared with $1.8 million for the three months ended March 31, 2009. Cash used during the
first quarter of 2010 primarily consisted of equipment purchases to support our manufacturing
operations. Cash used during the first quarter of 2009 primarily consisted of ongoing construction
and outfitting activities at our new facility in Fushun, China and payment for land use rights in
Shanghai.
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 $5.3 million with the work scheduled to be
completed near year end. 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 that 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
In the first quarter of 2010, we paid $4,000 to reduce notes payable to related parties.
Through March 31, 2009, we made principal payments totaling $1.0 million to reduce the notes
payable to related parties for the acquisition of RAE Beijing. These payments were made from
general working capital. The next scheduled principal payment of approximately $0.4 million is due
in July 2010. We also borrowed RMB 8.0 million, or approximately $1.2 million, to acquire land use
rights in Shanghai for the construction of the new Shanghai facility discussed above.
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, the ultimate resolution of issues arising from
our internal investigation regarding potential FCPA violations 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.
27
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, 2010, we had cash and cash equivalents of $18.4 million and restricted cash of
$2.1 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 are at fixed interest rates or at rates fixed for 12 months. 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, 2010, 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, 2010, 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, 2010, a substantial portion of our recognized revenue was
generated by our Asia operations (37%) that are primarily denominated in RMB. Revenue denominated
in U.S. dollars is generated primarily from operations in the Americas (44%), and revenue from our
European operations (19%) is primarily denominated in Euros. We manufacture a majority of our
component parts 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. In 2004 and 2006, we acquired a Beijing-based manufacturer and distributor
of environmental safety and security equipment. In late 2006, we formed RAE Fushun to capitalize
on increases in demand for safety equipment in the mining and energy market sectors in China. 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 loss would have been approximately $0.2 million for the three months ended March 31, 2010. 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 loss would
have been approximately $(0.1) million for the three months ended March 31, 2010. The difference of
$0.3 million is attributable to the impact of foreign currencies outside of China, principally the
Euro.
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.
28
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 effective as of March 31, 2010.
There were no changes in our internal control over financial reporting during the quarter
ended March 31, 2010, that have materially affected, or are reasonably likely to materially affect
our internal control over financial reporting.
29
PART II. Other Information
Item 1. Legal Proceedings
Regulatory Compliance
During fiscal year 2008, the Companys internal audit department identified certain payments
and gifts made by certain personnel in the Companys operations in the Peoples Republic of China
(China) that may have violated the United States Foreign Corrupt Practices Act (FCPA).
Following this discovery, the Audit Committee of the Board of Directors initiated an independent
investigation. The Company has made a voluntary disclosure to the United States Department of
Justice (DOJ) and the United States Securities and Exchange Commission (SEC) regarding the results
of its investigation. The Company has 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 violations. The Company is cooperating with the
DOJ and the SEC in connection with their review of the matter and is actively engaged in settlement
discussions. Although no assurances can be given as to whether the matter will settle or the
amount of any settlement, the company booked an accrual of $3.5 million in the third quarter 2009
relating to this potential settlement. The timing and final outcome of this or any future
government investigation cannot be predicted with certainty and any indictment, conviction or
material fine, debarment or settlement arising out of these investigations could have a material
adverse affect on the Companys business, financial condition, results of operation and future
prospects.
Polimaster Ltd. et al. v. RAE Systems Inc., United States District Court for the Northern District
of California, Case No. 05-CV-01887-JF, United States Court of Appeals for the Ninth Circuit, No.
08-15708 and 09-15369
Polimaster Ltd. and Na&Se Trading Company, Ltd. (Polimaster) filed a complaint against the
Company on May 9, 2005, in the United States District Court for the Northern District of California
in a case titled Polimaster Ltd., et al. v. RAE Systems Inc. (Case No. 05-CV-01887-JF). The
complaint alleges, among other things, that the Company breached its contract with Polimaster and
infringed upon Polimasters intellectual property rights. The dispute was subject to a contractual
arbitration agreement, although the federal court retained jurisdiction over the matter pending
completion of the arbitration. The arbitration was conducted in the spring of 2007.
In September 2007, a Final Award was issued in the arbitration. The arbitrator ruled that
Polimaster failed to prove its claims and was not entitled to any relief; that the Company had
proven its counterclaims and was awarded damages of approximately $2.4 million; and that as the
prevailing party, the Company was entitled to recover costs in the amount of $46,000. On October 5,
2007, RAE Systems filed a motion to confirm the Final Award. On October 17, 2007, Polimaster filed
an opposition to RAE Systems motion to confirm the Final Award and filed its own motion to vacate
the Final Award. Both motions were heard on December 7, 2007, and the district court confirmed the
Final Award in an order dated February 25, 2008. Polimaster appealed from the district courts
order confirming the arbitration award in Polimaster Ltd. et al. v. RAE Systems Inc., No. 08-15708.
The appeal is currently pending in the United States Court of Appeals for the Ninth Circuit.
Briefing on the appeal has been completed by both sides. Oral argument has not been scheduled at
this time.
When the district court confirmed the Final Award in favor of RAE Systems it did not enter
judgment, an omission the district court described as a non-substantive clerical error. On
September 9, 2008, the court of appeal granted leave for the district court to correct this
clerical error. On January 23, 2009, the district court entered judgment in favor of RAE Systems
and against Polimaster, and included in the judgment post-arbitration/pre-judgment interest and
post-judgment interest. Polimaster has appealed the inclusion of these two interest components in
the judgment, in Polimaster Ltd. et al. v. RAE Systems Inc., No. 09-15369, and briefing on the
appeal has been completed by both sides and the appeal was argued and submitted to the Ninth
Circuit for decision on January 15, 2010.
On May 14, 2009, Polimaster and RAE Systems entered a First Amended And Restated Stipulation
And Order Re Stay Of Execution Of Judgment In Favor Of RAE Systems Inc. (the stipulation),
pursuant to which Polimaster wire transferred $1.4 million to the client trust account of RAE
Systems counsel McLeod, Witham & Flynn LLP, and agreed to wire transfer an additional $116,224.25
per month until the entire amount deposited equals the amount of the judgment (approximately $2.8
million) plus accrued interest at the judgment rate of 0.43 percent per annum. Pursuant to the
stipulation, the amounts transferred by Polimaster are being maintained in the client trust account
of McLeod, Witham & Flynn LLP, and shall not be distributed to RAE Systems or Polimaster, until the
Ninth Circuit has ruled on Polimasters appeal (Nos. 08-15708 and 09-15369). McLeod, Witham & Flynn
LLP shall release the funds in the account to RAE Systems and/or Polimaster within seven days of
the Ninth Circuits final ruling on the appeal, in accordance with the Ninth Circuits
30
decision. Polimaster is currently in compliance with the payment schedule provided in the
stipulation. If RAE Systems is successful on appeal, it is expected that the Company would receive
approximately $1.9 million, net of attorneys fees and expenses. The timing of a final ruling on
the appeal is not currently determinable.
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.
We have discovered potential violations of the Foreign Corrupt Practices Act, the resolution of
which could have a material adverse impact on our financial condition and results of operations.
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
have made a voluntary disclosure to the DOJ and the SEC regarding the results of our investigation.
We have 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 are cooperating with the DOJ and the SEC in connection with
their review of the matter and are actively engaged in settlement discussions. Although no
assurances can be given as to whether the matter will settle or the amount of any settlement, the
Company recorded an accrual of $3.5 million in the third quarter of 2009 relating to the potential
settlement of this matter. The timing and final outcome of this or any future government
investigation cannot be predicted with certainty and any indictment, conviction or material fine,
debarment or settlement arising out of these investigations could have a material adverse affect on
our business, financial condition, results of operation and future prospects.
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
31
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 recorded net losses of $5.8 million, $7.2 million and $14.7 million for 2009, 2008 and
2007, 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
return to 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. In addition, 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 continue to
incur losses, any particular financial event could result in a relatively large change in our
financial results or could be the difference between us having a profit or a loss for the
particular quarter in which it occurs.
We may require additional capital in the future, which may not be available or may only be
available 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:
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devote greater resources to marketing and promotional campaigns;
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adopt more aggressive pricing policies; or
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devote more resources to technology and systems development.
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In light of these factors, we may be unable to compete successfully.
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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.
32
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.
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.
Our business is dependent in part upon government funded projects. 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.
33
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, 2009 and 2008,
approximately 41% and 43% of our revenues, respectively, were from sales to customers located in
Asia and approximately 17% and 16% 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.
Our international operations are subject to economic and other risks inherent in doing
business in foreign countries, including the following:
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difficulties with staffing and managing international operations;
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transportation and supply chain disruptions and increased transportation expense as a
result of epidemics, terrorist activity, acts of war or hostility, increased security and
less developed infrastructure;
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economic slowdown and/or downturn in foreign markets;
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international currency fluctuations;
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political and economic uncertainty caused by epidemics, terrorism or acts of war or
hostility;
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legislative and regulatory responses to terrorist activity such as increased restrictions
on cross-border movement of products and technology;
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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;
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increased costs and complexities associated with complying with Section 404 of the
Sarbanes-Oxley Act of 2002;
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general strikes or other disruptions in working conditions;
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labor shortages;
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political instability;
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changes in tariffs;
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generally longer periods to collect receivables;
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unexpected legislative or regulatory requirements;
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reduced protection for intellectual property rights in some countries;
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significant unexpected duties or taxes or other adverse tax consequences;
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difficulty in obtaining export licenses and other trade barriers; and
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ability to obtain credit and access to capital issues faced by our international
customers.
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34
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 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.
35
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.
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, are currently 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. For example, for the last several years we have been involved in a dispute with
Polimaster Ltd. which required us to incur substantial professional fees. Although we ultimately
prevailed, it is uncertain whether we will be able to recover any of the amounts awarded to us.
Claims of this type, regardless of merit, can be time-consuming to defend, result in costly
litigation, divert managements attention and resources or require us to enter into royalty or
license agreements. The terms of any such license agreements may not be available on reasonable
terms, if at all, and the assertion or prosecution of any infringement claims could significantly
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.
36
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 retain 70%
ownership. In August 2007, we determined to discontinue the Aegison and Securay businesses. 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,
contingent liabilities or expenses related to goodwill recognition and other intangible assets, any
of which could harm our business.
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 32% of our common stock and,
accordingly, may exert substantial influence over the Company.
Our executive officers and directors, in the aggregate, beneficially own approximately 32% of
our common stock as of March 31, 2010. 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.
37
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
Item 6. Exhibits
The following is a list of exhibits filed as part of this Report on Form 10-Q.
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Exhibit
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Number
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Description of Document
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10.23
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Amendment No. 8 to Loan and Security Agreement with Silicon Valley Bank.
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31.1
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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.
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31.2
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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.
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32.1
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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.
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32.2
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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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38
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 7, 2010
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RAE SYSTEMS INC.
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By:
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/s/ Randall Gausman
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Randall Gausman
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Vice President and Chief Financial Officer
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39
Exhibit Index
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Exhibit
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Number
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Description of Document
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10.23
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Amendment No. 8 to Loan and Security Agreement with Silicon Valley Bank.
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31.1
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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.
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31.2
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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.
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32.1
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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.
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32.2
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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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40
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