UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September 30, 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: 333-37508
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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)
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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 October 31, 2001, 49,985,328 shares of the Registrant's common stock
were outstanding.
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LANTRONIX, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2001
INDEX
Page
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PART I. FINANCIAL INFORMATION.................................................................................... 2
Item 1. Financial Statements..................................................................................... 2
Condensed Consolidated Balance Sheets at September 30, 2001 (unaudited) and June 30, 2001................ 2
Unaudited Condensed Consolidated Statements of Operations for the Three Months
Ended September 30, 2001 and 2000........................................................................ 3
Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended
September 30, 2001 and 2000.............................................................................. 4
Notes to Unaudited Condensed Consolidated Financial Statements........................................... 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk............................................... 22
PART II. OTHER INFORMATION........................................................................................ 23
Item 1. Legal Proceedings........................................................................................ 23
Item 2. Change in Securities and Use of Proceeds................................................................. 23
Item 3. Defaults Upon Senior Securities.......................................................................... 23
Item 4. Submission of Matters to a Vote of Security Holders...................................................... 23
Item 5. Other Information........................................................................................ 23
Item 6. Exhibits and Reports on Form 8-K......................................................................... 23
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
LANTRONIX, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
September 30, June 30,
-------------- ------------
2001 2001
---- ----
(Unaudited)
ASSETS
------
Current assets:
Cash and cash equivalents.................................................................... $ 58,223 $ 15,367
Short-term investments....................................................................... 1,974 1,973
Accounts receivable, net..................................................................... 18,533 14,175
Related party receivable..................................................................... 553 1,804
Inventories.................................................................................. 9,980 10,788
Deferred income taxes........................................................................ 2,231 2,231
Prepaid income taxes......................................................................... 543 973
Prepaid expenses and other current assets.................................................... 4,666 3,805
-------- --------
Total current assets....................................................................... 96,703 51,116
Property and equipment, net.................................................................... 6,367 5,492
Goodwill and other purchased intangible assets, net............................................ 54,977 55,601
Long-term investments.......................................................................... 3,287 2,424
Other assets................................................................................... 4,928 4,911
-------- --------
Total assets............................................................................... $166,262 $119,544
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable............................................................................. $ 5,681 $ 5,698
Accrued payroll and related expenses......................................................... 1,534 1,243
Other current liabilities.................................................................... 3,487 3,742
-------- --------
Total current liabilities.................................................................. 10,702 10,683
Deferred income taxes.......................................................................... 5,895 5,895
Stockholders' equity:..........................................................................
Common stock................................................................................. 5 4
Additional paid-in capital................................................................... 157,757 109,871
Employee notes receivable.................................................................... (790) (790)
Deferred compensation........................................................................ (9,253) (10,020)
Retained earnings............................................................................ 2,230 4,052
Accumulated other comprehensive loss......................................................... (284) (151)
-------- --------
Total stockholders' equity................................................................. 149,665 102,966
-------- --------
Total liabilities and stockholders' equity................................................. $166,262 $119,544
======== ========
See accompanying notes.
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
Three Months Ended
------------------
September 30,
-------------
2001 2000
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Net revenues (A)............................................................................... $16,863 $12,037
Cost of revenues (B) (C)....................................................................... 7,932 5,349
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Gross profit................................................................................... 8,931 6,688
------- -------
Operating expenses:............................................................................
Selling, general and administrative (C)...................................................... 7,577 5,153
Research and development (C)................................................................. 2,092 1,052
Stock-based compensation (C)................................................................. 1,199 663
Amortization of purchased intangible assets.................................................. 286 203
------- -------
Total operating expenses....................................................................... 11,154 7,071
------- -------
Loss from operations........................................................................... (2,223) (383)
Interest income (expense), net................................................................. 536 497
Other income (expense), net.................................................................... (335) (74)
------- -------
Income (loss) before income taxes.............................................................. (2,022) 40
Provision (benefit) for income taxes........................................................... (200) 63
------- -------
Net loss....................................................................................... $(1,822) $ (23)
======= =======
Basic and diluted loss per share............................................................... $(0.04) $(0.00)
======= =======
Weighted average shares (basic and diluted).................................................... 47,500 32,817
======= =======
(A) Includes net revenues from related parties................................................. $ 199 $ 790
======= =======
(B) Cost of revenues includes the following:
Amortization of purchased intangible assets.............................................. $ 338 $ --
======= =======
(C) Excludes stock-based compensation as follows:
Cost of revenues......................................................................... $ 27 $ 11
Selling, general and administrative expenses............................................. 833 571
Research and development expenses........................................................ 339 81
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$ 1,199 $ 663
======= =======
See accompanying notes.
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Three Months Ended
------------------
September 30,
-------------
2001 2000
---- ----
Cash flows from operating activities:
Net loss....................................................................................... $(1,822) $ (23)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation................................................................................. 560 157
Amortization of purchased intangible assets.................................................. 624 203
Stock-based compensation..................................................................... 1,199 663
Provision for doubtful accounts.............................................................. 165 76
Revaluation of strategic investment.......................................................... 500 --
Changes in operating assets and liabilities:
Accounts receivable........................................................................ (3,272) (965)
Inventories................................................................................ 808 (2,032)
Prepaid income taxes....................................................................... 430 75
Prepaid expenses and other current assets.................................................. (877) 40
Accounts payable........................................................................... (18) (121)
Other current liabilities.................................................................. 37 (563)
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Net cash used in operating activities.......................................................... (1,666) (2,490)
------- -------
Cash flows from investing activities:
Purchase of property and equipment, net...................................................... (1,435) (1,152)
Purchase of minority investments, net.... ................................................... (1,524) --
------- -------
Net cash used in investing activities.......................................................... (2,959) (1,152)
------- -------
Cash flows from financing activities:..........................................................
Net proceeds from underwritten offerings of common stock..................................... 47,113 54,286
Net proceeds from other issuances of common stock............................................ 341 12
------- -------
Net cash provided by financing activities...................................................... 47,454 54,298
Effect of foreign exchange rates on cash....................................................... 27 (6)
------- -------
Increase in cash and cash equivalents.......................................................... 42,856 50,650
Cash and cash equivalents at beginning of period............................................... 15,367 1,988
------- -------
Cash and cash equivalents at end of period..................................................... $58,223 $52,638
======= =======
See accompanying notes.
LANTRONIX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 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 September 30, 2001, and the consolidated results of its operations
and cash flows for the three months ended September 30, 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 months ended September 30, 2001 are not necessarily indicative of the
results to be expected for the full year or any future interim periods.
The accompanying unaudited condensed consolidated financial statements do
not include certain footnotes and financial presentations normally required
under generally accepted accounting principles. Therefore, these financial
statements 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 filed with the Securities and Exchange
Commission ("SEC").
2. Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, Business
Combinations ("SFAS No. 141"), 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 in accordance with SFAS Nos. 141 and 142. Other intangible
assets will continue to be amortized over their useful lives.
The Company has elected to early adopt the new rules on accounting for
goodwill and other intangibles as of July 1, 2001. For the three months ended
September 30, 2001, early adoption resulted in non-amortization of goodwill of
$1.7 million or $0.03 per share based on the weighted average shares outstanding
for the three months ended September 30, 2001. The Company expects to perform
the first of the required impairment tests of goodwill under the new rules as of
April 1, 2002. The Company has not yet determined what the effect of these tests
will be on the consolidated results of operations and financial position of the
Company.
3. Loss per Share
Basic loss per share is calculated by dividing net loss by the weighted
average number of common shares outstanding during the period. Diluted loss per
share is calculated by adjusting outstanding shares assuming any dilutive
effects of options. However, these shares are excluded due to the extent of
their antidilutive effect for periods in which the Company incurred a net loss.
The following table sets forth the computation of loss per share (In thousands,
except per share amounts):
Three Months Ended
--------------------------------
September 30,
--------------------------------
2001 2000
---- ----
Numerator: Net loss.......................................... $(1,822) $ (23)
------- -------
Denominator:
Weighted-average shares outstanding......................... 48,140 32,817
Less: Non-vested common shares outstanding.................. (640) --
------- -------
Denominator for basic and diluted loss per share............. 47,500 32,817
======= =======
Basic and diluted loss per share............................. $ (0.04) $ (0.00)
======= =======
4. Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market
and consist of the following:
September 30, June 30,
2001 2001
---- ----
(Unaudited)
(In thousands)
Raw materials......................................... $ 4,816 $ 6,752
Finished goods........................................ 7,554 6,526
------- -------
12,370 13,278
Reserve for excess and obsolete inventory............. (2,390) (2,490)
------- -------
$ 9,980 $10,788
======= =======
5. Long-term investments
In September 2001, the Company purchased a convertible promissory note from
Xanboo Inc. in the principal amount of $1.5 million. The note has a ten year
maturity and will automatically convert into the next round of equity securities
of Xanboo that raises at least $5.0 million. If Xanboo does not complete such a
financing prior to February 1, 2002, the Company can convert the note into a
newly created series of preferred stock of Xanboo. The Company is considering
investing additional money in this company as well as other companies. See Note
8.
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 three months ended September
30, 2001, the Company recorded a $500,000 write-down of a strategic investment.
This amount is included within the condensed consolidated statement of
operations as other expense.
6. Stockholders' Equity
In July 2001, the Company completed a public offering of 9,200,000 shares of
its common stock, including an underwriter's over-allotment option to purchase
an additional 1,200,000 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.
In August 2001, the Company issued 250,000 stock options to employees and
removed the revenue targets and related commitments entered into in connection
with the purchase of U.S. Software. The estimated value of $481,000 related to
these stock options will be accounted for as compensation expense over the
vesting period of the options of up to four years.
7. 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. Other comprehensive loss
includes foreign currency translations adjustments and net unrealized losses on
investments. The components of comprehensive loss are as follows:
Three Months ended
------------------
September 30,
-------------
2001 2000
---- ----
Net loss................................................... $(1,822) $ (23)
Other comprehensive loss:..................................
Change in net unrealized loss on investment............... (160) --
Change in accumulated translation adjustments............. 27 (6)
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Total comprehensive loss................................... $(1,955) $ (29)
======= =====
8. Litigation
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 against us in the United
States District Court for the District of Minnesota claiming patent infringement
and alleging that certain of our Multiport Device Servers, specifically our ETS
line of products, when coupled with a device driver called the Comm Port
Redirector, infringe upon U.S. Patent No. 6,047,319 owned by Digi. 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, attorney's 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.
To date discovery has not begun and a trial date has not been set. Based on the
facts known to date, Lantronix believes that the claims are without merit and
intends to vigorously defend this suit.
9. Subsequent Events
On October 18, 2001, the Company completed the acquisition of Synergetic
Micro Systems, Inc. (Synergetic), a provider of embedded network communication
solutions. In connection with the acquisition, the Company paid cash
consideration of $3.0 million and issued an aggregate of 2,234,715 shares of
its common stock in exchange for all outstanding shares of Synergetic
common stock and reserved 615,685 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. In connection with the acquisition, the Company will
record a one-time charge for purchased in-process research and development
expenses related to the acquisition in its second fiscal quarter ending December
31, 2001.
In October 2001, the Company purchased an additional $1.5 million
convertible promissory note from Xanboo Inc. The note has a ten year maturity
and will automatically convert into the next round of equity securities of
Xanboo that raises at least $5.0 million. If Xanboo does not complete such a
financing prior to February 1, 2002, the Company can convert the note into a
newly created series of preferred stock of Xanboo.
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 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 Registration Statements on Form
S-1, our Annual Report on Form 10-K for the year ended June 30, 2001 and our
subsequent reports on Form 8-K, that discuss our business in greater detail.
The sections entitled "Risk Factors That May Affect Future Results of
Operations" set forth below, and similar discussions in our other SEC filings,
discuss some of the important risk factors that may affect our business, results
of operations and financial condition. You should carefully consider those
risks, 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 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.
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 intend 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.
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 three months ended September 30, 2001,
compared to 11.5% for the three months ended September 30, 2000. Another
distributor, Tech Data, accounted for 7.3% of our net revenues for the three
months ended September 30, 2001, compared to 15.2% for the three months ended
September 30, 2000. Transtec AG, an international OEM and related party due to
common ownership by our Chairman and major stockholder, accounted for no net
revenues for the three months ended September 30,
2001, compared to 6.6% for the three months ended September 30, 2000.
In July 2001, the Company completed a public offering of 9,200,000 shares of
its common stock, including an underwriter's over-allotment option to purchase
an additional 1,200,000 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.
On October 18, 2001, we completed the acquisition of Synergetic Micro
Systems, Inc. (Synergetic), a provider of embedded network communication
solutions. In connection with the acquisition, we paid cash consideration of
$3.0 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
615,685 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. In connection with the acquisition, we will record a one-time charge
for purchased in-process research and development expenses related to the
acquisition in the second fiscal quarter ending December 31, 2001.
In September and October 2001, we purchased convertible promissory notes
from Xanboo Inc. totaling $3.0 million. The notes have ten year maturities and
will automatically convert into the next round of equity securities of Xanboo
that raises at least $5.0 million. If Xanboo does not complete such a financing
prior to February 1, 2002, we can convert the notes into a newly created series
of preferred stock of Xanboo. We are considering investing additional money in
this company as well as other companies.
Net revenue is generally recognized upon product shipment. We grant certain
distributors limited rights to return products and provide price protection for
inventories held by certin resellers at the time of published price reductions.
The Company establishes an estimated allowance for future product returns based
on historical returns experience when the related revenue is recorded and
provides for appropriate price protection reserves when pricing adjustments are
approved. Revenue from licensed software is recognized at the time of shipment,
provided that we have vendor-specific objective evidence of the fair value of
each element of the software offering and collectibility is probable. Revenue
from post-contract customer support and any other future deliverables is
deferred and recognized over the support period or as contract elements are
delivered.
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 of the vested portion of non-employee stock options utilizing the
Black-Scholes option pricing model. Deferred compensation also includes the
value of employee stock options assumed in connection with the acquisitions of
United States Software Corporation (USSC) and Lightwave Communication
(Lightwave) 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 September 30, 2001, a deferred compensation balance of
$9.3 million remains and will be amortized as follows: $2.2 million in the
remainder of fiscal 2002, $3.0 million in fiscal 2003, $2.5 million in fiscal
2004, $1.4 million in fiscal 2005 and $153,000 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.
Results of Operations for the Three Months Ended September 30, 2001 compared to
the Three Months Ended September 30, 2000
The following table sets forth certain statement of operations data expressed as
a percentage of total net revenues:
Three Months
------------
Ended
-----
September 30,
-------------
2001 2000
------ -----
Net revenues.................................................. 100.0% 100.0%
Cost of revenues.............................................. 47.0 44.4
------ -----
Gross profit.................................................. 53.0 55.6
------ -----
Operating expenses:...........................................
Selling, general and administrative......................... 44.9 42.8
Research and development.................................... 12.4 8.7
Stock based-compensation.................................... 7.1 5.5
Amortization of purchased intangible assets................. 1.7 1.7
------ -----
Total operating expenses.................................... 66.1 58.7
------ -----
Loss from operations.......................................... (13.2) (3.2)
Interest income (expense), net................................ 3.2 4.1
Other income (expense), net................................... (2.0) (0.6)
------ -----
Income (loss) before income taxes............................. (12.0) 0.3
Provision (benefit) for income taxes.......................... (1.2) 0.5
------ -----
Net loss...................................................... (10.8)% (0.2)%
====== =====
Net Revenues
Net revenues increased $4.8 million, or 40.1%, to $16.9 million for the
three months ended September 30, 2001 from $12.0 million for the three months
ended September 30, 2000. The increase was primarily attributable to an increase
in net revenues of our Multiport Device Server products, partially offset by a
decline in our Device Server, Print Server and other products. Multiport Device
Server net revenues increased $5.5 million, or 183.2%, to $8.5 million or 50.6%
of net revenues for the three months ended September 30, 2001 from $3.0 million
or 25.0% of net revenues for the three months ended September 30, 2000. The
increase in our Multiport Device Server net revenues is primarily attributable
to the acquisition of Lightwave. Device Server net revenues decreased $367,000,
or 4.6%, to $7.7 million or 45.4% of net revenues for the three months ended
September 30, 2001 from $8.0 million or 66.7% of net revenues for the three
months ended September 30, 2000. Device Server net revenues for the three months
ended September 30, 2001 includes $501,000 of software revenue generated from
USSC. No software revenue was recorded for the three months ended September 30,
2000. Print Server and other net revenues decreased $322,000, or 32.2%, to
$677,000, or 4.0% of net revenues for the three months ended September 30, 2001
from $1.0 million, or 8.3% of net revenues for the three months ended September
30, 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 $6.0 million, or
68.3%, to $14.8 million or 87.5% of net revenues for the three months ended
September 30, 2001 from $8.8 million or 72.9% of net revenues for the three
months ended September 30, 2000. Our net revenues derived from customers located
in Europe decreased $1.0 million, or 38.6%, to $1.6 million or 9.8% of net
revenues for the three months ended September 30, 2001 from $2.7 million or
22.3% of net revenues for the three months ended September 30, 2000. Our net
revenues derived from customers located in Europe as a percentage of total net
revenues decreased due to the acquisition of Lightwave who primarily
sells in the Americas. Our net revenues derived from customers located in other
geographic areas decreased slightly to $453,000 or 2.7% of net revenues for the
three months ended September 30, 2001 from $585,000 or 4.9% of net revenues for
the three months ended September 30, 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 months ended September 30, 2001 consisted of
$338,000 of non-cash amortization of acquisition-related charges. No charges
were recorded for the three months ended September 30, 2000. As part of our
agreement with Gordian, Inc., an outside research and development firm, a
royalty charge is included in cost of revenues and is calculated based on the
related products sold. Gross profit increased by $2.2 million, or 33.5%, to $8.9
million or 53.0% of net revenues for the three months ended September 30, 2001
from $6.7 million or 55.6% of net revenues for the three months ended September
30, 2000. For the three months ended September 30, 2001 and 2000, Gordian
royalties were $416,000 and $522,000, 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 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 $2.4 million, or 47.0%,
to $7.6 million or 44.9% of net revenues for the three months ended September
30, 2001 from $5.2 million or 42.8% of net revenues for the three months ended
September 30, 2000. This increase is due primarily to depreciation of deployed
fixed assets, increased personnel-related costs and facilities costs from the
acquisitions of USSC and Lightwave as well as hiring of sales personnel, legal
and other professional fees. We expect selling, general and administrative
expenses in absolute dollars will continue to increase in the foreseeable future
to support the global expansion of our operations and decrease as a percentage
of net revenues due to increased net revenue.
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
$1.0 million, or 98.9%, to $2.1 million or 12.4% of net revenues for the three
months ended September 30, 2001 from $1.1 million or 8.7% of net revenues for
the three months ended September 30, 2000. This increase resulted primarily from
increased personnel- related costs due to the acquisition of USSC and Lightwave
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 $496,000 of deferred compensation for
the three months ended September 30, 2001 and a total of $4.2 million of
deferred compensation in fiscal 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 $536,000 or
80.8% to $1.2 million or 7.1% of net revenues for the three months ended
September 30, 2001 from $663,000 or 5.5% of net revenues for the three months
ended September 30, 2000. The increase in stock-based compensation primarily
reflects stock options assumed in two purchase transactions completed during
fiscal 2001 that were accounted for in accordance with 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.
Amortization of Purchased Intangible Assets
In connection with the two purchase transactions completed during fiscal
2001, we recorded approximately $56.6 million of goodwill and purchased
intangible assets. 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. We obtained independent appraisals of
the fair value of tangible and intangible assets acquired in order to allocate
the purchase price. Purchased intangible assets are amortized on a straight-line
basis over the economic lives of the respective assets, generally three to seven
years. The amortization of purchased intangible assets increased $83,000 or
40.9%, to $286,000 or 1.7% of net revenues for the three months ended September
30, 2001 from $203,000 or 1.7% of net revenues for the three months ended
September 30, 2000. In addition, approximately $337,000 of amortization of
purchased intangible assets has been classified as cost of revenue for the three
months ended September 30, 2001. No comparable amortization of purchased
intangible assets was classified as cost of revenue for the three months ended
September 30, 2000.
In June 2001, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 141, Business Combinations ("SFAS No. 141"), 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
intangible assets deemed to have indefinite lives will no longer be amortized
but will be subject to annual impairment tests in accordance with SFAS Nos. 141
and 142. Other intangible assets will continue to be amortized over their useful
lives.
We have applied the new rules on accounting for goodwill and other
intangible assets beginning July 1, 2001. For the three months ended September
30, 2001, adoption of these new rules resulted in non-amortization of goodwill
totaling $1.7 million or $0.03 per share based on the weighted average shares
outstanding for the three months ended September 30, 2001. We expect to perform
the first of the required impairment tests of goodwill under the new rules as of
April 1. 2002. We have not yet determined what the effect of these tests will be
on our consolidated results of operations and financial position.
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 $536,000 and $497,000 for the three months ended September
30, 2001 and 2000, respectively. The increase is primarily due to higher average
investment balances for the three months ended September 30, 2001 compared to
September 30, 2000, as a result of the proceeds from our secondary public
offering completed in July 2001.
Other Income (Expense), Net
Other income (expense), net consists primarily of the revaluation of a
strategic investment and the effects of exchange gains and losses from foreign
currency transactions. Other income (expense), net was $(335,000) and $(74,000)
for the three months ended September 30, 2001 and 2000, respectively. The
increase is primarily attributable to the $500,000 revaluation of a strategic
investment, less gains on foreign currency translation.
Provision for Income Taxes
The Company utilizes the liability method of accounting for income taxes as
set forth in Financial Accounting Standards Board ("FASB") Statement No. 109,
Accounting for Income Taxes.
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 $58.2 million at September 30, 2001. Short-
term investments consist of investments maturing in twelve months or less and
totaled $2.0 million at September 30, 2001. Long-term investments consist of
investments in two privately held companies and totaled $3.3 million at
September 30, 2001.
Our operating activities used cash of $1.7 million for the three months
ended September 30, 2001. We incurred a net loss of $1.8 million, which includes
amortization and depreciation of $1.2 million, amortization of stock-based
compensation of $1.2 million and the revaluation of a strategic investment of
$500,000, all of which is non-cash. This was reduced by increased accounts
receivable of $3.3 million, and increased prepaid expenses and other current
assets of $877,000 offset by a decrease in inventory of $808,000 and prepaid
income taxes of $430,000. The increase in accounts receivable was due to
increased sales in the last month of the quarter as well as slower collections
from some of our U.S. distributors and European customers. The increase in
prepaid expenses and other current assets is primarily attributable to a deposit
to secure inventory. We decreased our inventory as we transition from procuring
our own raw materials to having our contract manufacturers procure our raw
materials. Our operating activities used cash of $2.5 million for the three
months ended September 30, 2000.
Our investing activities used $3.0 million of cash for the three months
ended September 30, 2001. We used $1.5 million of our public offering proceeds
to purchase a note with a ten year maturity that will automatically convert into
the next round of equity securities of Xanboo. We also used cash to purchase
property and equipment, primarily computer hardware and software of $1.3 million
pertaining to Oracle software enhancements, support of our international
operations and a software package to support our sales force. Our investing
activities used cash of $1.2 million for the three months ended September 30,
2000, primarily related to the purchase of property and equipment.
Cash provided by financing activities was $47.5 million for the three months
ended September 30, 2001, primarily related
to the net proceeds from our secondary public offering completed in July 2001.
Cash provided by financing activities was $54.3 million for the three months
ended September 30, 2000, primarily related to the net proceeds from our initial
public offering on August 4, 2000.
We intend to use a portion of the proceeds from our recent public offering
to substantially increase our research and development activities. Specific
amounts allocated to future research and development and sales and marketing
expenditures will be budgeted based upon market conditions existing at that
time.
We believe that the net proceeds from our initial public offering and
secondary offering, our existing cash and cash expected to be generated from
operations 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.
Factors That May Affect Future Results of Operation
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;
. changes in demand for our products generally;
. loss 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. We have also announced
that we may acquire 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 and
Synergetic. 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. For example, in March 2001, we purchased 283,476 shares of Series A
Preferred Stock of Premise Systems for $2.0 million. In September and October
2001, we paid an aggregate of $3.0 million to Xanboo Inc. for notes with ten
year maturities that are convertible into equity securities of Xanboo. These
investments are speculative in nature, and there is a significant chance we will
lose part or all of our investments.
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 as a result of actual or threatened terrorist
attacks or military action could disrupt our operations in the United States and
worldwide. Disruptions 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 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.
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 $496,000 at September 30, 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 $9.3 million remains at September 30, 2001
and will be amortized as follows: $2.2 million in the remainder of fiscal 2002,
$3.0 million in fiscal 2003, $2.5 million in fiscal 2004, $1.4 million in fiscal
2005, and $153,000 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. 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 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 three months ended September 30, 2001, research and development expenses
comprised 12.4% 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.
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
$677,000 or 4.0% of our net revenues, compared to $1.0 million or 8.3% of our
total net revenues for the three months ended September 30, 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 business could be harmed.
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.
We might be unable to manage our growth, and if we cannot do so, our
business could be harmed.
Our business has grown rapidly. At September 30, 2001, we had 249 employees
and as of September 30, 2000 we had 158 employees. In addition, we have
experienced expansion in our manufacturing and shipping requirements, our
product lines and our customer base. This rapid expansion has placed significant
strain on our administrative, operational and financial resources. These changes
have increased the complexity of managing our Company. Our current systems,
management and other resources will need to grow rapidly in order to meet the
demands of any future growth. If we are unable to successfully expand and
improve our systems as required, or if we are otherwise unable to manage any
future growth, our business will 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. See Competition.
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 have
only recently entered into relationships with APW, Inc. and Irvine Electronics,
and we intend to transition a significant portion of our workload to these
manufacturers during approximately the next six 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 APW, Inc.
and Irvine Electronics. 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.
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.
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 30.0% and our top ten customers
accounted for 36.0% of our net revenues for the three months ended September 30,
2001. Ingram Micro, a domestic distributor, accounted for 13.8% of our net
revenues for the three months ended September 30, 2001. The number and timing of
sales to our distributors have been difficult for us to predict. For the three
months ended September 30, 2001, large individual sales to the distributors, as
well as sales to other customers, 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 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. Average selling
prices and gross margins for our products also might decline as the products
mature in their life cycles. 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.
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 against us in the United
States District Court for the District of Minnesota claiming patent infringement
and alleging that certain of our Multiport Device Servers, specifically our ETS
line of products, when coupled with a device driver called the Comm Port
Redirector, infringe upon U.S. Patent No. 6,047,319 owned by Digi. 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. To date
discovery has not begun and a trial date has not been set. Based on the facts
known to date, Lantronix believes that the claims are without merit and intends
to vigorously defend this suit.
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. Patent litigation is particularly
complex and can extend for a protracted time, which can substantially increase
the cost of such litigation. 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 our agreement with Gordian, Inc. is terminated, we could lose the rights
to valuable intellectual property.
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.
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. The
agreement with Gordian currently provides that we are required to pay royalties
based on the gross margin of products sold under the agreement. For the three
months ended September 30, 2001 and 2000, we paid Gordian approximately $416,000
and $522,000 in royalties, respectively. In the event that the Gordian agreement
is terminated, we could lose our rights to the intellectual property developed
under the Gordian agreement and this might prevent us from marketing some or all
of our MSS line of products in the future. If the Gordian contract is cancelled,
we could lose customers and net revenues, which would harm our business.
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 12.5% and 27.1% of net
revenues for the three months ended September 30, 2001 and 2000, respectively.
Net revenues from Europe represented 9.8% and 22.3% of our net revenues for the
three months ended September 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;
. differing 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.
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.
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 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.
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
marks 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.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
There has not been any material change in our exposure to interest rate and
foreign currency risks since the date of our Annual Report on Form 10-K for the
year ended June 30, 2001.
Interest Rate Risk. Our exposure to interest rate risk is limited to the
exposure related to our cash and cash equivalents and our credit facilities,
which is tied to market interest rates. As of September 30, 2001, we had cash
and cash equivalents of $60.2 million, which consisted of cash and short-term
investments with original maturities of 90 days or less, both domestically and
internationally. We believe our short term investments will decline in value by
an insignificant amount if interest rates increase, and therefore 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 September 30, 2001 our investments in two privately held
companies totaled $3.3 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.
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 against us in the United
States District Court for the District of Minnesota claiming patent infringement
and alleging that certain of our Multiport Device Servers, specifically our ETS
line of products, when coupled with a device driver called the Comm Port
Redirector, infringe upon U.S. Patent No. 6,047,319 owned by Digi. 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. To date
discovery has not begun and a trial date has not been 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
In July 2001, the Company completed a public offering of 9,200,000 shares of
its common stock, including an underwriter's over-allotment option to purchase
an additional 1,200,000 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.
In August 2001, the Company issued 250,000 stock options to employees and
removed the revenue targets and related commitments entered into in connection
with the purchase of U.S. Software. The estimated value of $481,000 related to
these stock options will be accounted for as compensation expense over the
vesting period of the option of up to four years.
On October 18, 2001, the Company completed the acquisition of Synergetic
Micro Systems, Inc. (Synergetic), a provider
of embedded network communication solutions. In connection with the acquisition,
the Company paid cash consideration of $3.0 million and issued an aggregate of
2,234,715 shares of its common stock in exchange for all outstanding shares of
Synergetic common stock and reserved 615,685 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. In connection with the acquisition, the Company will record a one-
time charge for purchased in-process research and development expenses related
to the acquisition in its second fiscal quarter ending December 31, 2001.
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.
(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.
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 14th day of November, 2001.
LANTRONIX, INC.
By: /s/ STEVEN V. COTTON
---------------------------------
Steven V. Cotton
Chief Financial Officer and Chief
Operating Officer