Note 5. Merger Agreement with Mobile X Global, Inc.
On June 10, 2022, Electro-Sensors, Inc. (“ELSE” or “Electro-Sensors”) entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Mobile X Newco, Inc., a Delaware corporation, a wholly owned subsidiary of ELSE (the “Merger Sub”), and Mobile X Global, Inc., a Delaware corporation (“Mobile X”) (together with ELSE and Merger Sub the “Parties”). Mobile X Global, Inc. is a new entrant in the global mobile industry founded by its CEO Peter Adderton. Mobile X plans to launch a new mobile wireless brand called Mobile X in the United States in 2022, enabled by a network agreement with a major carrier. The financial information in this Note 5 is stated in actual dollars, rather than thousands.
The Merger is structured as a statutory reverse triangular merger under Delaware and Minnesota law, under which Merger Sub will be merged with and into Mobile X Global, Inc., with Mobile X Global, Inc. surviving the Merger and becoming a wholly owned subsidiary of ELSE. In connection with the Merger, ELSE will reincorporate in Delaware, be re-named Mobile X Global, Inc., and operate both the new MobileX wireless business and the existing Electro-Sensors business. The Merger Agreement also provides that Electro-Sensors, Inc. will effect a four-for-one reverse stock split shortly before completion of the Merger, unless the Parties agree on a different reverse split ratio. If the Merger does not close by January 31, 2023, either Party may terminate the Merger Agreement, subject to specific exceptions set forth in the Merger Agreement.
In connection with the execution of the Merger Agreement, a third-party institutional investor entered into a commitment letter with Mobile X Global, Inc. to provide equity financing in the form of convertible preferred stock of up to $20.0 million upon closing of the Merger. The commitment is subject to diligence and definitive agreements satisfactory to the third-party institutional investor, including an agreement for a $50.0 million equity line of credit to be provided by the investor. The equity line of credit would provide additional liquidity, at the option of Mobile X. The commitment letter originally would have terminated on October 31, 2022. On September 20, 2022, Mobile X and the third-party institutional investor extended the commitment letter expiration date to January 31, 2023.
ELSE expects that the 325,000 currently outstanding options to acquire ELSE shares would be exercised in connection with the Merger prior to the record date of the cash dividend discussed below. Assuming this exercise, and based on the relative valuations agreed to by Mobile X and ELSE, and after giving effect to the reverse stock split at a ratio of four-for-one, the legacy ELSE shareholders would own approximately 932,005 (11%) shares, the Mobile X stockholders would own approximately 6,668,294 (76%) shares, the third-party institutional investor noted above (or an alternative investor agreed to by the Parties to the Merger Agreement) would own approximately 1,066,860 (12%) shares (on an as-converted to common basis) assuming the closing of $20.0 million of equity financing on the terms in the commitment letter, and approximately 75,851 (1%) shares would be held by others.
In addition to their continuing interest in the combined company, legacy Electro-Sensors shareholders as of a record date to be determined before the closing of the Merger would receive special cash dividends expected to be approximately $18.0 million in the aggregate, with the amount of the dividends possibly adjusted based on the amount of ELSE transaction expenses and its working capital balance at the closing of the Merger, and further adjusted for indebtedness, if any, and transaction bonuses, if any, approved by the ELSE board of directors. Aggregate cash dividends of $18.0 million would be approximately $4.83 per share based on the current, pre-reverse split, fully diluted shares of Electro-Sensors.
ELECTRO-SENSORS, INC.NOTES TO CONDENSED FINANCIAL STATEMENTSFOR THE PERIOD ENDED SEPTEMBER 30, 2022(in thousands except share and per share amounts)(unaudited)
Closing of the Merger is subject to specified conditions, including, among other matters: (i) the approval by Mobile X stockholders and ELSE shareholders of the Merger; (ii) a registration statement becoming effective under the Securities Act of 1933, as amended, related to the shares being issued to the Mobile X stockholders in the Merger and the clearance of the proxy statement related to the approval by the ELSE shareholders of the Merger; (iii) receipt of $20.0 million in third party equity financing; (iv) listing of the combined company's common stock on Nasdaq; and (v) the filing of an amendment to ELSE's Articles of Incorporation to increase the number of shares of common stock authorized for issuance to a number at least large enough to consummate the Merger, allowing the issuance of shares to former Mobile X stockholders and any third-party investors, after giving effect to the reverse stock split described above.
In connection with the execution of the Merger Agreement, Electro-Sensors' directors, officers, and certain major shareholders, who collectively own a majority of Electro-Sensors' outstanding shares, have entered into agreements with Mobile X to vote their shares in favor of the Merger at a special meeting of shareholders to be held before the closing of the Merger on a date to be announced. In addition, directors, officers and certain major stockholders of Mobile X, who collectively own a majority of Mobile X's outstanding shares, have entered into similar voting agreements. No written consents have been granted nor have any votes been cast. The Voting Agreements may be terminated in connection with a termination of the Merger Agreement. Closing will follow the special meeting of shareholders of Electro-Sensors, consent of stockholders of Mobile X Global, and satisfaction of other customary and specified closing conditions, including the U.S. Securities and Exchange Commission ("SEC") having declared effective a registration statement, and The Nasdaq Stock Market having approved the listing of the common stock of the combined company.
A full description of the terms of the Merger Agreement will be provided in a combined Form S-4 Registration Statement/Proxy Statement for the shareholders of ELSE (the “Merger Proxy Statement”) to be filed with the SEC. ELSE urges investors, shareholders, and other interested persons to read, when available, the preliminary proxy statement as well as other documents filed with the SEC because these documents will contain important information about ELSE, Mobile X, and the proposed transaction. The definitive Merger Proxy Statement will be mailed to ELSE shareholders as of a record date to be established for voting on the proposed transaction. Shareholders will also be able to obtain a copy of the definitive Merger Proxy Statement (when available), without charge, by directing a request to: Electro-Sensors, Inc., 6111 Blue Circle Drive, Minnetonka Minnesota 55343. The preliminary and definitive proxy statement, once available, can also be obtained, without charge, at the SEC’s website (www.sec.gov).
Electro-Sensors, Inc. originally expected the Merger to close in the second half of 2022 and now expects the Merger to close in the first half of 2023. For a description of risk and other relevant factors regarding the Merger Agreement, see Forward-looking Statements in Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements regarding our expectations, beliefs, intentions or strategies regarding the future. Forward-looking statements include, but are not limited to, statements about the success of our marketing efforts; our efforts to accelerate future growth or income; our business development activities; our efforts to maintain or reduce production costs; our ability to continue to obtain components and other raw materials for our products at reasonable prices as well as our ability to pass along any increased costs to our customers; our cash requirements; and the sufficiency of our cash flows. Based on rapidly changing dynamics in global supply chains of materials and components, we may experience both price increases and difficulty in sourcing materials and components. In addition, we may experience changes in transportation and freight availability that may make it difficult to have materials and components shipped to us or our products shipped to customers in a timely manner. Any statement that is not based solely upon historical facts, including our strategies for the future and the outcome of events that have not yet occurred, is a forward-looking statement.
This Form 10-Q also includes certain forward-looking statements concerning Electro-Sensors, Mobile X Global and the proposed transactions within the meaning of the Private Securities Litigation Reform Act of 1995, including, but not limited to, statements regarding future financial performance, future growth, and the development of future products and services; the benefits of the proposed transactions, including anticipated growth and synergies; the combined company’s plans, objectives and expectations and intentions; the expected timing of the proposed transactions; and future acquisitions. These statements are based on current expectations or beliefs and are subject to uncertainty and changes in circumstances. There can be no guarantee that the proposed transactions described in this Form 10-Q will be completed, or that they will be completed as currently proposed, or at any particular time. Actual results may vary materially from those expressed or implied by the statements here due to changes in economic, business, competitive or regulatory factors, and other risks and uncertainties affecting the operation of Electro-Sensors as well as the business of Mobile X Global. Many of these risks, uncertainties and contingencies related to Electro-Sensors are presented in Electro- Sensors’ Annual Report on Form 10-K and, from time to time, in Electro-Sensors’ other filings with the SEC. These and other risks related to the business of Mobile X Global will be presented in the proxy statement/prospectus/consent solicitation statement to be filed with the SEC.
The information here should be read considering these risks and the following considerations: the ability of the merger parties to obtain definitive investment documents and close on the equity investments necessary to complete the Merger; the ability of MobileX to successfully launch its business, attract subscribers, and achieve the levels of customer service, revenues and costs that it currently expects; the ability of the combined company to successfully maintain a Nasdaq Capital Market listing; the ability of the combined company to successfully access the capital markets to finance expansion and acquisitions; the ability of the combined company to identify and acquire appropriate acquisition targets and successfully integrate these companies into its operations; the ability of the combined company to achieve synergies between its legacy sensor business and its new MobileX business; the conditions to the closing of the Merger may not be satisfied or an event, change or other circumstance could occur that could give rise to the termination of the Merger Agreement; the Merger may involve unexpected costs, liabilities or delays, resulting in the Merger not being consummated within the expected time period; risks that the announced merger may disrupt current Electro-Sensors plans and operations or that the business or stock price of Electro-Sensors may suffer as a result of uncertainty surrounding the Merger; the outcome of any legal proceedings related to the Merger; and Electro-Sensors or Mobile X Global may be adversely affected by other economic, business, or competitive factors. Additional information regarding the Merger is available in Note 5 to the financial statements.
All forward-looking statements in this document are based on information available to us as of the date of this Form 10-Q, and we assume no obligation to update any of these forward-looking statements, other than as required by law. Our actual results could differ materially from those projected or indicated in these forward-looking statements. These forward-looking statements are subject to certain risks and uncertainties that could cause future results to differ materially from our recent results or those projected in the forward-looking statements, including the accuracy of management’s assumptions with respect to industry trends, fluctuations in industry conditions, the accuracy of management’s assumptions regarding expenses and our cash needs and those listed under the heading “Forward-Looking Statements” under “Item 1—Business,” in our Annual Report on Form 10-K for the year ended December 31, 2021, as well as any effect the COVID-19 pandemic and supply chain dynamics may have on the efficiency of our business operations, our customer base and the domestic or worldwide economy.
CRITICAL ACCOUNTING ESTIMATES
The preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make decisions based upon estimates, assumptions, and factors it considers relevant to the circumstances. These decisions include the selection of applicable accounting principles and the use of judgment in their application and affect reported amounts and disclosures. Changes in economic conditions or other business circumstances may affect the outcomes of management’s estimates and assumptions. An in-depth description of our accounting estimates can be found in the interim financial statements included in this report and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021.
SELECTED FINANCIAL INFORMATION
The following table contains selected financial information, for the periods indicated, from our Condensed Statements of Comprehensive Income (Loss) expressed as a percentage of net sales.
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Three Months Ended September 30
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Nine Months Ended September 30,
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2022
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2021
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2022
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|
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2021
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Net sales
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100.0 |
% |
|
100.0 |
% |
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100.0
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%
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100.0
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% |
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Cost of goods sold
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47.5 |
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44.1 |
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46.0
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45.2
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Gross profit
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52.5 |
|
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55.9 |
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54.0
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54.8
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| |
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Operating expenses
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Selling and marketing
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16.1 |
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17.4 |
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17.7
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16.6
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General and administrative
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22.4 |
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28.8 |
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30.7
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23.3
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Research and development
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8.6 |
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8.8 |
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9.3
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10.4
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Total operating expenses
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47.1 |
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55.0 |
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57.7
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50.3
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| |
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Operating income (loss)
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5.4 |
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0.9 |
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(3.7)
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4.5
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Non-operating income
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Interest income
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1.6 |
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0.1 |
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0.6
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0.1
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Total non-operating income, net
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1.6 |
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0.1 |
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0.6
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0.1
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| |
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Income (loss) before income tax expense (benefit)
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7.0 |
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1.0 |
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(3.1)
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4.6
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| |
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Income tax expense (benefit)
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1.4 |
|
|
0.2 |
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(0.7)
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0.9
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| |
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Net income (loss)
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5.6 |
% |
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0.8 |
% |
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(2.4)
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%
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3.7
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% |
The following paragraphs discuss the Company’s performance for the three and nine months ended September 30, 2022 and 2021.
RESULTS OF OPERATIONS (in thousands)
Net Sales
Net sales for the three-month period ended September 30, 2022 were $2,216, an increase of $62, or 2.9%, from $2,154 during the comparable period in 2021. Net sales for the nine months ended September 30, 2022 were $6,915, an increase of $398, or 6.1%, from $6,517 during the comparable period in 2021. The increase during the three-month period was primarily a result of increased sales of HazardPRO wireless hazard monitoring systems. The increase during the nine-month period was primarily a result of increased domestic sales of traditional wired products for industrial automation and agricultural applications.
Gross Profit
Gross profit for the third quarter of 2022 decreased $41 to $1,163, or 3.4%, over the same period in 2021. Gross profit for the nine months ended September 30, 2022 increased $167 to $3,737, or 4.7%, over the same period in 2021. Gross margin decreased in the third quarter of 2022 to 52.5% from 55.9% during the same period in 2021. Gross margin for the nine months ended September 30, 2022 decreased to 54.0% from 54.8% over the same period in 2021. The decrease in gross margin for both periods was primarily due to an increase in raw material costs across all product lines.
Operating Expenses
Total operating expenses decreased $140, or 11.8% to $1,044 for the third quarter of 2022 compared to the same period in 2021, and decreased as a percentage of net sales to 47.1% from 55.0%. Total operating expenses increased $714, or 21.7%, for the nine months ended September 30, 2022 compared to the same period in 2021, and increased as a percentage of net sales to 57.7% from 50.3%. The increase in operating expenses in the 2022 nine-month period was primarily due to increases in legal and professional fees directly related to the pending Merger with Mobile X as discussed in Note 5 to the financial statements.
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●
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Selling and marketing expenses in the third quarter of 2022 decreased $18 to $357, or 4.8%, from the same period in 2021 and decreased as a percentage of net sales to 16.1% from 17.4%. Selling and marketing expenses in the nine months ended September 30, 2022 increased $143 to $1,230, or 13.2%, from the same period in 2021 and increased as a percentage of net sales to 17.7% from 16.6%. The decrease for three-month period was primarily due to decreased tradeshow related expenses, partially offset by additional sales headcount. The decrease in tradeshow expenses in 2022 occurred because a majority of tradeshows in 2021 were held during the third quarter, versus being held in earlier quarters in 2022. The increase for nine months ended September 30, 2022 was primarily due to additional sales headcount and increased travel expenses.
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●
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General and administrative expenses decreased $123 to $497, or 19.8%, in the third quarter of 2022 compared to the same period in 2021 and decreased as a percentage of net sales to 22.4% from 28.8%. General and administrative expenses increased $604 to $2,125, or 39.7%, for the nine months ended September 30, 2022 compared to the same period in 2021 and increased as a percentage of net sales to 30.7% from 23.3%. The decrease for three-month period was primarily due to decreased legal and other professional fees related to the June 10, 2022 execution of the Merger Agreement and related matters, described in Note 5 to the financial statements and amortization expense related to the HazardPRO technology, which was fully amortized in the third quarter of 2021. The increase for the nine months ended September 30, 2022 was primarily due to increased legal and other professional fees related to the Merger Agreement and related matters, partially offset by a decrease in amortization expense related to the HazardPRO technology.
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●
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Research and development expenses increased $1 to $190, or 0.5%, in the third quarter of 2022 from the same period in 2021 and decreased as a percentage of net sales to 8.6% from 8.8%. Research and development expenses decreased $33 to $642, or 4.9%, in the nine months ended September 30, 2022 from the same period in 2021 and decreased as a percentage of net sales to 9.3% from 10.4%. The decrease for the nine-month period was due to lower third-party engineering costs related to product development and enhancements.
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Non-Operating Income
Net non-operating income increased by $40, or 1,333.3%, for the nine months ended September 30, 2022 compared to the same period in 2021. The increase is the result of additional interest income earned as a result of higher interest rates of Treasury Bills.
Income (Loss) Before Income Tax Expense (Benefit)
Income before income tax expense was $154 for the third quarter of 2022, representing an increase of $133 compared to income before income tax expense of $21 for the same period in 2021. Loss before income tax benefit was $217 for the nine months ended of September 30, 2022, representing a decrease of $507 compared to an income before income tax expense of $290 for the same period in 2021. The increase for third quarter was primarily the result of lower operating expenses as discussed above. The decrease for nine-month period was primarily the result of higher legal and other professional fees related to the Merger Agreement and related matters.
Income Tax Expense (Benefit)
Income tax expense was $32 or 1.4% of net sales in the third quarter of 2022 compared to $4 or 0.2% of net sales in the third quarter of 2021. The income tax benefit was $46 or (0.7)% of net sales, in the nine months ended September 30, 2022 compared to an income tax expense of $61 or 0.9% of net sales, for the nine months ended September 30, 2021. The increase in the third quarter is due to a higher income before income tax expense in 2022. The decrease in the nine-month period is due to loss before income tax benefit in 2022 compared to a net income before income tax in 2021.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents were $9,518 at September 30, 2022 and $6,713 at December 31, 2021. The increase was primarily the result of an increase in Treasury Bills classified as cash equivalents as of September 30, 2022 as compared to September 30, 2021.
Cash used in operating activities was $213 for the nine months ended September 30, 2022 as compared to cash generated from operating activities of $547 for the nine months ended September 30, 2021. The $760 increase in cash used in operations was due primarily to an increase in the net loss. The 2022 net loss compared to the 2021 net income was primarily due to the increase in legal and professional fees related to the Merger Agreement and related matters.
Cash from investing activities was $2,991 for the nine months ended September 30, 2022 compared to $2,987 for the nine months ended September 30, 2021. The increase in cash from investing activities was due to an increase in Treasury Bill maturities as compared to the purchase price for Treasury Bills classified as investments.
Cash from financing activities in the nine months ended September 30, 2022 was $27 as compared to cash used in financing activities of $4 for the nine months ended September 30, 2021. In the third quarter of 2022, three directors exercised 7,500 stock options for a total exercise price of $31.
Subject to the following sections, entitled "COVID-19 Pandemic Discussion" and "Supply Chain Dynamics," the Company believes its ongoing cash requirements will be primarily for capital expenditures, research and development, working capital, and corporate and business development initiatives and that cash on hand and any cash generated from operations will be sufficient to meet these cash requirements through at least the next 12 months.
COVID-19 Pandemic Discussion
While many regions of the United States have reduced the various restrictions implemented beginning in 2020, many of our customers and potential customers continue to operate under modified and changing restrictions based on the number of local or regional COVID-19 cases. The lingering effects of COVID-19 creates uncertainty in our business and may negatively affect our 2022 financial results.
Supply Chain Dynamics
We traditionally have had one or more robust sources for production components and materials. However, we are continuing to experience disruptions in our supply chain, resulting in difficulty sourcing some parts and materials. Additionally, we are experiencing price increases for many of the components used in our products. In certain situations, we are modifying product designs to accommodate new components that are more readily available. There is no guarantee that we will continue to be successful in updating these designs and sourcing alternative components, and we could experience significant delays or run out of certain components and materials. We are also seeing delays in shipping and transportation services, which may adversely affect our ability to make timely deliveries to our customers. Furthermore, the labor market for qualified employees able to fill our production positions is challenging and may result in delays in filling open positions. While we continue to closely manage each of these activities, our actions may not be successful and may result in a negative effect on our sales and profit margins.
Future Corporate and Business Development Activities
We continue to seek growth opportunities, both internally through our existing portfolio of products, technologies, and markets, as well as externally through technology partnerships or related-product or business acquisitions. In addition, we continued to explore other strategic investments that we believed presented good opportunities for the Company and its shareholders. We substantially increased these business development activities in the second half of 2021 and first nine months of 2022. On June 10, 2022, we announced that we had entered into the Merger Agreement with Mobile X Newco, Inc. and Mobile X Global, Inc.
Off-balance Sheet Arrangements
As of September 30, 2022, the Company had no off-balance sheet arrangements or transactions.
Not Applicable.
Evaluation of Disclosure Controls and Procedures
Based on an evaluation with the participation of the Company’s management, the Company’s principal executive officer and principal financial officer has concluded that the Company’s disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”), were effective as of September 30, 2022.
Changes in Internal Control Over Financial Reporting
There were no changes in the Company’s internal control over financial reporting during the third quarter of 2022 that were identified in connection with management’s evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.