Item 1. Business
Corporate Overview and Our Products
CUI Global, Inc. and Subsidiaries are collectively referred to as ‘‘CUI Global’’ or “The Company.” CUI Global is a Colorado corporation organized on April 21, 1998 with its principal place of business located at 20050 SW 112th Avenue, Tualatin, Oregon 97062, phone (832) 467-1420. The Company is a platform company dedicated to maximizing shareholder value through the acquisition and development of innovative companies to create a diversified energy services platform. In 2019, the Company made the decision to divest of its Power and Electromechanical segment. The domestic portion of the segment was sold in 2019 in two separate transactions and the Company has subsidiaries held for sale in Canada and Japan. The Company's continuing operations fall into one reportable segment referred to as the Energy segment. In addition, the Company’s corporate overhead activities are included in an ‘‘Other’’ category. CUI Global has continuing operations in 2 countries, including the United States and United Kingdom. Through its energy subsidiaries, CUI Global is a leader in innovative gas solutions with more than 30 years of experience in design, installation and the commissioning of industrial gas sampling, measurement and delivery systems providing solutions to the energy, power and processing markets.
Energy Segment
Orbital Gas Systems, Ltd. and Orbital Gas Systems, North America, Inc. - Subsidiaries
Orbital Gas Systems, Ltd. (Orbital-UK) is based in Stone, Staffordshire in the United Kingdom and Orbital Gas Systems, North America, Inc. (Orbital North America), is based in Houston, Texas. The Energy segment subsidiaries, collectively referred to as Orbital Gas Systems (Orbital) are leaders in innovative gas solutions, with more than 30 years of experience in design, installation and the commissioning of industrial gas sampling, measurement and delivery systems. Operating globally within energy, power and processing markets, Orbital manufactures and delivers a broad range of technologies including environmental monitoring, gas metering, process control, telemetry, gas sampling and BioMethane.
Orbital Gas Systems has developed a portfolio of products, services and resources to offer a diverse range of personalized gas engineering solutions to the gas utilities, power generation, emissions, manufacturing and automotive industries. Its proprietary VE® Technology enhances the capability and speed of our GasPT® Technology. VE Technology provides a superior method of penetrating the gas flow without the associated vortex vibration, thereby making it a ‘‘stand-alone’’ product for thermal sensing (thermowells) and trace-element sampling.
We work with several independent licensors for whose intellectual property we compete with other manufacturers. Rights to such intellectual property, when acquired by us, are usually exclusive and the agreements require us to pay the licensor a royalty on our net sales of the item. These license agreements, in some cases, also provide for advance royalties and minimum guarantees to maintain technical rights and exclusivity.
GasPT®
Through an exclusive licensing contract with DNV GL, CUI Global owns exclusive rights to manufacture, sell and distribute a gas quality inferential measurement device designed by DNV GL on a worldwide basis, now marketed as the GasPT. The Company has minimum commitments, including royalty payments, under this licensing contract.
The GasPT, is a low-cost solution for measuring natural gas quality. The customary method for determining the properties of Natural Gas has traditionally been Gas Chromatography (GC). This time-tested methodology is a versatile and historically established technology, however, its conservative format has rooted a number of issues and problems. GasPT’s unique combination of features enables it to eliminate the anachronisms found in traditional gas properties analyzers to provide:
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Near real time and continuous analysis that enhances sampling frequency eliminating uncertainty;
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The lowest operational cost of any equivalent instrument;
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Installed in hours not days;
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No utility or carrier gas required;
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Accredited industry standard accuracy;
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No ongoing calibration required;
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Virtually no maintenance required;
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No configuration or set-up required (“Plug & Play”); and
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No highly skilled personnel needed for day to day operation.
The GasPT includes the following approvals:
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Fiscal approvals:
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OIML R140 - Class A;
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Class 1 Div 2;
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Hazardous Area approvals:
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Class 1 Div 2;
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Zone 1;
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ATEX;
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IECEx; and
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CSA.
When connected to a natural gas system GasPT provides a fast, accurate, close to real time measurement of the physical properties of the gas, such as thermal conductivity, speed of sound and carbon dioxide content. From these measurements it infers an effective gas mixture comprising five components: methane, ethane, propane, nitrogen, and measured carbon dioxide and then uses ISO6976 to calculate the gas quality characteristics of calorific value (CV), Wobbe index (WI), relative density (RD), and compression factor (Z). An ISO, International Organization for Standardization, is a documented agreement containing technical specifications or other precise criteria to be used consistently as rules, guidelines or definitions of characteristics to ensure that materials, products, processes and services are fit for their purpose.
This innovative technology has been certified for use in fiscal monitoring by Ofgem in the United Kingdom, the Polish Oil & Gas Company Department of Testing and Calibration in Warsaw, NOVA Chemical/TransCanada in Canada, the Pipeline Research Counsel International (PRCI) in the US, ENGIE (the French energy giant), and NMi & The International Organization of Legal Metrology (‘‘OIML’’). There is no equivalent product competition. There are instruments like gas chromatographs (‘‘GC’’) that technically can be considered competition, but they are slow, complicated to use and as much as five times the installed price of the GasPT.
VE Technology®
During the year ended 2019, Orbital held exclusive worldwide rights to manufacture, sell, design, and otherwise market the VE-Probe, VE sample system, VE thermowell and VE Technology® from its United Kingdom-based inventor, EnDet Ltd. The agreement, which included certain royalty commitments and provided Orbital exclusive and sole control of all technology related to its revolutionary GasPT natural gas metering systems. On January 1, 2020, Orbital Gas Systems purchased the VE Technology related intellectual property for 1.5 million British Pounds, approximately $2 million dollars. The acquisition of the VE Technology intellectual property requires no ongoing royalties or other fees, providing CUI Global full control of the technology.
The VE sampling probe and sample system are designed for the representative measurement of calorific value and trace elements such as moisture, H2S and mercury faster, more simply and more efficiently. VE sample systems are simple, optimized systems to deliver representative samples to any analyzer with no dead volume, threaded connections or components in the sample pathway.
The VE Technology provides for:
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Patented helical strakes to eliminate vortex shedding and the need for wake calculations;
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Option of fixed or retractable sampling probe;
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Allows for sampling to be taken from the central 1/3 of the pipeline in practically any application;
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Patented aerodynamic sampling probe tip ensures particulate is actively rejected to minimize filtration and avoid contamination of samples allowing for small bore to optimize sample transit time;
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Reduced internal volume with all surfaces electropolished (and coated when required) for optimum response;
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VE Conditioning Unit preheats the gas to avoid retrograde condensation due to the Joule Thomson effect;
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Removes all components and other flow disturbing elements from the sample pathway;
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Provides precise flow and pressure control and monitoring with full ASME/PED approved relief valve; and
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Easy validation and backflush built into the sample probe system.
The VE Technology allows for very quick and simple customization to suit applications including: Natural gas sampling;
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Trace element sampling;
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Moisture (H20) sampling;
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Mercury (Hg) sampling;
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Hydrogen sulfide (H2S) sampling;
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Oil sampling;
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Chemical sampling;
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Continuous automated and manual sample systems;
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LNG sample systems;
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Bespoke sample conditioning units;
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Tailored solutions for drier beds, MRUs, fiscal metering, super critical phase process and many more.
GasPTi - combined GasPT and VE Technology Solution
The GasPTi, combines the two patented technologies of GasPT and VE Technology which provides a completely re-engineered approach to Natural gas sampling and analysis. Through the combination of the fast and accurate measurement of the physical properties of Natural Gas utilizing the GasPT technology with the equally unique VE Technology that can provide a gas sample from a high-pressure transmission line in less than two seconds, Orbital has created the GasPTi metering system.
The GasPTi metering system can accurately provide nearly real-time data to the natural gas operator in a total cycle-time of less than five seconds. It provides this analysis at a fraction of the installation cost of current technology with none of the associated maintenance, carrier gas, calibration gas, or other ancillary costs associated with traditional technology.
The GasPTi is a complete, compact, low cost, integrated solution that can be flange mounted directly to the pipeline or onto a nearby wall or post to provide continuous measurement, requiring no carrier or calibration gases or maintenance. By design, GasPTi removes the need for expensive conditioning equipment, filters, pressure and flow control systems, long heated sample lines and a large cabinet/cubicle with HVAC with few hazardous areas limitations (certified for Zone 1 applications) and no specially trained personnel required for installation or technical support required onsite. The GasPT technology measures and analyzes the VE gathered samples, calculating thermal conductivity, speed of sound and CO2 in the natural gas, providing end users the Calorific Value need to control their systems. Typical appliatons for GasPTi include:
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Analysis of Natural Gas in power plants for quality control and turbine optimization;
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Analysis of Natural Gas for control, blending and custody transfer across gas transmission and distribution networks;
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Pipeline monitoring;
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Analysis of Natural Gas for large volume users to optimize process or combustion (glass manufacture, heat treatement, brickworks (kilns), fiber glass manufacturing);
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Offshore platform production monitoring;
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Gas quality measurement at storage facilities;
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Analysis of Natural Gas for quality control, development and product performance (turbine manufacturers, gas appliance manufacturers);
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Analysis fo Bio-Natural Gas in pre-processing plants;
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Existing gas chromatograph systems for performance checking and validation;
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Analysis of Natural Gas in liquefaction and regasification plants (LNG regasification and storage);
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Marine safety applications for bulk LNG transportation and LNG driven marine engines;
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Determination of calorific value on compressors or gas transfer stations;
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Gas blending and ballasting; and
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Analysis of calorific value in Natural Gas preparation plants.
BioMethane
From its inception Orbital has been involved in the control of BioMethane, or Renewable Natural Gas to grid. In fact our background in environmental and renewables analysis goes back more than 30 years to protecting basic landfill gas generators.
BioMethane gas (produced wherever organic material is decaying) can be, and is a significant source of environmentally-friendly, carbon neutral energy throughout the world. The specific advantages of BioMethane as a source of energy is that it uses already-existing pipeline infrastructure to quickly and efficiently deliver energy to the end-user, who, in most cases, is already connected to the grid.
Orbital’s recognized expertise in energy measurement, process control and odorization offered a complete package that led to designing, building and instigating the very first UK BioMethane-To-Grid system.
Today, Orbital’s BioMethane systems range from basic monitoring through complete “flange-to-flange” solutions that include:
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Energy measurement;
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Gas quality measurements;
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Fiscal metering system;
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Pressure control including slam-shut valve;
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Interface control rack / flow computation rack;
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Gas odorization system;
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BioMethane recirculation facility;
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Reject gas pressure control; and
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Liquid propane injection system
Anticipated Growth Strategy
Our strategy includes:
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We will continue to market our GasPT inferential natural gas monitoring device, VE technology products, and other product and integrated solutions.
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Acquire and/or develop greenfield companies focused on energy infrastructure services to include oil and gas, renewable energy including gas and solar, telecommunications services, and electric utility transmission, delivery and substation related services.
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For GasPT, our strategy has been to identify the large gas utility companies who would most likely provide opportunities for batch sales rather than single unit sales. This approach has focused most significantly on the United Kingdom, Europe and North America. The Company will continue its efforts in those areas.
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Orbital will continue to work with its distribution partner SAMSON AG for the GasPT. Through a distribution agreement, SAMSON AG may introduce the technology in various territories wherein Orbital has no access, including, but not limited to China, Russia, various CIS countries, and throughout Asia.
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Beyond this, our strategy is based on identification of the main geographic locations for liquefied natural gas importation (pipelines and terminals), mixing and blending points and strategic locations for security of supply strategies, which can be current or planned pipelines and import terminals where additional gas quality monitoring may be required.
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Orbital continues to develop new integrated solutions, promote existing technologies, and increase customer relationships.
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The Company will continue to identify opportunities to utilize the unique VE Technology beyond the existing product offering, with a focus on gas sampling, thermowells, and trace element sampling applications.
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During 2016, Orbital signed a Technology and Patent License Agreement with Daily Thermetrics, a globally-respected design and manufacturing company providing process industries with precise temperature measurement instrumentation. The Agreement calls for the manufacture and sale of the patented natural gas sampling VE Technology in North America.
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Orbital will continue to market its BioMethane solution globally as the demand for clean renewable energy continues to increase.
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The Company will expand its service capabilities for gas and LNG facilities in North America.
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The Company will continue to seek new opportunities to design, manufacture, and produce innovative solutions to increase customer reach, product innovation, and growth.
ISO 9001:2015 Certification
Orbital Gas Systems, Ltd. and Orbital Gas Systems, North America Inc. are certified to the ISO 9001:2015 Quality Management Systems standards and guidelines. These entities are registered as conforming to the requirements of standard: ISO 9001:2015. Orbital’s Quality Management Systems are designed to safeguard product quality, health and safety and the environment through the design, manufacture, supply and commissioning (and consulting on); sampling and analysis equipment, and system and process instrumentation.ISO 9001 is accepted worldwide as the inclusive international standard that defines quality.
Orbital-UK's Environmental Management System has also been verified by an independent third party (NQA) as complying with the requirements of BS EN ISO 14001:2008. This assists Orbital in meeting applicable environmental legislation and to control the environmental aspects of our activities as a company.
The certification of compliance with ISO 9001:2015 recognizes that our policies, practices and procedures ensure consistent quality in the design services, technology and products we provide to our customers.
Acquisition Strategy
We are constantly alert to potential acquisition targets with a specific focus on energy infrastructure services. As part of our acquisition strategy, we are focused on acquiring targets with positive EBITDA and margins that are better than the industry average, with revenue visibility, good outlook for growth, having leaders with demonstrated excellence in operations management and who have their growth presently constrained by their balance sheet. We will consider each potential acquisition as they arise with a careful analysis of the relevant synergies with our current business, along with the potential for increasing revenue, earnings and/or market share.
Research and Development Activities
Research and development costs for CUI Global's continuing operations were approximately $0.1 million, $0.2 million and $0.2 million for the years ended December 31, 2019, 2018 and 2017, respectively. Research and development costs are related to the various technologies for which CUI Global has acquired licensing rights or is developing internally. The expenditures for research and development have been directed primarily towards the further development of the GasPT and VE technologies. The Company expects that research and development expenses will continue during 2020 as the Company continues to expand its product and solutions offerings utilizing these technologies.
Employees
As of December 31, 2019, CUI Global, Inc., together with its consolidated subsidiaries, had 257 employees including 112 employees at its discontinued operations in Canada and Japan. As of December 31, 2019, 73 of its employees in Canada are represented by a labor union. This is a decrease in total employees from the 357 total employees reported as of December 31, 2018 and the same number of unionized employees as at December 31, 2018. Most of the decrease in employees relates to the sale of the Company's domestic Power and Electromechanical business in 2019. The Company considers its relations with its employees to be good. The Company may add additional staff as needed to handle all phases of its business.
Intellectual Property Protection
The Company relies on various intellectual property laws and contractual restrictions to protect its proprietary rights in products, logos and services. These include confidentiality, invention assignment and nondisclosure agreements with employees, contractors, suppliers and strategic partners. The confidentiality and nondisclosure agreements with employees, contractors and suppliers are in perpetuity or for a sufficient length of time so as to not threaten exposure of proprietary information.
Under the United States Trademark Act of 1946, as amended, and the system of international registration of trademarks governed by international treaties, the Madrid Agreement, which maintains the international register and, in several instances, direct trademark registration in foreign countries, we and our subsidiaries actively maintain up to date the following trademarks: CUI Global, GasPT, IRIS, and Orbital Gas Systems.
The Company continuously reviews and updates the existing intellectual property filings and files new documentation both nationally and internationally (Patent Cooperation Treaty) in a continuing effort to maintain up-to-date protection of its intellectual property.
For those intellectual property applications pending, there is no assurance that the registrations will be granted. Furthermore, the Company is exposed to the risk that other parties may claim the Company infringes their existing patent and trademark rights, which could result in the Company’s inability to develop and market its products unless the Company enters into licensing agreements with the technology owner or could force the Company to engage in costly and potentially protracted litigation.
Competitive Business Conditions
The natural gas inferential metering device, the GasPT along with our VE Technology, competes in a mature industry with established competitors. There are significant investments being made globally into the natural gas extraction and transportation infrastructure. Our natural gas quality measurement system is a comparably low-cost solution to measuring natural gas quality as compared to our best competition. It can be connected to a natural gas system to provide a fast, accurate, close to real-time measurement of the physical properties, such as thermal conductivity, speed of sound and carbon dioxide content. From these measurements it infers an effective gas mixture comprising five components: methane, ethane, propane, nitrogen and measured carbon dioxide and then uses ISO6976 to calculate the gas quality characteristics of calorific value (CV), Wobbe index (WI), relative density (RD) and compression factor (Z). This technology has been certified for use in fiscal monitoring by Ofgem in the United Kingdom and ARERA in Italy. There is no equivalent product competition. There are instruments like gas chromatographs that are technically competition, but they are slower and more complicated to use and as much as five times the installed price of the GasPT system. Our integrated solutions and services focused on the natural gas and LNG industries face significant competition from local as well as multinational competitors.
Philanthropic Philosophy
One of CUI’s values is generosity, which includes philanthropic giving. We give in our local community and we want to also give in the communities in which we do business. Giving is comprised of both employee service time as well as financial contributions to the communities we serve.
Item 1A.
Item 1A. Risk Factors
RISK FACTORS
Our business is subject to various risks and uncertainties. Investors should read carefully the following factors as well as the cautionary statements referred to in ‘‘Forward-Looking Statements’’ herein. If any of the risks and uncertainties described below or elsewhere in this annual report on Form 10-K actually occur, the Company's business, financial condition or results of operations could be materially adversely affected.
Risks Related to Our Business and Products
Historically, we have generated annual losses from operations, and we may need additional funding in the future.
Historically, on an annual basis, we have not generated sufficient revenues from operations to self-fund our capital and operating requirements. For the year ended 2019, we had a net loss of $1.1 million and our accumulated deficit as of December 31, 2019 was $122.2 million. If we are not able to generate sufficient income and cash flows from operations to fund our operations and growth plans, we may seek additional capital from equity and debt placements or corporate arrangements. Additional capital may not be available on terms favorable to us, or at all. If we raise additional funds by issuing equity securities, our shareholders may experience dilution. Debt financing, if available, may involve restrictive covenants or security interests in our assets. If we raise additional funds through collaboration arrangements with third parties, it may be necessary to relinquish some rights to technologies or products. If we are unable to raise adequate funds or generate them from operations, we may have to delay, reduce the scope of, or eliminate some or all of our growth plans or liquidate some or all of our assets.
There is no assurance we will achieve or sustain profitability.
For the year ended December 31, 2019, we had a net loss of $1.1 million. There is no assurance that we will achieve or sustain profitability. If we fail to achieve or sustain profitability, the price of our common stock could fall and our ability to raise additional capital could be adversely affected.
Some of our business expansion activities may not be successful and may divert our resources from our existing business activities.
Our historical business was a commoditized power and electromechanical parts distribution business, which we have moved to held-for-sale and discontinued operations during 2019. CUI Global has focused our business on the acquisition and development of energy infrastructure services. We may not be successful in acquiring energy infrastructure services companies that are commercially viable. We may fail to successfully develop or commercialize such products, solutions and services that we acquire. Research, development and commercialization of such acquired products, solutions and services may disproportionately divert our resources from our other business activities.
If our manufacturers or our suppliers are unable to provide an adequate supply of products, our growth could be limited and our business could be harmed.
We rely on third parties to supply components for and to manufacture our products. In order to grow our business to achieve profitability, we may need our manufacturers and suppliers to increase, or scale up, production and supply by a significant factor over current levels. There are technical challenges to scaling up capacity that may require the investment of substantial additional funds by our manufacturers or suppliers and hiring and retaining additional management and technical personnel who have the necessary experience. If our manufacturers and suppliers are unable to do so, we may not be able to meet the requirements to grow our business to anticipated levels. We also may represent only a small portion of our supplier’s or manufacturer’s business, and if they become capacity constrained, they may choose to allocate their available resources to other customers that represent a larger portion of their business.
Our global operations are subject to increased risks, which could harm our business, operating results and financial condition.
Our ability to manage our business and conduct our operations internationally requires considerable management attention and resources and is subject to a number of risks, including the following:
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challenges caused by distance, language and cultural differences and by doing business with foreign agencies and governments;
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longer payment cycles in some countries;
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uncertainty regarding liability for services and content;
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credit risk and higher levels of payment fraud;
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currency exchange rate fluctuations and our ability to manage these fluctuations;
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foreign exchange controls that might prevent us from repatriating cash earned in countries outside the U.S.;
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import and export requirements that may prevent us from shipping products or providing services to a particular market and may increase our operating costs;
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potentially adverse tax consequences;
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higher costs associated with doing business internationally;
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political, social and economic instability abroad, terrorist attacks and security concerns in general;
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natural disasters, public health issues including impacts from global or national health epidemics and concerns such as the recent coronavirus, and other catastrophic events;
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reduced or varied protection for intellectual property rights in some countries; and
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different employee/employer relationships and the existence of workers’ councils and labor unions.
In addition, compliance with complex foreign and U.S. laws and regulations that apply to our international operations increases our cost of doing business in international venues and could expose us or our employees to fines and penalties. These numerous and sometimes conflicting laws and regulations include import and export requirements, content requirements, trade restrictions, tax laws, sanctions, internal and disclosure control rules, data privacy requirements, labor relations laws, U.S. laws such as the Foreign Corrupt Practices Act and local laws prohibiting corrupt payments to governmental officials. Violations of these laws and regulations could result in fines, civil and criminal penalties against us, our officers or our employees, prohibitions on the conduct of our business and damage to our reputation. Any such violations could include prohibitions on our ability to offer our products and services in one or more countries and could also materially damage our reputation, our brand, our international expansion efforts, our ability to attract and retain employees, our business and our operating results.
Our revenues depend on key customers and suppliers.
The Company’s major product lines in 2019, 2018 and 2017 were natural gas infrastructure and high-tech solutions.
During 2019, over 31% of revenues were derived from two customers, S&B Engineers with 21% and Costain Oil, Gas & Process Ltd with 10%. During 2018, over 27% of revenues were derived from two customers, National Grid with 15% and S&B Engineers with 12%. During 2017, 55% of revenues were derived from three customers, National Grid with 26%, Scotia Gas Networks with 18%, and S&B Engineers with 11%.
At December 31, 2019, of the gross trade accounts receivable totaling approximately $5.3 million, there were three individual customers that made up approximately 50% of the Company's total trade accounts receivable: Energy Transfer at 24%, Costain Oil, Gas and Process Ltd at 14% and S&B Engineers at 12%. At December 31, 2018, of the gross trade accounts receivable totaling approximately $5.1 million, approximately 38% was due from two customers: Costain Oil, Gas & Process Ltd at 24% and National Grid at 14%.
During 2019, 2018, and 2017, the Company did not have any supplier concentrations that provided over 10% of our inventory purchases.
The United Kingdom operations of Orbital result in foreign revenue and accounts receivable concentrations in the United Kingdom for the year ended and at December 31, 2019 of 57% and 49%, respectively, for the year ended and at December 31, 2018 of 74% and 80%, respectively and for the year ended and at December 31, 2017, of 77% and 79%, respectively.
There is no assurance that we will continue to maintain all of our existing key customers in the future. Should we, for any reason, discontinue our business relationship with any one of these key customers, the impact to our revenue stream would be substantial. For additional information on our concentrations, see Note 15 - Concentrations.
The novel coronavirus outbreak, or other similar pandemic, epidemic or outbreak of infectious disease, could adversely impact our business, financial condition and results of operations and acquisitions.
In January 2020, the World Health Organization declared the novel coronavirus outbreak originating in Wuhan, China to be a public health emergency, prompting precautionary government-imposed travel restrictions and temporary closures of business operations, and in March 2020, the outbreak was declared to be a pandemic. Certain of our suppliers and the manufacturers of certain of our products may be adversely impacted by the novel coronavirus outbreak. As a result, we may face delays or difficulty sourcing products and services, which could negatively affect our business and financial results. Even if we are able to find alternate sources for such products and services, they may cost more, which could adversely impact our results of operations and financial condition. If we temporarily close our locations for periods of time or if our partners temporarily close, demand for our products and services may be reduced, and our revenues, results of operations and financial condition could be materially adversely affected.
At this time, there is significant uncertainty relating to the potential effect of the novel coronavirus on our business. Infections have become more widespread, which may worsen the supply shortage or force us to restrict our operations. In addition, due to the further spread of the outbreak where we have corporate offices, we have implemented various measures including remote working solutions, reduced hours, adjusted shifts, and placed various restrictions on access to our offices, which could negatively impact productivity, particularly if we restrict access to our offices for a longer period of time. Any of these occurrences may have a negative impact on our business, financial condition or results of operations.
A significant outbreak of COVID-19 and other infectious diseases could result in a widespread health crisis that could adversely affect the economies and financial markets worldwide, and the business of any potential target business with which we consummate a business combination could be materially and adversely affected. Furthermore, we may be unable to complete a business combination if continued concerns relating to COVID-19 restrict travel, limit the ability to have meetings with potential investors or the target company’s personnel, vendors and services providers are unavailable to negotiate and consummate a transaction in a timely manner. The extent to which COVID-19 impacts our search for a business combination will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of COVID-19 and the actions to contain COVID-19 or treat its impact, among others. If the disruptions posed by COVID-19 or other matters of global concern continue for an extensive period of time, our ability to consummate a business combination, or the operations of a target business with which we ultimately consummate a business combination, may be materially adversely affected.
We are a relatively small energy infrastructure services business and face formidable competition.
We are a relatively small company with limited capitalization in comparison to many of our international competitors. Because of our size and capitalization, we believe that we have not yet established sufficient market awareness that is essential to our continued growth and success in all of our markets. We face formidable competition in every aspect of our business from other companies, many of whom have greater name recognition, more resources and broader product offerings than ours.
We also expect competition to intensify in the future. For example, the market for our inferential natural gas monitoring device, the GasPT, is emerging and is characterized by rapid technological change, evolving industry standards, increasing data requirements, frequent new product introductions and shortening product life cycles. Our future success in keeping pace with technological developments and achieving product acceptance depends upon our ability to enhance our current products and to continue to develop and introduce new product offerings and enhanced performance features and functionality on a timely basis at competitive prices. Our inability, for technological or other reasons, to enhance, develop, introduce or deliver compelling products in a timely manner, or at all, in response to changing market conditions, technologies or customer expectations, could have a material adverse effect on our operating results and growth prospects. Our ability to compete successfully will depend in large measure on our ability to maintain a technically skilled development and engineering staff and to adapt to technological changes and advances in the industry, including providing for the continued compatibility of our products and solutions with evolving industry standards and protocols in a competitive environment.
Acquisitions could result in operating difficulties, dilution and other harmful consequences.
We expect to continue to pursue acquisitions which require integration into our own business model. We expect to continue to evaluate and enter into discussions regarding a wide array of potential strategic transactions focused on energy infrastructure services. These transactions could be material to our financial condition and results of operations. The process of integrating an acquired company, business or technologies may create unforeseen operating difficulties and expenditures. The areas where we face risks include:
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implementation or remediation of controls, procedures and policies of the acquired company;
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diversion of management time and focus from operating our business to acquisition integration challenges;
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coordination of product, engineering and sales and marketing functions;
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transition of operations, users and customers into our existing customs;
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cultural challenges associated with integrating employees from the acquired company into our organization;
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retention of employees from the businesses we acquire;
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integration of the acquired company’s accounting, management information, human resource and other administrative systems;
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liability for activities of the acquired company before the acquisition, including patent and trademark infringement claims, violations of laws, commercial disputes, tax liabilities and other known and unknown liabilities;
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litigation or other claims in connection with the acquired company, including claims from terminated employees, customers, former shareholders, or other third parties;
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in the case of foreign acquisitions, the need to integrate operations across different cultures and languages and to address the particular economic, currency, political and regulatory risks associated with specific countries;
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failure to successfully further develop the acquired technologies; and
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other as yet unknown risks that may impact our business.
Our failure to address these risks or other problems encountered in connection with our past or future acquisitions could cause us to fail to realize the anticipated benefits of such acquisitions, incur unanticipated liabilities and harm our business generally. For example, a majority of Orbital-UK’s revenues for each of its last two fiscal years has come from a small number of customers. If we fail to continue to do business with Orbital-UK’s primary customers at substantially similar or greater levels than recent historical levels, our financial condition, results of operations and growth prospects would be significantly harmed.
Future acquisitions could also result in dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities or amortization expenses, write-offs of goodwill, or reductions to our tangible net worth any of which could harm our business, financial condition, results of operations and prospects. Also, the anticipated benefit of many of our acquisitions may not materialize.
We will need to grow our organization and we may encounter difficulties in managing this growth.
As of December 31, 2019, CUI Global, Inc., together with its consolidated subsidiaries, had 145 full-time employees excluding 112 employees at our discontinued operations, primarily in Canada. We expect to experience growth in the number of our employees and the scope of our operations as we follow our growth strategy. To manage our anticipated future growth, we must continue to implement and improve our managerial, operational and financial systems, expand our facilities and continue to recruit and train additional qualified personnel. Also, our management may need to divert a disproportionate amount of its attention away from our day-to-day activities and devote a substantial amount of time to managing these growth activities. Due to our limited resources, we may not be able to effectively manage the expansion of our operations or recruit and train additional qualified personnel, which may result in weaknesses in our infrastructure, give rise to operational mistakes, loss of business opportunities, loss of employees and reduced productivity among remaining employees. The physical expansion of our operations may lead to significant costs and may divert financial resources from other projects, such as the development of new products, solutions and services. If our management is unable to effectively manage our expected growth, our expenses may increase more than expected, our ability to generate or increase our revenue could be reduced and we may not be able to implement our business strategy. Our future financial performance and our ability to commercialize new products, solutions and services and compete effectively will depend, in part, on our ability to effectively manage any future growth.
Our operating results will vary over time and such fluctuations could cause the market price of our common stock to decline.
Our operating results may fluctuate significantly due to a variety of factors, many of which are outside of our control. Because revenues for any future period are not predictable with any significant degree of certainty, you should not rely on our past results as an indication of our future performance. If our revenues or operating results fall below the expectations of investors or securities analysts or below any estimates we may provide to the market, the price of our common shares would likely decline substantially. Factors that could cause our operating results and stock price to fluctuate include, among other things:
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varying demand for our products, solutions and services due to the financial and operating condition of our customers, and general economic conditions;
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inability of our suppliers and subcontractors to meet our demand;
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success and timing of new product, solutions and services introductions by us and the performance of those generally;
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announcements by us or our competitors regarding products, solutions, services, promotions or other transactions;
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costs related to responding to government inquiries related to regulatory compliance;
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our ability to control and reduce product, solutions and services costs;
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changes in the manner in which we sell products, solutions and services;
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volatility in foreign exchange rates, changes in interest rates and/or the availability and cost of financing or other working capital to our customers; and
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the impact of write downs of excess and obsolete inventory.
Our operating expenses will increase as we make further expenditures to enhance and expand our operations in order to support additional growth in our business and national stock market reporting and compliance obligations.
In the future, we expect our operations and marketing investments to increase to support our anticipated growth and as a result of our listing on the NASDAQ Stock Market. We have made significant investments in using professional services and expanding our operations outside the United States. We may make additional investments in personnel and continue to expand our operations to support anticipated growth in our business. In addition, we may determine the need in the future to increase our direct sales force, add distributors and sales representatives to market and sell our products, solutions and services. Such changes to our existing sales model would likely result in higher selling, general and administrative expenses as a percentage of our revenues. We expect such increased investments could adversely affect operating income in the short term while providing long-term benefit.
Our business depends on a strong brand and failing to maintain and enhance our brand would hurt our ability to expand our base of customers.
We believe that we have not yet established sufficient market awareness in our various markets. Market awareness of our capabilities and products, solutions and services is essential to our continued growth and our success in all of our markets. We expect the brand identity that we have developed through GasPT and Orbital Gas Systems to significantly contribute to the success of our business. Maintaining and enhancing these brands is critical to expanding our base of customers. If we fail to maintain and enhance our brands, or if we incur excessive expenses in this effort, our business, operating results and financial condition will be materially and adversely affected. Maintaining and enhancing our brands will depend largely on our ability to be a technology leader and continue to provide high-quality products, solutions and services, which we may not do successfully.
New entrants in our markets may harm our competitive position.
New entrants seeking to gain market share by introducing new technology, products, solutions and services may make it more difficult for us to sell our products, solutions and services and could create increased pricing pressure, reduced profit margins, increased sales and marketing expenses or the loss of market share or expected market share, any of which may significantly harm our business, operating results and financial condition.
Adverse conditions in the global economy and disruption of financial markets may significantly restrict our ability to generate revenues or obtain debt or equity financing.
The global economy continues to experience volatility and uncertainty and governments in many countries continue to evaluate and implement spending cuts designed to reduce budget deficits. These conditions and deficit reduction measures could reduce demand for our products and services, including through reduced government infrastructure projects, which would significantly jeopardize our ability to achieve our sales targets. These conditions could also affect our potential strategic partners, which in turn, could make it more difficult to execute a strategic collaboration. Moreover, volatility and disruption of financial markets could limit our customers’ ability to obtain adequate financing or credit to purchase and pay for our products, solutions and services in a timely manner, or to maintain operations and result in a decrease in sales volume. General concerns about the fundamental soundness of domestic and international economies may also cause customers to reduce purchases. Changes in governmental banking, monetary and fiscal policies to restore liquidity and increase credit availability may not be effective. Economic conditions and market turbulence may also impact our suppliers’ and subcontractors’ ability to supply sufficient resources in a timely manner, which could impair our ability to fulfill sales orders. It is difficult to determine the extent of the economic and financial market problems and the many ways in which they may affect our suppliers, customers, investors and business in general. Continuation or further deterioration of these financial and macroeconomic conditions could significantly harm sales, profitability and results of operations.
One of our subsidiaries and certain suppliers is located in an area subject to natural disasters or other events that could stop us from having our products made or shipped or could result in a substantial delay in our production or development activities.
We have sales, development and manufacturing resources in Houston, Texas. The risk of hurricanes and other natural disasters in this geographic area is significant due to the proximity of this subsidiary to the coast and its propensity to flood. Despite precautions taken by us and our third-party providers, a natural disaster or other unanticipated problems, at our location in Texas or at third-party providers could cause interruptions in the products that we provide. Any disruption resulting from these events could cause significant delays in shipments of our products until we are able to shift our manufacturing, assembly or testing from the affected contractor(s) to another third-party vendor. We cannot assure you that alternative capacity could be obtained on favorable terms, if at all.
Defects in our products and solutions could harm our reputation and business.
Our products and solutions are complex and have contained and may contain undetected defects or errors, especially when first introduced or when new versions are released. Defects in our products may lead to product returns and require us to implement design changes or updates.
Any defects or errors in our products, or the perception of such defects or errors, could result in:
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expenditure of significant financial and product development resources in efforts to analyze, correct, eliminate or work around errors or defects;
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loss of existing or potential customers;
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delayed or lost revenue;
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delay or failure to attain market acceptance;
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delay in the development or release of new products or services;
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negative publicity, which will harm our reputation;
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warranty claims against us;
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an increase in collection cycles for accounts receivable, which could result in an increase in our provision for doubtful accounts and the risk of costly litigation; and
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harm to our results of operations.
We and our contract manufacturers purchase some components, subassemblies and products from a limited number of suppliers. The loss of any of these suppliers may substantially disrupt our ability to obtain orders and fulfill sales as we design and qualify new components.
We rely on third-party components and technology to build and operate our products and solutions and we rely on our contract manufacturers to obtain the components, subassemblies and products necessary for the manufacture of our products. Shortages in components that we use in our products and solutions are possible and our ability to predict the availability of such components is limited. If shortages occur in the future, as they have in the past, our business, operating results and financial condition would be materially adversely affected. Unpredictable price increases of such components due to market demand may occur. While components and supplies are generally available from a variety of sources, we and our contract manufacturers currently depend on a single or limited number of suppliers for several components for our products. If our suppliers of these components or technology were to enter into exclusive relationships with other providers or were to discontinue providing such components and technology to us and we were unable to replace them cost effectively, or at all, our ability to provide our products would be impaired. Therefore, we may be unable to meet customer demand for our products, which would have a material adverse effect on our business, operating results and financial condition.
We depend on key personnel and will need to recruit new personnel as our business grows.
As a small company, our future success depends in a large part upon the continued service of key members of our senior management team who are critical to the overall management of CUI Global and our subsidiary companies, as well as the development of our technologies, products, solutions and service offerings, our business culture and our strategic direction. The loss of any of our management or key personnel could seriously harm our business and we do not maintain any key-person life insurance policies on the lives of these critical individuals.
If we are successful in expanding our product and customer base, we will need to add additional key personnel as our business continues to grow. If we cannot attract and retain enough qualified and skilled staff, the growth of the business may be limited. Our ability to provide services to customers and expand our business depends, in part, on our ability to attract and retain staff with professional experiences that are relevant to technology development and other functions the Company performs. Competition for personnel with these skills is intense. We may not be able to recruit or retain the caliber of staff required to carry out essential functions at the pace necessary to sustain or expand our business.
We believe our future success will depend in part on the following:
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the continued employment and performance of our senior management;
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our ability to retain and motivate our officers and key employees; and
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our ability to identify, attract, hire, train, retain and motivate other highly skilled technical, managerial, marketing, sales and customer service personnel.
Our insurance policies may not cover all operating risks and a casualty loss beyond the limits of our coverage could adversely impact our business.
Our business is subject to operating hazards and risks relating to handling, storing, transporting and use of the products, solutions and services we sell. We maintain insurance policies in amounts and with coverage and deductibles that we believe are reasonable and prudent. Nevertheless, our insurance coverage may not be adequate to protect us from all liabilities and expenses that may arise from claims for personal injury or death or property damage arising in the ordinary course of business, and our current levels of insurance may not be maintained or available in the future at economical prices. If a significant liability claim is brought against us that is not adequately covered by insurance, we may have to pay the claim with our own funds, which could have a material adverse effect on our business, consolidated financial condition, results of operations, or cash flows.
Expanding and evolving data privacy laws and regulations could impact our business and expose us to increased liability.
The General Data Protection Regulation ("GDPR") became effective in the European Union in May 2018, imposes significant new requirements on how we collect, process and transfer personal data, as well as significant financial penalties for non-compliance. Global privacy legislation, enforcement, and policy activity in this area are rapidly expanding and creating a complex regulatory compliance environment. The California Consumer Privacy Act (“CCPA”) becomes effective in 2020. CCPA creates new consumer rights relating to the access to, deletion of, and sharing of personal information that is collected by businesses. Costs to comply with and implement these privacy-related and data protection measures could be significant. In addition, even our inadvertent failure to comply with federal, state, or international privacy-related or data protection laws and regulations could result in proceedings against us by governmental entities or others. Any inability to adequately address privacy concerns, even if unfounded, or to comply with the more complex privacy or data protection laws, regulations and privacy standards, could lead to significant financial penalties, which may result in a material and adverse effect on our results of operations.
We are subject to taxation in multiple jurisdictions. As a result, any adverse development in the tax laws of any of these jurisdictions or any disagreement with our tax positions could have a material adverse effect on our business, consolidated financial condition or results of operations. In addition, our annual effective income tax rate can change materially as a result of changes in our mix of U.S. and foreign earnings and other factors, including changes in tax laws and changes made by regulatory authorities.
We are subject to taxation in, and to the tax laws and regulations of, multiple jurisdictions as a result of the global scope of our operations and our corporate and financing structure. We are also subject to transfer pricing laws with respect to our intercompany transactions. Adverse developments in these laws or regulations, or any change in position regarding the application, administration or interpretation thereof, in any applicable jurisdiction, could have a material adverse effect on our business, consolidated financial condition or results of our operations. In addition, the tax authorities in any applicable jurisdiction, including the United States, may disagree with the positions we have taken or intend to take regarding the tax treatment or characterization of any of our transactions. If any applicable tax authorities, including U.S. tax authorities, were to successfully challenge the tax treatment or characterization of any of our transactions, it could have a material adverse effect on our business, consolidated financial condition or consolidated results of our operations.
Our overall effective income tax rate is equal to our total tax expense as a percentage of total earnings before tax. However, income tax expense and benefits are not recognized on a global basis but rather on a jurisdictional or legal entity basis. Losses in one jurisdiction may not be used to offset profits in other jurisdictions and may cause an increase in our tax rate. Changes in statutory tax rates and laws, as well as ongoing audits by domestic and international authorities, could affect the amount of income taxes and other taxes paid by us. Also, changes in the mix of earnings (or losses) between jurisdictions and assumptions used in the calculation of income taxes, among other factors, could have a significant effect on our overall effective income tax rate.
Our operating results may be affected by fluctuations in foreign currency exchange rates, which may affect our operating results in U.S. dollar terms.
A portion of our revenue arises from our international operations and we anticipate that, as we grow, our revenues from international operations will increase. Revenues generated and expenses incurred by our international operations are often denominated in foreign currencies. As a result, our consolidated U.S. dollar financial statements are subject to fluctuations due to changes in exchange rates as revenues and expenses of our international operations are translated from local currencies into U.S. dollars. In addition, our financial results are subject to changes in exchange rates that impact the settlement of transactions. The Company does not currently undertake any hedges to protect against adverse foreign currency exposure.
The United Kingdom’s withdrawal from the European Union, commonly referred to as Brexit, could have an adverse effect on our business and financial results.
On January 31, 2020, the United Kingdom (“UK”) formally withdrew from the European Union (“EU”), entering a transitional period which is currently expected to end on December 31, 2020. During this transitional period, EU law will continue to apply in the UK while providing time for the UK and EU to negotiate the details of their future relationship. The impact of the withdrawal may adversely affect business activity, political stability and economic conditions in the U.K., the European Union and elsewhere. The economic conditions and outlook could be further adversely affected by the uncertainty concerning new or modified trading arrangements between the U.K. and other countries. Any of these developments could negatively affect economic growth or business activity in the U.K., the European Union and elsewhere, and could materially and adversely affect our business and results of operations. We continue to closely monitor the negotiations and the impact to foreign currency markets, however we cannot predict the direction of Brexit-related developments or the impact of those developments on our UK operations and the economies of the markets in which we operate.
Our gas quality inferential measurement device, GasPT®, has not gained market acceptance as rapidly as we anticipated.
Our future financial performance and ability to commercialize the GasPT device and compete successfully will depend on our ability to effectively manage acceptance and introduction of our GasPT device in the natural gas quality inferential measurement device market. Although we have entered into agreements and letters of understanding with third parties, which could result in substantial sales of the GasPT device over the next several years, there is no assurance we will sell at or near the number of units forecasted under these contracts.
Several factors have and may continue to contribute to the slower than anticipated market acceptance of the GasPT device, such as: disruptive technologies, such as the GasPT device, are slow to be accepted in a mature industry, such as natural gas distribution; extensive testing and research required by large natural gas distribution customers takes an extended period of time before such potential customers place firm orders; macro-economic issues in the natural gas industry may slow or impede capital expenditures; and registration, regulatory approvals, certifications and licensing requirements in foreign countries.
Our strategy has been to establish market acceptance and credibility with potential customers through a campaign of product exposure and disclosure of highly acceptable test results of recognized international testing laboratories along with industry seminars, conventions, trade shows, professional periodicals and public relations. While we believe that the base has been laid for substantial sales of our GasPT device over the next several years, there is no assurance that our strategy and efforts will be successful.
Risks Related to Our Intellectual Property and Technology
If we fail to protect our intellectual property rights adequately, our ability to compete effectively or to defend ourselves from litigation could be impaired.
We rely primarily on patent, copyright, trademark and trade secret laws, as well as confidentiality and non-disclosure agreements and other methods, to protect our proprietary technologies and know-how. Given the costs of obtaining patent protection, we may choose not to protect certain innovations that later turn out to be important. Furthermore, there is always the possibility, despite our efforts, that the scope of the protection gained will be insufficient or that an issued patent may be deemed invalid or unenforceable. We license a significant amount of our underlying intellectual property from third parties, i.e., GasPT technology and VE Technology. The loss of our rights as a licensee under any of these or future technology licensing arrangements, or the exclusivity provisions of these agreements, could have a material adverse impact upon our financial position, results of operations, and cash flows.
Monitoring unauthorized use of our intellectual property is difficult and costly. Unauthorized use of our intellectual property may occur in the future without our knowledge. The steps we have taken may not prevent unauthorized use of our intellectual property. Further, we may not be able to detect unauthorized use of, or take appropriate steps to enforce our intellectual property rights. Our competitors may also independently develop similar technology. Our failure to effectively protect our intellectual property could reduce the value of our technology in licensing arrangements or in cross-licensing negotiations and could impair our ability to compete. Any failure by us to meaningfully protect our intellectual property could result in competitors offering products that incorporate our most technologically advanced features, which could seriously reduce demand for our products.
In the future we may need to initiate infringement claims or litigation. Litigation, whether we are a plaintiff or a defendant, can be expensive and time-consuming and may divert the efforts of our technical staff and managerial personnel, which could result in lower revenues and higher expenses, whether or not such litigation results in a determination favorable to us.
Confidentiality agreements with employees and others may not adequately prevent disclosure of our trade secrets and other proprietary information.
We have devoted substantial resources to the development of our proprietary technology and trade secrets. In order to protect our proprietary technology and trade secrets, we rely in part on confidentiality agreements with our key employees, licensees, independent contractors and other advisors. These agreements may not effectively prevent disclosure of our trade secrets and may not provide an adequate remedy in the event of unauthorized disclosure of our trade secrets. We may have difficulty enforcing our rights to our proprietary technology and trade secrets, which could have a material adverse effect on our business, operating results and financial condition. In addition, others may independently discover trade secrets and proprietary information and in such cases we could not assert any trade secret rights against such parties. Costly and time consuming litigation could be necessary to determine and enforce the scope of our proprietary rights and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.
If a third party asserts that we are infringing on its intellectual property, whether successful or not, it could subject us to costly and time-consuming litigation and our business may be adversely affected.
Certain industries where we compete are characterized by the existence of a large number of patents, trademarks and copyrights and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. Third parties may assert patent and other intellectual property infringement claims against us or the parties from whom we license our technological rights in the form of lawsuits, letters or other forms of communication. These claims, whether or not successful, could:
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divert management’s attention;
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result in costly and time-consuming litigation;
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require us to enter into royalty or licensing agreements, which may not be available on acceptable terms, or at all; and
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require us to redesign our products to avoid infringement.
As a result, any third-party intellectual property claims against us could increase our expenses and adversely affect our business. Even if we have not infringed any third parties’ intellectual property rights, we cannot be sure our legal defenses will be successful and even if we are successful in defending against such claims, our legal defense could require significant financial resources and management time. Finally, if a third party successfully asserts a claim that our products infringe its proprietary rights, royalty or licensing agreements might not be available on terms we find acceptable or at all and we may be required to pay significant monetary damages to such third party.
If our contract manufacturers and subcontractors do not respect our intellectual property and trade secrets, our business, operating results and financial condition could be materially adversely affected.
Although we attempt to enter into agreements with our manufacturers and subcontractors to preclude them from using our intellectual property and trade secrets, we may be unsuccessful in monitoring and enforcing our intellectual property rights. Although we take steps to stop counterfeits, we may not be successful and customers who purchase these counterfeit goods may have a bad experience and our brand may be harmed. If such an impermissible use of our intellectual property or trade secrets were to occur, our ability to sell our products at competitive prices and to be the sole provider of our products may be adversely affected and our business, operating results and financial condition could be materially and adversely affected.
Cyber risk and the failure to maintain the integrity of our operational or security systems or infrastructure, or those of third parties with which we do business, could have a material adverse effect on our business, consolidated financial condition and results of operations.
We are subject to an increasing number of various types of information technology vulnerabilities, threats and targeted computer crimes which pose a risk to the security of our systems and networks and the confidentiality, availability and integrity of our data. Disruptions or failures in the physical infrastructure or operating systems that support our businesses and customers, or cyber-attacks or security breaches of our networks or systems, could result in the loss of customers and business opportunities, legal liability, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensatory costs, and additional compliance costs, any of which could materially adversely affect our business, financial condition and results of operations. While we attempt to mitigate these risks, our systems, networks, products, solutions and services remain potentially vulnerable to advanced and persistent threats. Despite our efforts, our facilities and systems and those of our customers and third-party service providers may be vulnerable to security breaches, theft, misplaced or lost data, programming and/or human errors that could lead to the compromising of sensitive, confidential or personal data or information, improper use of our systems, software solutions or networks, unauthorized access, use, disclosure, modification or destruction of information, defective products, production downtimes and operational disruptions, which in turn could adversely affect our consolidated financial condition and results of operations.
Risks Related to Our Common Stock
Our common stock price may be volatile, which could result in substantial losses for individual shareholders.
The market price for the Company’s common stock is volatile and subject to wide fluctuations in response to factors, including the following, some of which are beyond our control, which means our market price could be depressed and could impair our ability to raise capital:
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actual or anticipated variations in our quarterly operating results;
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announcements of technological innovations or new products, solutions or services by the Company or our competitors;
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conditions or trends relating to our gas technologies;
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changes in the economic performance and/or market valuations of gas metering, monitoring and sampling related companies;
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changes in the economic performance and/or market valuations of other inferential natural gas monitoring device-related companies;
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additions or departures of key personnel;
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fluctuations of the stock market as a whole;
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announcements about our earnings that are not in line with expectations;
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announcements by our competitors of their earnings that are not in line with expectations;
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the volume of shares of common stock available for public sale;
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sales of stock by us or by our shareholders;
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short sales, hedging and other derivative transactions on shares of our common stock;
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our ability to retain existing customers, attract new customers and satisfy our customers’ requirements;
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general economic conditions;
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changes in our pricing policies;
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our ability to expand our business;
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the effectiveness of our personnel;
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new product and service introductions;
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technical difficulties or interruptions in our services;
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the timing of additional investments in our products and solutions;
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regulatory compliance costs;
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costs associated with future acquisitions of technologies and businesses; and
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extraordinary expenses such as litigation or other dispute-related settlement payments.
These factors may materially and adversely affect the market price of our common stock, regardless of our performance. In addition, the stock market in general and the market for energy infrastructure services companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our actual operating performance. Additionally, because the trading volume of our stock is not large, there can be a disparity between the bid and the asked price that may not be indicative of the stock’s true value.
Offers or availability for sale of a substantial number of shares of our common stock may cause the price of our common stock to decline.
Sales of a significant number of shares of our common stock in the public market could harm the market price of our common stock and make it more difficult for us to raise funds through future offerings of common stock.
We have never paid dividends on our common stock and do not expect to pay any in the foreseeable future.
Potential purchasers should not expect to receive a return on their investment in the form of dividends on our common stock. The Company has never paid cash dividends on its common stock and the Company does not expect to pay dividends in the foreseeable future.
We currently anticipate that we will retain future earnings for the development, operation and expansion of our business and do not anticipate declaring or paying any cash dividends for the foreseeable future. Our payment of any future dividends will be at the discretion of our board of directors after taking into account various factors, including but not limited to our financial condition, operating results, cash needs, growth plans and the terms of any credit agreements that we may be a party to at the time. Our ability to pay dividends may be further restricted by the terms of any of our future debt or preferred securities. Accordingly, investors must rely on sales of their own common stock after price appreciation, which may never occur, as the only way to realize their investment. Investors seeking cash dividends should not purchase shares of our stock.
There is a limited public trading market for our common stock so you may not be able to resell your stock and may not be able to turn your investment into cash.
Our common stock is currently traded on the NASDAQ Stock Market under the trading symbol ‘‘CUI.’’ Our shares of common stock are thinly traded. Due to the illiquidity, the market price may not accurately reflect our relative value. There can be no assurance that there will be an active market for our shares of common stock either now or in the future. Because our common stock is thinly traded, a large block of shares traded can lead to a dramatic fluctuation in the share price and investors may not be able to liquidate their investment in us at all or at a price that reflects the value of the business.
Nasdaq may delist our common stock from its exchange which could limit your ability to make transactions in our securities and subject us to additional trading restrictions.
If for 30 consecutive trading days, the bid price of our common stock closes below the $1.00 per share minimum required for continued listing on the Nasdaq Capital Market pursuant to Nasdaq Listing Rule 5550(a)(2) (the “Minimum Bid Price Requirement”), Nasdaq will send us a Notice. The Notice would not have an immediate effect on the listing of our common stock, and our common stock would continue to trade on the Nasdaq Capital Market under the symbol “CUI.” Under Nasdaq Listing Rule 5810(c)(3)(A), if during the 180 calendar day period following the date of the Notice (the “Compliance Period”), the closing bid price of our common stock would be at or above $1.00 for a minimum of 10 consecutive business days, we would regain compliance with the Minimum Bid Price Requirement and our common stock would continue to be eligible for listing on the Nasdaq Capital Market, absent noncompliance with any other requirement for continued listing. If we did not regain compliance with the Minimum Bid Price Requirement by the end of the Compliance Period (or the Compliance Period as may be extended) the Company’s common stock would be subject to delisting. If this were to happen, we would monitor the closing bid price of our common stock and may, if appropriate, consider implementing available options to regain compliance with the Minimum Bid Price Requirement under the Nasdaq Listing Rules.
If our common stock is delisted, our common stock would likely then trade only in the over-the-counter market. If our common stock were to trade on the over-the-counter market, selling our common stock could be more difficult because smaller quantities of shares would likely be bought and sold, transactions could be delayed, and we could face significant material adverse consequences, including: a limited availability of market quotations for our securities; reduced liquidity with respect to our securities; a determination that our shares are a “penny stock,” which will require brokers trading in our securities to adhere to more stringent rules, possibly resulting in a reduced level of trading activity in the secondary trading market for our securities; a reduced amount of news and analyst coverage for our Company; and a decreased ability to issue additional securities or obtain additional financing in the future. These factors could result in lower prices and larger spreads in the bid and ask prices for our common stock and would substantially impair our ability to raise additional funds and could result in a loss of institutional investor interest and fewer development opportunities for us.
In addition to the foregoing, if our common stock is delisted from Nasdaq and it trades on the over-the-counter market, the application of the “penny stock” rules could adversely affect the market price of our common stock and increase the transaction costs to sell those shares. The SEC has adopted regulations which generally define a “penny stock” as an equity security that has a market price of less than $5.00 per share, subject to specific exemptions. If our common stock is delisted from Nasdaq and it trades on the over-the-counter market at a price of less than $5.00 per share, our common stock would be considered a penny stock. The SEC’s penny stock rules require a broker-dealer, before a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document that provides information about penny stocks and the risks in the penny stock market. The broker-dealer must also provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and the salesperson in the transaction, and monthly account statements showing the market value of each penny stock held in the customer’s account. In addition, the penny stock rules generally require that before a transaction in a penny stock occurs, the broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s agreement to the transaction. If applicable in the future, these rules may restrict the ability of brokers-dealers to sell our common stock and may affect the ability of investors to sell their shares, until our common stock no longer is considered a penny stock.
Risks Relating to Shareholder Rights
Our board of directors has the authority, without shareholder approval, to issue preferred stock with terms that may not be beneficial to existing common shareholders and with the ability to adversely affect shareholder voting power and perpetuate their control.
Although we do not have any preferred stock outstanding presently, our Articles of Incorporation allow us to issue shares of preferred stock without any vote or further action by our shareholders. Our board of directors has the authority to issue preferred stock without further shareholder approval, as well as the authority to fix and determine the relative rights and preferences of preferred stock. As a result, our board of directors could authorize the issuance of a series of preferred stock that would grant to holders the preferred right to our assets upon liquidation, the right to receive dividend payments before dividends are distributed to the holders of common stock or other preferred shareholders and the right to the redemption of the shares, together with a premium, prior to the redemption of our common stock.
Preferred stock could be used to dilute a potential hostile acquirer. Accordingly, any future issuance of preferred stock or any rights to purchase preferred shares may have the effect of making it more difficult for a third party to acquire control of us. This may delay, defer or prevent a change of control or an unsolicited acquisition proposal. The issuance of preferred stock also could decrease the amount of earnings attributable to and assets available for distribution to, the holders of our common stock and could adversely affect the rights and powers, including voting rights, of the holders of our common stock and preferred stock.
Our Articles of Incorporation limits director liability, thereby making it difficult to bring any action against them for breach of fiduciary duty.
CUI Global, Inc. is a Colorado corporation. As permitted by Colorado law, the Company’s Articles of Incorporation limits the liability of directors to CUI Global, Inc. or its shareholders for monetary damages for breach of a director’s fiduciary duty, with certain exceptions. These provisions may discourage shareholders from bringing suit against a director for breach of fiduciary duty and may reduce the likelihood of derivative litigation brought by shareholders on behalf of the Company against a director.
Our charter documents may inhibit a takeover that shareholders consider favorable.
Provisions of our Articles of Incorporation and Bylaws may delay or discourage transactions involving an actual or potential change in control of the Company, including transactions in which shareholders might otherwise receive a premium for their shares, or transactions that our shareholders might otherwise deem to be in their best interests. These provisions:
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provide that the authorized number of directors may be changed by resolution of the board of directors;
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provide that all vacancies, including newly created directorships, may, except as otherwise required by law, be filled by the affirmative vote of a majority of directors then in office, even if less than a quorum; and
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do not provide for cumulative voting rights.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
During December 2018, our wholly owned subsidiary, CUI Properties, LLC signed closing documents on the sale and leaseback of our Tualatin, Oregon corporate office real estate located at 20050 SW 112th Avenue in the Tualatin Franklin Business Park for a ten-year lease.
In November 2017, the Company's Houston operations, rented office and warehouse space in Houston, Texas, of approximately 40,000 square feet for which the lease runs until 2022.
In March 2015, as part of the Tectrol (CUI-Canada) acquisition in the the discontinued Power and Electromechanical segment, the Company leased a 73,700 square foot manufacturing facility in Toronto, Canada that runs until November 2020.
In September 2015, Orbital, completed the construction of a new 46,000 square foot state-of-the-art manufacturing/administration/research and development facility on its existing site in the UK to supplement existing office space.
Additionally, CUI Japan, in the discontinued Power and Electromechanical segment, has leased space in Tokyo, Japan, which is used as a sales office and is leased through March 2021.
The Company has enough manufacturing and office capacity to meet its business needs for the foreseeable future.
Item 3.
Item 3. Legal Proceedings
The Company and its subsidiaries are not parties in any legal proceedings. No director, officer or affiliate of the Company, any owner of record or beneficially of more than five percent of any class of voting securities of the Company or any associate of any such director, officer, affiliate of the Company or security holder is a party adverse to the Company or any of its subsidiaries or has a material interest adverse to the Company or any of its subsidiaries.
Item 4.
Item 4. Mine Safety Disclosure
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Description of Securities
The Company’s Common Stock is traded on The NASDAQ Stock Market under the trading symbol ‘‘CUI.’’ The Company currently has authorized 325,000,000 common shares, par value $0.001 per share, and as of December 31, 2019, the Company’s issued and outstanding shares consisted of 28,383,373 shares of common stock of which 28,246,147 shares are freely tradable without restriction or limitation under the Securities Act. As of December 31, 2019, the Company had in excess of 3,000 beneficial holders of our common stock and in excess of 2,300 shareholders of record. The actual number of shareholders is greater than this number of record holders and includes shareholders who are beneficial owners, but whose shares are held in street name by brokers and other nominees.
The holders of Common Stock are entitled to one vote per share and do not have cumulative voting rights. Holders of the Company’s Common Stock do not have any pre-emptive or other rights to subscribe for or purchase additional shares of capital stock and no conversion rights, redemption or sinking-fund provisions.
Market Value
The Company’s Common Stock is traded on the NASDAQ Stock Market under the trading symbol ‘‘CUI.’’ The following table sets forth, the high and low sales prices of our Common Stock on the NASDAQ during each quarter of the two most recent years.
Stock Performance Graph
The following graph compares the performance of our common stock to the performance of the NASDAQ Composite Index and the Russell 2000 Index. The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity markets. The comparisons in the chart below are provided in response to SEC disclosure requirements and are not intended to forecast or be indicative of future performance of our common stock. We issued 7,392,856 shares in October 2017, which increased the total number of shares outstanding by about 35% and this had a dilutive effect on the share price as reflected in the following graph.
* Assumed $100 invested on 12/31/2014 in stock or index, including reinvestment of dividends. Fiscal year ended December 31.
Source: S&P Global Market Intelligence
©2020
Dividend Policy
The Company has never paid cash dividends on its Common Stock and the Company does not expect to pay dividends in the foreseeable future.
We currently expect to retain future earnings to finance the growth and development of our business. The timing, amount and form of future dividends, if any, will depend on, among other things, our future results of operations and cash flows; our general financial condition and future prospects; our capital requirements and surplus; contractual restrictions; the amount of distributions, if any, received by us from our subsidiaries; and other factors deemed relevant by our board of directors. Any future dividends on our common shares would be declared by and subject to the discretion of our board of directors.
Common Stock Reserved for Future Issuances
Set forth below is a summary of the outstanding securities, transactions and agreements, which relate to 849,635 shares of common stock the Company is required to reserve for potential future issuances.
•
849,635 common shares reserved for outstanding options issued under our Equity Compensation Plans.
As of December 31, 2019, there were reserved for issuance an aggregate of 849,635 shares of common stock for options outstanding under the Company’s 2008 Equity Incentive Plan and the Company’s 2009 Equity Incentive Plan (Executive).
Other than as described herein, as of the date of this report, there are currently no plans, arrangements, commitments or understandings for the issuance of additional shares of Common Stock.
RECENT SALES OF UNREGISTERED SECURITIES
Following is a list of all securities we sold within the past three years, which were not registered under the Securities Act. The Company relied on Section 4(2) of the Securities Act of 1933 as the basis for an exemption from registration for the following issuances.
2019 Sales of Unregistered Securities
Common Stock Issued During 2019
(1) Total excludes $36 thousand of 2019 stock compensation and $3 thousand of 2018 stock compensation related to royalties that were recorded as expense but not issued and outstanding as of December 31, 2019.
2018 Sales of Unregistered Securities
Common Stock Issued During 2018
(1) Includes bonus and royalties of $170 thousand that was accrued and expensed in 2017.
(2) Total excludes $3 thousand of stock compensation related to royalties that were recorded as expense but not issued and outstanding as of December 31, 2018.
(3) Excludes $24 thousand of stock compensation for stock issued in 2017 that was amortized from prepaid expense in 2018.
2017 Sales of Unregistered Securities
Common Stock Issued During 2017
(1)
Includes bonuses and royalty of $176 thousand that were accrued and expensed in 2016.
(2)
The Company received $0 for the issuance in the cashless option exercises.
(3)
Amount includes $24 thousand that was included in prepaid expense at December 31, 2017.
(4)
Does not include stock expense of $170 thousand included in accrued liabilities at December 31, 2017 for unissued stock.
(5)
Does not include registered 7,392,856 shares issued in October 2017 via the S-3 registration statement. See Note 10. Shareholders' Equity for more information on the October share issuances.
Shares Eligible for Future Sale
As of December 31, 2019, we had outstanding 28,383,373 shares of Common Stock. Of these shares, 28,246,147 shares are freely tradable without restriction or limitation under the Securities Act.
The 137,226 shares of Common Stock held by existing shareholders as of December 31, 2019 that are ‘‘restricted’’ within the meaning of Rule 144 adopted under the Securities Act (the ‘‘Restricted Shares’’), may not be sold unless they are registered under the Securities Act or sold pursuant to an exemption from registration, such as the exemption provided by Rule 144 promulgated under the Securities Act. The Restricted Shares were issued and sold by us in private transactions in reliance upon exemptions from registration under the Securities Act.
Issuer Purchases of Equity Securities
On December 3, 2019, the Board of Directors of the Company authorized and approved a two-year share repurchase program for up to $5 million of the then outstanding shares of the Company's common stock. The following table provides information regarding repurchases of the Company's common stock during the quarter ended December 31, 2019:
Item 6.
Item 6. Selected Financial Data
The following tables contain selected consolidated financial data as of the dates and for the periods presented. The selected consolidated balance sheet data as of December 31, 2019 and 2018 and the selected consolidated statement of operations data for the years ended December 31, 2019, 2018, and 2017 have been derived from our consolidated financial statements and related notes that we have included elsewhere in this Form 10-K. The selected consolidated balance sheet data as of December 31, 2017, 2016, and 2015 and the selected consolidated statement of operations data for the years ended December 31, 2016 and 2015 have been derived from consolidated financial statements that are not presented in this Form 10-K. The timing of acquisitions and divestitures completed during the years presented affects the comparability of the selected financial data.
The selected historical consolidated financial data as of any date and for any period are not necessarily indicative of the results that may be achieved as of any future date or for any future period. You should read the following selected historical financial data in conjunction with the more detailed information contained in Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Important Note about Forward-Looking Statements
The following discussion and analysis should be read in conjunction with our audited consolidated financial statements as of December 31, 2019 and notes thereto included in this document and our unaudited 10-Q filings for the first three quarters of 2019 and the notes thereto. In addition to historical information, the following discussion and other parts of this Form 10-K contain forward-looking information that involves risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking information due to factors discussed elsewhere in this Form 10-K.
The statements that are not historical constitute ‘‘forward-looking statements.’’ Said forward-looking statements involve risks and uncertainties that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements, expressed or implied by such forward-looking statements. These forward-looking statements are identified by the use of such terms and phrases as ‘‘expects,’’ ‘‘intends,’’ ‘‘goals,’’ ‘‘estimates,’’ ‘‘projects,’’ ‘‘plans,’’ ‘‘anticipates,’’ ‘‘should,’’ ‘‘future,’’ ‘‘believes,’’ and ‘‘scheduled.’’
The variables, which may cause differences include, but are not limited to, the following: general economic and business conditions; competition; success of operating initiatives; operating costs; advertising and promotional efforts; the existence or absence of adverse publicity; changes in business strategy or development plans; the ability to retain management; availability, terms and deployment of capital; business abilities and judgment of personnel; availability of qualified personnel; labor and employment benefit costs; availability and costs of raw materials and supplies; and changes in, or failure to comply with various government regulations. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate; therefore, there can be no assurance that the forward-looking statements included in this Form 10-K will prove to be accurate.
In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any person that the objectives and expectations of the Company will be achieved.
Overview
CUI Global, Inc. is a Colorado corporation organized on April 21, 1998. The Company’s principal place of business is located at 20050 SW 112th Avenue, Tualatin, Oregon 97062, phone (832) 467-1420. CUI Global is a platform company dedicated to maximizing shareholder value through the acquisition, development and commercialization of new, innovative technologies. Through its subsidiaries, CUI Global has built a diversified portfolio of industry leading technologies that touch many markets.
Critical Accounting Policies
Our financial statements and related public financial information are based on the application of accounting principles generally accepted in the United States (‘‘GAAP’’). GAAP requires the use of estimates, assumptions, judgments and subjective interpretations of accounting principles that have an impact on the assets, liabilities, revenue, and expense amounts reported. These estimates can also affect supplemental information contained in our external disclosures including information regarding contingencies, risk and financial condition. We believe our use of estimates and underlying accounting assumptions adhere to GAAP and are consistently applied. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions. We continue to monitor significant estimates made during the preparation of our financial statements.
While all of our significant accounting policies impact the Company’s financial condition and results of operations, we view certain of these policies as critical. Policies determined to be critical are those policies that have the most significant impact on our financial statements and require management to use a greater degree of judgment and estimates. Actual results may differ from those estimates. Our management believes that given current facts and circumstances, it is unlikely that applying any other reasonable judgments or estimate methodologies would have caused a material change in our results of operations, financial position or liquidity for the periods presented in this report.
Asset Impairment
The Company reviews its long-lived assets including finite-lived intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset exceeds its fair value and may not be recoverable. In performing the review for recoverability, the Company estimates the future cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss is recognized as the excess of the carrying amount over the fair value. Otherwise, an impairment loss is not recognized. Management estimates the fair value and the estimated future cash flows expected. Any changes in these estimates could impact whether there was impairment and the amount of the impairment.
In the fourth quarter of 2019, the Company determined that certain acquisition intangibles related to CUI-Canada, which were classified as held for sale in 2019 did not have adequate forecasted revenue to justify the current valuation and were written off. This was primarily driven by the Company's decision to close the facility by the end of 2020. The impairment of $92 thousand is reported in discontinued operations.
In the fourth quarter of 2018, the Company determined that certain long-term prepaid assets classified on the balance sheet as deposits and other assets, which were reliant on future revenue in order to be amortized to expense, did not have adequate forecasted revenue to justify the current valuation. This was primarily driven by the lack of substantial sales over the previous two years and uncertainty regarding the level of future sales. For that reason, the Company recorded a $1.5 million impairment to deposits and other assets included in cost of revenues and reclassified $0.1 million to prepaid assets. The amount reclassified to prepaid assets related to prepaid royalties associated with expected 2019 revenue.
Indefinite-Lived Intangibles and Goodwill Assets
The Company accounts for business combinations under the acquisition method of accounting in accordance with ASC 805, ‘‘Business Combinations,’’ where the total purchase price is allocated to the tangible and identified intangible assets acquired and liabilities assumed based on their estimated fair values. The purchase price is allocated using the information currently available, and may be adjusted, up to one year from acquisition date, after obtaining more information regarding, among other things, asset valuations, liabilities assumed and revisions to preliminary estimates. The purchase price in excess of the fair value of the tangible and identified intangible assets acquired less liabilities assumed is recognized as goodwill.
2019 Goodwill Impairments
In the fourth quarter of 2019, the Company determined that it was more likely than not that the fair value of its goodwill at CUI-Canada and CUI Japan was less than the carrying amounts. The Company hired a third-party valuation expert to perform a valuation and it was determined that the remaining goodwill held by CUI-Canada and CUI Japan should be written down to zero. With those write downs, the Company does not have any remaining goodwill.
2018 Goodwill Impairments
During our review of Goodwill as of May 31, 2018, the Company determined that there were indicators present to suggest that it was more likely than not that the fair value of the Orbital-UK reporting unit was less than its carrying amount.
The significant changes for the Orbital-UK reporting unit subsequent to the most recent impairment test performed as of December 31, 2017 included a decline in the 2018 actual revenue, operating income and cash flows compared to prior forecasts for the same period and a negative change in the 2018 forecasted revenue, operating income and cash flows for the remainder of the year due in part to the longer than expected halt in shipping of its GasPT product to a major customer in Italy and market uncertainty due to the continuing effects of Brexit.
The Company performed a quantitative test for the Orbital-UK reporting unit, which resulted in a goodwill impairment charge of $1.3 million during the second quarter of 2018.
December 2018 Interim Test. During the fourth quarter of 2018, the Company determined that there were additional indicators present to suggest that it was more likely than not that the fair value of the Orbital-UK reporting unit was less than its carrying amount. The significant changes for the Orbital-UK reporting unit subsequent to the annual goodwill impairment test performed as of May 31, 2018 were driven by a slower recovery than what was originally forecasted. Actual GasPT revenue continued to lag behind forecasted revenue as acceptance of the technology continued to be slower than anticipated and continued delays associated with existing customer contracts that had not yet resumed even though previously communicated issues had been resolved. This slower than expected recovery, led to lower 2018 revenue, operating income and cash flows than originally forecasted.
As a result of its analysis, the Company performed another quantitative test of goodwill. The quantitative test for the Orbital-UK reporting unit resulted in a further goodwill impairment charge of $3.1 million during the fourth quarter of 2018, which was a write-off of the remaining Energy segment goodwill. In addition, the reporting units in the discontinued Power and Electromechanical segment were tested for impairment due to the overall decrease in market capitalization experienced in 2018, with no impairment identified.
December 2017 Interim Test. During the fourth quarter of 2017, the Company determined that there were indicators present to suggest that it was more likely than not that the fair value of the Orbital-UK reporting unit was less than its carrying amount. The significant changes for the Orbital-UK reporting unit subsequent to the annual goodwill impairment test performed as of May 31, 2017 included a decline in the 2017 actual revenue, operating income and cash flows compared to previously forecasted results and a decline in the 2018 forecasted revenue, operating income and cash flows due in part to the longer than expected halt in shipping of its GasPT product to a major customer in Italy and market uncertainty due to the continuing effects of Brexit.
The Company performed a quantitative analysis and concluded that the carrying value of the Orbital-UK reporting unit exceeded its estimated fair value. The quantitative test resulted in an impairment for the Orbital-UK reporting unit, and the Company recorded a goodwill impairment charge of $3.2 million during the fourth quarter of 2017.
Long-lived assets and finite lived intangible assets
Besides goodwill being tested for impairment, the Company also tested its long-lived assets and finite lived intangible assets for Orbital-UK. The result of the quantitative test of undiscounted cash flows, did not result in any impairment.
Stock-Based Compensation
The Company accounts for stock-based compensation using FASB Accounting Standards Codification No. 718 (‘‘FASB ASC 718’’), ‘‘Compensation - Stock Compensation.’’ FASB Codification No. 718 requires the fair value of all stock-based employee compensation awarded to employees to be recorded as an expense over the related vesting period.
Stock bonuses issued to employees are recorded at fair value using the market price of the stock on the date of grant and expensed over the vesting period or immediately if fully vested on date of issuance. Employee stock options are recorded at fair value using the Black-Scholes option pricing model. The underlying assumptions used in the Black-Scholes option pricing model by the Company are taken from publicly available sources including: (1) volatility and grant date stock price, which are sourced from historic stock price information; (2) the appropriate discount rates are sourced from the United States Federal Reserve; and (3) other inputs are determined based on previous experience and related estimates. With regards to expected volatility for determining the fair value of our stock options, the Company utilizes an appropriate period for historical share prices for CUI Global, Inc. that best reflects the expected weighted average lifespan of the options.
Valuation of Non-Cash Capital Stock Issuances
The Company values its stock transactions based upon the fair value of the equity instruments. Various methods can be used to determine the fair value of an equity instrument. The Company may use the fair value of the consideration received, the quoted market price of the stock or a contemporaneous cash sale of the common or preferred stock. Each of these methods may produce a different result. Management uses the method it determines most appropriately reflects the stock transaction. If a different method was used it could impact the expense and equity stock accounts. In 2019, 2018, and 2017, the Company used the quoted market price of the Company's common stock to estimate the fair value of stock transactions.
Revenue Recognition
On January 1, 2018, we adopted the accounting standard ASC 606, “Revenue from Contracts with Customers” and all the related amendments (“revenue standard"), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. This guidance includes the required steps to achieve the core principle that a company should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The revenue standard was applied using the modified retrospective method. We recognized the cumulative effect of initially applying the revenue standard as an adjustment to accumulated deficit as of January 1, 2018. As a result of the adoption of this standard, certain changes have been made to the condensed consolidated balance sheets. We expect the ongoing impact of the adoption of the standard to primarily affect the timing of revenue recognition. The most significant impact was on the discontinued operations of the Power and Electromechanical segment revenue with certain distribution customers that were previously recorded as “sell through." Under the revenue accounting guidance, we record the revenue upon sale to the distributor with an appropriate amount reserved for estimated returns and allowances as the Company recognizes revenue at the time the related performance obligation is satisfied by transferring a promised good or service to its customers. For the majority of contracts, revenue is still measured over time using the cost-to-cost method. The change that most affected the transition adjustment on revenue was the requirement to limit revenue recognition on contracts without an enforceable right to payment for performance completed to date. Revenue on contracts without a specific enforceable right to payment on work performed to date was "clawed back" as part of the Company's transition adjustment. The cumulative effect adjustment recorded as of January 1, 2018 was a net $1.9 million decrease to accumulated deficit due to a $2.8 million transition adjustment from the discontinued Power and Electromechanical segment partially offset by a $(0.9) million transition adjustment from the Energy segment, net of deferred tax.
The Company generates its revenue from a portfolio of products, services and resources that offer a diverse range of personalized gas engineering solutions to the gas utilities, power generation, petrochemical, emissions, manufacturing and automotive industries, among others.
Orbital accounts for a majority of its contract revenue proportionately over time. For our performance obligations satisfied over time, we recognize revenue by measuring the progress toward complete satisfaction of that performance obligation. The selection of the method to measure progress towards completion can be either an input method or an output method and requires judgment based on the nature of the goods or services to be provided.
For our construction contracts, revenue is generally recognized over time. Our fixed price construction projects generally use a cost-to-cost input method to measure our progress towards complete satisfaction of the performance obligation as we believe it best depicts the transfer of control to the customer. Under the cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation.
The timing of revenue recognition for Energy products also depends on the payment terms of the contract, as our performance does not create an asset with an alternative use to us. For those contracts which we have a right to payment for performance completed to date at all times throughout our performance, inclusive of a cancellation, we recognize revenue over time. As discussed above, these performance obligations use a cost-to-cost input method to measure our progress towards complete satisfaction of the performance obligation as we believe it best depicts the transfer of control to the customer. However, for those contracts for which we do not have a right, at all times, to payment for performance completed to date, we recognize revenue at the point in time when control is transferred to the customer, generally when shipped.
For our services contracts, revenue is generally recognized over time as the customer simultaneously receives and consumes the benefits of our performance as we perform the service. For our fixed price service contracts with specified service periods, revenue is generally recognized on a straight-line basis over such service period when our inputs are expended evenly, and the customer receives and consumes the benefits of our performance throughout the contract term.
For certain of our revenue streams, such as call-out repair and service work, outage services and training that are performed under time and materials contracts, our progress towards complete satisfaction of such performance obligations is measured using an output method as the customer receives and consumes the benefits of our performance completed to date.
Due to uncertainties inherent in the estimation process, it is possible that estimates of costs to complete a performance obligation will be revised in the near-term. For those performance obligations for which revenue is recognized using a cost-to-cost input method, changes in total estimated costs, and related progress towards complete satisfaction of the performance obligation, are recognized on a cumulative catch-up basis in the period in which the revisions to the estimates are made. When the current estimate of total costs for a performance obligation indicate a loss, a provision for the entire estimated loss on the unsatisfied performance obligation is made in the period in which the loss becomes evident.
Product-type contracts (for example, sale of GasPT units) for which revenue does not qualify to be recognized over time are recognized at a point in time. Revenues from extended warranty and maintenance activities are recognized ratably over the term of the warranty and maintenance period.
Accounts Receivable, Contract Assets and Contract Liabilities
Accounts receivable are recognized in the period when our right to consideration is unconditional. We also assess our customers' ability and intention to pay, which is based on a variety of factors, including our historical payment experience with and the financial condition of our customers. Payment terms and conditions vary by contract, although our standard terms include a requirement of payment within 30 days. Accounts receivable are recognized net of an allowance for doubtful accounts.
The timing of revenue recognition may differ from the timing of invoicing to customers. Contract assets include unbilled amounts from our construction projects when revenue recognized under the cost-to-cost measure of progress exceeds the amounts invoiced to our customers, as the amounts cannot be billed under the terms of our contracts. Such amounts are recoverable from our customers based upon various measures of performance, including achievement of certain milestones, completion of specified units or completion of a contract. Also included in contract assets are amounts we seek or will seek to collect from customers or others for errors or changes in contract specifications or design, contract change orders or modifications in dispute or unapproved as to both scope and/or price or other customer-related causes of unanticipated additional contract costs (claims and unapproved change orders). Our contract assets do not include capitalized costs to obtain and fulfill a contract. Contract assets are generally classified as current within the Consolidated Balance Sheets.
Contract liabilities from our construction contracts occur when amounts invoiced to our customers exceed revenues recognized under the cost-to-cost measure of progress. Contract liabilities additionally include advanced payments from our customers on certain contracts. Contract liabilities decrease as we recognize revenue from the satisfaction of the related performance obligation and are recorded as either current or long-term, depending upon when we expect to recognize such revenue.
Performance Obligations
Remaining Performance Obligations
Remaining performance obligations represents the transaction price of contracts with customers for which work has not been performed and excludes unexercised contract options and potential orders under ordering-type contracts. As of December 31, 2019, the Company's remaining performance obligations are generally expected to be filled within the next 12 months.
Any adjustments to net revenues, cost of revenues, and the related impact to operating income are recognized as necessary in the period they become known. These adjustments may result from positive program performance, and may result in an increase in operating income during the performance of individual performance obligations, if we determine we will be successful in mitigating risks surrounding the technical, schedule and cost aspects of those performance obligations. Likewise, these adjustments may result in a decrease in operating income if we determine we will not be successful in mitigating these risks. Changes in estimates of net revenues, cost of revenues and the related impact to operating income are recognized on a cumulative catch-up basis in the period they become known, which recognizes in the current period the cumulative effect of the changes on current and prior periods based on a performance obligation's percentage of completion. A significant change in one or more of these estimates could affect the profitability of one or more of our performance obligations. For separately priced extended warranty or product maintenance performance obligations, when estimates of total costs to be incurred on the performance obligation exceed total estimates of revenue to be earned, a provision for the entire loss on the performance obligation is recognized in the period the loss is determined.
Performance Obligations Satisfied Over Time
To determine the proper revenue recognition method for contracts, we evaluate whether a single contract should be accounted for as more than one performance obligation. This evaluation requires significant judgment and the decision to separate the single contract into multiple performance obligations could change the amount of revenue and profit recorded in a given period.
For most of our contracts, the customer contracts with us to provide a significant service of integrating a complex set of tasks and components into a single project or capability (even if that single project results in the delivery of multiple units). Hence, the entire contract is accounted for as one performance obligation. Less commonly, however, we may promise to provide distinct goods or services within a contract in which case we separate the contract into more than one performance obligation. If a contract is separated into more than one performance obligation, we allocate the total transaction price to each performance obligation in an amount based on the estimated relative standalone selling prices of the promised goods or services underlying each performance obligation. We infrequently sell standard products with observable standalone sales. In cases where we do, the observable standalone sales are used to determine the standalone selling price. More frequently, we sell a customized customer specific solution, and in these cases we typically use the expected cost plus a margin approach to estimate the standalone selling price of each performance obligation.
Performance Obligations Satisfied at a Point in Time.
Revenue from goods and services transferred to customers at a single point in time accounted for 29% and 22% of revenues for the years ended December 31, 2019 and 2018. Revenue on these contracts is recognized when the product is shipped and the customer takes ownership of the product. Determination of control transfer is determined by shipping terms delineated on the customer purchase orders and is generally when shipped.
Variable Consideration
The nature of our contracts gives rise to several types of variable consideration, including new product returns and scrap return allowances. In rare instances, we include in our contract estimates, additional revenue for submitted contract modifications or claims against the customer when we believe we have an enforceable right to the modification or claim, the amount can be estimated reliably and its realization is probable. In evaluating these criteria, we consider the contractual/legal basis for the claim, the cause of any additional costs incurred, the reasonableness of those costs and the objective evidence available to support the claim. We include new product introduction and scrap return estimates in our calculation of net revenue when there is a basis to reasonably estimate the amount of the returns. These estimates are based on historical return experience, anticipated returns and our best judgment at the time. These amounts are included in our calculation of net revenue recorded for our contracts and the associated remaining performance obligations.
Significant Judgments
Our contracts with certain customers may be subject to contract cancellation clauses. Contracts with other cancellation provisions may require judgment in determining the contract term, including the existence of material rights, transaction price and identifying the performance obligations and whether a contract should be accounted for over time or on a completed contract basis. Revenue is recognized for certain integration systems over time using cost-based input methods, in which significant judgement is required to evaluate assumptions including the amount of total estimated costs to determine our progress towards contract completion and to calculate the corresponding amount of revenue to recognize.
At times, customers may request changes that either amend, replace or cancel existing contracts. Judgment is required to determine whether the specific facts and circumstances within the contracts require the changes to be accounted for as a separate contract or as a modification. Generally, contract modifications containing additional goods and services that are determined to be distinct and sold at their stand-alone selling price are accounted for as a separate contract. For contract modifications where goods and services are not determined to be distinct and sold at their stand-alone selling price, the original contract is updated and the required adjustments to revenue and contract assets, liabilities, and other accounts will be made accordingly.
Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately rather than together may require significant judgment. For, example, we consider many of our contracts that coordinate multiple products into an integrated system to be a single performance obligation, while the same products would be considered separate performance obligations if not so integrated.
In contracts where there are timing differences between when we transfer a promised good or service to the customer and when the customer pays for that good or service, we have determined that, our contracts do not include a significant financing component.
Liquidity and Capital Resources
General
As of December 31, 2019, CUI Global held Cash and cash equivalents of $23.4 million. Operations, other intangible assets, and equipment have been funded through cash on hand and short-term credit facilities during the year ended December 31, 2019.
Cash used in Operations
There was a use of cash from operations of approximately $11.5 million during the year ended December 31, 2019. This was a decrease from the use of cash from operations of approximately $12.3 million and an increase from approximately $9.4 million for the years ended December 31, 2018 and 2017, respectively. Overall, the change in cash used in operations is primarily the result of the loss from continuing operations, net of income taxes in 2019 before non-cash expenses affected by changes in assets and liabilities.
Cash used in operations of $11.5 million in 2019 was a $0.8 million decrease in cash used compared to the amount used in operations in 2018. The year ended December 31, 2019 benefited from improved results in the Energy segment, which used $8.3 million of cash in 2019, a decrease from the $11.1 million used in 2018. The Company's discontinued operations included the Company's domestic power and electromechanical businesses, which were divested in 2019, resulting in lower cash generated in 2019 compared to 2018, with $2.7 million generated in 2019 compared to $4.5 million in 2018. Cash used in the other category increased to $5.9 million in 2019 compared to $5.7 million in 2018. This increased use of cash by the other category was due primarily to increased merger, and acquisition activity in 2019 compared to 2018 culminating in the divestiture of the domestic power and electromechanical business in two separate transactions.
During 2019, in addition to the Company's net loss after non-cash items, significant factors affecting cash used in operating activities included the change in trade accounts receivable and accrued liabilities. The change in trade accounts receivable accounted for $1.5 million source of cash in operating activities and was due to lower overall fourth quarter revenues in the Energy segment compared to the revenues in the fourth quarter of 2018. Increased cash source of $2.2 million from change in accrued liabilities was due to a non-cash severance accrual recorded at CUI-Canada in preparation for closing that facility in late 2020. Refund liabilities were a $1.3 million use of cash as customers looked to utilize their refunds prior to the divesture of the power and electromechanical business. A $14.1 million gain on the sale of the company's domestic power and electromechanical businesses and a $2.6 million deferred tax gain were non-cash income statement items that did not affect cash from operations.
We believe cash used in operating activities will improve in 2020, primarily due to the expected continued improvement in revenue from other integration related systems including biomethane to grid solutions and new product and service opportunities currently being pursued. We believe the cash usage rate in the other category will be flat to slightly higher due to continued merger and acquisition activity expected in 2020.
For the 2018 year, in addition to the Company's net loss after non-cash items, significant factors affecting cash used in operating activities included the change in trade accounts receivable and inventories. The change in trade accounts receivable accounted for $3.8 million of cash used in operating activities and was due to higher fourth quarter revenues in the Energy segment and discontinued operations compared to the revenues in the fourth quarter of 2017. Increased cash usage of $2.2 million from change in inventories were due to a build-up of inventories in our discontinued power and electromechanical business due to longer lead times for these products and timing related to customer order and delivery schedules, partially offset by positive changes to inventories in the Energy segment. Also contributing to the increased cash usage was a decrease in contract liabilities of $2.3 million. The increased cash usage was partially offset by a combined $3.4 million of cash provided by changes in accounts payable, accrued expenses and refund liabilities.
The cash from operations in 2017 was negatively affected by a larger net loss attributable to the Energy segment compared to 2016 and the timing of accounts receivable collections and accounts payable payments in both the Energy segment and discontinued operations.
During 2017, in addition to the change in trade accounts receivable and accounts payable, significant factors that impacted the cash used in operations included cash used for inventory purchases of approximately $0.4 million associated with timing of customer orders and ongoing projects, $0.5 million related to the change in deposits and other assets due to the increase in long-term prepaid royalties at Orbital-UK, $0.5 million use of cash related to changes in accrued expenses primarily due to a change in accrued compensation in the Energy segment and a $0.4 million use of cash from changes in prepaid assets that affected the Energy segment, discontinued operations and the other category. Changes in the combined contract assets and contract liabilities were a combined approximate $2.8 million source of cash in the period related to billings on projects in the Energy segment and increases in deferred revenue from distributor activity within discontinued operations.
On a segment basis, in 2017, the discontinued Power and Electromechanical businesses contributed cash from operations of approximately $3.9 million while the Energy segment used cash of approximately $8.4 million and the Other category used cash of approximately $4.9 million. The Energy segment was hampered by the continued costs of building brand awareness in North America and a regulatory issue in Italy unrelated to the technology that delayed the next phase of a significant GasPT project.
During 2019, 2018 and 2017, the Company used stock and options as a form of payment to certain vendors, consultants, directors and employees. For years ended December 31, 2019, 2018 and 2017, the Company recorded a total of $0.2 million, $0.2 million and $0.4 million, respectively for share-based compensation related to equity given, or to be given, to employees, directors and consultants for services provided and as payment for royalties earned. The decreases in 2019 compared to 2018 and in 2018 compared to 2017 were due to lower stock-based bonuses, and lower stock-based services. There were no stock option vesting expense in 2019, 2018, or 2017.
Proceeds from Sale of Businesses, Proceeds from Sale of Building, Capital Expenditures and Investments
In 2019, the Company sold its domestic power and electromechanical businesses in two separate transactions for total proceeds of $35.4 million.
In December 2018, the Company completed the sale and leaseback of its Tualatin headquarters. The sale for $8.1 million generated net cash proceeds of $4.2 million after transaction related expenses and after paying off the mortgage on the building and related interest rate swap derivative.
During the years ended 2019, 2018 and 2017, CUI Global invested $0.3 million, $1.0 million and $0.9 million, respectively, in fixed assets. These investments typically include additions to equipment for engineering and research and development, tooling for manufacturing, furniture, computer equipment for office personnel, facilities improvements and other fixed assets as needed for operations. The Company anticipates further investment in fixed assets during 2020 in support of its on-going business and continued development of product lines, technologies and services.
CUI Global invested $0.4 million, $0.5 million, and $0.6 million in other intangible assets during 2019, 2018 and 2017, respectively. These investments typically include product certifications, technology rights, capitalized website development, software for engineering and research and development and software upgrades for office personnel. Investments in 2019, 2018 and 2017 primarily related to product certifications in the discontinued Power and Electromechanical businesses and investments in software in the Energy segment. In the short-term, investments in other intangibles are expected to be down due to the divestiture of the domestic power and electromechanical businesses. The Company expects to continue to invest in software and technology throughout 2020.
During 2019, CUI Global made cash investments of $2.1 million and elected to convert its $0.7 million of convertible notes receivable to VPS stock. In addition to the cash investments, the Company contributed certain property and equipment, other intangible assets, inventories, prepaid assets, open purchases orders, research and development expenditures and the convertible note receivable for a total investment of $5.9 million for a 21.4% equity investment in Virtual Power Systems ("VPS"). Through December 31, 2019, the noncash portion of the investment was $3.8 million. The Company's share ownership percentage was diluted to 20.58% as of December 31, 2019 due to additional share issuances by VPS.
During 2018, CUI Global made investments of $0.7 million in convertible notes receivable with Virtual Power Systems (“VPS”) to support the two companies’ continued collaboration and development of Software Defined Power technologies. The notes accrued interest at 2% per annum and the interest was compounded annually. These investments were converted to VPS stock in 2019.
Investments made by the Company are subject to an investment policy, which limits our risk of loss exposure by setting appropriate credit quality requirements for investments held, limiting maturities to be one year or less, and setting appropriate concentration levels to prevent concentrations. This includes a requirement that no more than 3% of the portfolio, or $500,000, whichever is greater, may be invested in one particular issue. Since the investment in VPS was considered a strategic investment, the board and management reviewed and approved the investment above the board set limit for individual issuers.
Financing Activities
During the years ended December 31, 2019, 2018, and 2017, the Company issued payments of $4 thousand, $3 thousand and $29 thousand, respectively, against capital leases of motor vehicles and equipment. The Company paid $3.4 million and $89 thousand against the mortgage note payable in 2018 and 2017, respectively, with the payoff coming in 2018 as part of the sale-leaseback of the Company's headquarters building. In addition, with the payoff of the mortgage on the Company's headquarters building, the Company also closed out its interest rate swap derivative with a payment of $0.2 million. Also in 2018 and 2017, the Company issued payments of $45 thousand, and $61 thousand, respectively, toward the contingent liability associated with the Tectrol acquisition.
At December 31, 2018, the Company had a 1.5 million British pound sterling overdraft facility (approximately $1.9 million at December 31, 2018) and a $5.0 million revolving line of credit (LOC).
During April 2019, CUI Global replaced the existing line of credit and overdraft facilities with a new two-year credit facility with Bank of America for CUI Inc. and CUI-Canada, perfected by a first security lien on all assets of CUI Inc. and CUI-Canada. The facility also included a $3 million sub-limit for use by CUI-Global non-loan party subsidiaries as a reserve under the borrowing base. The credit facility provided for working capital and general corporate purposes. The credit facility provided up to $10,000,000 in a Revolving Line of Credit Facility (“Revolver”), including a sub-limit for letters of credit. Interest was based upon Daily Floating LIBOR at LIBOR + 2.00%. The Company discontinued this line of credit in 2019 upon the sale of the domestic power and electromechanical businesses. The additional credit was no longer needed due to the cash influx from the sale of the businesses, and the sold businesses were a primary source of collateral for the line of credit.
For the year ended December 31, 2019, 2018, and 2017, the Company recorded proceeds of $6.8 million, $19.5 million, and $9.8 million, respectively, from the Company's overdraft facility in the U.K., and $27.5 million, $20.0 million, and $22.3 million respectively, from the Company's line of credit. Those proceeds were paid back during that time and in 2019 both facilities were discontinued.
S-3 registration
The Company filed an S-3 registration statement on March 14, 2017 containing a prospectus that was effective March 29, 2017. With this filing, CUI Global may from time to time issue various types of securities, including common stock, preferred stock, debt securities and/or warrants, up to an aggregate amount of $100 million.
The Company utilized this registration in October 2017, when the Company issued an additional 7,392,856 shares at a public offering price of $2.80 per share.
As the Company focuses on strategic acquisitions, technology development, product line additions, and increasing its energy infrastructure services market presence, it will fund these activities together with related sales and marketing efforts for its various product offerings with cash on hand, including proceeds from future issuances of equity through the S-3 registration statement, and available debt.
CUI Global may raise additional capital needed to fund the further development and marketing of its products as well as payment of its debt obligations.
See the section entitled Recent Sales of Unregistered Securities for a complete listing of all unregistered securities transactions.
Financing activities - related party activity
During 2019, 2018 and 2017, $0.2 million, $0.3 million, and $0.3 million, respectively in interest payments were made in relation to the promissory notes issued to related party, IED, Inc. The promissory note terms included a due date of May 15, 2020 and an interest rate of 5% per annum, with interest payable monthly and the principal due as a balloon payment at maturity. In 2019, this note was assumed by the buyer as part of the sale of the Electromechanical operations.
Recap of Liquidity and Capital Resources
During the year ended December 31, 2019, the Company generated $35.4 million in cash through the sale of its domestic power and electromechanical businesses. In 2019, the Company's Energy segment continued to use cash while the Company's discontinued operations generated cash while owned by the Company. Along with an ongoing focus on research and development and growth initiatives, cash usage was greater than what it will be when the Energy businesses are fully mature. The net cash used in operating activities decreased to $11.5 million in 2019 from $12.3 million in 2018 with much of that due to the ongoing efforts to grow the current businesses.
The Company's line of credit and overdraft facility were paid off in 2019 and were made unnecessary by the cash generated from the sale of the Company's domestic power and electromechanical businesses.
At December 31, 2019, the Company had cash and cash equivalents balances of $23.4 million. At December 31, 2019 and 2018, the Company had $1.0 million and $0.3 million, respectively, of cash and cash equivalents balances at domestic financial institutions, which were covered under the FDIC insured deposits programs and $0.3 million and $67 thousand, respectively, at foreign financial institutions covered under the United Kingdom Financial Services Compensation (FSC) and the Canada Deposit Insurance Corporation (CDIC). At December 31, 2019 and 2018, the Company held $0.2 million and $0.3 million, respectively, in Japanese foreign bank accounts, $0.6 million and $0, respectively, in European foreign bank accounts and $0.2 million and $67 thousand, respectively, in Canadian bank accounts.
The following tables present our contractual obligations as of December 31, 2019:
As of December 31, 2019, the Company had an accumulated deficit of $122.2 million.
The Company expects the revenues from its continuing operations, and cash on hand, to cover operating and other expenses for the next twelve months of operations. However, in the short-term, the Company expects its Orbital operations in Houston and the U.K. to continue to need cash support as the businesses increase their market positions and revenue.
Off-Balance Sheet Arrangements - Obligations under Certain Guarantee Contracts
The Company may enter into guarantee arrangements in the normal course of business to facilitate commercial transactions with third parties. As of December 31, 2019, the Company is an indemnitor on a surety bond for an unconsolidated third party related to a $4.6 million project that is approximately 90% complete and expected to be completed in 2020. The Company does not expect any liability associated with this off-balance sheet arrangement.
Results of Operations
The following tables set forth, for the periods indicated, certain financial information regarding revenue and costs by segment:
Revenue
2019 compared to 2018
Revenues in 2019 are attributable to continued sales and marketing efforts. Net revenues for the year ended December 31, 2019 were greater than in 2018 due to higher integration revenues in the Company's North America operations offset by lower integration revenues in the Company's U.K. operations. North American operations had significantly higher overall revenues than in 2018 after a strong fourth quarter. U.K. operations were down overall for the year and had a weak fourth quarter with the continued delay in shipment of GasPTs toward a significant project in Italy. The U.K. market continues to face headwinds surrounding Brexit and the impact of the political environment on investment within the sector. Revenues will fluctuate generally around the timing of customer project delivery schedules.
At December 31, 2019, the Energy segment held a backlog of customer orders of approximately $9.6 million compared to approximately $15.7 million at December 31, 2018.
2018 compared to 2017
Higher revenue in 2018 is associated with a strong fourth quarter for revenues due to the timing of customer project delivery schedules. Revenue was higher in both our UK and Houston facilities.
At December 31, 2018, the Energy segment held a backlog of customer orders of approximately $15.7 million compared to approximately $12.6 million at December 31, 2017.
Cost of Revenues
2019 compared to 2018
The cost of revenues as a percentage of revenue decreased to 75% during the year ended December 31, 2019 from 87% during the year ended December 31, 2018. The decrease in the cost of revenues as a percentage of revenue was due largely to a 2018 increase to inventory reserves of $1.4 million related to a write-down of inventory and a 2018 $1.5 million write down of long-term deposits and other assets that were prepaid within the Energy segment. Both of these accounting adjustments increased the cost of sales as a percent of revenues in 2018. The Company expects improved cost of revenues as a percentage of revenues in 2020 as a result of increased sales of higher margin products and better mix of integration and service projects.
2018 compared to 2017
The cost of revenues as a percentage of revenue increased to 87% during the year ended December 31, 2018 from 69% during the year ended December 31, 2017. The increase in the cost of revenues as a percentage of revenue was due largely to an increase to inventory reserves of $1.4 million related to a write-down of inventory and a $1.5 million write down of long-term deposits and other assets that were prepaid within the Energy segment in 2018. Also contributing to the higher percentage was a less favorable revenue mix of integration projects in 2018.
Selling, General and Administrative Expense
Selling, General and Administrative (SG&A) expenses includes such items as wages, commissions, consulting, general office expenses, business promotion expenses and costs of being a public company including legal and accounting fees, insurance and investor relations. SG&A expenses are generally associated with the ongoing activities to reach new customers, promote new product lines including GasPT, VE, and other new product and service introductions.
2019 compared to 2018
During the year ended December 31, 2019, SG&A increased $1.4 million compared to the year ended December 31, 2018. The increase in SG&A for the year was due to increased corporate costs largely due to strategic initiatives, which included increased professional fees including legal, accounting, tax, investor relations, and costs associated with due diligence activities related to prospective acquisitions. Partially offsetting the increased SG&A costs in the Other category were decreased costs in the Energy segment primarily due to improved operating costs including lower professional fees in 2019 and lower translated costs at our U.K. operations due to generally lower foreign exchange rates and higher costs in the 2018 comparable period from increased marketing expenses related to the 2018 World Gas Conference.
SG&A decreased to 85% of total revenue in 2019 compared to 92% of total revenue during the year ended December 31, 2018 due to economies of scale on 16% higher consolidated revenues.
2018 compared to 2017
During the year ended December 31, 2018, SG&A increased $1.1 million compared to the year ended December 31, 2017. The increase for the year is due to increased costs in the Energy segment primarily due to higher selling expenses on the higher sales within the segment, higher professional fees in the Energy segment and higher SG&A expenses at the new Houston facility. Also contributing to the higher SG&A expenses in the Energy segment in 2018 were increased marketing expenses related to the World Gas Conference. SG&A decreased slightly to 92% of total revenue in 2018 compared to 93% of total revenue during the year ended December 31, 2017 due to economies of scale on 8% higher consolidated revenues.
Depreciation and Amortization
(1) The Other category included depreciation and amortization of discontinued operations.
The depreciation and amortization expenses are associated with depreciating buildings, furniture, vehicles, equipment, software and other intangible assets over the estimated useful lives of the related assets.
2019 compared to 2018
Depreciation and amortization decreased for the year ended December 31, 2019 compared to the comparable period in 2018. The majority of the decrease was in the Other category primarily as a result of the Company's sale and leaseback of the Tualatin facility in December 2018 and the transfer of certain fixed assets as part of the VPS equity-method investment. Depreciation included in the Other category is primarily related to the Company's discontinued operations.
2018 compared to 2017
Depreciation and amortization increased slightly for the year ended December 31, 2018 compared to the comparable period in 2017. The increase was a result of an increase in the Energy segment due to generally increased foreign currency translation rates in 2018 compared to 2017 and increased software amortization due to Orbital's new ERP system going into service in 2018.
Research and Development
Research and development costs are associated with the continued research and development of new and existing technologies including GasPT and VE Technology and other products. Research and development expense was down in the Energy segment for both the year ended December 31, 2019 compared to the year ended December 31, 2018 and in the year ended December 31, 2018 compared to 2017. Research and development activities primarily focused on GasPT and VE technologies.
Impairment Loss
In 2018, management calculated an excess carrying amount for its Orbital-UK goodwill resulting in the remaining goodwill at Orbital-UK being written off, which was a total of $4.3 million impairment for the year. As of December 31, 2017, management calculated an excess carrying amount for its Orbital-UK goodwill resulting in a $3.2 million impairment. See Note 2 Summary of Significant Accounting Policies - Indefinite-Lived Intangibles and Goodwill Assets for information on the impairment to goodwill in 2018 and 2017.
Provision (Credit) for Bad Debt
Provision for (credit to) bad debt in 2019, 2018 and 2017 represents less than 1% of total revenues and relates to miscellaneous receivables, which the Company has either recorded an allowance for doubtful collections of the receivable or for which the Company has determined the balance to be uncollectible. Credits to the provision for bad debt are generated when aged receivables are collected at a higher rate than was previously reserved, which results in the calculated reserve being reduced.
Other Income (Expense)
Fluctuations in Other Income (Expense) are largely due to fluctuations in foreign currency rates. Foreign currency gains and losses are primarily related to intercompany receivables/payables between CUI Global and its U.K Orbital Gas Systems subsidiary. The derivative liability was an interest rate derivative related to the Company's mortgage interest rate and was settled in 2018 as part of the Company's sale leaseback transaction for it's headquarters building. The increase in interest income is primarily related to the related-party note receivable the Company holds, which was received as part of the Company's sale of its electromechanical business in 2019.
Investment Income
During the three months ended March 31, 2016, CUI Global's investment in Test Products International, Inc. ("TPI"), was exchanged for a note receivable from TPI of $0.4 million, which was the carrying value of the investment, earning interest at 5% per annum, through maturity. The Company recorded interest income on the note of $8 thousand, $17 thousand and $18 thousand for the years ended December 31, 2019, 2018 and 2017, respectively. The interest receivable was settled on a quarterly basis via a non-cash offset against the finders-fee royalties earned by TPI on GasPT sales. Any remaining finders-fee royalties balance was offset against the note receivable quarterly. The Company received full payment on the note during 2019.
During 2018, CUI Global made investments of $0.7 million in convertible notes receivable with Virtual Power Systems (“VPS”) to support the two companies’ continued collaboration and development of industry transforming Software Defined Power technologies. The notes accrued interest at 2% per annum and the interest was to compound annually. Unless converted into shares earlier, principal and accrued interest was to convert automatically on the maturity date (October 27, 2019) into shares of VPS common stock at the then current fair market value.
On March 30, 2019, the Company converted its $0.7 million in notes receivable into preferred stock of VPS. In addition, the Company contributed $0.3 million of cash and $2.5 million of other assets, as well as $1.8 million of future expenditures recorded as liabilities by the Company, of which $1.7 million were paid in 2019. In return, the Company acquired a 21.4% ownership share of VPS. During the three months ended June 30, 2019, the Company recorded a $0.6 million gain based on the fair value of the non-cash assets contributed as part of the investment in VPS, which is included in discontinued operations. As of December 31, 2019, the Company's ownership percentage has been reduced to 20.58% following VPS's issuance of additional equity. Based on current accounting guidance, the Company will record its share of VPS's income or loss under the equity method of accounting. Under the equity method of accounting, results will not be consolidated, but the Company will record a proportionate percentage of the profit or loss of VPS as an addition to or a subtraction from the VPS investment asset. The VPS investment basis at December 31, 2019 was $4.9 million as reflected on the consolidated balance sheets.
Interest Expense
The Company incurred $61 thousand, $0.2 million, and $0.2 million of interest expense during 2019, 2018 and 2017, respectively. Interest expense is for interest on the short-term note payable, its secured note, secured promissory note, and line of credit and overdraft facility. The Company's secured note was repaid in December 2018 as part of the Company's sale-leaseback transaction, and its secured promissory note, line of credit and overdraft facilities were paid off in 2019. At December 31, 2019 the Company was incurring interest only on its short-term note payable for $0.5 million related to certain financed insurance policies.
Provision (benefit) for taxes
The Company is subject to taxation in the U.S., various state and foreign jurisdictions. We continue to record a full valuation allowance against the Company's U.S. and U.K. net deferred tax assets as it is "not more likely than not," that the Company will realize a benefit from these assets in a future period. In future periods, tax benefits and related deferred tax assets will be recognized when management concludes realization of such amounts is "more likely than not."
2019 compared to 2018
In 2019, a net tax benefit of $3.0 million, was recorded to the income tax provision from continuing operations for the year ended December 31, 2019 resulting in an effective tax rate of 17.8% compared to a $1.3 million tax benefit from continuing operations for the year ended December 31, 2018 and an effective tax rate of 5.9%. For the year ended December 31, 2019, the income tax benefit primarily represents benefits from losses from continuing operations partially offset by foreign tax rates differing from USA tax rates and an increase in the valuation allowance. For the year ended December 31, 2018, the income tax benefit primarily represents benefits from losses from continuing operations partially offset by foreign tax rates differing from USA tax rates, impairment of foreign purchased goodwill and an increase in the valuation allowance. As of December 31, 2019, we have federal, state and foreign net operating loss carry forwards of approximately $37.2 million, $32.3 million, and $15.5 million, respectively, and for which the federal and state net operating loss carry-forwards will expire between 2027 and 2038.
During 2019, the Company provided for a partial valuation allowance against the Company’s Canada net deferred tax assets, which are included in assets held for sale, as it is not “more likely than not,” that the Company will realize a benefit from a portion of these assets in a future period. In future periods, tax benefits and related deferred tax assets will be recognized when management concludes realization of such amounts is "more likely than not."
2018 compared to 2017
During 2018, the Company provided for a full valuation allowance against the Company’s U.K. net deferred tax assets as it was considered not “more likely than not,” that the Company will realize a benefit from these assets in a future period. In 2018, a net benefit of $1.3 million, was recorded to the income tax provision for the year ended December 31, 2018 resulting in an effective tax rate of 5.9% compared to a $2.3 million tax benefit for the year ended December 31, 2017 and an effective tax rate of 13.9%. For the year ended December 31, 2018, the income tax benefit primarily represents benefits from losses from continuing operations partially offset by foreign tax rates differing from USA tax rates, impairment of foreign purchased goodwill and an increase in the valuation allowance. For the year ended December 31, 2017, the income tax benefit primarily represents benefits from losses from continuing operations partially offset by foreign tax rates differing from USA tax rates, impairment of foreign purchased goodwill and an increase in the valuation allowance.
Loss from Continuing Operations, net of income taxes
2019 compared to 2018
The Company had a loss from continuing operations, net of income taxes of $13.6 million for the year ended December 31, 2019 compared to a loss of $21.3 million in 2018. The decreased loss from continuing operations, net of income taxes was due to higher sales and greater margins in 2019 compared to 2018, greater tax benefits and lower goodwill and other asset impairments in 2019 compared to 2018.
2018 compared to 2017
The Company had a loss from continuing operations, net of income taxes of $21.3 million for the year ended December 31, 2018 compared to a loss from continuing operations, net of income taxes of $13.9 million in 2017. The increased loss from continuing operations, net of income taxes was due to lower margins due largely to an increase to inventory reserves of $1.4 million related to a write-down of inventory and a $1.5 million write down of long-term deposits and other assets that were prepaid within the Energy segment. Also contributing to the higher percentage was a less favorable revenue mix of integration projects in 2018 compared to 2017.
Income from Discontinued Operations, net of income taxes
2019 compared to 2018
The Company had income from discontinued operations, net of income taxes of $12.5 million for the year ended December 31, 2019 compared to $4.0 million in 2018. The increase is primarily due to the gain on sale of businesses for 2019.
2018 compared to 2017
The Company had income from discontinued operations, net of income taxes of $4.0 million for the year ended December 31, 2018 compared to $1.4 million in 2017 due to a slightly more favorable product mix in the Power and Electromechanical businesses on greater volume.
Consolidated Net Loss
2019 compared to 2018
The Company had a net loss of $1.1 million for the year ended December 31, 2019 compared to a net loss of $17.3 million for the year ended December 31, 2018. The decrease in the consolidated net loss for 2019 was primarily the result of the gain on the sale of the domestic power and electromechanical businesses and lower goodwill and other asset impairments.
2018 compared to 2017
The Company had a net loss of $17.3 million for the year ended December 31, 2018 compared to a net loss of $12.6 million for the year ended December 31, 2017. The increase in the consolidated net loss for 2018 was primarily the result of higher goodwill impairments, higher inventory reserves and impairment of deposits and other assets.
Effect of Inflation and Changing Prices
The Company believes, that during fiscal years ended December 31, 2019, 2018 and 2017, the effect of a hypothetical 100 basis point shift in foreign currency exchange rates applicable to our business would not have had a material impact on our consolidated financial statements.
Recently Adopted and Recently Issued Accounting Standards
Information on recently adopted and recently issued accounting standards is included in Note 2 Summary of Significant Accounting Policies - Recent Accounting Pronouncements, to the Consolidated Financial Statements under Part II, Item 8, ‘‘Financial Statements and Supplementary Data.’’
Item 7A.
Item 7A. Quantitative and Qualitative Disclosure about Market Risk
We are exposed to market risk in the ordinary course of our business. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. This market risk exposure is primarily a result of fluctuations in foreign currency exchange rates and interest rates. The Company neither holds nor issues financial instruments for trading purposes.
The following sections provide quantitative information on the Company’s exposure to foreign currency exchange rate risk and stock price risk. The Company makes use of sensitivity analyses that are inherently limited in estimating actual losses in fair value that can occur from changes in market conditions.
Foreign Currency Exchange Rates
The Company conducts continuing operations in two principal currencies: the U.S. dollar, and the British pound sterling. These currencies operate primarily as the functional currency for the Company’s U.S., and UK operations. Cash is managed centrally within each of the two regions with net earnings invested in the U.S. and working capital requirements met from existing U.S. intercompany liquid funds.
Because of fluctuations in currency exchange rates, the Company is subject to currency translation exposure on the results of its operations. Foreign currency translation risk is the risk that exchange rate gains or losses arise from translating foreign entities’ statements of earnings and balance sheets from functional currency to the Company’s reporting currency, the U.S. dollar, for consolidation purposes. As currency exchange rates fluctuate, translation of our Statements of Operations into U.S. dollars affects the comparability of revenues and operating expenses between years.
Revenues and operating expenses are primarily denominated in the currencies of the countries in which our continuing operations are located, the U.S., and UK. Our consolidated results of operations and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates and may be adversely affected in the future due to changes in foreign exchange rates.
The table below details the percentage of revenues and expenses by the two principal currencies for the fiscal years ended December 31, 2019, 2018 and 2017:
To date, we have not entered into any hedging arrangements with respect to foreign currency risk and have limited activity with forward foreign currency contracts or other similar derivative instruments.
Investment Risk
The Company has an Investment Policy that, inter alia, provides an internal control structure that takes into consideration safety (credit risk and interest rate risk), liquidity and yield. Our Investment officers, CEO and CFO, oversee the investment portfolio and compile a quarterly analysis of the investment portfolio when applicable for internal use. In addition, the Company implemented a new Investment Committee in 2019 to administer and operate the portfolio. At December 31, 2019, the Investment Committee is comprised of C. Stephen Cochennet, Corey A. Lambrecht, Chairman, and Daniel Ford, CFO. See Item 10 of this Form 10-K for more information on the Company’s Investment Committee.
Cash and cash equivalents are diversified and maintained with several financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and are maintained with financial institutions of reputable credit, therefore, bear minimal credit risk.
The Company has trade receivable and revenue concentrations with large customers, which include a large concentration of trade receivables and revenues in the United Kingdom.
Item 8.
Item 8. Financial Statements and Supplementary Data
This item includes the following financial information:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
CUI Global, Inc.
Opinion on the financial statements
We have audited the accompanying consolidated balance sheet of CUI Global, Inc. and subsidiaries (the “Company”) as of December 31, 2019, the related consolidated statements of operations and comprehensive income and (loss), changes in stockholders’ equity, and cash flows for the year then ended, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
Adoption of new accounting standard
As discussed in Note 16 to the consolidated financial statements, the Company changed its method of accounting for leases in 2019 due to the adoption of Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842), and the related amendments.
Basis for opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audit provide a reasonable basis for our opinion.
/s/ GRANT THORNTON LLP
We have served as the Company’s auditor since 2019.
Portland, Oregon
March 30, 2020
Report of Independent Registered Public Accounting Firm
Stockholders and Board of Directors
CUI Global, Inc.
Tualatin, Oregon
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheet of CUI Global, Inc. and Subsidiaries (the “Company”) as of December 31, 2018, the related consolidated statements of operations, comprehensive income and (loss), changes in stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2018, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiaries at December 31, 2018, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.
Adoption of New Accounting Standard
As discussed in Note 2 to the consolidated financial statements, the Company has changed its method for the recognition, measurement, presentation and disclosure of revenue in the year ended December 31, 2018 due to the adoption of ASC 606, Revenue from Contracts with Customers.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Emphasis of a Matter
As discussed in Note 2 to the consolidated financial statements, on September 30, 2019 and on November 11, 2019, the Company entered into agreements to divest itself of certain businesses and components of its Power and Electromechanical segment and has also decided to discontinue the remaining businesses of the segment. The consolidated balance sheet as of December 31, 2018 and the consolidated statements of operations for each of the two years in the period ended December 31,2018 and the accompanying notes to consolidated financial statements have been adjusted to reflect the Power and Electromechanical segment as discontinued operations.
/s/ Perkins & Company, P.C.
We have previously served as the Company's auditor from 2014 through 2018.
Portland, Oregon
March 18, 2019, except for Note 2, which is as of March 30, 2020
CUI Global, Inc.
Consolidated Balance Sheets
As of December 31, 2019 and 2018
See accompanying notes to consolidated financial statements
CUI Global, Inc.
Consolidated Statements of Operations
For the Years Ended December 31, 2019, 2018 and 2017
See accompanying notes to consolidated financial statements
CUI Global, Inc.
Consolidated Statements of Comprehensive Income and (Loss)
For the Years Ended December 31, 2019, 2018 and 2017
(In thousands)
See accompanying notes to consolidated financial statements
CUI Global, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
For the Years Ended December 31, 2019, 2018 and 2017
(In thousands, except share amounts)
See accompanying notes to consolidated financial statements
CUI Global, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2019, 2018 and 2017
(In thousands)
See accompanying notes to consolidated financial statements
CUI Global, Inc.
Notes to Consolidated Financial Statements
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
CUI Global Inc. (CUI Global) is a platform company composed of one segment, the Energy segment. In 2019, the Company divested of most of its previous Power and Electromechanical segment and most of the remaining portion of that segment was included in assets held for sale at December 31, 2019.
The Company’s Energy segment is made up of Orbital Gas Systems Ltd. (Orbital-UK) and Orbital Gas Systems, North America, Inc. (Orbital North America), collectively referred to as Orbital Gas Systems (Orbital). Orbital-UK is a United Kingdom-based provider of natural gas infrastructure and advanced technology, including metering, odorization, remote telemetry units (‘‘RTU’’) and provides a diverse range of personalized gas engineering solutions to the gas utilities, power generation, emissions, manufacturing and automotive industries. Orbital Gas Systems, North America, Inc. is a wholly owned subsidiary that represents the Energy segment in the North American market. GasPT® and VE® Technology products are sold through Orbital.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates include estimates used to review the Company’s goodwill, impairment estimations of long-lived assets, revenue recognition on cost-to-cost type contracts, allowances for uncollectible accounts, inventory valuation, warranty reserves, valuations of non-cash capital stock issuances, estimates of the incremental borrowing rate for long-term leases, fair value estimates and the valuation allowance on deferred tax assets. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable in the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Company Conditions
The continued delays in shipment of GasPTs on a significant project, and the related slower than expected acceptance of this new disruptive technology and the ongoing impact of Brexit has caused a delay in our expected profitability from continuing operations.
The Company had net loss of $1.1 million and cash used in operating activities of $11.5 million during the year ended December 31, 2019. As of December 31, 2019, our accumulated deficit is $122.2 million.
Management believes the Company's present cash flows will meet its obligations for twelve months from the date these financial statements are available to be issued. Including our cash balance, we have $25.7 million of positive working capital primarily related to assets held for sale, trade accounts receivable, prepaid assets, contract assets and our inventory less current liabilities that we will manage in the next twelve months to create positive cash flow. Considering the above factors management believes the Company can meet its obligations for the twelve-month period from the date the financial statements are available to be issued.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of CUI Global, Inc. and its wholly owned subsidiaries Orbital Gas Systems, Ltd. and Orbital Gas Systems, North America, Inc. hereafter referred to as the ‘‘Company.’’ Additional wholly owned subsidiaries, CUI Holdings Inc. (formerly CUI, Inc.), CUI Japan, CUI-Canada, and CUI Properties, LLC are included in these financial statements as discontinued operations. The primary assets and liabilities of CUI Holdings Inc. were sold or settled during 2019 and CUI Japan, and CUI-Canada are classified as held for sale. CUI Properties is a dormant administrative entity. Significant intercompany accounts and transactions have been eliminated in consolidation.
Discontinued Operations and Sales of Businesses
As part of the Company’s stated strategy to transform CUI Global into a diversified energy infrastructure services platform serving North American and U.K. energy customers, the Company’s board of directors made the decision to divest of its Power and Electromechanical businesses. On September 30, 2019, CUI Global, Inc. entered into an asset sale agreement by and among, CUI, Inc. ("Seller"), a wholly owned subsidiary of the Company ("Parent"), and Back Porch International, Inc. ("Buyer") to sell the Company’s Electromechanical business to a management led group. In November 2019, CUI Global, Inc. entered into an asset sale agreement by and among, the Seller and Bel Fuse, Inc. to sell the domestic Power supply business. Both sales closed in 2019 for combined cash proceeds of $35.4 million and combined gain on sale of $14.1 million. At December 31, 2019, the assets and liabilities of the Company's CUI-Canada and CUI Japan subsidiaries are included as held for sale.
Pursuant to the terms of the asset sale agreement with Back Porch International, Inc., the Seller and Parent agreed to sell and assign to the management-led group, Back Porch International, Inc., the rights and obligations of Seller and Parent to the assets constituting the non-power supply electromechanical components product group of Seller and Parent effective the close of business September 30, 2019 for $15 million (the "Purchase Consideration"). The Purchase Consideration consisted of approximately $4.7 million in cash at closing, assumption of debt of the CUI Parent in the approximate amount of $5.3 million, and a 5-year note with the timing of payments based upon a multiple of EBITDA of the Business above $3.5 million, guaranteed to be a total of $5 million (fair value of $3.3 million at December 31, 2019). In addition to the assets purchased, the Buyer shall assume and agree to pay, perform and discharge certain liabilities agreed to by the Buyer and Seller ("Assumed Liabilities") including scheduled accounts payable and vendor purchase orders at the closing of the disposition, with the Sellers generally remaining obligated for remaining pre-closing liabilities other than the assumed liabilities (the “Excluded Liabilities”).
Pursuant to the terms of the asset sale agreement with Bel Fuse Inc., the Seller and Parent, excluding CUI-Canada and CUI Japan, agreed to sell and assign to the Bel Fuse Inc., the rights and obligations of Seller and Parent to the assets constituting the majority of its power supply business of Seller and Parent, excluding CUI-Canada and CUI Japan, effective upon close of the transaction for $32 million subject to closing working capital adjustments (the "Purchase Consideration"). In addition to the assets purchased, the Buyer assumed and agreed to pay, perform and discharge certain liabilities agreed to by the Buyer and Seller ("Assumed Liabilities") including scheduled accounts payable and vendor purchase orders at the closing of the disposition, with the Sellers generally remaining obligated for remaining pre-closing liabilities other than the assumed liabilities (the “Excluded Liabilities”).
The associated results of operations of the discontinued Power and Electromechanical segment are separately reported as Discontinued Operations for all periods presented on the Consolidated Statements of Operations. Balance sheet items for the discontinued businesses, from the former Power and Electromechanical segment have been reclassified to assets held for sale within current assets and liabilities held for sale within current liabilities in the Consolidated Balance Sheets as of December 31, 2019 and have been reclassified to assets held for sale within current and noncurrent assets and liabilities held for sale within current and noncurrent liabilities as of December 31, 2018. Cash flows from these discontinued businesses are included in the consolidated cash flow statements. See below for additional information on operating and investing cash flows of the discontinued operations. Results from continuing operations for the Company and segment highlights exclude the former Power and Electromechanical segment, which is included in these discontinued operations. The notes to the consolidated financial statements have also been adjusted for the years ended December 31, 2018 and 2017 from previous disclosures as a result of the discontinued operations of the Power and Electromechanical segment.
The former Power and Electromechanical segment consists of the wholly owned subsidiaries: CUI Holding, Inc. (CUI), based in Tualatin, Oregon; CUI Japan, based in Tokyo, Japan; CUI-Canada, based in Toronto, Canada; and the entity that previously held the corporate building, CUI Properties. All three operating subsidiaries are providers of power and electromechanical components for Original Equipment Manufacturers (OEMs). Remaining goodwill at CUI-Canada and CUI Japan was written down to $0 in 2019 as well as the remaining $92 thousand of customer relationship intangible at CUI-Canada.
The Power and Electromechanical segment aggregates its product offerings into two categories: power solutions - including external and embedded ac-dc power supplies, dc-dc converters and basic digital point of load modules and offering a technology architecture that addresses power and related accessories; and components - including connectors, speakers, buzzers, and industrial control solutions including encoders and sensors. These offerings provide a technology architecture that addresses power and related accessories to industries as broadly ranging as telecommunications, consumer electronics, medical and defense.
Selected data for these discontinued businesses consisted of the following:
Reconciliation of the Major Classes of Line Items Constituting Pretax Income from Discontinued Operations to the After-Tax Income from Discontinued Operations That Are Presented in the Statement of Operations
Reconciliation of the Carrying Amounts of Major Classes of Assets and Liabilities of the Discontinued Operation to Total Assets and Liabilities of the Disposal Group Classified as Held for Sale
* The assets and liabilities of the disposal group classified as held for sale are classified as current on the December 31, 2019 balance sheet because it is probable that the sale will occur and proceeds will be collected within one year.
Net cash provided by operating activities of discontinued operations for 2019, 2018 and 2017 was $2.7 million and $4.5 million, and $3.7 million, respectively.
Net cash used in investing activities of discontinued operations for 2019, 2018 and 2017 was $0.5 million and $1.3 million, and $1.0 million, respectively.
Fair Value of Financial Instruments
Accounting Standards Codification (‘‘ASC’’) 820 ‘‘Fair Value Measurements and Disclosures’’ (‘‘ASC 820’’) defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles in the U.S., and enhances disclosures about fair value measurements. ASC 820 describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value, which are the following:
•
Level 1 - Pricing inputs are quoted prices available in active markets for identical assets or liabilities as of the reporting date.
•
Level 2 - Pricing inputs are quoted for similar assets, or inputs that are observable, either directly or indirectly, for substantially the full term through corroboration with observable market data. Level 2 includes assets or liabilities valued at quoted prices adjusted for legal or contractual restrictions specific to these investments.
•
Level 3 - Pricing inputs are unobservable for the assets or liabilities; that is, the inputs reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability.
The Company determines when a financial instrument transfers between levels based on management’s judgment of the significance of unobservable inputs used to calculate the fair value of the financial instrument.
Management believes the carrying amounts of the short-term financial instruments, including cash and cash equivalents, investment, note receivable, accounts receivable, contract assets, prepaid expense and other assets, accounts payable, accrued liabilities, contract liabilities, and other liabilities reflected in the accompanying consolidated balance sheet approximate fair value at December 31, 2019 and 2018 due to the relatively short-term nature of these instruments. Notes payable approximate fair value based on current market conditions.
Cash and Cash Equivalents
Cash includes deposits at financial institutions with maturities of three months or less. The Company at times has cash in banks in excess of FDIC insurance limits and places its temporary cash investments with high credit quality financial institutions. The Company considers all highly liquid marketable securities with maturities of 90 days or less at the date of acquisition to be cash equivalents. Cash equivalents include money market funds, certificates of deposit and commercial paper. At December 31, 2019 and 2018, the Company had $1.0 million and $0.3 million, respectively, of cash and cash equivalents balances at domestic financial institutions that were covered under the FDIC insured deposits programs and $0.3 million and $67 thousand, respectively, at foreign financial institutions covered under the United Kingdom Financial Services Compensation (FSC) and the Canada Deposit Insurance Corporation (CDIC). At December 31, 2019 and 2018, the Company held $0.2 million and $0.3 million, respectively, in Japanese foreign bank accounts and $0.6 million and $0, respectively, in European foreign bank accounts and $0.2 million and $67 thousand, respectively, in Canadian bank accounts. In addition to the Company's unrestricted cash and cash equivalents at December 31, 2019 and 2018, the Company has $0 and $0.5 million, respectively, of long-term restricted cash on its balance sheet related to a contract guarantee. Restricted cash is combined with other cash and cash equivalents in reconciling the change in cash on the Company's Consolidated Statements of Cash Flows.
Investments and Notes Receivable
The Company obtained a note receivable in 2019 as part of the divestiture of the Company's electromechanical components business. The note has a future value of $5 million, and is presented on the balance sheet at its present value of $3.3 million.
Test Products International, Inc. ("TPI") is a provider of handheld test and measurement equipment. The Company had a note receivable with TPI, which originated in 2016 earning interest at 5% per annum with an original value of $0.4 million and which was due June 30, 2019. The Company recorded interest income on the note of $8 thousand, $17 thousand and $18 thousand for the years ended December 31, 2019, 2018 and 2017, respectively. The interest receivable was settled on a quarterly basis via a non-cash offset against the finders-fee royalties earned by TPI on GasPT sales. Finders-fee royalties of $36 thousand, $10 thousand and $16 thousand were earned by TPI in the years ended December 31, 2019, 2018 and 2017, respectively, and $13 thousand, $10, thousand and $16 thousand, respectively for those years, were offset against the note receivable on a quarterly basis. This note receivable was collected in 2019. Also, in 2018 and 2017, the Company received $19 thousand and $39 thousand, respectively, in cash payments against the note. The balance on the note receivable at December 31, 2019 and 2018 was $0 and $318 thousand, respectively.
During 2018, the Company made two strategic investments in convertible notes receivable with Virtual Power Systems ("VPS") for a total of $655 thousand. CUI Holdings, Inc. was the exclusive third-party design and development provider of VPS's ICE (Intelligent Control of Energy) products. These notes were converted to VPS stock in 2019. See Note 3, Investments and Fair Value Measurements for more information on these convertible notes.
Accounts Receivable and Allowance for Uncollectible Accounts
Accounts receivable consist of the receivables associated with revenue derived from product sales including present amounts due to contracts accounted for under cost-to-cost method. An allowance for uncollectible accounts is recorded to allow for any amounts that may not be recoverable, based on an analysis of prior collection experience, customer credit worthiness and current economic trends. Based on management’s review of accounts receivable, an allowance for doubtful accounts of $47 thousand and $17 thousand at December 31, 2019 and 2018, respectively, is considered adequate. The reserve in both periods considers aged receivables that management believes should be specifically reserved for as well as historic experience with bad debts to determine the total reserve appropriate for each period. Receivables are determined to be past due based on the payment terms of original invoices. The Company grants credit to its customers, with standard terms of Net 30 days. The Company routinely assesses the financial strength of its customers and, therefore, believes that its accounts receivable credit risk exposure is limited.
Activity in the allowance for doubtful accounts for the years ended December 31, 2019, 2018 and 2017 is as follows:
Inventories
Inventories consist of finished and unfinished products and are stated at the lower of cost or market through either the first-in, first-out (FIFO) method as a cost flow convention or through the moving average cost method.
At December 31, 2019, and 2018, inventory is presented on the balance sheet net of reserves. The Company provides reserves for inventories estimated to be excess, obsolete or unmarketable. The Company’s estimation process for assessing the net realizable value is based upon its known backlog, projected future demand, historical usage and expected market conditions. Manufactured inventory includes material, labor and overhead. Inventory by category consists of:
Activity in inventory reserves is as follows:
Land, Buildings, Improvements, Furniture, Vehicles, Equipment, and Leasehold Improvements
Land is recorded at cost and includes expenditures made to ready it for use. Land is considered to have an infinite useful life.
Buildings and improvements are recorded at cost.
Furniture, vehicles, and equipment are recorded at cost and include major expenditures, which increase productivity or substantially increase useful lives.
Leasehold improvements are recorded at cost and are depreciated over the lesser of the lease term, estimated useful life.
The cost of buildings, improvements, furniture, vehicles, and equipment is depreciated over the estimated useful lives of the related assets.
Depreciation is computed using the straight-line method for financial reporting purposes. The estimated useful lives for buildings, improvements, furniture, vehicles, and equipment are as follows:
Maintenance, repairs and minor replacements are charged to expenses when incurred. When buildings, improvements, furniture, equipment and vehicles are sold or otherwise disposed of, the asset and related accumulated depreciation are removed and any gain or loss is included in the statement of operations.
Long-Lived Assets
Long-lived assets including finite-lived intangible assets are periodically reviewed for impairment whenever circumstances and situations change such that there is an indication that the carrying amounts may not be recoverable. In performing the review for recoverability, the future cash flows expected to result from the use of the asset and its eventual disposition are estimated. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the long-lived asset, an impairment loss is recognized as the excess of the carrying amount over the fair value. Otherwise, an impairment loss is not recognized. Management estimates the fair value and the estimated future cash flows expected. Any changes in these estimates could impact whether there was impairment and the amount of the impairment.
In the fourth quarter of 2018, the Company determined that certain long-term prepaid assets classified on the balance sheet as deposits and other assets, which were reliant on future revenue in order to be amortized to expense, did not have adequate forecasted revenue to justify the current valuation. This was primarily driven by the lack of substantial sales over a two-year period and uncertainty regarding the level of future sales. For that reason, the Company recorded a $1.5 million impairment to deposits and other assets and reclassified $0.1 million to prepaid assets. The amount reclassified to prepaid assets related to prepaid royalties associated with expected 2019 revenue.
Other than on goodwill, no impairments were recognized on long-lived assets in 2019, 2018 or 2017. In 2018, the Company performed an undiscounted cash flows impairment analysis as prescribed under ASC 360 Property, Plant and Equipment on its long-lived fixed assets and its finite lived intangible assets at Orbital-UK due to an indication that the overall carrying value of the operating unit was not recoverable. Based upon that analysis, no impairment was identified for those assets.
Identifiable Intangible Assets
Intangible assets are stated at cost net of accumulated amortization and impairment. The fair value for intangible assets acquired through acquisitions is measured at the time of acquisition utilizing the following inputs, as needed:
1.
Inputs used to measure fair value are unadjusted quote prices available in active markets for the identical assets or liabilities if available.
2.
Inputs used to measure fair value, other than quoted prices included in 1, are either directly or indirectly observable as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in inactive markets. This includes assets and liabilities valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates and volatility factors, are corroborated by readily observable data from actively quoted markets for substantially the full life of the asset.
3.
Inputs used to measure fair value are unobservable inputs supported by little or no market activity and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.
4.
Expert appraisal and fair value measurement as completed by third-party experts.
The following are the estimated useful life for the intangible assets:
(1)
Technology rights are amortized over a 20-year life or the term of the rights agreement.
Indefinite-Lived Intangibles and Goodwill Assets
The Company accounts for business combinations under the acquisition method of accounting in accordance with ASC 805, ‘‘Business Combinations,’’ where the total purchase price is allocated to the tangible and identified intangible assets acquired and liabilities assumed based on their estimated fair values. The purchase price is allocated using the information currently available, and may be adjusted, up to one year from acquisition date, after obtaining more information regarding, among other things, asset valuations, liabilities assumed and revisions to preliminary estimates. The purchase price in excess of the fair value of the tangible and identified intangible assets acquired less liabilities assumed is recognized as goodwill.
2019 Goodwill impairments
In the fourth quarter of 2019, the Company determined that it was more likely than not that the fair value of its goodwill at CUI-Canada and CUI Japan was less than its carrying amounts. The Company hired a third-party valuation expert to perform a valuation and it was determined that the remaining goodwill held by CUI-Canada and CUI Japan should be written down to zero. With those write downs, the Company does not have any remaining goodwill on any of its subsidiaries.
2018 Goodwill impairments
During our review of Goodwill as of May 31, 2018, the Company determined that there were indicators present to suggest that it was more likely than not that the fair value of the Orbital-UK reporting unit was less than its carrying amount.
The significant changes for the Orbital-UK reporting unit included a decline in the 2018 actual revenue, operating income and cash flows compared to prior forecasts for the same period and a negative change in the 2018 forecasted revenue, operating income and cash flows for the remainder of the year due in part to the longer than expected temporary halt in shipping of its GasPT product to a major customer in Italy and market uncertainty due to the continuing effects of Brexit.
The Company performed a quantitative test for the Orbital-UK reporting unit, which resulted in an impairment for the Orbital-UK reporting unit, and the Company recorded a Goodwill impairment charge of $1.3 million during the second quarter of 2018.
December 2018 Interim Test. During the fourth quarter of 2018, the Company determined that there were additional indicators present to suggest that it was more likely than not that the fair value of the Orbital-UK reporting unit was less than its carrying amount. The significant changes for the Orbital-UK reporting unit subsequent to the annual goodwill impairment test performed as of May 31, 2018 were driven by a slower recovery than what was originally forecasted. Actual GasPT revenue continued to lag behind forecasted revenue as acceptance of the technology continued to be slower than anticipated and continued delays associated with existing customer contracts that had not yet resumed. This slower than expected recovery, led to lower 2018 revenue, operating income and cash flows than originally forecasted.
As a result of its analysis, the Company performed another quantitative test of goodwill, which resulted in further impairment for the Orbital-UK reporting unit, and the Company recorded a goodwill impairment charge of $3.1 million during the fourth quarter of 2018, to write-off the remaining Energy segment goodwill. In addition, the reporting units in the discontinued Power and Electromechanical segment were also tested for impairment due to the overall decrease in market capitalization experienced in 2018, with no impairment required.
December 2017 Interim Test. During the fourth quarter of 2017, the Company determined that there were indicators present to suggest that it was more likely than not that the fair value of the Orbital-UK reporting unit was less than its carrying amount. The significant changes for the Orbital-UK reporting unit subsequent to the annual goodwill impairment test performed as of May 31, 2017 included a decline in the 2017 actual revenue, operating income and cash flows compared to previously forecasted results and a decline in the 2018 forecasted revenue, operating income and cash flows due in part to the longer than expected halt in shipping of its GasPT product to a major customer in Italy and market uncertainty due to the continuing effects of Brexit.
The Company performed a quantitative analysis. As a result of the analysis, the Company concluded that the carrying value of the Orbital-UK reporting unit exceeded its estimated fair value. The quantitative test for the Orbital-UK reporting unit resulted in an impairment for the Orbital-UK reporting unit, and the Company recorded a goodwill impairment charge of $3.2 million during the fourth quarter of 2017.
Accrued expenses
Accrued expenses are liabilities that reflect expenses on the statement of operations that have not been paid or recorded in accounts payable at the end of the period. At December 31, 2019 and December 31, 2018, accrued expenses of $5.2 million and $1.9 million, respectively, included $1.1 million and $0.9 million, respectively, of accrued compensation and $0.2 million and $0.1 million, respectively, of accrued inventory payable. In addition, at December 31, 2019, accrued expenses included a $2.8 million working capital adjustment on the sale of the domestic power business to Bel Fuse Inc that was paid out in January 2020.
Derivative instruments
The Company uses various derivative instruments including forward currency contracts, and interest rate swaps to manage certain exposures. These instruments are entered into under the Company’s corporate risk management policy to minimize exposure and are not for speculative trading purposes. The Company recognizes all derivatives as either assets or liabilities in the consolidated balance sheet and measures those instruments at fair value. Changes in the fair value of derivatives are recognized in earnings. The Company has limited involvement with derivative instruments and does not trade them. From time to time, the Company may enter into foreign currency exchange contracts to minimize the risk associated with foreign currency exchange rate exposure from expected future cash flows. The Company had entered into one interest rate swap, which had a maturity date of ten years from the date of inception, and was used to minimize the interest rate risk on the variable rate mortgage. During the years ended 2018 and 2017, the Company had a non-cash gain and unrealized gains of $129 thousand and $111 thousand, respectively, related to the derivative liabilities. During the year ended December 31, 2018, the Company paid $227 thousand to close out the interest rate swap in conjunction with the repayment of the related variable rate mortgage.
Derivative Liabilities
The Company evaluates embedded conversion features pursuant to FASB Accounting Standards Codification No. 815 (‘‘FASB ASC 815’’), ‘‘Derivatives and Hedging,’’ which requires a periodic valuation of the fair value of derivative instruments and a corresponding recognition of liabilities associated with such derivatives. The Company has limited involvement with derivative instruments and does not trade them. Prior to 2019, the Company had an interest rate swap, which had a maturity date of ten years from the date of inception, and was used to minimize the interest rate risk on the variable rate mortgage. The Company closed out this derivative in December 2018 as part of the Company's sale/leaseback transaction and the Company has not owned any derivative instruments in 2019.
Stock-Based Compensation
The Company records its stock-based compensation expense under its stock option plans and also issues stock for services. The Company accounts for stock-based compensation using FASB Accounting Standards Codification No. 718 (‘‘FASB ASC 718’’), ‘‘Compensation - Stock Compensation.’’ FASB ASC 718 requires the fair value of all stock-based employee compensation awarded to employees to be recorded as an expense over the related service period.
Stock bonuses issued to employees are recorded at fair value using the market price of the stock on the date of grant and expensed over the service period or immediately if fully vested on date of issuance. Employee stock options are recorded at fair value using the Black-Scholes option pricing model. The underlying assumptions used in the Black-Scholes option pricing model by the Company are taken from publicly available sources including: (1) volatility and grant date stock price, which are sourced from historic stock price information; (2) the appropriate discount rates are sourced from the United States Federal Reserve; and (3) other inputs are determined based on previous experience and related estimates. With regards to expected volatility, the Company utilizes an appropriate period for historical share prices for CUI Global that best reflect the expected volatility for determining the fair value of its stock options.
See Note 10 Stockholders' Equity for additional disclosure and discussion of the employee stock plan and activity.
Common stock and stock options are also recorded on the basis of their fair value, as required by FASB ASC 505, which is measured as of the date required by FASB ASC 505, ‘‘Equity - Based Payments to Non-Employees.’’ In accordance with FASB ASC 505, the stock options or common stock warrants are valued using the Black-Scholes option pricing model on the basis of the market price of the underlying common stock on the ‘‘valuation date,’’ which for options and warrants related to contracts that have substantial disincentives to non-performance is the date of the contract, and for all other contracts is the performance completion date. Expense related to the options and warrants is recognized on a straight-line basis over the shorter of the period over which services are to be received or the vesting period. Where expense must be recognized prior to a valuation date, the expense is computed based off an estimate of the fair value of the stock award as valued under the Black-Scholes option pricing model on the basis of the market price of the underlying common stock at the end of the period, and any subsequent changes in the market price of the underlying common stock up through the valuation date is reflected in the expense recorded in the subsequent period in which that change occurs.
Common stock issued to other than employees or directors subject to performance (performance based awards) require interpretation to include ASC 505-50-30-13 as to when the counterparty’s performance is complete based on delivery, or other relevant performance criteria in accordance with the relevant agreement. When performance is complete, the common stock is issued and the expense recorded on the basis of their value as required by FASB ASC 505 on the date the performance requirement is achieved.
Defined Contribution Plans
The Company has a 401(k) retirement savings plan that allows employees to contribute to the plan after they have completed 60 days of service and are 18 years of age. The Company matches the employee's contribution up to 6% of total compensation. Orbital Gas Systems, North America, Inc., and CUI Global made total employer contributions, net of forfeitures, of $0.2 million, $0.1 million, and $74 thousand for 2019, 2018 and 2017, respectively. In addition, the Company made contributions of $0.3 million, $0.4 million, and $0.3 million associated with discontinued operations.
Revenue Recognition
On January 1, 2018, we adopted the accounting standard ASC 606, “Revenue from Contracts with Customers” and all the related amendments (“new revenue standard"), which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. This guidance includes the required steps to achieve the core principle that a company should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The new revenue standard was applied using the modified retrospective method. We recognized the cumulative effect of initially applying the new revenue standard as an adjustment to accumulated deficit as of January 1, 2018. As a result of the adoption of this standard, certain changes have been made to the consolidated balance sheets. We expect the ongoing impact of the adoption of the new standard to primarily affect the timing of revenue recognition. For the majority of contracts, revenue is still measured over time using the cost-to-cost method. The change that most affected the transition adjustment on revenue was the requirement to limit revenue recognition on contracts without an enforceable right to payment for performance completed to date. Revenue on contracts without a specific enforceable right to payment on work performed to date was "clawed back" as part of the Company's transition adjustment. The cumulative effect adjustment recorded as of January 1, 2018 was a net $1.9 million decrease to accumulated deficit due to a $2.8 million transition adjustment from the discontinued Power and Electromechanical segment partially offset by a $(0.9) million transition adjustment from the Energy segment, net of deferred tax.
On January 1, 2018, we adopted ASC Topic 606 and the related amendments ("ASC 606") using the modified retrospective method applied to those contracts which were not completed as of December 31, 2017. Results for operating periods beginning after January 1, 2018 are presented under ASC 606, while comparative information has not been restated for 2017 and continues to be reported in accordance with the accounting standards in effect for those periods. The adoption of ASC 606 had no impact on the Company’s cash flows from operations.
The Energy segment subsidiaries, collectively referred to as Orbital Gas Systems (Orbital), generate their revenue from a portfolio of products, services and resources that offer a diverse range of personalized gas engineering solutions to the gas utilities, power generation, petrochemical, emissions, manufacturing and automotive industries, among others.
Orbital accounts for a majority of its contract revenue proportionately over time. For our performance obligations satisfied over time, we recognize revenue by measuring the progress toward complete satisfaction of that performance obligation. The selection of the method to measure progress towards completion can be either an input method or an output method and requires judgment based on the nature of the goods or services to be provided.
For our construction contracts, revenue is generally recognized over time. Our fixed price construction projects generally use a cost-to-cost input method to measure our progress towards complete satisfaction of the performance obligation as we believe it best depicts the transfer of control to the customer. Under the cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation.
The timing of revenue recognition for Energy products also depends on the payment terms of the contract, as our performance does not create an asset with an alternative use to us. For those contracts which we have a right to payment for performance completed to date at all times throughout our performance, inclusive of a cancellation, we recognize revenue over time. As discussed above, these performance obligations use a cost-to-cost input method to measure our progress towards complete satisfaction of the performance obligation as we believe it best depicts the transfer of control to the customer. However, for those contracts for which we do not have a right, at all times, to payment for performance completed to date, we recognize revenue at the point in time when control is transferred to the customer, generally when shipped.
For our service contracts, revenue is also generally recognized over time as the customer simultaneously receives and consumes the benefits of our performance as we perform the service. For our fixed price service contracts with specified service periods, revenue is generally recognized on a straight-line basis over such service period when our inputs are expended evenly, and the customer receives and consumes the benefits of our performance throughout the contract term.
For certain of our revenue streams, such as call-out repair and service work, and outage services, that are performed under time and materials contracts, our progress towards complete satisfaction of such performance obligations is measured using an output method as the customer receives and consumes the benefits of our performance completed to date.
Due to uncertainties inherent in the estimation process, it is possible that estimates of costs to complete a performance obligation will be revised in the near-term. For those performance obligations for which revenue is recognized using a cost-to-cost input method, changes in total estimated costs, and related progress towards complete satisfaction of the performance obligation, are recognized on a cumulative catch-up basis in the period in which the revisions to the estimates are made. When the current estimate of total costs for a performance obligation indicate a loss, a provision for the entire estimated loss on the unsatisfied performance obligation is made in the period in which the loss becomes evident.
Product-type contracts (for example, sale of GasPT units) for which revenue does not qualify to be recognized over time are recognized at a point in time. Revenues from extended warranty and maintenance activities are recognized ratably over the term of the warranty and maintenance period.
Accounts Receivable, Contract Assets and Contract Liabilities
Accounts receivable are recognized in the period when our right to consideration is unconditional. We also assess our customers' ability and intention to pay, which is based on a variety of factors, including our historical payment experience with and the financial condition of our customers. Payment terms and conditions vary by contract, although our standard terms include a requirement of payment within 30 days. Accounts receivable are recognized net of an allowance for doubtful accounts.
The timing of revenue recognition may differ from the timing of invoicing to customers. Contract assets include unbilled amounts from our construction projects when revenue recognized under the cost-to-cost measure of progress exceed the amounts invoiced to our customers, as the amounts cannot be billed under the terms of our contracts. Such amounts are recoverable from our customers based upon various measures of performance, including achievement of certain milestones, completion of specified units or completion of a contract. Also included in contract assets are amounts we seek or will seek to collect from customers or others for errors or changes in contract specifications or design, contract change orders or modifications in dispute or unapproved as to both scope and/or price or other customer-related causes of unanticipated additional contract costs (claims and unapproved change orders). Our contract assets do not include capitalized costs to obtain and fulfill a contract. Contract assets are generally classified as current within the Consolidated Balance Sheets.
Contract liabilities from our construction contracts occur when amounts invoiced to our customers exceed revenues recognized under the cost-to-cost measure of progress. Contract liabilities additionally include advanced payments from our customers on certain contracts. Contract liabilities decrease as we recognize revenue from the satisfaction of the related performance obligation and are recorded as either current or long-term, depending upon when we expect to recognize such revenue.
Balances and activity in the current contract liabilities as of and for the years ended December 31, 2019 and 2018 is as follows:
(1) Long-term contract liabilities are included in Other long-term liabilities on the Consolidated Balance Sheets.
Performance Obligations
Remaining Performance Obligations
Remaining performance obligations, represents the transaction price of contracts with customers for which work has not been performed and excludes unexercised contract options and potential orders under ordering-type contracts. As of December 31, 2019, the Company's remaining performance obligations are generally expected to be filled within the next 12 months.
Any adjustments to net revenues, cost of revenues, and the related impact to operating income are recognized as necessary in the period they become known. These adjustments may result from positive program performance, and may result in an increase in operating income during the performance of individual performance obligations, if we determine we will be successful in mitigating risks surrounding the technical, schedule and cost aspects of those performance obligations. Likewise, these adjustments may result in a decrease in operating income if we determine we will not be successful in mitigating these risks. Changes in estimates of net revenues, cost of revenues and the related impact to operating income are recognized on a cumulative catch-up basis in the period they become known, which recognizes in the current period the cumulative effect of the changes on current and prior periods based on a performance obligation's percentage of completion. A significant change in one or more of these estimates could affect the profitability of one or more of our performance obligations. For separately priced extended warranty or product maintenance performance obligations, when estimates of total costs to be incurred on the performance obligation exceed total estimates of revenue to be earned, a provision for the entire loss on the performance obligation is recognized in the period the loss is determined.
Performance Obligations Satisfied Over Time
To determine the proper revenue recognition method for our contracts, we evaluate whether a single contract should be accounted for as more than one performance obligation. This evaluation requires significant judgment and the decision to separate the single contract into multiple performance obligations could change the amount of revenue and profit recorded in a given period.
For most of our contracts, the customer contracts with us to provide a significant service of integrating a complex set of tasks and components into a single project or capability (even if that single project results in the delivery of multiple units). Hence, the entire contract is accounted for as one performance obligation. Less commonly, however, we may promise to provide distinct goods or services within a contract in which case we separate the contract into more than one performance obligation. If a contract is separated into more than one performance obligation, we allocate the total transaction price to each performance obligation in an amount based on the estimated relative standalone selling prices of the promised goods or services underlying each performance obligation. We infrequently sell standard products with observable standalone sales. In cases where we do, the observable standalone sales are used to determine the standalone selling price. More frequently, we sell a customized customer specific solution, and in these cases we typically use the expected cost plus a margin approach to estimate the standalone selling price of each performance obligation.
Performance Obligations Satisfied at a Point in Time.
Revenue from goods and services transferred to customers at a single point in time accounted for 29% and 22% of revenues for the year ended December 31, 2019 and 2018. Revenue on these contracts is recognized when the product is shipped and the customer takes ownership of the product. Determination of control transfer is determined by shipping terms delineated on the customer purchase orders and is generally when shipped.
Variable Consideration
The nature of our contracts gives rise to several types of variable consideration, including new product returns and scrap return allowances primarily in the discontinued operations of Power and Electromechanical segment. In rare instances in our Energy segment, we include in our contract estimates, additional revenue for submitted contract modifications or claims against the customer when we believe we have an enforceable right to the modification or claim, the amount can be estimated reliably and its realization is probable. In evaluating these criteria, we consider the contractual/legal basis for the claim, the cause of any additional costs incurred, the reasonableness of those costs and the objective evidence available to support the claim. We include new product introduction and scrap return estimates in our calculation of net revenue when there is a basis to reasonably estimate the amount of the returns. These estimates are based on historical return experience, anticipated returns and our best judgment at the time. These amounts are included in our calculation of net revenue recorded for our contracts and the associated remaining performance obligations.
Significant Judgments
Our contracts with certain customers may be subject to contract cancellation clauses. Contracts with other cancellation provisions may require judgment in determining the contract term, including the existence of material rights, transaction price and identifying the performance obligations and whether a contract should be accounted for over time or on a completed contract basis. Revenue is recognized for certain integration systems over time using cost-based input methods, in which significant judgement is required to evaluate assumptions including the amount of total estimated costs to determine our progress towards contract completion and to calculate the corresponding amount of revenue to recognize.
At times, customers may request changes that either amend, replace or cancel existing contracts. Judgment is required to determine whether the specific facts and circumstances within the contracts require the changes to be accounted for as a separate contract or as a modification. Generally, contract modifications containing additional goods and services that are determined to be distinct and sold at their stand-alone selling price are accounted for as a separate contract. For contract modifications where goods and services are not determined to be distinct and sold at their stand-alone selling price, the original contract is updated and the required adjustments to revenue and contract assets, liabilities, and other accounts will be made accordingly.
Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately rather than together may require significant judgment. For, example, we consider many of our contracts that coordinate multiple products into an integrated system to be a single performance obligation, while the same products would be considered separate performance obligations if not so integrated.
In contracts where there are timing differences between when we transfer a promised good or service to the customer and when the customer pays for that good or service, we have determined that, our contracts do not include a significant financing component.
The following table presents our revenues disaggregated by timing of revenue recognition for the year ended December 31, 2019 and 2018:
The following table presents our revenues disaggregated by region for the years ended December 31, 2019 and 2018:
Revenue Recognition - 2017
As discussed above, ASC 606 was adopted on a modified retrospective basis and accordingly the 2017 financial statements were not restated for ASC 606. For 2017, revenue was recognized as follows.
For production-type contracts meeting the Company’s minimum threshold, revenues and related costs on these contracts were recognized using the ‘‘percentage of completion method’’ of accounting in accordance with ASC 605-35, Accounting for Performance of Construction-Type and Certain Production Type Contracts (‘‘ASC 605-35’’). Under this method, contract revenues and related expenses were recognized over the performance period of the contract in direct proportion to the costs incurred as a percentage of total estimated costs for the entirety of the contract. Costs included direct material, direct labor, subcontract labor and any allocable indirect costs. The Company captured certain job costs as work progressed, including labor, material and costs not invoiced. Margin adjustments were made as information pertaining to contracts changed. All un-allocable indirect costs and corporate general and administrative costs were charged to the periods as incurred. The amount of costs not invoiced were captured to ensure an estimated margin consistent with that expected at the completion of the project. In the event a loss on a contract was foreseen, the Company recognized the loss when it was determined. Contract costs plus recognized profits were accumulated as deferred assets, and billings and/or cash received were recorded to a deferred revenue liability account. The net of these two accounts for any individual project was presented as ‘‘Costs in excess of billings,’’ an asset account, or ‘‘Billings in excess of costs,’’ a liability account.
Production-type contracts that did not qualify for use of the percentage of completion method were accounted for using the ‘‘completed contract method’’ of accounting in accordance with ASC 605-35-25-57. Under this method, contract costs were accumulated as deferred assets, and billings and/or cash received was recorded to a deferred revenue liability account, during the periods of construction, but no revenues, costs, or profits were recognized in operations until the period within which completion of the contract occurred. A contract was considered complete when all costs except insignificant items were incurred; the equipment was operating according to specifications and was accepted by the customer.
For product sales, revenue was recognized in the period when persuasive evidence of an arrangement with a customer existed, the products were shipped and title had transferred to the customer, the price was fixed or determinable, and collection was reasonably assured.
Revenues from warranty and maintenance activities were recognized ratably over the term of the warranty and maintenance period and the unrecognized portion was recorded as deferred revenue.
Advertising
The costs incurred for producing and communicating advertising are charged to operations as incurred. Advertising expense for the years ended December 31, 2019, 2018 and 2017 were $0.4 million, $0.6 million, and $0.5 million, respectively.
Income Taxes
Income taxes are accounted for under the asset and liability method of FASB Accounting Standards Codification No. 740 (‘‘FASB ASC 740’’), ‘‘Income Taxes.’’ Under FASB ASC 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income in the period that includes the enactment date. Deferred tax assets are reduced by a valuation allowance to the extent that management believes it is more likely than not that such deferred tax assets will not be realized.
Valuation allowances have been established against all domestic based deferred tax assets and U.K. based deferred tax assets due to uncertainties in the Company’s ability to generate sufficient taxable income in future periods to make realization of such assets more likely than not. In future periods, tax benefits and related domestic and U.K. deferred tax assets will be recognized when management considers realization of such amounts to be more likely than not. The Company has not provided for valuation allowances on deferred tax assets in any other jurisdiction.
The Company recognizes interest and penalties, if any, related to its tax positions in income tax expense.
CUI Global files consolidated income tax returns with its U.S. based subsidiaries for federal and many state jurisdictions in addition to separate subsidiary income tax returns in Japan, the United Kingdom and Canada. As of December 31, 2019, the Company is not under examination by any income tax jurisdiction. The Company is no longer subject to USA examination for years prior to 2015.
Net Loss per Share
In accordance with FASB Accounting Standards Codification No. 260 (‘‘FASB ASC 260’’), ‘‘Earnings per Share,’’ basic net loss per share is computed by dividing the net loss available to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed by dividing net loss available to common stockholders by the weighted average number of diluted shares outstanding during the period calculated using the treasury stock method. Due to the Company’s net loss in 2019, 2018 and 2017, the assumed exercise of stock options using the treasury stock method would have had an antidilutive effect and therefore all options for each of the three years were excluded from the calculation of diluted net loss per share. Accordingly, diluted net loss per share is the same as basic net loss per share for 2019, 2018 and 2017. The weighted average shares outstanding included 37,312; 1,844 and 63,602 of shares that are considered outstanding, but unissued as of December 31, 2019, 2018 and 2017, respectively, for shares to be issued in accordance with a royalty agreement pertaining to sales of the GasPT devices and unpaid equity share bonuses in 2017.
The following table summarizes the number of stock options outstanding excluding amounts applicable to contingent conversion option in 2018 and 2017:
Any common shares issued as a result of stock options would come from newly issued common shares as granted under our equity incentive plans.
The following is the calculation of basic and diluted earnings per share:
Foreign Currency Translation
The financial statements of the Company's foreign offices have been translated into U.S. dollars in accordance with FASB ASC 830, ‘‘Foreign Currency Matters’’ (FASB ASC 830). All balance sheet accounts have been translated using the exchange rate in effect at the balance sheet date. Statement of Operations amounts have been translated using an appropriately weighted average exchange rate for the year. The translation gains and losses resulting from the changes in exchange rates during 2019, 2018 and 2017 have been reported in accumulated other comprehensive income (loss), except for gains and losses resulting from the translation of intercompany receivables and payables, which are included in earnings for the period.
Segment Reporting
Operating segments are defined in accordance with ASC 280-10 as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The measurement basis of segment profit or loss is income (loss) from operations. Management has identified three operating segments based on the activities of the Company in accordance with ASC 280-10. These operating segments have been aggregated into two reportable segments. The two reportable segments are Energy and Other. The Energy segment is focused on the operations of Orbital Gas Systems Ltd. and Orbital Gas Systems, North America, Inc. which includes gas related test and measurement systems, including the GasPT. The Other segment represents the remaining activities that are not included as part of the other reportable segments and represent primarily corporate activity. In 2019, the Company sold its domestic power and electromechanical businesses and reclassified the income of the former Power and Electromechanical segment to income from discontinued operations. Unsold portions of the segment were reclassified to assets held for sale. Prior years have been reclassified to reflect this change, with assets held for sale included in the Other category.
The following information represents segment activity as of and for the year ended December 31, 2019:
The following information represents segment activity as of and for the year ended December 31, 2018:
The following information represents segment activity as of and for the year ended December 31, 2017:
(1)
For the years ended December 31, 2019, 2018 and 2017, depreciation and amortization totals included $0.8 million, $1.5 million and $1.5 million, respectively that were classified in income from discontinued operations on the Consolidated Statements of Operations.
(2)
Includes purchases of property, plant and equipment and investment in other intangible assets.
The following information represents revenue by country:
The following information represents long-lived assets (excluding deferred tax assets) by country:
Reclassifications
Certain reclassifications primarily related to discontinued operations and assets and liabilities held for sale have been made to the 2018 consolidated balance sheet, and 2018 and 2017 statements of operations in order to conform to the 2019 presentation.
Recent Accounting Pronouncements
In January 2020, the FASB issued ASU 2020-01, Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815): Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. ASU 2020-01 clarifies the interaction between accounting standards related to equity securities, equity method investments, and certain derivatives, and is expected to reduce diversity in practice and increase comparability of the accounting for these interactions. The amendments in ASU 2020-01 are effective for the Company's 2021 fiscal year, including interim periods. The Company does not expect a material impact of this ASU on its consolidated financial statements and currently expects to adopt the standard in 2021.
In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes, which is guidance intended to simplify various aspects related to accounting for income taxes, eliminate certain exceptions within ASC 740 and clarify certain aspects of the current guidance to promote consistency among reporting entities. The pronouncement is effective for the Company's 2021 fiscal year, including interim periods. The Company does not expect a material impact of this ASU on its consolidated financial statements and currently expects to adopt the standard in 2021.
In August 2018, the FASB issued Accounting Standards Update ("ASU") No. 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract ("ASU 2018-15"). The amendments in ASU 2018-15 align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The guidance will be effective for the fiscal year beginning after December 15, 2019, including interim periods within that year. The Company does not expect a material impact of this ASU on its consolidated financial statements and will adopt the standard in 2020.
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”). The amendments in this update modify the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement, including requiring the disclosure of the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The guidance will be effective for the fiscal year beginning after December 15, 2019, including interim periods within that year. The Company currently has two level three investments, for which we will evaluate on an ongoing basis to determine if there are significant unobservable inputs that will need to be disclosed as a range and weighted average upon adoption. We will adopt the standard in 2020.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 is intended to provide financial statement users with more useful information about expected credit losses on financial assets held by a reporting entity at each reporting date. The new standard replaces the existing incurred loss impairment methodology with a methodology that requires consideration of a broader range of reasonable and supportable forward-looking information to estimate all expected credit losses. This ASU is effective for fiscal years and interim periods within those years beginning after December 15, 2019. The Company does not expect the impact of this ASU on its consolidated financial statements to be material and will adopt the standard in 2020.
3. INVESTMENTS AND FAIR VALUE MEASUREMENTS
The Company’s fair value hierarchy for its cash equivalents, marketable securities and derivative instruments as of December 31, 2019 and December 31, 2018, respectively, was as follows:
(1) Investment is a 12-month certificate of deposit classified as available for sale and included in Deposits and other assets on the balance sheet.
There were no transfers between Level 3 and Level 2 in 2019 as determined at the end of the reporting period.
The fair values of the reporting units subject to the Company’s quantitative impairment analysis were determined utilizing a blend of a market and an income approach to determine the estimated fair values of the reporting units, as discussed in Note 2. The fair value measurements and models were classified as non-recurring Level 3 measurements.
The convertible notes receivable balance was with Virtual Power Systems ("VPS") and considered a restricted security. The fair value measurement of a restricted security includes consideration of whether the restriction would be factored in by market participants in pricing the asset. The fair value of a restricted security could be based on the quoted price for an otherwise identical unrestricted security of the same issuer that trades in a public market, adjusted to reflect the effect of the restriction. The adjustment would reflect the amount market participants would demand because of the risk relating to the inability to access a public market for the security for the specified period. The Company concluded based on the history of VPS having raised substantial funds under its bridge loan/purchase agreement prior to and subsequent to CUI’s investments, that the value of the notes had neither increased significantly or decreased significantly.
Equity Method Investment in VPS
On March 30, 2019, the Company converted its $0.7 million in notes receivable into preferred stock of VPS. In addition, the Company contributed $0.3 million of cash and $2.5 million of other assets, as well as $1.8 million of future expenditures recorded as liabilities by the Company, of which $1.7 million were paid in 2019. In return, the Company acquired a 21.4% ownership share of VPS. During the three months ended June 30, 2019, the Company recorded a $0.6 million gain based on the fair value of the non-cash assets contributed as part of the investment in VPS, which is included in discontinued operations. As of December 31, 2019, the Company's ownership percentage has been reduced to 20.58% following VPS's issuance of additional equity. Based on current accounting guidance, the Company will record its share of VPS's income or loss under the equity method of accounting. Under the equity method of accounting, results will not be consolidated, but the Company will record a proportionate percentage of the profit or loss of VPS as an addition to or a subtraction from the VPS investment asset. The VPS investment basis at December 31, 2019 was $4.9 million as reflected on the consolidated balance sheets. A summary of the unaudited financial statements of the affiliate as of December 31, 2019 is as follows:
4. PROPERTY AND EQUIPMENT, NET
Property and equipment from continuing operations is summarized as follows:
Depreciation expense from continuing operations for the years ended December 31, 2019, 2018 and 2017 was $0.3 million, $0.3 million, and $0.3 million, respectively.
During the year ended December 31, 2019, the Company's continuing operations disposed of $0.2 million of property and equipment with an accumulated depreciation at disposal of $0.2 million.
During the year ended December 31, 2018, the Company's continuing operations disposed of $5.6 million of property and equipment with an accumulated depreciation at disposal of $0.8 million. Included in disposals in 2018, was the sale of the Company's headquarters building for $8.1 million with a ten-year lease back and, accordingly, included a deferred gain of $2.9 million that was net of $0.4 million of sale-related expenses. As a result of the implementation and transition to the accounting guidance in ASC 842, Accounting for Leases, the deferred gain was recognized on January 1, 2019 as a credit to accumulated deficit.
5. GOODWILL AND OTHER INTANGIBLE ASSETS
At December 31, 2019 and 2018, the gross carrying amount and accumulated amortization of intangible assets, other than goodwill, are as follows:
* All intangibles are reviewed annually for impairment, or sooner if circumstances change.
Intangible asset amortization by category was as follows:
Estimated future amortization by category of finite-lived intangible assets at December 31, 2019 was as follows:
Management reviews other intangible assets for impairment when facts or circumstances suggest. As of December 31, 2019, management has evaluated the remaining finite-lived and indefinite-lived intangible assets and believes no impairment exists.
The following table reflects the carrying amount of goodwill as of December 31, 2018 and 2017, and the 2018 activity. There was no goodwill included in the consolidated balance sheet at December 31, 2019 and December 31, 2018.
See Note 2 Summary of Significant Accounting Policies - Indefinite-Lived Intangibles and Goodwill Assets for information on the 2019 impairments to goodwill included in discontinued operations and the impairments included in continuing operations in 2018 and 2017.
6. INSTRUMENTS AND RISK MANAGEMENT
The Company has limited involvement with derivative instruments and does not trade them. The Company does use derivatives to manage certain interest rate and foreign currency exchange rate exposures.
At December 31, 2019 and 2018, the Company had no derivative instruments designated as effective hedges.
From time to time, to minimize risk associated with foreign currency exposures on receivables for sales denominated in foreign currencies, the Company enters into various foreign currency forward exchange contracts, which are intended to minimize the currency exchange rate exposure from expected future cash flows. The forward currency contracts have maturity dates of up to one year at the date of inception. At December 31, 2019 and 2018, no foreign currency forward exchange contracts were outstanding.
In conjunction with the mortgage note payable for the purchase of the headquarters facility completed in 2013, the Company entered into a Swap Transaction Confirmation agreement effective October 1, 2013, which had a maturity date of ten years incorporating the terms and definitions of the International Swaps and Derivatives Association, Inc. (ISDA) that effectively fixed our effective annual interest rate at 6.27%.
In December 2018, the Company closed out the swap upon the sale and leaseback of the Company's headquarters since the underlying mortgage note payable was paid off.
The amount of gain recognized in income on the statement of operations is summarized below:
7. NOTES PAYABLE
Notes payable is summarized as follows:
(a)
The note payable to International Electronic Devices, Inc. (formerly CUI, Inc.) is associated with the acquisition of CUI, Inc. The promissory note was due May 15, 2020 and included a 5% interest rate per annum, with interest payable monthly and the principal due as a balloon payment at maturity. The note included a contingent conversion feature, such that in the event of default on the note the holder of the note could, at the holder’s option, convert the note principal into common stock at $0.001 per share. Upon the sale of the Company's electromechanical components business on September 30, 2019, the buyer also assumed the $5.3 million related party note payable as partial payment.
(b)
Two notes payable for $358 thousand and $374 thousand to First Insurance Funding were executed in July and November 2019 by CUI Global for the purpose of financing a portion of the Company's insurance coverage. Note 1 has an annual percentage rate of 4.83% with eight monthly payments of approximately $46 thousand and will be paid off by March 1, 2020 and Note 2 has an annual percentage rate of 4.85% with ten monthly payments of approximately $38 thousand and will be paid off by September 1, 2020 .
The following table details the maturity of the notes payable for CUI Global, Inc.:
8. OVERDRAFT FACILITY AND LINE OF CREDIT
On October 5, 2016, Orbital Gas Systems Ltd. signed a $1.5 million pounds sterling five-year agreement with the London branch of Wells Fargo Bank N.A. for a multi-currency variable rate overdraft facility at a base rate plus a 2.25% margin (2.5% at December 31, 2018).
During April 2019, CUI Global replaced the existing line of credit and overdraft facilities with a new two-year credit facility with Bank of America for CUI Inc. and CUI-Canada, perfected by a first security lien on all assets of CUI Inc. and CUI-Canada. The facility also included a $3 million sub-limit for use by CUI-Global non-loan party subsidiaries as a reserve under the borrowing base. The credit facility provided for working capital and general corporate purposes. The credit facility provided up to $10,000,000 in a Revolving Line of Credit Facility (“Revolver”), including a sub-limit for letters of credit. Interest was based upon Daily Floating LIBOR at LIBOR + 2.00%. The Company discontinued this line of credit in 2019 upon the sale of the domestic power and electromechanical businesses. The additional credit was no longer needed due to the cash influx from the sale of the businesses, and the sold businesses were a primary source of collateral for the line of credit.
9. COMMITMENTS AND CONTINGENCIES
Legal Matters
The Company may be involved in certain legal actions arising from the ordinary course of business. While it is not feasible to predict or determine the outcome of these matters, we do not anticipate that any of these matters, or these matters in the aggregate, will have a material adverse effect on the financial position or results of operations.
Commissions, Royalty and License Fee Agreements
Royalty and license fees are paid in accordance with their related agreements, either on a monthly or quarterly basis. We deal with a number of independent licensors for whose intellectual property we compete with other manufacturers. Rights to such intellectual property, when acquired by us, are usually exclusive and the agreements require us to pay the licensor a royalty on our net sales of the item. These license agreements, in some cases, also provide for advance royalties and minimum guarantees in order to maintain technical rights and exclusivity. As of December 31, 2019 and 2018, $9 thousand and $3 thousand, respectively, was accrued for royalty and license fees payable in accrued expenses.
Employment Agreements
As of the year ended December 31, 2019, the following employment agreements were in place:
William J. Clough, General Counsel of CUI Global, Inc. and Executive Chairman of the Company’s board of directors
Mr. Clough is employed under a three-year employment contract with the Company, which became effective May 14, 2019. Said contract provides, in relevant part, for salary in year 1 of $750 thousand, year 2 of $800 thousand and year 3 of $850 thousand. The employment agreement includes bonus provisions for each calendar year targeted at seventy-five percent of base salary to be based on performance objectives, goals and milestones for each calendar year including company performance. Bonuses are approved based on various performance-related factors and an evaluation of current performance and includes a discretionary bonus of up to twenty-five percent of salary based upon the reasonable judgment of the compensation committee. Employee has the ability to earn a larger bonus based on the performance criteria set forth and the reasonable judgment and discretion of the compensation committee. Mr. Clough's employment agreement includes a grant for 1,600,000 options; however, the grant is subject to the approval of an equity incentive plan by shareholders within one year of the employment agreement. As of December 31, 2019, the shareholders have not approved an equity incentive plan. The agreement provides for up to $9,999 of annual premium life insurance expenses along with the ordinary benefits provided to employees of the Company. The agreement entitles Mr. Clough to severance package of 2.5 times the sum of annual base salary and target bonus along with eighteen months of medical coverage under the Company's medical plans. At December 31, 2019, 2018, and 2017, there was an accrual of $0, $30 thousand, and $33 thousand, respectively, for compensation owed to Mr. Clough.
Daniel N. Ford, Chief Financial Officer of CUI Global Inc. and Subsidiaries, Chief Operating Officer of the Energy Division
Mr. Ford is employed under a three-year employment contract with the Company, which became effective May 14, 2019. Said contract provides, in relevant part, for salary in year 1 of $500 thousand, year 2 of $550 thousand and year 3 of $600 thousand. The employment agreement includes bonus provisions for each calendar year targeted at seventy-five percent of base salary to be based on performance objectives, goals and milestones for each calendar year including company performance. Bonuses are approved based on various performance-related factors and an evaluation of current performance and includes a discretionary bonus of up to twenty-five percent of salary based upon the reasonable judgment of the compensation committee. Employee has the ability to earn a larger bonus based on the performance criteria set forth and the reasonable judgment and discretion of the compensation committee. Mr. Ford's employment agreement includes a grant for 960,000 options; however, the grants are subject to the approval of an equity incentive plan by shareholders within one year of the grant. As of December 31, 2019, the shareholders have not approved an equity incentive plan. The agreement provides for ordinary benefits provided to employees of the Company. The agreement entitles Mr. Ford to a severance package of 2.0 times the sum of annual base salary and target bonus along with eighteen months of medical coverage under the Company's medical plans. At December 31, 2019, 2018, and 2017, there was an accrual of $0, $21 thousand, and $22 thousand, respectively, for compensation owed to Mr. Ford.
James F. O’Neil III, Chief Executive Officer, Vice Chairman of the Board of Directors, and Chief Executive Officer of the Company’s wholly owned subsidiaries
Mr. O'Neil is employed under a three-year employment contract with the Company, which became effective October 1, 2019. Said contract provides, in relevant part, for salary in year 1 of $750 thousand, year 2 of $800 thousand and year 3 of $850 thousand. The employment agreement includes bonus provisions for each calendar year targeted at seventy-five percent of base salary to be based on performance objectives, goals and milestones for each calendar year including company performance. Bonuses are approved based on various performance-related factors and an evaluation of current performance and includes a discretionary bonus of up to twenty-five percent of salary based upon the reasonable judgment of the compensation committee. Employee has the ability to earn a larger bonus based on the performance criteria set forth and the reasonable judgment and discretion of the compensation committee. Mr. O'Neil's employment agreement includes a grant for 1,000,000 options and he also received a grant for 600,000 options when he was initially appointed to the Board of Directors, however the grants are subject to the approval of an equity incentive plan by shareholders within one year of the grants. As of December 31, 2019, the shareholders have not approved an equity incentive plan. The agreement provides for up to $9,999 of annual premium life insurance expenses along with the ordinary benefits provided to employees of the Company. The agreement entitles Mr. O'Neil to a severance package of 2.5 times the sum of annual base salary and target bonus along with eighteen months of medical coverage under the Company's medical plans.
Off-Balance Sheet Arrangements - Obligations under Certain Guarantee Contracts
The Company may enter into guarantee arrangements in the normal course of business to facilitate commercial transactions with third parties. As of December 31, 2019, the Company is an indemnitor on a surety bond for an unconsolidated third party related to a $4.6 million project that is approximately 90% complete and expected to be completed in 2020. The Company does not expect any liability associated with this off-balance sheet arrangement.
10. STOCKHOLDERS’ EQUITY
Common Stock Dividend Restrictions
As of December 31, 2019, there are no restrictions on common stock dividends. Also, at December 31, 2019 and 2018, retained earnings were not restricted upon involuntary liquidation.
Common Stock Issuances
(1)
Total excludes $36 thousand of 2019 stock compensation and $3 thousand of 2018 stock compensation related to royalties that were recorded as expense but not issued and outstanding as of December 31, 2019.
(2)
Includes bonus and royalty of $170 thousand that was accrued and expensed in 2017.
(3)
Total excludes $3 thousand of stock compensation related to royalties that were recorded as expense but not issued and outstanding as of December 31, 2018.
(4)
Excludes $24 thousand of stock compensation for stock issued in 2017 that was amortized from prepaid expense in 2018.
(5)
Includes bonuses and royalty of $176 thousand that were accrued and expensed in 2016.
(6)
The Company received $0 for the issuance in the cashless option exercises.
(7)
Amount includes $24 thousand that was included in prepaid expense at December 31, 2017.
(8)
Does not include stock expense of $170 thousand included in accrued liabilities at December 31, 2017 for unissued stock.
S-3 registration
The Company filed an S-3 registration statement on March 14, 2017 containing a prospectus that was effective March 29, 2017. With this filing, CUI Global may from time to time issue various types of securities, including common stock, preferred stock, debt securities and/or warrants, up to an aggregate amount of $100 million.
On October 23, 2017, the Company closed on an underwritten public offering of 7,392,856 shares at a public offering price of $2.80 per share, including 964,285 shares sold at the public offering price pursuant to the underwriter's exercise in full of its option to purchase additional shares to cover over-allotments. The net proceeds to CUI Global (after deducting underwriting discount and other expenses payable by the Company) were approximately $18.9 million. The Company has used the net proceeds from the offering primarily for general corporate purposes, which includes operating expenses, working capital to improve and promote its commercially available products, advance product candidates, to expand international presence and commercialization.
Employee Stock Options
All options issued are presented at post reverse quantities.
On May 16, 2008 the Company’s board of directors adopted the 2008 Equity Incentive Plan (the ‘‘Equity Incentive Plan’’) and authorized 1,500,000 shares of Common Stock to fund the Plan. At the 2008 Annual Meeting of Shareholders held on September 15, 2008, the Equity Incentive Plan was approved by the Company shareholders. At the 2009 Annual Meeting of Shareholders held on September 29, 2009, the shareholders approved an amendment to the 2008 Equity Incentive Plan to increase the number of common shares issuable under the plan from 1,500,000 to 3,000,000. All of these shares have been registered under Form S-8.
The 2008 Equity Incentive Plan is intended to: (a) provide incentive to employees of the Company and its affiliates to stimulate their efforts toward the continued success of the Company and to operate and manage the business in a manner that will provide for the long-term growth and profitability of the Company; (b) encourage stock ownership by employees, directors and independent contractors by providing them with a means to acquire a proprietary interest in the Company by acquiring shares of stock or to receive compensation, which is based upon appreciation in the value of Stock; and (c) provide a means of obtaining and rewarding employees, directors, independent contractors and advisors.
The 2008 Equity Incentive Plan provides for the issuance of incentive stock options (ISOs) and Non-Statutory Options (NSOs) to employees, directors and independent contractors of the Company. The Board shall determine the exercise price per share in the case of an ISO at the time an option is granted and such price shall be not less than the fair market value or 110% of fair market value in the case of a ten percent or greater stockholder. In the case of an NSO, the exercise price shall not be less than the fair market value of one share of stock on the date the option is granted. Unless otherwise determined by the Board, ISOs and NSOs granted under both plans have a maximum duration of ten years.
On January 5, 2009 the Company board of directors received and approved a written report and recommendations of the Compensation Committee, which included a detailed executive equity compensation report and market analysis and the recommendations of Compensia, Inc., a management consulting firm that provides executive compensation advisory services to compensation committees and senior management of knowledge-based companies. The Compensation Committee used the report and analysis as a basis for its formal written recommendation to the board. Pursuant to a January 8, 2009 board resolution the 2009 Equity Incentive Plan (Executive), a Non-Qualified Stock Option Plan, was created and funded with 4,200,000 shares of $0.001 par value common stock. The Compensation Committee was appointed as the Plan Administrator to manage the plan. On October 11, 2010, CUI Global authorized an additional 3,060,382 options under the 2009 Equity Incentive Plan (Executive). On September 21, 2012, CUI Global authorized an additional 330,000 options under the 2009 Equity Incentive Plan (Executive).
The 2009 Equity Incentive Plan (Executive) provides for the issuance of Incentive Non Statutory Options to attract, retain and motivate executive and management employees and directors and to encourage these individuals to acquire an equity interest in the Company, to make monetary payments to certain management employees and directors based upon the value of the Company’s stock and to provide these individuals with an incentive to maximize the success of the Company and further the interest of the shareholders. The Administrator of the plan is authorized to determine the exercise price per share at the time the option is granted, but the exercise price shall not be less than the fair market value on the date the option is granted. Stock options granted under the 2009 Plan have a maximum duration of ten years.
A summary of the options issued to employees and directors and changes during the year are presented below:
As of December 31, 2019, 2018, and 2017 all issued and outstanding stock options were fully vested. There were no options granted during 2019, 2018 or 2017. As of December 31, 2019, there are no remaining shares available to grant under these equity incentive plans.
11. RELATED PARTY TRANSACTIONS
During 2019, 2018 and 2017, $0.2 million, $0.3 million and $0.3 million, respectively in interest payments were made in relation to the promissory notes issued to related party, IED, see Note 7 Notes Payable, for further details.
Executive Chairman of the Board of Directors, Chief Legal Counsel, and former Chief Executive Officer, William J. Clough’s son Nicholas J. Clough, serves as President at Orbital Gas Systems, North America, Inc., a wholly owned subsidiary of the Company, and as Chief Sales Officer for the Energy Division. In 2019, 2018, and 2017, Mr. Clough received an aggregate salary of $269 thousand, $213 thousand, and $200 thousand, respectively, and received a cash bonus of $158 thousand, $150 thousand, and $150 thousand in fiscal 2019, 2018, and 2017, respectively. He also received other benefits valued at $49 thousand, $49 thousand, and $41 thousand in 2019, 2018, and 2017, respectively. As of December 31, 2019 and 2018, there was an accrual of $0 thousand and $13 thousand, respectively, for compensation accrued to Nicholas J. Clough. Nicholas J. Clough does not report to the William J. Clough nor does William J. Clough have input regarding Nicholas J. Clough’s salary, bonus, or performance. Mr. Clough’s salary and bonus is set by his direct supervisor and relevant market conditions, while his performance is evaluated and monitored by his direct supervisor. In addition, pursuant to Company policy, any related-party bonus and/or salary change in excess of $50,000 is independently reviewed and approved by the Company’s Compensation Committee, comprised of Independent Board Members from the Company’s Board of Directors.
Orbital employs three owners of EnDet, Ltd. from which the Company licenses its VE Technology. See Note 9 - Commitments and Contingencies - Commissions, Royalty and License Fee Agreements for more information on license fee agreements.
12. ACCUMULATED OTHER COMPREHENSIVE LOSS
The components of accumulated other comprehensive loss are as follows:
13. RESTRUCTURING AND IMPAIRMENT CHARGES
During the fourth quarter of 2019, the Company completed the sale of its largest group within the Power and Electromechanical segment. The remaining assets remain held-for-sale. However, in conjunction with that sale, it was concluded that should the remaining power and electromechanical operations not sell, the Company will fulfill its backlog obligations and wind down the remaining operations of CUI-Canada and CUI Japan during 2020. As such, the Company has recorded an accrued liability of $3.1 million for estimated employee termination costs. The termination costs are expected to begin during 2020 based around backlog production and delivery schedule requirements. The lease for the CUI-Canada facility completes during 2020 and the CUI Japan lease includes a four-month notice period to terminate. During the fourth quarter of 2019, the Company performed an impairment assessment for the remaining power and electromechanical assets, resulting in $0.3 million of impairments associated with CUI-Canada goodwill, CUI-Japan goodwill, and certain CUI-Canada acquisition intangibles that were written off.
14. INCOME TAXES
(Loss) income before income taxes consisted of the following:
Loss from continuing operations before taxes consisted of the following:
The income tax (benefit) expense allocation for the years ended December 31, 2019, 2018, and 2017 consisted of the following:
The income tax (benefit) from continuing operations consisted of the following:
The following table provides a reconciliation of the federal statutory tax at 21% to the recorded tax expense (benefit) from continuing operations for the years ended December 31, 2019 and 2018, respectively, and 34% to the recorded tax expense (benefit) for the year ended December 31, 2017:
The Company accounts for income taxes under the asset-liability method. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Valuation allowances are provided when it is “more likely than not” that the benefits of existing deferred tax assets will not be realized in a future period. Significant components of the Company’s deferred tax assets and liabilities as of December 31, 2019 and 2018, respectively, are as follows:
The Company adopted the provisions of ASU 2015-17 in 2015. ASU 2015-17 requires that all deferred tax assets and liabilities be classified as noncurrent on the balance sheet. The net deferred tax liability is recorded as of December 31, 2019 and December 31, 2018 as follows were zero for both year-end dates:
As of December 31, 2019 and 2018, the Company recorded a valuation allowance of $12.4 million and $12.3 million, respectively. During the year ended December 31, 2019 and 2018, the Company recorded an increase in valuation allowance of $0.1 million and $2.0 million, respectively. As of December 31, 2019, the Company has available federal, state and foreign net operating loss carry forwards of approximately $37.2 million, $32.3 million and $15.5 million, respectively which have various expiration dates beginning in 2027 through 2038.
The Company files consolidated income tax returns for federal and many state jurisdictions in addition to separate subsidiary income tax returns in Canada, Japan and the United Kingdom. As of December 31, 2019, the Company is not under examination by any income tax jurisdiction. The Company is no longer subject to examination in the USA for years prior to 2016.
The Company accounts for income tax uncertainties using a threshold of "more-likely-than-not" in accordance with the provisions of ASC Topic 740, Income Taxes ("ASC 740"). As of December 31, 2019, the Company has reviewed all of its tax filings and positions taken on its returns and has not identified any material current or future effect on its consolidated results of operations, cash flows or financial position. As such, the Company has not recorded any tax, penalties or interest on tax uncertainties. It is Company policy to record any interest on tax uncertainties as a component of income tax expense.
15. CONCENTRATIONS
During 2019, 31% of revenues were derived from two customers that individually had over 10% of our total revenues: S&B Engineers with 21% and Costain Oil, Gas & Process Ltd with 10%. During 2018, 27% of revenues were derived from two customers that individually had over 10% of our total revenues: National Grid with 15% and S&B Engineers with 12%. During 2017, 55% of revenues were derived from three customers that individually had over 10% of our total revenues: National Grid with 26%, Scotia Gas Networks with 18%, and S&B Engineers with 11%.
The Company’s major product lines in 2019, 2018 and 2017 were natural gas infrastructure solutions.
At December 31, 2019, of the gross trade accounts receivable totaling approximately $5.3 million, three individual customers that made up approximately 50% of the Company's total trade accounts receivable: Energy Transfer at 24%, Costain Oil, Gas and Process Ltd at 14% and S&B Engineers at 12%. At December 31, 2018, of the gross trade accounts receivable totaling approximately $5.1 million, approximately 38% was due from two customers: Costain Oil, Gas & Process Ltd at 24% and National Grid at 14%.
There were no suppliers greater than 10% of purchases in 2019, 2018 or 2017.
With the operations of Orbital UK, the Company has foreign revenue and trade accounts receivable concentrations in the United Kingdom. For the years ended December 31, 2019, 2018 and 2017, the Company had foreign revenue concentrations in the United Kingdom of 57%, 74%, and 77%, respectively. Also during the years ended December 31, 2019, 2018 and 2017, the Company had trade accounts receivable concentrations in the United Kingdom of 49%, 80%, and 79%, respectively.
16. LEASES
Effective January 1, 2019, the Company implemented the new accounting guidance on leases found in ASC 842, Leases. As part of its transition, the Company elected to utilize the transition method of adoption. Under the transition method, the Company includes the new required disclosures for the current period and provides the disclosures required by the previous guidance found in ASC 840 for the prior year comparative periods. In addition, the Company elected the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allowed the Company to carry forward the historical lease classifications and allowed the Company to exclude leases with an initial term of 12 months or less (after consideration of renewal options) from being recorded on the Company's consolidated balance sheet; the Company recognizes lease expense for these short-term leases on a straight-line basis over the lease term. At December 31, 2019 the Company did not factor in any renewal options when calculating its consolidated right-of-use assets and lease obligations as the options were not considered reasonably certain to be exercised. As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at the commencement date in determining the present value of future payments. The Company reviewed outstanding service contracts to determine if any of the Company's service contracts contained an embedded lease. Determining whether a contract contains a lease requires judgement. The Company did not identify any new leases through this process. The new lease accounting guidance also changes the name of leases formerly referred to as Capital leases under ASC 840 to Financing leases under ASC 842.
In December 2018, the Company entered into a sale-lease back transaction to sell and leaseback the CUI, Inc. Tualatin facility. The Company sold the Tualatin headquarters and warehouse for $8.1 million at a deferred gain of $2.9 million and has leased back the facility for approximately $53 thousand per month until December 2028. The lease includes two options to renew the term for periods of five years each at the then prevailing market rate per rentable square foot for the premises. As a result of the implementation and transition to the accounting guidance in ASC 842, the deferred gain was recognized on January 1, 2019 as a credit to accumulated deficit.
Orbital-UK has a number of operating leases on vehicles, equipment, and accommodations for visiting personnel. During the year ended December 31, 2019, the monthly combined rent on these leases was approximately $35 thousand.
The Company rents office and warehouse space in Houston, Texas through December 2022 and have one truck lease and a copier lease. During the year ended December 31, 2019, rent expense on these leases were a combined approximately $33 thousand per month. The office and warehouse lease includes two options to renew the term for periods of five years each at the then prevailing market rate per rentable square foot for the premises.
Consolidated rental expense was $1.3 million for the year ended December 31, 2019 and is included in selling, general and administrative expense, on the condensed consolidated statement of operations.
Future minimum operating lease obligations for continuing operations at December 31, 2019 are as follows for the years ended December 31:
Total lease cost and other lease information is as follows:
* Includes $7.7 million recorded at the date of implementation of ASC 842 on January 1, 2019 less $1.5 million later reclassified to assets held for sale at our discontinued operations.
Variable lease costs primarily include common area maintenance costs, real estate taxes and insurance costs passed through to the Company from lessors.
The following lease disclosures as of December 31, 2018 for continuing operations were required under previous accounting guidance under ASC 840 and under the transition guidance of ASC 842:
CUI executed a sale-leaseback transaction of its Tualatin, Oregon headquarters facility in December of 2018. There was $16 thousand of rent expense associated with this lease in 2018.
Orbital-UK has a number of leases, on vehicles, equipment, and on accommodations for visiting personnel. During the year ended December 31, 2018, the monthly combined rent on these leases was approximately $32 thousand.
In January 2015, the Company rented office and warehouse space in Houston, Texas for its Orbital North America operations. During the year ended December 31, 2017, the monthly rent of this lease, which terminated in January 2018, was approximately $10 thousand. In November 2017, the Company relocated to another rented office and warehouse space in Houston, Texas. Rent expense on this lease is approximately $30 thousand per month.
Rental expense from continuing operations was $0.8 million in 2018 and is included in selling, general and administrative expense on the statement of operations for the year ended December 31, 2018.
Future minimum operating lease obligations from continuing operations as of December 31, 2018 were as follows:
17. SUBSEQUENT EVENTS
Management has reviewed for subsequent events and identified the following:
In December 2019, a novel strain of coronavirus (SARS-CoV-2), which causes COVID-19, was reported to have surfaced in China. The spread of this virus has caused business disruption beginning in the first quarter of 2020, including supply chain disruptions, delays in some customer projects, and adjustments for staffing to work from home, among other things. In March 2020, the World Health Organization declared the outbreak of COVID-19 to be a pandemic, and the U.S. economy began to experience pronounced effects including a significant decline in the stock market, employee absences and adjustment to work from home situations, among other things. At this time, there is significant uncertainty relating to the potential effect of the novel coronavirus on our business. Although our operations qualify as “Essential Critical Infrastructure Work” under the most recent US Department of Homeland Security guidelines, infections have become more widespread, which may worsen the supply shortage or force us to restrict our operations. In addition, due to the further spread of the outbreak where we have corporate offices, we have implemented various measures including remote working solutions, reduced hours, adjusted shifts, and placed various restrictions on access to our offices, which could negatively impact productivity, particularly if we restrict access to our offices for a longer period of time. Any of these occurrences may have a negative impact on our business, financial condition or results of operations. Therefore, while we expect this matter to negatively impact our results, the related financial impact cannot be reasonably estimated at this time.
On January 1, 2020, the Company agreed to the purchase of the VE Technology designated intellectual property for a total of 1.5 million British Pounds (approximately $2.0 million), payable 750 thousand GBP during Q1 2020 and the remaining balance due July 31, 2020. Through this acquisition, the Company will no longer owe royalties on sales of its VE Technology products and will control all rights to the use of the VE Technology.
CUI Global announced that on March 24, 2020, it entered into a definitive agreement to acquire Reach Construction Group, LLC, an industry-leading solar construction company. The transaction will consist of third-party debt and company equity valued at approximately $37.0 million (excluding working capital and certain other adjustments upon closing). The acquisition is expected to close in April 2020, subject to customary closing conditions. On March 13, 2020, the Company entered into a short-term promissory note receivable for $3 million with Reach Construction Group. The note accrues interest at 6% per annum and is payable in sixty days. Upon closing of the acquisition of Reach Construction Group, that note will become an intercompany receivable.
Stock Issuances in 2020
On February 3, 2020, 37,312 shares of common stock were issued to a third party pursuant to a royalty agreement. The shares were valued at $39 thousand based on the dates earned under the royalty agreement.
QUARTERLY FINANCIAL DATA - UNAUDITED
CUI Global, Inc.
(In thousands, except share and per share information)
(1) Total cost of revenue for the fourth quarter of 2018 includes a $1.4 million adjustment to inventory reserve and a $1.5 million impairment of Deposits and other assets in the Energy segment.
Item 9.
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
Effective June 20, 2019, Perkins & Company, P.C. (Perkins) was dismissed from the client-auditor relationship by CUI Global, Inc. (“the Company”). The termination of the relationship with the independent registered accounting firm was approved by the Audit Committee and ratified by the CUI Global Board of Directors.
In connection with the audit of CUI Global Inc., during the three fiscal years ended December 31, 2018, 2017 and 2016 and the subsequent period through June 20, 2019, there were no (1) disagreements between the Company and Perkins on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements if not resolved to their satisfaction would have caused them to make reference in connection with their opinion to the subject matter of the disagreement, or (2) reportable events as set forth in Item 304(a)(1)(iv) of Regulation S-K.
Effective June 20, 2019, the Audit Committee appointed Grant Thornton LLP, as its independent registered public accounting firm to audit CUI Global, Inc.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company's management, with the participation of the Company's Chief Executive Officer and its Chief Financial Officer, evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this annual report. In designing and evaluating our disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management is required to apply their judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based upon that evaluation, the Company's management, including the CEO and the CFO, concluded that, as of December 31, 2019, the Company’s disclosure controls and procedures were not effective.
Management's Annual Report on Internal Control over Financial Reporting
Management of CUI Global, Inc. is responsible for establishing and maintaining effective internal control over financial reporting. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”). Our internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP and that receipts and expenditures of the Company are being made only in accordance with authorizations of the Company’s management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company assets that could have a material effect on the financial statements.
Internal control over financial reporting, no matter how well designed, has inherent limitations. Because of such inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019, based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework (“2013 framework”). A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Management identified the following material weakness as of December 31, 2019: insufficient resources within the accounting function related to technical accounting interpretation and guidance, financial transaction processing and reporting. Because of this material weakness, management concluded that the Company’s internal control over financial reporting was not effective as of December 31, 2019. The deficiencies largely have arisen during 2019 because of the divestiture of certain operations and the loss of personnel supporting the financial transaction processing and reporting functions. The deficiencies did not result in material adjustment to the fiscal year ended December 31, 2019.
To remediate our internal control weakness, management has and will continue to implement subsequent to December 31, 2019 the following measures:
• Add sufficient accounting personnel or outside consultants to properly segregate duties and to effect timely, accurate preparation of the financial statements.
• Review, assess and replace as needed third party consultants and professional advisors involved in the accounting policies, procedures and financial reporting processes.
• Provide adequate training and resources for the additional personnel or outside consultants.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting during the quarter ended December 31, 2019 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
There are no matters to be reported under this Item.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Our bylaws permit the number of directors to be fixed by resolution of the board of directors, but to be no less than one. The board of directors has set the maximum number of members to no more than eight members. Directors are elected by a majority of the votes cast by the stockholders and serve a one-year term or until their successors have been elected and qualified or their earlier resignation or removal. At December 31, 2019, we have seven directors, four of whom are ‘‘independent’’ in accordance with applicable rules promulgated by the Securities and Exchange Commission and within the meaning of Rule 5605(a)(2) of the NASDAQ Stock Market.
The board of directors has five standing committees: Audit Committee, Compensation Committee, Disclosure Committee, Investment Committee and Nomination Committee, each of which has a written charter and/or statement of policy approved by our board. Our board currently appoints the members of each committee. Copies of the current committee charters and/or statement of policy for each committee are posted on our website at www.CUIGlobal.com. During 2019, two directors missed two board meetings each. In each of those instances, the board members were informed of the meeting agenda and results. All directors attended, either in person or electronically, all of the meetings held by the committees on which such director served.
The following are officers and directors of the Company with their ages as of December 31, 2019, and a list of the members of our five standing committees: Audit Committee, Compensation Committee, Disclosure Committee, Investment Committee and Nomination Committee.
William J. Clough, Esq. General Counsel of CUI Global, Inc. Mr. Clough is also a Director and Executive Chairman of the Company’s board of directors age 68 (Seat 1)
Mr. Clough has served on the board of directors since 2006. Mr. Clough was reelected at the 2019 Annual Meeting of Shareholders to serve a one-year term.
During his tenure, he has led several strategic initiatives, including the Company’s acquisition of Orbital Gas Systems Limited and the Company’s natural gas technology line; the opening of Orbital Gas Systems, North America, Inc.; in addition, Mr. Clough steered the Company through its 2012, 2013, and 2017 equity raises and its listing on the Nasdaq Capital Market in 2012.
Before joining the Company, Clough, an attorney, operated his own law firm for 14 years, with offices in Los Angeles, San Francisco and Honolulu. In that capacity, he successfully represented leading movie studios and media conglomerates.
Mr. Clough received his Juris Doctorate, cum laude, from Hastings College of the Law in 1990. He obtained one of the largest ever non-wrongful death jury verdicts in Los Angeles County Superior Court in 2000 and successfully represented parties in multi-million-dollar cases throughout the United States. Mr. Clough is certified to practice law in state and federal courts in California, Illinois, Hawaii, and before the United States Supreme Court. Mr. Clough worked as a police officer for 16 years at the local, state, and federal level including as a Federal Air Marshall flying in Southern Europe and the Middle East.
C. Stephen Cochennet, Director, age 63 (Seat 2)
Mr. Cochennet was appointed to the CUI Global Board of Directors at its December 1, 2017 annual meeting to fill a director vacancy on the board of directors. Mr. Cochennet is an independent director within the meaning of Rule 5605(a)(2) of The NASDAQ Stock Market. Mr. Cochennet was elected at the 2019 Annual Meeting of Shareholders to serve a one-year term.
Mr. Cochennet has served as CEO/President, of Kansas Resource Development Company, a private oil and gas exploration company since 2011. From 2011 through 2015 he was also the CEO and president of Guardian 8 Corporation. From 2005 to 2010 Mr. Cochennet was the Chairman, President, and Chief Executive Officer of EnerJex Resources, Inc., a publicly traded SEC registered Oil and Gas Company. Prior to joining EnerJex, Mr. Cochennet was President of CSC Group, LLC. in which he supported several Fortune 500 and international companies, as well as several natural gas/electric utilities and various startup organizations. Services provided included strategic planning, capital formation, corporate development, human resources, executive compensation, executive networking and transaction structuring. From 1985 to 2002, he held several executive positions with UtiliCorp United Inc. (Aquila) in Kansas City, Missouri. His responsibilities included finance, administration, operations, human resources, benefits, corporate development, natural gas/energy marketing, and initiating several startup operations. Prior to his experience at Aquila Mr. Cochennet served 6 years with the Federal Reserve System managing problem and failed banking institutions primarily within the oil and gas markets.
Mr. Cochennet graduated from the University of Nebraska with a B.A. in Finance and Economics.
Daniel N. Ford, Chief Financial Officer of CUI Global Inc. and Subsidiaries and Chief Operating Officer of the Energy Division, age 40
Mr. Ford has a background in audit with big 4 accounting firms, including KPMG. As CFO of CUI, Mr. Ford has consistently moved CUI into a position of efficiency, and forward thinking, transforming many of CUI's accounting and financial management processes while working directly with CUI’s operating groups.
Mr. Ford has implemented improved ERP systems, worked in conjunction with Mr. Clough on the 2012, 2013 and 2017 equity raises, listing onto the Nasdaq Capital Market, various acquisitions including Orbital Gas Systems Ltd. and the 2019 divestitures of the CUI Inc. power and electromechanical business units.
Mr. Ford serves on the board of the Portland Providence Medical Foundation whose purpose is to connect people with Providence to advance research, health care and wellness.
Mr. Ford earned his B.B.A with a double major in Finance and Accounting from the University of Portland and holds an MBA from George Fox University.
Corey A. Lambrecht, Director, age 50 (Seat 5)
Mr. Lambrecht was elected to serve as a director at the 2007 Annual Meeting of Shareholders and continues to serve on the board of directors as an independent director within the meaning of Rule 5605(a)(2) of The NASDAQ Stock Market. Mr. Lambrecht was reelected at the 2019 Annual Meeting of Shareholders to serve a one-year term.
Mr. Lambrecht is a 20+ year public company executive with broad experience in strategic acquisitions, corporate turnarounds, new business development, pioneering consumer products, corporate licensing, and interactive technology services. In addition, Mr. Lambrecht has held public company executive roles with responsibilities including day-to-day business operations, management, raising capital, board communication and investor relations. Mr. Lambrecht holds a certificate as a Certified Director from the UCLA Anderson Graduate School of Management Accredited Directors program.
Mr. Lambrecht has previously served as a director of ORHub to SaaS company as well as a strategic consultant for American Rebel Holdings, Inc. He served as Director of Sales for Leveraged Marketing Associates, the worldwide leader in licensed brand extension strategies. While Executive Vice President for Smith & Wesson Holding Corporation, he was responsible for Smith & Wesson Licensing, Advanced Technologies and Interactive Marketing divisions. He previously served as an independent Board Member for Lifestyle Wireless/Text-a-Day in conjunction with the Company's merger with publicly traded Carbon Credits International (now operating as SinglePoint), and recently rejoined the Company as its CFO. Previously, Mr. Lambrecht served as an independent director of Guardian 8 Holdings. He was the former President of A For Effort, an interactive database marketing company specializing in online content (advergaming) for clients such as the National Hockey League. Mr. Lambrecht's prior experience also includes Pre-IPO founder for Premium Cigars International and VP Sales/Marketing for ProductExpress.com.
James F. O’Neil III, Chief Executive Officer, Vice Chairman of the Board of Directors, Director, as well as Chief Executive Officer of the Company’s wholly owned subsidiaries, age 61
James Francis O'Neil III, a veteran executive of the power industry, earned a B.S. in Civil Engineering from Tulane University in 1980. He is the principal owner of Forefront Solutions, LLC. since October 2017.
Mr. O’Neil joined Quanta Services, Inc. in 1999 as Vice President of Operations Integration and in 2002 advanced to Senior Vice President of Operations Integration & Audit. He continued to advance to Chief Operating Officer from October 2008 to 2011, then as the Chief Executive Officer from May 19, 2011 to March 14, 2016 and President from October 2008 to March 14, 2016. Throughout his tenure at Quanta, he was responsible for various initiatives including the company’s growth strategy, internal audit, and merger and acquisition initiatives.
Mr. O’Neil currently serves on the board of Hennessy Capital Acquisition Corp. IV (Independent Director since February 2019), FirstEnergy Corp. (Independent Director since 2017) and NRC Group Holdings Corp. (NYSE American: NRCG) (director since 2017).
From 1980 to 1999, Mr. O'Neil held various positions with Halliburton Company, lastly as Director, Global Deepwater Development.
Mr. O’Neil and his wife, Tracey, are personally active and loyal financial supporters of Waller/Austin Counties, Texas non-profit programs devoted to providing scholarship funds to students who participate in the 4H Club and fair programs throughout the year.
Sean P. Rooney, Director, age 48 (Seat 3)
Mr. Rooney was elected to serve as a director at the 2008 Annual Meeting of Shareholders and continues to serve on the board of directors as an independent director within the meaning of Rule 5605(a)(2) of The NASDAQ Stock Market. Mr. Rooney was reelected at the 2019 Annual Meeting of Shareholders to serve a one-year term.
Mr. Rooney is a veteran of the financial markets and has served on the board of CUI Global since 2008. He brings over 20 years of financial management experience to the board of directors. Mr. Rooney currently is a Financial Advisor at the Pinnacle Financial Group, which is part of LPL Financial, the largest independent broker dealer in the United States. Prior to working with LPL, Mr. Rooney served as Senior Director of Investments at Oppenheimer & Co., a full-service investment banking, securities and wealth management firm. He has also worked in similar capacity at Investec Ernst & Company, an international specialist bank headquartered in South Africa and the U.K. Mr. Rooney currently advises a clientele of high net worth investors, institutions and foundations. He is an active member of various industry and charitable organizations.
Mr. Rooney graduated from C.W. Post University in 1993 with a Bachelor of Arts degree in Business Administration and holds Series 7 (General Securities Representative), Series 63 (Uniform Securities Law), Series 24 (General Securities Principal) and Series 65 (Uniform Investment Adviser) licenses.
Sarah Tucker, Director, age 74
Sarah Tucker was appointed to the Board of Directors, effective October 1, 2019, as an Independent Director within the meaning of Rule 5605(a)(2) of The Nasdaq Stock Market.
Sarah Tucker is a veteran executive for the business development, planning, engineering, procurement and construction of oil and gas projects globally. She has led projects with budgets from $5M to over $3B in refining, petrochemicals, power, and offshore (both shallow and deep-water) for oil and liquified natural gas in Angola, Brazil, China, India, Italy, Korea, Mexico, Nigeria, Oman, Qatar, Spain, the United Kingdom and the United States.
She has served as an operation executive and managing director for major engineering, construction and petrochemical technology companies including Kellogg, KBR, Kellogg-Mitsubishi Development Company, Raytheon Engineers and Constructors, Kvaerner Engineering and Construction of Norway.
Over the past several years, she has worked closely with Mexican national oil company PEMEX to establish the country’s first deep water project valued at $14B.
According to her personal and professional philosophy, Sarah believes in developing strong relationships and respecting diverse cultures. As part of her philosophy, she led in 1992 a program to author a 51-page report which became the American Petroleum Institute publication Environmental Design Considerations for Petroleum Refining Crude Processing Units.
Her parallel and subsequent effort with the World Bank was successful in striking a balance between the interests of indigenous people and major oil companies allowing projects to proceed in Africa. The publication became an influential guide for doing business in the developing world.
Sarah has studied at the University of Kansas, Rice University and Lamar University. She is a licensed professional engineer and holds a bachelor’s degree in Civil/Structural Engineering from Lamar.
She served on the Rice University Engineering and Construction Global Forum from 2008 - 2016, serving as chair from 2008 - 2010.
As a leading woman in her industry, she has been the first woman to hold several positions including that of vice president of operations. Sarah is a recipient of the 2015 National Women’s Council Award. She is an Executive Member of Women’s Energy Network and a Member of Executive Business Women’s Council in Mexico City.
Paul D. White, Senior Vice President of CUI Global, Inc. and Director, age 58 (Seat 4)
Mr. White was appointed in April 2014 as a director to fill a vacancy and continues to serve on the board of directors. Mr. White was reelected at the 2019 Annual Meeting of Shareholders to serve a one-year term.
Mr. White is a graduate of Humboldt State University and brings to the CUI Global board over 25 years of upper-level business management skills. Prior to being appointed Senior Vice President of CUI Global in 2019, Mr. White served as President of Orbital Gas Systems, Ltd. for approximately two years. Prior to Orbital, Mr. White served as Vice President of the Healthcare Division for Securitas Security Services, a global security company. His responsibilities included direct responsibility for profit and loss statements with approximately $130 million in revenues, along with management, control, and supervision of approximately 3,000 employees working at 44 Medical Centers & Hospitals and over 600 Medical Office and client corporate buildings throughout the United States. He previously served in the Office of the General Counsel and Risk Services, as an Environmental Risk Consultant with Sutter Health Support Services - Corporate Services. His key responsibilities included: formulating best practice solutions to minimize/eliminate existing and potential employee health & safety and security exposures as well as consultations of state, federal, and professional standards for Risk Control/Environmental Health, Security & Safety programs such as OSHA, TJC, DHS, EPA, NFPA, and DOT.
As a results-oriented business leader, Mr. White has skills in developing, managing and expanding business portfolios. Mr. White has senior management experience in contract management, public relations, program strategy and design and has been consistently recognized for effective financial management, leadership, integrity, team-building, and program management skills.
Corporate Governance and Board of Directors Matters
We are committed to maintaining the highest standards of business conduct and corporate governance, which we believe are essential to running our business efficiently, serving our stockholders well and maintaining our integrity in the marketplace. We have adopted a Corporate Code of Ethics and Business Conduct, a code of business conduct and ethics for employees, directors and officers (including our principal executive officer and principal financial and accounting officer). We have also adopted the following governance guides: Charters for each of the Audit Committee, Compensation Committee, Disclosure Committee, Investment Committee, Nominating Committee, a policy for Director Independence, and Whistleblower Policy, all of which, in conjunction with our certificate of incorporation and bylaws, form the framework for our corporate governance. These corporate governance documents are available on the Internet at our website www.CUIGlobal.com.
Our Corporate Governance Practices
We have always believed in strong and effective corporate governance procedures and practices. In that spirit, we have summarized several of our corporate governance practices below.
The Board of Director’s Role in Risk Oversight
The board of directors and its committees have an important role in the Company’s risk oversight, management and assessment process. The board regularly reviews with management the Company’s financial and business strategies, which include a discussion of relevant material risks as appropriate. The board discusses with the Company’s outside general counsel, as appropriate, its risk oversight and assessment as well as any material risks to the Company. In addition, the board delegates risk management responsibilities to the Audit Committee and Compensation Committee, which committees are each comprised of independent directors. The Audit Committee, as part of its charter, oversees the Company’s risk oversight, management and assessment of the Company and oversees and assesses the risks associated with the corporate governance and ethics of the Company. Risk considerations are a material aspect of the Compensation Committee. The Compensation Committee is responsible for overseeing the management of risks relating to executive compensation. In addition, the Compensation Committee also, as appropriate, assesses the risks relating to the Company’s overall compensation programs. The Investment Committee is responsible for overseeing and advising on possible investment opportunities as well as to administer and operate the Company’s investment portfolio. This includes aligning investment policies and strategies with the Company’s short and long-term goals, as well as setting benchmarks to evaluate long-term objectives and continual evaluation of the investment strategies. While the Committees oversee the management of the risk areas identified above, the entire board is regularly informed through committee reports about such risks. This enables the board and its committees to coordinate the risk management, assessment and oversight roles.
Adopting Governance Guidelines
Our board of directors has adopted a set of corporate governance guidelines to establish a framework within which it will conduct its business and to guide management in its running of the Company. The governance guidelines can be found on our website at www.CUIGlobal.com and are summarized below.
Monitoring Board Effectiveness
It is important that our board of directors and its committees are performing effectively and in the best interest of the Company and its stockholders. The board of directors and each committee are responsible for annually assessing their effectiveness in fulfilling their obligations.
Conducting Formal Independent Director Sessions
On a regular basis, at the conclusion of regularly scheduled board meetings, the independent directors are encouraged to meet privately, without our management or any non-independent directors.
Hiring Outside Advisors
The board and each of its committees may retain outside advisors and consultants of their choosing at our expense, without management's consent.
Avoiding Conflicts of Interest
We expect our directors, executives and employees to conduct themselves with the highest degree of integrity, ethics and honesty. Our credibility and reputation depend upon the good judgment, ethical standards and personal integrity of each director, executive and employee. In order to provide assurances to the Company and its stockholders, we have implemented standards of business conduct, which provide clear conflict of interest guidelines to its employees and directors, as well as an explanation of reporting and investigatory procedures.
Providing Transparency
We believe that it is important that stockholders understand our governance practices. In order to help ensure transparency of our practices, we have posted information regarding our corporate governance procedures on our website at www.CUIGlobal.com.
Whistleblower Policy
In furtherance of our governance transparency and ethical standards, we adopted a comprehensive Whistleblower Policy that encourages employees to report to proper authorities incorrect financial reporting, unlawful activity, activities that are not in line with the CUI Global Code of Business Conduct or activities, which otherwise amount to serious improper conduct. Our Whistleblower Policy is posted on our website at www.CUIGlobal.com.
Accuracy of All Public Disclosure
It is the Company's policy that all public disclosure made by the Company should be accurate and complete, fairly present, in all material respects, the Company's financial condition and results of operations, and be made on a timely basis as required by applicable laws and securities exchange requirements. In order to oversee this policy, a Disclosure Committee Charter has been adopted by the Chief Executive Officer and Chief Financial Officer and ratified by our Audit Committee. You can view a copy of this document on our website at www.CUIGlobal.com or obtain a copy by making a written request to the Company at CUI Global, Inc., 20050 SW 112th Avenue, Tualatin, Oregon 97062.
Communications with the Board of Directors
Stockholders may communicate with the board of directors by writing to the Company at CUI Global, Inc., 20050 SW 112th Avenue, Tualatin, Oregon 97062, or via telephone at (832) 467-1420. Stockholders who would like their submission directed to a member of the board may so specify and the communication will be forwarded as appropriate.
Standards of Business Conduct
The board of directors has adopted a Code of Ethics and Business Conduct for all our employees and directors, including the Company's principal executive and senior financial officers. You can obtain a copy of these documents on our website at www.CUIGlobal.com or by making a written request to the Company at CUI Global, Inc., 20050 SW 112th Avenue, Tualatin, Oregon 97062, or via telephone at (832) 467-1420. We will disclose any amendments to the Code of Ethics and Business Conduct or waiver of a provision therefrom on our website at www.CUIGlobal.com.
Ensuring Auditor Independence
We have taken several steps to ensure the continued independence of our independent registered public accounting firm. That firm reports directly to the Audit Committee, which also has the ability to pre-approve or reject any non-audit services proposed to be conducted by our independent registered public accounting firm.
Committees of the Board and Meetings
At December 31, 2019, our board of directors consists of seven directors. Four of our seven directors are ‘‘independent’’ as defined in Rule 5605(a)(2) of The NASDAQ Stock Market. Our board of directors has the following standing committees: Audit Committee, Compensation Committee, Disclosure Committee, Investment Committee and Nominating Committee. Each of the committees operates under a written charter adopted by the board of directors. All committee charters are available on our website at www.CUIGlobal.com.
Audit Committee
The Audit Committee is established pursuant to the Sarbanes-Oxley Act of 2002 for the purposes of overseeing the company’s accounts and financial reporting processes and audits of its financial statements. The Audit Committee reviews the financial information that will be provided to the stockholders and others, the systems of internal controls established by management and the board and the independence and performance of the Company’s audit process. The Audit Committee is directly responsible for, among other things, the appointment, compensation, retention and oversight of our independent registered public accounting firm, review of financial reporting, internal company processes of business/financial risk and applicable legal, ethical and regulatory requirements. During 2019, the Audit Committee held six formal meetings.
At December 31, 2019, the Audit Committee is comprised of Sean P. Rooney, Chairman, C. Stephen Cochennet, and Corey A. Lambrecht. Messrs. Rooney, Cochennet, and Lambrecht are independent in accordance with Rule 10A-3 under the Securities Exchange Act of 1934 and Rule 5605(a)(2) of The NASDAQ Stock Market.
Audit Committee Report
THE FOLLOWING REPORT OF THE AUDIT COMMITTEE DOES NOT CONSTITUTE SOLICITING MATERIAL AND SHOULD NOT BE DEEMED FILED OR INCORPORATED BY REFERENCE INTO ANY OTHER COMPANY FILING UNDER THE SECURITIES ACT OF 1933 OR THE SECURITIES EXCHANGE ACT OF 1934, EXCEPT TO THE EXTENT THE COMPANY SPECIFICALLY INCORPORATES THIS REPORT BY REFERENCE THEREIN.
Audit Committee Report
The Audit Committee reviews the financial information that will be provided to the stockholders and others, the systems of internal controls established by management and the board and the independence and performance of the Company’s audit process.
The Audit Committee has:
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reviewed and discussed with management the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K and the most recent Quarterly Report on Form 10-Q;
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discussed with Grant Thornton LLP., the Company’s independent registered public accounting firm, the matters required to be discussed by General Auditing Standard 1301: Communications with Audit Committees as adopted by the Public Company Accounting Oversight Board; and
•
received the written disclosures and letter from Grant Thornton LLP as required by applicable requirements of the Public Company Accounting Oversight Board regarding the independent accountant’s communications with the Audit Committee concerning independence and has discussed with Grant Thornton LLP its independence from CUI Global.
Based on these reviews and discussions, the Audit Committee has recommended that the audited consolidated financial statements be included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. The Audit Committee has also considered whether the amount and nature of non-audit services provided by Grant Thornton LLP is compatible with the auditor’s independence and determined that it is compatible.
Submitted by: Audit Committee by
Sean P. Rooney, Chairman
C. Stephen Cochennet
Corey A. Lambrecht
Nominating Committee
The nominating committee consists of all of the members of the board of directors who are ‘‘independent directors’’ within the meaning of Rule 5605(a)(2) of The NASDAQ Stock Market. The nominating committee is responsible for the evaluation of nominees for election as director, the nomination of director candidates for election by the stockholders and evaluation of sitting directors. The board has developed a formal policy for the identification and evaluation of nominees, Charter of the Nominating Committee of the Board of Directors, which can be reviewed on our website at www.CUIGlobal.com. In general, when the board determines that expansion of the board or replacement of a director is necessary or appropriate, the nominating committee will review, through candidate interviews with members of the board and management, consultation with the candidate's associates and through other means, a candidate's honesty, integrity, reputation in and commitment to the community, judgment, personality and thinking style, willingness to invest in the Company, residence, willingness to devote the necessary time, potential conflicts of interest, independence, understanding of financial statements and issues, and the willingness and ability to engage in meaningful and constructive discussion regarding Company issues. The committee reviews any special expertise, for example, that qualifies a person as an audit committee financial expert, membership or influence in a geographic or business target market, or other relevant business experience. To date the Company has not paid any fee to any third party to identify or evaluate, or to assist it in identifying or evaluating, potential director candidates.
The nominating committee considers director candidates nominated by stockholders during such times as the Company is actively considering obtaining new directors. Candidates recommended by stockholders will be evaluated based on the same criteria described above. Stockholders desiring to suggest a candidate for consideration should send a letter to the Company's secretary and include: (a) a statement that the writer is a shareholder (providing evidence if the person's shares are held in street name) and is proposing a candidate for consideration; (b) the name and contact information for the candidate; (c) a statement of the candidate's business and educational experience; (d) information regarding the candidate's qualifications to be director, including but not limited to an evaluation of the factors discussed above which the board would consider in evaluating a candidate; (e) information regarding any relationship or understanding between the proposing shareholder and the candidate; (f) information regarding potential conflicts of interest and (g) a statement that the candidate is willing to be considered and willing to serve as director if nominated and elected. Because of the small size of the Company and the limited need to seek additional directors, there is no assurance that all shareholder proposed candidates will be fully considered, that all candidates will be considered equally or that the proponent of any candidate or the proposed candidate will be contacted by the Company or the board and no undertaking to do so is implied by the willingness to consider candidates proposed by stockholders.
Disclosure Committee
We have formed a Disclosure Committee, which has been adopted by our CEO and CFO (‘‘Principal Officers’’) and ratified by our Audit Committee. The Disclosure Committee assists our Principal Officers in fulfilling their responsibility for oversight of the accuracy, completeness and timeliness of our public disclosures including, but not limited to our SEC filings, press releases, correspondence disseminated to security holders, presentations to analysts and release of financial information or earnings guidance to security holders or the investment community. The Disclosure Committee consists of our Principal Officers, the individual or representative of the firm primarily charged with investor/public relations, the Audit Committee Chairman and outside SEC counsel. Our Executive Chairman is Chairman of the committee. Our Senior Officers may replace or add new members from time to time. Our Senior Officers have the option to assume all the responsibilities of this committee or designate a committee member, who shall be a person with expertise in SEC and SRO rules and regulations with respect to disclosure, who shall have the power, acting together with our Senior Officers, to review and approve disclosure statements when time or other circumstances do not permit the full committee to meet. You may review the full text of our Disclosure Committee Charter on our website, www.CUIGlobal.com, under the link, governance.
Generally, the committee serves as a central point to which material information should be directed and a resource for people who have questions regarding materiality and the requirement to disclose. In discharging its duties, the committee has full access to all Company books, records, facilities and personnel, including the board of directors, Audit Committee, independent public accountants and outside counsel.
Investment Committee
The purpose of the investment committee is to administer and to operate the portfolio. The members of the investment committee are fiduciaries of the portfolio, with responsibility for overseeing investment policies, general policies, guidelines, investment performance and related risk management. Committee members will fulfill their duties solely on behalf of the company’s mission. In addition to aligning investment policies and strategies with the company’s short- and long-term goals, investment committees must set benchmarks to evaluate long-term objectives and continually evaluate their strategies to keep pace with market fluctuations and changes.
Investment Committee shall also provide initial oversight and analysis of potential acquisition targets being considered by Management. In that capacity, Investment Committee members may, among other things, participate in reviewing initial due diligence; visit prospective acquisition targets; participate in strategy and other discussions with Management; and, where appropriate, more.
At December 31, 2019, the Investment Committee is comprised of C. Stephen Cochennet, Corey A. Lambrecht, Chairman, and Daniel Ford, CFO.
Compensation Committee
The Compensation Committee discharges the board’s responsibilities relating to general compensation policies and practices and to compensation of our executives. In discharging its responsibilities, the Compensation Committee establishes principles and procedures in order to ensure to the board and the shareholders that the compensation practices of the Company are appropriately designed and implemented to attract, retain and reward high quality executives and are in accordance with all applicable legal and regulatory requirements. In this context, the Compensation Committee’s authority, duties and responsibilities are:
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To annually review the Company’s philosophy regarding executive compensation.
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To periodically review market and industry data to assess the Company’s competitive position, and to retain any compensation consultant to be used to assist in the evaluation of directors’ and executive officers’ compensation.
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To establish and approve the Company goals and objectives, and associated measurement metrics relevant to compensation of the Company’s executive officers.
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To establish and approve incentive levels and targets relevant to compensation of the executive officers.
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To annually review and make recommendations to the board to approve, for all principal executives and officers, the base and incentive compensation, taking into consideration the judgment and recommendation of the Chief Executive Officer for the compensation of the principal executives and officers.
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To separately review, determine and approve the Chief Executive Officer’s applicable compensation levels based on the Committee’s evaluation of the Chief Executive Officer’s performance considering the Company’s and the individual goals and objectives.
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To review for any related party employee situations, to ensure appropriate controls are implemented surrounding compensation changes, bonuses and performance reviews of the related party employee, and to participate in such controls as appropriate.
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To periodically review and make recommendations to the board with respect to the compensation of directors, including board and committee retainers, meeting fees, equity-based compensation and such other forms of compensation as the Compensation Committee may consider appropriate.
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To administer and annually review the Company’s incentive compensation plans and equity-based plans.
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To review and make recommendations to the board regarding any executive employment agreements, any proposed severance arrangements or change in control and similar agreements/provisions, and any amendments, supplements or waivers to the foregoing agreements, and any perquisites, special or supplemental benefits.
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To review and discuss with management, the Compensation Discussion and Analysis (CD&A), and determine the Committee’s recommendation for the CD&A’s inclusion in the Company’s annual report filed with the SEC on Form 10-K and proxy statement on Schedule 14A.
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The Committee may, in its sole discretion, retain or obtain the advice of a compensation consultant, legal counsel or other adviser.
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The Committee shall be directly responsible for the appointment, compensation and oversight of the work of any compensation consultant, legal counsel and other adviser retained by the Committee. The Company must provide for appropriate funding, as determined by the Committee, for payment of reasonable compensation to a compensation consultant, legal counsel or any other adviser retained by the Committee.
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The Committee may select, or receive advice from, a compensation consultant, legal counsel or other adviser to the Committee, other than in-house legal counsel, only after taking into consideration the following factors:
(i)
the provision of other services to the Company by the person that employs the compensation consultant, legal counsel or other adviser;
(ii)
the amount of fees received from the Company by the person that employs the compensation consultant, legal counsel or other adviser, as a percentage of the total revenue of the person that employs the compensation consultant, legal counsel or other adviser;
(iii)
the policies and procedures of the person that employs the compensation consultant, legal counsel or other adviser that are designed to prevent conflicts of interest;
(iv)
any business or personal relationship of the compensation consultant, legal counsel or other adviser with a member of the Committee;
(v)
any stock of the Company owned by the compensation consultant, legal counsel or other adviser; and
(vi)
any business or personal relationship of the compensation consultant, legal counsel, other adviser or the person employing the adviser with an executive officer of the Company.
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The Committee is not required to implement or act consistently with the advice or recommendations of the compensation consultant, legal counsel or other adviser to the Committee.
Compensation Committee Members
The Compensation Committee of the board of directors is appointed by the board of directors to discharge the board’s responsibilities with respect to all forms of compensation of the Company’s executive officers, to administer the Company’s equity incentive plans and to produce an annual report on executive compensation for use in the Company’s Form 10-K and the proxy statement on Schedule 14A. At December 31, 2019, the Compensation Committee consists of two independent members of the board of directors, Messrs. Corey A. Lambrecht, and C. Stephen Cochennet, both of whom are ‘‘independent directors’’ within the meaning of Rule 5605(a) (2) of the NASDAQ Stock Market.
Committee Meetings
Our Compensation Committee meets formally and informally as often as necessary to perform its duties and responsibilities. The Compensation Committee held three formal meetings during fiscal 2019. On an as requested basis, our Compensation Committee receives and reviews materials prepared by management, consultants or committee members, in advance of each meeting. Depending on the agenda for the particular meeting, these materials may include, among other factors:
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minutes and materials from the previous meeting(s);
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reports on year-to-date Company financial performance versus budget;
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reports on progress and levels of performance of individual and Company performance objectives;
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reports on the Company’s financial and stock performance versus a peer group of companies;
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reports from the Committee’s compensation consultant regarding market and industry data relevant to executive officer compensation;
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reports and executive compensation summary worksheets, which sets forth for each executive officer: current total compensation and incentive compensation target percentages, current equity ownership holdings and general partner ownership interest and current and projected value of each and all such compensation elements, including distributions and dividends therefrom, over a five-year period.
Compensation Committee Charter
Our Compensation Committee Charter is posted on our website at www.CUIGlobal.com.
Compensation Committee Interlocks and Insider Participation
None of the members of the Company’s Compensation Committee is or has at any time during the last completed fiscal year been an officer or employee of the Company. None of the Company’s executive officers has served as a member of the board of directors, or as a member of the compensation or similar committee, of any entity that has one or more executive officers who served on the Company’s board of directors or Compensation Committee during the last completed fiscal year.
Compensation Committee Report
We have reviewed and discussed the Compensation Discussion and Analysis with management and based on our review and discussion with management, we have recommended to the board of directors that the Compensation Discussion and Analysis be included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 and the proxy statement on Schedule 14A for the 2020 Annual Meeting of Shareholders.
Submitted by:
Compensation Committee by
Corey A. Lambrecht, Chairman
C. Stephen Cochennet
Item 11.
Item 11. Executive Compensation
Compensation Discussion and Analysis
General Philosophy
Our compensation philosophy is based on the premise of attracting, retaining and motivating exceptional leaders, setting high goals, working toward the common objectives of meeting the expectations of customers and stockholders and rewarding outstanding performance. Following this philosophy, in determining executive compensation, we consider all relevant factors, such as the competition for talent, our desire to link pay with performance, the use of equity to align executive interests with those of our stockholders, individual contributions, teamwork and performance, each executive’s total compensation package and internal pay equity. We strive to accomplish these objectives by compensating all employees with total compensation packages consisting of a combination of competitive base salary and incentive compensation.
Pay for Performance
At the core of our compensation philosophy is our strong belief that pay should be directly linked to performance. We believe in a pay for performance culture that places a significant portion of executive officer total compensation as contingent upon, or variable with, individual performance, Company performance and achievement of strategic goals including increasing shareholder value.
The performance based compensation for our executives may be in the form of (i) annual cash incentives to promote achievement of, and accountability for, shorter term performance plans and strategic goals and (ii) equity grants, designed to align the long-term interests of our executive officers with those of our shareholders, by creating a strong and direct link between executive compensation and shareholder return over a multiple year performance cycle. Long-term incentive equity awards are typically granted in restricted stock or stock options. These awards generally vest over a two to four-year period. This opportunity for share ownership was to provide incentive and retain key employees and align their interests with our long-term strategic goals. As of December 31, 2019, the Company does not have an approved equity incentive plan, and expects to submit a proposal for a new equity incentive plan to shareholders for approval during 2020.
Base Compensation to be Competitive within Industry
A key component of an executive’s total compensation base salary is designed to compensate executives commensurate with their respective level of experience, scope of responsibilities, sustained individual performance and future potential. The goal has been to provide for base salaries that are sufficiently competitive with other similar-sized companies, both regionally and nationally, to attract and retain talented leaders.
Compensation Setting Process
Management’s Role in the Compensation Setting Process
Management plays a significant role in the compensation-setting process. The most significant aspects of management’s role are:
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assisting in establishing business performance goals and objectives;
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evaluating employee and Company performance;
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CEO and/or Executive Chairman recommending compensation levels and awards for executive officers;
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implementing the board approved compensation plans; and
•
assistance in preparing agenda and materials for the Committee meetings.
The Chief Executive Officer and/or Executive Chairman generally attends the Committee meetings; however, the Committee also regularly meets in executive session. The Chief Executive Officer and/or Executive Chairman makes recommendations with respect to financial and corporate goals and objectives and makes non-CEO executive compensation recommendations to the Compensation Committee based on Company performance, individual performance and the peer group compensation market analysis. The Compensation Committee considers and deliberates on this information and in turn makes recommendations to the board of directors, for the board’s determination and approval of the executives’ and other members of senior management’s compensation, as necessary, including base compensation, short-term cash incentives and long-term equity incentives. For related party employee matters, appropriate personnel meet with the Compensation Committee to determine compensation and incentives and to review ongoing performance of the employee. The Chief Executive Officer’s and/or Executive Chairman’s performance and compensation are reviewed, evaluated and established separately by the Compensation Committee and ratified and approved by the board of directors.
Setting Compensation Levels
To evaluate whether total compensation is competitive and provides appropriate rewards to attract and retain talented leaders, as discussed above, we may rely on analyses of peer companies performed by independent compensation consultants and on other industry and occupation specific survey data available. Our general benchmark is to establish both base salary and total compensation for the executive officers at or near the compensation of peer group data, recognizing that a significant portion of executive officer total compensation should be contingent upon, or variable with, achievement of individual and Company performance objectives and strategic goals, as well as being variable with stockholder value. Further, while the objective for base salary is at that of peer group data, executives’ base salaries are designed to reward core competencies and contributions to the Company and may be increased above this general benchmark based on (i) the individual’s increased contribution over the preceding year; (ii) the individual’s increased responsibilities over the preceding year; and (iii) any increase in median competitive pay levels.
Setting Performance Objectives
The Company’s business plans and strategic objectives are generally presented by management annually and as needed to the board of directors. The board engages in an active discussion concerning the financial targets, the appropriateness of the strategic objectives and the difficulty in achieving the same. In establishing the compensation plan, our Compensation Committee then utilizes the primary financial targets and strategic objectives from the adopted business plan as the primary targets for determining the executive officers’ short-term cash incentives and long-term equity incentive compensation. The Committee also establishes additional non-financial performance goals and objectives, the achievement of which is required for funding of a significant portion, approximately twenty five percent, of the executive officers’ incentive compensation. In 2019, these non-financial performance goals and objectives included among other factors, divestiture of significant portions of the Power and Electromechanical segment, the identification and procurement process to enhance and enable the growth of the Company through strategic industry-specific acquisitions; the continued growth of the Orbital Gas Systems, North America operations; investment in VPS and reduction of costs at CUI-Canada; continued expansion within the global natural gas and energy markets; continued product development and new product introductions including various VE technology-based sample systems; and general and administrative management responsibilities. In addition, such factors as revenue growth; new product adoption; market penetration; M&A activities; and investment banking transactions were and are considered in setting compensation levels.
Annual Evaluation
The Chief Executive Officer and/or Executive Chairman recommends the actual incentive award amounts for all other executives based on actual Company performance relative to the targets set as well as on individual performance and recommends the executives’ base salary levels. The Compensation Committee considers these recommendations generally following the end of each fiscal year in determining its recommendations to the board of directors for the final short-term cash incentive and long-term equity award amounts for each executive. Executive base salary levels are reviewed in accordance with their respective employment agreements. The actual incentive amounts awarded to each executive are ultimately subject to the discretion of the Compensation Committee and the board of directors.
Voting Results on Executive Compensation (Say-on-Pay) Advisory Vote
As required by Section 14A of the Exchange Act, under the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Compensation Committee considers the prior year shareholder advisory vote on the compensation of the Named Executive Officers as appropriate for making compensation decisions. At the annual meeting of shareholders held December 3, 2019, 41% percent of the shareholders present and voting on the proposal approved, on an advisory basis, the compensation disclosed in the Company’s proxy statement for the meeting filed with the Securities and Exchange Commission on October 2, 2019. As a result, the Compensation Committee concluded that the Company's shareholders were not supportive of the Company's executive compensation philosophy, policies and programs and the Compensation Committee will continue to reach out to shareholders regarding compensation matters. The Compensation Committee determined to review such philosophy, policies and programs, with such updates and modifications as appropriate for changing circumstances.
Special Evaluation
Additional equity-based awards may also be granted to executives, as well as other employees, upon commencement of employment, promotions, for special performance recognition or for retention purposes, based on the recommendation of the Chief Executive Officer or Chief Financial Officer. In determining whether to recommend additional grants to an executive, the Chief Executive Officer typically considers the individual’s performance and any planned change in functional responsibility.
Elements of Executive Compensation
Total Compensation
Total compensation for our executives consists of three elements: (i) base salary; (ii) incentive cash award based on achieving specific performance targets as measured by revenues, cash flow and other objectives and (iii) equity incentive award, which is also performance based and may be paid out over a future period in the form of stock, restricted stock, stock appreciation rights, or stock purchase options. Base salaries are the value upon which both the incentive compensation percentage targets are measured against. For evaluation and comparison of overall compensation of the executives and to assist it in making its compensation decisions, the Compensation Committee reviews an executive compensation summary, which sets forth for each executive: current compensation and current equity ownership holdings as well as the projected value of each and all such compensation elements, including distributions and dividends therefrom. Also included in the summary are comparative performance numbers, specific milestones, strategic objectives, and other elements used to measure each executive's individual performance.
Base Salaries
Base salaries are designed to compensate executives commensurate with their respective level of experience, scope of responsibilities and to reward sustained individual performance and future potential. The goal has been to provide for base salaries that are sufficiently competitive with other similar-sized companies, both regionally and nationally, to attract and retain talented leaders.
Incentive Compensation
Incentive compensation is intended to align compensation with business objectives and performance and enable the Company to attract, retain and reward high quality executive officers whose contributions are critical to both the short and long-term success of the Company. The executives’ incentive awards are based upon three key performance metrics: (i) the Company’s earnings before interest, taxes, depreciation, and amortization (EBITDA); (ii) achievement of agreed-upon strategic and corporate performance goals; and/or (iii) existing Employment Agreement.
The strategic and corporate performance goals are not intended to be a specific agreed-upon goal, but rather a general objective. Management and the board of directors discuss these factors and set objectives that are dynamic and change periodically. In setting these periodic goals, the board of directors discusses with management the nature of the objective and management’s proposed method of achieving the goal. These goals change throughout the operational process because of changing dynamics such as economic conditions, current success of marketing, availability of materials, availability of funding and overall momentum toward achieving the goal.
Incentive Plan Compensation
Incentive awards are typically paid out in cash, restricted common stock or option awards. The incentive award targets for the executives are established at the beginning of the year, generally, as a percentage of their base salary and the actual awards are determined in the following year at a board of directors’ meetings based on actual Company performance relative to established goals and objectives, as well as on evaluation of the executive’s relevant departmental and individual performance during the past year. In many instances the award of restricted common stock and stock options vests over a multi-year term in equal periodic tranches. The award of restricted common stock purchased through options generally, although not in every instance, vests immediately upon exercise of the option and generally has a validity of up to ten years and a per share purchase price of no less than the fair market value of our common stock on the date of grant. The awards are intended to serve as a means of incentive compensation for performance.
Retirement Plans
CUI Global and its wholly owned subsidiaries, CUI Inc. and Orbital Gas Systems, North America, Inc. maintain a 401(k) plan. The Company 401(k) retirement savings plan allows employees to contribute to the plan after they have completed 60 days of service and are 18 years of age. The Company matches the employee’s contribution up to 6% of total compensation. Total employer contributions, net of forfeitures were $0.5 million, $0.5 million, and $0.4 million for 2019, 2018 and 2017, respectively. These amounts include $0.3 million, $0.4 million, and $0.3 million associated with discontinued operations.
Involuntary Termination, Resignation for Good Reason and Change in Control
Our executives are awarded protection from involuntary termination, resignation for good reason and change in control specifically provided in their employment contracts.
Under involuntary termination without cause or resignation for good reason, the Executive Chairman and Chief Executive Officer each would receive any amounts earned, accrued or owing but not yet paid; full vesting of any unvested stock options and any deferred past bonuses that have been earned but not paid. Should the executive be terminated on account of disability he is entitled to 75% of his then current annual base salary for six months and eighteen months of medical coverage.
Under involuntary termination without cause or resignation for good reason, our Chief Financial Officer would receive any amounts earned, accrued or owing but not yet paid; full vesting of any unvested stock options and any deferred past bonuses that have been earned but not paid. Should the executive be terminated on account of disability he is entitled to 75% of his then current annual base salary for six months and eighteen months of medical coverage.
Perquisites
The Company does not provide for any perquisites or any other benefits for its senior executives that are not generally available to all employees.
Employment Agreements
During fiscal year 2019, four executive officers were employed under employment agreements. Those executive officers are:
•
Executive Chairman, General Counsel, former Chief Executive Officer;
•
Chief Executive Officer;
•
Chief Financial Officer of CUI Global, Inc. and Chief Operating Officer of the Energy Division; and
•
Former President of CUI Inc., and Chief Operating Officer of the Power and Electromechanical Division;
To see the material terms of each named executive officer’s employment agreement, please see the footnotes to the Summary Compensation Table.
Executive Salary and Bonus Performance Assessment Considerations
Bonuses for certain executive officers and employees of CUI Global and subsidiaries are calculated based on historical financial and non-financial information and accomplishments based on an ongoing review and approval by the Compensation Committee and the Chief Executive Officer. Accordingly, the Company accrues bonuses through components calculated on prior data. This review also considers ongoing performance and incentives for those officers and employees to increase their performance. As such, bonuses calculated based on fiscal 2019 data are not necessarily earned or owed to the employees as of December 31, 2019 and there is no legal right by the employees to receive such bonuses upon either termination by the Company or voluntary termination, unless they have been approved based on the subsequent review of subjective items.
The performance assessment considerations for William J. Clough, Esq. in his capacity as President, Chief Executive Officer and General Counsel of CUI Global, Inc. and subsidiaries through September 30, 2019 and Chief Legal Officer and Executive Chairman, thereafter, include his successful management and implementation of acquisition and growth strategy, both domestically and internationally, that resulted in the March 2015 asset acquisition of Tectrol, Inc., a Canadian electronics company by CUI Inc. and the highly lucrative February 2016 purchase order from Europe’s largest natural gas transmission company for our GasPT product. This purchase order culminates several years of Mr. Clough’s personal effort. The Tectrol asset purchase entailed complex labor union negotiations and ongoing management support. Mr. Clough continues to expand new technology development, implementation, branding and sales by strategically expanding the VE Technology product recognition through adoption of mercury sampling and thermowells. As a primary initiator of the Company’s growth strategy, he engineered the Company’s launch of Orbital Gas Systems, North America, Inc. as a unified international GasPT and VE Technology sales headquarters. Mr. Clough continues to expand investor relations and strengthen investment banking relationships through regular investor meetings and conferences. In addition, Mr. Clough is the point-person for the Company's mergers and acquisition (M&A) strategy. In that capacity:
•
Mr. Clough spearheaded the divestiture of both the CUI Electromechanical Division (to a Management-led group) and divestiture of the CUI Power Division (to Bel Fuse) for a combined value of approximately $44.2 million - comprised of forgiveness of a $5.3 million Note; receipt of a $5.0 million Note Payable; and approximately $33.9 million in cash after working capital adjustments;
•
Mr. Clough identified and recruited James F. O’Neil, CUI Global’s chief executive officer, in order to begin a strategic acquisition and divestiture strategy designed to make CUI Global an energy-centric, services company along the lines of Quanta (Mr. O’Neil’s prior employer) and MasTec; and,
•
Mr. Clough provides insight, tactics, targets, and potential relationships to expand the Company's opportunities through strategic partnerships and acquisitions. His efforts have included strategic relationships with SAMSON AG, Socrate S.p.A., Daily Thermetrics, and others, along with various acquisition opportunities currently being explored by the Company.
As Corporate General Counsel, Mr. Clough is “hands on” in his management of corporate governance and legal issues, addressing employee concerns, providing personal direction and oversight of drafting revised and restated corporate bylaws and regularly communicating with the directors pertaining to various corporate matters as they arise.
The performance assessment considerations for James F. O’Neil, Chief Executive Officer of CUI Global, Inc. and its subsidiaries since October 1, 2019, include his extensive experience and prior success at building shareholder value and significant return-on-investment. Mr. O’Neil is a veteran executive of the energy infrastructure industry and has been instrumental in formulating and overseeing execution on CUI Global’s transformation plan that reshapes the company into a diversified energy services platform.
The performance assessment considerations for Daniel N. Ford, Chief Financial Officer of CUI Global, Inc. and subsidiaries and Chief Operating Officer of the Energy Division include his successful management of financial resources for CUI Global and subsidiaries including investments, corporate portfolio, cash and debt positions. Mr. Ford’s daily duties include ongoing development and oversight of global banking relationships and overall financial performance oversight and management of the accounting staff of CUI Global, Inc. and all subsidiaries. In 2016, Mr. Ford added the responsibility of Chief Operating Officer for the Energy Division including direct management of the Division's leadership teams as well as coordinating ongoing activities, planning and initiatives to continue growth within this division on a global basis. Mr. Ford efficiently communicates with the board pertaining to company activities, audit results and findings, growth and acquisition strategy and investment tactics. Mr. Ford oversees SEC filing compliance, internal reporting matters, and works directly with internal and external audit and tax firms. As an integral part of this management, it is necessary that he continue to be up to date on all current accounting and SEC regulatory standards such as ICFR and SOX. Mr. Ford works closely with the Executive Chairman and CEO regarding financial reporting, Energy Division activities, divestitures, M&A, investments, investor management and investor relations activities. Mr. Ford is integral to the M&A efforts and assists with analysis and identification of specific strategic partnerships and acquisitions. Mr. Ford has been particularly involved in the integration of previous acquisitions including Tectrol (CUI-Canada), Orbital-UK, and the greenfield startup of Orbital North America within the CUI Global portfolio.
The performance assessment considerations for Matthew M. McKenzie, former President of CUI Inc. were directed toward corporate operations for the Power and Electromechanical Division. Mr. McKenzie managed the daily operations of CUI Inc., CUI Japan, and CUI-Canada, Inc. In 2019, Mr. McKenzie was instrumental in coordinating and consummating the sale of the CUI Power Division to Bel Fuse. Mr. McKenzie successfully managed the construction of our research and development facility and implementation of our ICE product development project. Mr. McKenzie was involved in the Company’s investment in Virtual Power Systems ("VPS") (the owner of the VPS software that empowers our ICE hardware) and in the Company's efforts to expand and strengthen its relationship with VPS. Mr. McKenzie’s employment contract allows for performance and discretionary bonuses. He and his management group (under the name Back Porch) purchased the CUI Electromechanical Division in late-2019.
Pay Ratio Disclosure Rule
In August 2015, pursuant to a mandate of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd - Frank Act”), the Securities and Exchange Commission (“SEC”) adopted a rule requiring annual disclosure of the ratio of the median employee’s annual total compensation to the total annual compensation of the principal executive officer (‟PEO”). The Company’s PEO Mr. James F. O’Neil was appointed October 1, 2019. Mr. O’Neil’s compensation has been annualized for 2019 pay ratio purposes. The purpose of the new required disclosure is to provide a measure of the equitability of pay within the organization. The Company believes its compensation philosophy and process yield an equitable result and is presenting such information in compliance with the required disclosure as follows:
When determining the median employee, we included the following compensation in our calculations:
•
Salary or wages
•
Bonuses
•
Stock awards
•
Other compensation including health insurance benefits, disability insurance benefits, life insurance benefits and 401(k) match benefits provided by the Company but excluding health and pension benefits provided by certain governments.
Mr. O’Neil’s actual compensation for 2019 along with details of his employment agreement can be reviewed in more detail in the Summary Compensation Table.
We elected to exclude our CUI-Japan sales office from the calculation due to there being less than 5% of the total number of employees there (5 employees).
Full and part-time employee compensation for employees that were hired during the year was annualized based on the average compensation they received during the period they were employed. The number of employees was determined as of December 31, 2019 when there were 252 total employees (Excluding CUI-Japan), 40 of which are considered US employees and 212 of which were considered non-US employees.
Summary Compensation Table
The following table sets forth the compensation paid and accrued to be paid by the Company for the fiscal years 2019, 2018 and 2017 to the Company’s Chief Executive Officer, Chief Financial Officer and President of CUI Inc.
Summary Compensation Table
Footnotes:
1.
Mr. Clough joined the Company on September 1, 2005. Effective September 13, 2007, Mr. Clough was appointed CEO/President of CUI Global and Chief Executive Officer of all wholly owned subsidiaries of the Company. Effective October 1, 2019 Mr. Clough stepped down as Chief Executive Officer and was appointed Executive Chairman and Chief Legal Counsel.
2.
Mr. Clough is employed under a three-year employment contract with the Company, which became effective May 14, 2019. Said contract provides, in relevant part, for salary in year 1 of $750 thousand, year 2 of $800 thousand and year 3 of $850 thousand. The employment agreement includes bonus provisions for each calendar year targeted at seventy-five percent of base salary to be based on performance objectives, goals and milestones for each calendar year including company performance. Bonuses are approved based on various performance-related factors and an evaluation of current performance and includes a discretionary bonus of up to twenty-five percent of salary based upon the reasonable judgment of the compensation committee. Employee has the ability to earn a larger bonus based on the performance criteria set forth and the reasonable judgment and discretion of the compensation committee. Mr. Clough's employment agreement includes a grant for 1,600,000 options; however, the grant is subject to the approval of an equity incentive plan by shareholders within one year of the employment agreement. As of December 31, 2019, the shareholders have not approved an equity incentive plan. The agreement provides for up to $9,999 of annual premium life insurance expenses along with the ordinary benefits provided to employees of the Company. The agreement entitles Mr. Clough to severance package of 2.5 times the sum of annual base salary and target bonus along with eighteen months of medical coverage under the Company's medical plans. At December 31, 2019, 2018, and 2017, there was an accrual of $0, $30 thousand, and $33 thousand, respectively, for compensation owed to Mr. Clough.
3.
Mr. Ford joined the Company May 15, 2008 and serves as Chief Financial Officer of CUI Global and subsidiaries, and Chief Operating Officer of the Energy Division.
4.
Mr. Ford is employed under a three-year employment contract with the Company, which became effective May 14, 2019. Said contract provides, in relevant part, for salary in year 1 of $500 thousand, year 2 of $550 thousand and year 3 of $600 thousand. The employment agreement includes bonus provisions for each calendar year targeted at seventy-five percent of base salary to be based on performance objectives, goals and milestones for each calendar year including company performance. Bonuses are approved based on various performance-related factors and an evaluation of current performance and includes a discretionary bonus of up to twenty-five percent of salary based upon the reasonable judgment of the compensation committee. Employee has the ability to earn a larger bonus based on the performance criteria set forth and the reasonable judgment and discretion of the compensation committee. Mr. Ford's employment agreement includes a grant for 960,000 options; however, the grants are subject to the approval of an equity incentive plan by shareholders within one year of the grant. As of December 31, 2019, the shareholders have not approved an equity incentive plan. The agreement provides for ordinary benefits provided to employees of the Company. The agreement entitles Mr. Ford to a severance package of 2.0 times the sum of annual base salary and target bonus along with eighteen months of medical coverage under the Company's medical plans. At December 31, 2019, 2018, and 2017, there was an accrual of $0, $21 thousand, and $22 thousand, respectively, for compensation owed to Mr. Ford.
5.
Mr. O'Neil was appointed Director July 9, 2019 and was appointed Chief Executive Officer effective October 1, 2019.
6.
Mr. O'Neil is employed under a three-year employment contract with the Company, which became effective October 1, 2019. Said contract provides, in relevant part, for salary in year 1 of $750 thousand, year 2 of $800 thousand and year 3 of $850 thousand. The employment agreement includes bonus provisions for each calendar year targeted at seventy-five percent of base salary to be based on performance objectives, goals and milestones for each calendar year including company performance. Bonuses are approved based on various performance-related factors and an evaluation of current performance and includes a discretionary bonus of up to twenty-five percent of salary based upon the reasonable judgment of the compensation committee. Employee has the ability to earn a larger bonus based on the performance criteria set forth and the reasonable judgment and discretion of the compensation committee. Mr. O'Neil's employment agreement includes a grant for 1,000,000 options and he also received a grant for 600,000 options when he was initially appointed to the Board of Directors, however the grants are subject to the approval of an equity incentive plan by shareholders within one year of the grants. As of December 31, 2019, the shareholders have not approved an equity incentive plan. The agreement provides for up to $9,999 of annual premium life insurance expenses along with the ordinary benefits provided to employees of the Company. The agreement entitles Mr. O'Neil to a severance package of 2.5 times the sum of annual base salary and target bonus along with eighteen months of medical coverage under the Company's medical plans.
7.
Mr. McKenzie joined the Company May 15, 2008 and served as President of CUI Inc. and Chief Operating Officer of the Power and Electromechanical Division. Effective September 30, 2019 Mr. McKenzie's employment was terminated with the disposition of the non-power supply electromechanical products group to Back Porch International, Inc.
8.
Mr. McKenzie was employed under a multi-year employment contract with the Company, which became effective July 1, 2013 and which was extended to run to and through December 31, 2019. Said contract provides, in relevant part, for salary in 2018 of $320 thousand, an annual 4% cost of living adjustment, an eighteen-month severance package and bonus provisions up to one hundred twenty-five percent of base salary to be based on performance objectives, goals, and milestones for each calendar year, including revenue performance in the Power and Electromechanical segment. The bonus includes a discretionary bonus of up to twenty-five percent of salary based upon the reasonable judgment of the compensation committee. Employee has the ability to earn a larger bonus based on the performance criteria set forth and the reasonable judgment and discretion of the compensation committee. Bonuses are approved quarterly based on the above factors and an evaluation of current performance. All such bonus payments shall be paid to Mr. McKenzie in equal monthly installments following the period in which the bonus is earned and shall be paid on the 15th day of each month. At December 31, 2019, 2018, and 2017, there was an accrual of $0, $18 thousand, and $12 thousand, respectively, for compensation owed to Mr. McKenzie. Mr. McKenzie terminated his employment with CUI Inc. to lead Back Porch International Inc.'s purchase of the electromechanical components business that was announced in October 2019.
9.
Mr. White served as President of Orbital Gas Systems, Ltd. from July 2017, initially in a consulting role, until July 2019. Upon accepting the permanent role of President of Orbital Gas Systems, Ltd. effective December 1, 2017, Mr. White ceased to be independent as a director of the Company. In July 2019, Mr. White became Senior Vice President for CUI Global.
10.
Mr. White is employed under a three-year employment contract with the Company through December 1, 2020 and provides, in relevant part, for an initial annual salary of $225 thousand in year 1 along with a $30 thousand one-time signing bonus, and increases to $250 thousand and $275 thousand in years 2 and 3, respectively, a severance of the Executive’s salary for the remainder of his severance term upon termination, bonus provisions to be based on performance objectives, goals, and milestones for each calendar year, including revenue performance at Orbital-UK. The bonus includes a discretionary bonus of up to twenty-five percent of salary based upon the reasonable judgment of the compensation committee. Employee has the ability to earn a larger bonus based on the performance criteria set forth and the reasonable judgment and discretion of the compensation committee. Bonuses are approved on an ongoing basis based on the above factors and an evaluation of current performance. All such bonus payments shall be paid to Mr. White following the period in which the bonus is earned. During 2017, Mr. White received $50 thousand of cash compensation and $50 thousand of stock awards for his services as an independent director. Further, during his time during the year ended December 31, 2017 serving as a consultant as interim President of Orbital Gas Systems, Limited, Mr. White received $46 thousand of compensation. At December 31, 2019, 2018 and 2017, there was an accrual of $0, $155 thousand, and $40 thousand, respectively, for compensation owed to Mr. White.
11.
As of December 31, 2019, William J. Clough, CEO/Director held 558,085 outstanding options, Daniel N. Ford, CFO held 125,196 outstanding options, Matthew M. McKenzie, COO/Director held 86,800 outstanding options, and Paul D. White, Senior Vice President/Director held 7,500 options.
12.
All other compensation includes health care, insurance and 401(k) matching benefits.
The following table summarizes potential payments upon termination of employment to each of the named executive officers employed on the last day of our most recently completed fiscal year. The amounts set forth in the table are based on the assumption that the triggering event occurred on the last business day of our last completed fiscal year.
1.
Mr. Clough's employment contract with the Company entitles Mr. Clough to a severance package of 2.5 times the sum of annual base salary and target bonus along with eighteen months of medical coverage under the Company's medical plans. Under involuntary termination without cause or resignation for good reason, Mr. Clough would receive any amounts earned, accrued or owing but not yet paid; full vesting of any unvested stock options and any deferred past bonuses that have been earned but not paid. Should Mr. Clough be terminated on account of disability he is entitled to 75% of his then current annual base salary for six months and eighteen months of medical coverage.
2.
Mr. Ford's employment contract with the Company entitles Mr. Ford to a severance package of 2.0 times the sum of annual base salary and target bonus along with eighteen months of medical coverage under the Company's medical plans. Under involuntary termination without cause or resignation for good reason, Mr. Ford would receive any amounts earned, accrued or owing but not yet paid; full vesting of any unvested stock options and any deferred past bonuses that have been earned but not paid. Should Mr. Ford be terminated on account of disability he is entitled to 75% of his then current annual base salary for six months and eighteen months of medical coverage.
3.
Mr. O'Neil's employment contract with the Company entitles Mr. Clough to a severance package of 2.5 times the sum of annual base salary and target bonus along with eighteen months of medical coverage under the Company's medical plans. Under involuntary termination without cause or resignation for good reason, Mr. O'Neil would receive any amounts earned, accrued or owing but not yet paid; full vesting of any unvested stock options and any deferred past bonuses that have been earned but not paid. Should Mr. O'Neil be terminated on account of disability he is entitled to 75% of his then current annual base salary for six months and eighteen months of medical coverage.
2019 Grants of Plan-Based Awards
(1) These columns show the possible payouts for each named executive officer under the Incentive Plan for 2019 based on the goals set. Additional information is included in the Compensation Discussion and Analysis, and detail regarding actual awards under the Incentive Plan is reported in the Summary Compensation Table.
Outstanding Equity Awards at Fiscal Year-End
The following table sets forth the outstanding equity awards at December 31, 2019 to each of the named executive officers:
Footnotes:
1.
Effective October 11, 2010, Mr. Clough, Mr. Ford and Mr. McKenzie received bonus options to purchase 37,177 (5,422 remaining outstanding), 12,598 and 15,100 common shares, respectively, within ten years from date of issuance, at a price of $9.00 per share that vested over 4 years: 25% at year one and thereafter in equal monthly installments. Additionally, effective October 11, 2010, for service as a director of the Company, Mr. McKenzie received an option to purchase 3,300 common shares within ten years from date of issuance at a price of $9.00 per share that vested one year after issuance.
2.
Effective April 16, 2012, Mr. Clough, Mr. Ford and Mr. McKenzie received bonus options to purchase 37,177 (19,363 remaining outstanding), 12,598, and 15,100 common shares, respectively, within ten years from date of issuance, at a price of $4.56 per share that vested over 4 years: 25% at year one and thereafter in equal monthly installments. Additionally, effective April 16, 2012, for their service as directors of the Company, Mr. Clough and Mr. McKenzie each received an option to purchase 3,300 common shares, within ten years from date of issuance, at a price of $4.56 per share that vested one year after issuance.
3.
Effective September 21, 2012, under the terms of his contract extension, Mr. Clough received a bonus option to purchase 330,000 common shares, within ten years from date of issuance, at a price of $6.00 per share that vested in equal monthly installments over 4 years.
4.
Effective June 24, 2013, Mr. Clough, Mr. Ford and Mr. McKenzie received bonus options to purchase 200,000, 100,000 and 50,000 common shares, respectively, within ten years from date of issuance, at a price of $6.25 per share that vested one third per year over 3 years.
Director Compensation
For 2019, each of our directors received the following compensation pursuant to our director compensation plan:
Non-employee directors received annual compensation of $100,000.
•
The $100,000 annual compensation for non-employee directors is issued in the form of $50,000 cash compensation and $50,000 common stock calculated by using the Nasdaq Stock Market closing price per share on the date of issuance.
•
In addition, the Chairman and member of the Investment Committee received an additional $67,500 and $22,500, respectively, for their services.
•
At the election of each director, all or any portion of the cash compensation may be converted to stock purchase options calculated by using the strike price of ten percent (10%) above the Nasdaq Stock Market closing price per share on the date of grant.
•
At the election of each director, all or any portion of the cash compensation may be converted to stock calculated by using the Nasdaq Stock Market closing price per share on the date of conversion.
The following table sets forth the compensation of the non-employee directors for the fiscal year ended December 31, 2019:
Footnotes:
(1) Ms. Tucker was appointed to the Board of Directors, effective October 1, 2019.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information regarding beneficial ownership of our voting shares as of December 31, 2019 by: (i) each shareholder known by us to be the beneficial owner of 5% or more of the outstanding voting shares, (ii) each of our directors and executives and (iii) all directors and executive officers as a group. Except as otherwise indicated, we believe that the beneficial owners of the voting shares listed below, based on information furnished by such owners, have sole investment and voting power with respect to such shares, subject to community property laws where applicable. Shares of common stock issuable upon exercise of options and warrants that are currently exercisable or that will become exercisable within 60 days of December 31, 2019 have been included in the table.
No shares of preferred stock are outstanding at the date of this report.
Beneficial Interest Table
Footnotes:
1.
Except as otherwise indicated, the address of each beneficial owner is c/o CUI Global, Inc., 20050 SW 112th Avenue, Tualatin, Oregon 97062.
2.
Calculated on the basis of 28,383,373 shares of common stock issued and outstanding at December 31, 2019 except that shares of common stock underlying options exercisable within 60 days and issued within 60 days of the date hereof are deemed to be outstanding for purposes of calculating the beneficial ownership of securities of such holder of options and shares. A * denotes less than 1 percent beneficially owned.
3.
Mr. Clough’s common stock includes vested options to purchase 558,085 common shares. Mr. Clough is a Director, Chairman and Chief Executive Officer/President/General Counsel of CUI Global, Inc.
4.
Mr. Cochennet was appointed to the board of directors in December 2017.
5.
Mr. Ford’s shares include vested options to purchase 125,196 common shares. Mr. Ford is the Chief Financial Officer of CUI Global, Inc. and Chief Operating Officer for the Energy Division.
6.
Mr. Lambrecht’s shares include vested options to purchase 16,600 common shares. Mr. Lambrecht is a Director.
7.
Mr. Rooney’s shares include vested options to purchase 36,987 common shares. Mr. Rooney is a Director.
8.
Mr. White’s shares include vested options to purchase 7,500 common shares. Mr. White is a Director and President of Orbital-UK.
We relied upon Section 4(2) of the Securities Act of 1933 as the basis for an exemption from registration for the issuance of the above securities.
Employee Equity Incentive Plans
At December 31, 2019, the Company had outstanding the following equity compensation plan information:
Equity Compensation Plans Approved by Shareholders
On May 16, 2008 the Company’s board of directors adopted the 2008 Equity Incentive Plan and authorized 1,500,000 shares of Common Stock to fund the Plan which was approved by the Company shareholders at the 2008 Annual Meeting of Shareholders. At the 2009 Annual Meeting of Shareholders, the shareholders approved an amendment to the 2008 Equity Incentive Plan to increase the number of common shares issuable under the plan from 1,500,000 to 3,000,000. These shares have been registered under Form S-8.
As of December 31, 2019 there are no remaining shares available to grant under the 2008 Equity Incentive Plan.
Equity Compensation Plans Not Approved by Shareholders
Pursuant to a board resolution in January 2009, following recommendation by the Compensation Committee, the 2009 Equity Incentive Plan (Executive), a Non-Qualified Stock Option Plan, was created and funded with 4,200,000 shares of $0.001 par value common stock. The Compensation Committee was appointed as the Plan Administrator to manage the plan. In October 2010 and September 2012, the board of directors authorized an additional 3,060,382 and 330,000 options, respectively, under the 2009 Equity Incentive Plan (Executive).
Issuances of stock options under the 2009 Equity Incentive Plan (Executive) were made to attract, retain and motivate executive and management employees and directors and to encourage these individuals to acquire an equity interest in the Company, to make monetary payments to certain management employees and directors based upon the value of the Company’s stock and to provide these individuals with an incentive to maximize the success of the Company and further the interest of the shareholders. The 2009 Plan allowed for the issuance of Incentive Non-Statutory Options.
The Company has outstanding at December 31, 2019, the following options issued under equity compensation plans not approved by security holders:
•
During 2010, the Company issued options to purchase restricted common stock at $9.00 per share to officers and directors as follows: 19,800 options that vest one year after the October 11, 2010 grant date and 82,213 options that vest over four years, 25% at one year after the grant date, thereafter in equally monthly installments. Of these 2010 grants, 51,321 remain outstanding and fully vested at December 31, 2019.
•
During 2012, the Company granted options to purchase restricted common stock at $4.56 per share to officers and directors as follows: 19,800 options that vest one year after the April 16, 2012 grant date; 64,875 options that vest over four years, 25% at one year after the grant date, thereafter in equal monthly installments, and 330,000 options to purchase restricted common stock at $6.00 per share were granted to an officer that vest in equal monthly installments over the course of forty-eight consecutive months beginning September 2012. Of these 2012 grants, 390,261 remain outstanding and fully vested at December 31, 2019.
•
During 2013, the Company issued 350,000 options to purchase restricted common stock at $6.25 per share to three officers as follows: one third that vest one year after the June 24, 2013 grant date, one third that vest two years after the grant date and the balance that vest three years after the grant date. At December 31, 2019, 350,000 of these 2013 granted options are outstanding and fully vested.
•
During 2014, the Company issued options to purchase 10,000 shares of restricted common stock at a price of $6.92 per share to each board member who is not an employee of the Company. The options vested in twelve equal installments during 2014. The Company issued options to purchase 42,890 restricted shares of common stock at a price of $6.92 per share to two board members, who chose to receive a portion of their annual board compensation in the form of equity. The Company granted options to purchase 7,500 restricted shares of common stock at a price of $8.15 per share to each of the two newly elected directors that vested August 31, 2015. Of these 2014 options grants, 47,887 options are outstanding and fully vested at December 31, 2019.
As of December 31, 2019, there are no remaining shares available to grant under the 2009 Equity Incentive Plan (Executive).
The description of the Company’s capital stock does not purport to be complete and is subject to and qualified by its Articles of Incorporation, Bylaws, and amendments thereto and by the provisions of applicable Colorado law. The Company’s transfer agent is Computershare Trust Company, Inc., 350 Indiana Street, Suite 800, Golden, Colorado 80401.
Item 13.
Item 13. Certain Relationships and Related Transactions and Director Independence
The Board of Directors is responsible for the review and approval of all related party transactions. Although the Board does not have written policies and procedures with respect to the review of related party transactions, we intend that any such transactions will be reviewed by the Board of Directors or one of its committees, which will consider all relevant facts and circumstances and will consider, among other factors:
•
the material terms of the transaction;
•
the nature of the relationship between the Company and the related party;
•
the significance of the transaction to the Company; and
•
whether or not the transaction would be likely to impair (or create the appearance of impairing) the judgment of a director or executive officer to act in the best interest of the Company.
Except as set forth herein, no related party of the Company, including, but not limited to, any director, officer, nominee for director, immediate family member of a director or officer, immediate family member of any nominee for director, security holder that beneficially owns, directly or indirectly, shares carrying more than 5% of the voting rights attached to its outstanding shares, or immediate family member of any such security holder, since the beginning of fiscal year 2019, has any material interest, direct or indirect, in any transaction or in any presently proposed transaction with the Company where the amount involved exceeds $120,000 which has or will materially affect the Company.
Chief Legal Counsel and Executive Chairman of the Board of Directors, William J. Clough’s son, Nicholas J. Clough, serves as President at Orbital Gas Systems, North America, Inc., a wholly owned subsidiary of the Company. Additional Information on Nicholas Clough’s compensation is included in Note 11 Related Party Transactions, to the Consolidated Financial Statements under Part II, Item 8, ‘‘Financial Statements and Supplementary Data.’’
Item 14.
Item 14. Principal Accountants Fees and Services
Fees or controlled billings for services billed by the Company’s principal accountant, Perkins & Company, P.C. through June 20, 2019 and Grant Thornton LLP from June 20, 2019 through December 31, 2019, were as follows:
(1)
Fees and expenses for professional services rendered in connection with the audit of the Company's financial statements and internal control over financial reporting and the reviews of the financial statements included in each of the Company's quarterly reports on Form 10-Q.
(2)
Tax fees are lower in 2019 as a result of the Company's tax returns prepared in 2019 not being prepared by the principal accountant.
In accordance with the requirements of the Sarbanes-Oxley Act of 2002 and the rules and regulations promulgated thereunder, the Audit Committee has adopted an informal approval policy that it believes will result in an effective and efficient procedure to pre-approve services performed by the independent registered public accounting firm.
Section 16(A) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires our executive officers, directors and persons owning more than 10% of our common stock to file reports of ownership and reports of changes of ownership with the Securities and Exchange Commission. These reporting persons are required to furnish us with copies of all Section 16(a) forms that they file. We have made all officers and directors aware of their reporting obligations and have appointed an employee to oversee Section 16 compliance for future filings.
Shareholder Communications
Company shareholders who wish to communicate with the board of directors or an individual director may write to CUI Global, Inc., 20050 SW 112th Avenue, Tualatin, Oregon 97062, phone (832) 467-1420 or to the attention of an individual director. Your letter should indicate that you are a shareholder and whether you own your shares in street name. Letters received will be retained until the next Board meeting when they will be available to the addressed director. Such communications may receive an initial evaluation to determine, based on the substance and nature of the communication, a suitable process for internal distribution, review and response or other appropriate treatment. There is no assurance that all communications will receive a response.
Certain Provisions of the Articles of Incorporation and Colorado Business Corporation Act Relating to Indemnification of Directors and Officers
The Colorado General Corporation Act, as revised, provides that if so provided in the articles of incorporation, the corporation shall eliminate or limit the personal liability of a director to the corporation or to its shareholders for monetary damages for breach of fiduciary duty as a director; except that any such provision shall not eliminate or limit the liability of a director to the corporation or to its shareholders for monetary damages for any breach of the director's duty of loyalty to the corporation or to its shareholders, acts or omissions not in good faith or, which involve intentional misconduct or a knowing violation of law, unlawful distributions, or any transaction from which the director directly or indirectly derived an improper personal benefit.
Our Articles of Incorporation and bylaws provide that a person who is performing his or her duties shall not have any liability by reason of being or having been a director of the corporation and that the Company shall indemnify and advance expenses to a director or officer in connection with a proceeding to the fullest extent permitted or required by and in accordance with the indemnification sections of Colorado statutes.
Insofar as indemnification for liabilities may be invoked to disclaim liability for damages arising under the Securities Act of 1933, as amended, or the Securities Act of 1934 (collectively, the ‘‘Acts’’), as amended, it is the position of the Securities and Exchange Commission that such indemnification is against public policy as expressed in the Acts and are therefore, unenforceable.
Reports to Shareholders
We intend to voluntarily send Form 10-Ks to our shareholders, which will include audited consolidated financial statements. We are a reporting company and file reports with the Securities and Exchange Commission (SEC), including this Form 10-K as well as quarterly reports under Form 10-Q. The public may read and copy any materials filed with the SEC at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The company files its reports electronically and the SEC maintains an Internet site that contains reports, proxy and information statements and other information filed by the company with the SEC electronically. The address of that site is www.sec.gov.
The company also maintains an Internet site, which contains information about the company, news releases, governance documents and summary financial data. The address of that site is www.CUIGlobal.com.
Part IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
No schedules are included because the required information is inapplicable, not required or are presented in the financial
statements or the related notes thereto.
EXHIBITS
The following exhibits are included as part of this Form 10-K.
Exhibit
No.
Description
2.1 1
Asset purchase agreement between and among CUI, Inc., CUI Global, Inc. and Back Porch International, Inc.
2.2 2
Asset purchase agreement between and among CUI, Inc., CUI Global, Inc. and Bel Fuse Inc.
3.11(i) 3
Amended Restated Articles of Incorporation that compile prior amendments into a single document.
3.12(ii) 4
Amended and restated corporate bylaws that compile requirements for the nomination of persons for election to the Board of Directors and the proposal of other business to be considered by the corporation’s stockholders.
10.86 5
Asset Purchase Agreement dated February 23, 2015 to acquire the assets of Tectrol, Inc. and commercial lease attached as exhibits to our Form 8-K filed with the commission March 3, 2015.
10.87 8
Promissory note dated March 13, 2020 for $3,000,000 with Reach Construction Group.
10.88 8
Security agreement with Reach Construction group dated March 13, 2020.
10.90 8
Three-year lease for Sherman, Texas facility effective December 1, 2019.
10.91 8
Four-year lease for Irving, Texas facility effective January 1, 2020.
10.92 6
Five-year lease for Houston, Texas facility effective November 1, 2017.
10.93 6
Employment agreement with Paul D. White effective December 1, 2017.
10.94 4
10-year lease for Tualatin, OR facility effective December 21, 2018.
10.95 7
Employment agreement with William J. Clough effective May 14, 2019.
10.96 7
Employment agreement with Daniel N. Ford effective May 14, 2019.
10.97 1
Employment agreement with James F. O'Neil effective October 1, 2019.
10.98 8
Agreement dated January 1, 2020 between Orbital Gas Systems Limited and VE Technology Limited to acquire VE Technology designated intellectual property.
21.3 8
List of all subsidiaries, state of incorporation and name under which the subsidiary does business.
23.1 8
Consent of Perkins & Company, P.C.
23.2 8
Consent of Grant Thornton LLP
31.1 8
Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
31.2 8
Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
32.1 8
Certification of Chief Executive Officer Pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.
32.2 8
Certification of Chief Financial Officer Pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.
101 8
XBRL-Related Documents.
101.INS8
XBRL Instance Document.
101.SCH8
XBRL Taxonomy Extension Schema Document.
101.CAL8
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF8
XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB8
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE8
XBRL Taxonomy Extension Presentation Linkbase Document.
Footnotes to Exhibits:
1.
Incorporated by reference to our Report on Form 8-K filed with the Commission on October 2, 2019.
2.
Incorporated by reference to our Report on Form 8-K filed with the Commission on November 14, 2019.
3.
Incorporated by reference to our Proxy Statement and Notice of 2013 Annual Shareholder Meeting filed with the Commission September 17, 2013.
4.
Incorporated by reference to our Report on Form 10-K filed with the Commission on March 18, 2019.
5.
Incorporated by reference to our Report on Form 8-K filed with the Commission on March 3, 2015 and Form 8-K/A filed with the Commission on May 13, 2015.
6.
Incorporated by reference to our Report on Form 10-K filed with the Commission on March 14, 2018.
7.
Incorporated by reference to our Report on Form 10-Q filed with the Commission on May 15, 2019.
8.
Filed herewith.
Item 16. Form 10-K Summary
None.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
CUI Global, Inc.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities on the dates indicated.