TIDMCTS TIDMCTSU
RNS Number : 5181P
Catalytic Solutions, Inc.
19 July 2010
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| For Immediate Release | 19 July 2010 |
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Catalytic Solutions, Inc.
(the "Company")
results for the THREE months ended 31 MARCH 2010
Catalytic Solutions, Inc. (AIM: CTS and CTSU), the Company behind Mixed Phase
Catalyst (MPC ) technology, is pleased to announce its results for the three
months ended 31 March 2010. The Company is releasing these results as they will
be included in the amended registration statement on Form S-4A filed by Clean
Diesel Technologies, Inc. ("CDTI") with the U.S. Securities and Exchange
Commission ("SEC") in connection with the proposed merger with the Company in
accordance with applicable rules and regulations of the SEC.
HIGHLIGHTS FOR THE QUARTER
· Revenue from continuing operations increased 34% to $12.4 million (Q1
2009: $9.3 million)
· Gross profit from continuing operations increased 50% to $3.6 million (Q1
2009: $2.4 million)
· Operating loss excluding gain on sale of intellectual property was $0.6
million (Q1 2009: $3.0 million excluding gain on sale of intellectual property)
· Net income including discontinued operations was $2.6 million (Q1 2009:
net loss $3.3 million); net income from continuing operations was $2.7 million
(Q1 2009: net loss $2.0 million)
· Cash and cash equivalents balance of $2.2 million as of 31 March 2010
RECENT DEVELOPMENTS
· Entered into a merger agreement with Clean Diesel Technologies, Inc.
· Completed negotiations and executed finalized agreements for a $4.0
million capital raise, with $2.0 million contingent upon closing of the merger
with Clean Diesel Technologies, Inc.
· Forbearance from secured lender extended to 31 August 2010; further
extension until 30 November 2010 to be granted upon meeting certain criteria
For further details please contact:
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| Catalytic Solutions, Inc. | Canaccord | Buchanan |
| Charlie Call, Chief | Genuity Limited | Communications |
| Executive Officer | Robert Finlay | Charles Ryland |
| Tel: +1 (805) 639-9463 | Guy Blakeney | Christian Goodbody |
| Steve Golden, Chief | | |
| Technical Officer | | |
| Tel: +1 (805) 639-9464 | | |
| Nikhil Mehta, Chief | Tel: 020 7050 | Tel: 020 7466 5000 |
| Financial Officer | 6500 | |
| Tel: +1 (805) 639-9461 | | |
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About Catalytic Solutions, Inc.
Catalytic Solutions, Inc. is a global manufacturer and distributor of emissions
control systems and products, focused in the heavy duty diesel and light duty
vehicle markets. The Company's emissions control systems and products are
designed to deliver high value to its customers while benefiting the global
environment through air quality improvement, sustainability and energy
efficiency. Catalytic Solutions, Inc. is listed on AIM of the London Stock
Exchange (AIM: CTS and CTSU) and currently has operations in the USA, Canada,
France, Japan and Sweden as well as an Asian joint venture.
This announcement was approved by the Audit Committee of the Board of Directors
on 16 July 2010. A copy of this release is available on the Company's website
at www.catalyticsolutions.com.
This announcement and the information contained herein is restricted and is not
for publication, release or distribution in whole or in part in, or into, the
United States of America, Canada, Australia, The Republic of Ireland, Japan or
South Africa.
Canaccord Genuity Limited, which is authorised and regulated by the Financial
Services Authority, is not acting for any other person in connection with the
matters referred to in this announcement and will not be responsible to anyone
other than Catalytic Solutions, Inc. for providing the protections afforded to
clients of Canaccord Genuity Limited or for giving advice in relation to the
matters referred to in this announcement.
The material set forth herein is for informational purposes only and is not
intended, and should not be construed, as an offer of securities for sale into
the United States or any other jurisdiction. The securities of Catalytic
Solutions, Inc. described herein have not been registered under the U.S.
Securities Act of 1933, as amended (the "Securities Act"), or the laws of any
state, and may not be offered or sold within the United States, except pursuant
to an exemption from, or in a transaction not subject to, the registration
requirements of the Securities Act and applicable state laws. There is no
present intention to register Catalytic Solutions, Inc. securities in the United
States or to conduct a public offering of securities in the United States. The
circular to be provided to Catalytic Solutions, Inc. shareholders in connection
with the proposed merger will be included in a registration statement on Form
S-4, which was initially filed by CDTI with the U.S. Securities and Exchange
Commission on 14 May 2010.
This announcement and the information contained herein include forward-looking
statements. Forward-looking statements are identified by words such as
"believe," "anticipate," "expect," "intend," "plan," "will,"
"may," "should," "could," "think," "estimate" and "predict," and
other similar expressions. In addition, any statements that refer to
expectations, projections or other characterizations of future events or
circumstances are forward-looking statements. We based these forward-looking
statements on our current expectations and projections about future events. Our
actual results could differ materially from those discussed in, or implied by,
these forward-looking statements. Factors that could cause actual results to
differ from those implied by the forward-looking statements include a number of
risks and uncertainties, described in the section entitled "Risks and
uncertainties", which could have a material impact on the Company's long-term
performance and prospects. Additional factors are discussed in our AIM
admission document, which was published in November 2006, as well as in the Form
S-4 filed by CDTI with the U.S. Securities and Exchange Commission on 14 May
2010. The Company assumes no responsibility to update any of the
forward-looking statements contained herein. Further, any indication in this
announcement of the price at which common shares have bought or sold in the past
cannot be relied upon as a guide to future performance.
BUSINESS AND FINANCIAL REVIEW
The Company reports its first quarter 2010 financial results under U.S. GAAP,
consistent with prior periods and the placing and admission on AIM.
Overview
We are a global manufacturer and distributor of emissions control systems and
products, focused in the heavy duty diesel and light duty vehicle markets. Our
emissions control systems and products are designed to deliver high value to our
customers while benefiting the global environment through air quality
improvement, sustainability and energy efficiency.
Heavy Duty Diesel (HDD) Systems Division: Through our HDD Systems division we
design and manufacture verified exhaust emissions control solutions. The HDD
Systems division offers a full range of products for the original equipment
manufacturer (OEM), occupational health driven and verified retrofit markets
that reduce exhaust emissions created by on-road, off-road and stationary diesel
and alternative fuel engines including propane and natural gas. Revenues from
our HDD Systems division accounted for approximately 60% of our total
consolidated revenues for the three months ended 31 March 2010.
Catalyst Division: Through our Catalyst division, we produce catalyst
formulations for gasoline, diesel and natural gas induced emissions that are
offered for multiple markets and a wide range of applications. A family of
unique high-performance catalysts has been developed - with base metals or
low-platinum group metal (PGM) and zero-PGM content - to provide increased
catalytic function and value for technology-driven automotive industry
customers. Our technical and manufacturing competence in the light duty vehicle
market is aimed at meeting auto makers' most stringent requirements, having
supplied over 9 million parts to light duty vehicle customers since 1996. In
addition to auto makers, we also provide catalyst formulations for our HDD
Systems division.
Since the fourth quarter of 2008, we have taken several actions to restructure
and realign our Catalyst division. These actions included reducing excess
workforce and capacity, consolidating certain functions, focusing our marketing
and product development strategies around heavy duty diesel catalysts and
existing and selected new customers in the light duty vehicle market. The
overall objectives of the restructuring actions were to lower costs and position
the Catalyst division to break even at lower sales and to make the division
profitable. To date, these efforts have helped enhance our ability to reduce
operating losses, retain and expand existing relationships with existing
customers and attract new business. Revenues from our Catalyst division
accounted for approximately 40% of our total consolidated revenues for the three
months ended 31 March 2010.
Sources of Revenues and Expenses
Revenues
Revenues are generated primarily from the sale of our emission control systems
and products. We generally recognize revenues from the sale of our emission
control systems and products upon shipment of these products to our customers.
However, for certain customers, where risk of loss transfers at the destination
(typically the customer's warehouse), revenue is recognized when the products
are delivered to the destination (which is generally within five days of the
shipment).
Cost of Revenues
Cost of revenues consists primarily of our direct costs for the manufacture of
our emission control systems and products, including cost of raw materials,
costs of leasing and operating manufacturing facilities and wages paid to
personnel involved in production, manufacturing quality control, testing and
supply chain management. In addition, cost of revenues include normal scrap and
shrinkage associated with the manufacturing process and expense from write-down
of obsolete and slow moving inventory. We include the direct material costs and
factory labor as well as factory overhead expense in the cost of revenue.
Indirect factory expense includes the costs of freight (inbound and outbound for
direct material and finished goods), purchasing and receiving, inspection,
testing, warehousing, utilities and deprecation of facilities and equipment
utilized in the production and distribution of products.
Sales and Marketing Expenses
Sales and marketing expenses consist primarily of compensation paid to sales and
marketing personnel, and marketing expenses. Costs related to sales and
marketing are expensed as they are incurred. These expenses include the salary
and benefits for the sales and marketing staff as well as travel, samples
provided at no-cost to customers and marketing materials.
Research and Development Expenses
Research and development expenses consist of costs associated with research
related to new product development and product enhancement expenditures.
Research and development costs also include costs associated with getting our
HDD systems verified and approved for sale by the United States Environmental
Protection Agency (EPA), the California Air Resources Board (CARB) and other
regulatory authorities. These expenses include the salary and benefits for the
research and development staff as well as travel, research materials, testing
and legal expense related to patenting intellectual property. Also included is
any depreciation related to assets utilized in the development of new products.
General and Administrative Expenses
General and administrative expenses consist primarily of compensation paid to
administrative personnel, legal and professional fees, corporate expenses and
regulatory, bad debt and other administrative expenses. These expenses include
the salary and benefits for the administrative staff as well as travel, legal,
accounting and tax consulting. Also included is any depreciation related to
assets utilized in the general and administrative functions.
Total Other Income (Expense)
Total other income (expense) primarily reflects interest expense, but also
includes interest income as well as our share of income and losses from our
Asian joint venture and income or losses from sale of fixed assets.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles requires the use of estimates and assumptions
that affect the reported amounts of assets and liabilities, revenues and
expenses, and related disclosures in the financial statements. Critical
accounting policies are those accounting policies that may be material due to
the levels of subjectivity and judgment necessary to account for highly
uncertain matters or the susceptibility of such matters to change, and that have
a material impact on financial condition or operating performance. While we base
our estimates and judgments on our experience and on various other factors that
we believe to be reasonable under the circumstances, actual results may differ
from these estimates under different assumptions or conditions. We believe the
following critical accounting policies used in the preparation of our financial
statements require significant judgments and estimates. For additional
information relating to these and other accounting policies, see Note 2 to our
Condensed Consolidated Financial Statements.
Revenue Recognition
Revenue is generally recognized when products are shipped and the customer takes
ownership and assumes risk of loss, collection of the related receivable is
reasonably assured, persuasive evidence of an arrangement exists, and the sales
price is fixed or determinable. Where installation services, if provided, are
essential to the functionality of the equipment, we defer the portion of revenue
for the sale attributable to installation until we have completed the
installation. When terms of sale include subjective customer acceptance
criteria, we defer revenue until the acceptance criteria are met. Concurrent
with the shipment of the product, we record estimated liabilities for product
returns and warranty expenses. Critical judgments include the determination of
whether or not customer acceptance criteria are perfunctory or inconsequential.
The determination of whether or not the customer acceptance terms are
perfunctory or inconsequential impacts the amount and timing of the revenue that
we recognize. Critical judgments also include estimates of warranty reserves,
which are established based on historical experience and knowledge of the
product.
Allowance for Doubtful Accounts
Allowance for doubtful accounts involves estimates based on management's
judgment, review of individual receivables and analysis of historical bad debts.
We monitor collections and payments from our customers and maintain allowances
for doubtful accounts for estimated losses resulting from the inability of our
customers to make required payments. We also assess current economic trends that
might impact the level of credit losses in the future. If the financial
condition of our customers were to deteriorate, resulting in difficulties in
their ability to make payments as they become due, additional allowances could
be required, which would have a negative effect on our earnings and working
capital.
Inventory Valuation
Inventory is stated at the lower of cost or market. Cost is determined on the
first-in, first-out method. We write-down inventory for slow-moving and obsolete
inventory based on assessments of future demands, market conditions and
customers who are expected to reduce purchasing requirements as a result of
experiencing financial difficulties. Such assessments require the exercise of
significant judgment by management. If these factors were to become less
favorable than those projected, additional inventory write-downs could be
required, which would have a negative effect on our earnings and working
capital.
Accounting for Income Taxes
Income tax expense is dependent on the profitability of our various
international subsidiaries including those in Canada and Sweden. These
subsidiaries are subject to income taxation based on local tax laws in these
countries. Our United States operations have continually incurred losses since
inception. Our annual tax expense is based on our income, statutory tax rates
and available tax planning opportunities in the various jurisdictions in which
we operate. Tax laws are complex and subject to different interpretations by the
taxpayer and respective governmental taxing authorities. Significant judgment is
required in determining our tax expense and in evaluating our tax positions
including evaluating uncertainties. We review our tax positions quarterly and
adjust the balances as new information becomes available. If these factors were
to become less favorable than those projected, or if there are changes in the
tax laws in the jurisdictions in which we operate, there could be an increase in
tax expense and a resulting decrease in our earnings and working capital.
Deferred income tax assets represent amounts available to reduce income taxes
payable on taxable income in future years. Such assets arise because of
temporary differences between the financial reporting and tax bases of assets
and liabilities, as well as from net operating loss and tax credit
carry-forwards. We evaluate the recoverability of these future tax deductions by
assessing the adequacy of future expected taxable income from all sources,
including reversal of taxable temporary differences, forecasted operating
earnings and available tax planning strategies. These sources of income
inherently rely on estimates. To provide insight, we use our historical
experience and our short- and long-range business forecasts. We believe it is
more likely than not that a portion of the deferred income tax assets may expire
unused and have established a valuation allowance against them. Although
realization is not assured for the remaining deferred income tax assets,
primarily related to foreign tax jurisdictions, we believe it is more likely
than not that the deferred tax assets will be fully recoverable within the
applicable statutory expiration periods. However, deferred tax assets could be
reduced in the near term if our estimates of taxable income in certain
jurisdictions are significantly reduced or available tax planning strategies are
no longer viable.
Business Combinations
Under the purchase method of accounting, we allocate the purchase price of
acquired companies to the tangible and identifiable intangible assets acquired
and liabilities assumed based on our estimated fair values. We record the excess
of purchase price over the aggregate fair values as goodwill. We engage
third-party appraisal firms to assist us in determining the fair values of
assets acquired and liabilities assumed. These valuations require us to make
significant estimates and assumptions, especially with respect to intangible
assets. Critical estimates in valuing purchased technology, customer lists and
other identifiable intangible assets include future cash flows that we expect to
generate from the acquired assets. If the subsequent actual results and updated
projections of the underlying business activity change compared with the
assumptions and projections used to develop these values, we could experience
impairment charges. In addition, we have estimated the economic lives of certain
acquired assets and these lives are used to calculate depreciation and
amortization expense. If our estimates of the economic lives change,
depreciation or amortization expenses could be accelerated or slowed.
Goodwill
We test goodwill for impairment at the reporting unit level at least annually,
using a two-step process, and more frequently upon the occurrence of certain
triggering events. Only our HDD Systems reporting unit has goodwill subject to
impairment review, which totalled $4.3 million at 31 March 2010. Goodwill
impairment testing requires us to estimate the fair value of our reporting unit.
The estimate of fair value is based on internally developed assumptions
approximating those that a market participant would use in valuing the reporting
unit. At 31 December 2009, we derived the estimated fair value of the HDD
Systems reporting unit primarily from a discontinued cash flow model.
Significant assumptions used in deriving the fair value of the reporting unit
included: annual revenue growth over the next eight years ranging from 10.5% to
15.7%, long-term revenue growth of 3% and a discount rate of 25.3%. While the
revenue growth rates used are consistent with our historical growth patterns and
consider future growth potential identified by management, there is no assurance
such growth will be achieved. In addition, we considered the overall fair value
of our reporting units as compared to the fair value of the Company. Because
the estimated fair value of the reporting unit exceeded its carrying value by
6%, we determined that no goodwill impairment existed as of 31 December 2009;
however, it is reasonably possible that future results may differ from the
estimates made during 2009 and future impairment tests may result in a different
conclusion for the goodwill of the HDD Systems reporting unit. In addition, the
use of different estimates or assumptions by management could lead to different
results. Our estimate of fair value of the reporting unit is sensitive to
certain factors, including but not limited to the following: movements in our
share price, changes in discount rates and our cost of capital, growth of the
reporting unit's revenue, cost structure of the reporting unit, successful
completion of research and development, capital expenditures, customer
acceptance of new products, competition, general economic conditions and
approval of the reporting unit's product by regulatory agencies. We further
evaluated the reporting unit to assess if a triggering event occurred subsequent
to 31 December 2009 through 31 March 2010 necessitating a detailed Step I (of
the annual impairment test process) analysis and concluded there was no such
triggering event.
Impairment of Long-Lived Assets Other Than Goodwill
Long-lived assets are evaluated, including intangible assets other than
goodwill, for impairment whenever events or changes in circumstances indicate
that the carrying value of an asset may not be recoverable. An impairment is
considered to exist if the total estimated future cash flows on an undiscounted
basis are less than the carrying amount of the assets. If an impairment does
exist, we measure the impairment loss and record it based on discounted
estimated future cash flows. In estimating future cash flows, we group assets at
the lowest level for which there are identifiable cash flows that are largely
independent of cash flows from other asset groups. Considerable judgment is
necessary to estimate the fair value of the assets and accordingly, actual
results could vary significantly from such estimates. Our most significant
estimates and judgments relating to the long-lived asset impairments include the
timing and amount of projected future cash flows, which is based upon, among
other things, certain assumptions about expected future operating performance,
growth rates and other factors. Although we believe the assumptions and
estimates we have made in the past have been reasonable and appropriate,
different assumptions and estimates could materially affect our reported
financial results. To the extent additional events or changes in circumstances
occur, we may conclude that a non-cash impairment charge against earnings is
required, which could have an adverse effect on our financial condition and
results of operations.
During the year ended 31 December 2008, an impairment test was performed on the
long-lived assets of the Catalyst division. This analysis was triggered by a
combination of the following factors:
· Historic losses in this business segment
· The overall downturn in the automotive sector
· Expectation of a slow recovery in the automotive sector
As a result of this impairment test, we recorded a $4.9 million impairment
charge during the year ended 31 December 2008, reducing the book value of the
Catalyst division's fixed assets from $5.8 million to $0.9 million. We utilized
a discounted cash flows model to estimate the fair value of the long-lived
assets. The following two scenarios were given equal weighting in determining
the expected cash flows for purposes of both the recoverability test and fair
value: a) the business achieves its growth plan of revenue growth of (2%) to 50%
per year over the next 5 years, and b) the business continues to experience cash
flow losses and does not achieve profitability. The cash flows were discounted
at the risk free rate of interest of 1.6%. This analysis indicated that the
assets were impaired and the assets were written down to their fair value as of
31 December 2008.
In 2009, and again through 31 March 2010, we considered whether any events or
changes in circumstance indicated that the carrying amount of the Catalyst
division long-lived assets may not be recoverable. When making this assessment,
we considered that the Catalyst division's actual 2009 cash flows exceeded the
probability weighed cash flows used in the 2008 impairment assessment by 32% and
the outlook for future cash flows exceeded those utilized during 2008. We
therefore concluded that there were no events or changes in circumstances
occurring during 2009 and through 31 March 2010 which would indicate that the
Catalyst division's long-lived assets were not recoverable.
The estimated fair value is dependent on a number of factors, including revenue
growth, cost of revenue, operating expenses and capital expenditures. In the
event that these differ from our forecasts, or the future outlook diminishes,
the fair value of these assets could potentially decrease in the future,
requiring an impairment charge.
Stock-Based Compensation Expense
Share-based compensation is accounted for using fair value recognition and we
record stock-based compensation as a charge to earnings net of the estimated
impact of forfeited awards. As such, we recognize stock-based compensation cost
only for those stock-based awards that are estimated to ultimately vest over
their requisite service period, based on the vesting provisions of the
individual grants.
The process of estimating the fair value of stock-based compensation awards and
recognizing stock-based compensation cost over their requisite service period
involves significant assumptions and judgments. We estimate the fair value of
stock option awards on the date of grant using a Monte Carlo univariate pricing
model for awards with market conditions and the Black-Scholes option-valuation
model for the remaining awards, which requires that we make certain assumptions
regarding: (i) the expected volatility in the market price of our common stock;
(ii) dividend yield; (iii) risk-free interest rates; and (iv) the period of time
employees are expected to hold the award prior to exercise (referred to as the
expected holding period). As a result, if we revise our assumptions and
estimates, our stock-based compensation expense could change materially for
future grants.
Legal and Other Contingencies
We are subject to various claims and legal proceedings. Each year, we review the
status of each significant legal dispute to which we are a party and assess our
potential financial exposure, if any. If the potential financial exposure from
any claim or legal proceeding is considered probable and the amount can be
reasonably estimated, we record a liability and an expense for the estimated
loss. Significant judgment is required in both the determination of probability
and the determination as to whether an exposure is reasonably estimable. Because
of uncertainties related to these matters, accruals are based only on the best
information available at the time. As additional information becomes available,
we reassess the potential liability related to our pending claims and litigation
and revise our estimates accordingly. Such revisions in the estimates of the
potential liabilities could have a material effect on our results of operations
and financial position.
Recent Developments
Proposed Merger with Clean Diesel Technologies, Inc.
On 14 May 2010, we announced that we had entered into a merger agreement with
Clean Diesel Technologies, Inc., or CDTI, a U.S.-based company that designs,
markets and licenses patented technologies and solutions that reduce harmful
emissions from internal combustion engines while improving fuel economy and
engine power (the "Merger"). We entered into an Agreement and Plan of Merger
(the "Merger Agreement"), dated as of 13 May 2010, with CDTI and CDTI Merger
Sub, Inc., a California corporation and wholly-owned subsidiary of CDTI ("Merger
Sub"). The proposed Merger, to be effected by way of a reverse merger, is a
transaction that will result in the combination of our business with CDTI,
whereby we will become a wholly-owned subsidiary of CDTI.
In exchange for their shares of the Company's common stock and warrants to
purchase shares of the Company's common stock, our security holders will receive
shares of CDTI common stock and (excluding investors in the capital raise
discussed below) warrants to purchase CDTI common stock. Our shareholders
(including investors in the capital raise and our financial advisor, Allen &
Company, LLC) will receive such numbers of CDTI common stock so that after the
Merger they will own 60% of the outstanding shares of CDTI common stock and
(excluding investors in the capital raise and also our financial advisor)
warrants to purchase up to three million shares of CDTI common stock. Our
financial advisor will hold warrants to purchase an additional one million
shares of CDTI common stock.
The Merger is conditional, among other things, on obtaining the Company's
shareholders approval and CDTI stockholders approval The Merger Agreement
contains provisions regarding an adjustment to the merger consideration based on
a closing cash adjustment depending on whether each company meets certain cash
targets determined at 30 June 2010. Both companies have met such cash targets at
30 June 2010, and therefore no cash adjustment is necessary.
CDTI will use commercially reasonable efforts to cause all shares of CDTI common
stock to be issued in connection with the Merger and all shares of CDTI common
stock to be issued upon exercise of the warrants to purchase shares of CDTI
common stock to be listed on the NASDAQ Stock Market as of the effective time of
the Merger.
Neither company will be required to complete the Merger if the shares of CDTI
common stock to be issued in connection with the Merger are not approved for
listing, subject to notice of issuance, on the NASDAQ Stock Market.
Following completion of the Merger:
· Merger Sub will merge with and into the Company and the Company will be
the surviving corporation.
· As a result of the Merger, the business and assets of the Company will be
a wholly-owned subsidiary of CDTI.
· The Company will cease trading on the Alternative Investment Market (AIM).
· The board of directors of the combined company is expected to comprise
seven directors, four from our existing board of directors (Charles F. Call,
Alexander Ellis, III, Charles R. Engles Ph.D. and Bernard H. Cherry) and three
from CDTI (Mungo Park, Michael L. Asmussen and Derek R. Gray).
· The executive management team of the combined company is expected to be
composed of the following members of the current management team of our company:
Charles F. Call, Nikhil A. Mehta and Stephen J. Golden Ph.D., and Michael L.
Asmussen, a member of the current management team of CDTI.
CDTI has filed a Form S-4 Registration Statement containing a joint proxy
statement/information statement and prospectus, providing our shareholders with
information about the background to and the reasons for the Merger and capital
raise (the "Circular"), and containing a notice of a special meeting of our
shareholders to be convened on a date to be agreed and will be sent to
shareholders when declared effective. The Circular outlining the terms of the
Merger and capital raise will seek shareholder approval to, among other things,
enable us to complete the Merger and capital raise.
The Merger will be completed once both companies have approved the Merger and
the conditions are satisfied. The timing of the shareholders' meetings of both
companies is dependant on when the Registration Statement is declared effective,
which cannot be determined now. Final timing relating to the date of the
shareholders' meetings and the expected completion date for the Merger will be
set out in the Circular that is dispatched to shareholders of both companies.
Capital Raise
On 2 June 2010, we entered into agreements with a group of accredited investors
providing for the sale of $4.0 million of secured convertible notes. Under the
agreements, $2.0 million of the secured convertible notes have been issued in
four equal instalments ($500,000 on each of 2 June 2010, 8 June 2010, 28 June
2010 and 12 July 2010), with the remaining $2.0 million to be issued after our
shareholders approve the Merger and after other necessary approvals under our
articles of incorporation, but prior to the effective time of the Merger. The
secured convertible notes are secured by a subordinated lien on our assets (the
security interest is subordinate to the first priority security interest of
Fifth Third Bank). Under the terms of the agreements, it is a condition to the
obligations of the investors with respect to the final $2.0 million tranche that
all conditions precedent to the closing of the Merger be satisfied or waived
(among other items). Under the terms of the secured convertible notes, assuming
the necessary shareholder approvals are received at the special meeting of our
shareholders to permit conversion thereof, the $4.0 million of secured
convertible notes will be converted into newly created "Class B" common stock
immediately prior to the Merger such that at the effective time of the Merger,
this group of accredited investors will receive approximately 66.0066% of the
Fully Diluted Pre Merger CSI Stock. "Fully Diluted Pre Merger CSI Stock" means
the total number of shares of the existing Class A and Class B common stock of
the Company outstanding immediately prior to the closing of the Merger including
the equivalent number of shares to be issued to the Company's financial advisor,
Allen & Company LLC, upon closing of the Merger.
This capital raise provides us with financing for our immediate working capital
needs, as well as the $2.0 million cash balance necessary such that our
shareholders will receive 60% of the shares of CDTI pursuant to the terms of the
Merger.
One of the Directors of our Board, Mr. Alexander ("Hap") Ellis, III, is a
partner of Rockport Capital LLP ("Rockport"), a shareholder in our Company which
subscribed for the secured convertible notes. In light of its size, Rockport's
subscription for the secured convertible notes was deemed to be a related party
transaction under the AIM Rules. Our Directors, other than Mr. Ellis who was
deemed to be a related party for this purpose, considered, having consulted with
our nominated adviser, Canaccord Genuity Limited, that the terms of Rockport's
subscription was fair and reasonable insofar as the shareholders were concerned.
Forbearance from Fifth Third Bank Extended
In June 2010, Fifth Third Bank, our secured lender, agreed to extend forbearance
under the terms of our credit facility until 31 August 2010. A further
extension until 30 November 2010 will be granted if the proposed Merger with
CDTI is completed by 1 August 2010, and as of 31 August 2010, the secured
convertible notes issued by us in connection with the capital raise have been
converted to common equity and the security granted to the secured convertible
note holders has been released; we have $3.0 million of free cash on our balance
sheet; our Engine Control Systems subsidiary has Canadian $2.0 million available
under the existing loan agreement; and no default, forbearance default or event
of default (as defined in the credit and forbearance agreements) is outstanding.
Under the terms of the extension, the current credit limit was reduced to
Canadian $7.0 million from Canadian $7.5 million and the interest rate remained
unchanged at US/Canadian Prime Rate plus 2.75%.
Factors Affecting Future Results
The nature of our business and, in particular, our HDD Systems division, are
heavily influenced by government funding of emissions control projects and
increased diesel emission control regulations, compliance with which drives
demand for our products. For example, due to the California state budget crisis
in late 2008 and early 2009, a state-funded emissions control project that was
anticipated to commence in the first half of 2009, did not receive funding and
its commencement date, if ever, remains uncertain. As such, our HDD Systems
division had lower revenues than anticipated in the first half of 2009 due to
the lack of funding available to potential users of our products. However,
following the passage of the American Recovery and Reinvestment Act of 2009
(commonly referred to as the Stimulus Bill), government spending (both federal
and state) increased. As such, in the second half of 2009, additional
government emissions control programs were funded, including a different
California-state funded program, and consequently, our HDD Systems division
revenues improved in the second half of 2009 due to the availability of
government funding for users of our products. Future budget crises and changes
in government funding levels will have a similar effect on the revenues of our
HDD Systems division.
Because the customers of our Catalyst division are auto makers, our business is
also affected by macroeconomic factors that impact the automotive industry
generally, which can result in increased or decreased purchases of vehicles, and
consequently demand for our products. The global economic crisis in the latter
half of 2008 that continued through 2009 had a negative effect on our customers
in the automotive industry. As such demand for our products (which our auto
maker customers incorporate into the vehicles they sell), decreased. In the
future, if similar macroeconomic factors or other factors affect our customer
base, our revenues will be similarly affected.
In addition, two auto maker customers account for a significant portion of our
Catalyst division revenues. In the second half of 2010, one of these auto
makers will accelerate manufacture of a vehicle that requires a catalyst product
meeting a higher regulatory standard than the product currently supplied to such
auto maker by our Catalyst division. Although we had already commenced the
necessary testing and approval process for the products under the higher
regulatory standard, such processes are not yet complete. Accordingly, we now
expect lower revenues from the Catalyst division for the second half of 2010 and
early 2011, as compared to the three months ended 31 March 2010 on an annualized
basis, as this auto maker winds down production of the vehicle that incorporates
our verified product. Although we expect that sales of our Catalyst products to
this auto maker will resume in the first half of 2011 once it has received the
necessary regulatory approvals and customer verifications, there is no guarantee
that this will occur.
Results of Operations
Comparison of Three Months Ended 31 March 2010 to Three Months Ended 31 March
2009
Revenue
The table below and the tables in the discussion that follows are based upon the
way we analyze our business. See Note 13 to the Condensed Consolidated Financial
Statements for additional information about our division segments.
+------------------------------------------+--------------+----------+---------+----------+-------------+----------+---------+----------+--------+----------+--------+
| | 31 | | % of | | 31 | | % of | | | | |
| | March | | Total | | March | | Total | | $ | | % |
| | 2010 | |Revenue | | 2009 | |Revenue | |Change | |Change |
+------------------------------------------+--------------+----------+---------+----------+-------------+----------+---------+----------+--------+----------+--------+
| | (Dollars in millions) |
+------------------------------------------+-------------------------------------------------------------------------------------------------------------------------+
| Heavy duty | $ | | 60.5% | | $ | | 48.4% | | $ | | 66.7% |
| diesel systems | 7.5 | | | | 4.5 | | | | 3.0 | | |
+------------------------------------------+--------------+----------+---------+----------+-------------+----------+---------+----------+--------+----------+--------+
| Catalyst................................ | 5.1 | | 41.1% | | 4.9 | | 52.7% | | 0.2 | | 4.1% |
| | | | | | | | | | | | |
+------------------------------------------+--------------+----------+---------+----------+-------------+----------+---------+----------+--------+----------+--------+
| Intercompany | (0.2) | | (1.6)% | | (0.1) | | (1.1)% | | (0.1) | | 100% |
| revenue....... | | | | | | | | | | | |
+------------------------------------------+--------------+----------+---------+----------+-------------+----------+---------+----------+--------+----------+--------+
| Total | $ | | | | $ | | | | $ | | 33.3% |
| revenue.............. | 12.4 | | | | 9.3 | | | | 3.1 | | |
+------------------------------------------+--------------+----------+---------+----------+-------------+----------+---------+----------+--------+----------+--------+
Total revenue for the three months ended 31 March 2010 increased by $3.1
million, or 33.3%, to $12.4 million from $9.3 million for the three months ended
31 March 2009.
Revenues for our HDD Systems division for the three months ended 31 March 2010
increased $3.0 million, or 66.7%, to $7.5 million, from $4.5 million for the
three months ended 31 March 2009. The increase was due largely to an expansion
of our distributor channels in the United States as well as continued benefit
from funding allocated to diesel emission control under the American Recovery
and Reinvestment Act of 2009 (commonly referred to as the Stimulus Bill), which
provided customers an incentive to acquire our emission control products. In
addition, revenues for the three months ended 31 March 2009 were adversely
impacted by the global economic slowdown and the California budget crisis,
resulting in a favorable year over year comparison of first quarter 2010 versus
2009.
Revenues for our Catalyst division for the three months ended 31 March 2010
increased $0.2 million, or 4.1%, to $5.1 million, from $4.9 million for the
three months ended 31 March 2009. Sales for this division increased modestly
year over year but continue to be weak due to the continued downturn in
world-wide automobile sales. We do not expect Catalyst division revenues to
continue at this pace for the remainder of 2010 and anticipate a decrease in
light of a decision by one of our auto maker customers to accelerate production
of a vehicle that needs a product for which we have not yet received the
necessary approvals.
Intercompany sales by the Catalyst division to our HDD Systems division are
eliminated in consolidation.
Cost of revenues
Cost of revenues increased by $1.9 million, or 27.5%, to $8.8 million for the
three months ended 31 March 2010 compared to $6.9 million for the three months
ended 31 March 2009. The primary reason for the increase in costs was higher
product sales volume.
Gross profit
The following table shows our gross profit and gross margin (gross profit as a
percentage of revenues) by division for the periods indicated.
+---------------------------------------------------------------------------+---------------+----------+---------+----------+-------------+----------+---------+
| | 31 | | % of | | 31 | | % of |
| | March | |Revenue | | March | |Revenue |
| | 2010 | | (1) | | 2009 | | (1) |
+---------------------------------------------------------------------------+---------------+----------+---------+----------+-------------+----------+---------+
| | (Dollars in millions) |
+---------------------------------------------------------------------------+----------------------------------------------------------------------------------+
| Heavy duty diesel | $ | | 33.3% | | $ | | 33.3% |
| systems............................... | 2.5 | | | | 1.5 | | |
+---------------------------------------------------------------------------+---------------+----------+---------+----------+-------------+----------+---------+
| Catalyst................................................................. | 1.1 | | 21.6% | | 0.9 | | 18.4% |
| | | | | | | | |
+---------------------------------------------------------------------------+---------------+----------+---------+----------+-------------+----------+---------+
| Total gross | $ | | 29.0% | | $ | | 25.8% |
| profit........................................ | 3.6 | | | | 2.4 | | |
+---------------------------------------------------------------------------+---------------+----------+---------+----------+-------------+----------+---------+
(1) Division calculation based on division revenue. Total based on total
revenue.
Gross profit increased by $1.2 million, or 50.0%, to $3.6 million for the three
months ended 31 March 2010, from $2.4 million for the three months ended 31
March 2009. Gross margin increased to 29.0% for the three months ended 31 March
2010 from 25.8% for the three months ended 31 March 2009. The increase in gross
profit was primarily due to both the increased sales of the HDD Systems division
and reductions in manufacturing overhead costs, as well as continued increases
in efficiency in the Catalyst division following the restructuring efforts
implemented in 2008 and 2009.
Operating expenses
The following table shows our operating expenses and operating expenses as a
percentage of revenues for the periods indicated.
+----------------------------------------------------+---------------+----------+---------+----------+-------+----------+---------+----------+--------+----------+---------+
| | 31 | | % of | | 31 | | % of | | | | |
| | March | | Total | |March | | Total | | $ | | % |
| | 2010 | |Revenue | | 2009 | |Revenue | |Change | | Change |
+----------------------------------------------------+---------------+----------+---------+----------+-------+----------+---------+----------+--------+----------+---------+
| | (Dollars in millions) |
+----------------------------------------------------+---------------------------------------------------------------------------------------------------------------------+
| Sales and | $ | | 6.5% | | $ | | 12.9% | | $ | | (33.3)% |
| marketing........... | 0.8 | | | | 1.2 | | | | (0.4) | | |
+----------------------------------------------------+---------------+----------+---------+----------+-------+----------+---------+----------+--------+----------+---------+
| Research and | 1.0 | | 8.1% | | 1.7 | | 18.3% | | (0.7) | | (41.2)% |
| development... | | | | | | | | | | | |
+----------------------------------------------------+---------------+----------+---------+----------+-------+----------+---------+----------+--------+----------+---------+
| General and | 2.3 | | 18.5% | | 2.0 | | 21.5% | | 0.3 | | 15.0% |
| administrative..... | | | | | | | | | | | |
+----------------------------------------------------+---------------+----------+---------+----------+-------+----------+---------+----------+--------+----------+---------+
| Gain on sale of | (3.9) | | (31.5)% | | (2.5) | | (26.9)% | | (1.4) | | (56.0)% |
| intellectual | | | | | | | | | | | |
| property.......................................... | | | | | | | | | | | |
+----------------------------------------------------+---------------+----------+---------+----------+-------+----------+---------+----------+--------+----------+---------+
| Severance and | 0.1 | | 0.8% | | 0.5 | | 5.4% | | (0.4) | | (80.0)% |
| other charges | | | | | | | | | | | |
+----------------------------------------------------+---------------+----------+---------+----------+-------+----------+---------+----------+--------+----------+---------+
| Total | $ | | 2.4 % | | $ | | 31.2% | | $ | | (89.7)% |
| operating | 0.3 | | | | 2.9 | | | | (2.6) | | |
| expenses | | | | | | | | | | | |
+----------------------------------------------------+---------------+----------+---------+----------+-------+----------+---------+----------+--------+----------+---------+
For the three months ended 31 March 2010, operating expenses decreased by $2.6
million, or 89.7%, to $0.3 million from $2.9 million for the three months ended
31 March 2009. The primary reason for the decrease in operating expenses was
the recognition of a $3.9 million gain in the three months ended 31 March 2010
as a result of the sale of specific three-way catalyst and zero PGM patents to
Tanaka Kikinzoku Kogyo K.K. (TKK), our Asian joint venture partner, and to a
lesser extent, continued improvements in expense management as a result of the
cost reduction efforts implemented as part of the Catalyst division
restructuring.
Sales and marketing expenses
For the three months ended 31 March 2010, sales and marketing expenses decreased
by $0.4 million, or 33.3%, to $0.8 million, from $1.2 million for the three
months ended 31 March 2009. The reduction is primarily due to the cost reduction
efforts implemented in 2008 and 2009 as part of the Catalyst division
restructuring. Sales and marketing expenses as a percentage of sales decreased
to 6.5% in the three months ended 31 March 2010 compared to 12.9% in the three
months ended 31 March 2009.
Research and development expenses
For the three months ended 31 March 2010, research and development expenses
decreased by $0.7 million, or 41.2%, to $1.0 million from $1.7 million for the
three months ended 31 March 2009. The decrease in research and development
expenses was primarily attributable to the cost reduction efforts implemented in
2008 and 2009 as part of the Catalyst division restructuring. As a percentage
of revenues, research and development expenses were 8.1% in the three months
ended 31 March 2010, compared to 18.3% in the three months ended 31 March 2009.
General and administrative expenses
For the three months ended 31 March 2010, general and administrative expenses
increased by $0.3 million, or 15.0%, to $2.3 million, from $2.0 million for the
three months ended 31 March 2009. This increase was primarily due to higher
professional fees incurred as a result of the proposed Merger. General and
administrative expenses as a percentage of sales decreased to 18.5% in the three
months ended 31 March 2010 as compared to 21.5% in the three months ended 31
March 2009.
Severance and other charges
For the three months ended 31 March 2010, we incurred $0.1 million of severance
and recapitalization charges, which charges related to fees for strategic
advisors in connection with the Catalyst division restructuring. In the three
months ended 31 March 2009, we incurred $0.5 million of severance and
recapitalization charges, in connection with severance fees incurred in the cost
reductions taken in 2009, as well as fees for strategic advisors in connection
with the Catalyst division recapitalization.
Non-operating income (expense)
+---------------------------------------------------------+-------+----------+---------+----------+-------+----------+---------+
| | 31 | | % of | | 31 | | % of |
| |March | | Total | |March | | Total |
| | 2010 | |Revenue | | 2009 | |Revenue |
+---------------------------------------------------------+-------+----------+---------+----------+-------+----------+---------+
| | (Dollars in millions) |
+---------------------------------------------------------+--------------------------------------------------------------------+
| Interest | (0.1) | | (0.8)% | | (1.1) | | (11.8)% |
| expense................................................ | | | | | | | |
+---------------------------------------------------------+-------+----------+---------+----------+-------+----------+---------+
| Other expense, | (0.3) | | (2.4)% | | (0.2) | | (2.2)% |
| net............................................ | | | | | | | |
+---------------------------------------------------------+-------+----------+---------+----------+-------+----------+---------+
| Total | $ | | (3.2)% | | $ | | (14.0)% |
| non-operating expense, | (0.4) | | | | (1.3) | | |
| net.......... | | | | | | | |
+---------------------------------------------------------+-------+----------+---------+----------+-------+----------+---------+
Interest expense
In the three months ended 31 March 2010, we incurred interest expense of $0.1
million, compared to $1.1 million in the three months ended 31 March 2009. This
decrease is a result of the reduction in outstanding indebtedness from $16.2
million at 31 March 2009 to $6.6 million at 31 March 2010. In addition, the
three months ended 31 March 2009 included $0.5 million in acceleration of
deferred financing expense due to the violation of covenants under our borrowing
agreements with Fifth Third Bank and Cycad Group, LLC.
Other income (expense)
For the three months ended 31 March 2010, other expenses were $0.3 million
compared to $0.2 million for the three months ended 31 March 2009, an increase
of $0.1 million. This increase was primarily a result of loss on foreign
exchange of $0.4 million in the three months ended 31 March 2010 compared to a
gain on foreign exchange of $0.1 million in the three months ended March 31,
2009, which loss was partially offset by improvement in our share of the net
loss in our Asian joint venture (due to the decrease in our interest in such
venture) in the three months ended 31 March 2010.
Income taxes
For the three months ended 31 March 2010, we had income tax expense from
continuing operations of $0.2 million, unchanged from the three months ended 31
March 2009. We have no significant tax expense in our U.S.-based operations.
Our Canadian and Swedish operations have an effective tax rate of 32%.
Net income (loss)
For the foregoing reasons, we had net income of $2.6 million for the three
months ended 31 March 2010 compared to a net loss of $3.3 million for the three
months ended 31 March 2009. Excluding loss from discontinued operations, we had
net income from continuing operations of $2.7 million for the three months ended
31 March 2010 compared to a net loss from continuing operations of $2.0 million
for the three months ended 31 March 2009.
Liquidity and capital resources
We have suffered recurring losses and negative cash flows from operations since
inception, and since the second half of 2008, our working capital has been
severely limited. During 2009, we took several actions to improve our
liquidity. These actions included: (i) reduction in cash used in operations
through cost reductions and improved working capital management; (ii) sale of
assets including the sale of the assets of Applied Utility Systems and sale of
intellectual property; and (iii) repayment of debt. In addition, in the second
quarter of 2010, we undertook the capital raise discussed above under "Recent
Developments." Notwithstanding these actions, we are currently operating under
a forbearance agreement with Fifth Third Bank (see "Description of Indebtedness"
below), and although Fifth Third Bank has extended its forbearance through 31
August 2010, this debt has nevertheless been classified as current and due and
payable in 2010.
We had $2.2 million in cash and cash equivalents at 31 March 2010 and $2.3
million at 31 December 2009, and total current liabilities of $17.6 million at
31 March 2010 and $22.9 million at 31 December 2009. As of 31 March 2010, we
had an accumulated deficit of approximately $146.8 million and a working capital
deficit of $1.4 million. Our access to working capital continues to be limited
and our debt service obligations and projected operating costs for 2010 exceed
our cash balance at 31 March 2010. These matters raise substantial doubt about
the Company's ability to continue as a going concern. Failure to recapitalize
or to renegotiate payment terms for debt due will result in the Company not
having sufficient cash to operate.
In order to address this uncertainty, in the first quarter of 2009, we retained
a U.S.-based investment banking firm to act as a financial advisor in exploring
alternatives to recapitalize the Company. Alternatives under consideration
include the sale of the Company's stock and/or a sale of the Company's assets,
while negotiating with our lenders to modify loan terms in order to delay
repayments while alternative capital is secured. At this time, we cannot
provide any assurances that we will be successful in our continuing efforts to
recapitalize the balance sheet or work with our lenders on loan modifications.
In the event that we are not successful in the immediate future, we will be
unable to continue operations and may be required to file bankruptcy. There can
be no assurances that we will be able to reorganize through bankruptcy and might
be forced to effect a liquidation of our assets. The condensed consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
The following table summarizes our cash flows for the three months ended 31
March 2010 and 2009.
+---------------------------------------------------------------+------------------+----------+---------+----------+-----------+----------+---------+
| | 31 | | 31 | | | | |
| | March | | March | | $ | | % |
| | 2010 | | 2009 | | Change | | Change |
+---------------------------------------------------------------+------------------+----------+---------+----------+-----------+----------+---------+
| | (Dollars in millions) |
+---------------------------------------------------------------+-----------------------------------------------------------------------------------+
| Cash provided by (used in): | | | | | | | |
+---------------------------------------------------------------+------------------+----------+---------+----------+-----------+----------+---------+
| Operating | $ | | $ | | $ | | (95.7)% |
| activities.................................................. | (0.1) | | (2.3) | | 2.2 | | |
+---------------------------------------------------------------+------------------+----------+---------+----------+-----------+----------+---------+
| Investing | 1.9 | | 2.3 | | (0.4) | | (17.4)% |
| activities................................................... | | | | | | | |
+---------------------------------------------------------------+------------------+----------+---------+----------+-----------+----------+---------+
| Financing | (1.8) | | (1.5) | | 0.3 | | (20.0)% |
| activities.................................................. | | | | | | | |
+---------------------------------------------------------------+------------------+----------+---------+----------+-----------+----------+---------+
Cash used in operating activities
Cash used in operating activities in the three months ended 31 March 2010 was
$0.1 million, a decrease of $2.2 million from three months ended 31 March 2009,
when our operating activities used $2.3 million of cash. This improvement was
primarily due to improved operating performance, higher margins and lower
operating expenses in the three months ended 31 March 2010 compared to the same
period in 2009.
Cash provided by investing activities
Net cash generated by investing activities was $1.9 million in the three months
ended 31 March 2010, a decrease of $0.4 million as compared to the $2.3 million
generated by investing activities in the three months ended 31 March 2009. This
decrease was primarily the result of $2.0 million received from our Asian joint
venture partner, TKK, from the sale of intellectual property in the three months
ended 31 March 2010 compared to the $2.5 million in the three months ended 31
March 2009, as well as lower capital expenditures in the three months ended 31
March 2010 of $0.1 million compared to $0.2 million in the same period of 2009.
Cash used in financing activities
Net cash used in financing activities was $1.8 million in the three months ended
31 March 2010, a $0.3 million increase as compared to net cash used in financing
activities of $1.5 million in the three months ended 31 March 2009. The higher
usage was primarily due to a greater pay-down of debt for the three months ended
31 March 2010 as compared to the same period of 2009.
Description of Indebtedness
Our outstanding borrowing at 31 March 2010 and December 31, 2009 are summarized
as follows:
+-------------------------------------------------------------------------------------------------------------------------------+-----------+-+-----------+
| | 31 March | | 31 |
| | 2010 | | December |
| | | | 2009 |
+-------------------------------------------------------------------------------------------------------------------------------+-----------+-+-----------+
| | US $000 | | US $000 |
+-------------------------------------------------------------------------------------------------------------------------------+-----------+-+-----------+
| Line of | 3,563 | | 5,147 |
| credit....................................................................................................................... | | | |
+-------------------------------------------------------------------------------------------------------------------------------+-----------+-+-----------+
| Consideration | 3,000 | | 3,000 |
| payable....................................................................................................... | | | |
+-------------------------------------------------------------------------------------------------------------------------------+-----------+-+-----------+
| Capital lease | 68 | | 75 |
| obligations............................................. | | | |
+-------------------------------------------------------------------------------------------------------------------------------+-----------+-+-----------+
| Total | 6,631 | | 8,222 |
| borrowings................................................................................................ | | | |
+-------------------------------------------------------------------------------------------------------------------------------+-----------+-+-----------+
Fifth Third Bank
In December 2007, the Company and its subsidiaries, including Engine Control
Systems, entered into borrowing agreements with Fifth Third Bank as part of the
cash consideration paid for the December 2007 purchase of Engine Control
Systems. The borrowing agreements initially provided for three facilities
including a revolving line of credit and two term loans. The line of credit was
a two-year revolving term operating loan up to a maximum principal amount of
$8.2 million (Canadian $10 million), with availability based upon eligible
accounts receivable and inventory. The other facilities included a five-year
non-revolving term loan of up to $2.5 million, which was paid off during 2008,
and a non-revolving term loan of $3.5 million which was paid off in October
2009.
At 31 March 2010, the line of credit consisted of a Canadian $7.0 million demand
revolving credit line, subject to further reductions in the amount of
availability during any forbearance period. At 31 December 2009, borrowings
under this credit line bore interest at either (i) the U.S. Prime Rate plus
2.50% for borrowings in U.S. dollars; or (ii) the Canadian Prime Rate plus 2.50%
for borrowings in Canadian dollars. As of 31 January 2010, the interest rates
were increased as part of the forbearance agreement to U.S. Prime Rate plus
2.75% for U.S. dollar borrowings and to Canadian Prime Rate plus 2.75% for
Canadian dollar borrowings.
Under the terms of the Fifth Third Bank borrowing agreement, our Engine Control
Systems subsidiary is restricted from making any distributions to us, the parent
company, other than those for arms length transactions and management fees up to
$250,000. The credit facility also requires that we maintain certain financial
covenants and we pledged, as security for our obligations under the facility,
our assets including share ownership and assets of principal subsidiaries. If
our financial results do not reach the levels required by the covenants and we
are unable to obtain a waiver, the credit facility would be in default and
subject to acceleration. In addition to the foregoing, the credit facility also
includes a material adverse change clause that is exercisable if, in the opinion
of Fifth Third Bank, there is a material adverse change in the financial
condition, ownership or operation of our Company or our principal subsidiary
(Engine Control Systems). If Fifth Third Bank were to deem that such a material
adverse change had occurred it may terminate our right to borrow under the
facility and demand payment of all amounts outstanding.
On 31 March 2009, we failed to achieve two of the covenants under our Fifth
Third Bank credit facility. We failed to achieve covenants related to annualized
EBITDA and the funded debt to EBITDA ratio for our Engine Control Systems
subsidiary. Fifth Third Bank agreed to temporarily suspend its rights until 1
July 2009 subject to us, in Fifth Third Bank's opinion, making reasonably
satisfactory progress in our efforts to recapitalize our balance sheet and the
provision of an audit report on the collateral pledged by us to Fifth Third
Bank. In July 2009, the bank extended its forbearance until 30 September 2009,
subject to similar terms. In October 2009, on the repayment of the term loan of
$3.5 million, the bank verbally extended its forbearance until 30 November 2009.
In December 2009, the bank extended its forbearance until 31 January 2010 and
converted the revolving line to a demand facility, reduced the credit limit to
Canadian $8.5 million and raised the interest charged to Prime Rate plus 2.5%.
This conversion to a demand facility effectively rendered the financial
covenants under the original loan agreement meaningless. In January 2010, the
bank extended forbearance until 30 April 2010 and further reduced the credit
limit to Canadian $7.5 million with a Canadian $100,000 reduction per month for
the forbearance period. The interest rate was further increased to U.S./Canadian
Prime Rate plus 2.75%. In June 2010, in connection with the capital raise, the
bank further extended forbearance until 31 August 2010 and reduced the credit
limit on the revolving line of credit, previously denominated in part U.S.
Dollar and part Canadian Dollar, to a total of Canadian $7.0 million. The
interest rate on the line remained unchanged at U.S./Canadian Prime Rate plus
2.75%. The Bank has agreed to a further extension until 30 November 2010 if the
proposed Merger with CDTI is completed by 1 August 2010, and as of 31 August
2010, the notes issued by us in connection with the capital raise have been
converted to common equity and the security granted to the noteholders has been
released; we have $3.0 million of free cash on our balance sheet; our Engine
Control Systems subsidiary has Canadian $2.0 million available under the
existing loan agreement; and no default, forbearance default or event of default
(as defined in the credit and forbearance agreements) is outstanding.
Although Fifth Third Bank has periodically agreed to temporarily suspend its
rights with respect to the breach of these two covenants, there is no guarantee
that it will continue to do so, and the current forbearance period, which is
subject to us, in Fifth Third Bank's opinion, making reasonably satisfactory
progress in our efforts to recapitalize our balance sheet and the provision of
an audit report on the collateral pledged by us to Fifth Third Bank, ends on 31
August 2010.
For further information regarding our credit agreement with Fifth Third Bank,
see Note 4 to the Condensed Consolidated Financial Statements.
Secured convertible notes
In June 2010, pursuant to the terms of our capital raise, we agreed to issue up
to $4 million of secured convertible notes. The secured convertible notes, as
amended, bear interest at a rate of 8% per annum, mature on 2 August 2010, and
are secured by a subordinated lien on the Company's assets, but are subordinated
to Fifth Third Bank. Under the terms of the secured convertible notes, assuming
the necessary shareholder approvals are received at the special meeting of the
Company's shareholders to permit conversion thereof, the $4.0 million of secured
convertible notes will be converted into newly created "Class B" common stock
immediately prior to the Merger such that at the effective time of the Merger,
this group of accredited investors will receive approximately 66% of the Fully
Diluted Pre Merger CSI Stock. "Fully Diluted Pre Merger CSI Stock" means the
total number of shares of the existing Class A and Class B common stock of the
Company outstanding immediately prior to the closing of the Merger including the
equivalent number of shares to be issued to the Company's financial advisor,
Allen & Company LLC, upon closing of the Merger.
The Company has a 10-business day grace period to make payments due under the
secured convertible notes, either at maturity, a date fixed for prepayment, or
by acceleration or otherwise, before it is considered an "Event of Default" as
defined in the secured convertible notes. In the event the merger has not
occurred prior to the maturity date of the secured convertible notes, the
Company has a 10-business day grace period, during which time it could seek the
agreement of the noteholders to extend the maturity date of the notes, before it
would be required to pay the secured convertible notes in full. If the Company
is not able to complete the merger prior to the maturity of the notes, as such
may be extended with the agreement of the noteholders, the outstanding principal
amount under the secured convertible notes, including any interest and an
additional payment premium of two times (2x) the outstanding principal amount
will be due to the investors.
Consideration payable
We have $3.0 million of consideration due to the seller under the Applied
Utility Systems Asset Purchase Agreement dated 28 August 2006. The consideration
was due 28 August 2009 and accrues interest at 5.36%. At 31 March 2010, we had
accrued $578,000 of unpaid interest. In addition, we may be obligated to pay in
connection with our acquisition of the assets of Applied Utility Systems in 2006
an earn-out amount with respect to the period during which we operated the
acquired business. We have claimed that the seller breached the asset purchase
agreement in addition to certain other related agreements and have withheld
payments pending the resolution of arbitration proceedings. For more information
relating to this dispute, see Note 12 to the Condensed Consolidated Financial
Statements.
Related-Party Transactions
One of our Directors of our Board, Mr. Alexander ("Hap") Ellis, III, is a
partner of Rockport Capital LLP ("Rockport"), a shareholder in our Company which
subscribed for the secured convertible notes in connection with the capital
raise discussed above. In light of its size, Rockport's subscription for the
secured convertible notes was deemed to be a related party transaction under the
AIM Rules. The Directors of our Board, other than Mr. Ellis who was deemed to be
a related party for this purpose, consider, having consulted with the Company's
nominated adviser, Canaccord Genuity Limited, that the terms of Rockport's
subscription was fair and reasonable insofar as the shareholders were concerned.
In October 2008, the Company's Board of Directors unanimously adopted a
resolution to waive the Non-Executive Directors' right to receive, and the
Company's obligation to pay, any director fees with respect to participation in
Board and Committee meetings and other matters with effect from 1 July 2008 and
continuing thereafter until the Directors elect to adopt resolutions reinstating
such fees. On 1 May 2009, the Directors adopted a resolution to reinstate the
accrual of director fees effective 1 January 2009, with a payment schedule to be
determined at a later date. As part of the $4 million capital raise discussed
in Note 14 of the Condensed Consolidated Financial Statements, the accrued
director fees as of 31 December 2009, which amounted to $405,822, will be paid
in a combination of common stock and cash, with the cash portion being $0.1
million. The stock portion is contemplated to be issued just prior to the
Merger and converted to CDTI common stock post merger. 2010 director fees will
be paid in cash.
Risks and Uncertainties
Our business and results of operations are subject to numerous risks,
uncertainties and other factors that you should be aware of, some of which are
described below. The risks, uncertainties and other factors described in the
following risk factors are not the only ones facing us. Additional risks,
uncertainties and other factors not presently known to us or that we currently
deem immaterial may also impair our business operations. Any of the risks,
uncertainties and other factors could have a materially adverse effect on our
business, financial condition, results of operations, cash flows or product
market share.
The forbearance agreement in place with respect to our principal credit
agreement expires on 31 August 2010.
Our principal credit agreement has been in default since 31 March 2009. A
forbearance agreement is in place that expires on 31 August 2010, with an
additional extension through 30 November 2010 possible, provided certain
criteria are met. If in Fifth Third Bank's opinion, the Company has a material
adverse change, Fifth Third Bank may demand payment prior to the date the
current forbearance expires. Although no demand for repayment has been made, we
cannot guarantee that our lender will continue to further extend its
forbearance.
Our auditors' report for the fiscal year 2009 included a "going concern"
explanatory paragraph.
We have suffered recurring losses and negative cash flows from operations since
inception, and our working capital is severely limited. As of 31 March 2010, we
had an accumulated deficit of approximately $146.8 million and a working capital
deficit of $1.4 million. Our access to working capital continues to be limited
and our debt service obligations and projected operating costs for 2010 exceed
our cash balance at 31 March 2010. Failure to recapitalize or to renegotiate
payment terms for debt due will result in us not having sufficient cash to
operate and may be forced to liquidate or declare bankruptcy. As a result, our
auditors' report for fiscal year 2009 included an explanatory paragraph that
expressed substantial doubt about our ability to continue as a "going concern."
We have $3.0 million consideration payable in connection with our 2006
acquisition of the assets of Applied Utility Systems in addition to a possible
earn-out amount. We have not paid any amounts due and are disputing our payment
obligations. The dispute is subject to arbitration and there can be no
certainty that the arbitration will be decided in our favor.
We have $3.0 million of consideration due to the seller under the Applied
Utility Systems Asset Purchase Agreement dated 28 August 2006, which was due 28
August 2009 and accrues interest at 5.36%. We have not paid the foregoing amount
and, at 31 March 2010, we had accrued $578,000 of unpaid interest. In addition
to the consideration, the Asset Purchase Agreement also contemplated the payment
of an earn-out by the Company to the seller based on the revenues and net
profits from our conduct of the acquired business. The earn-out amount is
potentially payable over a period of ten years beginning 1 January 2009. The
maximum earnable under the earn-out provision is $21.0 million over the ten year
period.We have not paid any earn-out amount for the fiscal year ended 31
December 2009 and the assets of the business were sold on 1 October 2009. The
payment of the foregoing amounts is the subject of an ongoing arbitration
between the Company and the seller. For more information relating to this
dispute, see Note 12 to the Condensed Consolidated Financial Statements. At
this time, we intend to vigorously assert our claims against the seller under
the Asset Purchase Agreement and to defend against any action or arbitration by
the seller to collect on the consideration and any earn-out amounts payable
under the Asset Purchase Agreement. If we do not prevail in our claims and the
seller is awarded the full-earn-out to which it claims it is entitled for the
full ten-year period, it would have a material adverse effect on our financial
condition.
Certain of our assets may be subject to a writ of attachment issued in
connection with an ongoing arbitration. If we are not successful in limiting
the adverse effects of the writ of attachment, it could limit our ability to
conduct our operations in the ordinary course and restrict the use of certain of
our assets.
In connection with the Applied Utility Systems arbitration proceedings (see Note
12 to the Condensed Consolidated Financial Statements) the seller sought a writ
of attachment with respect to its claims. A writ of attachment is a method used
to secure the retention of assets pending resolution of a legal disagreement.
On 1 June 2010, the arbitrator issued an interim order granting the seller a
right to a writ in the amount of approximately $2.4 million. On 24 June 2010,
the arbitrator issued an order confirming that her interim order must be
confirmed by an applicable court. As of the date of this release, the seller
has neither had the arbitrator's award confirmed by an applicable court nor had
the writ of attachment imposed against any of our assets. If confirmed and
imposed, $2.4 million of our assets would be subject to limitations on their use
and disposition pending resolution of the underlying arbitration. We intend to
continue to vigorously defend our interests to limit any adverse effects of the
writ of attachment and the imposition of the writ against any of our assets,
pending any final decision on the merits of the underlying claims in the
arbitration. This arbitration is in the preliminary stages and it is not
possible to predict the outcome of the arbitration.
We face constant changes in governmental standards by which our products are
evaluated.
We believe that, due to the constant focus on the environment and clean air
standards throughout the world, a requirement in the future to adhere to new and
more stringent regulations both domestically and abroad is possible as
governmental agencies seek to improve standards required for certification of
products intended to promote clean air. In the event our products fail to meet
these ever-changing standards, some or all of these products may become
obsolete.
Future growth of our business depends, in part, on market acceptance of our
catalyst products, successful verification of our systems products and retention
of our verifications.
While we believe that there exists a viable market for our developing catalyst
products, there can be no assurance that such technology will succeed as an
alternative to competitors' existing and new products. The development of a
market for the products is affected by many factors, some of which are beyond
our control. The adoption cycles of our key customers are lengthy and require
extensive interaction with the customer to develop an effective and reliable
catalyst for a particular application. While we continue to develop and test
products with key customers, there can be no guarantee that all such products
will be accepted and commercialized. Our relationships with our customers are
based on purchase orders rather than long-term formal supply agreements.
Generally, once a catalyst has successfully completed the testing and
certification stage for a particular application, it is generally the only
catalyst used on that application and therefore highly unlikely that, unless
there are any defects, the customer will try to replace that catalyst with a
competing product. However, our customers usually have alternate suppliers for
their products and there is no assurance that we will continue to win the
business. If a market fails to develop or develops more slowly than
anticipated, we may be unable to recover the costs we will have incurred in the
development of our products and may never achieve profitability. In addition, we
cannot guarantee that we will continue to develop, manufacture or market our
products or components if market conditions do not support the continuation of
the product or component. We believe that it is an essential requirement of the
U.S. retrofit market that emissions control products and systems are verified
under the Environmental Protection Agency (EPA) and/or California Air Resources
Board (CARB) protocols to qualify for funding from the EPA and/or CARB programs.
Funding for these emissions control products and systems is generally limited to
those products and technologies that have already been verified. We have no
assurance that our product will be verified by CARB or that such a verification
will be acceptable to the EPA. Verification is also useful for commercial
acceptability.
We may not be able to successfully market new products that are developed.
Some of our catalyst products and heavy duty diesel systems are still in the
development or testing stage with targeted customers. We are developing
technologies in these areas that are intended to have a commercial application.
However, there is no guarantee that such technologies will actually result in
any commercial applications. Our proposed operations are subject to all of the
risks inherent in a developing business enterprise, including the likelihood of
continued operating losses, although we have sought to mitigate these risks by
jointly developing our new products, where possible, with respected partners.
The likelihood of our business success must be considered in light of the
problems, expenses, difficulties, complications, and delays frequently
encountered in connection with the growth of an existing business, the
development of products and channels of distribution, and current and future
development in several key technical fields, as well as the competitive and
regulatory environment in which we operate.
Future growth of our business depends, in part, on enforcement of existing
emissions-related environmental regulations and further tightening of emission
standards worldwide.
We expect that our future business growth will be driven, in part, by the
enforcement of existing emissions-related environmental regulations and
tightening of emissions standards worldwide. If such standards do not continue
to become stricter or are loosened or are not enforced by governmental
authorities, it could have a material adverse effect on our business, operating
results, financial condition and long-term prospects.
We face competition and technological advances by competitors.
There is significant competition among companies that provide solutions for
pollutant emissions from diesel engines. Several companies market products that
compete directly with our products. Other companies offer products that
potential customers may consider to be acceptable alternatives to our products
and services, including products that are verified by EPA and/or CARB, or other
environmental authorities. We face direct competition from companies with
greater financial, technological, manufacturing and personnel resources. Newly
developed products could be more effective and cost efficient than our current
or future products. We also face indirect competition from vehicles using
alternative fuels, such as methanol, hydrogen, ethanol and electricity.
We depend on intellectual property and the failure to protect our intellectual
property could adversely affect future growth and success.
We rely on patent, trademark and copyright law, trade secret protection, and
confidentiality and other agreements with employees, customers, partners and
others to protect our intellectual property. However, some of our intellectual
property is not covered by any patent or patent application, and, despite
precautions, it may be possible for third parties to obtain and use our
intellectual property without authorization. We do not know whether any patents
will be issued from pending or future patent applications or whether the scope
of the issued patents is sufficiently broad to protect our technologies or
processes. Moreover, patent applications and issued patents may be challenged or
invalidated. We could incur substantial costs in prosecuting or defending patent
infringement suits. Furthermore, the laws of some foreign countries may not
protect intellectual property rights to the same extent as do the laws of the
United States. As part of our confidentiality procedures, we generally have
entered into nondisclosure agreements with employees, consultants and corporate
partners. We also have attempted to control access to and distribution of our
technologies, documentation and other proprietary information. We plan to
continue these procedures. Despite these procedures, third parties could copy or
otherwise obtain and make unauthorized use of our technologies or independently
develop similar technologies. The steps that we have taken and that may occur in
the future might not prevent misappropriation of our solutions or technologies,
particularly in foreign countries where laws or law enforcement practices may
not protect the proprietary rights as fully as in the United States. There can
be no assurance that we will be successful in protecting our proprietary rights.
Any infringement upon our intellectual property rights could have an adverse
effect on our ability to develop and sell commercially competitive systems and
components.
Our results may fluctuate due to certain regulatory, marketing and competitive
factors over which we have little or no control.
The factors listed below, some of which we cannot control, may cause our revenue
and results of operations to fluctuate significantly:
· Actions taken by regulatory bodies relating to the verification,
registration or health effects of our products.
· The timing and size of customer purchases.
· Customer concerns about the stability of our business, which could cause
them to seek alternatives to our solutions and products.
Failure of one or more key suppliers to timely deliver could prevent, delay or
limit us from supplying products. Delays in delivery times for platinum group
metal purchases could also result in losses due to fluctuations in prices.
Due to customer demands, we are required to source critical materials and
components such as ceramic substrates from single suppliers. Failure of one or
more of the key suppliers to timely deliver could prevent, delay or limit us
from supplying products because we would be required to qualify an alternative
supplier. For certain products and customers, we are required to purchase
platinum group metal materials. As commodities, platinum group metal materials
are subject to daily price fluctuations and significant volatility, based on
global market conditions. Historically, the cost of platinum group metals used
in the manufacturing process has been passed through to the customer. This
limits the economic risk of changes in market prices to platinum group metal
usage in excess of nominal amounts allowed by the customer. However, going
forward there can be no assurance that we will continue to be successful passing
platinum group metal price risk onto our current and future customers to
minimize the risk of financial loss. Additionally, platinum group metal material
is accounted for as inventory and therefore subject to lower of cost or market
adjustments on a regular basis at the end of accounting periods. A drop in
market prices relative to the purchase price of platinum group metal could
result in a write-down of inventory. Due to the high value of platinum group
metal materials, special measures have been taken to secure and insure the
inventory. There is a risk that these measures may be inadequate and expose us
to financial loss.
Failure to attract and retain key personnel could have a material adverse effect
on our future success.
Our success depends, in part, on our ability to retain current key personnel,
attract and retain future key personnel, additional qualified management,
marketing, scientific, and engineering personnel, and develop and maintain
relationships with research institutions and other outside consultants. The loss
of key personnel or the inability to hire or retain qualified personnel, or the
failure to assimilate effectively such personnel could have a material adverse
effect on our business, operating results and financial condition.
If third parties claim that our products infringe upon their intellectual
property rights, we may be forced to expend significant financial resources and
management time litigating such claims and our operating results could suffer.
Third parties may claim that our products and systems infringe upon third-party
patents and other intellectual property rights. Identifying third-party patent
rights can be particularly difficult, especially since patent applications are
not published until up to 18 months after their filing dates. If a competitor
were to challenge our patents, or assert that our products or processes infringe
their patent or other intellectual property rights, we could incur substantial
litigation costs, be forced to make expensive product modifications, pay
substantial damages or even be forced to cease some operations. Third-party
infringement claims, regardless of their outcome, would not only drain financial
resources but also divert the time and effort of management and could result in
customers or potential customers deferring or limiting their purchase or use of
the affected products or services until resolution of the litigation.
We have been dependent on a few major customers for a significant portion of our
revenue and revenue could decline if we are unable to maintain or develop
relationships with current or potential customers.
Historically, we have derived a significant portion of our revenue from a
limited number of customers. For the three months ended 31 March 2010, two
customers accounted for approximately 39% of our revenue. For the three months
ended 31 March 2009, two customers accounted for approximately 40% of our
revenue. We intend to establish long-term relationships with existing customers
and continue to expand our customer base. While we diligently seek to become
less dependent on any single customer, it is likely that certain business
relationships may result in one or more customers contributing to a significant
portion of our revenue in any given year for the foreseeable future. The loss of
one or more significant customers may result in a material adverse effect on our
revenue, our ability to become profitable or our ability to continue our
business operations.
We have recently undertaken significant restructuring of our operations and
implemented cost savings initiatives to improve our operating margins. If we
were to experience significant declines in revenues, our ability to implement
corresponding significant additional reductions in costs may be limited.
We undertook a restructuring of our Catalyst division, divested certain
businesses and implemented a number of initiatives to control our costs to
improve our operating margins. As such, although we are focused on controlling
costs on an ongoing basis and implementing further cost control measures as
necessary, if we were to experience significant declines in revenues, our
ability to implement corresponding significant reductions in costs by making
significant additional structural changes in our operations in the future may be
limited.
Foreign currency fluctuations could impact financial performance.
Because of our activities in Canada, Europe, South Africa and Asia, we are
exposed to fluctuations in foreign currency rates. We may manage the risk to
such exposure by entering into foreign currency futures and option contracts of
which there was one in 2009. Foreign currency fluctuations may have a
significant effect on our operations in the future.
Any liability for environmental harm or damages resulting from technical faults
or failures of our products could be substantial and could materially adversely
affect our business and results of operations.
Customers rely upon our products to meet emissions control standards imposed
upon them by government. Failure of our products to meet such standards could
expose us to claims from our customers. Our products are also integrated into
goods used by consumers and therefore a malfunction or the inadequate design of
our products could result in product liability claims. Any liability for
environmental harm or damages resulting from technical faults or failures could
be substantial and could materially adversely affect our business and results of
operations. In addition, a well-publicized actual or perceived problem could
adversely affect the market's perception of our products, which would materially
impact our financial condition and operating results.
CATALYTIC SOLUTIONS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Unaudited)
+----------------------------------------------------+-----------+-+-----------+
| | March | | December |
| | 31, 2010 | | 31, 2009 |
+----------------------------------------------------+-----------+-+-----------+
| | US $000 | | US $000 |
+----------------------------------------------------+-----------+-+-----------+
| Assets | | | |
+----------------------------------------------------+-----------+-+-----------+
| Current assets: | | | |
+----------------------------------------------------+-----------+-+-----------+
| Cash and cash equivalents | 2,247 | | 2,336 |
+----------------------------------------------------+-----------+-+-----------+
| Trade accounts receivable, net | 6,104 | | 8,066 |
+----------------------------------------------------+-----------+-+-----------+
| Inventories | 6,568 | | 6,184 |
+----------------------------------------------------+-----------+-+-----------+
| Prepaid expenses and other current assets | 1,278 | | 2,010 |
+----------------------------------------------------+-----------+-+-----------+
| | | | |
+----------------------------------------------------+-----------+-+-----------+
| Total current assets | 16,197 | | 18,596 |
| | | | |
+----------------------------------------------------+-----------+-+-----------+
| Property and equipment, net | 2,840 | | 2,897 |
+----------------------------------------------------+-----------+-+-----------+
| Intangible assets, net | 4,421 | | 4,445 |
+----------------------------------------------------+-----------+-+-----------+
| Goodwill | 4,309 | | 4,223 |
+----------------------------------------------------+-----------+-+-----------+
| Other assets | 80 | | 82 |
+----------------------------------------------------+-----------+-+-----------+
| Total assets | 27,847 | | 30,243 |
+----------------------------------------------------+-----------+-+-----------+
| | | | |
+----------------------------------------------------+-----------+-+-----------+
| Liabilities and stockholders' equity | | | |
+----------------------------------------------------+-----------+-+-----------+
| Current liabilities: | | | |
+----------------------------------------------------+-----------+-+-----------+
| Line of credit | 3,563 | | 5,147 |
+----------------------------------------------------+-----------+-+-----------+
| Current portion of long-term debt | 3,000 | | 3,000 |
+----------------------------------------------------+-----------+-+-----------+
| Accounts payable | 5,085 | | 4,967 |
+----------------------------------------------------+-----------+-+-----------+
| Deferred revenue | - | | 195 |
+----------------------------------------------------+-----------+-+-----------+
| Accrued salaries and benefits | 1,144 | | 1,294 |
+----------------------------------------------------+-----------+-+-----------+
| Accrued expenses | 2,765 | | 2,990 |
+----------------------------------------------------+-----------+-+-----------+
| Deferred gain on sale of intellectual | - | | 1,900 |
| property | | | |
+----------------------------------------------------+-----------+-+-----------+
| Accrued professional and consulting fees | 1,499 | | 2,375 |
+----------------------------------------------------+-----------+-+-----------+
| Income taxes payable | 527 | | 1,081 |
+----------------------------------------------------+-----------+-+-----------+
| Total current liabilities | 17,583 | | 22,949 |
+----------------------------------------------------+-----------+-+-----------+
| Long-term debt, excluding current portion | 68 | | 75 |
+----------------------------------------------------+-----------+-+-----------+
| Deferred tax liability | 1,358 | | 1,336 |
+----------------------------------------------------+-----------+-+-----------+
| | | | |
+----------------------------------------------------+-----------+-+-----------+
| Total liabilities | 19,009 | | 24,360 |
+----------------------------------------------------+-----------+-+-----------+
| Commitments and contingencies (Note 12) | | | |
+----------------------------------------------------+-----------+-+-----------+
| Stockholders' equity: | | | |
+----------------------------------------------------+-----------+-+-----------+
| Common stock, no par value. Authorized | | | |
| 148,500,000 shares; issued and outstanding | 156,262 | | 156,216 |
| 69,761,902 shares at March 31, 2010 and December | | | |
| 31, 2009 | | | |
+----------------------------------------------------+-----------+-+-----------+
| Treasury stock at cost (60,000 shares) | (100) | | (100) |
+----------------------------------------------------+-----------+-+-----------+
| Accumulated other comprehensive loss | (572) | | (889) |
+----------------------------------------------------+-----------+-+-----------+
| Accumulated deficit | (146,752) | | (149,344) |
+----------------------------------------------------+-----------+-+-----------+
| Total stockholders' equity | 8,838 | | 5,883 |
+----------------------------------------------------+-----------+-+-----------+
| Total liabilities and | 27,847 | | 30,243 |
| stockholders' equity | | | |
+----------------------------------------------------+-----------+-+-----------+
See accompanying notes to condensed consolidated financial statements.
CATALYTIC SOLUTIONS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(Unaudited)
+---------------------------------------------------+---------+-+---------+
| | Three Months Ended |
| | March 31 |
+---------------------------------------------------+---------------------+
| | 2010 | | 2009 |
+---------------------------------------------------+---------+-+---------+
| | US $000 | | US $000 |
+---------------------------------------------------+---------+-+---------+
| Revenues | 12,445 | | 9,278 |
+---------------------------------------------------+---------+-+---------+
| Cost of revenues | 8,839 | | 6,896 |
+---------------------------------------------------+---------+-+---------+
| Gross margin | 3,606 | | 2,382 |
+---------------------------------------------------+---------+-+---------+
| Operating expenses: | | | |
+---------------------------------------------------+---------+-+---------+
| Sales and marketing | 779 | | 1,152 |
+---------------------------------------------------+---------+-+---------+
| Research and development | 988 | | 1,724 |
+---------------------------------------------------+---------+-+---------+
| General and administrative | 2,258 | | 1,987 |
+---------------------------------------------------+---------+-+---------+
| Severance expense | - | | 170 |
+---------------------------------------------------+---------+-+---------+
| Recapitalization expense | 167 | | 354 |
+---------------------------------------------------+---------+-+---------+
| Gain on sale of intellectual property | (3,900) | | (2,500) |
+---------------------------------------------------+---------+-+---------+
| Total operating expenses | 292 | | 2,887 |
+---------------------------------------------------+---------+-+---------+
| Income (loss) from operations | 3,314 | | (505) |
+---------------------------------------------------+---------+-+---------+
| Other income (expense): | | | |
+---------------------------------------------------+---------+-+---------+
| Interest income | 3 | | 5 |
+---------------------------------------------------+---------+-+---------+
| Interest expense | (147) | | (1,132) |
+---------------------------------------------------+---------+-+---------+
| Other | (297) | | (141) |
+---------------------------------------------------+---------+-+---------+
| Total other expense, net | (441) | | (1,268) |
+---------------------------------------------------+---------+-+---------+
| Income (loss) from continuing operations | 2,873 | | (1,773) |
| before income taxes | | | |
+---------------------------------------------------+---------+-+---------+
| | | | |
+---------------------------------------------------+---------+-+---------+
| Income tax expense from continuing operations | 206 | | 188 |
+---------------------------------------------------+---------+-+---------+
| Net income (loss) from continuing operations | 2,667 | | (1,961) |
+---------------------------------------------------+---------+-+---------+
| Discontinued operations: | | | |
+---------------------------------------------------+---------+-+---------+
| Net loss from operations of discontinued Energy | (75) | | (1,300) |
| Systems division | | | |
+---------------------------------------------------+---------+-+---------+
| Net income (loss) | 2,592 | | (3,261) |
+---------------------------------------------------+---------+-+---------+
| | | | |
+---------------------------------------------------+---------+-+---------+
| Basic net income (loss) per share: | | | |
+---------------------------------------------------+---------+-+---------+
| Net income (loss) from continuing | $0.04 | | $(0.03) |
| operations | | | |
+---------------------------------------------------+---------+-+---------+
| Discontinued operations | | | $(0.02) |
| | - | | |
+---------------------------------------------------+---------+-+---------+
| Basic net income (loss) per share | $0.04 | | $(0.05) |
+---------------------------------------------------+---------+-+---------+
| Diluted net income (loss) per share: | | | |
+---------------------------------------------------+---------+-+---------+
| Net income (loss) from continuing | $0.04 | | $(0.03) |
| operations | | | |
+---------------------------------------------------+---------+-+---------+
| Discontinued operations | | | $(0.02) |
| | - | | |
+---------------------------------------------------+---------+-+---------+
| Diluted net income (loss) per share | $0.04 | | $(0.05) |
+---------------------------------------------------+---------+-+---------+
| Weighted average number of common shares | | | |
| outstanding (000s): | | | |
+---------------------------------------------------+---------+-+---------+
| Basic | 69,762 | | 69,762 |
+---------------------------------------------------+---------+-+---------+
| Diluted | 69,925 | | 69,762 |
+---------------------------------------------------+---------+-+---------+
See accompanying notes to condensed consolidated financial statements.
CATALYTIC SOLUTIONS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Three Months Ended |
| | March 31 |
+--------------------------------------------------------------+-----------------------------------+
| | 2010 | | 2009 |
+--------------------------------------------------------------+---------+-+-----------------------+
| | | US $000 | | US $000 |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Cash flows from operating activities: | | | |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Net income (loss) | 2,592 | | (3,261) |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Loss from discontinued operations | 75 | | 1,300 |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Adjustments to reconcile net income (loss) to net | | | |
| | cash used in operating activities: | | | |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Depreciation and amortization | 310 | | 310 |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Recovery of doubtful accounts, net | (14) | | (13) |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Stock-based compensation | 46 | | 172 |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Loss on unconsolidated affiliate | 56 | | 284 |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Loss on foreign currency transactions | 301 | | 19 |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Gain on sale of intellectual property | (3,900) | | (2,500) |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Changes in operating assets and liabilities: | | | |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Trade accounts receivable | 2,069 | | (1,193) |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Inventories | (310) | | 1,570 |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Prepaid expenses and other assets | 750 | | 2,208 |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Accounts payable | 57 | | (486) |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Deferred revenue | (195) | | - |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Income taxes payable | (538) | | 89 |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Accrued expenses and other current | (1,355) | | (1,458) |
| | liabilities | | | |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Cash used in operating activities | (56) | | (2,959) |
| | of continuing operations | | | |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Cash (used in) provided by | (75) | | 618 |
| | operating activities of discontinued operations | | | |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Net cash used in operating | (131) | | (2,341) |
| | activities | | | |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Cash flows from investing activities: | | | |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Purchases of property and equipment | (78) | | (241) |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Proceeds from sale of intellectual property | 2,000 | | 2,500 |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Net cash provided by investing | 1,922 | | 2,259 |
| | activities | | | |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Cash flows from financing activities: | | | |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Borrowings under line of credit | 248 | | - |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Repayments under line of credit | (2,073) | | (1,485) |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Repayment of long-term debt | (7) | | (2) |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Payments for debt issuance costs | - | | (12) |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Net cash used in financing | (1,832) | | (1,499) |
| | activities | | | |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Effect of exchange rates on cash | (48) | | (286) |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Net change in cash and cash | (89) | | (1,867) |
| | equivalents | | | |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Cash and cash equivalents at beginning of period | 2,336 | | 6,726 |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Cash and cash equivalents at end of period | 2,247 | | 4,859 |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Supplemental disclosures of cash flow | | | |
| | information: | | | |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Cash paid for: | | | |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Interest | 107 | | 339 |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | Income taxes | 646 | | 1 |
+----------+---------------------------------------------------+---------+-+-----------------------+
| | | | | |
+----------+---------------------------------------------------+---------+-+-----------------------+
See accompanying notes to condensed consolidated financial statements.
Notes to Condensed Consolidated Financial Statements (unaudited)
1. Basis of Preparation
a. Description of Business
Catalytic Solutions, Inc. (the "Company") is a global manufacturer and
distributor of emissions control systems and products, focused in the heavy duty
diesel and light duty vehicle markets. The Company's emissions control systems
and products are designed to deliver high value to its customers while
benefiting the global environment through air quality improvement,
sustainability and energy efficiency. Catalytic Solutions, Inc. is listed on AIM
of the London Stock Exchange (AIM: CTS and CTSU) and currently has operations in
the USA, Canada, France, Japan and Sweden as well as an Asian joint venture.
b. Liquidity
The accompanying consolidated financial statements have been prepared assuming
the Company will continue as a going concern. Therefore, the consolidated
financial statements contemplate the realization of assets and liquidation of
liabilities in the ordinary course of business. The Company has suffered
recurring losses and negative cash flows from operations since its inception,
resulting in an accumulated deficit of $146.8 million at March 31, 2010. The
Company has funded its operations through equity sales, debt and bank
borrowings. In addition, due to non-compliance with certain loan covenants
(described below) and per the repayment obligations under the Company's loan
agreements, substantially all the debt of the Company has been classified as
current at March 31, 2010. As a result of this classification, the Company has a
working capital deficit of $1.4 million. The covenants are almost exclusively
based on the performance of the Company's Engine Control Systems subsidiary. As
of March 31, 2009, the Company had failed to achieve two of the covenants under
the bank loan agreement with Fifth Third Bank (see Note 4 for a discussion of
the Fifth Third Bank loan agreement). The covenants that the Company failed to
achieve are those related to the annualized EBITDA and the funded debt to EBITDA
ratio for the Engine Control Systems subsidiary. The bank agreed to temporarily
suspend its rights with respect to the breach of these two covenants under a
Forbearance Agreement that expires on August 31, 2010, with an additional
extension through 30 November 2010, provided certain criteria are met.
At March 31, 2010 the Company had $2.2 million in cash. The Company's access to
working capital is limited and its debt service obligations and projected
operating costs for 2010 exceed its cash balance at March 31, 2010.
These matters raise substantial doubt about the Company's ability to continue as
a going concern. The Company has entered into agreements to merge with Clean
Diesel Technologies, Inc., or CDTI, and to issue $4.0 million of secured
convertible notes to a group of qualifying investors. These agreements are
discussed in greater detail in note 14. At this time, the Company cannot
provide any assurance that the announced Merger and secured convertible notes
issuance will be approved and completed. In the event that the Company is not
successful in completion of the Merger and/or secured convertible notes
issuance, the Company may not be able to continue operations and may be required
to file bankruptcy. There can be no assurance that the Company will be able to
reorganize through bankruptcy and might be forced to effect a liquidation of its
assets. The condensed consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
c. Preparation based on U.S. Generally Accepted Accounting Principles (U.S.
GAAP)
The consolidated financial statements and accompanying notes are presented in
U.S. dollars and have been prepared in accordance with U.S. GAAP.
2. Summary of Significant Accounting Policies
a. Principles of Consolidation
The consolidated financial statements include the financial statements of
Catalytic Solutions, Inc. and its wholly owned subsidiaries. All significant
inter-company balances and transactions have been eliminated in consolidation.
b. Concentration of Risk
For the periods presented below, certain customers accounted for 10% or more of
the Company's revenues as follows:
+----------+---------------+-+---------------+
| | Three Months Ended March 31 |
+----------+---------------------------------+
|Customer | 2010 | | 2009 |
+----------+---------------+-+---------------+
| | | | |
+----------+---------------+-+---------------+
| A | 22% | | 20% |
+----------+---------------+-+---------------+
| B | 17% | | 20% |
+----------+---------------+-+---------------+
The customers above are automotive OEMs and relate to sales within the Catalyst
segment.
For the periods presented below, certain customers accounted for 10% or more of
the Company's accounts receivable balance as follows:
+----------+---------------+-+---------------+
|Customer | March 31, | | December 31, |
| | 2010 | | 2009 |
+----------+---------------+-+---------------+
| | | | |
+----------+---------------+-+---------------+
| A | 21% | | 18% |
+----------+---------------+-+---------------+
| B | 14% | | 15% |
+----------+---------------+-+---------------+
Customer A above is an automotive OEM, and customer B is a diesel systems
distributor.
For the periods presented below, certain vendors accounted for 10% or more of
the Company's raw material purchases as follows:
+---------+---------------+-+---------------+
| | Three Months Ended March 31 |
+---------+---------------------------------+
| Vendor | 2010 | | 2009 |
+---------+---------------+-+---------------+
| | | | |
+---------+---------------+-+---------------+
| A | 22% | | 8% |
+---------+---------------+-+---------------+
| B | 16% | | 19% |
+---------+---------------+-+---------------+
| C | 13% | | 8% |
+---------+---------------+-+---------------+
Vendor A above is a catalyst supplier, vendor B is a precious metals supplier
and vendor C is a substrate supplier.
c. Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires
management of the Company to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Areas
where significant judgments are made include, but are not limited to the
following: impairment of long-lived assets, stock-based compensation, allowance
for doubtful accounts, inventory valuation, taxes and contingent and accrued
liabilities. Actual results could differ from those estimates. These estimates
and assumptions are based on the Company's best estimates and judgment. The
Company evaluates its estimates and assumptions on an ongoing basis using
historical experience and other factors, including the current economic
environment, which it believes to be reasonable under the circumstances.
Estimates and assumptions are adjusted when facts and circumstances dictate.
Illiquid credit markets, volatile equity, foreign currency, and declines in
customer spending have combined to increase the uncertainty inherent in such
estimates and assumptions. As future events and their effects cannot be
determined with precision, actual results could differ from these estimates.
Changes in estimates resulting from continuing changes in the economic
environment will be reflected in the financial statements in future periods.
d. Accounting Changes
On January 1, 2009, the Company adopted EITF 07-05, "Determining Whether an
Instrument (or Embedded Feature) is Indexed to an Entity's Own Stock," included
in Accounting Standards Codification (ASC) topic 815. EITF 07-05 provides
guidance on determining what types of instruments or embedded features in an
instrument held by a reporting entity can be considered indexed to its own
stock. Upon adoption of the EITF, the Company reclassified certain of its
warrants from equity to liabilities. See further discussion in Note 3.
The Company adopted Statement of Financial Accounting Standards No. 157, "Fair
Value Measurements" (SFAS 157) included in ASC Topic 820, for all assets and
liabilities effective January 1, 2008 except for nonfinancial assets and
liabilities that are recognized or disclosed at fair value on a non-recurring
basis where the adoption was January 1, 2009. The adoption of this standard did
not have a material effect on the Company's consolidated financial statements.
ASC 820 prioritizes the inputs used in measuring fair value into the following
hierarchy:
· Level 1: Quoted prices (unadjusted) in active markets for identical
assets or liabilities.
· Level 2: Inputs other than quoted prices included within Level 1 that are
either directly or indirectly observable.
· Level 3: Unobservable inputs in which little or no market activity
exists, therefore requiring an entity to develop its own assumptions about the
assumptions that market participants would use in pricing.
Goodwill impairment testing requires the Company to estimate the fair value of
its reporting unit. The Company's estimate of fair value of its reporting unit
involves level 3 inputs. The estimated fair value of the HDD Systems reporting
unit was derived primarily from a discounted cash flow model utilizing
significant unobservable inputs including expected cash flows and discount
rates. In addition, the Company considered the overall fair values of its
reporting units as compared to the market capitalization of the Company. The
Company determined that no goodwill impairment existed as of December 31, 2009
or March 31, 2010; however, it is reasonably possible that future impairment
tests may result in a different conclusion for the goodwill of the HDD Systems
reporting unit. The estimate of fair value of the reporting units is sensitive
to certain factors including but not limited to the following: movements in the
Company's share price, changes in discount rates and the Company's cost of
capital, growth of the reporting unit's revenue, cost structure of the reporting
unit, successful completion of research and development and customer acceptance
of new products and approval of the reporting unit's product by regulatory
agencies.
During 2009, the Company elected to change its accounting policy for legal costs
incurred during the registration of patents to expense such costs as incurred.
Previously, the Company capitalized such costs when they concluded such costs
resulted in probable future benefits. Due to the administrative difficulties in
documenting support for the future benefit of such costs as a result of
uncertainty of ultimate patent approval, the Company concluded the new method of
accounting was preferable.
e. Fair Value of Financial Instruments
The fair values of the Company's cash and cash equivalents, trade accounts
receivable, prepaid expenses and other current assets, accounts payable, accrued
salaries and benefits and accrued expenses approximate carrying values due to
the short maturity of these instruments. The fair values of the Company's debt
and off-balance sheet commitments are less than their carrying values as a
result of deteriorating credit quality of the Company and, therefore, it is
expected that current market rates would be higher than those currently being
experienced by the Company.
It is not practical to estimate the fair value of these instruments as the
Company's debt is not publicly traded and the Company's current financial
position and the recent credit crisis experienced by financial institutions have
caused current financing options to be limited.
3. Warrants
The exercisable warrants and their associated exercise prices are shown below at
March 31, 2010:
+------------------------------------------------------------+------------+
| Warrants exercisable into common stock (issued in USD) | 37,500 |
+------------------------------------------------------------+------------+
| Exercise price | $1.67 |
+------------------------------------------------------------+------------+
| Warrants exercisable into common stock (issued in GBX) | 4,367,115 |
+------------------------------------------------------------+------------+
| Weighted average exercise price | $1.02 |
+------------------------------------------------------------+------------+
The Company has outstanding warrants to purchase its common stock held by Cycad
Group, LLC, Capital Works ECS Investors, LLC and Silicon Valley Bank. The
Company adopted EITF 07-05 on January 1, 2009. With the adoption of EITF 07-05,
the warrants to Cycad Group, LLC and Capital Works ECS Investors, LLC were
determined not to be solely linked to the stock price of the Company and
therefore require classification as liabilities. As a result of the adoption on
January 1, 2009, the Company recorded a cumulative effect of change in
accounting principle of $2.3 million directly as a reduction of accumulated
deficit representing the decline in fair value between the issuance and adoption
date. For the three months ended March 31, 2009, the application of EITF 07-05
resulted in an increase to other income of $53,000 resulting from a decline in
fair value of the warrants during the period. Silicon Valley Bank has agreed to
cancel its 37,500 warrants contingent upon, and immediately prior to, completion
of the Merger.
4. Debt
The Company has a demand revolving credit line through Fifth Third Bank with a
maximum principal amount of Canadian $7.0 million and availability based upon
eligible accounts receivable and inventory. At March 31, 2010, the outstanding
balance in U.S. dollars was $3.6 million with $3.7 million available for
borrowings by Engine Control Systems in Canada. The loan is collateralized by
the assets of the Company. The interest rate on the line of credit is variable
based upon Canadian and U.S. Prime Rates. As of March 31, 2010, the weighted
average borrowing rate on the line of credit was 5.76% compared to 4.48% as of
December 31, 2009. The Company is also subject to covenants on minimum levels
of tangible capital funds, fixed charge coverage, earnings before interest,
taxes, depreciation and amortization (EBITDA), funded debt-to-earnings before
income tax and depreciation and amortization. In the event of default, the bank
may demand payment on all amounts outstanding immediately. The Company is also
restricted from paying corporate distributions in excess of $250,000. The loan
agreement also includes a material adverse change clause, exercisable if, in the
opinion of the bank, there is a material adverse change in the financial
condition, ownership or operation of Engine Control Systems or the Company. If
the bank deems that a material adverse change has occurred, the bank may
terminate the Company's right to borrow under the agreement and demand payment
of all amounts outstanding under the agreement. As of March 31, 2009, the
Company had failed to achieve two of the covenants under the bank loan agreement
with Fifth Third Bank. The covenants that the Company failed to achieve are
those related to the annualized EBITDA and the funded debt to EBITDA ratio for
the Engine Control Systems subsidiary. The bank agreed to temporarily suspend
its rights with respect to the breach of these two covenants under a Forbearance
Agreement that expires on August 31, 2010. A further extension until November
30, 2010 will be granted if the proposed Merger with CDTI is completed by August
1, 2010, and as of August 31, 2010, the secured convertible notes issued by the
Company in connection with the capital raise have been converted to common
equity and the security granted to the convertible noteholders has been
released; the Company has $3.0 million of free cash on its balance sheet; the
Engine Control Systems subsidiary has Canadian $2.0 million available under the
existing loan agreement; and no default, forbearance default or event of default
(as defined in the credit and forbearance agreements) is outstanding.
The Company has $3.0 million of consideration due to the seller as part of the
Applied Utility Systems acquisition. The consideration was due August 28, 2009
and accrues interest at 5.36%. At March 31, 2010 the Company had accrued
$578,000 of unpaid interest. In addition, the Company may be obligated to pay
in connection with its acquisition of the assets of Applied Utility Systems in
2006 an earn-out amount with respect to the period during which it operated the
acquired business. The Company is currently in arbitration with seller on these
matters.
Long-term debt at March 31, 2010 and December 31, 2009 is summarized as follows:
+-------------------------------------+-------------+-+-------------+
| | March 31, | | December |
| | 2010 | | 31, 2009 |
+-------------------------------------+-------------+-+-------------+
| | US $000 | | US $000 |
+-------------------------------------+-------------+-+-------------+
| Line of credit | 3,563 | | 5,147 |
+-------------------------------------+-------------+-+-------------+
| Consideration payable | 3,000 | | 3,000 |
+-------------------------------------+-------------+-+-------------+
| Capital lease obligation | 68 | | 75 |
+-------------------------------------+-------------+-+-------------+
| | 6,631 | | 8,222 |
+-------------------------------------+-------------+-+-------------+
| Less current portion | (6,563) | | (8,147) |
+-------------------------------------+-------------+-+-------------+
| | 68 | | 75 |
+-------------------------------------+-------------+-+-------------+
5. Severance Expense
The Company has taken actions to reduce its cost base beginning in 2008 and
continuing into the three months ended March 31, 2010. As a result of these
actions, the Company has accrued severance costs, included in accrued expenses
on the accompanying consolidated balance sheets, as follows:
+-------------------------------------+-------------+-+-------------+
| |Three Months Ended March 31 |
+-------------------------------------+-----------------------------+
| | 2010 | | 2009 |
+-------------------------------------+-------------+-+-------------+
| | US $000 | | US $000 |
+-------------------------------------+-------------+-+-------------+
| Balance at beginning of period | 670 | | 187 |
+-------------------------------------+-------------+-+-------------+
| Accrued severance expense | - | | 170 |
+-------------------------------------+-------------+-+-------------+
| Paid severance expense | (240) | | (209) |
+-------------------------------------+-------------+-+-------------+
| Balance at end of period | 430 | | 148 |
+-------------------------------------+-------------+-+-------------+
6. Accrued Warranty
The Company accrues warranty upon shipment of its products. Accrued warranties
are included in accrued expenses on the accompanying consolidated balance
sheets. The accrued warranty for the three months ended March 31, 2010 and 2009
is as follows:
+-------------------------------------+-------------+-+-------------+
| |Three Months Ended March 31 |
+-------------------------------------+-----------------------------+
| | 2010 | | 2009 |
+-------------------------------------+-------------+-+-------------+
| | US $000 | | US $000 |
+-------------------------------------+-------------+-+-------------+
| Balance at beginning of period | 371 | | 178 |
+-------------------------------------+-------------+-+-------------+
| Accrued warranty expense | 59 | | 32 |
+-------------------------------------+-------------+-+-------------+
| Warranty claims paid | (34) | | (49) |
+-------------------------------------+-------------+-+-------------+
| Translation adjustment | 10 | | (5) |
+-------------------------------------+-------------+-+-------------+
| Balance at end of period | 406 | | 156 |
+-------------------------------------+-------------+-+-------------+
7. Net Income (loss) per Share
Basic net income (loss) per share is computed using the weighted average number
of common shares outstanding during the period. Diluted net income (loss) per
share is computed using the weighted average number of common shares and
dilutive potential common shares. Diluted net income (loss) per share excludes
certain dilutive potential common shares outstanding, as their effect is
anti-dilutive on loss from continuing operations. Dilutive potential common
shares consist of employee stock options and other warrants that are convertible
into the Company's common stock. The Company had potential dilutive securities
totaling 8,604,842 and 9,508,209 for the three months ended March 31, 2010 and
2009.
For the three months ended March 31, 2010 and 2009 the effect of the dilutive
securities totaling 7,354,842 and 9,508,209 equivalent shares, respectively,
have been excluded in the computation of net loss per share and net loss from
continuing operations per share as their impact would be anti-dilutive.
8. TCC Joint Venture
In February 2008, the Company entered into an agreement with Tanaka Kikinzoku
Kogyo K.K. (TKK) to form a new joint venture company, TC Catalyst Incorporated
(TCC), a Japanese corporation. The joint venture is part of the Catalyst
division. The Company entered the joint venture in order to improve its
presence in Japan and Asia and strengthen its business flow into the Asian
market.
In December 2008, the Company agreed to sell and transfer specific heavy duty
diesel catalyst technology and intellectual property to TKK for use in the
defined territory for a total selling price of $7.5 million. TKK will provide
that intellectual property to TCC on a royalty-free basis. The Company also
sold shares in TCC to TKK reducing its ownership to 30%. $5.0 million of the
sale was completed and recognized in 2008 with $2.5 million recognized in the
three months ended March 31, 2009.
In December 2009, the Company agreed to sell and transfer specific three-way
catalyst and zero PGM patents to TKK for use in specific geographic regions.
The patents were sold for $3.9 million. TKK paid the Company $1.9 million in
2009 and $2.0 million in the first quarter of 2010. The Company recognized the
gain on sale of the patents of $3.9 million in the three months ended March 31,
2010. As part of the transaction, the Company also sold shares in TCC, bringing
its ownership in the joint venture down to 5%.
The Company's investment in TCC is accounted for using the equity method as the
Company still has significant influence over TCC as a result of having a seat on
TCC's board. In February 2010, the Company entered into an agreement to loan
37,500,000 JPY (approximately $405,000) to TCC to fund continuing operations.
The loan is funded in four monthly tranches starting in February 2010 and ending
in May 2010. As of March 31, 2010, the Company had loaned TCC 18,000,000 JPY.
If the loan is not repaid by TCC, it will offset the Company's obligation to
fund its portion of TCC's losses. Given TCC's historical losses, the loan has
been recorded as a reduction of such obligations. At March 31, 2010, the
Company's interest in the accumulated deficit of TCC less the loan to TCC is
reflected as an accrued liability of $0.1 million. TCC operates with a March 31
fiscal year-end. Financial information for TCC as of and for the three months
ended March 31, 2010 and 2009 is as follows:
+-------------------------------------+-------------+-+-------------+
| |Three Months Ended March 31 |
+-------------------------------------+-----------------------------+
| | 2010 | | 2009 |
+-------------------------------------+-------------+-+-------------+
| | US $000 | | US $000 |
+-------------------------------------+-------------+-+-------------+
| Assets | 7,168 | | 12,473 |
+-------------------------------------+-------------+-+-------------+
| Liabilities | 12,452 | | 13,091 |
+-------------------------------------+-------------+-+-------------+
| Deficit | (5,284) | | (617) |
+-------------------------------------+-------------+-+-------------+
| | | | |
+-------------------------------------+-------------+-+-------------+
| Net sales | 130 | | 378 |
+-------------------------------------+-------------+-+-------------+
| Gross Margin | (100) | | (93) |
+-------------------------------------+-------------+-+-------------+
| Net loss | (1,252) | | (928) |
+-------------------------------------+-------------+-+-------------+
9. Sale of Energy Systems Division
On October 1, 2009 the Company sold all significant assets of Applied Utility
Systems, Inc., which comprised the Company's Energy Systems division, for up to
$10.0 million, including $8.6 million in cash and contingent consideration of
$1.4 million. Of the contingent consideration, $0.5 million was contingent upon
Applied Utility Systems being awarded certain projects and $0.9 million is
retention against certain project and contract warranties and other obligations.
The Company has not recognized any of the contingent consideration as of March
31, 2010 and will only do so if the contingencies are resolved favorably. The
$0.5 million of contingent consideration that was contingent on the award of
certain projects was not earned and is not likely to be paid. The income
statement of the Energy Systems division is presented as discontinued
operations. There was no revenue included within discontinued operations for
the period ended March 31, 2010. Revenue included within discontinued
operations was $2.0 million for the three months ended March 31, 2009.
10. Related-party Transactions
One of the Company's Directors, Mr. Alexander ("Hap") Ellis, III, is a partner
of Rockport Capital LLP ("Rockport"), a shareholder in the Company which
subscribed for the secured convertible notes in connection with the capital
raise discussed in Note 14.
In October 2008, the Company's Board of Directors unanimously adopted a
resolution to waive the Non-Executive Directors' right to receive, and the
Company's obligation to pay, any director fees with respect to participation in
Board and Committee meetings and other matters with effect from July 1, 2008 and
continuing thereafter until the Directors elect to adopt resolutions reinstating
such fees. On May 1, 2009, the Directors adopted a resolution to reinstate the
accrual of director fees effective January 1, 2009, with a payment schedule to
be determined at a later date. As of March 31, 2010 an amount of $474,000 was
accrued for Directors fees and was due and payable to the Directors. As part of
the $4 million capital raise discussed in Note 14, the accrued director fees as
of December 31, 2009, which amounted to $405,822, will be paid in a combination
of common stock and cash, with the cash portion being $0.1 million. The stock
portion is contemplated to be issued just prior to the Merger and converted to
CDTI common stock post merger. 2010 director fees will be paid in cash.
11. Goodwill and Intangible Assets
The changes in the carrying amount of goodwill for the year ended December 31,
2009 and three months ended March 31, 2010 are as follows:
+---------------------------------------------------+---------------+
| | US $000 |
+---------------------------------------------------+---------------+
| Balance at December 31, 2008 | 6,319 |
+---------------------------------------------------+---------------+
| Sale of Energy Systems division | (2,600) |
+---------------------------------------------------+---------------+
| Effect of translation adjustment | 504 |
+---------------------------------------------------+---------------+
| | |
+---------------------------------------------------+---------------+
| Balance at December 31, 2009 | 4,223 |
+---------------------------------------------------+---------------+
| Effect of translation adjustment | 86 |
+---------------------------------------------------+---------------+
| Balance at March 31, 2010 | 4,309 |
+---------------------------------------------------+---------------+
Intangible assets as of March 31, 2010 and December 31, 2009 are summarized as
follows:
+------------------------+--------+-------------+---+---------------+
| Useful life | March 31, | | December 31, |
| | 2010 | | 2009 |
+---------------------------------+-------------+---+---------------+
| | | US $000 | | US $000 |
+------------------------+--------+-------------+---+---------------+
| Trade name | 15-20 | 760 | | 738 |
| | years | | | |
+------------------------+--------+-------------+---+---------------+
| Patents and know-how | 5-10 | 3,724 | | 3,792 |
| | years | | | |
+------------------------+--------+-------------+---+---------------+
| Customer relationships | 8 | 1,222 | | 1,206 |
| | years | | | |
+------------------------+--------+-------------+---+---------------+
| | | 5,706 | | 5,736 |
+------------------------+--------+-------------+---+---------------+
| Less accumulated | | (1,285) | | (1,291) |
| amortization | | | | |
+------------------------+--------+-------------+---+---------------+
| | | 4,421 | | 4,445 |
+------------------------+--------+-------------+---+---------------+
Aggregate amortization for amortizable intangible assets, using the
straight-line amortization method, for the three months ended March 31, 2010 and
2009 was $0.1 million. Estimated amortization expense for existing intangible
assets for the next five years is $546,000 in each year.
12. Legal Proceedings
In connection with the Company's acquisition of the assets of Applied Utility
Systems, Inc., Applied Utility Systems entered into a Consulting Agreement with
M.N. Mansour, Inc. ("Mansour, Inc."), pursuant to which Mansour, Inc. and Dr.
M.N. Mansour ("Dr. Mansour") agreed to perform consulting services for Applied
Utility Systems. As further discussed in Note 9, the income statement of
Applied Utility Systems is presented as discontinued operations. During
February 2008, Applied Utility Systems terminated the Consulting Agreement for
cause and alleged that Mansour, Inc. and Dr. Mansour had breached their
obligations under the Consulting Agreement. The matter was submitted to binding
arbitration in Los Angeles, California. On April 13, 2010, the Arbitrator
rendered a Final Award (a) finding that the Consulting Agreement was properly
terminated by the Company on February 27, 2008, (b) excusing the Company from
any obligation to make any further payments under the Consulting Agreement, (c)
obligating Mansour, Inc. to pay the Company an amount equal to 75% of all
amounts paid to Mansour Inc. by the Company under the Consulting Agreement, and
(d) awarding the Company attorney's fees in the amount of $450,000, resulting in
a total award of approximately $1.2 million. The Company has initiated action
to enter a judgment pursuant to the award and Mansour, Inc. has petitioned the
court to set aside the award, which matters are scheduled for hearing on August
2, 2010. Included in accrued liabilities at March 31, 2010, is an accrual for
the consulting fees under this arrangement through the date of the award
totaling $1.5 million. The Company will reverse such liability and record an
associated gain from discontinued operations during the quarter ending June 30,
2010, which represents the period in which the Company was legally released from
its liability.
The Company has $3.0 million of consideration due to the seller under the
Applied Utility Systems Asset Purchase Agreement dated August 28, 2006. The
consideration was due August 28, 2009 and accrues interest at 5.36%. At March
31, 2010 the Company had accrued $578,000 of unpaid interest. The Company has
not paid the foregoing amounts. In addition, the Asset Purchase Agreement
provides that the Company would pay the seller an earn-out amount based on the
revenues and net profits from the conduct of the acquired business of Applied
Utility Systems. The earn-out potentially was payable over a period of ten
years beginning January 1, 2009. The Company has not paid any earn-out amount
for the fiscal year ended December 31, 2009. The assets of the business were
sold on October 1, 2009 and the Company believes that it has no obligation to
pay any earn-out for any period post the sale of the business. The seller
commenced an action in California Superior Court to compel arbitration regarding
the consideration which was due in August 2009. Such action was stayed by the
court and the seller was directed to pursue any collection action through
arbitration. The seller has commenced arbitration proceedings to collect the
consideration which was due in August 2009 and any earn-out amounts payable
under the Asset Purchase Agreement. The earn-out requested under the
proceedings is $21 million, which is the maximum earnable over the ten year
period of the earn-out defined in the Asset Purchase Agreement. The Company has
certain claims against the seller under the terms of the Asset Purchase
Agreement. While the arbitration is in the preliminary stages and it is not
possible to predict the outcome of the arbitration, the Company intends to
vigorously assert its claims against the seller under the Asset Purchase
Agreement and to defend against any action or arbitration by the seller to
collect on the consideration and earn-out. The Company believes the outcome of
these matters will not exceed the liabilities recorded as of March 31, 2010. In
connection with the arbitration proceedings, the seller sought a writ of
attachment with respect to the foregoing amounts. On June 24, 2010, the
arbitrator issued an interim award granting the seller a right to a writ in the
amount of approximately $2.4 million (which amount was the net amount of the
approximately $3.6 million that the seller claimed was payable by the Company
during August 2009 and the amount of $1.2 million that the Company was awarded
against the seller in a separate arbitration action by the Company relating to
the seller's breach of his Consulting Agreement with the Company). Thus far, the
seller has neither had the arbitrator's award confirmed by an applicable court
nor had the writ of attachment imposed against any of the Company's assets. The
Company intends to continue to vigorously defend its interests to limit any
adverse effects of the writ of attachment and the imposition of the writ against
any of the Company's assets, pending any final decision on the merits of the
underlying claims in the arbitration. Under the terms of the Fifth Third
forbearance agreement described in Note 4, the Company is restricted from making
any payment to unsecured creditors, including seller, until the conditions of
the forbearance agreement have been met.
In connection with the Company's acquisition of the assets of Applied Utility
Systems, Inc., the seller entered into an agreement not to compete pursuant to
which he agreed to refrain from taking certain actions that would be competitive
with the business of Applied Utility Systems, Inc. The Company believes that
the seller has breached his obligations under the agreement not to compete and
on November 19, 2009, commenced suit in California Superior Court for Orange
County, California, to enjoin any continuing breaches and to recover damages for
the alleged breaches. The seller has demurred to the complaint. A hearing on
the demurrer was held on May 10, 2010, at which hearing the court granted the
demur but permitted the Company to file an Amended Complaint. The Company has
filed an amended complaint and a further demurrer hearing is scheduled for July
26, 2010. The suit is in the preliminary stages and it is not possible to
predict the outcome of the suit.
On September 30, 2008, Applied Utility Systems, Inc. ("AUS"), a former
subsidiary of the Company, filed a complaint against Benz Air Engineering, Inc.
("Benz Air"). The complaint was amended on January 16, 2009, and asserts claims
against Benz Air for breach of contract, common counts and slander. AUS seeks
$183,000 in damages, plus interest, costs and applicable penalties. In response
to the complaint, Benz Air filed a cross-complaint on November 17, 2008, which
named both AUS and the Company as defendants. The cross-complaint asserts
claims against AUS and the Company for breach of oral contract, breach of
express warranty, breach of implied warranty, negligent misrepresentation and
intentional misrepresentation and seeks not less than $300,000 in damages, plus
interest, costs and punitive damages. The Company is unable to estimate any
potential payment for punitive damages as they have not been quantified by Benz
Air. The Company believes it is more likely than not to prevail in this matter.
The trial began on June 14, 2010 and was postponed to July 19, 2010.
13. Segment Reporting
The Company has two division segments based on the products it delivers:
Heavy Duty Diesel (HDD) Systems division - The HDD Systems division includes
retrofit of legacy diesel fleets with emissions control systems and the emerging
opportunity for new engine emissions controls for on- and off-road vehicles. In
2007, the Company acquired Engine Control Systems (ECS), an Ontario,
Canada-based company focused on a variety of heavy duty vehicle applications.
This environmental business segment specializes in the design and manufacture of
verified exhaust emissions control solutions. Globally, the HDD Systems division
offers a range of products for the OEM, aftermarket and retrofit markets in
order to reduce exhaust emissions created by on-road, off-road and stationary
diesel, gasoline and alternative fuel engines including propane and natural gas.
The retrofit market in the U.S. is driven in particular by state and municipal
environmental regulations and incentive funding for voluntary early compliance.
The HDD Systems division derives significant revenues from retrofit with a
portfolio of solutions verified by the California Air Resources Board and the
United States Environmental Protection Agency.
Catalyst division - The Catalyst division is the original part of the Catalytic
Solutions (CSI) business behind the Company's proprietary Mixed Phase Catalyst
(MPC ) technology enabling the Company to produce catalyst formulations for
gasoline, diesel and natural gas induced emissions that offer performance,
proven durability and cost effectiveness for multiple markets and a wide range
of applications. A family of unique catalysts has been developed - with
base-metals or low platinum group metal (PGM) and zero PGM content - to provide
increased catalytic function and value for technology-driven automotive industry
customers.
Corporate - Corporate includes cost for personnel, insurance and public company
expenses such as legal, audit and taxes that are not allocated down to the
operating divisions. During 2009, the Company changed its internal reporting to
the Company's chief operational decision makers to report corporate expenses
separately from the Catalyst division. All data reported reflect this change.
Discontinued operations - In 2006, the Company purchased Applied Utility
Systems, Inc., a provider of cost-effective, engineered solutions for the clean
and efficient utilization of fossil fuels. Applied Utility Systems, referred to
as the Company's Energy Systems division, provided emissions control and energy
systems solutions for industrial and utility boilers, process heaters, gas
turbines and generation sets used largely by major utilities, industrial process
plants, OEMs, refineries, food processors, product manufacturers and
universities. The Energy Systems division delivered integrated systems built for
customers' specific combustion processes. As discussed in Note 9, this division
was sold on October 1, 2009.
Summarized financial information for our reportable segments as of and for the
three months ended March 31, 2010 and 2009 is shown in the following table:
+-------------------------------------+-------------+-+-------------+
| |Three Months Ended March 31 |
+-------------------------------------+-----------------------------+
| | 2010 | | 2009 |
+-------------------------------------+-------------+-+-------------+
| | US $000 | | US $000 |
+-------------------------------------+-------------+-+-------------+
| Net sales | | | |
+-------------------------------------+-------------+-+-------------+
| HDD Systems | 7,499 | | 4,492 |
+-------------------------------------+-------------+-+-------------+
| Catalyst | 5,084 | | 4,877 |
+-------------------------------------+-------------+-+-------------+
| Corporate | - | | - |
+-------------------------------------+-------------+-+-------------+
| Eliminations (1) | (138) | | (91) |
+-------------------------------------+-------------+-+-------------+
| Total | 12,445 | | 9,278 |
+-------------------------------------+-------------+-+-------------+
| Income (loss) from operations | | | |
+-------------------------------------+-------------+-+-------------+
| HDD Systems | 1,102 | | (11) |
+-------------------------------------+-------------+-+-------------+
| Catalyst | 3,658 | | 1,205 |
+-------------------------------------+-------------+-+-------------+
| Corporate | (1,446) | | (1,699) |
+-------------------------------------+-------------+-+-------------+
| Total | 3,314 | | (505) |
+-------------------------------------+-------------+-+-------------+
(1) Elimination of Catalyst revenue related to sales to HDD Systems.
The Catalyst division income from operations includes $3.9 million of gain on
sale of intellectual property to TKK in 2010 and $2.5 million in 2009.
Net sales by geographic region based on location of sales organization for the
three months ended March 31, 2010 and 2009 is shown in the following table:
+-------------------------------------+-------------+-+-------------+
| |Three Months Ended March 31 |
+-------------------------------------+-----------------------------+
| | 2010 | | 2009 |
+-------------------------------------+-------------+-+-------------+
| | US $000 | | US $000 |
+-------------------------------------+-------------+-+-------------+
| United States | 5,767 | | 5,575 |
+-------------------------------------+-------------+-+-------------+
| Canada | 5,150 | | 2,630 |
+-------------------------------------+-------------+-+-------------+
| Europe | 1,528 | | 1,073 |
+-------------------------------------+-------------+-+-------------+
| Total | 12,445 | | 9,278 |
+-------------------------------------+-------------+-+-------------+
14. Subsequent Events
The Company has evaluated subsequent events from the balance sheet date through
July 19, 2010, the date at which the unaudited condensed consolidated financial
statements were issued.
Proposed Merger with Clean Diesel Technologies, Inc. - On May 14, 2010, the
Company announced that it had entered into a merger agreement with Clean Diesel
Technologies, Inc., or CDTI, a U.S.-based company that designs, markets and
licenses patented technologies and solutions that reduce harmful emissions from
internal combustion engines while improving fuel economy and engine power (the
"Merger"). The Company entered into an Agreement and Plan of Merger (the
"Merger Agreement"), dated as of May 13, 2010, with CDTI and CDTI Merger Sub,
Inc., a California corporation and wholly-owned subsidiary of CDTI ("Merger
Sub"). The proposed Merger, to be effected by way of a reverse merger, is a
transaction that will result in the combination of the Company's business with
CDTI, whereby the Company will become a wholly-owned subsidiary of CDTI.
In exchange for their shares of the Company's common stock and warrants to
purchase shares of the Company's common stock, the Company's security holders
will receive shares of CDTI common stock and (excluding investors in the capital
raise discussed below) warrants to purchase CDTI common stock. The Company's
shareholders (including investors in the capital raise and the Company's
financial advisor, Allen & Company, LLC) will receive such numbers of CDTI
common stock so that after the Merger they will own 60% of the outstanding
shares of CDTI common stock and (excluding investors in the capital raise and
also the Company's financial advisor) warrants to purchase up to three million
shares of CDTI common stock. The Company's financial advisor will hold warrants
to purchase an additional one million shares of CDTI common stock.
The Merger is conditional, among other things, on obtaining the Company's
shareholder approval and CDTI stockholder approval. The Merger Agreement
contains provisions regarding an adjustment to the merger consideration based on
a closing cash adjustment depending on whether each company meets certain cash
targets determined at June 30, 2010. Both companies have met such cash targets
at June 30, 2010, and therefore no cash adjustment is necessary.
CDTI will use commercially reasonable efforts to cause all shares of CDTI common
stock to be issued in connection with the Merger and all shares of CDTI common
stock to be issued upon exercise of the warrants to purchase shares of CDTI
common stock to be listed on the NASDAQ Stock Market as of the effective time of
the Merger.
Neither company will be required to complete the Merger if the shares of CDTI
common stock to be issued in connection with the Merger are not approved for
listing, subject to notice of issuance, on the NASDAQ Stock Market.
Following completion of the Merger:
· Merger Sub will merge with and into the Company and the Company will be
the surviving corporation.
· As a result of the Merger, the business and assets of the Company will be
a wholly-owned subsidiary of CDTI.
· The Company will cease trading on the Alternative Investment Market (AIM).
· The board of directors of the combined company is expected to comprise
seven directors, four from the Company's existing board of directors (Charles F.
Call, Alexander Ellis, III, Charles R. Engles Ph.D. and Bernard H. Cherry) and
three from CDTI (Mungo Park, Michael L. Asmussen and Derek R. Gray).
· The executive management team of the combined company is expected to be
composed of the following members of the current management team of the Company:
Charles F. Call, Nikhil A. Mehta and Stephen J. Golden Ph.D., and Michael L.
Asmussen, a member of the current management team of CDTI.
CDTI has filed a Form S-4 Registration Statement containing a joint proxy
statement/information statement and prospectus, providing the Company's
shareholders with information about the background to and the reasons for the
Merger and capital raise (the "Circular"), and containing a notice of a special
meeting of the Company's shareholders to be convened on a date to be agreed and
will be sent to shareholders when declared effective. The Circular outlining
the terms of the Merger and capital raise will seek shareholder approval to,
among other things, enable the Company to complete the Merger and capital raise
discussed below.
The Merger will be completed once both companies have approved the Merger and
the conditions are satisfied. The timing of the shareholders' meetings of both
companies is dependant on when the Registration Statement is declared effective,
which cannot be determined now. Final timing relating to the date of the
shareholders' meetings and the expected completion date for the Merger will be
set out in the Circular that is dispatched to shareholders of both companies.
$4 Million Capital Raise - On June 2, 2010, the Company entered into agreements
with a group of accredited investors providing for the sale of $4.0 million of
secured convertible notes. The secured convertible notes, as amended, bear
interest at a rate of 8% per annum, mature on August 2, 2010, and are secured by
a subordinated lien on the Company's assets (the security interest is
subordinate to the first priority security interest of Fifth Third Bank). Under
the agreements, $2.0 million of the secured convertible notes have been issued
by the Company in four equal instalments ($500,000 on each of June 2, 2010, June
8, 2010, June 28, 2010 and July 12, 2010), with the remaining $2.0 million to be
issued after the Company's shareholders approve the Merger and after other
necessary approvals under its articles of incorporation, but prior to the
effective time of the Merger. Under the terms of the agreements, it is a
condition to the obligations of the investors with respect to the issuance of
the final $2.0 million tranche that all conditions precedent to the closing of
the Merger be satisfied or waived (among other items). Under the terms of the
secured convertible notes, assuming the necessary shareholder approvals are
received at the special meeting of the Company's shareholders to permit
conversion thereof, the $4.0 million of secured convertible notes will be
converted into newly created "Class B" common stock immediately prior to the
Merger such that at the effective time of the Merger, this group of accredited
investors will receive approximately 66.0066% of the Fully Diluted Pre Merger
Company Stock. "Fully Diluted Pre Merger Company Stock" means the total number
of shares of the existing Class A and Class B common stock of the Company
outstanding immediately prior to the closing of the Merger including the
equivalent number of shares to be issued to the Company's financial advisor,
Allen & Company LLC, upon closing of the Merger.
The Company has a 10-business day grace period to make payments due under the
secured convertible notes, either at maturity, a date fixed for prepayment, or
by acceleration or otherwise, before it is considered an "Event of Default" as
defined in the secured convertible notes. In the event the merger has not
occurred prior to the maturity date of the secured convertible notes, the
Company has a 10-business day grace period, during which time it could seek the
agreement of the noteholders to extend the maturity date of the notes, before it
would be required to pay the secured convertible notes in full. If the Company
is not able to complete the merger prior to the maturity of the notes, as such
may be extended with the agreement of the noteholders, the outstanding principal
amount under the secured convertible notes, including any interest and an
additional payment premium of two times (2x) the outstanding principal amount
will be due to the investors.
This capital raise provides the Company with financing for its immediate working
capital needs, as well as the $2.0 million cash balance necessary such that the
Company's shareholders will receive 60% of the shares of CDTI pursuant to the
terms of the Merger.
One of the Directors of the Company's Board of Directors, Mr. Alexander ("Hap")
Ellis, III, is a partner of Rockport Capital LLP ("Rockport"), a shareholder in
the Company which has subscribed for a portion of the secured convertible notes.
Forbearance From Secured Lender Extended - Fifth Third Bank, the Company's
secured lender, has agreed to extend forbearance under the terms of its loan to
the Company until August 31, 2010. Under the terms of the extension, the credit
limit on the Company's revolving line of credit, which is part US Dollar and
part Canadian Dollar denominated, has been reduced to a total of Canadian $7.0
million from Canadian $7.5 million. The interest rate on the line will remain
at US/Canadian Prime Rate plus 2.75 percent. A further extension until November
30, 2010 will be granted if the proposed Merger with CDTI is completed by August
1, 2010, and as of August 31, 2010, the secured convertible notes issued by the
Company in connection with the capital raise have been converted to common
equity and the security granted to the secured convertible note holders has been
released; the Company has $3.0 million of free cash on its balance sheet; the
Engine Control Systems subsidiary has Canadian $2.0 million available under the
existing loan agreement; and no default, forbearance default or event of default
(as defined in the credit and forbearance agreements) is outstanding.
This information is provided by RNS
The company news service from the London Stock Exchange
END
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