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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-Q/A
Amendment No. 1
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended December 31, 2001
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to ___________.
Commission file number: 1-16027
LANTRONIX, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0362767
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
15353 Barranca Parkway Irvine, California 92618
(Address of principal executive offices and zip code)
------------------
(949) 453-3990
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(D) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
As of January 31, 2002, 52,771,640 shares of the Registrant's common stock
were outstanding.
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EXPLANATORY NOTE
This Amendment No. 1 to Quarterly Report on Form 10-Q/A of Lantronix, Inc.
(the "Company") amends Part I of the Company's Quarterly Report on Form 10-Q for
the quarter ended December 31, 2001, as filed by the Company on February 14,
2002 (the "Original 10-Q"), to reflect the changes described below.
The Company changed its accounting method for recognizing revenue on sales
to distributors effective as of the beginning of fiscal 2001, July 1, 2000.
Under the new accounting method, recognition of revenue and related gross profit
on sales to distributors is deferred until the distributor resells the product
to an end customer. Previously, the Company had recognized revenue from these
transactions upon shipment of product to the distributor, net of estimates for
possible returns and allowances. In addition, for the quarterly periods ended
September 30, 2001 and December 31, 2001, the Company also made further
corrections to its condensed consolidated financial statements (1) to defer the
recognition of certain sales made to customers who were not distributors as
revenue because they did not meet all of the criteria for revenue recognition at
the time of shipment, and (2) to reclassify to other expense certain amounts
originally charged in error to other comprehensive income. The effect of these
matters is to reduce net revenues by $713,000 and $429,000 and increase loss
before cumulative effect of accounting change by $746,000 or $0.02 per share and
$286,000 or $0.01 per share in the quarters ended December 31, 2001 and 2000,
respectively. The effect of these matters for the six month periods ended
December 31, 2001 and 2000 are to reduce net revenues by $1,151,000 and $822,000
and increase loss before cumulative effect of accounting change by $869,000 or
$0.02 per share and $492,000 or $0.02, respectively. Additionally, the
cumulative effect of the accounting change recorded as of July 1, 2000 was a
charge of $597,000 (net of income tax benefit of $176,000) or $0.02 per share.
See Note 2 to the financial statements, "Accounting Change and Restatement of
Financial Statements", for more detail. Conforming changes reflecting the
foregoing are made in: Part I - Item 1 Financial Statements (and footnotes
thereto); and - Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations.
In addition, the Company made changes to the Original 10-Q to clarify or
correct information with respect to the following:
. Part I Item 1 "Financial Statements": separation in the condensed
consolidated balance sheet of accounts as follow: "Goodwill" and
"Purchased intangible assets, net"; and "Officer loans" and
"Other assets";
. Part I Item 1 "Financial Statements", reclassification of amounts
between "Selling, General and Administrative" and "Amortization
of Purchased Intangibles"; and between "Interest Income
(Expense), Net" and "Other Income (Expense), Net";
. Part I Item 1 "Financial Statements": additions to Note 3 "Recent
Accounting Pronouncements" and Note 6 "Goodwill and Purchased
Intangible Assets" to provide additional information concerning
the Company's adoption of SFAS 142 "Goodwill and Other Intangible
Assets";
. Part I Item 1 "Financial Statements": addition to Note 3 "Recent
Accounting Pronouncements" for newly issued SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets";
. Part I Item 1 "Financial Statements": clarification in Note 8
"Stockholders' Equity" of the number of shares sold in the
secondary offering;
. Part I Item 2 "Management's Discussion and Analysis of Financial
Condition and Results of Operations": clarification under the
heading "Net Revenues" as to European sales;
. Part I Item 2 "Management's Discussion and Analysis of Financial
Condition and Results of Operations": clarification under the
heading "Gross Profit" as to royalty payments to Gordian;
. Part I Item 2 "Management's Discussion and Analysis of Financial
Condition and Results of Operations": additional information
under the heading "Impact of Adoption of New Accounting
Standards";
. Part II Item 2 "Changes in Securities and Use of Proceeds":
clarification of the number of shares sold in our secondary
offering; and
. Part II Item 2 "Changes in Securities and Use of Proceeds":
clarification regarding the acquisition of U.S. Software.
Except as noted above, this Form 10-Q does not reflect events occurring after
the filing of the Original 10-Q on February 14, 2002, nor does it modify or
update the disclosures contained in such original report, except as necessary or
appropriate to reflect the effects of the restatement.
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2
LANTRONIX, INC.
FORM 10-Q/A
FOR THE QUARTER ENDED DECEMBER 31, 2001
INDEX
Page
PART I. FINANCIAL INFORMATION ................................................................................... 4
Item 1. Financial Statements .................................................................................... 4
Condensed Consolidated Balance Sheets at December 31, 2001 (unaudited) and June 30, 2001
(restated) ......................................................................................... 4
Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months Ended
December 31, 2001 and 2000 (restated) ................................................................ 5
Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended
December 31, 2001 and 2000 (restated) ................................................................ 6
Notes to Unaudited Condensed Consolidated Financial Statements .......................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ................... 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk .............................................. 28
PART II. OTHER INFORMATION ....................................................................................... 28
Item 1. Legal Proceedings ....................................................................................... 28
Item 2. Changes in Securities and Use of Proceeds ............................................................... 28
Item 3. Defaults Upon Senior Securities ......................................................................... 29
Item 4. Submission of Matters to a Vote of Security Holders ..................................................... 29
Item 5. Other Information ....................................................................................... 29
Item 6. Exhibits and Reports on Form 8-K ........................................................................ 29
3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
LANTRONIX, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
December 31, June 30,
2001 2001
---- ----
(Unaudited)
(Restated - Note 2)
ASSETS
------
Current assets:
Cash and cash equivalents ................................................. $ 38,649 $ 15,367
Short-term investments .................................................... 9,872 1,973
Accounts receivable, net .................................................. 7,418 9,134
Inventories ............................................................... 16,176 13,560
Deferred income taxes ..................................................... 5,297 3,621
Prepaid income taxes ...................................................... 622 973
Prepaid expenses and other current assets ................................. 7,015 3,805
-------- --------
Total current assets .................................................. 85,049 48,433
Property and equipment, net .................................................... 7,014 5,492
Long-term investments .......................................................... 6,981 2,424
Goodwill ....................................................................... 57,303 42,273
Purchased intangible assets, net ............................................... 21,296 13,328
Officer loans. ................................................................. 4,131 4,131
Other assets ................................................................... 1,724 780
-------- --------
Total assets .......................................................... $183,498 $116,861
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable .......................................................... $ 5,376 $ 5,698
Due to related party ...................................................... 711 787
Accrued payroll and related expenses ...................................... 1,284 1,243
Other current liabilities ................................................. 3,559 3,742
-------- --------
Total current liabilities ............................................. 10,930 11,470
Deferred income taxes .......................................................... 10,995 5,895
Stockholders' equity:
Common stock .............................................................. 5 4
Additional paid-in capital. ............................................... 174,682 109,871
Employee notes receivable ................................................. (790) (790)
Deferred compensation ..................................................... (8,719) (10,020)
Retained earnings (accumulated deficit) ................................... (3,613) 582
Accumulated other comprehensive income (loss).............................. 8 (151)
-------- --------
Total stockholders' equity ............................................ 161,573 99,496
-------- --------
Total liabilities and stockholders' equity ............................ $183,498 $116,861
======== ========
See accompanying notes.
4
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
Three Months Ended Six Months Ended
December 31, December 31,
------------ ------------
2001 2000 2001 2000
---- ---- ---- ----
(Restated- Note 2)
Net revenues (A) ............................................................... $ 15,726 $ 12,036 $ 31,557 $ 23,680
Cost of revenues (B) ........................................................... 7,538 5,566 15,077 10,802
-------- -------- -------- --------
Gross profit ................................................................... 8,188 6,470 16,480 12,878
-------- -------- -------- --------
Operating expenses:
Selling, general and administrative (C) ................................... 7,695 5,819 15,272 10,972
Research and development (C) .............................................. 1,956 1,021 4,048 2,073
Stock-based compensation (B)(C) ........................................... 781 660 1,953 1,312
Amortization of purchased intangible assets ............................... 523 203 809 406
-------- -------- -------- --------
Total operating expenses ....................................................... 10,955 7,703 22,082 14,763
-------- -------- -------- --------
Loss from operations ........................................................... (2,767) (1,233) (5,602) (1,885)
Interest income (expense), net ................................................. 479 671 1,015 1,168
Other income (expense), net .................................................... (176) 79 (804) 5
-------- -------- -------- --------
Loss before income taxes and cumulative effect of
accounting change ........................................................... (2,464) (483) (5,391) (712)
Benefit for income taxes ....................................................... (547) (146) (1,196) (146)
-------- -------- -------- --------
Loss before cumulative effect of accounting change ............................. (1,917) (337) (4,195) (566)
Cumulative effect of accounting change, net of income
taxes of $176 (Note 2) ...................................................... -- 176 -- (597)
-------- -------- -------- --------
Net loss ....................................................................... $ (1,917) $ (161) $ (4,195) $ (1,163)
======== ======== ======== ========
Basic and diluted loss per share before cumulative
effect of accounting change ................................................. $ (0.04) $ (0.01) $ (0.09) $ (0.02)
Cumulative effect of accounting change per share ............................... -- 0.00 -- (0.02)
-------- -------- -------- --------
Basic and diluted net loss per share ........................................... $ (0.04) $ (0.01) $ (0.09) $ (0.04)
======== ======== ======== ========
Weighted average shares (basic and diluted) .................................... 51,261 36,709 49,374 35,058
======== ======== ======== ========
(A) Includes net revenues from related parties ................................ $ 579 $ 1,172 $ 1,096 $ 2,089
======== ======== ======== ========
(B) Cost of revenues includes the following:
Amortization of purchased intangible assets ............................ $ 560 $ -- $ 898 $ --
Stock-based compensation ............................................... 48 14 75 25
-------- -------- -------- --------
$ 608 $ 14 $ 973 $ 25
======== ======== ======== ========
(C) Stock-based compensation is excluded from the following:
Selling, general and administrative expenses ........................... $ 676 $ 578 $ 1,509 $ 1,149
Research and development expenses ...................................... 105 82 444 163
-------- -------- -------- --------
$ 781 $ 660 $ 1,953 $ 1,312
======== ======== ======== ========
See accompanying notes.
5
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Six Months Ended
December 31,
------------
2001 2000
---- ----
(Restated - Note 2)
Cash flows from operating activities:
Net loss ............................................................................. $ (4,195) $ (1,163)
Adjustments to reconcile net loss to net cash used in operating activities:
Cumulative effect of accounting change, net of income taxes of $176 ............... - 597
Depreciation ...................................................................... 1,225 234
Amortization of purchased intangible assets ....................................... 1,707 406
Stock-based compensation .......................................................... 2,028 1,337
Provision for doubtful accounts ................................................... 464 220
Deferred income taxes ............................................................. (565) (69)
Revaluation of investment ......................................................... 500 -
Equity losses from unconsolidated business ........................................ 476 -
Loss on disposal of asset ......................................................... - 20
Changes in operating assets and liabilities, net of effect from acquisitions:
Accounts receivable ............................................................. 2,540 (2,007)
Inventories ..................................................................... (2,310) (3,674)
Prepaid expenses and other current assets ....................................... (2,176) 209
Other assets .................................................................... (1,004) (465)
Accounts payable ................................................................ (2,781) 317
Other current liabilities ....................................................... (72) (407)
-------- --------
Net cash used in operating activities ................................................ (4,163) (4,445)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment, net ........................................... (2,625) (1,985)
Purchase of minority investments, net ............................................. (4,318) -
Acquisition of businesses, net of cash acquired ................................... (3,393) 324
Purchase of held-to-maturity investments .......................................... (12,184) (28,015)
Proceeds from sale of held-to-maturity investments ................................ 1,975 -
-------- --------
Net cash used in investing activities ................................................ (20,545) (29,676)
-------- --------
Cash flows from financing activities:
Net proceeds from underwritten offerings of common stock .......................... 47,085 53,713
Net proceeds from other issuances of common stock ................................. 869 143
-------- --------
Net cash provided by financing activities ............................................ 47,954 53,856
Effect of foreign exchange rates on cash ............................................. 36 7
-------- --------
Increase in cash and cash equivalents ................................................ 23,282 19,742
Cash and cash equivalents at beginning of period ..................................... 15,367 1,988
-------- --------
Cash and cash equivalents at end of period ........................................... $ 38,649 $ 21,730
======== ========
See accompanying notes.
6
LANTRONIX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001
1. Basis of Presentation
The condensed consolidated financial statements included herein are
unaudited. They contain all normal recurring accruals and adjustments which, in
the opinion of management, are necessary to present fairly the consolidated
financial position of Lantronix, Inc. and its subsidiaries (collectively, the
"Company") at December 31, 2001, and the consolidated results of its operations
and its cash flows for the three and six months ended December 31, 2001 and
2000. All intercompany accounts and transactions have been eliminated. It should
be understood that accounting measurements at interim dates inherently involve
greater reliance on estimates than at year-end. The results of operations for
the three and six months ended December 31, 2001 are not necessarily indicative
of the results to be expected for the full year or any future interim periods.
These financial statements do not include certain footnotes and
financial presentations normally required under generally accepted accounting
principles. Therefore, they should be read in conjunction with the audited
consolidated financial statements and notes thereto for the year ended June 30,
2001, included in the Company's Annual Report on Form 10-K/A filed with the
Securities and Exchange Commission ("SEC") in June 2002.
In May 2002, the Company undertook a special investigation of its
accounting and determined that certain sales to distributors and others made in
fiscal 2001 and 2002 did not qualify for recognition as revenue upon shipment.
As a result, the Company has restated its condensed consolidated financial
statements contained herein as well as all other interim and annual financial
statements for periods within fiscal 2001 and the first six months of fiscal
2002 (July 1, 2000 through December 31, 2001) as further described in Note 2. In
addition to this form 10-Q/A, the Company has filed a Form 10-K/A for the fiscal
year ended June 30, 2001, and a Form 10-Q/A for the quarterly period ended
September 30, 2001 to reflect the restatement.
Also effective July 1, 2001, the Company elected to early adopt
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets" ("SFAS No. 142"). As a result, the Company will no
longer amortize goodwill and certain intangible assets deemed to have indefinite
lives (Note 3).
2. Accounting Change and Restatement of Financial Statements
In originally preparing the condensed consolidated financial statements
at December 31, 2001, the Company changed its accounting method for recognizing
revenue on sales to distributors effective as of July 1, 2001, the beginning of
fiscal 2002. Under the new accounting method, the recognition of revenue and
related gross profit on sales to distributors is deferred until the distributor
resells the product to an end customer. Formerly, the Company recognized revenue
from these transactions upon shipment of product to the distributor, net of
estimates for possible returns and allowances.
In May 2002, the Company undertook a special investigation of its
accounting, which revealed that beginning in the third and fourth quarters of
fiscal 2001 certain shipments made to distributors and recorded as revenues in
fiscal 2001 and 2002 did not qualify for revenue recognition upon shipment due
to terms present in agreements with the distributors that were not considered in
the Company's original accounting decisions. As a result, the Company's new
method of accounting for distributor sales, which is based on recognizing
revenue and related gross profit on sales to distributors only as the
distributor resells the product to end customers, has been adopted effective as
of July 1, 2000, the beginning of fiscal 2001, or one year earlier. This manner
of correcting the errors in sales recognition made in previously issued
financial statements for fiscal 2001 is deemed to be preferable in the
circumstances because (1) it eliminates from revenue any effect of shipping
excessive levels of inventory to the distributors; (2) all revenue from
distributor sales in fiscal 2001 and 2002 will be recognized on a common basis;
and (3) there is assurance that any additional agreements with distributors that
may have existed with respect to specific orders but are presently unknown will
not have an impact on amounts reported as revenue after the restatement. The
restatement for the year ended June 30, 2001, results in a reduction in revenue
of approximately $6.2 million and an increase in the loss before cumulative
effect of accounting change of $2.9 million or $0.07 per share. The cumulative
effect of the accounting change for the six months ended December 31, 2000
recorded as of July 1, 2000 was a charge of $597,000 (net of income tax benefit
of $176,000) or $0.02 per share.
Management believes that the new accounting method better reflects the
substance of the transactions considering the Company's recent entry into the
semiconductor marketplace and the changing business environment; is consistent
with other
7
companies in the Company's industry thereby providing greater comparability in
the presentation of financial results among the Company and its peers, and
better focuses the Company on end customer sales.
In the special investigation conducted in May 2002, the Company also
discovered (i) that the terms and circumstances of certain sales made in the
first six months of fiscal 2002 to customers who were not distributors also
preclude revenue from being recognized upon shipment, as originally reported
(ii) that certain amounts initially reported as other comprehensive income
(loss) should be accounted for as elements of net loss. Accordingly, in the
accompanying restated condensed consolidated financial statements, the Company
has made corrections to defer the recognition of such sales as revenue until all
revenue recognition criteria have been met and to reclassify to other expense
the amounts improperly charged to other comprehensive income (loss). These
corrections result in a reduction in revenue of approximately $1.2 million and
an increase in the loss before cumulative effect of accounting change of
$869,000 or $0.02 per share in the six months ended December 31, 2001.
The effects of these corrections on net revenues; loss before
cumulative effect of accounting change, net of income tax benefit; cumulative
effect of accounting change; net loss; and related per share amounts for the
interim periods of fiscal 2001 and 2002 are shown in the tables below (in
thousands, except per share amounts):
Three Months Ended Six Months Ended
December 31, December 31,
------------ ------------
2001 2000 2001 2000
---- ---- ---- ----
As reported:
Net revenues ....................................................................... $ 16,439 $ 12,465 $ 32,708 $ 24,502
======== ======== ======== ========
Loss before cumulative effect of accounting change ................................. $ (1,171) $ (51) $ (3,326) $ (74)
Cumulative effect of accounting change, net of income tax benefit of $1,049 ........ -- -- (2,557) --
-------- -------- -------- --------
Net loss ........................................................................... $ (1,171) $ (51) $ (5,883) $ (74)
======== ======== ======== ========
Loss per share before cumulative effect of accounting change ....................... $ (0.02) $ (0.00) $ (0.07) $ (0.00)
Cumulative effect of accounting change per share ................................... -- -- (0.05) --
-------- -------- -------- --------
Basic and diluted net loss per share ............................................... $ (0.02) $ (0.00) $ (0.12) $ (0.00)
======== ======== ======== ========
As restated:
Net revenues ....................................................................... $ 16,439 $ 12,465 $ 32,708 $ 24,502
Corrections ........................................................................ (713) (429) (1,151) (822)
-------- -------- -------- --------
Net revenues, as restated .......................................................... $ 15,726 $ 12,036 $ 31,557 $ 23,680
======== ======== ======== ========
Loss before cumulative effect of accounting change ................................. $ (1,171) $ (51) $ (3,326) $ (74)
Corrections, net of tax ............................................................ (746) (286) (869) (492)
-------- -------- -------- --------
Loss before cumulative effect of accounting change, as restated .................... (1,917) (337) (4,195) (566)
Cumulative effect of accounting change, net of income tax benefit of $176, as
restated ........................................................................ -- 176 -- (597)
-------- -------- -------- --------
Net loss, as restated .............................................................. $ (1,917) $ (161) $ (4,195) $ (1,163)
======== ======== ======== ========
Loss per share before cumulative effect of accounting change, as
restated ...................................................................... $ (0.04) $ (0.01) $ (0.09) $ (0.02)
Cumulative effect of accounting change per share, as restated ...................... -- -- -- (0.02)
-------- -------- -------- --------
Basic and diluted net loss per share, as restated .................................. $ (0.04) $ (0.01) $ (0.09) $ (0.04)
======== ======== ======== ========
3. Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 141, "Business Combinations" ("SFAS No. 141"), effective for
acquisitions consummated after June 30, 2001, and SFAS No. 142, effective for
fiscal years beginning after December 15, 2001. Under the new rules, goodwill
and certain intangible assets deemed to have indefinite lives will no longer be
amortized but will be subject to annual impairment tests. Other intangible
assets will continue to be amortized over their useful lives.
The Company has elected to early adopt the rules set forth in SFAS No.
142 on accounting for goodwill and other intangibles effective as of July 1,
2001. For the six months ended December 31, 2001, early adoption resulted in
non-amortization of goodwill of $3.5 million or $0.07 per share based on the
weighted average shares outstanding for the six months ended December 31, 2001.
The transition provisions of SFAS No. 142 require that the Company
complete its assessment of whether impairment may exist as of the date of
adoption by December 31, 2001 and complete its determination of the amount of
any impairment as of the date of adoption by June 30, 2002. Any impairment that
is required to be recognized when adopting SFAS 142 will be reflected as the
cumulative effect of a change in accounting principle as of July 1, 2001. The
Company has completed its initial assessment and concluded that goodwill arising
from the acquisition of United States Software Corporation (USSC), having a
carrying amount of approximately $5.4 million as of July 1, 2001, may be
impaired. The Company expects to complete its
8
determination of the amount of the impairment charge, if any, to be reflected as
a cumulative effect of a change in accounting principle during the fourth fiscal
quarter ending June 30, 2002.
The Company intends to perform the first of the required annual
impairment tests of goodwill under the guidelines of SFAS No. 142 effective as
of April 1, 2002. The Company has not yet determined the effect, if any, that
this test will have on its consolidated statement of operations or financial
position. An impairment charge, if any, identified as a result of completing the
Company's annual impairment test will be reflected as an operating expense in
the fourth quarter of fiscal 2002.
In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" ("SFAS No. 121") and the accounting and reporting provisions of
Accounting Principles Board Opinion No. 30, "Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions." This
statement retains certain requirements of SFAS No. 121 relating to the
recognition and measurement of impairment of long-lived assets to be held and
used. Additionally, this statement results in one accounting model, based on the
framework established in SFAS No. 121, for long-lived assets to be disposed of
by sales and also addresses certain implementation issues related to SFAS No.
121, including the removal of goodwill from its scope due to the issuance of
SFAS No. 142. SFAS No. 144 is effective for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal years. The Company
has not yet determined the effect, if any, on the carrying value of its
long-lived assets resulting from the adoption of SFAS No. 144.
4. Business Combinations
On October 18, 2001, the Company completed the acquisition of
Synergetic Micro Systems, Inc. ("Synergetic"). This acquisition has been
accounted for under the purchase method of accounting. The condensed
consolidated financial statements include the results of operations of the
acquisition of Synergetic after its acquisition date. The acquisition of
Synergetics provides the Company with high-performance embedded network
communications to complement its external device products. A summary of the
transaction is outlined below:
Shares
Reserved For Total Shares
Date Shares Options Issued or Cash
Company Acquired Acquired Business Issued Assumed Reserved Consideration
---------------- -------- -------- ------ ------- -------- -------------
Synergetic.................... Oct. 2001 Embedded network 2,234,715 615,705 2,850,420 $2.7 million
communications solutions
provider
The share issuance was exempt from registration pursuant to section
3(a)(10) of the Securities Act of 1933, as amended. Portions of the cash
consideration and shares issued will be held in escrow pursuant to the terms of
the acquisition agreement.
Allocation of Purchase Consideration
The Company is in the process of obtaining an independent appraisal of
the fair value of the tangible and intangible assets acquired in order to
allocate the purchase price in accordance with SFAS No. 141. The Company does
not expect that the final allocation of purchase price will produce materially
different results from those reflected herein. The preliminary purchase price
was allocated as follows based upon management's best estimate of the tangible
and intangible assets (in thousands):
Net Tangible
Assets Purchased Deferred Deferred Tax Total
Company Acquired Acquired Goodwill Intangibles Compensation Liabilities Consideration
---------------- -------- -------- ----------- ------------ ----------- -------------
Synergetic ................................... $178 $13,608 $11,100 $203 $(5,213) $19,876
The consideration for the purchase transaction was calculated as
follows: a) common shares issued were valued based upon the Company's stock
price for a short period just before and after the companies reached agreement
and the proposed transaction was announced and b) employee stock options were
valued in accordance with FIN 44, "Accounting for Certain Transactions involving
Stock Compensation - an interpretation of APB Opinion No. 25." Net tangible
assets acquired in connection with the purchase transaction include the
acquisition costs incurred by the Company. Additionally, the net tangible assets
reflect an outstanding note payable and credit facility aggregating $626,000,
which was paid in full by the Company in connection with the terms of the merger
agreement.
9
Pro Forma Data
The pro forma statements of operations data of the Company set forth below
gives effect to the acquisition of Synergetic as if it had occurred at the
beginning of fiscal 2001. The following unaudited pro forma statements of
operations data includes the amortization of purchased intangible assets and
stock-based compensation. This pro forma data is presented for informational
purposes only and does not purport to be indicative of the results of future
operations of the Company or the results that would have actually occurred had
the acquisition taken place at the beginning of fiscal 2001 (in thousands,
except per share data):
Three Months Ended Six Months Ended
December 31, December 31,
------------ ------------
2001 2000 2001 2000
---- ---- ---- ----
(Restated)
Net revenues ......................................................................... $17,474 $12,711 $35,862 $24,911
======= ======= ======= =======
Loss before cumulative effect of accounting change ................................... $(2,851) $ (735) $(5,044) $(1,696)
Cumulative effect of accounting change, net of income
taxes of $176 ...................................................................... -- 176 -- (597)
------- ------- ------- -------
Net loss ............................................................................. $(2,851) $ (559) $ 5,044) $(2,293)
======= ======= ======= =======
Loss per share before cumulative effect of accounting
change ............................................................................. $ (0.06) $ (0.02) $ (0.10) $ (0.05)
Cumulative effect of accounting change per share ..................................... - (0.00) - (0.02)
------- ------- ------- -------
Basic and diluted net loss per share ................................................. $ (0.06) $ (0.02) $ (0.10) $ (0.07)
======= ======= ======= =======
5. Net Loss per Share
Basic net loss per share is calculated by dividing net loss by the weighted
average number of common shares outstanding during the period. Diluted net loss
per share is calculated by adjusting outstanding shares assuming any dilutive
effects of options. However, for periods in which the Company incurred a net
loss, these shares are excluded because their effect would be to reduce recorded
net loss per share. The following table sets forth the computation of net loss
per share (in thousands, except per share amounts):
Three Months Ended Six Months Ended
December 31, December 31,
------------ ------------
2001 2000 2001 2000
---- ---- ---- ----
(Restated)
Numerator:
Loss before cumulative effect of accounting change ................................... $(1,917) $ (337) $(4,195) $ (566)
Cumulative effect of accounting change, net of income
taxes of $176 ...................................................................... -- 176 -- (597)
------- ------- ------- -------
Net loss ............................................................................. $(1,917) $ (161) $(4,195) $(1,163)
======= ======= ======= =======
Denominator:
Weighted-average shares outstanding .................................................. 51,842 36,709 49,955 35,058
Less: Non-vested common shares outstanding ........................................... (581) -- (581) --
------- ------- ------- -------
Denominator for basic and diluted loss per share ..................................... 51,261 36,709 49,374 35,058
======= ======= ======= =======
Loss per share before cumulative effect of accounting
change ............................................................................. $ (0.04) $ (0.01) $ (0.09) $ (0.02)
Cumulative effect of accounting change per share ..................................... -- (0.00) -- (0.02)
------- ------- ------- -------
Basic and diluted net loss per share ................................................. $ (0.04) $ (0.01) $ (0.09) $ (0.04)
======= ======= ======= =======
6. Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market and
consist of the following (in thousands):
December 31, June 30,
2001 2001
---- ----
(Restated)
Raw materials ..................................................................................... $ 5,529 $ 6,752
Finished goods .................................................................................... 8,609 6,526
Inventory at distributors ......................................................................... 4,219 2,772
------- -------
18,357 16,050
Reserve for excess and obsolete inventory ......................................................... (2,181) (2,490)
------- -------
$16,176 $13,560
======= =======
10
7. Goodwill and Purchased Intangible Assets
Goodwill
The changes in the carrying amount of goodwill for the six months ended
December 31, 2001, are as follows (in thousands):
Balance as of July 1, 2001 .......................................................................................... $ 43,025
Goodwill acquired during the period (based, in part, on preliminary allocations) .................................... 13,608
Reclassification of assembled workforce in connection with adoption of SFAS No. 142 at July 1, 2001 ................. 1,458
----------
58,091
Less: accumulated amortization ..................................................................................... (788)
----------
Balance as of December 31, 2001 ..................................................................................... $ 57,303
==========
Purchased Intangible Assets
The composition of purchased intangible assets is as follows (in
thousands):
December 31, 2001 June 30, 2001
----------------- -------------
Useful Accumulated Accumulated
Lives Gross Amortization Net Gross Amortization Net
----- ----- ------------ --- ----- ------------ ---
Existing technology .................. 5 years $ 12,245 $(1,119) $ 11,126 $ 6,745 $ (188) $ 6,557
Customer agreements .................. 5 3,800 (154) 3,646 -- -- --
Customer lists ....................... 5 3,500 (394) 3,106 3,500 (44) 3,456
Patent/core technology ............... 5 1,600 (232) 1,368 299 (150) 149
Tradename/trademark .................. 5 1,258 (185) 1,073 1,162 (65) 1,097
Assembled workforce .................. 5 -- -- -- 1,458 (68) 1,390
Distribution network ................. 5 755 (151) 604 755 (76) 679
Non-compete agreements ............... 3 400 (27) 373 -- -- --
-------- ------- -------- ------- ------- --------
Total $ 23,558 $(2,262) $ 21,296 $13,919 $ (591) $ 13,328
======== ======== ======== ======= ======= ========
As required by SFAS No. 142, assembled workforce was reclassified as
goodwill effective July 1, 2001.
The amortization expense for purchased intangible assets for the six
months ended December 31, 2001 was $1.7 million, of which $898,000 was amortized
to cost of revenues and $809,000 was amortized to operating expenses. The
estimated amortization expense for the remainder of fiscal 2002 and the next
five years are as follows:
Cost of Operating
Revenues Expenses Total
Fiscal year ending June 30: -------- -------- -----
2002 $ 1,225 $ 1,158 $ 2,383
2003 2,449 2,316 4,765
2004 2,449 2,286 4,735
2005 2,449 2,162 4,611
2006 2,228 1,938 4,166
2007 326 310 636
-------- -------- --------
Total $ 11,126 $ 10,170 $ 21,296
======== ======== ========
8. Long-term Investments
In September and October 2001, the Company paid an aggregate of $3.0
million to Xanboo Inc. ("Xanboo") for convertible promissory notes, which are
convertible to Xanboo preferred stock. The notes have a ten year maturity and
provide for automatic conversion into the next round of equity securities of
Xanboo that raises at least $5.0 million. The notes accrue interest at 8% per
annum (Note 12).
11
Throughout fiscal 2002, the Company loaned $1.2 million to Premise
Systems Inc ("Premise"). The notes commencing in September 2001 bear interest at
the rate of 9.0% per annum (Note 12).
The Company periodically reviews its investments for which fair value
is less than cost to determine if the decline in value is other than temporary.
If the decline in value is judged to be other than temporary, the cost basis of
the security is written down to fair value. During the six months ended December
31, 2001, the Company recorded a $500,000 revaluation of a non-marketable equity
investment resulting from an other-than-temporary decline in its value. This
amount is included within the condensed consolidated statement of operations as
other expense.
9. Stockholders' Equity
In July 2001, the Company completed a public offering of 8,534,000
shares of its common stock, including an underwriters' over-allotment option to
purchase an additional 534,000 shares, at an offering price of $8.00 per share.
The Company sold 6,000,000 shares and selling stockholders sold 2,000,000 shares
of the primary offering. Additionally, the Company sold 400,500 shares and
selling stockholders sold 133,500 shares of the over-allotment option. The
Company received net proceeds of approximately $47.1 million in connection with
this offering.
10. Comprehensive Loss
SFAS No. 130, "Reporting Comprehensive Income (Loss)," establishes
standards for reporting and displaying comprehensive income (loss) and its
components in the condensed consolidated financial statements. The components of
comprehensive loss are as follows (in thousands):
Three Months ended Six Months ended
December 31, December 31,
------------ ------------
2001 2000 2001 2000
---- ---- ---- ----
(Restated)
Net loss ......................................................... $(1,917) $ (161) $(4,195) $(1,163)
Other comprehensive loss:
Change in net unrealized loss on investment ................. -- -- 134 --
Change in accumulated translation adjustments ............... (2) 13 25 7
------- ------ ------- -------
Total comprehensive loss ......................................... $(1,919) $ (148) $(4,036) $(1,156)
======= ====== ======= =======
11. Litigation
From time to time, the Company has received letters claiming that their
products infringe upon patents or other intellectual property of third-parties.
On July 3, 2001, Digi International, Inc., filed a complaint in the United
States District Court for the district of Minnesota claiming patent infringement
and alleging that Lantronix directly and/or indirectly infringes upon Digi's
U.S. Patent No. 6,047,319 by making, using, selling and or offering for sale
certain of Lantronix's Multiport device servers, including the ETS line of
products, coupled with a device driver called the Comm Port Redirector Software.
Digi alleges that the Company has willfully and intentionally infringed Digi's
patent, and its complaint seeks injunctive relief as well as unspecified
damages, treble damages, attorney's fees, interest and costs. On August 17,
2001, the Company filed its answer to the complaint, asserting affirmative
defenses, and counterclaiming for a declaratory judgment that the patent in
issue is invalid. The Court has scheduled a pre-trial conference for February
19, 2002, in which discovery parameters and a trial date will likely be set.
Based on the facts known to date, the Company believes that the claims are
without merit and intends to vigorously defend the suit.
From time to time, the Company is subject to legal proceedings and
claims in the ordinary course of business. The Company currently is not aware of
any such legal proceedings or claims that it believes will have, individually or
in the aggregate, a material adverse effect on its business, prospects,
financial position, operating results or cash flows.
12. Subsequent Events
On January 11, 2002, the Company completed the acquisition of Premise,
a developer of client-side software applications. Prior to the acquisition, the
Company held shares of Premise representing 19.99% ownership interest and in
addition held convertible promissory notes of $1.2 million with interest accrued
thereon at the rate of 9.0%. The convertible promissory notes were converted
into equity securities of Premise at the closing of the transaction. The Company
agreed to issue an aggregate of 1,063,371 shares of its common stock in exchange
for all remaining outstanding shares of Premise common stock and reserved
875,000 additional shares of common stock for issuance upon exercise of
outstanding employee stock options and other rights of Premise. Pursuant to the
Acquisition Agreement, 106,337 of such shares will be held in escrow to secure
certain indemnification obligations, and 531,686 of such shares will be held in
escrow pending achievement of certain performance obligations. The
12
Company intends to issues those shares on or around February 18, 2002. In
connection with the acquisition, the Company expects to record a one-time charge
for purchased in-process research and development expenses related to the
acquisition in its fourth fiscal quarter ending June 30, 2002.
In January 2002, Xanboo (Note 8) completed a $13.0 million equity
round. As a result, the Company's $3.0 million investment in Xanboo convertible
promissory notes was converted into shares of Xanboo preferred stock. In
addition, the Company purchased $4.0 million of Xanboo preferred stock in
January 2002. After these transactions, the Company holds an 18.73% ownership
interest in Xanboo.
In January 2002, the Company entered into a two-year line of credit
with a bank in an amount not to exceed $20.0 million. Borrowings under the line
of credit bear interest at the prime rate or the LIBOR rate plus 2.0%. The
Company is required to pay a $100,000 facility fee of which $50,000 was paid
upon the closing and $50,000 is to be paid in January 2003. The Company is also
required to pay a quarterly unused line fee of .125% of the unused line of
credit balance. The line of credit contains customary affirmative and negative
covenants. To date the Company has not borrowed against this line of credit.
Effective January 2, 2002, the Company entered into revised employment
agreements with the Company's Chief Executive and Chief Financial Officers. The
agreement with the Chief Executive Officer provides that employment is at-will
and sets forth a revised annual base salary of $325,000, a signing bonus of
$206,250, and incentive compensation of up to 100% of his annual base salary.
Pursuant to this agreement, the Chief Executive Officer was granted 300,000
options that will vest over the next four years. The agreement with the Chief
Financial Officer provides that employment is at-will and sets forth a revised
annual base salary of $262,500, a signing bonus of $144,722, and incentive
compensation of up to 100% of his annual base salary. Pursuant to this
agreement, the Chief Financial Officer was granted 250,000 options that will
vest over the next four years. Upon termination or resignation due to a change
in control, the Chief Executive Officer and Chief Financial Officer will
continue to receive their annual base salary with benefits and bonuses for a
period of two years following termination or resignation.
13
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
You should read the following discussion and analysis in conjunction
with the Unaudited Condensed Consolidated Financial Statements and related Notes
thereto contained elsewhere in this Report. The information in this Quarterly
Report on Form 10-Q/A is not a complete description of our business or the risks
associated with an investment in our common stock. We urge you to carefully
review and consider the various disclosures made by us in this Report and in
other reports filed with the SEC, including our restated Annual Report on Form
10-K/A for the fiscal year ended June 30, 2001, Form 10-Q/A for the fiscal
quarter ended September 30, 2001, and our subsequent reports on Form 8-K, that
discuss our business in greater detail.
We have restated our consolidated financial statements for the fiscal
quarters covered hereby and for our fiscal year ended June 30, 2001 and each
fiscal quarter therein in a Form 10-K/A filed in June 2002. To the extent the
following discussion and analysis refers to data from our consolidated
financial statements for such periods, such references are to the data as
restated.
The sections entitled "Risk Factors" set forth below, and similar
discussions in our other SEC filings, discuss some of the important factors that
may affect our business, results of operations and financial condition. You
should carefully consider those factors, in addition to the other information in
this Report and in our other filings with the SEC, before deciding to invest in
our company or to maintain or increase your investment.
This report contains forward-looking statements which include, but are
not limited to, statements concerning projected net revenues, expenses, gross
profit and income (loss), the need for additional capital, market acceptance of
our products, our ability to consummate acquisitions and integrate their
operations successfully, our ability to achieve further product integration, the
status of evolving technologies and their growth potential and our production
capacity. These forward-looking statements are based on our current
expectations, estimates and projections about our industry, management's
beliefs, and certain assumptions made by us. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "seeks," "estimates," "may," "will"
and variations of these words or similar expressions are intended to identify
forward-looking statements. In addition, any statements that refer to
expectations, projections or other characterizations of future events or
circumstances, including any underlying assumptions, are forward-looking
statements. These statements are not guarantees of future performance and are
subject to certain risks, uncertainties and assumptions that are difficult to
predict. Therefore, our actual results could differ materially and adversely
from those expressed in any forward- looking statements as a result of various
factors. We undertake no obligation to revise or update publicly any
forward-looking statements for any reason.
Accounting Change and Restatement of Financial Statments
In originally preparing the condensed consolidated financial statements
at December 31, 2001, we changed our accounting method for recognizing revenue
on sales to distributors effective as of July 1, 2001, the beginning of fiscal
2002. Under the new accounting method, the recognition of revenue and related
gross profit on sales to distributors is deferred until the distributor resells
the product to an end customer. Formerly, we recognized revenue from these
transactions upon shipment of product to the distributor, net of estimates for
possible returns and allowances.
In May 2002, we undertook a special investigation of our accounting,
which revealed that beginning in the third and fourth quarters of fiscal 2001
certain shipments made to distributors and recorded as revenues in fiscal 2001
and 2002 did not qualify for revenue recognition upon shipment due to terms
present in agreements with the distributors that were not considered in our
original accounting decisions. As a result, our new method of accounting for
distributor sales, which is based on recognizing revenue and related gross
profit on sales to distributors only as the distributor resells the product to
end customers, has been adopted effective as of July 1, 2000, the beginning of
fiscal 2001, or one year earlier. This manner of correcting the errors in sales
recognition made in previously issued financial statements for fiscal 2001 is
deemed to be preferable in the circumstances because (1) it eliminates from
revenue any effect of shipping excessive levels of inventory to the
distributors; (2) all revenue from distributor sales in fiscal 2001 and 2002
will be recognized on a common basis; and (3) there is assurance that any
additional agreements with distributors that may have existed with respect to
specific orders but are presently unknown will not have an impact on amounts
reported as revenue after the restatement. The restatement for the year ended
June 30, 2001, results in a reduction in revenue of approximately $6.2 million
and an increase in the loss before cumulative effect of accounting change of
$2.9 million or $0.07 per share. The cumulative effect of the accounting change
recorded for the six months ended December 31, 2000 as of July 1, 2000 was a
charge of $597,000 (net of income tax benefit of $176,000) or $0.02 per share.
We believe that the new accounting method better reflects the substance
of the transactions considering our recent entry into the semiconductor
marketplace and the changing business environment; is consistent with other
companies in our industry
14
thereby providing greater comparability in the presentation of financial results
among us and our peers, and better focuses us on end customer sales.
In the special investigation conducted in May 2002, we also discovered
(i) that the terms and circumstances of certain sales made in the first six
months of fiscal 2002 to customers who were not distributors also preclude
revenue from being recognized upon shipment, as originally reported and (ii)
that certain amounts initially reported as other comprehensive income (loss)
should be accounted for as elements of net loss. Accordingly, in the
accompanying restated condensed consolidated financial statements, we have made
corrections to defer the recognition of such sales as revenue until all revenue
recognition criteria have been met and to reclassify to other expense the
amounts improperly charged to other comprehensive income (loss). These
corrections result in a reduction in revenue of approximately $1.2 million and
an increase in the loss before cumulative effect of accounting change of
$869,000 or $0.02 per share in the six months ended December 31, 2001.
The effects of these error corrections on net revenues; loss before
cumulative effect of accounting change, net of income tax benefit; cumulative
effect of accounting change; net loss; and related per share amounts for the
interim periods of fiscal 2001 and 2002 are shown in the tables below (in
thousands, except per share amounts):
Three Months Ended Six Months Ended
December 31, December 31,
------------ ------------
2001 2000 2001 2000
---- ---- ---- ----
As originally reported:
Net revenues .............................................................. $ 16,439 $ 12,465 $ 32,708 $ 24,502
======== ======== ======== ========
Loss before cumulative effect of accounting change ........................ $ (1,171) $ (51) $ (3,326) $ (74)
Cumulative effect of accounting change, net of income tax benefit
of $1,049 .............................................................. -- -- (2,557) --
-------- -------- -------- --------
Net loss .................................................................. $ (1,171) $ (51) $ (5,883) $ (74)
======== ======== ======== ========
Loss per share before cumulative effect of accounting change .............. $ (0.02) $ (0.00) $ (0.07) $ (0.00)
Cumulative effect of accounting change per share .......................... -- -- (0.05) --
-------- -------- -------- --------
Basic and diluted net loss per share ...................................... $ (0.02) $ (0.00) $ (0.12) $ (0.00)
======== ======== ======== ========
As restated:
Net revenues .............................................................. $ 16,439 $ 12,465 $ 32,708 $ 24,502
Error corrections ......................................................... (713) (429) (1,151) (822)
-------- -------- -------- --------
Net revenues, as restated ................................................. $ 15,726 $ 12,036 $ 31,557 $ 23,680
======== ======== ======== ========
Loss before cumulative effect of accounting change ........................ $ (1,171) $ (51) $ (3,326) $ (74)
Error corrections, net of tax ............................................. (746) (286) (869) (492)
-------- -------- -------- --------
Loss before cumulative effect of accounting change, as restated ........... (1,917) (337) (4,195) (566)
Cumulative effect of accounting change, net of income tax benefit
of $176, as restated ................................................... -- 176 -- (597)
-------- -------- -------- --------
Net loss, as restated ..................................................... $ (1,917) $ (161) $ (4,195) $ (1,163)
======== ======== ======== ========
Loss per share before cumulative effect of accounting change and
error corrections, as resta ............................................ $ (0.04) $ (0.01) $ (0.09) $ (0.02)
Cumulative effect of accounting change per share, as restated ............. -- -- -- (0.02)
-------- -------- -------- --------
Basic and diluted net loss per share, as restated ......................... $ (0.04) $ (0.01) $ (0.09) $ (0.04)
======== ======== ======== ========
Under the leadership of new management, we are actively working to
strengthen our policies, procedures, personnel, controls and internal
communications in response to the circumstances that led to the restatement.
Overview
Lantronix designs network-enabling and system management solutions
consisting of hardware and software that permit almost any electronic device to
be accessed, managed, controlled over the Internet, intranets or other networks.
Since our inception in 1989, we have developed an array of network-enabling
products including external Device Servers, embedded Device Servers, Multiport
Device Servers, Print Servers and other products. Beginning in fiscal year 1999,
we began to experience an increase in sales of our Device Servers reflecting our
focus on this higher margin product line. At the same time, we began to
experience a decline in sales of Print Server and other products as we shifted
resources to our Device Server business, which we believe represents a greater
opportunity for long-term growth. We believe sales in our Device Server business
will continue to represent an increasing percentage of our net revenues in the
future. Our strategy for continuing to increase sales of our Device Server
product line involves a two-fold approach. First, we have and intend to continue
to substantially increase our research and development expenditures to enhance
our Device Server product line and develop new products. Second, we intend to
grow our Device Server business through strategic acquisitions, investments and
partnerships, which we believe will support our product lines and allow us to
secure additional intellectual property, increase our customer base and provide
access to new markets.
15
Our products are sold to original equipment manufacturers (OEMs),
value added resellers (VARs), systems integrators and distributors, as well as
directly to end-users. One of our distributors, Ingram Micro, accounted for
13.8% of our net revenues for the six months ended December 31, 2001, compared
to 13.2% for the six months ended December 31, 2000. Another distributor, Tech
Data, accounted for 7.4% of our net revenues for the six months ended December
31, 2001, compared to 10.9% for the six months ended December 31, 2000. transtec
AG, an international OEM and related party due to common ownership by our
Chairman and major stockholder, accounted for 3.5% of our net revenues for the
six months ended December 31, 2001, compared to 8.5% for the six months ended
December 31, 2000. There was no outstanding accounts receivable balance due from
transtec AG at December 31, 2001.
In July 2001, we completed a public offering of 8,534,000 shares of
our common stock, including an underwriter's over-allotment option to purchase
an additional 534,000 shares, at an offering price of $8.00 per share. We sold
6,000,000 shares and selling stockholders sold 2,000,000 shares of the primary
offering. Additionally, we sold 400,500 shares and selling stockholders sold
133,500 shares of the over-allotment option. We received net proceeds of
approximately $47.1 million in connection with this offering.
On October 18, 2001, we completed the acquisition of Synergetic, a
provider of high performance embedded network communication solutions that
compliment our external device products. In connection with the acquisition, we
paid cash consideration of $2.7 million and issued an aggregate of 2,234,715
shares of our common stock in exchange for all outstanding shares of Synergetic
common stock and reserved 615,705 additional shares of common stock for issuance
upon exercise of outstanding employee stock options and other rights of
Synergetic. Portions of the cash consideration and shares issued will be held in
escrow pursuant to the terms of the acquisition agreement.
On January 11, 2002, we completed the acquisition of Premise, a
developer of client-side software applications that compliment our device
networking products by providing superior management and control capabilities
for devices that have been network and internet enabled. Prior to the
acquisition, we held shares of Premise representing 19.9% ownership and, in
addition, held convertible promissory notes of $1.2 million with interest
accrued there-on at a rate of 9.0%. The convertible promissory notes were
converted into equity securities of Premise at the closing of the transaction.
We issued an aggregate of 1,063,371 shares of our common stock in exchange for
all remaining outstanding shares of Premise common stock and reserved 875,000
additional shares of common stock for issuance upon exercise of outstanding
employee stock options and other rights of Premise. Pursuant to the acquisition
agreement, 106,337 shares will be held in escrow to secure certain
indemnification obligations, and 531,686 of such shares will be held in escrow
pending achievement of certain performance obligations. The transaction was
exempt from registration pursuant to section 4(2) of the Securities Act of 1933,
as amended. In connection with the acquisition, we expect to record a one-time
charge for purchased in-process research and development expenses related to the
acquisition in our fourth fiscal quarter ending June 30, 2002.
In September and October 2001, we paid an aggregate of $3.0 million to
Xanboo for convertible promissory notes, which converted in January 2002, in
accordance with their terms, into Xanboo preferred stock. In addition, we
purchased $4 million of Xanboo preferred stock in January 2002. As of January
2002, we hold an 18.7% ownership interest in Xanboo and, accordingly, we will
account for our investment in Xanboo using the equity method of accounting based
upon our ability through representation on Xanboo's board of directors to
exercise significant influence over its operations.
Stock-based compensation primarily relates to deferred compensation
recorded in connection with the grant of stock options to employees where the
option exercise price is less than the estimated fair value of the underlying
shares of common stock as determined for financial reporting purposes, as well
as the fair market value (determined using the Black-Scholes option pricing
model) of the vested portion of non-employee stock options determined. Deferred
compensation also includes the value of employee stock options assumed in
connection with acquisitions of businesses calculated in accordance with current
accounting guidelines. Deferred compensation is presented as a reduction to
stockholders' equity and is amortized over the vesting period of the related
stock options, which is generally four years. At December 31, 2001, a deferred
compensation balance of $8.7 million remains and will be amortized as follows:
$1.6 million in the remainder of fiscal 2002, $3.0 million in fiscal 2003, $2.6
million in fiscal 2004, $1.4 million in fiscal 2005 and $174,000 in fiscal 2006.
The amount of stock-based compensation in future periods will increase if we
grant stock options where the exercise price is less than the quoted market
price of the underlying shares or if we assume employee stock options in
connection with additional acquisitions of businesses. The amount of stock-based
compensation actually recognized in future periods could decrease if options for
which deferred compensation has been recorded are forfeited.
On February 6, 2002, we announced and began implementing a plan to
restructure our operations in response to the current economic climate and to
integrate and consolidate recent acquisitions. In connection with this plan, we
expect to record in the third fiscal quarter ending March 31, 2002 a one-time
restructuring charge of approximately $2.8 million.
16
Results of Operations
The following table sets forth certain statement of operations data expressed as
a percentage of total net revenues:
Three Months Ended Six Months Ended
December 31, December 31,
------------ ------------
2001 2000 2001 2000
---- ---- ---- ----
(restated)
Net revenues .................................................................. 100.0% 100.0% 100.0% 100.0%
Cost of revenues .............................................................. 47.9 46.2 47.8 45.6
------ ------ ------ ------
Gross profit .................................................................. 52.1 53.8 52.2 54.4
------ ------ ------ ------
Operating expenses:
Selling, general and administrative ........................................ 48.9 47.0 48.4 46.3
Research and development ................................................... 12.4 8.5 12.8 8.8
Stock based-compensation ................................................... 5.0 5.5 6.2 5.5
Amortization of purchased intangible assets ................................ 3.3 3.0 2.6 1.7
------ ------ ------ ------
Total operating expenses ...................................................... 69.7 64.0 70.0 62.3
------ ------ ------ ------
Loss from operations .......................................................... (17.6) (10.2) (17.8) (8.0)
Interest income (expense), net ................................................ 3.0 5.6 3.2 5.0
Other income (expense), net ................................................... (1.1) 0.7 (2.5) (0.0)
------ ------ ------ ------
Loss before income taxes and cumulative effect of accounting change ........... (15.7) (4.0) (17.1) (3.0)
Benefit for income taxes ...................................................... (3.5) (1.2) (3.8) (0.6)
------ ------ ------ ------
Loss before cumulative effect of accounting change ............................ (12.2) (2.8) (13.3) (2.4)
Cumulative effect of accounting change, net of income taxes of $176 ........... (-) 1.5 -- (2.5)
------ ------ ------ ------
Net loss ...................................................................... (12.2)% (1.3)% (13.3)% (4.9)%
====== ====== ====== ======
Net Revenues
Net revenues increased $3.7 million, or 30.7%, to $15.7 million for
the three months ended December 31, 2001 from $12.0 million for the three months
ended December 31, 2000. Net revenues increased $7.9 million, or 33.3%, to $31.6
million for the six months ended December 31, 2001 from $23.7 million for the
six months ended December 31, 2000. The increase was primarily attributable to
an increase in net revenues of our Multiport Device Server and Device Server
products, partially offset by a decline in our Print Server and other products.
Multiport Device Server net revenues increased $2.8 million, or 101.4%, to $5.6
million, or 35.9% of net revenues, for the three months ended December 31, 2001
from $2.8 million, or 23.3% of net revenues, for the three months ended December
31, 2000. Multiport Device Server net revenues increased $7.9 million, or
138.5%, to $13.6 million, or 43.2% of net revenues, for the six months ended
December 31, 2001 from $5.7 million, or 24.1% of net revenues, for the six
months ended December 31, 2000. The increase in our Multiport Device Server net
revenues is primarily attributable to the acquisition of Lightwave
Communications, Inc. ("Lightwave"). Device Server net revenues increased $1.4
million, or 17.4%, to $9.7 million, or 61.7% of net revenues, for the three
months ended December 31, 2001 from $8.3 million, or 68.6% of net revenues, for
the three months ended December 31, 2000. Device Server net revenues increased
$888,000, or 5.5%, to $16.9 million, or 53.6% of net revenues, for the six
months ended December 31, 2001 from $16.0 million, or 67.7% of net revenues, for
the six months ended December 31, 2000. Device Server net revenues for the three
months ended December 31, 2001 and 2000 includes $548,000 and $238,000,
respectively, of software revenue generated from United States Software
Corporation ("USSC"). Device Server net revenues for the six months ended
December 31, 2001 and 2000 includes $909,000 and $238,000, respectively, of
software revenue generated from USSC. In addition, Device Server net revenue for
the three and six months ended December 31, 2001 includes $259,000 of Destiny
LX-1 chip revenue. No Destiny LX-1 chip revenue was recorded for the three and
six months ended December 31, 2000. The increase in our Device Server net
revenue is primarily due to an increase in our Embedded Device Servers offset by
a decrease in our External Device Servers. This change between Embedded and
External is consistent with our expectations as our customers shift to an
Embedded solution. Print Server and other net revenues decreased $591,000, or
60.7%, to $383,000, or 2.4% of net revenues, for the three months ended December
31, 2001 from $973,000, or 8.1% of net revenues, for the three months ended
December 31, 2000. Print Server and other net revenues decreased $923,000, or
47.6%, to $1.0 million, or 3.2% of net revenues, for the six months ended
December 31, 2001 from $1.9 million, or 8.2% of net revenues, for the six months
ended December 31, 2000. The decreases in our Print Server and other products
net revenues are due to a more rapid transition to our Multiport Device Server
and Device Server products.
Net revenues generated from sales in the Americas increased $4.9
million, or 62.8%, to $12.8 million, or 81.4% of net revenues, for the three
months ended December 31, 2001 from $7.9 million, or 65.3% of net revenues, for
the three months ended December 31, 2000. Net revenues generated from sales in
the Americas increased $10.3 million, or 63.0%, to $26.6 million, or 84.4% of
net revenues, for the six months ended December 31, 2001 from $16.3 million, or
69.0% of net revenues, for the six months ended December 31, 2000. Our net
revenues derived from customers located in Europe decreased $1.0 million, or
28.5%, to $2.5 million, or 16.0% of net revenues, for the three months ended
December 31, 2001 from $3.5 million, or 29.2% of net revenues, for the three
months ended December 31, 2000. Our net revenues derived from customers located
in Europe decreased
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$2.0 million, or 33.3%, to $4.1 million, or 12.9% of net revenues, for the six
months ended December 31, 2001 from $6.1 million, or 25.8% of net revenues, for
the six months ended December 31, 2000. Our net revenues derived from customers
located in Europe as a percentage of total net revenues decreased due to the
acquisition of Lightwave which primarily sells in the Americas. Our net revenues
derived from customers located in other geographic areas decreased slightly to
$415,000, or 2.6% of net revenues, for the three months ended December 31, 2001
from $659,000, or 5.5% of net revenues, for the three months ended December 31,
2000. Our net revenues derived from customers located in other geographic areas
decreased to $841,000, or 2.7% of net revenues, for the six months ended
December 31, 2001 from $1.2 million, or 5.2% of net revenues, for the six months
ended December 31, 2000.
Gross Profit
Gross profit represents net revenues less cost of revenues. Cost of
revenues consists primarily of the cost of raw material components, subcontract
labor assembly from outside manufacturers and associated overhead costs.
Additionally, cost of revenues for the three and six months ended December 31,
2001 consisted of $560,000 and $898,000, respectively, of non-cash amortization
of purchased intangible assets. No similar charges were recorded for the three
and six months ended December 31, 2000. We pay Gordian, Inc., an outside
research and development firm, a royalty based on the sale of certain of our
products. As a result, a royalty charge is included in cost of revenues and is
calculated based on the related products sold. Gross profit increased by $1.7
million, or 26.5%, to $8.2 million, or 52.1% of net revenues, for the three
months ended December 31, 2001 from $6.5 million, or 53.8% of net revenues, for
the three months ended December 31, 2000. Gross profit increased by $3.6
million, or 28.0%, to $16.5 million, or 52.2% of net revenues, for the six
months ended December 31, 2001 from $12.9 million, or 54.4% of net revenues, for
the six months ended December 31, 2000. For the three months ended December 31,
2001 and 2000, Gordian royalties were $431,000 and $488,000, respectively. For
the six months ended December 31, 2001 and 2000, Gordian royalties were $847,000
and $1.0 million, respectively. The increase in gross profit was mainly
attributable to the significant increase in the Multiport Device Server product.
The decrease in gross profit as a percentage of net revenues for the six months
ended December 31, 2001 is primarily attributable to non-cash amortization of
acquisition-related charges, volume-pricing agreements and competitive pricing
strategies.
Selling, General and Administrative
Selling, general and administrative expenses consist primarily of
personnel-related expenses including salaries and commissions, facility
expenses, information technology, trade show expenses, advertising, and
professional fees. Selling, general and administrative expenses increased $2.0
million, or 36.0%, to $7.7 million, or 48.9% of net revenues, for the three
months ended December 31, 2001 from $5.7 million, or 47.0% of net revenues, for
the three months ended December 31, 2000. Selling, general and administrative
expenses increased $4.3 million, or 39.2%, to $15.3 million, or 48.4% of net
revenues, for the six months ended December 31, 2001 from $11.0 million, or
46.3% of net revenues, for the six months ended December 31, 2000. This increase
is due primarily to increased depreciation of fixed assets, increased
personnel-related costs and facilities costs from the acquisitions of USSC,
Lightwave and Synergetic as well as hiring of sales personnel, and increased
legal and other professional fees. We expect selling, general and administrative
expenses in absolute dollars will decrease in the foreseeable future as a result
of our planned restructuring announced February 6, 2002 and decrease as a
percentage of net revenues. Selling, general and administrative expenses will
include the signing bonuses for the Chief Executive and Chief Financial Officer
totaling $351,000 in the third fiscal quarter of 2002.
Research and Development
Research and development expenses consist primarily of salaries and
the related costs of employees, as well as expenditures to third-party vendors
for research and development activities. Research and development expenses
increased $935,000, or 91.6%, to $2.0 million, or 12.4% of net revenues, for the
three months ended December 31, 2001 from $1.0 million, or 8.5% of net revenues,
for the three months ended December 31, 2000. Research and development expenses
increased $2.0 million, or 95.3%, to $4.0 million, or 12.8% of net revenues, for
the six months ended December 31, 2001 from $2.1 million, or 8.8% of net
revenues, for the six months ended December 31, 2000. This increase resulted
primarily from increased personnel-related costs due to the acquisition of USSC,
Lightwave and Synergetic, as well as hiring of senior management and expenses
related to new product development.
Stock-based Compensation
Stock-based compensation generally represents the amortization of
deferred compensation. We recorded approximately $885,000 of deferred
compensation for the six months ended December 31, 2001. Deferred compensation
represents the difference between the fair value of the underlying common stock
for accounting purposes and the exercise price of the stock options at the date
of grant. Deferred compensation is presented as a reduction of stockholders'
equity and is amortized ratably over the respective vesting periods of the
applicable options, which is generally four years. Stock-based compensation
increased
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$120,000, or 18.2%, to $780,000, or 5.0% of net revenues, for the three months
ended December 31, 2001 from $660,000, or 5.5% of net revenues, for the three
months ended December 31, 2000. Stock-based compensation increased $641,000, or
48.9%, to $2.0 million, or 6.2% of net revenues, for the six months ended
December 31, 2001 from $1.3 million, or 5.5% of net revenues, for the six months
ended December 31, 2000. The increase in stock-based compensation primarily
reflects stock options assumed in three purchase transactions that were
accounted for in accordance with the Financial Accounting Standards Board
("FASB") Interpretation No. 44, "Accounting for Certain Transactions Involving
Stock Compensation--An Interpretation of APB Opinion No. 25". We expect to incur
additional stock-based compensation in future periods as a result of the
continued amortization of deferred compensation related to these and other stock
option grants. Included in cost revenues is stock-based compensation of $49,000
and $14,000 for the three months ended December 31, 2001 and 2000, respectively,
and $75,000 and $25,000 for the six months ended December 31, 2001 and 2000,
respectively.
Amortization of Purchased Intangible Assets
In connection with the two purchase transactions completed during
fiscal 2001 and the one purchase transaction completed during the second fiscal
quarter of 2002, we recorded approximately $14.2 million and $11.1 million of
identified purchased intangible assets, respectively. Goodwill is recorded as
the difference, if any, between the aggregate consideration paid for an
acquisition and the fair value of the net tangible and intangible assets
acquired. Generally, we obtain independent appraisals of the fair value of
tangible and intangible assets acquired in order to allocate the purchase price.
We are in the process of obtaining an independent appraisal of the fair value of
the tangible and intangible assets acquired related to the acquisition of
Synergetic in order to allocate the purchase price in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations"
("SFAS No. 141"). We do not expect that the final allocation of purchase price
will produce materially different results from those reflected herein. Purchased
intangible assets are amortized on a straight-line basis over the economic lives
of the respective assets, generally three to five years. The amortization of
purchased intangible assets increased $161,000, or 44.4%, to $524,000, or 3.3%
of net revenues, for the three months ended December 31, 2001 from $363,000, or
3.0% of net revenues, for the three months ended December 31, 2000. The
amortization of purchased intangible assets increased $403,000, or 99.3%, to
$809,000, or 2.6% of net revenues, for the six months ended December 31, 2001
from $406,000, or 1.7% of net revenues, for the six months ended December 31,
2000. In addition, approximately $560,000 and $898,000 of amortization of
purchased intangible assets have been classified as cost of revenue for the
three and six months ended December 31, 2001, respectively. No comparable
amortization of purchased intangible assets was classified as cost of revenue
for the three and six months ended December 31, 2000.
Interest Income (Expense), Net
Interest income (expense), net consists primarily of interest earned
on cash, cash equivalents, short-term and long-term investments. Interest income
(expense), net was $479,000 and $671,000 for the three months ended December 31,
2001 and 2000, respectively. Interest income (expense), net was $1.0 million and
$1.2 million for the six months ended December 31, 2001 and 2000, respectively.
The decrease is primarily due to lower average investment balances and interest
rates for the three and six months ended December 31, 2001 compared to December
31, 2000, as a result of the acquisitions of USSC, Lightwave and Synergetic as
well as loans to Premise Systems and Xanboo.
Other Income (Expense), Net
Other income (expense), net was $(176,000) and $79,000 for the three
months ended December 31, 2001 and 2000, respectively. Other income (expense),
net was $(804,000) and $5,000 for the six months ended December 31, 2001 and
2000, respectively. The increase in other expense for the six months ended
December 31, 2001 is primarily attributable to the $500,000 revaluation of a
strategic investment, less gains on foreign currency translation.
Provision for Income Taxes - Effective Tax Rate
We utilize the liability method of accounting for income taxes as set
forth in SFAS No. 109, "Accounting for Income Taxes." Our effective tax rate was
22% for the six months ended December 31, 2001, and 21% for the six months ended
December 31, 2000. The federal statutory rate was 34% for both periods. Our
effective tax rate associated with the income tax benefit for the six months
ended December 31, 2001, was lower than the federal statutory rate primarily due
to foreign losses and amortization of stock-based compensation for which no
current year tax benefit was provided. Our effective tax rate associated with
the income tax benefit for the six months ended December 31, 2001, was lower
than the statutory rate primarily due to the nondeductible goodwill
amortization, amortization of stock-based compensation for which no benefit was
provided, and the effects of an unfavorable foreign tax rate variance.
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Impact of Adoption of New Accounting Standards
In June 2001, the FASB issued SFAS No. 141 "Business Combinations"
("SFAS No. 141"), effective for acquisitions consummated after June 30, 2001,
and SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"),
effective for fiscal years beginning after December 15, 2001. Under the new
rules, goodwill and certain intangible assets deemed to have indefinite lives
will no longer be amortized but will be subject to annual impairment tests.
Other intangible assets will continue to be amortized over their useful lives.
We have elected to early adopt the rules set forth in SFAS No. 142 on
accounting for goodwill and other intangibles effective as of July 1, 2001. For
the six months ended December 31, 2001, early adoption resulted in
non-amortization of goodwill of $3.5 million or $0.07 per share based on the
weighted average shares outstanding for the six months ended December 31, 2001.
The transition provisions of SFAS No. 142 require that we complete our
assessment of whether impairment may exist as of the date of adoption by
December 31, 2001 and complete our determination of the amount of any impairment
as of the date of adoption by June 30, 2002. Any impairment that is required to
be recognized when adopting SFAS No. 142 will be reflected as the cumulative
effect of a change in accounting principle as of July 1, 2001. We have completed
our initial assessment and concluded that goodwill arising from the acquisition
of USSC having a carrying amount of approximately $5.4 million as of July 1,
2001 may be impaired. We expect to complete our determination of the amount of
the impairment charge, if any, to be reflected as a cumulative effect of a
change in accounting principle during the fourth fiscal quarter ending June 30,
2002.
We intend to perform the first of the required annual impairment tests
of goodwill under the guidelines of SFAS No. 142 effective as of April 1, 2002.
We have not yet determined the effect, if any, that this test will have on our
consolidated statement of operations or financial position. An impairment
charge, if any, identified as a result of completing our annual impairment test
will be reflected as an operating expense in the fourth quarter of fiscal 2002.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" ("SFAS No. 121") and the accounting and reporting provisions of
Accounting Principles Board Opinion No. 30, "Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions." This
statement retains certain requirements of SFAS No. 121 relating to the
recognition and measurement of impairment of long-lived assets to be held and
used. Additionally, this statement results in one accounting model, based on the
framework established in SFAS No. 121, for long-lived assets to be disposed of
by sales and also addresses certain implementation issues related to SFAS No.
121, including the removal of goodwill from its scope due to the issuance of
SFAS No. 142. SFAS No. 144 is effective for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal years. We have not
yet determined the effect, if any, on the carrying value of our long-lived
assets resulting from the adoption of SFAS No. 144.
Liquidity and Capital Resources
Since inception, we have financed our operations through the issuance
of common stock and through net cash generated from operations. We consider all
highly liquid investments purchased with original maturities of 90 days or less
to be cash equivalents. Cash and cash equivalents consisting of money-market
funds and commercial paper totaled $38.6 million at December 31, 2001.
Short-term investments consist of investments maturing in twelve months or less
and totaled $9.9 million at December 31, 2001. Long-term investments totaled
$7.0 million at December 31, 2001 and consist of investments in debt securities
of two privately held companies, Premise Systems and Xanboo, and other
investments maturing in more than twelve months. Subsequent to December 31,
2001, we completed the acquisition of Premise Systems. Our convertible
promissory notes of Xanboo were converted into Xanboo Preferred Stock as a
result of Xanboo completing a $13.0 million equity round. In addition, we
purchased $4.0 million of preferred stock of Xanboo in January 2002. We
currently hold an 18.73% ownership interest in Xanboo.
Our operating activities used cash of $4.2 million for the six months
ended December 31, 2001 compared to $4.4 million for the six months ended
December 31, 2000. We incurred a net loss of $4.2 million, which includes
amortization and depreciation of $2.9 million, amortization of stock-based
compensation of $2.0 million, and the revaluation of a strategic investment of
$500,000, all of which are non-cash. This was reduced by increased inventories
of $2.3 million, increased prepaid expenses and other current assets of $2.2
million, an increase in other assets of $1.0 million, and decreased accounts
payable of $2.8 million, offset by a decrease in accounts receivable of $2.5
million. The increase in inventory was primarily due to a one-time purchase of
embedded chips in preparation for our entry into the semiconductor industry, as
well as slower than expected sales of our Multiport Device Server product line.
The increase in prepaid expenses and other current assets was primarily due to
increased receivables from our contract manufacturers and convertible notes from
Premise. The increase in other assets was primarily due to the purchase of
intellectual property for the development of embedded chips. The decrease in
accounts payable
20
was primarily due to a reduction of Synergetic liabilities subsequent to the
acquisition. The decrease in accounts receivable was primarily due to improved
cash collections from customers.
Our investing activities used $20.5 million of cash for the six months
ended December 31, 2001. We used $3.4 million, net of cash acquired, to acquire
Synergetic in October 2001. We used $10.2 million to invest in held-to-maturity
investments in debt securities, net of $2.0 million in proceeds from the sales
of securities. We used $3.0 million to purchase convertible promissory notes
with ten year maturities that automatically convert into the next round of
equity securities of Xanboo.
We also used $2.6 million to purchase property and equipment, primarily
computer hardware and software pertaining to Oracle software enhancements to
support of our international operations and a software package to support our
sales force.
Cash provided by financing activities was $48.0 million for the six
months ended December 31, 2001, primarily related to the net proceeds from our
secondary public offering completed in July 2001. Cash provided by financing
activities was $53.9 million for the six months ended December 31, 2000,
primarily related to the net proceeds from our initial public offering in August
2000.
In January 2002, we entered into a two-year line of credit with a bank in
an amount not to exceed $20.0 million. Borrowings under the line of credit bear
interest at the prime rate or the LIBOR rate plus 2.0%. We are required to pay a
$100,000 facility fee of which $50,000 was paid and $50,000 is to be paid in
January 2003. We are also required to pay a quarterly unused line fee of .125%
of the unused line of credit balance. The line of credit contains customary
affirmative and negative covenants. To date we have not borrowed against this
line of credit.
We believe that our existing cash, cash equivalents and short-term
investments and any available borrowings under our line of credit facility will
be adequate to meet our anticipated cash needs through at least the next 12
months. Our future capital requirements will depend on many factors, including
the timing and amount of our net revenues and research and development and
infrastructure investments as well as our intentions to make strategic
acquisitions or investments in other companies, which will affect our ability to
generate additional cash. If cash generated from operations and financing
activities is insufficient to satisfy our working capital requirements, we may
need to borrow funds through bank loans, sales of securities or other means.
There can be no assurance that we will be able to raise any such capital on
terms acceptable to us, if at all. If we are unable to secure additional
financing, we may not be able to develop or enhance our products, take advantage
of future opportunities, respond to competition or continue to operate our
business.
Risk Factors
You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only ones facing our company. Our business operations may be impaired by
additional risks and uncertainties that we do not know of or that we currently
consider immaterial.
Our business, results of operations or cash flows may be adversely
affected if any of the following risks actually occur. In such case, the trading
price of our common stock could decline, and you may lose all or part of your
investment.
VARIATIONS IN QUARTERLY OPERATING RESULTS, DUE TO FACTORS INCLUDING
CHANGES IN DEMAND FOR OUR PRODUCTS AND CHANGES IN OUR MIX OF NET REVENUES, COULD
CAUSE OUR STOCK PRICE TO DECLINE.
Our quarterly net revenues, expenses and operating results have varied in the
past and might vary significantly from quarter to quarter in the future. We
therefore believe that quarter-to-quarter comparisons of our operating results
are not a good indication of our future performance, and you should not rely on
them to predict our future performance or the future performance of our stock
price. Our short-term expense levels are relatively fixed and are based on our
expectations of future net revenues. If we were to experience a reduction in net
revenues in a quarter, we would likely be unable to adjust our short-term
expenditures. If this were to occur, our operating results for that quarter
would be harmed. If our operating results in future quarters fall below the
expectations of market analysts and investors, the price of our common stock
would likely fall. Other factors that might cause our operating results to
fluctuate on a quarterly basis include:
. changes in the mix of net revenues attributable to higher-margin and
lower-margin products;
. customers' decisions to defer or accelerate orders;
. variations in the size or timing of orders for our products;
. short-term fluctuations in the cost or availability of our critical
components, such as flash memory;
21
. changes in demand for our products generally;
. loss or gain of significant customers;
. announcements or introductions of new products by our competitors;
. defects and other product quality problems; and
. changes in demand for devices that incorporate our connectivity
products.
IF WE MAKE UNPROFITABLE ACQUISITIONS OR ARE UNABLE TO SUCCESSFULLY
INTEGRATE ANY FUTURE ACQUISITIONS, OUR BUSINESS COULD SUFFER.
We have in the past and intend to continue in the future to acquire
businesses, client lists, products or technologies that we believe complement or
expand our existing business. In October 1998, we acquired ProNet GmbH, a German
supplier of industrial application Device Server technology. In December 2000,
we acquired USSC, a company that provides software solutions for use in embedded
technology applications. In June 2001, we acquired Lightwave, a company that
provides console management solutions. In October 2001, we acquired Synergetic,
a provider of embedded network communication solutions. In January 2002, we
acquired Premise Systems, a developer of client-side software applications.
Acquisitions of this type involve a number of risks, including:
. difficulties in assimilating the operations and employees of acquired
companies;
. diversion of our management's attention from ongoing business
concerns;
. our potential inability to maximize our financial and strategic
position through the successful incorporation of acquired technology
and rights into our products and services;
. additional expense associated with amortization of acquired assets;
. maintenance of uniform standards, controls, procedures and policies;
and
. impairment of existing relationships with employees, suppliers and
customers as a result of the integration of new management employees.
Any acquisition or investment could result in the incurrence of debt and
the loss of key employees. Moreover, we often assume specified liabilities of
the companies we acquire. Some of these liabilities, such as environmental and
tort liabilities, are difficult or impossible to quantify. If we do not receive
adequate indemnification for these liabilities our business may be harmed. In
addition, acquisitions are likely to result in a dilutive issuance of equity
securities. For example, we issued common stock and assumed options to acquire
our common stock in connection with our acquisitions of USSC, Lightwave,
Synergetic and Premise Systems. We cannot assure you that any acquisitions or
acquired businesses, client lists, products or technologies associated therewith
will generate sufficient net revenues to offset the associated costs of the
acquisitions or will not result in other adverse effects. Moreover, from time to
time we may enter into negotiations for the acquisition of businesses, client
lists, products or technologies, but be unable or unwilling to consummate the
acquisition under consideration. This could cause significant diversion of
managerial attention and out of pocket expenses to us. We could also be exposed
to litigation as a result of an unconsummated acquisition, including claims that
we failed to negotiate in good faith, misappropriated confidential information
or other claims.
In addition, from time to time we intend to invest in businesses that we
believe present attractive investment opportunities, or provide other synergetic
benefits. In September and October 2001, we paid an aggregate of $3.0 million to
Xanboo for convertible promissory notes, which have converted, in accordance
with their terms, into Xanboo preferred stock. In addition, we purchased an
additional $4.0 million of preferred stock of Xanboo. We currently hold an
18.73% ownership interest in Xanboo. These investments are speculative in
nature, and there is a significant chance we will lose part or all of our
investments.
STOCK-BASED COMPENSATION WILL NEGATIVELY AFFECT OUR OPERATING RESULTS.
We have recorded deferred compensation in connection with the grant of
stock options to employees where the option exercise price is less than the
estimated fair value of the underlying shares of common stock as determined for
financial reporting purposes. We have recorded deferred compensation net of
forfeitures within stockholders' equity of $885,000 at December 31, 2001 and a
total of $14.2 million of deferred compensation through fiscal 2001, which is
being amortized over the vesting period of the related stock options, which is
generally four years. A balance of $8.7 million remains at December 30, 2001 and
will be amortized as follows: $1.6 million in the remainder of fiscal 2002, $3.0
million in fiscal 2003, $2.6 million in fiscal 2004, $1.4 million in fiscal
2005, and $174,000 in fiscal 2006.
22
The amount of stock-based compensation in future periods will increase if
we grant stock options where the exercise price is less than the quoted market
price of the underlying shares. The amount of stock-based compensation
amortization in future periods could decrease if options for which accrued, but
unvested deferred compensation has been recorded are forfeited.
WE PRIMARILY DEPEND ON THREE THIRD-PARTY MANUFACTURERS TO MANUFACTURE ALL
OF OUR PRODUCTS, WHICH REDUCES OUR CONTROL OVER THE MANUFACTURING PROCESS. IF
THESE MANUFACTURERS ARE UNABLE OR UNWILLING TO MANUFACTURE OUR PRODUCTS AT THE
QUALITY AND QUANTITY WE REQUEST, OUR BUSINESS COULD BE HARMED AND OUR STOCK
PRICE COULD DECLINE.
We primarily outsource all of our manufacturing to three third-party
manufacturers, APW, Inc., Irvine Electronics and Express Manufacturing. We
recently entered into a relationship with Uniprecision in China, and we intend
to transition a significant portion of our workload to this manufacturer during
approximately the next three months. Our reliance on these third-party
manufacturers exposes us to a number of significant risks, including:
. reduced control over delivery schedules, quality assurance,
manufacturing yields and production costs;
. lack of guaranteed production capacity or product supply; and
. reliance on third-party manufacturers to maintain competitive
manufacturing technologies.
Our agreements with these manufacturers provide for services on a
purchase-order basis. If our manufacturers were to become unable or unwilling to
continue to manufacture our products in required volumes, at acceptable quality,
quantity, yields and costs, or in a timely manner, our business would be
seriously harmed. We may also experience unforeseen problems as we attempt to
transition a significant portion of our manufacturing requirements to
Uniprecision. We do not have a significant operating history with either of
these entities and if these entities are unable to provide us with satisfactory
service, or we are unable to successfully complete the transition, our
operations could be interrupted. As a result, we would have to attempt to
identify and qualify substitute manufacturers, which could be time consuming and
difficult, and might result in unforeseen manufacturing and operations problems.
In addition, a natural disaster could disrupt our manufacturers' facilities and
could inhibit our manufacturers' ability to provide us with manufacturing
capacity on a timely basis, or at all. If this were to occur, we likely would be
unable to fill customers' existing orders or accept new orders for our products.
The resulting decline in net revenues would harm our business. In addition, we
are responsible for forecasting the demand for our individual products by
regional location. These forecasts are used by our contract manufacturers to
procure raw materials and manufacture our finished goods. If we forecast demand
too high, we may invest too much cash in inventory and we may be forced to take
a write-down of our inventory balance, which would reduce our earnings. If our
forecast is too low for one or more products, we may be required to pay expedite
charges which would increase our cost of sales or we may be unable to fulfill
customer orders thus reducing net revenues and therefore earnings.
WE MIGHT BECOME INVOLVED AND ARE CURRENTLY INVOLVED IN LITIGATION OVER
PROPRIETARY RIGHTS, WHICH COULD BE COSTLY AND TIME CONSUMING.
Substantial litigation regarding intellectual property rights exists in
our industry. There is a risk that third-parties, including current and
potential competitors, current developers of our intellectual property, our
manufacturing partners, or parties with which we have contemplated a business
combination will claim that our products, or our customers' products, infringe
on their intellectual property rights or that we have misappropriated their
intellectual property. In addition, software, business processes and other
property rights in our industry might be increasingly subject to third-party
infringement claims as the number of competitors grows and the functionality of
products in different industry segments overlaps. Other parties might currently
have, or might eventually be issued, patents that infringe on the proprietary
rights we use. Any of these third parties might make a claim of infringement
against us.
From time to time we have received letters claiming that our products
infringe upon patents or other intellectual property of third-parties. On July
3, 2001, Digi International, Inc. filed a complaint in the United States
District Court for the district of Minnesota claiming patent infringement and
alleging that Lantronix directly and/or indirectly infringes upon Digi's U.S.
Patent No. 6,047,319 by making, using, selling, and/or offering for sale certain
of Lantronix's Multiport device servers, including the ETS line of products,
coupled with a device driver called the Comm Port Redirector Software. Digi
alleges that Lantronix has willfully and intentionally infringed Digi's patent,
and its complaint seeks injunctive relief as well as unspecified damages, treble
damages, attorneys fees, interest and costs. On August 17, 2001, Lantronix filed
its answer to the complaint, asserting affirmative defenses, and counterclaiming
for a declaratory judgment that the patent in issue is invalid. The Court has
scheduled a pre-trial conference for February 19, 2002, in which discovery
parameters and a trial date will likely be set. Based on the facts known to
date, Lantronix believes that the claims are without merit and intends to
vigorously defend this suit.
23
Although we believe that the claims or any litigation arising there from
will have no material impact on us or our business, the litigation is in the
preliminary stage, and we cannot predict its outcome with certainty. The
litigation process is inherently uncertain and we may not prevail. Moreover,
patent litigation is particularly complex and can extend for a protracted time,
which can substantially increase the cost of such litigation. In the event the
Digi litigation is not resolved at a preliminary stage, the cost of defending
the claim will be substantial. In addition, the Digi litigation will likely
divert the efforts and attention of some of our key management and technical
personnel. Should the outcome of the litigation be adverse to us, we would be
required to pay monetary damages to Digi and we could be enjoined from selling
those of our products found to infringe Digi's patent unless and until we are
able to negotiate a license from Digi which may not be available on acceptable
terms or at all. If we are required to pay significant monetary damages, are
enjoined from selling any of our products or are required to make substantial
royalty payments pursuant to any such license agreement, our business would be
harmed. This litigation, or other similar litigation brought by us or others,
could result in the expenditure of significant financial resources and the
diversion of management's time and efforts.
In addition, from time to time we could encounter other disputes over
rights and obligations concerning intellectual property. We cannot assume that
we will prevail in intellectual property disputes regarding infringement,
misappropriation or other disputes. Litigation in which we are accused of
infringement or misappropriation might cause a delay in the introduction of new
products, require us to develop non-infringing technology, require us to enter
into royalty or license agreements, which might not be available on acceptable
terms, or at all, or require us to pay substantial damages, including treble
damages if we are held to have willfully infringed. In addition, we have
obligations to indemnify certain of our customers under some circumstances for
infringement of third-party intellectual property rights. If any claims from
third-parties were to require us to indemnify customers under our agreements,
the costs could be substantial, and our business could be harmed. If a
successful claim of infringement were made against us and we could not develop
non-infringing technology or license the infringed or similar technology on a
timely and cost-effective basis, our business could be significantly harmed.
IF WE ARE UNABLE TO CONTINUE USING INTELLECTUAL PROPERTY DEVELOPED BY
GORDIAN, INC. WE COULD LOSE THE RIGHTS TO VALUABLE INTELLECTUAL PROPERTY AND OUR
BUSINESS WOULD BE HARMED.
Gordian, Inc. developed intellectual property used in our Micro Serial
Server, or MSS, Print Servers and ETS and LRS lines of Multiport Device Server
products. These products represent a substantial portion of our net revenues. We
pay royalties based on the gross margin of certain of our products incorporating
Gordian Developed Technology. For the six months ended December 31, 2001 and
2000, we paid Gordian approximately $847,000 and $1.0 million in royalties,
respectively. Under the terms of an agreement dated February 29, 1989, between
Gordian and US, Gordian owns the rights to the intellectual property developed
by it. Our agreement with Gordian may be terminated by either Gordian or
ourselves with 30-days written notice. We have offered to purchase the Gordian
developed intellectual property that we will need to continue selling our MSS
products. Gordian and Lantronix have agreed to use the services of a neutral
third party to establish a reasonable price for intellectual property. Gordian
has expressed its intent to terminate its relationship with us in the event we
are unable to agree upon a price for this intellectual property. In the event we
are unable to continue using the Gordian Developed Technology we might be
prevented from marketing some or all of our MSS line of products in the future.
This would result in the loss of customers and net revenues, which would harm
our business.
THERE IS A RISK THAT OUR OEM CUSTOMERS WILL DEVELOP THEIR OWN INTERNAL
EXPERTISE IN NETWORK-ENABLING PRODUCTS, WHICH COULD RESULT IN REDUCED SALES OF
OUR PRODUCTS.
For most of our existence we primarily sold our products to VARs, system
integrators and OEMs. Although we intend to continue to use all of these sales
channels, we have begun to focus more heavily on selling our products to OEMs.
Selling products to OEMs involves unique risks, including the risk that OEMs
will develop internal expertise in network-enabling products or will otherwise
provide network functionality to their products without using our Device Server
Technology. If this were to occur, our stock price could decline in value and
you could lose part or all of your investment.
TERRORIST ATTACKS OR THREATS OR ATTACKS, AND BUSINESS INTERRUPTIONS
CAUSED BY SUCH ATTACKS, NATURAL DISASTERS AND ELECTRICAL BLACKOUTS IN THE STATE
OF CALIFORNIA COULD ADVERSELY AFFECT OUR BUSINESS.
Interruptions in business, a decline in demand in our products, or a
general economic decline resulting from actual or threatened terrorist attacks
or military action could harm our business. Adverse effects could include, but
are not limited to, physical damage to our facilities, and disruptions caused by
trade restrictions imposed by the United States or foreign governments. In
addition, a general economic downturn in any of our target markets or general
disruption of the financial markets caused by such attacks could substantially
harm our business. Moreover, our operations are vulnerable to interruption by
fire, earthquake, power loss, telecommunications failure and other events beyond
our control. We do not have a detailed disaster
24
recovery plan. Our facilities in the State of California may be subject to
electrical blackouts as a consequence of a shortage of available electrical
power. In the event these blackouts continue or increase in severity, they could
disrupt the operations of our affected facilities.
WE INTEND TO CONTINUE TO DEVOTE SIGNIFICANT RESOURCES TO OUR RESEARCH AND
DEVELOPMENT, WHICH, IF NOT SUCCESSFUL, COULD CAUSE A DECLINE IN OUR REVENUES AND
COULD HARM OUR BUSINESS.
We intend to continue to devote significant resources to research and
development in the coming years to enhance and develop additional products. For
the six months ended December 31, 2001, research and development expenses
comprised 12.8% of our net revenues. If we are unable to develop new products as
a result of this effort, or if the products we develop are not successful, our
business could be harmed. Even if we do develop new products that are accepted
by our target markets, we do not know whether the net revenue from these
products will be sufficient to justify our investment in research and
development.
IF A MAJOR CUSTOMER CANCELS, REDUCES, OR DELAYS PURCHASES, OUR NET
REVENUES MIGHT DECLINE AND OUR BUSINESS COULD BE ADVERSELY AFFECTED.
Our top five customers accounted for 31.8% and our top ten customers
accounted for 38.9% of our net revenues for the six months ended December 31,
2001. Ingram Micro and Tech Data, domestic distributors, accounted for 13.8% and
7.4% of our net revenues for the six months ended December 31, 2001,
respectively. The number and timing of sales to our customers have been
difficult for us to predict. For the six months ended December 31, 2001, large
individual sales have occurred in the last weeks or even days of a quarter,
which has resulted in a substantial portion of the net revenues for that quarter
being realized in the last month of the quarter. The loss or deferral of one or
more significant sales in a quarter could harm our operating results. We have in
the past, and might in the future, lose one or more major customers. If we fail
to continue to sell to our major customers in the quantities we anticipate, or
if any of these customers terminate our relationship, our reputation, the
perception of our products and technology in the marketplace and the growth of
our business could be harmed. The demand for our products from our OEM, VAR and
systems integrator customers depends primarily on their ability to successfully
sell their products that incorporate our Device Server Technology. Our sales are
usually completed on a purchase order basis and we have no long-term purchase
commitments from our customers.
Our future success also depends on our ability to attract new customers,
which often involves an extended process. The sale of our products often
involves a significant technical evaluation, and we often face delays because of
our customers' internal procedures used to evaluate and deploy new technologies.
For these and other reasons, the sales cycle associated with our products is
typically lengthy, often lasting six to nine months and sometimes longer.
Therefore, if we were to lose a major customer, we might not be able to replace
the customer on a timely basis or at all. This would cause our net revenues to
decrease and could cause the price of our stock to decline.
THE AVERAGE SELLING PRICES OF OUR PRODUCTS MIGHT DECREASE, WHICH COULD
REDUCE OUR GROSS MARGINS.
In the past, we have experienced some reduction in the average selling
prices and gross margins of products and we expect that this will continue for
our products as they mature. In the future, we expect competition to increase,
and we anticipate this could result in additional pressure on our pricing. In
addition, our average selling prices for our products might decline as a result
of other reasons, including promotional programs and customers who negotiate
price reductions in exchange for longer-term purchase commitments. In addition,
we might not be able to increase the price of our products in the event that the
price of components or our overhead costs increase. If this were to occur, our
gross margins would decline.
NET REVENUES FROM OUR LEGACY PRODUCTS, WHICH INCLUDE OUR PRINT SERVERS,
SWITCHES, HUBS AND OTHER PRODUCTS, HAVE DECREASED SIGNIFICANTLY AND WE EXPECT
THAT NET REVENUES FROM THESE LINES OF PRODUCTS WILL CONTINUE TO DECLINE IN THE
FUTURE AS WE FOCUS OUR EFFORTS ON THE DEVELOPMENT OF OTHER PRODUCT LINES.
Since 1993, net revenues from our legacy products have accounted for a
significant portion of our net revenues but have declined significantly
recently. For example, revenues from our legacy products were approximately $1.0
million or 3.2% of our net revenues, compared to $1.9 million or 8.2% of our
total net revenues for the six months ended December 31, 2001 and 2000,
respectively. We anticipate that net revenues from our legacy products will
continue to decline in the future as we plan to continue to focus on the
development of our current Device Server and Multiport Device Server product
lines. We do not know if this transition in product development will be
successful. We do not know whether our new product lines will be accepted by our
current and future target markets to the extent we anticipate. If the expected
decline in net revenues attributable to our legacy products is not offset by
increases in net revenues from our Device Server and Multiport Device Server
lines of product, our
25
business could be harmed.
NEW PRODUCT INTRODUCTIONS AND PRICING STRATEGIES BY OUR COMPETITORS COULD
ADVERSELY AFFECT OUR ABILITY TO SELL OUR PRODUCTS AND COULD REDUCE OUR MARKET
SHARE OR RESULT IN PRESSURE TO REDUCE THE PRICE OF OUR PRODUCTS.
The market for our products is intensely competitive, subject to rapid change
and is significantly affected by new product introductions and pricing
strategies of our competitors. We face competition primarily from companies that
network-enable devices, companies in the automation industry and companies with
significant networking expertise and research and development resources. Our
competitors might offer new products with features or functionality that are
equal to or better than our products. In addition, since we offer an open
architecture, our customers could develop products based on our technology that
compete with our offerings. We might not have sufficient engineering staff or
other required resources to modify our products to match our competitors.
Similarly, competitive pressure could force us to reduce the price of our
products. In each case, we could lose new and existing customers to our
competition. If this were to occur, our net revenues could decline and our
business could be harmed.
INABILITY OR DELAYS IN DELIVERIES FROM OUR COMPONENT SUPPLIERS COULD DAMAGE
OUR REPUTATION AND COULD CAUSE OUR NET REVENUES TO DECLINE AND HARM OUR RESULTS
OF OPERATIONS.
Our contract manufacturers and we are responsible for procuring raw
materials for our products. Our products incorporate components or technologies
that are only available from single or limited sources of supply. In particular,
some of our integrated circuits are available from a single source. From time to
time in the past, integrated circuits we use in our products have been phased
out of production. When this happens, we attempt to purchase sufficient
inventory to meet our needs until a substitute component can be incorporated
into our products. Nonetheless, we might be unable to purchase sufficient
components to meet our demands, or we might incorrectly forecast our demands,
and purchase too many or too few components. In addition, our products use
components that have in the past been subject to market shortages and
substantial price fluctuations. From time to time, we have been unable to meet
our orders because we were unable to purchase necessary components for our
products. We rely on a number of different component suppliers. Because we do
not have long-term supply arrangements with any vendor to obtain necessary
components or technology for our products, if we are unable to purchase
components from these suppliers, product shipments could be prevented or
delayed, which could result in a loss of sales. If we are unable to meet
existing orders or to enter into new orders because of a shortage in components,
we will likely lose net revenues and risk losing customers and harming our
reputation in the marketplace.
OUR INTELLECTUAL PROPERTY PROTECTION MIGHT BE LIMITED.
We do not rely on patents to protect our proprietary rights. We do rely on
a combination of laws, such as copyright, trademark and trade secret laws, and
contractual restrictions, such as confidentiality agreements and licenses, to
establish and protect our proprietary rights. Despite any precautions that we
have taken:
. laws and contractual restrictions might not be sufficient to prevent
misappropriation of our technology or deter others from developing
similar technologies;
. other companies might claim common law trademark rights based upon use
of that precede the registration of our marks;
. policing unauthorized use of our products and trademarks is difficult,
expensive and time-consuming, and we might be unable to determine the
extent of this unauthorized use;
. current federal laws that prohibit software copying provide only
limited protection from software pirates; and
. the companies we acquire may not have taken similar precautions to
protect their proprietary rights.
Also, the laws of other countries in which we market our products might
offer little or no effective protection of our proprietary technology. Reverse
engineering, unauthorized copying or other misappropriation of our proprietary
technology could enable third parties to benefit from our technology without
paying us for it, which could significantly harm our business.
UNDETECTED PRODUCT ERRORS OR DEFECTS COULD RESULT IN LOSS OF NET REVENUES,
DELAYED MARKET ACCEPTANCE AND CLAIMS AGAINST US.
We currently offer warranties ranging from 90 days to five years on each of
our products. Our products could contain undetected errors or defects. If there
is a product failure, we might have to replace all affected products without
being able to book revenue for replacement units, or we may have to refund the
purchase price for the units. Because of our recent introduction
26
of our line of Device Servers, we do not have a long history with which to
assess the risks of unexpected product failures or defects for this product
line. Regardless of the amount of testing we undertake, some errors might be
discovered only after a product has been installed and used by customers. Any
errors discovered after commercial release could result in loss of net revenues
and claims against us. Significant product warranty claims against us could harm
our business, reputation and financial results and cause the price of our stock
to decline operations are vulnerable to interruption by fire, earthquake, power
loss, telecommunications failure and other events beyond our control. We do not
have a detailed disaster recovery plan. Our facilities in the State of
California may be subject to electrical blackouts as a consequence of a shortage
of available electrical power. In the event these blackouts continue or increase
in severity, they could disrupt the operations of our affected facilities.
BECAUSE WE ARE DEPENDENT ON INTERNATIONAL SALES FOR A SUBSTANTIAL AMOUNT OF
OUR NET REVENUES, WE FACE THE RISKS OF INTERNATIONAL BUSINESS AND ASSOCIATED
CURRENCY FLUCTUATIONS, WHICH MIGHT ADVERSELY AFFECT OUR OPERATING RESULTS.
Net revenues from international sales represented 15.6% and 31.0% of net
revenues for the six months ended December 31, 2001 and 2000, respectively. Net
revenues from Europe represented 12.9% and 25.8% of our net revenues for the six
months ended December 30, 2001 and 2000, respectively.
We expect that international revenues will continue to represent a
significant portion of our net revenues in the foreseeable future. Doing
business internationally involves greater expense and many additional risks. For
example, because the products we sell abroad and the products and services we
buy abroad are priced in foreign currencies, we are affected by fluctuating
exchange rates. In the past, we have from time to time lost money because of
these fluctuations. We might not successfully protect ourselves against currency
rate fluctuations, and our financial performance could be harmed as a result. In
addition, we face other risks of doing business internationally, including:
. unexpected changes in regulatory requirements, taxes, trade laws and
tariffs;
. reduced protection for intellectual property rights in some countries;
. iffering labor regulations;
. compliance with a wide variety of complex regulatory requirements;
. changes in a country's or region's political or economic conditions;
. greater difficulty in staffing and managing foreign operations; and
. increased financial accounting and reporting burdens and complexities.
Our international operations require significant attention from our
management and substantial financial resources. We do not know whether our
investments in other countries will produce desired levels of net revenues or
profitability.
OUR EXECUTIVE OFFICERS AND TECHNICAL PERSONNEL ARE CRITICAL TO OUR
BUSINESS, AND WITHOUT THEM WE MIGHT NOT BE ABLE TO EXECUTE OUR BUSINESS
STRATEGY.
Our financial performance depends substantially on the performance of our
executive officers and key employees. We are dependent in particular on
Frederick G. Thiel, who serves as our President and Chief Executive Officer, and
Steven V. Cotton, who serves as our Chief Operating Officer and Chief Financial
Officer. We are also dependent upon our technical personnel, due to the
specialized technical nature of our business. If we lose the services of Mr.
Thiel, Mr. Cotton or any of our key personnel and are not able to find
replacements in a timely manner, our business could be disrupted, other key
personnel might decide to leave, and we might incur increased operating expenses
associated with finding and compensating replacements.
WE MIGHT BE UNABLE TO HIRE AND RETAIN THE SKILLED PERSONNEL NECESSARY TO
DEVELOP OUR OPERATIONS, SALES, TECHNICAL AND SUPPORT CAPABILITIES IN ORDER TO
CONTINUE TO GROW, WHICH COULD HARM OUR BUSINESS.
Our business cannot continue to grow if we do not hire and retain qualified
technical personnel. Competition for these individuals is intense, and we might
not be able to attract, assimilate or retain highly qualified technical
personnel in the future. In addition, we need to continue to hire and retain
operations, sales and support personnel. Our failure to attract and retain
highly trained personnel in these areas might limit the rate at which we can
develop, which would harm our business.
27
THE MARKET FOR OUR PRODUCTS IS NEW AND RAPIDLY EVOLVING. IF WE ARE NOT ABLE
TO DEVELOP OR ENHANCE OUR PRODUCTS TO RESPOND TO CHANGING MARKET CONDITIONS, OUR
NET REVENUES WILL SUFFER.
Our future success depends in large part on our ability to continue to
enhance existing products, lower product cost and develop new products that
maintain technological competitiveness. The demand for network-enabled products
is relatively new and can change as a result of innovations or changes. For
example, industry segments might adopt new or different standards, giving rise
to new customer requirements. Any failure by us to develop and introduce new
products or enhancements directed at new industry standards could harm our
business, financial condition and results of operations. These customer
requirements might or might not be compatible with our current or future product
offerings. We might not be successful in modifying our products and services to
address these requirements and standards. For example, our competitors might
develop competing technologies based on Internet Protocols, Ethernet Protocols
or other protocols that might have advantages over our products. If this were to
happen, our net revenue might not grow at the rate we anticipate, or could
decline.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Interest Rate Risk. Our exposure to interest rate risk is limited to the
exposure related to our cash, cash equivalents, short-term investments, and our
credit facilities, which are tied to market interest rates. As of December 31,
2001, we had cash, cash equivalents and short-term investments of $48.5 million,
which consisted of both domestic and foreign cash, cash equivalents and
short-term investments. We believe our cash equivalents and short term
investments would decline in value by only insignificant amounts if interest
rates increase, and therefore, such change in value would not have a material
effect on our financial condition or results of operations.
Foreign Currency Risk. We sell products internationally. As a result, our
financial results could be harmed by factors such as changes in foreign currency
exchange rates or weak economic conditions in foreign markets.
Investment Risk. At December 31, 2001, our investments in two privately
held companies totaled $5.9 million, both of which can still be considered in
the start-up or development stages. These investments are inherently risky as
the market for the technologies or products they have under development are
typically in the early stages and may never materialize. We could lose our
entire initial investment in these companies. Approximately $2.9 million of our
investment risk is in Premise Systems which we acquired in January 2002.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
From time to time we have received letters claiming that our products
infringe upon patents or other intellectual property of third-parties. On July
3, 2001, Digi International, Inc., filed a complaint in the United States
District Court for the district of Minnesota claiming patent infringement and
alleging that Lantronix directly and/or indirectly infringes upon Digi's U.S.
Patent No. 6,047,319 by making, using, selling and or offering for sale certain
of Lantronix's Multiport device servers, including the ETS line of products,
coupled with a device driver called the Comm Port Redirector Software. Digi
alleges that Lantronix has willfully and intentionally infringed Digi's patent,
and its complaint seeks injunctive relief as well as unspecified damages, treble
damages, attorneys fees, interest and costs. On August 17, 2001, Lantronix filed
its answer to the complaint, asserting affirmative defenses, and counterclaiming
for a declaratory judgment that the patent in issue is invalid. The Court has
scheduled a pre-trial Conference for February 19, 2002, in which discovery
parameters and a trial date will likely be set. Based on the facts known to
date, Lantronix believes that the claims are without merit and intends to
vigorously defend this suit.
Item 2. Changes in Securities and Use of Proceeds
On October 18, 2001, we completed the acquisition of Synergetic, a provider
of embedded network communication solutions. In connection with the acquisition,
we paid cash consideration of $2.7 million and issued an aggregate of 2,234,715
shares of our common stock in exchange for all outstanding shares of Synergetic
common stock and reserved 615,705 additional shares of common stock for issuance
upon exercise of outstanding employee stock options and other rights of
Synergetic. The transaction was exempt from registration pursuant to section
4(2) of the Securities Act of 1933, as amended. Portions of the cash
consideration and shares issued will be held in escrow pursuant to the terms of
the acquisition agreement as well as various employee share repurchase
agreements.
28
On January 11, 2002, we completed the acquisition of Premise, a developer
of client-side software applications. Prior to the acquisition we held shares of
Premise representing 19.99% ownership and in addition held notes receivable of
$1.2 million. We agreed to issue an aggregate of 1,063,371 shares of our common
stock in exchange for all remaining outstanding shares of Premise common stock
and reserved 875,000 additional shares of common stock for issuance upon
exercise of outstanding employee stock options and other rights of Premise.
Pursuant to the acquisition agreement, 106,337 of such shares will be held in
escrow to secure certain indemnification obligations, and 531,686 of such shares
will be held in escrow pending achievement of certain performance obligations.
We intend to issue these shares on or around February 18, 2002. The transaction
was exempt from registration pursuant to section 4(2) of the Securities Act of
1933, as amended. In connection with the acquisition, we expect to record a
one-time charge for purchased in-process research and development expenses
related to the acquisition in our third fiscal quarter ending March 31, 2002.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description of Document
2.1* Agreement and Plan of Reorganization by and among Lantronix, Inc., S
Company Acquisition Corporation, and Synergetic Micro Systems, Inc.
* Incorporated by reference to exhibit 5.1 previously filed with
Lantronix's Report on Form 8-K, originally filed September 20, 2001.
10.1 Employment Agreement between Lantronix, Inc. and Fred Thiel
10.2 Employment Agreement between Lantronix, Inc. and Steve Cotton
10.3 Loan and Security Agreement between Silicon Valley Bank and Lantronix,
Inc., United States Software Corporation, Lightwave Communications,
Inc. and Synergetic Micro Systems, Inc.
(b) Reports on Form 8-K
Date Item Reported On
September 20, 2001 Lantronix announced it had entered into an
agreement to acquire Synergetic Micro Systems,
Inc.
29
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, as amended,
Lantronix has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Irvine, State of
California, on the 24 day of June, 2002.
LANTRONIX, INC.
By: /s/ James Kerrigan
-----------------------------------
James Kerrigan
Interim Chief Financial Officer
30