1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES Exchange Act of 1934 for the quarterly period ended April 29, 2000. [ ] 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 0-21177 NETSILICON, INC. (Exact name of registrant as specified in its charter) MASSACHUSETTS 04-2826579 (State of incorporation) (I.R.S. Employer Identification No.) 411 WAVERLEY OAKS RD., SUITE 227, WALTHAM, MASSACHUSETTS 02452 (Address of principal executive office) (781) 647-1234 (Telephone number) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO - ------------ Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of the latest practicable date. 6,115,400 shares of Voting Common Stock, $0.01 par value, as of June 7, 2000 7,500,000 shares of Non-Voting Common Stock, $0.01 par value, as of June 7, 2000 2 NETsilicon, Inc. TABLE OF CONTENTS Page ---- PART I. FINANCIAL INFORMATION ITEM 1. Financial Statements Condensed Consolidated Balance Sheets April 29, 2000 and January 31, 2000................................................. 1 Condensed Consolidated Statements of Income Three Months Ended April 29, 2000 and April 30, 1999................................ 2 Condensed Consolidated Statements of Cash Flows Three Months Ended April 29, 2000 and April 30, 1999................................ 3 Notes to Condensed Consolidated Financial Statements................................ 4 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................................................... 5 ITEM 3. Quantitative and Qualitative Disclosure About Market Risk.............................. 20 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings...................................................................... 20 ITEM 2. Changes in Securities and Use of Proceeds.............................................. 21 ITEM 3. Defaults Upon Senior Securities........................................................ 21 ITEM 4. Submission of Matters to a Vote of Security Holders.................................... 21 ITEM 5. Other Information...................................................................... 21 ITEM 6. Exhibits and Reports on Form 8-K....................................................... 21 Signatures....................................................................................... 21 Exhibit 27.1 3 PART I. FINANCIAL INFORMATION ITEM 1. Financial Statements NETSILICON, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) APRIL 29, 2000 JANUARY 31, 2000 -------------- ---------------- ASSETS CURRENT ASSETS Cash and equivalents $ 6,833,200 $ 11,096,500 Short-term investments 11,284,400 8,203,700 Accounts receivable, net 3,455,900 2,266,000 Inventory, net 4,865,300 4,322,400 Prepaid expenses and other current assets 1,031,100 798,900 ------------ ------------ TOTAL CURRENT ASSETS 27,469,900 26,687,500 PROPERTY AND EQUIPMENT, NET 1,778,400 1,466,400 OTHER ASSETS 1,927,200 1,626,600 ------------ ------------ TOTAL ASSETS $ 31,175,500 $ 29,780,500 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES Short term debt $ -- $ 779,700 Accounts payable 3,142,700 3,013,200 Due to affiliate 55,600 56,900 Other current liabilities, including short term portion of capital lease obligation 4,248,800 3,322,700 ------------ ------------ TOTAL CURRENT LIABILITIES 7,447,100 7,172,500 ------------ ------------ CAPITAL LEASE OBLIGATION - Less current portion 22,200 125,100 ------------ ------------ TOTAL LIABILITIES 7,469,300 7,297,600 ------------ ------------ STOCKHOLDERS' EQUITY Preferred stock, $0.01 par value; 5,000,000 authorized; non issued -- -- Common stock, $0.01 par value; 35,000,000 authorized; issued and outstanding: Voting (6,098,375 and 6,037,500 shares) 61,000 60,400 Non-Voting (7,500,000 shares) 75,000 75,000 Additional paid-in capital 25,181,700 24,755,400 Accumulated other comprehensive loss (10,600) (26,400) Accumulated deficit (1,600,900) (2,381,500) ------------ ------------ TOTAL STOCKHOLDERS' EQUITY 23,706,200 22,482,900 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 31,175,500 $ 29,780,500 ============ ============ See accompanying notes to condensed consolidated financial statements. 1 4 NETSILICON, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) THREE MONTHS ENDED APRIL 29, 2000 APRIL 30, 1999 -------------- -------------- NET SALES $ 9,009,700 $ 5,814,500 COST OF SALES 3,395,900 3,120,100 ------------ ------------ GROSS MARGIN 5,613,800 2,694,400 ------------ ------------ OPERATING EXPENSES Selling and marketing 2,567,800 1,325,600 Engineering, research and development 1,509,600 502,100 General and administrative 980,000 612,800 ------------ ------------ TOTAL OPERATING EXPENSES 5,057,400 2,440,500 ------------ ------------ OPERATING INCOME 556,400 253,900 Interest income (expense) 224,200 (238,400) ------------ ------------ INCOME BEFORE TAXES ON INCOME 780,600 15,500 Taxes on income -- -- ------------ ------------ NET INCOME $ 780,600 $ 15,500 ============ ============ NET INCOME PER COMMON SHARE Basic $ 0.06 $ 0.00 Diluted 0.05 0.00 SHARES USED IN PER SHARE CALCULATION Basic 13,568,576 10,000,000 Diluted 15,864,715 10,000,000 See accompanying notes to condensed consolidated financial statements. 2 5 NETSILICON, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) THREE MONTHS ENDED APRIL 29, 2000 APRIL 30, 1999 -------------- -------------- CASH FLOW FROM OPERATING ACTIVITIES: Net income $ 780,600 $ 15,500 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 327,300 170,000 Changes in operating assets and liabilities: Accounts receivable (1,189,900) (517,700) Inventories (542,900) (359,800) Other current assets (232,200) 108,400 Accounts payable 129,500 793,100 Other current liabilities 962,600 336,800 ------------ ------------ NET CASH PROVIDED BY OPERATING ACTIVITIES 235,000 546,300 ------------ ------------ CASH FLOW USED IN INVESTING ACTIVITIES: Purchases of short-term investments (3,064,900) -- Purchases of property and equipment (523,600) (77,400) Software development costs (161,100) (315,500) Other assets (255,200) (103,400) ------------ ------------ NET CASH USED IN INVESTING ACTIVITIES (4,004,800) (496,300) ------------ ------------ CASH FLOW USED IN FINANCING ACTIVITIES: Repayments of affiliate advances (1,300) (866,200) Proceeds (repayments) of short-term debt, net (including repayment of capital lease obligation) (919,100) 263,100 Proceeds from exercise of stock options 426,900 -- ------------ ------------ NET CASH USED IN FINANCING ACTIVITIES (493,500) (603,100) ------------ ------------ DECREASE IN CASH AND EQUIVALENTS (4,263,300) (553,100) CASH AND EQUIVALENTS - BEGINNING OF PERIOD 11,096,500 582,600 ------------ ------------ CASH AND EQUIVALENTS - END OF PERIOD $ 6,833,200 $ 29,500 ============ ============ See accompanying notes to condensed consolidated financial statements. 3 6 NETsilicon, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of presentation: In the opinion of management, the accompanying condensed financial statements include all adjustments necessary for a fair presentation of NETsilicon, Inc.'s (the "Company") financial position, results of operations and cash flows for this interim period. This quarterly information should be read in conjunction with the audited financial statements and accompanying notes included in the Company's 2000 Form 10-K as filed with the Securities and Exchange Commission ("SEC") on May 1, 2000. The financial statements are prepared in conformity with generally accepted accounting principles which require management to make estimates that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. Actual results could differ from these estimates. Certain prior period amounts have been reclassified to conform to the current period presentation. These reclassifications had no effect on net income or stockholders' equity. Operating results for the interim period are not necessarily indicative of results that may be expected for the entire fiscal year. 2. Inventories: Inventories are stated at the lower of cost (first-in, first-out) or market. Cost is computed using standard costs, which approximate actual cost on a first-in, first-out basis. Inventories consist of: Inventory April 29, 2000 January 31, 2000 ------------------------------------ Raw material $3,507,000 $2,518,600 Work in process 1,095,000 1,693,400 Finished Goods 263,300 110,400 ---------- ---------- Total Inventory $4,865,300 $4,322,400 ========== ========== 3. Earnings per share calculation: Basic earnings per share is computed based on the weighted average number of shares outstanding during the period. Diluted earnings per share is computed based on the weighted average number of shares outstanding during the period increased by the effect of dilutive potential common shares which consist of shares issuable under stock benefit plans. The following is a reconciliation of the numerator and denominators of the basic and diluted per share computations: 4 7 Three months ended ---------------------------------- April 29, 2000 April 30, 1999 -------------- -------------- Net income available to common shareholders, basic and diluted $ 780,600 $ 15,500 =========== =========== Weighted-average number of common shares used in basic earnings per share 13,568,576 10,000,000 Effect of dilutive securities - stock options 2,296,139 -- ----------- ----------- Weighted-average number of common shares and dilutive potential common stock used in dilutive earnings per share 15,864,715 10,000,000 =========== =========== The shares issuable upon exercise of options and warrants represent the quarterly average of the shares issuable at exercise net of the shares assumed to have been purchased, at the average market price for the period, with the assumed exercise proceeds. Accordingly, options with exercise prices in excess of the average market price for the period are excluded because their effect would be anti-dilutive. 4. Recently issued accounting standards: In June 1998, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," which provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities and requires all derivatives to be recorded on the balance sheet at fair value. SFAS No. 133, as amended, is effective for years beginning after June 15, 2000. Adoption of SFAS No. 133, as amended, is not expected to have a material impact on our results of operations, financial position or cash flows. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Some of the information in this discussion and analysis contains forward-looking statements within the meaning of the federal securities laws. These statements include statements regarding our financial performance, product development plans, projected capital expenditures, liquidity and business strategy. Forward-looking statements typically are identified by use of terms such as may, will, expect, anticipate, estimate and similar words, although some forward-looking statements are expressed differently. You should be aware that our actual results could differ materially from those contained in the forward-looking statements due to a number of factors, including delays in product introductions, interruptions in supply and competitive product introductions. You should also consider carefully the "Business" and "Risk Factors" sections contained in the Company's 2000 Form 10-K as filed with the SEC and the "Risk Factors" section contained herein, which address additional factors that could cause our actual results to differ from those set forth in the forward-looking statements. You should read this discussion together with the unaudited financial statements and other information included in this document. OVERVIEW 5 8 We develop and market semiconductor devices and software products designed to meet the networking requirements of embedded systems. We commenced our operations in 1984 as Digital Products, Inc. From our inception, we have developed and marketed networking products for embedded systems that enable the connection of electronic devices to networks. In September 1996, Osicom Technologies, Inc. ("Osicom") acquired all of our outstanding capital stock from our stockholders. We were a wholly-owned subsidiary of Osicom from the date of the acquisition through our initial public offering in September of 1999. RESULTS OF OPERATIONS The following table sets forth information derived from our Statement of Operations expressed as a percentage of net sales for the three month periods ended April 29, 2000 and April 30, 1999. Three months ended ------------------------------ April 29, 2000 April 30, 1999 -------------- -------------- Net sales 100.0% 100.0% Cost of sales 37.7 53.7 ----- ----- Gross margin 62.3 46.3 ----- ----- Operating expenses: Selling and marketing 28.5 22.8 Engineering, research and 16.8 8.6 General and administrative 10.9 10.5 ----- ----- Total operating expenses 56.2 41.9 ----- ----- Operating income 6.1 4.4 Interest (income) expense (2.5) 4.1 ----- ----- Income before taxes on income 8.6 0.3 Taxes on income -- -- Net income 8.6% 0.3% ===== ===== Three Months Ended April 29, 2000 Compared to Three Months Ended April 30, 1999 Net sales. Net sales increased to $9.0 million for the three months ended April 29, 2000 from $5.8 million for the three months ended April 30, 1999, representing an increase of 55.0%. The increase in net sales was due primarily to an increase in OEM customers to which we shipped product from 27 for the three months ended April 1999 to 46 for the three months ended April 2000. Furthermore, the increase is attributable to increased sales to existing OEM imaging customers due to greater demand for their products and an increase in the number of projects we have with these customers. Backlog for our products and services was approximately $9.5 million and $8.4 million at April 29, 2000 and April 30, 1999, respectively, all of which was scheduled to be shipped within 12 months. Cost of sales; gross margin. Costs of goods sold consists principally of the cost of raw material components and subcontract labor assembly from outside manufacturers and suppliers. Gross margin increased to $5.6 million, or 62.3% of net sales, for the three months ended April 29, 2000 from $2.7 million, or 46.3% of net sales, for the three months ended April 30, 1999, representing an increase of 108.4%. The increase in gross margin percent for the three months ended April 29, 2000 from the prior year period was due primarily to (i) material and subcontract labor cost reductions which were partially 6 9 attributable to the increased sales volume, (ii) increases in non-recurring engineering fees related to new OEM imaging projects and royalties and (iii) a gradual shift in product mix to higher margin embedded market products, including our new NET+OS product which was released in April, 2000. Selling and marketing expenses. Selling and marketing expenses consist mainly of employee-related expenses, commissions to sales representatives, trade shows and travel expense. Selling and marketing expenses increased from $1.3 million, or 22.8% of net sales, for the three months ended April 30, 1999 to $2.6 million, or 28.5% of net sales, for the three months ended April 29, 2000, representing an increase of 93.7%. The increase was the result of (i) additional sales commissions due to increased sales volume and the expansion of our network of manufacturing representatives, distributors and authorized developers, (ii) additional payroll costs related to the expansion of our direct sales and marketing teams in the United States, Europe and Asia from 27 employees in April of 1999 to 44 employees in April of 2000 and (iii) greater marketing costs associated with the introduction of new products, greater participation in trade shows and costs associated with internet and web marketing activities. Engineering, research and development. Engineering, research and development expenses consist primarily of salaries and the related costs of employees engaged in research, design and development activities. Engineering, research and development expenses increased to $1.5 million, or 16.8% of net sales, for the three months ended April 29, 2000 from $502,000, or 8.6% of net sales, for the three months ended April 30, 1999, representing an increase of 200.7%. This increase is due primarily to increased payroll costs associated with an increase in headcount, as well as increases in contract labor and consulting costs related to our investment in product development, including investments in the development of products supporting the Linux operating system and Java programming language. Furthermore, the increase is due to higher recruiting costs and increased depreciation and amortization of purchased software tools. General and administrative expenses. General and administrative expenses consist mainly of salaries, employee-related expenses, legal expenses, audit fees and reserves for accounts receivable allowances. General and administrative expenses increased to $980,000, or 10.9% of net sales, for the three months ended April 29, 2000 from $613,000, or 10.5% of net sales, for the three months ended April 30, 1999, an increase of 59.9%. The increase in expenses is attributable to higher payroll costs related to an increase in headcount in addition to increased legal, accounting and insurance costs associated with becoming a public entity and costs associated with the continued development of our MIS group. Interest income/expense. Interest income includes interest earned on cash and short-term investment balances. Interest expense is the result of our borrowings against our line of credit with our former lender, Coast Business Credit, and the interest charged by our former sole shareholder, Osicom, for our borrowings from Osicom. Net interest income for the three months ended April 29, 2000 was $224,000, or 2.5% of net sales, and consisted of interest earned on cash and short-term investment balances which was offset in part by approximately $16,000 of interest expense. Interest expense for the three months ended April 30, 1999 was $238,000, or 4.1% of net sales, and consisted of interest on borrowings from both our line of credit and Osicom. The increase in interest income and the decrease in interest expense from the three month period ended April 30, 1999 to the three month period ended April 29, 2000 are the result of the proceeds raised by the sale of our stock in conjunction with our initial public offering on September 15, 1999 and our subsequent repayment of amounts due Coast Business Credit and Osicom. 7 10 Provision for income taxes. There was no net provision for income taxes for the three months ended April 29, 2000 and April 30, 1999 as the provision was offset by available net operating loss carryforwards. Liquidity and Capital Resources Prior to our public offering in September, 1999, we financed our operations through advances from Osicom and borrowings under our short-term bank line of credit. The Company received proceeds, net of offering costs, of approximately $22.2 million as a result of the initial public offering and sale of our stock. At April 29, 2000 we had working capital of $20.0 million and cash and cash equivalents of $6.8 million. Our operating activities provided cash of $235,000 and $546,000 for the three month periods ended April 29, 2000 and April 30, 1999, respectively. Cash provided by operating activities in the three month period ended April 29, 2000 was attributable to net income, the non-cash impact of depreciation and amortization and an increase in other current liabilities, offset in part by increases in accounts receivable and inventories which were related to the growth in sales and demand for our products. Cash provided in the three month period ended April 30, 1999 was attributable to increases in accounts payable and other current liabilities, offset in part by increases in accounts receivable and inventories. In order to support our anticipated growth, we expect that our sales and marketing expenses, engineering, research and development expenses and general and administrative expenses each will increase in the fiscal year ending January 31, 2001 and thereafter compared to the amounts of such expenses in the fiscal year ending January 31, 2000. There can be no assurance that our available cash and cash flow from operations will be sufficient to fund such additional expenses. Our standard payment terms are net 30 days. While we actively pursue collection within that time, receivables have frequently taken longer to collect in part because we sell products to large companies in Asia. Our investing activities used cash of $4.0 million and $496,000 during the three months ended April 29, 2000 and April 30, 1999, respectively. Cash used in investing activities during the three months ended April 29, 2000 related primarily to purchases of $3.1 million of short-term investments and $524,000 of property and equipment. Cash used in investing activities during the three months ended April 30, 1999 related primarily to software development costs of $316,000. Cash used in financing activities was $494,000 and $603,000 during the three months ended April 29, 2000 and April 30, 1999, respectively. Cash used in financing during the period ended April 29, 2000 related to repayments of short-term debt in the amount of $919,000 which were offset in part by proceeds from the exercise of stock options of $427,000. Cash used in the period ended April 30, 1999 was attributable to $866,000 of repayments of affiliate advances which were offset in part by net proceeds from short-term debt of $263,000. During the three months ended April 29, 2000 we repaid the balance due on our line of credit with Coast Business Credit and terminated the credit facility. We are in the process of negotiating and securing a replacement credit facility. During the fiscal year ended January 31, 2000, we entered into a technology development agreement with an entity and made a payment of $500,000, representing a deposit for future services, in accordance with the agreement. This payment is included in other 8 11 assets in the accompanying balance sheet at April 29, 2000. Additional payments totaling $2,000,000 are required under the agreement. The timing of the additional payments is based on delivery and acceptance of product. Payments required under this agreement are for products for which technological feasibility has been established. Accordingly, all payments will ultimately be recorded as capitalized software costs and amortized over the estimated two to three year lives of the underlying products. We anticipate that our available cash resources will be sufficient to meet our presently anticipated capital requirements through the next 12 months. Nonetheless, we may elect to sell additional equity securities, subject to the provisions of our 365-day lock-up agreement with the underwriters of our initial public offering, or to obtain additional credit. Our future capital requirements may vary materially from those now planned and will depend on many factors, including, but not limited to, the levels at which we maintain inventory and accounts receivable; the market acceptance of our products; the levels of promotion and advertising required to launch products or enter markets and attain a competitive position in the marketplace; volume pricing concessions; our business, product, capital expenditure and research and development plans and technology roadmap; capital improvements to new and existing facilities; technological advances; the response of competitors to our products; and our relationships with suppliers and customers. In addition, we may require an increase in the level of working capital to accommodate planned growth, hiring and infrastructure needs. Additional capital may be required for consummation of any acquisitions of businesses, products or technologies. To the extent that the funds generated from this offering, together with existing resources and cash generated from operations, are insufficient to fund our future activities, we may need to raise additional funds through public or private financings or borrowings. No assurance can be given that additional financing will be available or that, if available, such financing can be obtained on terms favorable to our shareholders and us. If additional funds are raised through the issuance of equity securities, the percentage ownership of then current stockholders of us will be reduced and such equity securities may have rights, preferences or privileges senior to those of holders of our common stock. If adequate funds are not available to satisfy short- or long-term capital requirements, we may be required to limit our operations significantly. Risk Factors You should carefully consider the following risks before investing in our common stock. These are not the only risks facing our company. Additional risks may also impair our business operations. If any of the following risks come to fruition, our business, results of operations or financial condition could be materially adversely affected. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment. You should also refer to the other information set forth in this report, and incorporated by reference, including the "Risk Factors" section contained in the Company's 2000 Form 10-K and our financial statements and the accompanying notes. This report contains certain "forward-looking statements" (statements that are not historical fact) based on our current expectations, assumptions, estimates and projections about our company and our industry. These forward-looking statements involve risks and uncertainties. Our actual results could differ materially from those anticipated in those forward-looking statements as a result of many factors, as more fully described in this section and elsewhere in this report. WE HAVE A HISTORY OF LOSSES AND AN ACCUMULATED DEFICIT THAT MAKE FUTURE OPERATING RESULTS AND PROFITABILITY DIFFICULT TO PREDICT. 9 12 We incurred net losses from continuing operations for the fiscal years ended January 31, 1997, 1998 and 1999. At April 29, 2000, we had an accumulated deficit of $1.6 million. Although we were profitable in fiscal year 2000, there can be no assurance that we will be able to maintain profitability on a quarterly or annual basis in the future. In addition, revenue growth is not necessarily indicative of future operating results and there can be no assurance that we will be able to sustain revenue growth. We continue to invest significant financial resources in product development, marketing and sales, and a failure of such expenditures to result in significant increases in revenue could have a material adverse effect on us. Due to the limited history and undetermined market acceptance of our new products, the rapidly evolving nature of our business and markets, potential changes in product standards that significantly influence many of the markets for our products, the high level of competition in the industries in which we operate and the other factors described elsewhere in Risk Factors, there can be no assurance that our investment in these areas will result in increases in revenue or that any revenue growth that is achieved can be sustained. Our history of losses, coupled with the factors described below, make future operating results difficult to predict. We and our future prospects must be considered in light of the risks, costs and difficulties frequently encountered by emerging companies. As a result, there can be no assurance that we will be profitable in any future period. THE UNPREDICTABILITY OF OUR QUARTERLY RESULTS MAY ADVERSELY AFFECT THE TRADING PRICE OF OUR COMMON STOCK. Our net sales and operating results have in the past and may in the future fluctuate substantially from quarter to quarter and from year to year. These results have varied significantly due to a number of factors, including: - market acceptance of and demand for our products and those of our customers; - unanticipated delays or problems in the introduction of our products; - the timing of large customer orders; - the timing and success of our customers' development cycles; - our ability to introduce new products in accordance with customer design requirements and design cycles; - new product announcements or product introductions by us and our competitors; - availability and cost of manufacturing sources for our products; - the volume of orders that are received and can be filled in a quarter; - the rescheduling or cancellation of orders by customers; - changes in product mix; - timing of "design wins" with our customers and related revenue; and - changes in currency exchange rates. Our operating results could also be harmed by: 10 13 - the growth rate of markets into which we sell our products; - changes in the mix of sales to customers and sales representatives; - costs associated with protecting our intellectual property; and - changes in product costs and pricing by us and our competitors. We budget expenses based in part on future revenue projections. We may be unable to adjust spending in a timely manner in response to any unanticipated declines in revenues. As a result of these and other factors, investors should not rely solely upon period-to-period comparisons of our operating results as an indication of future performance. It is likely that in some future period our operating results or business outlook will be below the expectations of securities analysts or investors, which would likely result in a significant reduction in the market price of the shares of common stock. OUR FAILURE TO INCREASE SALES TO EMBEDDED SYSTEMS MANUFACTURERS WILL ADVERSELY AFFECT OUR FINANCIAL RESULTS. Our financial performance and future growth is dependent upon our ability to sell our products to embedded systems developers in various markets, including markets in which networking solutions for embedded systems have not historically been sold, such as the industrial automation equipment, data acquisition and test equipment, Internet devices and security equipment markets. A substantial portion of our recent development efforts have been directed toward the development of new products for markets that are new and rapidly evolving. There can be no assurance that - the additional embedded systems markets targeted by us for our products and services will develop; - developers within each market targeted by us will choose our products and services to meet their needs; - we will successfully develop products to meet the industry-specific requirements of developers in our targeted markets or that design wins will result in significant sales; or - developers in our targeted markets will gain market acceptance for their devices which incorporate our products. We have limited experience in designing our products to meet the requirements of developers in these industries. Moreover, our products and services have, to date, achieved limited acceptance in these industries. WE ARE DEPENDENT ON THE IMAGING MARKET FOR A LARGE PORTION OF OUR REVENUES. The imaging market has historically accounted for substantially all of our revenues. In the fiscal years ended January 31, 2000, 1999 and 1998, 95%, 95% and 100%, respectively, of our revenues were generated from customers in the imaging market. Our success has been and continues to be dependent on the continued growth and success of the imaging market. Many of our customers face competition from larger, more established companies which may exert competitive or other pressures on them. Any decline in sales to the imaging market would have a material adverse effect on our business, results of operations and financial condition. 11 14 The imaging market is characterized by declining prices of existing products. Therefore, continual improvements in manufacturing efficiencies and the introduction of new products and enhancements to existing products are required for us to maintain our gross margins. In response to customer demands or competitive pressures, or to pursue new product or market opportunities, we may take certain pricing or marketing actions, such as price reductions or volume discounts. These actions could have a material adverse effect on us. A significant amount of our customers in the imaging market are headquartered in Japan. Our customers are subject to declines in their local economies, which have affected them from time to time in the past and may affect them in the future. The success of our customers affects their purchases from us. OUR HIGHLY CONCENTRATED CUSTOMER BASE INCREASES THE POTENTIAL ADVERSE EFFECT ON US FROM THE LOSS OF ONE OR MORE CUSTOMERS. Our products have historically been sold into the imaging markets for use in products such as printers, scanners, fax machines, copiers and multi-function peripherals. This market is highly concentrated. Accordingly, our sales are derived from a limited number of customers, with the top five OEM customers accounting for 72% and 52% of total revenues for the fiscal years ended 2000 and 1999, respectively. We expect that a small number of customers will continue to account for a substantial portion of our total revenues for the foreseeable future. All of our sales are made on the basis of purchase orders rather than under long-term agreements, and therefore, any customer could cease purchasing our products at any time without penalty. The decision of any key customer to cease using our products or a material decline in the number of units purchased by a significant customer would have a material adverse effect on us. THE LONG AND VARIABLE SALES CYCLE FOR OUR PRODUCTS MAKE IT MORE DIFFICULT FOR US TO PREDICT OUR OPERATING RESULTS AND MANAGE OUR BUSINESS. The sale of our products typically involves a significant technical evaluation and commitment of capital and other resources by potential customers, as well as delays frequently associated with customers' internal procedures to deploy new technologies within their products and to test and accept new technologies. For these and other reasons, the sales cycle associated with our products is typically lengthy, lasting nine months or longer, and is subject to a number of significant risks, including customers' internal acceptance reviews, that are beyond our control. Because of the lengthy sales cycle and the large size of customer orders, if orders forecasted for a specific customer for a particular quarter are not realized in that quarter, our operating results for that quarter could be materially adversely affected. OUR RELATIVELY LOW LEVEL OF BACKLOG INCREASES THE POTENTIAL VARIABILITY OF OUR QUARTERLY OPERATING RESULTS. Our backlog at the beginning of each quarter typically is not sufficient to achieve expected sales for the quarter. To achieve our sales objectives, we are dependent upon obtaining orders during each quarter for shipment during that quarter. Furthermore, our agreements with our customers typically permit them to change delivery schedules. Non-imaging customers may cancel orders within specified time frames (typically 30 days or more prior to the scheduled shipment date under our policies) without significant penalty. 12 15 Our customers have in the past built, and may in the future build, significant inventory in order to facilitate more rapid deployment of anticipated major products or for other reasons. Decisions by such customers to reduce their inventory levels have led and could lead to reductions in their purchases from us. These reductions, in turn, have caused and could cause adverse fluctuations in our operating results. OUR DEPENDENCE ON NEW PRODUCT DEVELOPMENT AND THE RAPID TECHNOLOGICAL CHANGE THAT CHARACTERIZES OUR INDUSTRY MAKE US SUSCEPTIBLE TO LOSS OF MARKET SHARE RESULTING FROM COMPETITORS' PRODUCT INTRODUCTIONS AND SIMILAR RISKS. The semiconductor and networking industries are characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions, short product life cycles and rapidly changing customer requirements. The introduction of products embodying new technologies and the emergence of new industry standards can render existing products obsolete and unmarketable. Our future success will depend on our ability to enhance our existing products, to introduce new products to meet changing customer requirements and emerging technologies, and to demonstrate the performance advantages and cost-effectiveness of our products over competing products. Any failure by us to modify our products to support new local-area network, or LAN, wide-area network, or WAN, and Internet technologies, or alternative technologies, or any failure to achieve widespread customer acceptance of such modified products could have a material adverse effect on us. In particular, we have dedicated significant resources to developing products based on the Linux operating system and on the Java programming language, and the failure of these products to achieve widespread acceptance could have a material adverse effect on us. We have in the past and may in the future experience delays in developing and marketing product enhancements or new products that respond to technological change, evolving industry standards and changing customer requirements. There can be no assurance that we will not experience difficulties that could delay or prevent the successful development, introduction and marketing of these products or product enhancements, or that our new products and product enhancements will adequately meet the requirements of the marketplace and achieve any significant or sustainable degree of market acceptance in existing or additional markets. Failure by us, for technological or other reasons, to develop and introduce new products and product enhancements in a timely and cost-effective manner would have a material adverse effect on us. In addition, the future introductions or announcements of products by us or one of our competitors embodying new technologies or changes in industry standards or customer requirements could render our then-existing products obsolete or unmarketable. There can be no assurance that the introduction or announcement of new product offerings by us or one or more of our competitors will not cause customers to defer the purchase of existing Company products. Such deferment of purchases could have a material adverse effect on us. OUR FAILURE TO EFFECTIVELY MANAGE PRODUCT TRANSITIONS COULD HAVE A MATERIAL ADVERSE EFFECT ON US. From time to time, we or our competitors may announce new products, capabilities or technologies that may replace or shorten the life cycles of our existing products. Announcements of currently planned or other new products may cause customers to defer or stop purchasing our products until new products become available. Furthermore, the introduction of new or enhanced products requires us to manage the transition from older product inventories and ensure that adequate supplies of new products can be delivered to meet customer demand. Our failure to effectively manage transitions from older products 13 16 could have a material adverse effect on our business, results of operations and financial condition. OUR FAILURE TO COMPETE SUCCESSFULLY IN OUR HIGHLY COMPETITIVE MARKET COULD RESULT IN REDUCED PRICES AND LOSS OF MARKET SHARE. The markets in which we operate are intensely competitive and characterized by rapidly changing technology, evolving industry standards, declining average selling prices and frequent new product introductions. A number of companies offer products that compete with one or more elements of our products. We believe that the competitive factors affecting the market for our products include product performance, price and quality, product functionality and features, the availability of products for existing and future platforms, the ease of integration with other hardware and software components of the customer's products, and the quality of support services, product documentation and training. The relative importance of each of these factors depends upon the specific customer involved. There can be no assurance that we will be able to compete successfully against current and future competitors, or that competitive factors faced by us will not have a material adverse effect on us. We primarily compete with the internal development departments of large manufacturing companies that have developed their own networking solutions, as well as established developers of embedded systems software and chips such as Axis Communications, Echelon, Emulex, Hitachi, Integrated Systems, Intel, Milan Technology, a division of Digi International, Motorola, Peerless Systems, Samsung and Wind River. In addition, we are aware of certain companies which have recently introduced products that address the markets targeted by us. We have experienced and expect to continue to experience increased competition from current and potential competitors, many of which have substantially greater financial, technical, sales, marketing and other resources, as well as greater name recognition and larger customer bases than ours. In particular, established companies in the networking or semiconductor industries may seek to expand their product offerings by designing and selling products using competitive technology that could render our products obsolete or have a material adverse effect on our sales. Increased competition may result in further price reductions, reduced gross margins and loss of market share. WE DEPEND ON THIRD-PARTY SOFTWARE THAT WE USE UNDER LICENSES THAT MAY EXPIRE. We rely on certain software that we license from third parties, including software that is integrated with internally developed software and used in our products to perform key functions. Our material software license agreements are with Integrated Systems, which terminates only if we default under the agreement; with Novell, which is renewable annually at the option of both parties, and with Peerless Systems, which expires in 2004 and is subject to year-to-year renewals thereafter at the option of both parties. These third-party software licenses may not continue to be available to us on commercially reasonable terms, and the related software may not continue to be appropriately supported, maintained or enhanced by the licensors. The loss of licenses to use, or the inability of licensors to support, maintain, and enhance any of such software, could result in increased costs, delays or reductions in product shipments until equivalent software is developed or licensed, if at all, and integrated. WE DEPEND ON MANUFACTURING, ASSEMBLING AND PRODUCT TESTING RELATIONSHIPS AND ON LIMITED SOURCE SUPPLIERS, AND ANY DISRUPTIONS IN THESE RELATIONSHIPS MAY CAUSE DAMAGE TO OUR CUSTOMER RELATIONSHIPS. We do not have our own semiconductor fabrication assembly or testing operations or contract manufacturing capabilities. Instead, we rely upon independent contractors to 14 17 manufacture our components, subassemblies, systems and products. Currently, all of our semiconductor devices are being manufactured, assembled and tested by Atmel Corporation in the United States, and we expect that we will continue to rely upon Atmel to manufacture, assemble and test a significant portion of our semiconductor devices in the future. We recently experienced a delay in the introduction of one of our products due to a problem with Atmel's design tools. While we are in the process of qualifying other suppliers, any qualification and pre-production periods could be lengthy and may cause delays in providing products to customers in the event that the sole source supplier of the semiconductor devices fails to meet our requirements. For example, Atmel uses its manufacturing facilities for its own products as well as those it manufactures on a contract basis. There is no assurance that Atmel will have adequate capacity to meet the needs of its contract manufacturing customers. In addition, semiconductor manufacturers generally experience periodic constraints on their manufacturing capacity. We also rely upon limited-source suppliers for a number of other components used in our products. There can be no assurance that these independent contractors and suppliers will be able to meet our future requirements for manufactured products, components and subassemblies in a timely fashion. We generally purchase limited-source components under purchase orders and have no guaranteed supply arrangements with these suppliers. In addition, the availability of many of these components to us is dependent in part on our ability to provide our suppliers with accurate forecasts of our future requirements. Any extended interruption in the supply of any of the key components currently obtained from limited sources would disrupt our operations and have a material adverse effect on our business, results of operations and financial condition. Delays or lost sales have been and could be caused by other factors beyond our control, including late deliveries by vendors of components, changes in implementation priorities or slower than anticipated growth in the market for networking solutions for embedded systems. Operating results in the past have also been adversely affected by delays in receipt of significant purchase orders from customers. In addition, we have experienced delays as a result of the need to modify our products to comply with unique customer specifications. In general, the timing and magnitude of our revenues are highly dependent upon our achievement of design wins, the timing and success of our customers' development cycles, and our customers' product sales. Any of these factors could have a material adverse effect on our business, results of operations and financial condition. THE CYCLICALITY OF THE SEMICONDUCTOR INDUSTRY MAY RESULT IN SUBSTANTIAL PERIOD-TO-PERIOD FLUCTUATIONS. Our semiconductor devices provide networking capabilities for embedded systems. The semiconductor industry is highly cyclical and subject to rapid technological change and has been subject to significant economic downturns at various times, characterized by diminished product demand, accelerated erosion of average selling prices and production overcapacity. The semiconductor industry also periodically experiences increased demand and production capacity constraints. As a result, we may experience substantial period-to-period fluctuations in future operating results due to general semiconductor industry conditions, overall economic conditions or other factors. OUR ABILITY TO COMPETE COULD BE JEOPARDIZED IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS. Our ability to compete depends in part on our proprietary rights and technology. We have no patents and rely primarily on a combination of copyright and trademark laws, trade secrets, confidentiality procedures and contract provisions to protect our proprietary rights. We generally enter into confidentiality agreements with our employees, and sometimes with our customers and potential customers and limit access to the distribution 15 18 of our software, hardware designs, documentation and other proprietary information. There can be no assurance that the steps taken by us in this regard will be adequate to prevent the misappropriation of our technology. While we have filed one patent application and plan to file various additional applications, such applications may be denied. Any patents, once issued, may be circumvented by our competitors. Furthermore, there can be no assurance that others will not develop technologies that are superior to ours. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, the laws of some foreign countries do not protect our proprietary rights as fully as do the laws of the United States. There can be no assurance that our means of protecting our proprietary rights in the United States or abroad will be adequate or that competing companies will not independently develop similar technology. Our failure to adequately protect our proprietary rights could have a material adverse effect on our business, results of operations and financial condition. We exclusively license the right to use the NET+ARM trademark from ARM Limited according to a royalty-free agreement expiring in 2008. We depend on ARM to enforce its rights to the trademark against third-party infringement. There can be no assurance that ARM will promptly and adequately enforce these rights which could have a material adverse effect on our business, results of operations and financial condition. WE COULD BECOME SUBJECT TO CLAIMS AND LITIGATION REGARDING INTELLECTUAL PROPERTY RIGHTS, WHICH COULD SERIOUSLY HARM US AND REQUIRE US TO INCUR SIGNIFICANT COSTS. The semiconductor industry is characterized by frequent litigation regarding patent and other intellectual property rights. Although we have not been notified that our products infringe any third-party intellectual property rights, there can be no assurance that we will not receive such notification in the future. Any litigation to determine the validity of third-party infringement claims, whether or not determined in our favor or settled by us, would at a minimum be costly and divert the efforts and attention of our management and technical personnel from productive tasks, which could have a material adverse effect on our business, results of operations and financial condition. There can be no assurance that any infringement claims by third parties or any claims for indemnification by customers or end users of our products resulting from infringement claims will not be asserted in the future or that such assertions, if proven to have merit, will not materially adversely affect our business, results of operations or financial condition. In the event of an adverse ruling in any such matter, we would be required to pay substantial damages, cease the manufacture, use and sale of infringing products, discontinue the use of certain processes or be required to obtain a license under the intellectual property rights of the third party claiming infringement. There can be no assurance that a license would be available on reasonable terms or at all. Any limitations on our ability to market our products, or delays and costs associated with redesigning our products or payments of license fees to third parties, or any failure by us to develop or license a substitute technology on commercially reasonable terms could have a material adverse effect on our business, results of operations and financial condition. WE FACE RISKS ASSOCIATED WITH OUR INTERNATIONAL OPERATIONS AND EXPANSION THAT COULD IMPAIR OUR ABILITY TO GROW OUR REVENUES ABROAD. In the fiscal years ended January 31, 2000, 1999 and 1998, international sales constituted approximately 50%, 51% and 30% of our net sales, respectively, and approximately 77%, 46% and 31% of our domestic sales, respectively, were to customers headquartered in Asia. We believe that our future growth is dependent in part upon our ability to increase sales in international markets, and particularly to manufacturers located in Japan, which 16 19 sell their products worldwide. These sales are subject to a variety of risks, including fluctuations in currency exchange rates, tariffs, import restrictions and other trade barriers, unexpected changes in regulatory requirements, longer accounts receivable payment cycles and potentially adverse tax consequences and export license requirements. In addition, we are subject to the risks inherent in conducting business internationally, including political and economic instability and unexpected changes in diplomatic and trade relationships. In particular, the economies of certain countries in the Asia-Pacific region are experiencing considerable economic instability and downturns. Because our sales to date have been denominated in United States dollars, increases in the value of the United States dollar could increase the price in local currencies of our products in non-US markets and make our products more expensive than competitors' products denominated in local currencies. In addition, an integral part of our business strategy is to form strategic alliances for the manufacture and distribution of our products with third parties, including foreign corporations. There can be no assurance that one or more of the factors described above will not have a material adverse effect on our business, results of operations and financial condition. We intend to expand our presence in Europe to address new markets. One change resulting from the formation of a European Economic and Monetary Union ("EMU") required EMU member states to irrevocably fix their respective currencies to a new currency, the euro, as of January 1, 1999. During the next three years, business in the EMU member states will be conducted in both the existing national currency such as the French franc or the Deutsche mark, and the euro. As a result, companies operating or conducting business in EMU member states will need to ensure that their financial and other software systems are capable of processing transactions and properly handling these currencies, including the euro. There can be no assurance that the conversion to the euro will not have a material adverse effect on our business, results of operations and financial condition. IF WE LOSE KEY PERSONNEL IT COULD PREVENT US FROM EXECUTING OUR BUSINESS STRATEGY. Our business and prospects depend to a significant degree upon the continuing contributions of our executive officers and our key technical personnel. We do not have employment contracts with any of our key personnel, with the exception of our Vice President, Industrial Automation, Embedded Markets Europe; Vice President, Finance, and Chief Financial Officer; and the Chairman, Chief Executive Officer and President, and we do not maintain any key-man life insurance policies. Competition for such personnel is intense, and there can be no assurance that we will be successful in attracting and retaining qualified personnel. Failure to attract and retain key personnel could result in our failure to execute our business strategy and have a material adverse effect on us. ANY FAILURE TO COMPLY WITH SIGNIFICANT REGULATIONS AND EVOLVING INDUSTRY STANDARDS COULD DELAY INTRODUCTION OF OUR PRODUCTS, WHICH COULD HURT OUR BUSINESS. The market for our products is subject to a significant number of communications regulations and industry standards, some of which are evolving as new technologies are deployed. In the United States, our products must comply with various regulations defined by the Federal Communications Commission and standards established by Underwriters' Laboratories. Some of our products may not comply with current industry standards, and this noncompliance must be addressed in the design of those products. Standards for networking are still evolving. As the standards evolve, we may be required to modify our products or develop and support new versions of our products. The failure of our products to comply or delays in compliance, with the various existing and evolving 17 20 industry standards could delay introduction of our products, which could have a material adverse effect on our business, results of operations and financial condition. ANY MATERIAL PRODUCT DEFECTS COULD RESULT IN LOSS OF MARKET SHARE, DELAY OF MARKET ACCEPTANCE OR PRODUCT LIABILITY CLAIMS OR LOSSES. Complex products such as those offered by us may contain undetected or unresolved defects when first introduced or as new versions are released. The occurrence of material errors in the future could, and the failure or inability to correct such errors would, result in the loss of market share, the delay or loss of market acceptance of our products, material warranty expense, diversion of engineering and other resources from our product development efforts, the loss of credibility with our customers or product recall. The use of our products for applications in devices that interact directly with the general public, where the failure of the embedded system could cause property damage or personal injury, could expose us to significant product liability claims. Although we have not experienced any product liability or economic loss claims to date, the sale and support of our products may entail the risk of such claims. Any of such occurrences could have a material adverse effect upon our business, results of operations and financial condition. IF WE DO NOT SUCCESSFULLY MANAGE OUR GROWTH, IT COULD HAVE A MATERIAL ADVERSE EFFECT ON US. We have limited internal infrastructure and any significant growth would place a substantial strain on our financial and management personnel and information systems and controls. Such growth would require us to implement new and enhance existing financial and management information systems and controls and add and train personnel to operate such systems effectively. Our intention to continue to pursue our growth strategy through efforts to increase sales of existing products and new products can be expected to place even greater pressure on our existing personnel and compound the need for increased personnel, expanded information systems, and additional financial and administrative control procedures. There can be no assurance that we will be able to successfully manage expanding operations. Our inability to manage our expanded operations effectively could have a material adverse effect on our business, results of operations and financial condition. A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON STOCK COULD BE SOLD INTO THE PUBLIC MARKET, WHICH COULD DEPRESS OUR STOCK PRICE. Sales of a substantial number of shares of common stock in the public market could adversely affect the market price for our common stock and reported earnings per share and could make it more difficult for us to raise funds through equity offerings in the future. Subject to applicable federal and securities laws and the restrictions set forth below, Osicom may sell any and all of the shares of common stock beneficially owned by it or distribute any or all such shares of common stock to its stockholders. Sales or distributions by Osicom of substantial amounts of common stock in the public market or to its stockholders, or the perception that such sales or distribution could occur, could adversely affect the prevailing market prices for the common stock. Osicom is not subject to any obligation to retain its shares in NETsilicon, except that in connection with our initial public offering, Osicom agreed not to sell or otherwise dispose of any shares of common stock for a period of 365 days after September 15, 1999, without the prior written consent of CIBC World Markets Corp. As a result, there can be no assurance concerning the period of time during which Osicom will maintain its beneficial ownership of our common stock. Moreover, there can be no assurance that, in any 18 21 transfer by Osicom of a controlling interest in us, any holders of common stock will be able to participate in such transaction or will realize any premium with respect to their shares of common stock. ANY ACQUISITIONS WE MAKE COULD DISRUPT OUR BUSINESS AND SERIOUSLY HARM OUR FINANCIAL CONDITION. We intend to consider investments in complementary companies, products or technologies. While we have no current agreements to do so, we may buy businesses, products or technologies in the future. In the event of any future purchases, we could: - issue stock that would dilute our current stockholders' percentage ownership; - incur debt; - assume liabilities; - incur amortization expenses related to goodwill and other intangible assets; or - incur large and immediate write-offs. OUR OPERATION OF ANY ACQUIRED BUSINESS WILL ALSO INVOLVE NUMEROUS RISKS, INCLUDING: - problems combining the purchased operations, technologies or products; - unanticipated costs; - diversion of management's attention from our core business; - adverse effects on existing business relationships with suppliers and customers; - risks associated with entering markets in which we have no or limited prior experience; and - potential loss of key employees, particularly those of the purchased organizations. We cannot assure you that we will be able to successfully integrate any businesses, products, technologies or personnel that we might acquire in the future and any failure to do so could disrupt our business and seriously harm our financial condition. BECAUSE THE NASDAQ NATIONAL MARKET IS LIKELY TO EXPERIENCE EXTREME PRICE AND VOLUME FLUCTUATIONS, THE PRICE OF OUR COMMON STOCK MAY DECLINE. The market price of our shares is likely to be highly volatile and could be subject to wide fluctuations in response to numerous factors, including the following: - actual or anticipated variations in our quarterly operating results or those of our competitors; 19 22 - announcements by us or our competitors of new products or technological innovations; - introduction and adoption of new industry standards; - changes in financial estimates or recommendations by securities analysts; - changes in the market valuations of our competitors; - announcements by us or our competitors of significant acquisitions or partnerships; and - sales of our common stock. Many of these factors are beyond our control and may negatively impact the market price of our common stock, regardless of our performance. In addition, the stock market in general, and the market for technology companies in particular, has been highly volatile. Our common stock may not trade at the same levels of shares as that of other technology companies and shares of technology companies, in general, may not sustain their current market prices. In the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. We may be the target of similar litigation in the future. Securities litigation could result in substantial costs and divert management's attention and resources, which could seriously harm our business and operating results. PROVISIONS OF OUR CHARTER DOCUMENTS MAY HAVE ANTI-TAKEOVER EFFECTS THAT COULD PREVENT A CHANGE OF CONTROL. Provisions of our amended and restated certificate of incorporation and bylaws could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK We own financial instruments that are sensitive to market risks as part of our investment portfolio. The investment portfolio is used to preserve our capital until it is required to fund operations, including our research and development activities. None of these market-risk sensitive instruments are held for trading purposes. We do not own derivative financial instruments in our investment portfolio. The investment portfolio contains instruments that are subject to the risk of a decline in interest rates. Investment Rate Risk. Our investment portfolio includes debt instruments that primarily have durations of less than one year. These bonds are subject to interest rate risk, and could decline in value if interest rates fluctuate. Our investment portfolio also at times includes certain commercial paper which is also subject to interest rate risk. Due to the short duration and conservative nature of these instruments, we do not believe that we have a material exposure to interest rate fluctuations. PART II. OTHER INFORMATION ITEM 1. Legal Proceedings 20 23 None ITEM 2. Changes in Securities and Use of Proceeds Not applicable. 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 -------------- ----------- 27.1 Financial Data Schedule b) Reports on 8-K None SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NETsilicon, Inc. ------------------------------------ Registrant Date June 12, 2000 By /s/ Cornelius Peterson VIII ---------------- ------------------------------------ Cornelius Peterson VIII, President, Chief Executive Officer and Director (Principal Executive Officer) Date June 12, 2000 By /s/ Daniel J. Sullivan ---------------- ------------------------------------ Daniel J. Sullivan, Vice President, Finance, Chief Financial Officer (Principal Financial and Accounting Officer) 21