10-K/A 1 body.htm ELAMEX 10-KA 3 12-31-2004 Elamex 10-KA 3 12-31-2004
FORM 10-K/A
(Amendment No. 2)
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

x  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended
Commission file number:
 December 31, 2004
0-27992
 
ELAMEX, S.A. DE C.V.
(Exact name of Registrant as specified in its charter)
 
 
Mexico
  
Not Applicable
  
 
(State or other jurisdiction of incorporation or organization)
  
(I.R.S. Employer Identification No.)
  
         
 
1800 Northwestern Dr.
  
79912
  
 
EL PASO, TX
  
(zip code)
  
 
(Address of principal executive offices)
      
 
(915) 298-3061
(Registrant's telephone number including area code, in El Paso, TX)
 
Securities registered pursuant to Section 12(b) of the Act:
None

Securities registered pursuant to Section 12(g) of the Act:

Title of each class
Name of exchange on which registered
Class I Common Stock, No Par Value
NASDAQ National Market

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes ¨     No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Act.     Yes x      No ¨

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x  No ¨ 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes ¨      No x
The aggregate market value of the voting stock (based upon the closing price of the NASDAQ National Market on July 2, 2004 of $2.25) held by non-affiliates of the registrant on that date was approximately $7,146,205.

The number of shares of Class I Common Stock of the registrant outstanding as of March 8, 2005 was: 7,502,561.

DOCUMENTS INCORPORATED BY REFERENCE
The Proxy Statement for the registrant’s 2005 Annual Meeting of Stockholders is incorporated by reference into Part III of this Form 10-K 
 
 
EXPLANATORY NOTE

This Annual Report on Form 10-K/A is being filed as an amendment to our Annual Report on Form 10-K for the fiscal year ended December 31, 2004 to revise certain disclosures contained in the original Form 10-K.

This amendment corrects Part II, Item 8 - Financial Statements and Supplementary Data, date on Report of Independent Registered Public Accounting Firm, Note 1, second table and paragraph eight of “Principles of Consolidation”. 

Elamex has a 50.1% investment in Qualcore, S. de R.L. de C.V. (“Qualcore”), a joint venture company with GE de Mexico, which is recorded under the equity method. In its original Form 10-K, the Company did not present Qualcore as a significant subsidiary as set forth in Rule 3-09 of Regulation S-X and only included a summary of unaudited financial information in a footnote disclosure instead of including separate financial statements for this significant unconsolidated subsidiary as an exhibit. This amended Form 10-K corrects the summary of financial information of Qualcore to include audited amounts and to attach separate audited financial statements of Qualcore.

Qualcore’s operations ceased in the third quarter of 2005, and as of the date of this amendment most of the machinery and equipment have been sold, the majority of the employees have been terminated and the building has been substantially vacated. The Company wrote down its investment in Qualcore to zero as of December 31, 2004, as such management does not believe that any additional adjustments are required in its previously issued financial statements. In the third quarter of 2005, the Company recognized a $2.0 million liability equal to 50.1% in recognition of its guarantee of a portion of the Qualcore plant lease, stated at the estimated fair value of the remaining life of the lease agreement.

Except as otherwise expressly noted herein, this Amendment No. 2 to Annual Report on Form 10-K/A does not reflect events occurring after the March 31, 2005 filing of our original annual Report on Form 10-K in any way, except to reflect the changes discussed in the amendment. Accordingly, this amendment should be read in conjunction with the original filing.
 

PART II
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of Elamex, S.A. de C.V.

We have audited the accompanying consolidated balance sheets of Elamex, S.A. de C.V. and subsidiaries (the “Company”) as of December 31, 2004 and 2003, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, 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. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Elamex, S.A. de C.V. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 2 to the accompanying consolidated financial statements, in 2002 the Company changed its method of accounting for goodwill and other intangible assets to conform to Statement of Financial Accounting Standards No. 142.

Galaz, Yamazaki, Ruiz Urquiza, S.C.
Member of Deloitte Touche Tohmatsu




Pedro Luis Castañeda

March 21, 2005,
November 21, 2005 with respect to Note 1

Ciudad Juárez, Chihuahua, México


ELAMEX, S.A. DE C.V. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS OF U.S. DOLLARS)


   
December 31, 2004
 
December 31, 2003
 
ASSETS
          
Current assets:
          
Cash and cash equivalents
  
$
2,072
  
$
2,299
  
Receivables:
              
Trade accounts receivable, net
    
9,609
   
7,400
 
Other receivables, net
    
512
   
854
 
 
    
10,121
   
8,254
 
 
              
Inventories, net
    
8,797
   
7,921
 
Income taxes receivable from Accel
    
326
   
579
 
Other taxes receivable
    
15
   
499
 
Prepaid expenses
    
992
   
1,024
 
Total current assets
    
22,323
   
20,576
 
 
              
Property, plant and equipment, net
    
26,956
   
39,956
 
Investment and loans to unconsolidated joint venture
          
864
 
Investment in unconsolidated subsidiary in bankruptcy
    
-
   
-
 
Goodwill, net
   
3,707
   
3,707
 
Deferred income taxes
   
621
   
885
 
Other assets, net
    
643
   
1,415
 
 
  
$
54,250
  
$
67,403
  
 
              
LIABILITIES AND STOCKHOLDERS' EQUITY
              
Current liabilities:
              
Notes payable and current portion of long-term debt
  
$
6,628
  
$
5,282
  
Note payable, guarantee of unconsolidated joint venture debt
    
1,700
       
Current portion of capital lease obligations
    
1,137
   
1,051
 
Accounts payable
    
7,546
   
6,251
 
Accrued expenses
    
6,251
   
5,999
 
Taxes payable
    
722
   
108
 
Current portion of deferred gain on sale-leaseback
    
184
       
Total current liabilities
    
24,168
   
18,691
 
 
              
Long-term debt, excluding current portion
    
-
   
1,827
 
Capital lease obligations, excluding current obligations
    
2,694
   
15,313
 
Deferred gain on sale-leaseback, excluding current portion
    
889
       
Excess of loss in investment and loans to unconsolidated joint venture
    
119
   
    
 
Total liabilities
    
27,870
   
35,831
 
 
              
Commitments and contingencies
    
-
   
-
 
 
              
Stockholders' equity:
              
Preferred stock, no par, 50,000,000 shares authorized, none issued or outstanding
              
Common stock, 22,400,000 shares authorized, 8,323,161 issued and 7,502,561 outstanding
   
37,466
   
37,507
 
Deficit
    
(8,539
)
  
(3,388
)
Treasury stock, 542,101 shares at cost
    
(2,547
)
  
(2,547
)
Total stockholders' equity
    
26,380
   
31,572
 
 
  
$
54,250
  
$
67,403
  

See accompanying notes to the consolidated financial statements
 

ELAMEX, S.A. DE C.V. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(IN THOUSANDS OF U.S. DOLLARS EXCEPT PER SHARE DATA)


   
2004
 
2003
 
2002
 
               
Net sales
  
$
97,587
  
$
157,250
  
$
134,269
  
Cost of sales
    
74,566
   
139,336
   
120,142
 
Gross profit
    
23,021
   
17,914
   
14,127
 
 
                    
Operating expenses:
                    
General and administrative
    
5,610
   
9,198
   
7,092
 
Selling
    
7,053
   
7,009
   
4,179
 
Distribution
    
10,367
   
9,463
   
4,149
 
Impairment of long lived assets
    
330
   
13,235
       
Goodwill impairment
              
8,120
            
Total operating expenses
    
23,360
   
47,025
   
15,420
 
Operating loss
    
(339
)
  
(29,111
)
  
(1,293
)
 
                    
Other (expense) income:
                    
Interest expense
    
(2,169
)
  
(3,503
)
  
(1,774
)
Gain on sale of certain Shelter operations
          
1,680
       
Other, net
    
142
   
852
   
(1,533
)
Total other expense
    
(2,027
)
  
(971
)
  
(3,307
)
 
                    
Loss before income taxes, equity in losses of unconsolidated joint venture and cumulative effect of change in accounting principle
    
(2,366
)
  
(30,082
)
  
(4,600
)
 
                    
Income tax provision (benefit)
    
1,377
   
2,419
   
(561
)
 
                    
Loss before equity in losses of unconsolidated affiliates and cumulative effect of change in accounting principle
    
(3,743
)
  
(32,501
)
  
(4,039
)
 
                    
Equity in losses of unconsolidated affiliates, net of tax
    
1,408
   
2,107
   
1,125
 
 
                    
Loss before cumulative effect of change in accounting principle
    
(5,151
)
  
(34,608
)
  
(5,164
)
                     
Cumulative effect of change in accounting principle, net of tax
    
   
   
   
   
(853
)
                     
Net loss
  
$
(5,151
)
$
(34,608
)
$
(6,017
)
 
                    
Other comprehensive income, net of income tax
                        
379
 
Comprehensive loss
  
$
(5,151
)
$
(34,608
)
$
(5,638
)
 
                    
Net loss per share, basic and diluted before cumulative effect of change in accounting principle
  
$
(0.69
)
$
(4.61
)
$
(0.72
)
                     
Cumulative effect of change in accounting principle, net of tax
    
   
   
   
 
$
(0.12
)
Net loss per share, basic and diluted
  
$
(0.69
)
$
(4.61
)
$
(0.84
)
                     
Shares used to compute net loss per share, basic and diluted
    
7,502,561
   
7,505,257
   
7,188,431
 
 
See accompanying notes to the consolidated financial statements


ELAMEX, S.A. DE C.V. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(IN THOUSANDS OF U.S. DOLLARS)


   
Common Stock
 
(Deficit)
      
Accumulated Other
 
Total
 
   
Shares Outstanding
 
Amount
 
Retained Earnings
 
Treasury Stock
 
Comprehensive Loss
 
Stockholders' Equity
 
                           
BALANCE, JANUARY 1, 2002
   
6,866,100
 
$
35,060
  
$
37,237
  
$
(2,518
)
$
(379
)
$
69,400
  
                                       
Common stock issued in purchase acquisition
   
923,161
   
2,865
                     
2,865
 
                                       
Common stock under escrow agreement
   
(278,499
)
  
(962
)
                    
(962
)
                                       
Net loss
               
(6,017
)
              
(6,017
)
                                       
Stock options vested
          
321
                      
321
  
                                       
Permanent impairment on investment securities
   
    
   
     
   
    
   
     
   
379
   
379
 
                                       
BALANCE, DECEMBER 31, 2002
   
7,510,762
   
37,284
   
31,220
   
(2,518
)
        
65,986
 
                                       
Treasury stock
   
(8,201
)
              
(29
)
        
(29
)
                                       
Net loss
               
(34,608
)
              
(34,608
)
                                       
Stock options vested
          
223
                      
223
  
BALANCE, DECEMBER 31, 2003
   
7,502,561
   
37,507
    
(3,388
)
  
(2,547
)
      
31,572
 
                                       
Net loss
               
(5,151
)
              
(5,151
)
                                       
Stock options forfeited, net
          
(41
)
                    
(41
)
BALANCE, DECEMBER 31, 2004
   
7,502,561
 
$
37,466
  
$
(8,539
)
$
(2,547
)
      
$
$ 26,380
  
 
See accompanying notes to the consolidated financial statements


ELAMEX, S.A. DE C.V. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(IN THOUSANDS OF U.S. DOLLARS)
 
   
2004
 
2003
 
2002
 
Cash flows from operating activities:
              
Net loss
  
$
(5,151
)
$
(34,608
)
$
(6,017
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
                    
Depreciation and amortization
    
3,134
   
6,085
   
4,750
 
Gain on sale of certain Shelter operations
          
(1,680
)
      
Cumulative effect of change in accounting principle
                
853
 
Provision for doubtful trade accounts receivable
    
111
   
1,294
   
141
 
Goodwill impairment loss
          
8,120
       
Provision for excess and obsolete inventory
    
31
         
1,176
 
Equity in loss of unconsolidated affiliates
    
1,408
   
2,107
   
1,125
 
Permanent impairment on investment securities
                
563
 
Deferred income tax expense (benefit)
    
264
   
1,326
   
(548
)
Losses on disposal-impairment of property, plant and equipment
    
330
   
13,235
   
613
 
Provision for guarantee of unconsolidated joint venture debt
    
1,700
              
Change in operating assets and liabilities, net of effects from deconsolidation of Precision in 2003 and acquisition of Franklin in 2002:
                    
Trade accounts receivable
    
(2,320
)
  
1,719
   
2,642
 
Other receivables
    
342
   
(901
)
  
1,777
 
Inventories
    
(907
)
  
1,013
   
(4,167
)
Refundable income taxes
    
737
   
1,117
   
870
 
Prepaid expenses
    
32
   
396
   
(304
)
Other assets
    
772
   
(71
)
  
(4,686
)
Accounts payable
    
1,295
   
1,671
   
839
 
Accrued expenses
   
211
   
1,384
   
(1,192
)
Taxes payable
    
614
   
30
   
11
 
Other liabilities
                
(57
)
Net cash provided by (used in) operating activities
    
2,603
    
2,237
   
(1,611
)
 
                    
Cash flows from investing activities:
                    
Purchase of property, plant and equipment
    
(929
)
  
(6,433
)
  
(6,237
)
Investment in joint venture
    
(425
)
  
(1,175
)
  
(1,550
)
Cash effects of deconsolidation of affiliates
          
(71
)
      
Acquisition of Franklin, net of cash acquired
                
(2,753
)
Proceeds from sale of certain Shelter operations
          
1,800
       
 Net cash used in investing activities
    
(1,354
)
  
(5,879
)
  
(10,540
)
 
                    
Cash flows from financing activities:
                    
Proceeds from notes payable and long term-debt
        
1,839
   
7,795
 
Payments on notes payable and long term-debt
    
(481
)
  
(3,912
)
  
(3,124
)
Principal repayments of capital lease obligations
    
(995
)
  
(905
)
  
(451
)
 Net cash (used in) provided by financing activities
    
(1,476
)
  
(2,978
)
  
4,220
 
 
                    
Net decrease in cash and cash equivalents
    
(227
)
  
(6,620
)
  
(7,931
)
 
                    
Cash and cash equivalents, beginning of period
    
2,299
   
8,919
   
16,850
 
Cash and cash equivalents, end of period
  
$
2,072
  
$
2,299
  
$
8,919
  
See accompanying notes to the consolidated financial statements

 
ELAMEX, S.A. DE C.V. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(IN THOUSANDS OF U.S. DOLLARS)

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
 
   
2004
 
2003
 
2002
 
               
Interest paid, net of amounts capitalized of $0, $136 and $106 for 2004, 2003 and 2002, respectively
  
$
2,126
  
$
2,709
  
$
3,826
  
Income taxes paid
  
$
1,582
  
$
823
  
$
393
  
                     
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCIAL ACTIVITIES:
                    
                     
Lease modification, sale -leaseback treatment of production plant
                    
 Property, plant and equipment
  
$
(10,413
)
            
 Obligations under related party capital lease
  
$
11,539
              
 Deferred gain on sale-leaseback transaction
  
$
1,126
              
                     
                     
Forfeited and vested stock options
  
$
(41
)
$
223
  
$
321
  
                     
                     
The Company discontinued consolidation of its Metal Stamping Segment (Precision) as of December 19, 2003. In conjunction with the deconsolidation, assets and liabilities removed from the consolidated balance sheet were as follows:
                    
                     
 Assets removed net of cash
        
$
32,198
        
 Liabilities removed
          
(32,269
)
      
 Net cash effect of deconsolidation
        
$
(71
)
      
                     
                     
Stock received for employee loan
        
$
29
        
                     
                     
The Company purchased Franklin in 2002. In conjunction with the acquisition, the fair value of assets acquired and liabilities assumed were as follows:
                    
                     
 Fair value of assets acquired
              
$
37,569
  
 Liabilities assumed
                
(32,913
)
 Common stock issued, net of amounts in escrow
                
(1,903
)
 Net cash paid
              
$
2,753
  


ELAMEX, S.A. DE C.V. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
(IN THOUSANDS OF U.S. DOLLARS)


1. ORGANIZATION AND BASIS OF PRESENTATION

COMPANY BACKGROUND - Elamex, S.A. de C.V. and its subsidiaries (“Elamex” or the “Company”) are a group of Companies in Mexico and the United States that provide manufacturing, packaging and distribution services. The Company provides customized manufacturing services in the candy and nut industry. The Company's manufacturing machinery and equipment are located in facilities in Ciudad Juarez, in Mexico, and in El Paso, Texas in the United States.

On December 19, 2003 the Metal Stamping segment, a wholly owned subsidiary, Precision Tool, Die and Machine Company ("Precision"), voluntarily filed for protection under Chapter 11 of the Federal Bankruptcy Code in the U.S. Bankruptcy Court to implement a restructuring of its debt. Also, in December 2003 the Company’s Board of Directors authorized the sale of Precision. As a consequence of seeking protection under bankruptcy laws, the Company no longer controls Precision’s operations as of December 19, 2003. The Company’s investment in Precision was deconsolidated and was recognized in accordance with the equity method of accounting in 2003. Due to the bankruptcy activity during 2004, the Company had no significant influence on Precision’s operations and changed from the equity method to the cost method with no effect on net loss.

In July 2002, the Company acquired the new Food Products segment, which is Mt. Franklin Holdings LLC and subsidiaries (“Franklin”). Franklin operates a retail nut and foodservice nut packaging and marketing company located in El Paso, Texas, and a candy manufacturing and packaging facility located in Ciudad Juarez, Mexico (see Note 3).

The Company is a subsidiary of Accel, S.A. de C.V. (Accel), which owns approximately 57.7% of the Company's issued and outstanding common shares at December 31, 2004.

BASIS OF PRESENTATION - These consolidated financial statements and the accompanying notes are prepared in U.S. dollars, the functional and reporting currency of Elamex.

PRINCIPLES OF CONSOLIDATION - The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (U.S.) and include the accounts of the Company and its wholly-owned and majority-owned, controlled subsidiaries. All significant intercompany balances and transactions are eliminated in consolidation.

Effective December 19, 2003, the results of operations of Precision, (Metal Stamping Segment) which was previously consolidated are being reported on the cost method. This was due to the voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy code.

Unaudited financial information for Precision as of and for the years ended December 31, 2004 and 2003 is as follows:

   
2004
  
2003
  
   
(In Thousands of U.S. Dollars)
  
Current assets
  
$
9,052
  
$
13,188
  
Non current assets
    
15,476
    
17,860
 
Current liabilities
    
29,067
   
32,547
  
Net sales
    
65,406
    
72,019
  
Gross margin
    
1,899
    
(1,861
)
Net loss
    
(2,246
)
  
(16,709
)

During the fourth quarter of 2003 Precision encountered circumstances that indicated that its carrying value may not
be recoverable, as such, the Company engaged an independent company to assist in the valuation of long-lived assets for impairment. Based on the analysis of future cash flows of the assets group the Company reported an impairment of Precision’s long-lived assets of $13.2 million in December 2003. This impairment is recorded in the statement of operations as impairment of long-lived assets.


During 2003 the Company loaned Precision $1.5 million in the form of a note receivable, to meet working capital needs. At December 31, 2004, the Company had notes receivable from Precision of $1.5 million.

The Company’s share of undistributed equity net of amounts receivable from Precision at December 31, 2004 and 2003 was $0.

Elamex also has a 50.1% investment in Qualcore, S. de R.L. de C.V., the “Joint Venture”, which manufactures plastics parts and metal parts with General Electric International Mexico, S.A. de C.V. and General Electric Mexico, S.A. de C.V. (jointly referred to as “GE Mexico”). Qualcore is jointly managed with GE Mexico and the investment in the Joint Venture is recorded under the equity method.

Audited financial information for Qualcore as of and for the years ended December 31, 2004 and 2003 is as follows:

   
(In Thousands of U.S. Dollars)
 
   
2004
  
2003
  
Current assets
  
$
6,050
  
$
3,473
  
Non current assets
    
3,908
    
9,232
 
Current liabilities
    
17,622
   
11,888
  
Net sales
    
24,126
    
18,798
  
Gross margin
    
(953
)
  
(2,067
)
Net loss
    
(6,805
)
  
(3,958
)

During 2004 and 2003 the Company loaned Qualcore $425 thousand and $1.0 million, respectively, in the form of a note receivable to meet working capital needs. At December 31, 2004 and 2003, the Company had notes receivable from Qualcore of $2.7 million and $2.3 million, respectively.

The Company’s share of undistributed equity (deficiency) net of amounts receivable from Qualcore at December 31, 2004 and 2003 was $(19) thousand and $864 thousand, respectively.

In September 2005, GE Mexico’s management and Elamex’s management approved the decision to cease the Joint Venture’s operations. In October 2005, most of its employees were terminated, except for three individuals that will complete the final administrative activities of the Joint Venture. The Joint Venture also sold most of its machinery and equipment, except for certain low-value assets. GE Mexico’s management and Elamex’s management are discussing the future operations of the Joint Venture.


MANAGEMENT ESTIMATES - The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make certain estimates that affect the reported amounts of assets and liabilities and 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 these estimates.
 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

CHANGE IN ACCOUNTING PRINCIPLE - As of January 1, 2002 the Company adopted Statement of Financial Accounting Standards No. 142 (“SFAS No. 142”), “Goodwill and Other Intangible Assets” which requires, among other things, the discontinuance of amortization of goodwill and intangible assets with indefinite lives. In addition, the standard includes provisions for the reclassification of certain existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential impairments of goodwill. SFAS No. 142 also required the Company to complete a transitional goodwill impairment test six months from the date of adoption. The result of the non-amortization provision of SFAS No. 142 was a decrease in the net loss of $492 thousand for the year ended December 31, 2002.

The Company engaged an independent company to assist in the valuation of goodwill assigned to Precision. The fair value of the operating entity was determined using a discounted cash flow model. Based on the analysis performed the Company completed its implementation analysis of goodwill arising from prior acquisitions and recorded an impairment charge of $853 thousand in the first quarter of 2002, which was recorded as a cumulative effect of change in accounting principle.

The Company completed its annual impairment test during the first quarter of 2003 and reported an impairment of goodwill of $3.6 million. The goodwill affected by the impairment analysis is that recorded at the time of the acquisition of Precision Tool, Die and Machine Co. in 1999. The primary reason for the impairment was an increase in required capital expenditures necessary to replace aging equipment and new capital for business expansion. The Company has elected to annually test goodwill for impairment during the first quarter of the year and whenever an indication of impairment occurs. As a consequence of the voluntary petition for reorganization under Chapter 11 of the U.S. Bankruptcy code filed by Precision the Company tested the value of the goodwill in December 2003 and determined an additional impairment of goodwill of $4.5 million for Precision goodwill. After impairment, goodwill remaining on the books is approximately $3.7 million of goodwill recorded during the third quarter of 2002 as a result of the acquisition of Mt. Franklin Holdings (See Note 3). The Company completed its annual impairment test of the Franklin goodwill in the first quarter of 2004 and determined that there was no impairment of goodwill.

CASH AND CASH EQUIVALENTS - The Company considers all highly liquid debt instruments and investments purchased with an original maturity of three months or less to be cash equivalents. Cash includes deposits in Mexican banks, denominated in Mexican Pesos (“Pesos”), of approximately $199 thousand and $0 thousand at December 31, 2004 and 2003, respectively. The Company had approximately $1.9 million and $2.3 million at December 31, 2004 and 2003, respectively, in short-term repurchase agreements, denominated in U.S. dollars, deposited in U.S. banks.

CONCENTRATION OF CREDIT RISK - Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash and accounts receivable. The Company monitors the risk of having deposits in bank in excess of the Federal Deposit Insurance Corporation limits and does not anticipate any losses. The Company performs ongoing credit evaluations of its customers and generally does not require collateral to support amounts due for the sale of its products.

ALLOWANCE FOR DOUBTFUL ACCOUNTS - The Company maintains an allowance for doubtful accounts based on its best estimate of accounts receivable considered to be uncollectible.

An analysis of the activity in the allowance for doubtful accounts for the years ended December 31, 2004, 2003 and 2002 is as follows:
 
   
2004
  
2003
  
2002
  
   
(In Thousands of U.S. Dollars)
  
Beginning balance
  
$
1,275
  
$
654
  
$
649
  
Additions charged to expense
    
111
    
1,294
   
141
 
Accounts written off
    
(85
)
  
(159
)
  
(136
)
Precision balance deconsolidated
    
  
   
(514
)
           
Ending balance
  
$
1,301
  
$
1,275
  
$
654
  
 

FOREIGN CURRENCY TRANSLATION - The functional currency of the Company is the U.S. dollar, the currency of the primary economic environment in which the Company operates. Gains and losses on foreign currency transactions and remeasurement of balance sheet amounts are reflected in net income. Included in other, net on the accompanying consolidated statements of operations are foreign exchange losses of $46 thousand, $211 thousand, and $328 thousand for the years ended December 31, 2004, 2003, and 2002, respectively. Assets and liabilities of the Company are denominated in U.S. dollars except for certain amounts as indicated below. Certain balance sheet amounts (primarily inventories, property, plant and equipment, accumulated depreciation, prepaid expenses, and common stock) denominated in other than U.S. dollars are remeasured at the rates in effect at the time the relevant transaction was recorded, and all other assets and liabilities are remeasured at rates effective as of the end of the related periods. Revenues and expenses denominated in other than U.S. dollars are remeasured at weighted-average exchange rates for the relevant period the transaction was recorded. Assets and liabilities denominated in Pesos are summarized as follows in thousands of U.S. dollars at the exchange rate published in the Diario Oficial de la Federacion (the Official Gazette of the Federation), which is the approximate rate at which a receivable or payable can be settled as of each period end:
 
   
2004
 
2003
 
   
(In Thousands of U.S. Dollars)
 
Cash and cash equivalents
  
$
199
  
$
  
Other receivables
    
509
   
854
 
Prepaid expenses and refundable taxes
    
342
   
1,282
 
Other assets, net
    
4
   
5
 
Accounts payable
    
(309
)
  
(189
)
Accrued expenses and other liabilities
    
(1,231
)
  
(546
)
Net foreign currency position
  
$
(486
)
$
1,406
  

In addition, the Company has recorded a net deferred tax liability pursuant to Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes (see Note 10). The recorded net deferred tax asset of $621 thousand and $885 thousand at December 31, 2004 and 2003 respectively, represent the net dollar value of amounts provided for temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective Mexican and U.S. tax bases.


FOREIGN EXCHANGE INSTRUMENTS - The Company maintains a policy of not engaging in futures contracts with the purpose of hedging U.S. dollar/Peso revenues or costs, with the exception of regular treasury operations to cover operating requirements for up to 30 days. The Company had no open hedge contracts at December 31, 2004 or 2003.

INVENTORIES - Inventories are stated at the lower of cost or market. Cost is determined using a moving weighted average. Inventory cost includes material, labor and overhead. Inventory reserves, which are charged to cost of sales, are provided for excess inventory, obsolete inventory, and for differences between inventory cost and its net realizable value.

PROPERTY, PLANT AND EQUIPMENT - Property, plant and equipment are stated at cost, less accumulated depreciation and amortization. Plant and equipment under capital leases are stated at the lower of their fair value at the inception of the lease or the present value of minimum lease payments. Depreciation and amortization are calculated using the straight-line method over the shorter of related lease terms or estimated useful lives of the assets. The Company charges amounts expended for maintenance and repairs to expense and capitalizes expenditures for major replacements and improvements.

LONG-LIVED ASSETS - The Company measures impairment losses on long-lived assets, including goodwill, when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. The Company measures impairment loss as the difference between the carrying value and the fair value of the asset.
 

STOCK-BASED COMPENSATION - The Company accounts for the stock option plans under APB Opinion No. 25, under which compensation cost of $(42) thousand and $223 thousand were recognized in 2004 and 2003, respectively. No additional compensation expense will be expensed in the future in connection with these options. Had compensation cost for these plans been determined consistent with SFAS No. 123, “Accounting for Stock Based Compensation”, the Company’s net loss and loss per share for the year ended December 31, 2004, 2003 and 2002, would have been adjusted to the following pro forma amounts:

   
(In Thousands of U. S. Dollars, Except per Share Data)
 
   
2004
 
2003
 
2002
 
               
Net loss as reported
 
$
(5,151
)
$
(34,608
)
$
(6,017
)
                     
Stock based employee compensation expense included in reported net loss
   
(42
)
  
223
   
321
 
                     
Total stock-based employee compensation expense determined under fair value based method
   
46
   
(282
)
  
(440
)
Pro forma net loss
 
$
(5,147
)
$
(34,667
)
$
(6,136
)
                     
Loss per share Basic and Diluted
                   
As reported
 
$
(0.69
)
$
(4.61
)
$
(0.84
)
Pro forma
   
(0.69
)
  
(4.62
)
  
(0.85
)


BASIC AND DILUTED NET LOSS PER SHARE - Basic and diluted net loss per share of common stock is calculated by dividing net loss by the weighted-average number of common shares outstanding for the year. Dilutive stock options for the years ended December 31, 2004 and 2003 have not been included in the calculation as their effect would be antidilutive due to the net loss.

INCOME TAXES - The Company accounts for income taxes under the asset and liability method, as required by SFAS No. 109. Under the asset and liability method, 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 in income in the period that includes the enactment date.
Provisions for taxes are made based upon the applicable tax laws of Mexico and the United States. Deferred tax assets and liabilities are not provided for differences related to assets and liabilities that are remeasured from Pesos into U.S. dollars using historical exchange rates and that result from inflation indexing for Mexican tax purposes or exchange rate changes.

REVENUE RECOGNITION - For metal stamping and food products, sales are recognized at the time the order is shipped in satisfaction of customer orders. For contract manufacturing, sales are recognized when the order is shipped for manufacturing contracts and over the contract period for assembly services. Anticipated losses on assembly services contracts are charged to operations as soon as they are determined.

EMPLOYEE STATUTORY PROFIT-SHARING - A provision for deferred employee statutory profit-sharing in Mexico is computed on income subject to employee statutory profit-sharing, which differs from net income, due to certain differences in the recognition of income and expenses for statutory profit-sharing and financial statement purposes. There has been no employee statutory profit-sharing expense for the years ended December 31, 2004, 2003, and 2002, respectively.

POST-RETIREMENT BENEFITS - Employees in Mexico are entitled to certain benefits upon retirement after 15 years or more of service (seniority premiums), in accordance with the Mexican Federal Labor Law. The benefits are accrued as a liability and recognized as expense during the year in which services are rendered.
 

FINANCIAL INSTRUMENTS - The carrying amounts of financial instruments, including cash and cash equivalents, receivables, accounts payable, accrued expenses, notes payable, taxes payable, and amounts due to related parties, approximated fair value as of December 31, 2004 because of the relatively short maturity of these instruments. The fair values of floating rate long-term debt are estimated to be equivalent to their carrying amount based on current market conditions.

ACCRUED REBATES - The Company enters into contractual agreements for rebates on certain products with its customers. Such amounts are netted against sales and included in accrued advertising and promotions based on management estimates at the date the sales occur.

PREPAID SLOTTING ALLOWANCES - Prepaid slotting allowances consist of payments to customers for store shelf space and distribution agreements and are amortized to sales revenue, using the straight line method over the term of the customer contract or proportionally with sales recorded, based on the nature of the slotting contract. Contracts generally vary in length from one to seven years and provide for fixed payments or payments upon achievement of sales benchmarks. Prepaid slotting allowances of $652 thousand and $1.3 million are included on the balance sheet as other assets at December 31, 2004 and 2003 respectively.

RECENT ACCOUNTING PRONOUNCEMENTS -  
 
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (revised 2004) (“Statement 123(R)”), “Share-Based Payment”, which revised Statement No. 123, “Accounting for Stock-Based Compensation”. This statement supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”. The revised statement addresses the accounting for share-based payment transactions with employees and other third parties, eliminates the ability to account for share-based compensation transactions using APB 25, and requires that the compensation costs relating to such transactions be recognized in the consolidated statement of operations. The revised statement is effective as of the first interim period beginning after June 15, 2005. The Company is allowed to select from three alternative transition methods, each having different reporting implications. The Company has not completed its evaluation of the methods of adopting Statement 123(R). Accordingly, the impact of adoption of Statement 123(R) cannot be predicted at this time because it will depend on the method of adoption selected and on levels of share-based payments granted in the future. However, had the Company adopted Statement 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net loss and net loss per share in the stock-based compensation accounting policy note included in the consolidated financial statements.
 
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 153 (“Statement 153”), “Exchanges of Nonmonetary Assets—an amendment of APB Opinion No. 29”. Statement 153 amends the guidance in APB Opinion No. 29, “Accounting for Nonmonetary Transactions”, based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. Statement 153 amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of Statement 153 are effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The provisions of Statement 153 are not expected to have a material effect on the Company’s consolidated financial statements.
 
In November 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 151, Inventory Costs—An Amendment of ARB No. 43, Chapter 4 (“SFAS 151”).  SFAS 151 amends the guidance in ARB No. 43, Chapter 4, Inventory Pricing , to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage).  Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight, and rehandling costs be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43.  Additionally, SFAS 151 requires that the allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities.  SFAS 151 is effective for fiscal years beginning after June 15, 2005 and is required to be adopted by the Company on January 1, 2006.  The company is currently evaluating the effect that the adoption of SFAS 151 will have on its consolidated results of operations and financial condition but does not expect SFAS 151 to have a material impact.
 

RECLASSIFICATIONS - Certain prior year amounts have been reclassified to conform to the 2004 financial statement presentation.


3. ACQUISITIONS AND DISPOSITION OF ASSETS

Effective at the close of business on July 4, 2003, the sale of certain assets was made to TECMA Group LLC, a private contract, shelter and manufacturing services provider headquartered in El Paso, Texas. The transaction included the sale of five Shelter Services customer contracts, miscellaneous assets and stock of five newly created companies. Substantially all Shelter Services operations personnel related to these contracts were transferred to the buyer. Elamex received approximately $1.8 million in cash. In connection with the disposition the Company transferred assets with a book value of $120 thousand to the buyer and recorded a gain of $1.7 million. The Company incurred other costs of approximately $575 thousand associated with the sale, which were included in operating expenses in the 2003 results of operations.

On July 18, 2002, Elamex USA, Corp. (“Elamex USA”), a wholly owned Delaware subsidiary of Elamex, completed the acquisition of Mt. Franklin Holdings, LLC (“Franklin”), Franklin Food Products LLC and the merger of Reprop Corporation with and into Elamex USA. The effective closing date for tax and accounting purposes was the close of business on June 28, 2002. Franklin operates a retail nut and foodservice nut packaging and marketing company, whose operations are located in El Paso, Texas and a candy manufacturing and packaging facility in Ciudad Juarez, Mexico. The purchase price was cash payment of $1,445,040 and 923,161 restricted shares of the common stock of Elamex. 278,499 of these shares were contingent and subject to escrow agreements, which required Franklin to reach certain income levels through December 31, 2003. Franklin did not reach the required income level; therefore the 278,499 shares in escrow will be canceled or used for a different purpose.

The unaudited proforma combined historical results of the Company, as if Franklin had been acquired at the beginning of fiscal 2002, are estimated in the following table:

   
(In Thousands of U.S. Dollars, Except Per Share Data)
  
   
December 31, 2002
  
Net sales
 
$
151,179
  
Gross profit
   
18,077
 
Net loss
   
(11,090
)
Net loss per share
   
(1.48
)

The above pro forma results include adjustments to give effect to intercompany sales, depreciation and other purchase price adjustments. The pro forma results are not necessarily indicative of the operating results that would have occurred had the acquisition been consummated as of the beginning of the period presented, nor are they necessarily indicative of future operating results.


4. INVENTORIES

Inventories consist of the following:
 
   
(In Thousands of U.S. Dollars)
  
   
2004
  
2003
  
Raw materials
 
$
2,560
  
$
1,841
  
Packaging supplies
   
2,446
   
2,140
 
Work-in-process
   
386
   
260
 
Finished goods
   
3,967
   
4,220
 
Sub total
   
9,359
   
8,461
 
Less reserve for excess and obsolete inventory
   
(562
)
  
(540
)
Total
 
$
8,797
  
$
7,921
  
 

The provision for excess and obsolete inventory is charged against cost of sales. An analysis of the excess and obsolete inventory reserve for the years ended December 31 is as follows:

   
2004
  
2003
  
2002
  
   
(In Thousands of U.S. Dollars)
  
               
Beginning balance
 
$
540
  
$
1,011
  
$
25
  
Additions charged to expense
   
31
         
1,176
 
Inventory disposed during the year
   
(9
)
  
(151
)
  
(190
)
Metal Stamping deconsolidation
         
(320
)
      
Ending balance
 
$
562
  
$
540
  
$
1,011
  


6. PROPERTY, PLANT AND EQUIPMENT

A summary of property, plant and equipment is as follows:

       
2004
  
2003
  
 
  
Estimated useful lives
  
(In Thousands of U.S. Dollars)
  
   
(Years)
          
Land
     
$
4,392
  
$
7,084
  
Buildings
  
20
    
23,268
   
31,154
 
Machinery and equipment
  
3-10
    
12,622
   
12,350
 
Vehicles
  
5
    
42
   
42
 
Subtotal
         
40,324
   
50,630
 
                     
Less accumulated depreciation
         
(13,368
)
  
(10,674
)
                     
Total
       
$
26,956
  
$
39,956
  


7. NOTES PAYABLE AND LONG-TERM DEBT

The following is a summary of notes payable and long-term debt at December 31, 2004 and 2003.

   
2004
  
2003
  
Line of credit with interest-only payments through April 30, 2005 at the bank's prime rate plus 0.75% (6.5% and 4.75% at December 31, 2004 and 2003, respectively); collateralized with substantially all assets of Franklin. Unused available credit as of December 31, 2004 is $2.2 million (1)
  
$
4,793
  
$
4,969
  
Building loan - note payable to a bank due in monthly installments of $34 thousand , including interest at the bank's prime rate plus 0.75% (6.0% and 4.75% at December 31, 2004 and 2003) through July 24, 2005; collateralized by substantially all assets of Franklin, net of unamortized loan fees of $2 thousand (1)
   
1,835
   
2,140
 
               
Total notes payable and long term debt
    
6,628
   
7,109
 
               
Less: Current maturities of notes payable and long-term debt
   
(6,628
)
  
(5,282
)
               
 
   $  -  
$
1,827
  
All notes payable and long-term debt mature during the year ending December 31, 2005.

 
(1)
In connection with the long-term debt and line of credit, Franklin is required to comply with certain financial covenants including minimum tangible net worth. As of December 31, 2004 Franklin was incompliance with such financial covenants. The company is in discussions with the bank to refinance its revolving note payable and its building loan.


8. LEASES

Prior to September 16, 2004, the Company financed, via a capital lease arrangement with a related party, a candy production plant located in Juarez, Mexico. This arrangement specified that, at the end of the lease term in November 2010, the Company would purchase the building at a specified price. On September 16, 2004, the Company and the related party entered into an agreement eliminating the purchase commitment. The transaction resulted in a deemed sale and subsequent leaseback of the property through the original lease term. At the date of the lease modification, land and buildings with a net book value aggregating $2.4 million and $8.1 million, respectively, and the related obligation under capital leases of $11.5 million were removed resulting in a deferred gain of $1.1 million. The deferred gain is being amortized through the remaining lease term ending in November 2010. For the year ended December 31, 2004, the amount of deferred gain recognized amounted to $53 thousand.

The Company utilizes certain machinery and equipment and occupies certain buildings under both capital and operating lease arrangements that expire at various dates through 2010, some of which have renewal options for additional periods. Rental expense under these operating lease agreements aggregated $6.9 million, $6.7 million, and $7.9 million for the years ended December 31, 2004, 2003, and 2002, respectively.

Future minimum lease obligations at December 31, 2004 having an initial or remaining term in excess of one year are as follows:
Year
  
Capital
  
Operating
  
   
(In Thousands of U.S. Dollars)
  
           
2005
  
$
1,397
  
$
3,062
  
2006
    
2,776
   
3,123
 
2007
          
3,106
 
2008
          
3,106
 
2009
          
3,106
 
Thereafter
    
    
   
9,793
 
Total minimum lease payments
    
4,173
 
$
25,296
  
               
Less amount representing interest at 7.83%
   
(342
)
      
Present value of minimum lease payments
    
3,831
       
Less current portion
    
(1,137
)
      
Long-term capital lease obligations
  
$
2,694
        

The Company leases manufacturing facilities to unrelated parties under operating lease agreements. The Company pays certain taxes on the properties and provides for general maintenance.

Rental income was $1.7 million, $1.5 million, and $882 thousand for the years ended December 31, 2004, 2003, and 2002, respectively. The future minimum rental income to be received under these operating leases is $1.7 million in 2005.


9. INCOME TAXES

Mexican tax legislation requires that companies pay a tax calculated as the greater of tax resulting from taxable income or tax on the value of certain assets less certain liabilities (asset tax). Taxes resulting from net income are calculated using Mexican tax regulations, which define deductibility of expenses and recognize certain effects of inflation.

Effective January 1, 1999, a tax rate was enacted in Mexico whereby the corporate tax rate was 35%. An amount equal to 30% is paid on taxable earnings reinvested in the Company and 5% on those earnings when they are distributed in the form of dividends for the year ended December 31, 2001.


On December 1, 2004, certain amendments to the tax and asset tax laws were enacted and are effective as of 2005. The most significant amendments are as follows: (a) the tax rate will be reduced to 30% in 2005, 29% in 2006 and 28% in 2007 and forward; (b) for purposes of the calculation of income tax, purchases of inventory are deductible only after being sold; the tax law previously allowed for the immediate deduction of all inventory purchases in the year acquired; (c) companies must establish a tax basis for their inventory balances as of December 31, 2004 using the specific costing methods allowed by the amendments to the tax law; companies may elect to ratably step-up such tax basis of inventories over a period from 4 to 12 years, as determined in conformity with the respective tax rules, which include deducting from the tax basis certain items such as unamortized tax loss carryforwards; (d) beginning January 1, 2006, paid employee statutory profit sharing will be fully deductible for tax purposes; (e) bank liabilities and liabilities with foreign entities are deductible in the determination of the asset tax taxable base, thereby decreasing the base on which the asset tax is calculated.


The tax provision differs from the statutory tax rate of 33% in 2004 and 34% for 2003 and 35% for 2002 on taxable income as follows:

   
2004
  
2003
  
2002
 
               
Taxes at Statutory Rate of 33%
    
33.0
%
  
34.0
%
  
35.0
%
Permanent Differences
                    
Asset Tax Expense
    
(66.9
)
  
(3.1
)
  
1.7
  
Foreign Currency Gains/Losses
    
(5.7
)
  
(1.2
)
  
(35.6
)
Loss of Subsidiary Not Recognized
                    
Non-Deductible Expenses
    
(0.8
)
        
(3.0
)
Inflationary Effects
    
28.1
    
1.0
    
10.3
  
Inflationary Effects - Fixed assets
    
15.6
    
0.6
    
8.2
  
Expiration of Tax Loss Carryforwards
                
(7.1
)
Expiration of Asset Tax Credit Carryforwards
          
(1.4
)
  
(11.5
)
Expiration of Capital Loss Carryforwards
          
(6.6
)
      
Effect of Tax Rate Change
    
(7.3
)
        
(2.9
)
State Taxes, net of federal benefit
          
0.9
    
0.6
 
Change in Valuation Allowance (Precision)
          
(14.8
)
      
Change in Valuation Allowance
    
(81.9
)
  
(8.8
)
  
26.5
  
Goodwill Amortization/Impairment
          
(9.2
)
  
(6.3
)
Other
    
27.7
    
0.6
    
(3.7
)
     
(58.2
)%
  
(8.0
)%
  
12.2
%

Income tax expense (benefit) consists of:

   
CURRENT ASSET TAX
  
CURRENT INCOME TAX
  
DEFERRED INCOME TAX
  
TOTAL
  
   
 (In Thousands of U.S. Dollars)
  
                   
Mexican
  
$
1,582
  
$
26
  
$
290
  
$
1,898
  
U.S. Companies
          
(521
)
        
(521
)
Year ended December 31, 2004
  
$
1,582
    
(495
)
$
290
  
$
1,377
  
                           
Mexican
  
$
923
  
$
72
  
$
2,496
  
$
3,491
  
U.S. Companies
          
99
    
(1,171
)
  
(1,072
)
Year ended December 31, 2003
  
$
923
  
$
171
  
$
1,325
  
$
2,419
  
                           
Mexican
  
$
(78
)
$
(485
)
$
1,756
  
$
1,193
  
U.S. Companies
          
(67
)
  
(1,687
)
  
(1,754
)
Year ended December 31, 2002
  
$
(78
)
$
(552
)
$
69
  
$
(561
)
 

The tax effects of significant temporary differences representing deferred tax assets and liabilities are as follows:

   
2004
  
2003
  
   
(In Thousands of U.S. Dollars)
  
Deferred Tax Assets:
          
Asset Tax Credit Carryforward - Mexico
  
$
4,620
  
$
2,400
  
NOL Carryforwards - Mexico
    
3,094
    
3,594
 
NOL Carryforwards - US
    
5,865
    
3,940
 
Capital Loss - US
    
71
    
71
 
Related Party Interest
    
849
    
849
 
Inventory
    
291
    
291
 
Bad Debts
    
583
    
591
 
Stock Option Plan
          
201
 
Accrued Liabilities
    
46
    
26
 
Guarantee
    
510
        
Subtotal
    
15,929
    
11,963
 
Less: Valuation Allowance - Mexico
    
(7,236
)
  
(4,701
)
Less: Valuation Allowance - US
    
(6,839
)
  
(5,115
)
Net Deferred Tax Asset
    
1,854
    
2,147
 
Deferred Tax Liabilities:
              
Property, plant and equipment
    
(815
)
  
(857
)
5% Deferred payment of Taxes - Mexico
    
(365
)
  
(335
)
Other
    
(53
)
  
(70
)
Total Deferred Tax Liabilities
    
(1,233
)
  
(1,262
)
Net Deferred Tax Asset
  
$
621
  
$
885
  

A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized in the future. The valuation allowances of $14.1 million and $9.8 million at December 31, 2004 and December 31, 2003, respectively, relate primarily to certain asset tax credit and tax net operating loss carryforwards of individual Mexican subsidiaries and the entire net deferred tax asset of the US companies. The increase in the valuation allowance at December 31, 2004 to $13.6 million relates primarily to the expiration of certain asset tax credits and capital loss carryforwards of individual Mexican subsidiaries, and the effect of reserving the entire net deferred asset tax related to the US companies. In addition, primarily as a result of the voluntary petition for reorganization filed by Precision under Chapter 11 of the U.S. Bankruptcy Code on December 19, 2003, the Company’s investment in Precision, reported under the equity method of accounting, was reduced by an increase in the valuation allowance against Precision’s underlying deferred tax assets of $4.5 million.

An analysis of the activity of the valuation allowance for the years ended December 31, 2004, 2003 and 2002 is as follows:

   
2004
  
2003
  
2002
  
   
(In thousands of U.S. Dollars)
  
Beginning balance
  
$
9,816
  
$
7,172
  
$
5,972
  
Additions charged to expense (Mexico)
    
2,602
    
2,743
    
1,340
  
Decreases recorded to income (Mexico)
    
(71
)
  
(804
)
  
(2,558
)
Expiration of capital loss carryforwards (Mexico)
          
(1,992
)
      
Additions recorded to goodwill (U.S.)
                
2,418
  
Additions charged to expense (U.S. - Precision)
          
4,465
        
Decrease - deconsolidation of Precision
          
(4,465
)
      
Increase recorded to income (U.S.)
    
1,728
    
2,697
    
   
 
Ending Balance
  
$
14,075
  
$
9,816
  
$
7,172
  
 

The Mexican net asset taxes paid, adjusted for inflation, may be used to offset income taxes that exceed the asset tax due for the year, for ten years following the payment of the tax. These asset tax carryforwards as of December 31, 2004 are $4.6 million and expire on various dates through 2014.


At December 31, 2004, certain of the Mexican companies had tax net operating loss carryforwards that can be utilized only by the Mexican company that incurred the losses. These net operating loss carryforwards, adjusted for inflation, expire as follows, if not utilized to offset taxable income:
 
YEAR
  
AMOUNT
  
   
(In Thousands of U.S. Dollars)
  
2007
  
$
297
  
2010
    
96
  
2011
    
7,011
  
2012
    
2,022
  
2013
    
809
  
2014
    
815
  
   
$
11,050
  

The majority stockholder has filed a consolidated tax return with Elamex's operations since 1995. The tax sharing agreement entered into between the majority stockholder, Accel, S.A. de C.V., and Elamex through 1998 provided that Elamex transfer monthly an amount equal to its estimated tax payment, less credits. Beginning in 1999, the Mexican tax law for consolidation required Elamex and its subsidiaries to pay amounts directly to the Mexican Tax Authority (SHCP) based on their individual tax calculations. The payments are calculated as required by the SHCP as if Elamex and subsidiaries were filing a stand-alone income tax return for such year. The majority stockholder further agrees to reimburse Elamex for use of any of Elamex's tax benefits at the time Elamex would otherwise realize the benefit.

Dividends paid by Mexican companies, which exceed earnings, and profits, as defined by the Mexican income tax law, are subject to a 33% income tax, payable by the Company on 1.5152 times the amount in excess of earnings and profits. Dividends paid which do not exceed earnings and profits are not currently subject to Mexican tax to either the Company or the stockholder. The Mexican companies paid no dividends on common stock in 2004, 2003 and 2002.

10. STOCKHOLDERS’ EQUITY

COMMON STOCK - Under the bylaws and Mexican law, the capital stock of Elamex, S.A. de C.V. must consist of fixed capital and may have, in addition thereto, variable capital. Stockholders holding shares representing variable capital common stock may require the Company, with a notice of at least three months prior to December 31 of the prior year, to redeem those shares at a price equal to the lesser of either (i) 95% of the market price, based on the average of trading prices in the stock exchange where it is listed during the 30 trading days preceding the end of the fiscal year in which the redemption is to become effective or (ii) the book value of the Company's shares as approved at the meeting of stockholders for the latest fiscal year prior to the redemption date. In July 2002, the Company issued 923,161 restricted shares of its authorized variable capital common stock in connection with the acquisition of Mt. Franklin Holdings (see Note 3). Although the variable capital common stock is redeemable by the terms described above, such shares would be classified as a component of stockholders' equity in the consolidated balance sheets. Management believes the variable common stock represents permanent capital because the timing and pricing mechanisms through which a stockholder would exercise this option to redeem are such that a stockholder, from an economic standpoint, would not exercise this option. At the time a stockholder is required to give notice of redemption, the stockholder will not be able to know at what price the shares would be redeemed and would not expect the present value of the future redemption payment to equal or exceed the amount which would be received by the stockholder in an immediate public sale.

Under Mexican law, dividends must be declared in Pesos. If dividends are declared in the future, the Company's intent is to pay the dividends to all stockholders in U.S. dollars, as converted from Pesos as of the date of record, unless otherwise instructed by the stockholder.
 

Mexican law requires that at least 5% of the Company's net income each year (after profit sharing and other deductions required by the law) be allocated to a legal reserve fund, which is not thereafter available for distribution, except as a stock dividend, until the amount of such fund equals 20% of the Company's historical capital stock. The legal reserve fund at December 31, 2004 and 2003 was approximately $1.6 million. The Company anticipates that no additional allocation will be made at its annual stockholders' meeting to be held on April 28, 2005. There were no retained earnings available for dividends under Mexican law at December 31, 2004 and 2003.
 
COMMON STOCK PURCHASE RESTRICTIONS AND PREEMPTIVE RIGHTS - Any person who seeks to acquire ownership of 15% or more of the total outstanding shares of the Company's common stock must receive written consent from the Company's Board of Directors. Should shares in excess of 15% be acquired without permission, the purchaser will be subject to liquidated damages, which will be used by the Company to repurchase stock in excess of the 15% ownership limitation. In addition, in the event that the Company issues additional shares, existing stockholders will have a preemptive right to subscribe for new shares, except when shares are issued in connection with a merger or for the conversion of convertible debentures. The 15,000,000 shares of variable capital are not subject to preemptive rights.

PREFERRED STOCK - Pursuant to the Company's bylaws, the Company's Board of Directors, at its discretion, can issue up to an aggregate of 50,000,000 shares of preferred stock in one or more series. The Board may attach any preferences, rights, qualifications, limitations, and restrictions to the shares of each series issued, including dividend rights and rates, conversion rights, voting rights, terms of redemption, and liquidation preferences. The shares may be issued at no par value or at a par value determined by the Board of Directors.

No shares of preferred stock have been issued as of December 31, 2004.

11. STOCK OPTION PLANS

On April 19, 2002, the shareholders approved the issuance of up to 850,000 Elamex stock options and authorized the Board of Directors to establish the terms and conditions of the grant of the stock options.

On July 19, 2002, the Board of Directors of the Company granted 200,000 stock options at $2.00 per share and 70,730 stock options at $6.00 per share. During the quarter ended September 30, 2004, 200,000 stock options were forfeited due to the termination of a senior executive. During the second and third quarter of 2003, 38,210 and 25,020, options respectively, were forfeited due to the resignation of one of the awarded executives during the second quarter and two awarded executives during the third quarter.
The following is a summary of option activity for the 3 years ended December 31, 2004:

   
Options Under Plan
 
Weighted Average Exercise Price
 
Outstanding at
          
January 1, 2002
          
Granted
    
270,730
  
$
3.05
  
Outstanding at
             
December 31, 2002
   
270,730
 
$
3.05
  
Forfeited
   
(63,230
)
$
6.00
  
Outstanding at
             
December 31, 2003
   
207,500
 
$
2.14
  
Forfeited
   
(200,000
)
$
2.00
  
Outstanding at
             
December 31, 2004
   
7,500
 
$
6.00
  

The following table summarizes information concerning currently outstanding and exercisable options:

Options Outstanding
Exercise Price
Life in Years
Number Exercisable at December 31, 2004
Stock Price at Grant Date
7,500
$6.00
10
-
$5.35
 

The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model using the following assumptions; risk free interest rate of 2.68%; expected dividend yield of 0.0%; expected life of 5 years and expected volatility of 61%.

In addition to the above, Franklin, a subsidiary of the Company has an options plan in shares of the subsidiary. There are 50,000 options outstanding under this plan with an exercise price of $12.87. No compensation expense has been recorded in connection with this plan. Also, based on an analysis of these options using the Black-Scholes method, the Company believes the fair value of such options is zero and no pro forma expense is recorded in connection with these options.

12. EMPLOYEE BENEFIT PLANS

The Company and its subsidiaries sponsor 401(k) defined contribution plans. Participants in the plans may contribute up to 10% of their salary for which the Company provides matching or discretionary contributions. In 2004, 2003 and 2002, approximately $7 thousand, $120 thousand and $118 thousand, respectively, have been charged to expense in connection with these plans.

Prior to its acquisition by the Company, Franklin had a 401(k) Savings Plan for eligible Franklin employees as defined in the plan agreement. The 401(k) Savings Plan provides for discretionary matching contributions. For the years ended December 31, 2004 and 2003 Franklin approved matching contributions of 100% of participating employees’ contributions up to a maximum of 6% of each employee’s compensation, which were approximately $147 thousand $136 thousand. No matching contributions were approved in year 2002, subsequent to the acquisition by the Company.


13. SEGMENTS AND GEOGRAPHIC INFORMATION

The Company’s reportable segments are 1) Shelter Services, 2) Metal Stamping, and 3) Food Services. During the third quarter of 2002 the Company acquired the third segment, Food Services. The Shelter Services segment provides shelter and assembly services in Mexico for non-electronics manufacturing services companies. Certain assets and contracts related to Shelter services were sold as of July 4, 2003 (See note 3). The Metal Stamping segment consists of Precision the subsidiary located in Louisville, Kentucky. Precision provides metal and stamping services primarily to the appliance and automotive sectors and was deconsolidated in December 2003 (see Note 1). The Food Services segment, Franklin, operates a retail nut and foodservice nut packaging and marketing company, located in El Paso, Texas and a candy manufacturing and packaging facility in Juarez, Mexico. The accounting policies for the segments are the same as for Elamex taken as a whole. Corporate expenses are not allocated to any of the segments and are presented separately. Inter-segment adjustments are related primarily to inter-segment sales at cost in the normal course of business.

Information about the operating segments for the years ended December 31, 2004, 2003 and 2002 was as follows:

   
Shelter (1)
Services
 
Metal (2)
Stamping
 
Food
Services
 
Unallocated
Corporate
and other
 
Inter-
segment
 
Total
 
Year ended December 31, 2004
                          
Net sales
 
$
15,230
        
$
95,341
        
$
(12,984
)
$
97,587
  
Operating Income (loss)
   
131
         
3,223
   
(3,693
)
        
(339
)
Net interest expense
   
36
         
2,118
   
15
         
2,169
 
Income (loss) before income taxes and equity in losses of affiliates
   
219
         
1,105
   
(3,690
)
        
(2,366
)
Net (loss) income
   
(1,679
)
        
1,105
   
(4,577
)
        
(5,151
)
Assets
   
13,422
         
40,932
   
1,427
    
(1,531
)
  
54,250
 
Depreciation & Amortization
   
735
         
2,391
   
8
         
3,134
 
Capital expenditures
   
4
         
925
   
   
   
     
   
929
 
Year ended December 31, 2003
                                      
Net sales
 
$
25,677
  
$
70,988
  
$
75,648
        
$
(15,063
)
$
157,250
  
Operating income (loss)
   
(333
)
  
(17,231
)
  
(292
)
  
(11,255
)
        
(29,111
)
Net interest expense (income)
   
41
   
754
   
3,071
   
(363
)
        
3,503
 
Loss before income taxes and equity in losses of affiliates
   
1,402
   
(18,304
)
  
(2,610
)
  
(10,570
)
        
(30,082
)
Net loss
   
(1,917
)
  
(15,915
)
  
(2,610
)
  
(14,166
)
        
(34,608
)
Assets
   
13,878
       
50,537
   
4,629
   
(1,641
)
  
67,403
 
Depreciation and amortization
   
868
   
2,938
   
2,271
 
$
8
          
6,085
 
Capital expenditures
   
313
   
4,327
   
1,750
   
43
   
    
   
6,433
 
Year ended December 31, 2002
                                      
Net sales
 
$
31,677
  
$
75,279
  
$
33,180
        
$
(5,867
)
$
134,269
  
Operating income (loss)
   
499
   
575
   
(264
)
  
(2,103
)
        
(1,293
)
Net interest expense (income)
   
1
   
815
   
1,672
   
(714
)
        
1,774
 
Loss before income taxes and equity in losses of affiliates
    
260
   
(669
)
  
(1,936
)
  
(2,255
)
        
(4,600
)
Net loss
   
(933
)
  
(145
)
  
(1,286
)
  
(3,653
)
        
(6,017
)
Assets
   
18,995
   
47,085
   
50,154
   
28,336
   
(10,069
)
  
134,501
 
Depreciation and amortization
   
1,275
   
2,416
   
1,059
               
4,750
 
Capital expenditures
   
286
   
5,075
   
876
   
    
   
    
   
6,237
 
 
(1) Certain assets and contracts related to this segment were sold as of July 4, 2003
(2) The Metal Stamping Segment (Precision) was consolidated through December 19, 2003. As a consequence of voluntary filing for Chapter 11 protection, the investment in Precision is now recognized in accordance with the cost method.

 
The Company has 10 facilities in the U.S. and Mexico to serve its customers. Geographic net sales information reflects the destination of the product shipped. Long-lived assets information is based on the physical location of the asset. The United States accounted for 66.5% and 74.7% of total long-lived assets in 2004 and 2003, respectively. Mexico accounted for 33.5% and 25.3% of total long-lived assets in 2004 and 2003, respectively.

Geographic net sales for the years ended December 31, were as follows:

   
2004
  
2003
  
2002
  
   
(In Thousands of U.S. Dollars)
  
United States
  
$
95,887
  
$
155,750
  
$
133,387
  
Mexico
    
1,700
    
1,500
    
882
  
   
$
97,587
  
$
157,250
  
$
134,269
  

Geographic net property, plant and equipment by location as of December 31, were as follows:

   
2003
  
2003
  
   
(In Thousands of U.S. Dollars)
  
United States
  
$
17,917
  
$
29,856
  
Mexico
    
9,039
   
10,100
 
   
$
26,956
  
$
39,956
  


14. MAJOR CUSTOMERS

Certain customers, all located in the United States, accounted for at least 10% of the Company's total sales during the years ended December 31, as follows:




Customer
  
Products and Services
  
2004
  
2003
  
2002
  
                   
A
   Major distributor    
20.4
%
  
11
%
      
     
 
                    
B
   Metal stamping of appliance products          
21
%
  
25
%
 
                          
C
   Metal stamping of automotive parts          
12
%
  
19
%


15. RELATED PARTY TRANSACTIONS

The Company paid for services rendered by Comercial Aerea, of which the chairman of the board of directors of Elamex is a principal, totaling approximately $31 thousand, $148 thousand, and $127 thousand during the years ended December 31, 2004, 2003, and 2002, respectively.
 
The Company purchases insurance through an insurance broker of which the chairman of the board of Elamex is a principal. Premiums paid were approximately $153 thousand, $337 thousand, and $393 thousand for the years ended December 31, 2004, 2003, and 2002, respectively.

The Company, through its wholly owned subsidiary Confecciones de Juarez (“Confecciones”), leases a candy manufacturing building owned by Franklin Inmobiliarios, S.A. de C.V. (“Inmobiliarios”), a Mexican company in which the chairman of the board has an indirect ownership interest. The building, located in Ciudad Juarez, Mexico, is the site on which all of Franklin’s candy manufacturing operations are performed. Confecciones passes the cost of this lease to Franklin under the terms of a shelter services agreement executed on July 24, 2000 (“Shelter Contract”). Shelter services companies generally lease real properties in the normal course of arranging shelter services for a US company. This lease agreement was executed on November 22, 2000, which was prior to the July 1, 2001 date on which Elamex acquired Franklin. On September 16, 2004, the Company and the related party entered into an agreement eliminating the purchase commitment. The lease modification resulted in a change in the lease from a capital lease to an operating lease (see note 8).

The rights to collect lease payments from Confecciones have been assigned by Inmobiliarios to the bank that financed the building. Franklin made lease payments directly to that bank on behalf of Inmobiliarios in the amounts of $2.0 million, $1.9 million and $1.9 million during 2004, 2003 and 2002 respectively.

During 2004 the Company loaned Qualcore $425 thousand in the form of a note receivable, to meet working capital needs. At December 31, 2004 and 2003, the Company had notes receivable from Qualcore of $2.7 million and $2.3 million, respectively.


16. COMMITMENTS AND CONTINGENCIES

The Company is a party to various claims, actions, and complaints, the ultimate disposition of which, in the opinion of management, will not have a material adverse effect on the operations or financial position of the Company.

The Mexican Federal Labor Law requires a severance payment for all permanent employees that are terminated by the employer. This payment is calculated on the basis of 90-days' pay for termination anytime during the first year of employment, with an additional 12 days pay for each year of service thereafter up to two times minimum wage. While most of the Company's Mexican assembly labor is hired under temporary labor contracts during the first two months of employment, the labor force is changed to permanent labor contracts after this period. The Company has agreements with many of its contract-assembly customers, which require that the customers pay the severance costs incurred, in the event that assembly contracts are terminated prior to their scheduled completion. In management's opinion, any severance costs incurred upon the termination of any manufacturing contracts would not be material.

Seniority premiums to which employees are entitled upon retirement after 15 years or more of service, in accordance with the Mexican Federal Labor Law, are recognized as expense during the year in which services are rendered. Included in other liabilities is approximately $30 thousand and $20 thousand as of December 31, 2004 and 2003, respectively, which fully accrues for these estimated seniority obligations.

 
One of the Company’s subsidiaries has entered into certain fixed-price commitments to purchase raw materials to be used in its manufacturing process over the next year. As of December 31, 2004, the aggregate value of these commitments was approximately $29.6 million.

On February 21, 2005, one of the Company’s customers filed Chapter 11 under the United States Bankruptcy Court. The Company received payments of approximately $226,000 within ninety days of the filing date that were paid outside of terms and subject to possible preference action by the Trustee for the bankruptcy estate. The payments received relate to 2004 sales and there were no sales to this customer in 2005. Based on a review of the facts and circumstances, management has provided an accrual, in other accrued expenses, of $135,000, which is believed to be a reasonable estimate of the probable loss associated with this matter.

 
17. GUARANTEES
 
In November 2002, Financial Accounting Standards Interpretation ("FIN") No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" was issued. FIN No. 45 requires a Company, at the time it issues a guarantee, to recognize an initial liability for the fair value of obligations assumed under the guarantee and to expand existing disclosure requirements. The Company has entered into contracts in the normal course of business, which include certain guarantees within the scope of FIN 45 under which it could be required to make payments to third parties upon the occurrence or non-occurrence of certain future events.  These guarantees primarily include:
 
1) Qualcore, the joint venture with GE de Mexico, entered into a 12-year lease agreement beginning January 2001 for the building that it occupies in Celaya Mexico. The monthly lease payments are approximately $94,628 and are guaranteed by both Elamex and GE de Mexico. Although the likelihood of funding under this guarantee is not considered by the Company to be probable, the maximum amount the Company may be liable for under such guarantee is approximately $4.5 million.

2) Qualcore also obtained bank financing from Wells Fargo and Eximbank for the plastic molding and metal stamping equipment for the Celaya plant in 2001. The original notes payable totaled $8.4 million with a five-year term and have equal semi-annual principal payments of $840 thousand plus interest. Guarantors include Elamex, S.A. de C.V. and GE Mexico, S.A. de C.V.

The guarantors are defined as primary obligors and guarantee the amounts as follows:
For Tranche A of $981 thousand.
 
a.
Elamex - 100%
 
b.
GE Mexico - 49.9%
Both parties are liable jointly and severally up to 49.9%.

For Tranche B of $2.4 million.
 
a.
Elamex - 50.1%
 
b.
GE Mexico 49.9%
The guarantors’ liability under Tranche B is several, but not joint.

As of December 31, 2004 the bank debt was approximately $3.4 million and Qualcore was in default under the loan agreement.

On January 1, 2005 the bank executed a forbearance agreement with Qualcore. The forbearance agreement provides Qualcore with a period of 120 days in which the bank will not issue a demand for payment of any or all of the outstanding debt. However, the bank did not waive the existing default. Should Qualcore not be able to make the payments within the forbearance period, the bank will require the guarantors to pay the debt.

The maximum liability exposure of Elamex is considered to be 50.1% of the total bank debt and as of December 31, 2004 Elamex recorded a liability of $1.7 million in recognition of the probability that it will be obligated to perform under this guarantee.
 

18. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) In thousands of U.S. dollars, except per share amounts:

   
2004 Quarters
  
2003 Quarters
  
   
1st
  
2nd
  
3rd
  
4th
  
1st
  
2nd
  
3rd
  
4th
  
                                   
Net sales
 
$
19,780
  
$
23,402
  
$
25,051
  
$
29,354
  
$
39,428
  
$
41,400
  
$
38,455
  
$
37,967
  
Gross profit
   
4,634
   
6,044
   
6,012
   
6,331
   
4,674
   
5,366
   
2,338
   
5,536
 
Net (loss) income
   
(1,345
)
  
(409
)
  
(959
)
  
(2,438
)
  
(5,436
)
  
220
   
(5,739
)
  
(23,653
)
Basic and diluted net (loss) income per common share
   
(0.18
)
  
(0.05
)
  
(0.13
)
  
(0.32
)
  
(0.72
)
  
0.03
   
(0.76
)
  
(3.16
)
 
 
******




 
(a)
1.     Financial Statements
 
The following financial statements are included herein at Item 8.
 
Consolidated Balance Sheets as of December 31, 2004 and 2003.
 
Consolidated Statements of Operations and comprehensive loss for the years ended December 31, 2004, 2003, and 2002.
 
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2004, 2003, and 2002.
 
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003, and 2002.
 
Notes to Consolidated Financial Statements.
 
Independent Auditors’ Report.
 
2.     Financial Statements Schedules
 
The financial statement schedules required to be included pursuant to this Item are not included herein because they are not applicable or the required information is shown in the financial statements or notes thereto which are incorporated by reference at subsection 1 of this Item, above.
 
3.      Exhibits

Audited financial statements of Qualcore, S. de R.L. de C.V. for the years ended December 31, 2004, 2003 and 2002.


SIGNATURES

Pursuant to the requirements 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. 

   
ELAMEX, S.A. DE C.V.
  
January 6, 2006
      
 
  
/S/ Richard R. Harshman
 
Date
  
Richard R. Harshman, President and Chief Executive Officer
  

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

January 6, 2006
      
 
  
/S/ Eloy S. Vallina
 
Date
  
Eloy S. Vallina, Chairman of the Board of Directors
  
       
January 6, 2006
      
 
  
/S/ Richard R. Harshman
 
Date
  
Richard R. Harshman, President and Chief Executive
  
   
(Principal Executive Officer)
  
       
January 6, 2006
      
 
  
/S/ Sam L. Henry
 
Date
  
Sam L. Henry, Senior Vice-President and Chief Financial Officer
  
   
(Principal Financial Officer)
  
   
(Principal Accounting Officer)
  
       
January 6, 2006
      
 
  
/S/ Eloy Vallina Garza
  
Date
  
Eloy Vallina Garza, Director
  
       
January 6, 2006
      
 
  
/S/ Richard P. Spencer
  
Date
  
Richard P. Spencer, Director
  
       
January 6, 2006
      
 
  
/S/ Martin W. Pitts
  
Date
  
Martin W. Pitts, Director
  
       
January 6, 2006
      
 
  
/S/ Keith Cannon
  
Date
  
Keith Cannon, Director
  
       
January 6, 2006
      
 
  
/S/ Benito Bucay
  
Date
  
Benito Bucay, Director
  
       
January 6, 2006
      
 
  
/S/ Carlos Hernandez
  
Date
  
Carlos Hernandez, Director
  
       
January 6, 2006
      
 
  
/S/ Manuel Muñoz
  
Date
  
Manuel Muñoz, Director
  
       
January 6, 2006
      
 
  
/S/ Fernando Todd
  
Date
  
Fernando Todd, Director
  
 
 
EXHIBIT

 

Qualcore, S. de R. L. de C. V. and Subsidiaries
(50.1% owned by Elamex, S. A. de C. V., and 49.9% owned by General Electric Mexico, S. A. de C. V.)

Consolidated Financial Statements for the Years Ended December 31, 2004, 2003 and 2002, and Report of Independent Registered Public Accounting Firm Dated May 24, 2005, November 21, 2005 with respect to Note 12

 
Qualcore, S. de R.L. de C.V. and Subsidiaries

Report of Independent Registered Public Accounting Firm and Consolidated Financial Statements 2004, 2003 and 2002


 

Report of Independent Registered Public Accounting Firm to the Board of Directors and Partners of Qualcore, S. de R.L. de C.V.


We have audited the accompanying consolidated balance sheets of Qualcore, S. de R. L. de C. V. and subsidiaries (the “Joint Venture”) as of December 31, 2004 and 2003, and the related consolidated statements of operations, partners’ deficit, and cash flows for each of the three years then in the period ended December 31, 2004 (all expressed in thousands of U.S. dollars). These financial statements are the responsibility of the Joint Venture’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Joint Venture’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our report dated May 24, 2005, we issued a qualified opinion on the 2004 consolidated financial statements because the Joint Venture had not recorded an impairment related to its long-lived assets when impairment indicators existed. As discussed in Note 12 to the accompanying amended consolidated financial statements, the Joint Venture subsequently recognized an impairment loss on such long-lived assets and included the loss in the accompanying amended 2004 consolidated financial statements. Accordingly, our present opinion on the amended 2004 consolidated financial statements, as expressed herein, is different from the report we previously issued dated May 24, 2005.

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Joint Venture as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America.

As of December 31, 2004 and 2003, the Joint Venture has an accumulated deficit in excess of 100% of its total paid-in capital. Under Mexican law, this condition allows the Joint Venture’s partners, creditors or other interested parties to force the Joint Venture into dissolution. In addition, the Joint Venture i) has a working capital deficiency of $11,572 and $8,709 as of December 31, 2004 and 2003, respectively, ii) incurred a net loss of $6,805, $3,958 and $2,249 for the years ended December 31, 2004, 2003 and 2002, respectively, iii) has a history of recurring losses and iv) has a total partners’ deficit of $7,679, and $874 as of December 31, 2004 and 2003, respectively. These factors raise substantial doubt about the Joint Venture’s ability to continue as a going concern. Initially, the Company had decided upon the sale of its stock. However, as discussed in Note 12 to the accompanying consolidated financial statements, as of September 2005, the Joint Venture’s operations were suspended, which resulted in the termination of a majority of the Joint Venture’s employees and the sale of the majority of the Joint Venture’s machinery and equipment. Management is deciding upon the future operating plans for the Joint Venture.

Galaz, Yamazaki, Ruiz Urquiza, S. C.
Member of Deloitte Touche Tohmatsu


Jorge Jaramillo Elías
May 24, 2005,
November 21, 2005 with respect to Note 12

Celaya, Guanajuato, Mexico


Qualcore, S. de R.L. de C.V. and Subsidiaries
(50.1% owned by Elamex, S.A. de C.V., and 49.9% owned by General Electric Mexico, S.A. de C.V.)

Consolidated Balance Sheets
As of December 31, 2004 and 2003
(Thousands of U.S. Dollars)

Assets
          
   
2004
  
2003
  
Current assets:
          
Cash and cash equivalents
  
$
1,381
  
$
339
  
Accounts receivable - net
    
2,606
    
1,998
  
Inventories - net
    
1,982
    
1,076
  
Prepaid expenses
    
81
    
60
  
Total current assets
    
6,050
    
3,473
  
 
              
Plant and equipment - net
   
3,903
    
9,228
  
 
              
Deferred income taxes
          
294
  
 
              
Other assets
    
5
    
4
  
               
Total
  
$
9,958
  
$
12,999
  
               
Liabilities and partners’ deficit
              
Current liabilities:
              
Accounts payable
  
$
3,962
  
$
5,145
  
Notes payable to joint venture partners
    
7,715
    
4,650
  
Customer advances
    
2,000
    
-
  
Current portion of long-term debt
    
3,460
    
1,680
  
Accrued liabilities
    
485
    
413
  
Deferred income taxes
    
-
    
294
  
Total current liabilities
    
17,622
    
12,182
  
 
              
Long-term debt
    
-
    
1,682
  
Labor obligations
   
15
    
9
  
Total liabilities
    
17,637
    
13,873
  
 
              
Commitments and contingencies (Note 10)
              
 
              
Partners’ deficit: 
              
Partnership capital, 44,834 partnership units issued and outstanding at par value of 1 Mexican peso
    
5,007
    
5,007
  
Additional paid-in capital
    
24,746
    
24,746
  
Accumulated deficit
    
(37,432
)
  
(30,627
)
Total partners’ deficit
    
(7,679
)
  
(874
)
               
Total
  
$
9,958
  
$
12,999
  

See accompanying notes to consolidated financial statements.


Qualcore, S. de R.L. de C.V. and Subsidiaries
(50.1% owned by Elamex, S.A. de C.V., and 49.9% owned by General Electric Mexico, S.A. de C.V.)

Consolidated Statements of Operations
For the years ended December 31, 2004, 2003 and 2002
(Thousands of U.S. Dollars)
   
2004
  
2003
  
2002
  
Revenues:
              
Net sales
  
$
21,797
  
$
18,798
  
$
15,422
  
Other
    
2,329
    
-
               
Total revenues
    
24,126
    
18,798
    
15,422
  
                     
Costs and expenses:
                    
Cost of sales
    
25,079
    
20,865
    
16,409
  
Selling, general and administrative expenses
   
1,014
    
902
    
952
  
Impairment of long-lived assets
    
4,155
    
-
    
-
  
Total costs and expenses
    
30,248
    
21,767
    
17,361
  
                     
Operating loss
    
(6,122
)
  
(2,969
)
  
(1,939
)
                     
Other expenses:
                    
Interest expense
    
512
    
91
    
401
  
Other expense (income) - net
    
47
    
867
    
(91
)
Total other expenses
    
559
    
958
    
310
  
                     
Loss before income taxes
   
(6,681
)
  
(3,927
)
  
(2,249
)
                     
Income tax expense
   
124
    
31
        
                     
Net loss
  
$
(6,805
)
$
(3,958
)
$
(2,249
)

See accompanying notes to consolidated financial statements.


Qualcore, S. de R.L. de C.V. and Subsidiaries
(50.1% owned by Elamex, S.A. de C.V., and 49.9% owned by General Electric Mexico, S.A. de C.V.)

Consolidated Statements of Partners’ Deficit
For the years ended December 31, 2004, 2003 and 2002
(Thousands of U.S. Dollars)
 
   
Partnership Capital
  
Additional
      
Total
  
           
Paid-in
  
Accumulated
  
Partners’
  
   
Units
  
Amount
  
Capital
  
Deficit
  
Deficit
  
                       
Balance, January 1, 2002
    
44,834
  
$
5,007
  
$
24,746
  
$
(24,420
)
$
5,333
  
                                 
Net loss
                      
(2,249
)
  
(2,249
)
                                 
Balance, December 31, 2002
    
44,834
    
5,007
    
24,746
    
(26,669
)
  
3,084
  
                                 
Net loss
                      
(3,958
)
  
(3,958
)
                                 
Balance, December 31, 2003
    
44,834
    
5,007
    
24,746
    
(30,627
)
  
(874
)
                                 
Net loss
                      
(6,805
)
  
(6,805
)
                                 
Balance, December 31, 2004
    
44,834
  
$
5,007
  
$
24,746
  
$
(37,432
)
$
(7,679
)

See accompanying notes to consolidated financial statements.
 

Qualcore, S. de R.L. de C.V. and Subsidiaries
(50.1% owned by Elamex, S.A. de C.V., and 49.9% owned by General Electric Mexico, S.A. de C.V.)

Consolidated Statements of Cash Flows
For the years ended December 31, 2004, 2003 and 2002
(Thousands of U.S. Dollars)

   
2004
  
2003
  
2002
  
Cash flows from operating activities:
              
Net loss
  
$
(6,805
)
$
(3,958
)
$
(2,249
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
                    
Depreciation and amortization
    
1,248
    
1,217
    
1,167
  
Loss on sale of machinery and equipment
    
-
    
5
    
-
  
Loss on disposal of machinery and equipment
    
-
    
169
    
-
  
Labor obligations
    
3
    
5
    
-
  
Impairment loss
    
4,155
    
-
    
-
  
Changes in operating assets and liabilities:
                    
Accounts receivable - net
    
(608
)
  
2,329
    
670
  
Inventories - net
    
(906
)
  
(337
)
  
277
  
Due from related parties
                
12
  
Prepaid expenses and other assets
    
(22
)
  
(60
)
  
332
  
Accounts payable
    
(1,183
)
  
1,227
    
(143
)
Customer advances 
    
2,000
    
-
    
-
  
Accrued liabilities and labor obligations
    
75
    
275
    
(1,431
)
Due to related parties
    
-
    
(107
)
  
107
  
Net cash (used in) provided by operating activities
    
(2,043
)
  
765
    
(1,258
)
 
                    
Cash flows from investing activities:
                    
Acquisitions of plant and equipment
    
(78
)
  
(347
)
  
(472
)
Proceeds from the sale of plant and equipment
    
-
    
10
    
-
  
Net cash used in investing activities
    
(78
)
  
(337
)
  
(472
)
 
                    
Cash flows from financing activities:
                    
Proceeds from notes payable to Joint Venture partners
    
3,163
    
2,050
    
3,100
  
Payments of notes payable
    
-
    
(900
)
  
-
  
Payments of long-term debt
    
-
    
(1,678
)
  
(1,680
)
Net cash provided by (used in) financing activities
    
3,163
    
(528
)
  
1,420
  
 
                    
Cash and cash equivalents:
                    
Net increase (decrease) for the year
    
1,042
    
(100
)
  
(310
)
Beginning of year
    
339
    
439
    
749
  
 
                    
End of year
  
$
1,381
  
$
339
  
$
439
  
 
                    
Supplemental disclosure of cash flow information:
                    
 
                    
Cash paid during the year for:
                    
Interest
  
$
-
  
$
169
  
$
401
  
Income taxes
  
$
124
  
$
31
  
$
-
  

See accompanying notes to consolidated financial statements.


Qualcore, S. de R.L. de C.V. and Subsidiaries
(50.1% owned by Elamex, S.A. de C.V., and 49.9% owned by General Electric Mexico, S.A. de C.V.)

Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
(Thousands of U.S. Dollars)


1.
Nature of business and basis of presentation

Nature of business, - Qualcore, S. de R.L. de C.V. and subsidiaries (the “Joint Venture”) consists of Mexican companies incorporated under the laws of Mexico on August 17, 1998. The Joint Venture was formed between Elamex, S.A. de C.V. (Elamex), General Electric International Mexico, S.A. de C.V. and General Electric Mexico, S.A. de C.V. (jointly referred to as GE Mexico) to produce plastic molding and stamped metal components primarily for companies located in the United States of America (U.S.), except for Elamex, which has operations located in Mexico. Elamex contributed its plastic molding and stamped metal operations to the Joint Venture in exchange for a 50.1% interest. GE Mexico contributed approximately $3,500 in exchange for its 49.9% interest. All manufacturing and administrative services, as well as other professional services, are provided by Plásticos y Troquelados, S.A. de C.V. (PYTSA), a subsidiary of the Joint Venture. All of the Joint Venture manufacturing machinery and equipment are located in facilities in Mexico.

The Joint Venture is a limited liability company, which combines the aspects of a partnership and a corporation. Joint venture partners are liable only to the extent of their capital contributions, but participatory interests are represented by participation units that are not freely negotiable.

Basis of presentation - At December 31, 2004 and 2003, the Joint Venture has an accumulated deficit in excess of 100% of its total paid-in capital. Under Mexican law, this condition allows the Joint Venture’s partners, creditors or other interested parties to force the Joint Venture into dissolution. In addition, the Joint Venture i) has a working capital deficiency of $11,572 and $8,709 at December 31, 2004 and 2003, respectively, ii) incurred a net loss of $6,805, $3,958 and $2,249 for the years ended December 31, 2004, 2003 and 2002, respectively, iii) has a history of recurring net losses and iv) has a partners’ deficit of $7,679 and $874 at December 31, 2004 and 2003, respectively. These factors raise substantial doubt about the Joint Venture’s ability to continue as a going concern. Initially, management was discussing plans to sell the Joint Venture’s stock. However, as of September 2005, the Joint Venture’s operations were suspended, which resulted in the termination of a majority of the Joint Venture’s employees and the sale of the majority of the Joint Venture’s machinery and equipment. See further discussion in Note 12. Management is currently deciding upon the future operating plans for the Joint Venture. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

The Joint Venture maintains its books and records in U.S. dollars and prepares financial statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for the application of the equity method by the Joint Venture partners.

Principles of consolidation - The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The consolidated financial statements include those of Qualcore, S. de R.L. de C.V. and its 99% owned subsidiary Plásticos y Troquelados de Celaya, S.A. de C.V. All material intercompany balances and transactions have been eliminated in consolidation.


2.
Significant accounting policies

A summary of the significant accounting policies used in the preparation of the accompanying financial statements follows:

Cash equivalents - The Joint Venture considers all highly-liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.


Accounts receivable - The Joint Venture reviews accounts receivable balances and determines whether an allowance for potential uncollectible accounts is necessary.

Foreign currency translation - Transactions denominated in foreign currencies are recorded at the rate of exchange in effect at the date of the transactions. Monetary assets and liabilities denominated in foreign currencies are converted into U.S. dollars, the functional currency of the Joint Venture, at the rate of exchange in effect at the balance sheet date; the effect of changes in exchange rates is recorded in the results of operations.

Inventories - Inventories are stated at the lower of cost or market value. Cost is determined using the first-in, first-out (FIFO) method.

Concentration of credit risk - For the years ended December 31, 2004, 2003 and 2002, the Joint Venture has one major customer that accounted for 83%, 86% and 76%, respectively of total sales and 50% and 60% of its accounts receivable at December 31, 2004 and 2003, respectively. However, the Joint Venture typically receives payment on a timely basis from this customer. The Joint Venture believes that any other potential credit risk is adequately covered by the allowance for doubtful accounts.

Plant and equipment - Plant and equipment are recorded at acquisition cost, net of accumulated depreciation and amortization. Cost includes major expenditures for improvements and replacements, which extend useful lives or increase capacity and interest costs associated with significant capital additions. Routine maintenance costs are expensed as incurred. Depreciation and amortization are calculated using the straight-line method, based on the estimated useful lives of the related assets, as follows:

 
Useful
 
Life
 
(Years)
Leasehold improvements
4
Machinery and equipment
3-10
 
Valuation of long-lived assets - The Joint Venture periodically evaluates the carrying value of long-lived assets held for use when events or circumstances indicate that the carrying amount of the asset may not be recoverable. The carrying value of a long-lived asset held for use is considered to not be recoverable when the anticipated separately identified undiscounted cash flows from the asset are less than the carrying value of the asset. In that event, an impairment loss is recognized based on the amount by which the carrying value exceeds the fair value of the long-lived asset.

During the four quarter of 2004, the Joint Venture identified certain conditions as indicators of asset impairment, including a substantial decline in its operations and evidence of a decrease in the market value of such long-lived assets, based on the Joint Venture’s consideration of the sale of such long-lived assets, which ultimately took place during 2005 at a market value below the carrying value of the assets at December 31, 2004. Accordingly, the Joint Venture assessed the recoverability of such assets using undiscounted cash flow projections, which indicated that such long-lived assets were not recoverable. The Joint Venture recorded an impairment loss of $4,155 during the fourth quarter of 2004. Management determined the asset impairment charges by comparing the actual market price of the equipment against the carrying values of the long-lived assets.

Income taxes - The Joint Venture recognizes deferred income tax and statutory employee profit-sharing assets and liabilities for the future consequences of temporary differences between the financial statement carrying amounts of assets and liabilities and their respective income tax or employee statutory profit-sharing bases, measured using enacted rates. The effects of changes in the statutory rates are accounted for in the period that includes the enactment date. Deferred income tax assets are also recognized for the estimated future effects of tax loss carryforwards and asset tax credit carryforwards. Deferred income tax and statutory employee profit-sharing assets are reduced by any benefits that, in the opinion of the management, more likely than not will not be realized.

Labor obligations - In accordance with Mexican Labor Law, the Joint Venture provides seniority premium benefits to its employees under certain circumstances. These benefits consist of a one-time payment equivalent to 12 days wages for each year of service (at the employee’s most recent salary, but not to exceed twice the legal minimum wage), payable to all employees with 15 or more years of service, as well as to certain employees terminated involuntarily prior to the vesting of their seniority premium benefit.


The Joint Venture also provides statutorily mandated severance benefits to its employees terminated under certain circumstances. Such benefits consist of a one-time payment of three months wages plus 20 days wages for each year of service payable upon involuntary termination without just cause.

Costs associated with these benefits are provided for based on actuarial computations using the projected unit credit method.

Revenue recognition - Revenues and related costs are recognized upon transfer of ownership, which generally coincides with the shipment of products to customers in satisfaction of orders. 

Use of estimates - The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Although management believes the estimates and assumptions used in the preparation of these financial statements were appropriate in the circumstances, actual results could differ from those estimates and assumptions.

 
New accounting standards -In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 153, "Exchanges of Nonmonetary Assets - an amendment of APB Opinion No. 29", to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. SFAS No. 153 is effective for nonmonetary assets exchanges occurring in fiscal periods beginning after June 15, 2005. The Joint Venture does not anticipate that the adoption of this statement will have a material effect on its consolidated financial position or results of operations.
 
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that certain financial instruments be classified as liabilities that were previously considered equity. The provisions of SFAS No. 150 are effective for financial instruments entered into or modified after May 31, 2003, and for pre-existing instruments, was effective beginning January 1, 2004, except for mandatorily redeemable financial instruments. For mandatorily redeemable financial instruments, this statement is effective for new or existing contracts for fiscal periods beginning after December 15, 2004. The adoption of SFAS No. 150 did not have a material impact on the Joint Venture’s financial position, results of operations or cash flows, and as the Joint Venture does not have any mandatorily redeemable financial instruments, it does not anticipate that the adoption of that provision of SFAS No. 150 will have a material impact on the Joint Venture’s financial position, results of operations or cash flows.

In December 2003, the FASB revised SFAS No. 132(R), “Employers’ Disclosures about Pensions and Other Postretirement Benefits”. SFAS No. 132(R) retain the disclosure requirements contained in the original standard but requires additional disclosures describing the types of plan assets, investment strategy, measurement dates, plan obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The additional disclosure requirements were applicable for these 2004 financial statements. The adoption of this statement did not materially affect the disclosures in the accompanying consolidated financial statements.

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). In December 2003, FIN 46 was replaced by FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities” or FIN 46(R). FIN 46(R) clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements”, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN46(R) requires an enterprise to consolidate a variable interest entity if that enterprise will absorb a majority of the entity’s expected losses, is entitled to receive a majority of the entity’s expected residual returns or both. The Joint Venture has immediately applied the provisions of FIN 46(R) to all variable interest entities created after December 31, 2003. For all other entities, the Joint Venture will begin to apply the provisions of FIN 46(R) as of January 1, 2005. The Joint Venture did not have any variable interest entities created after December 31, 2003 and does not anticipate that the adoption of FIN 46(R) will have a material impact on its financial position, results or operations or cash flows.


In March 2004, the Emerging Issues Task Force (“EITF”) confirmed as a consensus EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-1”). The objective of this Issue is to provide guidance on determining when an investment is considered impaired, whether that impairment is other-than-temporary, and the measurement of an impairment loss. The guidance also includes accounting considerations subsequent to the recognition of another-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. In September 2004, the FASB issued FASB Staff Position (“FSP”) EITF Issue 03-1-1 that delays the effective date for the measurement and recognition guidance included in EITF 03-1. The disclosures required by EITF 03-1 have not been deferred and were effective as of December 31, 2004.

In November 2003, the EITF confirmed as a consensus EITF Issue No. 03-10, “Application of EITF Issue No. 02-16 by Resellers to Sales Incentives Offered to Consumers by Manufacturers” (“EITF 03-10”). EITF 03-10 addresses the accounting for manufacturer sales incentives offered directly to consumers, including manufacturer coupons. The Joint Venture’s accounting policies related to vendor coupons and reimbursements are in accordance with the requirements of EITF 03-10. The adoption of this pronouncement had no material impact on the Joint Venture’s results of operations, financial position or cash flows in the reported periods.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs - an amendment of ARB No. 43, Chapter 4”, or SFAS No. 151. SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight, and re-handling costs be recognized as current-period charges regardless of whether they meet the criterion of "so abnormal" as stated in ARB No. 43. Additionally, SFAS 151 requires that the allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. The Joint Venture does not believe that the adoption of this pronouncement will have a material impact on the Joint Venture’s results of operations, financial position or cash flows.


3.
Accounts receivable

   
2004
  
2003
  
           
Trade
  
$
1,857
  
$
1,680
  
Recoverable value-added taxes
    
764
    
336
  
     
2,621
    
2,016
  
Less - allowance for doubtful accounts
    
(15
)
  
(18
)
   
$
2,606
  
$
1,998
  




An analysis of the activity in the allowance for doubtful accounts for the years ended December 31, 2004, 2003 and 2002 is as follows:

   
2004
  
2003
  
2002
  
               
Beginning balance
  
$
18
  
$
30
  
$
-
  
Additions charged to expense
    
-
    
-
    
30
  
Write-off of unrecoverable accounts
    
(3
)
  
(12
)
               
Ending balance
  
$
15
  
$
18
  
$
30
  


4.
Inventories

   
2004
  
2003
  
           
Finished goods
  
$
409
  
$
231
  
Raw materials
    
1,585
    
929
  
     
1,994
    
1,160
  
Less - reserve for obsolescence
    
(12
)
  
(84
)
   
$
1,982
  
$
1,076
  

The provision for excess and obsolete inventory is charged against cost of sales. An analysis of the changes to the reserve for obsolescence on inventory for the years ended December 31, 2004, 2003 and 2002 is as follows:

   
2004
  
2003
  
2002
  
               
Beginning balance
  
$
84
  
$
84
  
$
238
  
Additions charged to expense
    
-
    
-
    
-
  
Inventory disposed of during the year
    
(72
)
  
-
    
(154
)
Ending balance
  
$
12
  
$
84
  
$
84
  


5.
Plant and equipment

   
2004
  
2003
  
           
Leasehold improvements
  
$
136
  
$
136
  
Machinery and equipment
    
8,379
    
12,457
  
     
8,515
    
12,593
  
Less - accumulated depreciation and amortization
    
(4,612
)
  
(3,365
)
   
$
3,903
  
$
9,228
  

Depreciation expense was $1,248, $1,217 and $1,167 for the years ended December 31, 2004, 2003 and 2002, respectively.


6.
Notes payable and long-term debt

At December 31, 2004 and 2003, the Joint Venture had the following bank loans to third parties and U.S. dollar denominated notes payable to Joint Venture partners:


   
2004
  
2003
  
           
Bank loans, bearing interest at 1.625% over six-month LIBOR (4.4% and 1.4% at December 31, 2004 and 2003, respectively), principal and interest payable in semiannual payments of $840, guaranteed by the Joint Venture partners
  
$
3,460
  
$
3,362
  
Notes payable to Joint Venture partners
    
7,715
    
4,650
  
Total debt
    
11,175
    
8,012
  
Less - Current portion of long-term debt
    
(3,362
)
  
(1,680
)
Interest payable to bank loans
    
(98
)
  
-
  
Notes payable to Joint Venture partners due on demand
    
(7,550
)
  
(4,650
)
Interest payable to Joint Venture partners
    
(165
)
  
-
  
Long-term debt
  
$
-
  
$
1,680
  

The bank loans referred to above contain restrictive covenants, which require the Joint Venture to maintain certain financial ratios and restricts the payment of dividends, granting of loans and obtaining additional financings. As of December 31, 2004 the Joint Venture was not in compliance with these covenants and was in default under the loan agreement.

On January 1, 2005 Wells Fargo HSBC Trade Bank, N.A. (“Wells Fargo”) executed a forbearance agreement with the Joint Venture. The forbearance agreement provides the Joint Venture with a period of 120 days in which Wells Fargo will not issue a demand for payment of any or all of the outstanding debt. However, Wells Fargo did not waive the existing default. Should the Joint Venture not be able to make the payments within the forbearance period, Wells Fargo will require the guarantors to pay the debt. Accordingly, the debt has been classified as current in the accompanying 2004 consolidated balance sheet.


7.
Labor obligations

Net periodic expenses associated with labor obligations was $3 in 2004 and $5 in 2003. The associated accrued liability was $15 at December 31, 2004 and $9 at December 31, 2003.


8.
Partners’ deficit

Under the bylaws of the Joint Venture and Mexican law, the partners’ capital of the Joint Venture must consist of fixed capital and may have, in addition thereto, variable capital. Partners holding shares representing variable capital may require the Joint Venture, with a notice of at least three months prior to December 31 of the prior year, to redeem those shares at a price equal to the lesser of either (i) 95% of the market price, based on the average of trading prices in the stock exchange where it is listed during the thirty trading days preceding the end of the fiscal year in which the redemption is to become effective or (ii) the book value of the Joint Venture’s shares as approved by the board of directors for the latest fiscal year prior to the redemption date. At December 31, 2004 and 2003, the Joint Venture has not issued any of its authorized variable capital. Although the variable capital is redeemable by the terms described above, such shares would be classified as a component of partners’ equity in the consolidated balance sheet.

Management believes the variable capital represents permanent capital because the timing and pricing mechanisms through which a partner would exercise the option to redeem are such that a partner, from an economic standpoint, would not exercise this option. At the time a partner is required to give notice of redemption, the partner will not be able to know at what price the shares would be redeemed and would not expect the present value of the future redemption payment to equal or exceed the amount which would be received by the partner in an immediate public sale.


Mexican law requires that at least 5% of the Joint Venture’s net income each year (after profit sharing and other deductions required by law) be allocated to a legal reserve fund, which is not thereafter available for distribution, except as a capital dividend, until the amount of such fund equals 20% of the Joint Venture’s historical capital. No legal reserve fund allocation is required due to the net losses incurred by the Joint Venture.


9.
Balances and transactions with related parties

Transactions with related parties for the years ended December 31, 2004, 2003 and 2002 are as follows:

   
2004
  
2003
  
2002
  
               
Interest expense
  
$
165
  
$
20
  
$
90
  
Notes payable
    
2,900
    
2,050
    
2,600
  
Due to Joint Venture partners
    
-
    
111
    
90
  

At December 31, 2004 and 2003, the Joint Venture had U.S. dollar denominated notes payable to its Joint Venture partners, as discussed in Note 6.


10.
Commitments and contingencies

Leases - The Joint Venture leases a building under an operating lease that expires in 2012. Minimum rentals due under the lease are adjusted annually based on the Mexican inflation rate and are as follows:

Year ending December 31:
      
       
2005
  
$
1,135
  
2006
    
1,135
  
2007
    
1,135
  
2008
    
1,135
  
2009
    
1,135
  
Thereafter
    
3,410
  
Total minimum lease payments required
  
$
9,085
  

Rent expense for the years ended December 31, 2004, 2003 and 2002 was $1,135 for each year.

The monthly lease payments are guaranteed by both of the Joint Venture partners.

Litigation - The Ministry of Finance and Public Credit, in exercise of its rights, carried out a review of the Joint Venture to verify its compliance with foreign trade tax obligations. As a result of this review, on September 9, 2004 the tax authorities assessed taxes of Ps. $22,457 against the Joint Venture. However, the Joint Venture filed a motion for reversal of such resolution. On February 14, 2005, the Local Legal Office of Celaya issued a resolution annulling the above tax assessment and ordering the Local Tax Audit Office of Celaya to issue a properly supported resolution. As of May 24, 2005, this resolution had not yet been issued by the Local Tax Audit Office.

11.
Income and asset taxes

Current income tax expense for the year ended December 31, 2004 was $37, and deferred income tax expense, represented by the change in the valuation allowance for recoverable tax on assets paid, for the years ended December 31, 2004 and 2003, was $87 and $31, respectively. The Joint Venture generated a net tax loss carryforward for the year ended December 31, 2002, and recorded a full valuation allowance for the value of the net deferred tax asset, resulting in no current or deferred income tax expense for the Joint Venture.
 

At December 31, 2004 and 2003, the components of deferred income tax assets and liabilities were as follows: 

   
2004
  
2003
  
Current deferred tax assets:
          
Accrued liabilities
  
$
613
  
$
61
  
Valuation allowance
    
(19
)
  
-
 
Total current deferred tax assets
    
594
   
61
  
 
              
Current deferred tax liabilities:
              
Inventories
    
(594
)
  
(355
)
Total current deferred tax liabilities
    
(594
)
  
(355
)
Net current deferred tax liability
  
$
-
  
$
(294
)
 
              
Noncurrent deferred tax assets:
              
Net operating loss carryforwards
  
$
7,535
  
$
8,329
  
Asset tax
    
128
    
-
  
Plant and equipment
    
45
        
Valuation allowance
    
(7,708
)
  
(7,599
)
Total noncurrent deferred tax assets
    
-
    
730
  
 
              
Noncurrent deferred tax liabilities:
              
Plant and equipment
    
-
    
(436
)
Net deferred tax liabilities
    
-
    
(436
)
Net noncurrent deferred tax asset
 
$
-
  
$
294
  


A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized in the future. The valuation allowance as of December 31, 2004, 2003 and 2002 was $7,727, $7,599 and $7,268, respectively, and relates primarily to the lack of evidence regarding the future utilization of net operating losses and recoverable tax on assets paid.

An analysis of the activity of the valuation allowance for the years ended December 31, 2004, 2003 and 2002 is as follows:

   
2004
  
2003
  
2002
  
               
Beginning balance
  
$
7,599
  
$
7,268
  
$
8,160
  
Additions charged to income tax expense
    
128
    
331
        
Decreases charged against income tax expense
                
(892
)
Ending balance
  
$
7,727
  
$
7,599
  
$
7,268
  

The effective rate for the years ended December 31, 2004, 2003, and 2002 differs from the Mexican statutory income tax rate as follows:

   
2004
  
2003
  
2002
  
               
Statutory rate
    
33.0
%
  
34.0
%
  
35.0
%
Effect of permanent differences, mainly non-deductible expenses
    
-0.7
%
  
-4.8
%
  
0.0
%
Impairment of long-lived assets
    
-20.5
%
  
0.0
%
  
0.0
%
Inflationary effects
    
-3.1
%
  
-6.4
%
  
-1.6
%
Change in valuation allowance
    
-7.7
%
  
-15.5
%
  
-33.4
%
Other
    
-2.9
%
  
-8.1
%
  
0.0
%
     
-1.9
%
  
-0.8
%
  
0.0
%
 

Dividend tax - Partners’ equity, except restated paid-in capital and tax retained earnings, will be subject to a dividend tax, payable by the Joint Venture, in the event of distribution. In 2004, 2003 and 2002, the rate was 33%, 34% and 35%, respectively; it will decrease to 30% in 2005 and subsequently one percentage point each year until reaching 28% in 2007. Any income tax paid on such distribution may be credited against future income tax payable by the Joint Venture in the year in which the dividend tax is paid and in the following two years.

Statutory income tax rate - On December 1, 2004, certain amendments to the ISR and IMPAC Laws were enacted and are effective as of 2005. The most significant amendments are as follows: (a) the ISR rate will be reduced to 30% in 2005, 29% in 2006, and 28% in 2007 and thereafter; (b) for ISR purposes, cost of sales will be deducted instead of inventory purchases in the period and, if applicable, related conversion costs; (c) companies may elect in 2005 to ratably increase taxable income over a period from four to 12 years by the tax value of inventories on hand as of December 31, 2004 determined in conformity with the respective tax rules, which include deducting any previous tax basis of inventories and any unamortized tax loss carryforwards, and the tax basis of such inventories may be deducted as sold; (d) as of 2006, paid employee statutory profit sharing will be fully deductible for ISR purposes; (e) bank liabilities and liabilities with foreign entities are now included in the determination of the IMPAC taxable base.

Asset tax - The Joint Venture is also subject to an asset tax, which is similar to an alternative minimum tax, under Mexican tax law. The asset tax is calculated by applying 1.8% to the Joint Venture asset position, as defined in the law, and is payable to the extent it exceeds income taxes payable for the same period. Asset taxes paid may be used to offset future income taxes payable in the following 10 years if certain conditions in the tax law are met.

Carryforwards - At December 31, 2004, the Joint Venture has net operating loss carryforwards, which are available to offset future taxable income, and asset tax credits, which are available to offset future income taxes payable, as follows:

Year
  
Net Operating Loss Carryforwards
  
 
Asset Tax Credits
  
Year of Expiration
  
               
1998
  
$
1,512
  
$
-
    
2008
  
1999
    
373
    
-
    
2009
  
2000
    
6,021
    
-
    
2010
  
2001
    
13,838
    
-
    
2011
  
2002
    
1,685
    
-
    
2012
  
2003
    
3,482
    
41
    
2013
  
2004
    
-
    
87
    
2014
  
                     
   
$
26,911
  
$
128
        

The amounts presented above have been adjusted for Mexican inflation as permitted by Mexican tax law.

Statutory employee profit sharing - Statutory employee profit sharing was determined by applying the statutory rate of 10% to the profit sharing base determined in accordance with the applicable law.

12.
Subsequent events

 
a.
As of September 2005, the Joint Venture’s management approved the decision to cease the Joint Venture’s operations. In October 2005, most of its employees were terminated, except for three individuals that will complete the final administrative activities of the Joint Venture. The Company is still quantifying the termination expenses. The Joint Venture also sold most of its machinery and equipment, except for certain low-value assets. Management is discussing the future operations of the Joint Venture.

 
b.
In September 2005, the tax authorities, in full exercise of their rights, reassessed the tax mentioned in Note 10 for the amount of Ps. $23,227. Management and legal counsel believes that the Joint Venture has meritorious defenses against the assertion of the claim.

 
 
c.
As of June 15, 2005, GE Mexico purchased the outstanding debt of the Joint Venture with Wells Fargo, on which the Joint Venture had defaulted, as discussed in Note 6. The debt was purchased at a discounted price of approximately $2.5 million. The Joint Venture will pay GE with the proceeds of the sale of long-lived assets as discussed in 12.a above.

 
d.
On May 24, 2005, the Joint Venture previously issued consolidated financial statements as of and for the year ended December 31, 2004, which did not include the recognition of impairment losses on its long-lived assets for which impairment indicators existed. The accompanying consolidated financial statements represent the reissuance of the previous consolidated financial statements in order to recognize such impairment, which amounted to $4,155 and is included in the results for the year ended December 31, 2004.
 
 
* * * * *
17