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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 DECEMBER 31, 2000
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)
----------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(D) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
As of January 31, 2001, 37,885,752 shares of the Registrant's common stock
were outstanding.
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LANTRONIX, INC.
FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2000
INDEX
Page
----
PART I. FINANCIAL INFORMATION......................................... 3
Item 1. Financial Statements.......................................... 3
Condensed Consolidated Balance Sheets at December 31, 2000
(unaudited) and June 30, 2000................................ 3
Unaudited Condensed Consolidated Statements of Operations for
the Three and Six Months Ended December 31, 2000 and 1999.... 4
Unaudited Condensed Consolidated Statements of Cash Flows for
the Six Months Ended December 31, 2000 and 1999.............. 5
Notes to Unaudited Condensed Consolidated Financial
Statements.................................................... 6
Management's Discussion and Analysis of Financial Condition
Item 2. and Results of Operations..................................... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk.... 21
PART II. OTHER INFORMATION............................................. 22
Item 1. Legal Proceedings............................................. 22
Item 2. Change in Securities and Use of Proceeds...................... 22
Item 3. Defaults Upon Senior Securities............................... 22
Item 4. Submission of Matters to a Vote of Security Holders........... 22
Item 5. Other Information............................................. 22
Item 6. Exhibits and Reports on Form 8-K.............................. 22
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
LANTRONIX, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
June
December 31, 30,
2000 2000
------------ -------
(Unaudited)
ASSETS
------
Current assets:
Cash and cash equivalents............................... $21,730 $ 1,988
Short-term investments.................................. 25,144 --
Accounts receivable, net................................ 9,103 6,072
Inventories............................................. 8,798 5,385
Deferred income taxes................................... 1,420 1,425
Prepaid expenses and other current assets............... 2,628 2,832
------- -------
Total current assets.................................. 68,823 17,702
Property and equipment, net............................... 3,217 1,348
Intangible assets, net.................................... 7,985 586
Long-term investments..................................... 2,871 --
Other assets.............................................. 1,077 574
------- -------
$83,973 $20,210
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable........................................ $ 6,951 $ 3,197
Accrued payroll and related expenses.................... 1,085 764
Other current liabilities............................... 2,281 2,603
------- -------
Total current liabilities............................. 10,317 6,564
Deferred income taxes..................................... 1,003 1,003
Capital lease obligations, net of current portion......... 82 96
------- -------
11,402 7,663
------- -------
Stockholders' equity:
Common stock............................................ 4 3
Additional paid-in capital.............................. 72,251 13,221
Employee notes receivable............................... (284) (152)
Deferred compensation................................... (7,750) (8,942)
Retained earnings....................................... 8,353 8,427
Accumulated other comprehensive loss.................... (3) (10)
------- -------
Total stockholders' equity............................ 72,571 12,547
------- -------
$83,973 $20,210
======= =======
See accompanying notes.
3
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
Three Months Ended Six Months Ended
December 31, December 31,
-------------------- ------------------
2000 1999 2000 1999
--------- --------- -------- --------
Net revenues (A)..................... $ 12,465 $ 11,417 $ 24,502 $ 22,292
Cost of revenues (B)................. 5,689 5,517 11,038 10,218
--------- --------- -------- --------
Gross profit......................... 6,776 5,900 13,464 12,074
--------- --------- -------- --------
Operating expenses:
Selling, general and administrative
(B)............................... 6,022 4,221 11,378 7,815
Research and development (B)....... 1,021 711 2,073 1,433
Amortization of deferred
compensation...................... 674 -- 1,337 --
--------- --------- -------- --------
Total operating expenses........... 7,717 4,932 14,788 9,248
--------- --------- -------- --------
Income (loss) from operations........ (941) 968 (1,324) 2,826
Minority interest income (expense),
net................................. -- 19 -- (49)
Interest and other income, net....... 750 108 1,173 170
--------- --------- -------- --------
Income (loss) before income taxes.... (191) 1,095 (151) 2,947
Provision (benefit) for income
taxes............................... (140) 534 (77) 1,437
--------- --------- -------- --------
Net income (loss).................... $ (51) $ 561 $ (74) $ 1,510
========= ========= ======== ========
Basic earnings (loss) per share...... $ (0.00) $ 0.02 $ (0.00) $ 0.05
========= ========= ======== ========
Diluted earnings (loss) per share.... $ (0.00) $ 0.02 $ (0.00) $ 0.04
========= ========= ======== ========
Weighted average shares (basic)...... 36,709 28,961 35,058 28,853
========= ========= ======== ========
Weighted average shares (diluted).... 36,709 33,977 35,058 33,869
========= ========= ======== ========
- --------
(A) Includes revenues from related
parties............................. $ 1,302 $ 899 $ 2,093 $ 1,876
========= ========= ======== ========
(B) Excludes amortization of deferred
compensation as follows:
Cost of revenues................... $ 14 $ -- $ 25 $ --
Selling, general and administrative
expenses.......................... 578 -- 1,149 --
Research and development expenses.. 82 -- 163 --
--------- --------- -------- --------
$ 674 $ -- $ 1,337 $ --
========= ========= ======== ========
See accompanying notes.
4
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Six Months Ended
December 31,
-----------------
2000 1999
-------- -------
Cash flows from operating activities:
Net income (loss).......................................... $ (74) $ 1,510
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization............................ 640 574
Amortization of deferred compensation.................... 1,337 --
Provision for doubtful accounts.......................... 220 173
Loss on disposal of asset................................ 20 --
Change in operating assets and liabilities:
Accounts receivable.................................... (2,829) (1,130)
Inventories............................................ (3,413) (1,480)
Prepaid expenses and other current assets.............. 209 (330)
Other assets........................................... (465) --
Accounts payable....................................... 317 (381)
Income taxes........................................... -- 152
Other current liabilities.............................. (407) 1,127
Minority interest...................................... -- (20)
-------- -------
Net cash provided by (used in) operating activities........ (4,445) 195
-------- -------
Cash flows from investing activities:
Purchases of investments, net............................ (28,015) --
Purchases of property and equipment, net................. (1,985) (178)
Cash received from acquisition, net...................... 324 --
-------- -------
Net cash used in investing activities...................... (29,676) (178)
-------- -------
Cash flows from financing activities:
Net proceeds from initial public offering of common
stock................................................... 53,713 --
Net proceeds from issuances of common stock.............. 143 37
Net repayment of bank line of credit..................... -- (766)
-------- -------
Net cash provided by (used in) financing activities........ 53,856 (729)
Effect of foreign exchange rates on cash................... 7 10
-------- -------
Increase (decrease) in cash and cash equivalents........... 19,742 (702)
Cash and cash equivalents at beginning of period........... 1,988 5,833
-------- -------
Cash and cash equivalents at end of period................. $ 21,730 $ 5,131
======== =======
See accompanying notes.
5
LANTRONIX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
1. Basis of Presentation
The condensed consolidated financial statements included herein are
unaudited. They contain all normal recurring accruals and adjustments which, in
the opinion of management, are necessary to present fairly the consolidated
financial position of Lantronix, Inc. and its subsidiaries (collectively, the
"Company") at December 31, 2000 and 1999, the consolidated results of its
operations for the three and six months ended December 31, 2000 and 1999 and
the consolidated cash flows for the six months ended December 31, 2000 and
1999. All intercompany accounts and transactions have been eliminated. It
should be understood that accounting measurements at interim dates inherently
involve greater reliance on estimates than at year-end. The results of
operations for the three and six months ended December 31, 2000 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, 2000,
included in the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission ("SEC").
2. Summary of Significant Accounting Policies
Revenue Recognition
Revenue is recognized upon product shipment. The Company grants certain
distributors limited rights to return products and provides price protection
for inventories held by resellers at the time of published price reductions.
Revenue from licensed software is recognized at the time of shipment, provided
the Company has vendor-specific objective evidence of the fair value of each
element of the software offering. Revenue from post-contract customer support
and any other future deliverables is deferred and earned over the support
period or as contract elements are delivered. 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.
Investments
The Company accounts for its investments in debt and equity securities under
FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity
Securities. Management determines the appropriate classification of such
securities at the time of purchase and reevaluates such classification as of
each balance sheet date. Debt securities, which are classified as held-to-
maturity, are stated at cost, adjusted for amortization of premiums and
discounts to maturity. Realized gains and losses and declines in value judged
to be other than temporary are determined based on the specific identification
method and are reported in the statement of operations.
The Company also has certain other minority investments in nonpublic
companies for the promotion of business and strategic objectives. These
investments are included in long-term investments on the Company's balance
sheet and are carried at fair value or cost, as appropriate. The Company
monitors these investments for impairment and makes appropriate reductions in
carrying values when necessary. No impairment has been indicated to date.
Income Taxes
Income taxes are computed under the liability method. This method requires
the recognition of deferred tax assets and liabilities for temporary
differences between the financial reporting basis and the tax basis of the
Company's assets and liabilities. The impact on deferred taxes of changes in
tax rates, and laws, if any, are
6
applied to the years during which temporary differences are expected to be
settled and are reflected in the consolidated financial statements in the
period of enactment. There is no valuation allowance provided for deferred tax
assets because the Company believes that it is more likely than not that these
assets will be realized.
3. Business Combinations
On December 29, 2000, the Company completed the acquisition of United States
Software Corporation ("USSC"), a leading software solutions provider of
embedded technology applications. In connection with the acquisition, the
Company issued 653,846 shares of common stock and agreed to pay $2.5 million in
cash in exchange for all outstanding shares of USSC common stock. The Company
paid the $2.5 million on January 2, 2001 and such amount is included in
accounts payable in the accompanying condensed consolidated balance sheet at
December 31, 2000. Additionally, the Company reserved 133,333 shares of its
common stock for issuance upon exercise of outstanding stock options assumed by
the Company. If certain revenue targets for the period from December 1, 2000 to
June 30, 2004 are satisfied, the Company will issue up to a maximum of
1,625,000 additional shares of common stock to the shareholders of USSC.
This acquisition has been accounted for under the purchase method of
accounting. An independent valuation of the tangible and intangible assets and
in-process research and development ("IPRGD") acquired is being performed and
is expected to be completed in the third quarter of fiscal 2001. The allocation
of purchase price reflected in the December 31, 2000 condensed consolidated
balance sheet is preliminary. The preliminary purchase price was allocated,
based upon management's best estimate of the tangible and intangible assets
acquired as follows:
(in thousands)
Net tangible assets......................................... $ 303
Acquisition costs........................................... 708
Goodwill.................................................... 7,805
Deferred compensation....................................... 538
------
Total consideration......................................... $9,354
======
Deferred stock-based compensation, which is included in the purchase price
of the acquisition, has been valued in accordance with FASB Interpretation No.
44, Accounting For Certain Transactions Involving Stock Compensation (FIN 44).
This amount is being amortized over the remaining vesting period, generally
four years, of the underlying stock options assumed. Goodwill is being
amortized on a straight-line basis over its estimated remaining useful life of
seven years.
LANTRONIX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The results of operations of USSC are included in the consolidated financial
statements from the date of acquisition.
The pro forma statements of operations data below gives effect to the
acquisition as if it had occurred at the beginning of fiscal year 1999. The
following unaudited pro forma statements of operations data include
amortization of goodwill, identified intangibles and stock-based compensation
but excludes the charge for acquired IPR&D. This pro forma data is presented
for informational purposes only and does not purport to be indicative of the
results of future operations nor of the results that would have occurred had
the acquisition taken place at the beginning of fiscal 1999.
Six Months
Ended
December 31,
----------------
2000 1999
------- -------
Pro forma net revenues..................................... $26,313 $23,674
======= =======
Net income (loss) as reported.............................. $ (74) $ 1,510
Pro forma adjustments:
Amortization of goodwill................................. (518) (518)
Amortization of deferred compensation.................... (67) (67)
Pro forma results of USSC................................ 157 (147)
------- -------
Pro forma, net income (loss)........................... $ (502) $ 778
======= =======
Pro forma, net income (loss) per share..................... $ (0.01) $ 0.03
======= =======
4. Earnings (Loss) per Share
Basic earnings (loss) per share is calculated by dividing net income (loss)
by the weighted average number of common shares outstanding during the period.
Diluted earnings 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 earnings
(loss) per share:
Three Months Ended Six Months Ended
December 31, December 31,
-------------------- ------------------
2000 1999 2000 1999
--------- --------- -------- --------
(In thousands, except per share data)
Numerator: Net income (loss)....... $ (51) $ 561 $ (74) $1,510
========= ========= ======== ========
Denominator for basic earnings
(loss) per share:
Weighted-average shares
outstanding..................... 36,709 28,961 35,058 28,853
Effect of dilutive securities:
Stock options.................... -- 5,016 -- 5,016
--------- --------- -------- --------
Denominator for diluted earnings
(loss) per common share........... 36,709 33,977 35,058 33,869
========= ========= ======== ========
Basic earnings (loss) per share.... $ (0.00) $ 0.02 $ (0.00) $ 0.05
========= ========= ======== ========
Diluted earnings (loss) per share.. $ (0.00) $ 0.02 $ (0.00) $ 0.04
========= ========= ======== ========
7
LANTRONIX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
5. Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market
and consist of the following:
December 31, June 30,
2000 2000
------------ --------
(In thousands)
Raw materials.......................................... $6,912 $4,766
Finished goods......................................... 2,821 1,488
------ ------
9,733 6,254
Reserve for excess and obsolete inventory.............. (935) (869)
------ ------
$8,798 $5,385
====== ======
6. Stockholders' Equity
On August 4, 2000, the Company completed its initial public offering (the
"Offering") of common stock. The Company sold 6,000,000 shares, at a price of
$10.00 per share and received aggregate net proceeds from the Offering of $53.7
million. On December 29, 2000, in connection with the acquisition of USSC the
Company issued an aggregate of 653,846 shares of common stock and agreed to pay
$2.5 million in cash in exchange for all the outstanding shares of USSC.
7. Comprehensive Income (Loss)
Total comprehensive income (loss) was $(38,000) and $(67,000) for the three
and six months ended December 31, 2000, respectively, and $574,000 and $1.5
million for the three and six months ended December 31, 1999, respectively.
8. Segment, Geographic, and Revenue by Product Family
The Company designs and markets three major distinct product families within
one industry segment: network and Internet connectivity products, which consist
primarily of device, multiport device, and print servers.
Net revenue by product family consists of the following:
Three Months ended Six Months ended
December 31, December 31,
------------------- -----------------
2000 1999 2000 1999
--------- --------- -------- --------
(In thousands)
Device servers........................ $ 8,557 $ 5,393 $16,584 $10,641
Multiport device servers.............. 2,900 3,146 5,911 6,073
Print servers and other............... 1,008 2,878 2,007 5,578
--------- --------- -------- --------
Total net revenues.................. $ 12,465 $ 11,417 $24,502 $22,292
========= ========= ======== ========
8
Revenue by Geographic Area
Revenue by geographic area is based on where products are shipped. Net
revenue by geographic area consists of the following:
Three Months ended Six Months ended
December 31, December 31,
------------------- -----------------
2000 1999 2000 1999
--------- --------- -------- --------
(Amounts in thousands)
Americas.............. $ 8,143 $ 7,465 $16,914 $14,591
Europe................ 3,639 3,400 6,320 6,559
Other................. 683 552 1,268 1,142
--------- --------- -------- --------
$12,465 $ 11,417 $24,502 $22,292
========= ========= ======== ========
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and related notes thereto contained elsewhere
in this report. The information in this report 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 Securities and Exchange
Commission ("SEC"), including our Registration Statement on Form S-1 for our
Initial Public Offering and our Annual Report on Form 10-K for the year ended
June 30, 2000.
The sections entitled "Risk Factors" set forth in this Form 10-Q and in our
Registration Statement on Form S-1 and our Annual Report on Form 10-K for the
year ended June 30, 2000, 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, 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, develops and markets network device servers that enable
almost any electronic device to be accessed, managed, controlled, reprogrammed
and configured or reconfigured over the Internet or other networks using
standard protocols for connectivity, including fiber optic, Ethernet and
wireless. Since our inception in 1989, we have developed an array of network-
enabling products including 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
9
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. This trend
continued into Q2 2001. We believe sales of our Device Server products 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 over the next two years 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. We have two customers that accounted for more than 10%
of our net revenues. One of our distributors, Ingram Micro, accounted for 13.2%
of our net revenues for the six months ended December 31, 2000, compared to
14.3% for the six months ended December 31, 1999. Another distributor, Tech
Data, accounted for 10.9% of our net revenues for the six months ended December
31, 2000, compared to 10.5% for the six months ended December 31, 1999.
Transtec AG, an international OEM and related party due to common ownership by
our Chairman and major stockholder, accounted for 8.5% of our net revenues for
the six months ended December 31, 2000, compared to 8.4% for the six months
ended December 31, 1999.
In October 1998, we acquired ProNet GmbH, a German company that is a
supplier of industrial automation device server technology. In connection with
this acquisition, we acquired exclusive marketing rights to CoBox technology in
the United States and Canada from Dr. Peter Weisser, Sr. We also acquired non-
exclusive marketing rights to this technology world-wide, excluding Germany and
Switzerland. Under this agreement, we were required to make royalty payments to
Dr. Weisser through December 31, 2000. As a result, we recognized approximately
$726,000 of royalty expense and amortization relating to the marketing rights
agreement for the six months ended December 31, 2000. We expect to have no
further charges relating to these acquisitions.
In December 2000, we completed the acquisition of United States Software
Corporation ("USSC"), a leading software solutions provider for embedded
technology applications. This acquisition was accounted for as a purchase
transaction. Accordingly, the accompanying financial statements include the
results of operations of USSC as of its acquisition date. See Note 3 of Notes
to Unaudited Condensed Consolidated Financial Statements.
We recognize revenues upon product shipment. We have granted several
customers limited return privileges, as well as limited price protection for
inventories held at the time of published price reductions. Estimated reserves
have been recorded in the accompanying unaudited condensed consolidated
financial statements to reflect these agreements, as well as potential warranty
expenses, based on our five-year warranty policy from the date of shipment. The
allowance for doubtful accounts is recorded based upon anticipated collection
risk. This reserve has increased during the quarter ended December 31, 2000
primarily due to slower collections from some of our U.S. distributions and
European customers.
Amortization of stock-based compensation 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 at the grant date as determined for financial reporting
purposes. We have recorded deferred compensation within stockholders' equity of
approximately $10.6 million, that is being amortized over the vesting period of
the related stock options, generally four years. At December 31, 2000, a
balance of $7.7 million remains and will be amortized as follows: $1.4 million
in the remainder of fiscal 2001, $2.8 million in fiscal 2002, $1.8 million in
fiscal 2003, $1.4 million in fiscal 2004, $219,000 in fiscal 2005 and $153,000
in fiscal 2006. The amount of stock-based compensation amortized in future
periods could decrease if unvested options are forfeited.
10
Results of Operations for the Three and Six Months Ended December 31, 2000
compared to the Three and Six Months Ended December 31, 1999
The following table sets forth certain statement of operations data
expressed as a percentage of total net revenues:
Three Months Six Months
Ended Ended
December 31, December 31,
--------------- ---------------
2000 1999 2000 1999
------ ------ ------ ------
Net revenues.................................. 100.0% 100.0% 100.0% 100.0%
Cost of revenues.............................. 45.6 48.3 45.0 45.8
------ ------ ------ ------
Gross profit.................................. 54.4 51.7 55.0 54.2
------ ------ ------ ------
Operating expenses:
Selling, general and administrative......... 48.3 37.0 46.4 35.1
Research and development.................... 8.2 6.2 8.5 6.4
Amortization of deferred compensation....... 5.4 -- 5.5 --
------ ------ ------ ------
Total operating expenses.................... 61.9 43.2 60.4 41.5
------ ------ ------ ------
Income (loss) from operations................. (7.5) 8.5 (5.4) 12.7
Minority interest income (expense), net....... -- 0.2 -- (0.2)
Interest and other income, net................ 6.0 0.9 4.8 0.8
------ ------ ------ ------
Income (loss) before income taxes............. (1.5) 9.6 (0.6) 13.2
Provision (benefit) for income taxes.......... (1.1) 4.7 (0.3) 6.4
------ ------ ------ ------
Net income (loss)............................. (0.4)% 4.9% (0.3)% 6.8%
====== ====== ====== ======
Net Revenues
Net revenues increased $1.1 million, or 9.2%, to $12.5 million for the three
months ended December 31, 2000 from $11.4 million for the three months ended
December 31, 1999. Net revenues increased $2.2 million, or 9.9%, to $24.5
million for the six months ended December 31, 2000 from $22.3 million for the
six months ended December 31, 1999. The increase was primarily attributable to
an increase in net revenues of our Device Server products, partially offset by
a decline in our Multiport Device Server, Print Server and other products.
Device Server net revenues increased $3.2 million, or 58.7%, to $8.6 million or
68.6% of net revenues for the three months ended December 31, 2000 from $5.4
million or 47.2% of net revenues for the three months ended December 31, 1999.
Device Server revenues, net for the three months ended December 31, 2000
includes $238,000 of software revenue generated from the acquisition of USSC.
Device Server net revenues increased $5.9 million, or 55.9%, to $16.6 million
or 67.7% of net revenues for the six months ended December 31, 2000 from $10.6
million or 47.7% of net revenues for the six months ended December 31, 1999.
This increase is attributable to the rapid adoption rates of OEMs, as well as
strong sales of our UDS-10 Device Server product, which was introduced during
the fourth quarter of fiscal 2000. Multiport Device Server net revenues
decreased $246,000, or 7.8%, to $2.9 million or 23.3% of net revenues for the
three months ended December 31, 2000 from $3.1 million or 27.6% of net revenues
for the three months ended December 31, 1999. Multiport Device Server net
revenues decreased $164,000, or 2.7%, to $5.9 million or 24.1% of net revenues
for the six months ended December 31, 2000 from $6.1 million or 27.2% of net
revenues for the six months ended December 31, 1999. Print Server and other
revenues decreased $1.9 million, or 65.0%, to $1.0 million, or 8.1% of net
revenues for the three months ended December 31, 2000 from $2.9 million, or
25.2% of net revenues for the three months ended December 31, 1999. Print
Server and other revenues decreased $3.6 million, or 64.0%, to $2.0 million, or
8.2% of net revenues for the six months ended December 31, 2000 from $5.6
million, or 25.0% of net revenues for the six months ended December 31, 1999.
The decreases in our Multiport, Print and other products are due to a more
rapid transition to Device Server products.
11
Net revenues generated from sales in the Americas increased $678,000, or
9.1%, to $8.1 million or 65.3% of net revenues for the three months ended
December 31, 2000 from $7.5 million or 65.4% of net revenues for the three
months ended December 31, 1999. Net revenues generated from sales in the
Americas increased $2.3 million, or 15.9%, to $16.9 million or 69.0% of net
revenues for the six months ended December 31, 2000 from $14.6 million, or
65.5% of net revenues for the six months ended December 31, 1999. Our net
revenues derived from customers located in Europe increased $239,000, or 7.0%,
to $3.6 million or 29.2% of net revenues for the three months ended December
31, 2000 from $3.4 million or 29.8% of net revenues for the three months ended
December 31, 1999. Our net revenues derived from customers located in Europe
decreased $239,000, or 3.6%, to $6.3 million or 25.8% of net revenues for the
six months ended December 31, 2000 from $6.6 million, or 29.4% of net revenues
for the six months ended December 31, 1999, partially due to the devaluation of
the Euro. Our net revenues derived from customers located in other geographic
areas increased slightly to $683,000 or 5.5% of net revenues for the three
months ended December 31, 2000 from $552,000 or 4.8% of net revenues for the
three months ended December 31, 1999. Our net revenues derived from customers
located in other geographic areas increased to $1.3 million or 5.2% of net
revenues for the six months ended December 31, 2000 from $1.1 million or 5.1%
of net revenues for the six months ended December 31, 1999.
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. 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 $876,000, or 14.8%, to $6.8
million or 54.4% of net revenues for the three months ended December 31, 2000
from $5.9 million or 51.7% of net revenues for the three months ended December
31, 1999. Gross profit increased by $1.4 million, or 11.5%, to $13.5 million or
55.0% of net revenues for the six months ended December 31, 2000 from $12.1
million, or 54.2% of net revenues for the six months ended December 31, 1999.
For the three months ended December 31, 2000 and 1999, Gordian royalties were
$488,000 and $530,000, respectively. For the six months ended December 31, 2000
and 1999, Gordian royalties were $1.0 million and $1.1 million, respectively.
The increase in gross profit as a percentage of net revenues is primarily
attributable to increased sales volume of our Device Server product line
partially offset by competitive pricing strategies as well as cost containment
initiatives.
Selling, General and Administrative
Selling, general and administrative expenses consist primarily of personnel-
related expenses including salaries and commissions, facilities expenses,
information technology, trade show expenses, advertising, and professional
fees. Selling, general and administrative expenses increased $1.8 million, or
42.7%, to $6.0 million or 48.3% of net revenues for the three months ended
December 31, 2000 from $4.2 million or 37.0% of net revenues for the three
months ended December 31, 1999. Selling, general and administrative expenses
increased $3.6 million or 45.6%, to $11.4 million or 46.4% of net revenues for
the six months ended December 31, 2000 from $7.8 million or 35.1% of net
revenues for the six months ended December 31, 1999. This increase is due
primarily to an increase in our sales force, including new offices in Europe
and Asia, and an increase in marketing and advertising expenses to increase
brand awareness. We expect selling, general and administrative expenses will
continue to increase in the foreseeable future to support the global expansion
of our operations.
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 $310,000, or 43.6%, to $1.0 million or 8.2% of net revenues for the
three months ended December 31, 2000 from $711,000 or 6.2% of net revenues for
the three months ended December 31, 1999.
12
Research and development expenses increased $640,000, or 44.7%, to $2.1 million
or 8.5% of net revenues for the six months ended December 31, 2000 from $1.4
million or 6.4% of net revenues for the six months ended December 31, 1999.
This increase resulted primarily from increased headcount and expenses related
to new product development.
Interest and Other Income (Expense), Net
Interest and other income (expense), net consists primarily of interest
earned on cash, cash equivalents, short-term and long-term investments, less
interest on our bank lines of credit and capital lease obligations, the effects
of exchange gains and losses from foreign currency transactions, and gains and
losses from disposals of fixed assets. Interest and other income (expense), net
was $750,000 and $108,000 for the three months ended December 31, 2000 and
1999, respectively. Interest and other income (expense), net was $1.2 million
and $170,000 for the six months ended December 31, 2000 and 1999, respectively.
The increases are primarily due to higher average investment balances for the
three and six months ended December 31, 2000, as a result of the proceeds from
our initial public offering completed in August 2000.
Provision for Income Taxes
The effective tax rates for the three and six months ended December 31, 2000
were 73% and 51%, respectively. The effective tax rate for the three and six
months ended December 31, 1999 was 49%. 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. Our
effective tax rates for the three and six months ended December 31, 2000 were
effected by deferred compensation.
There is no valuation allowance provided for deferred tax assets since we
believe that it is more likely than not that these assets will be realized.
These assets are expected to be realized through the reversal of timing
differences and through future taxable income.
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 $21.7 million at December 31, 2000. Short-
term investments consist of investments maturing in twelve months or less and
totaled $25.1 million at December 31, 2000. Long-term investments consist of
investments maturing after twelve months and totaled $2.9 million at December
31, 2000.
Our operating activities used cash of $4.4 million for the six months ended
December 31, 2000. We incurred a net loss of $74,000, which includes
amortization and depreciation of $2.0 million, which was reduced by increased
inventory of $3.4 million and increased accounts receivable of $2.8 million.
The increase in accounts receivable was due to slow collections from some of
our U.S. distributors and European customers. We increased our inventory to
support our increasing sales activity and to provide better service levels to
our customers. Our operating activities provided cash of $195,000 for the six
months ended December 31, 1999.
Our investing activities used $29.7 million of cash for the six months ended
December 31, 2000. We used $28.0 million of our public offering proceeds to
purchase short-term and long-term investments. We also used cash to purchase
property and equipment, primarily computer hardware and software of $1.3
million pertaining to Oracle software enhancements to support our Order Entry
function, international operations and a customer resource management (CRM)
software package to support our sales force. In addition, we invested $326,000
in furniture and leasehold improvements for an office expansion project. Our
investing activities used cash of $178,000 for the six months ended December
31, 1999, primarily related to the purchase of property and equipment.
13
Cash provided by financing activities was $53.9 million for the six months
ended December 31, 2000, primarily related to the net proceeds from our initial
public offering on August 4, 2000. Cash used for financing activities was
$729,000 for the six months ended December 31, 1999, primarily for the
repayment on our bank line of credit related to our acquisition of ProNet GmbH.
We intend to use a portion of the proceeds from our recent public offering
to substantially increase our research and development activities. Over the
next two years, we expect our research and development expenses to increase to
approximately 10% of our net revenues. 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 public offering, our existing cash
and cash 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 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 under our bank line of
credit, or seek additional funding through additional 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
could 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;
. varying 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;
14
. announcements or introductions of new products by our competitors;
. defects and other product quality problems;
. changes in demand for devices that incorporate our connectivity
products; and
. foreign currency fluctuation.
Revenues from our Print Server line of products have decreased significantly
and we expect that revenues from our Print Server line of products will
continue to decline in the future as we focus our efforts on the development of
other product lines.
Since 1993, revenues from our Print Server line have accounted for a
significant portion of our net revenues but have declined significantly
recently. For example, revenues from our Print Server line accounted for
approximately 8.3% and 16.5% of our total net revenues for the six months ended
December 31, 2000 and 1999, respectively. Revenues from our Print Server line
also decreased significantly for the six months ended December 31, 2000 and
1999 to approximately $2.0 million from approximately $3.7 million,
respectively. We anticipate that revenues from our Print Server line will
continue to decline in the future as we plan to turn our focus to the
development of our current Device Server product line which we introduced in
mid 1998. We do not know if this transition in product development will be
successful. We do not know whether our current and future target markets to the
extent we anticipate will accept our new product line. If the expected decline
in net revenues attributable to our Print Server line of products is not offset
by increases in net revenues from our Device Server line of products, our
business could be harmed.
We intend to substantially increase our research and development efforts,
which if not successful, could cause a decline in our revenues and could harm
our business.
We intend to increase substantially our expenditures on research and
development in the next two years to enhance and develop additional products.
For the six months ended December 31, 2000, research and development expenses
comprised 8.5% of our net revenues. Over the next two years, we expect our
research and development expenses to increase to approximately 10% 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
cannot assure you that the revenue from these products will be sufficient to
justify our investment in research and development.
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.
Since our inception, we primarily sold our products to VARs, system
integrators and OEMs. Although we intend to continue to use these sales
channels, we intend to focus more heavily on selling our products to OEMs.
Selling products to OEMs involves unique risks, including the risk that the OEM
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, it could
harm our business.
Our business has grown rapidly in the last year. At December 31, 2000, we
had 185 employees. As of December 31, 1999, we had 105 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 our anticipated future growth. If we are unable to
successfully expand and improve our systems as required, or if we are otherwise
unable to manage our growth, our business will be harmed.
15
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, companies
with significant networking expertise and research and development resources,
and companies that produce semiconductors. Our competitors might offer new
products with features or functionality that are equal to or better than our
products. 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 revenues could decline and our business could be harmed.
We depend on two third-party manufacturing facilities to manufacture all of our
products, which reduce our control over the manufacturing process. We will also
need to secure an additional manufacturer in order to meet our expected future
commitments.
We currently outsource all of our manufacturing to two third-party
manufacturers, RTG Elektronik and Express Manufacturing. 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.
We do not have supply agreements with our manufacturers, and instead obtain
manufacturing services on a purchase-order basis. Our manufacturers have no
obligation to supply products to us in any specific quantity or at any specific
price. 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. As a result, we would have to attempt to identify and qualify
substitute manufacturers for our current 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 revenue would harm
our business.
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.
Although we outsource our manufacturing, we are responsible for procuring
raw materials for our products. Our products incorporate components or
technologies that are only available from limited sources of supply. In
particular, some of our integrated circuits are available from a single source.
In the past, from time to time, integrated circuits we used in our products
were 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. For example, the price of flash memory, a
component used in our products, has fluctuated significantly. 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
16
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.
For example, recently our supplier of gate array chips ended production of that
component, which caused an interruption in our ability to supply one of our
multiport products. 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.
For the six months ended December 31, 2000, our two largest customers, each
of whom are distributors, accounted for 24.1% of our net revenues. Ingram Micro
and Tech Data domestic distributors accounted for 13.2% and 10.9% respectively,
of our net revenues for the six months ended December 31, 2000. Our top five
and top ten customers accounted for 37.0% and 45.8% respectively, of our net
revenues for the six months ended December 31, 2000. Transtec AG, a major
international customer, accounted for 8.5% of our net revenues for the six
months ended December 31, 2000. Bernhard Bruscha, our Chairman of the Board, is
the majority stockholder and Chief Executive Officer of transtec AG. 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.
We cannot assure you that we will be able to maintain our average selling
prices and gross margins at current levels. In the past, we have experienced
some reduction in the average sale prices of products. For example, Embedded
Device Servers, External Device Servers and Print Server average selling prices
have decreased 7.2%, 13.2% and 10.1%, respectively, for the six months ended
December 31, 2000 compared to the six months ended December 31, 1999. 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.
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 31.0% and 34.5% of net
revenues for the six months ended December 31, 2000 and 1999, respectively. Net
revenues from Europe represented 25.8% and 29.4% of our net revenues for the
six months ended December 31, 2000 and 1999, respectively. We expect that
17
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 our
Chief Executive Officer, Frederick G. Thiel, as well as our technical
personnel, due to the specialized technical nature of our business. If we lose
the services of Mr. Thiel 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 hire and retain operations,
sales and support personnel in the near future. We expect to face greater
difficulty attracting qualified personnel with equity incentives as a public
company than we did as a privately held company. 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.
If we make unprofitable acquisitions or are unable to successfully integrate
any future acquisitions, our business could suffer.
We have in the past and from time to time in the future might acquire
businesses, client lists, products or technologies that we believe complement
or expand our existing business. For example, in October 1998, we acquired
ProNet GmbH, a German supplier of industrial application device server
technology. Also, in December 2000, we acquired United States Software
Corporation, a leading software solutions provider for embedded technology
applications. Acquisitions of this type involve a number of risks, including
the possibility that the operations of the acquired company will be
unprofitable or that our management's attention will be diverted from the day-
to-day operation of our business. An unsuccessful acquisition could reduce our
margins
18
or otherwise harm our financial condition. Any acquisition could result in a
dilutive issuance of equity securities, the incurrence of debt and the loss of
key employees. We cannot assure you that any acquisitions will be successfully
completed or that, if one or more acquisitions are completed, the acquired
businesses, client lists, products or technologies will generate sufficient
revenue to offset the associated costs of other acquisitions or other adverse
effects.
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 within
our target markets, which include industrial automation, healthcare,
security/access control, retail/point of sale, commercial/information
technology and telecommunications. 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 revenue might
not grow at the rate we anticipate, or could decline.
Undetected product errors or defects could result in loss of revenue, delayed
market acceptance and claims against us.
We currently offer a five-year warranty on all 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; and
. current federal laws that prohibit software copying provide only limited
protection from software "pirates."
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
19
of our proprietary technology could enable third parties to benefit from our
technology without paying us for it, which could significantly harm our
business.
If our agreement with Gordian, Inc. is terminated, we could lose the rights to
valuable intellectual property.
Pursuant to an agreement dated February 29, 1989 between Gordian, Inc., and
us Gordian 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 revenue. Our total Print
Server and Multiport Device Server products alone, without including MSS
products, represented approximately 32.3% and 43.7% of our net revenues for the
six months ended December 31, 2000 and 1999, respectively. Under the terms of
this agreement, Gordian owns the rights to the intellectual property developed
by it but has agreed that for the term of the agreement it will not develop
products for any other party, which will directly compete with a product
Gordian developed for us. The agreement with Gordian currently provides that we
are required to pay royalties with respect to sales of products covered by the
agreement. For the six months ended December 31, 2000 and 1999, we paid Gordian
approximately $1.0 million and $1.1 million 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. Although we believe that other products developed by us using
alternative technology can be substituted in the future for the products sold
by us using the technology developed by Gordian, there is no guarantee that we
will not lose customers and revenues which would harm our business.
We might become 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 and current developers of our intellectual property or our
manufacturing partners, will claim that our products, or our customers'
products, infringe on their intellectual property rights. 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 the proprietary rights we use infringe upon. Any of these
third parties might make a claim of infringement against us. Any 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 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 or require us to
enter into royalty or license agreements, which might not be available on
acceptable terms, or at all. 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 required
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.
The amortization of deferred stock compensation will negatively affect our
operating results.
We have recorded deferred stock 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 within
stockholders' equity of approximately $10.6 million at December 31, 2000, which
is being amortized over the vesting period of the
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related stock options, which is generally four years. A balance of $7.7 million
remains at December 31, 2000 and will be amortized as follows: $1.4 million in
the remainder of fiscal 2001, $2.8 million in fiscal 2002, $1.8 million in
fiscal 2003, $1.4 million in fiscal 2004, $219,000 in fiscal 2005, and $153,000
in fiscal 2006.
The amount of stock based compensation in future periods will increase if we
continue to grant stock options where the exercise price is less than the
estimated fair value of the underlying shares. The amount of stock based
compensation amortization in future periods could decrease if options for which
accrued, but unvested compensation has been recorded are forfeited.
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, 2000.
Interest Rate Risk. Our exposure to interest rate risk is limited to the
exposure related to our cash, cash equivalents, short-term and long-term
investments and our credit facilities, which is tied to market interest rates.
As of December 31, 2000, we had cash, cash equivalents, short-term and long-
term investments of $49.7 million, which includes our initial public offering
proceeds. This consisted of cash equivalents with original maturities of 90
days or less, short-term investments maturing within twelve months or less and
long-term investments maturing after twelve months, both domestically and
internationally. We believe our cash, cash equivalents and 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. We have invested $766,000 in two privately held companies,
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.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities and Use of Proceeds
For the six months ended December 31, 2000, we received net proceeds of
$53.7 million. During the six months ended December 31, 2000, we used $4.0
million of the proceeds for working capital, primarily related to increased
inventory levels to support our projected sales increase and higher accounts
receivable balances related to slow payment by some of our U.S. distributors
and European customers, as well as for property and equipment purchases.
On December 29, 2000, in connection with our acquisition of United States
Software Corporation ("USSC"), we issued 653,846 shares of common stock and
agreed to pay $2.5 million in cash in exchange for all outstanding shares of
USSC common stock. Additionally, we reserved 133,333 shares of our common stock
for issuance upon exercise of outstanding employee stock options. The Company
intends to rely on a private placement exemption under Rule 504 of Regulation D
of the Securities Act of 1933, as the purchasers have represented that they are
accredited investors under the definition set forth in Regulation D. The USSC
options that were assumed by the Company were registered on the Company's
Registration Statement on Form S-8, originally filed on February 2, 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.,
USS Acquisition Corporation, United States Software Corporation and
Donald Dunstan and Diane Dunstan.
3.2* Certificate of Incorporation
3.4* Bylaws
4.1** Form of registrant's common stock certificate.
10.1** Form of Indemnification Agreement entered into by registrant with
each of its directors and executive officers.
10.2** 1993 Stock Option Plan and forms of agreements thereunder.
10.3** 1994 Nonstatutory Stock Option Plan and forms of agreements
thereunder.
10.4** 2000 Stock Plan and forms of agreements thereunder.
10.5** 2000 Employee Stock Purchase Plan.
10.6** Form of Warranty.
10.7* Employment Agreement between registrant and Frederick Thiel.
10.8* Employment Agreement between registrant and Steven Cotton.
10.9* Employment Agreement between registrant and Johannes Rietschel.
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Exhibit
Number Description of Document
------- -----------------------
10.10*** Lease Agreement between registrant and The Irvine Company.
10.11** Loan and Security Agreement between registrant and Silicon Valley
Bank.
10.12+** Research and Development Agreement between registrant and Gordian.
10.13+** Distributor Contract between registrant and Tech Data Corporation.
10.14+** Distributor Contract between registrant and Ingram Micro Inc.
10.15***** United States Software Corporation 2000 Stock Plan.
- --------
* Incorporated by reference to the same numbered exhibit previously filed
with Lantronix's Registration Statement on Form S-1 (SEC file no. 333-
37508) originally filed May 19, 2000.
** Incorporated by reference to the same numbered exhibit previously filed
with Lantronix's Registration Statement on Form S-1, Amendment No. 1,
(SEC file no. 333-37508) originally filed June 13, 2000.
*** Incorporated by reference to the same numbered exhibit previously filed
with Lantronix's Annual Report on Form 10-K, originally filed September
28, 2000.
**** Incorporated by reference to the same numbered exhibit previously filed
with Lantronix's Report on Form 8-K, originally filed December 29, 2000.
***** Incorporated by reference to Exhibit 4.1 of Lantronix's Registration
Statement on Form S-8 filed February 2, 2001.
+ Confidential treatment granted as to portions of this exhibit.
(b) Reports on Form 8-K
Lantronix filed its Report on Form 8-K on December 29, 2000 reporting its
acquisition of United States Software Corporation.
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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 February, 2001.
LANTRONIX, INC.
/s/ Steven V. Cotton
By: _________________________________
Steven V. Cotton
Chief Financial Officer and Chief
Operating Officer
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