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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER 1-16027
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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)
(949) 453-3990
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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COMMON STOCK, $0.0001 PAR VALUE THE NASDAQ CAPITAL MARKET
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [ ] No |X|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes [ ] No |X|
The aggregate market value of the registrant's Common Stock held by
non-affiliates based upon the closing sales price of the common stock on
December 31, 2004, as reported by the NASDAQ Capital Market, was approximately
$28,408,000. Shares of common stock held by each current executive officer and
director and by each person who is known by the registrant to own 5% or more of
the outstanding common stock have been excluded from this computation in that
such persons may be deemed to be affiliates of the registrant. Share ownership
information of certain persons known by the registrant to own greater than 5% of
the outstanding common stock for purposes of the preceding calculation is based
solely on information on Schedule 13G filed with the Securities and Exchange
Commission and is as of December 31, 2004. This determination of affiliate
status is not a conclusive determination for other purposes.
As of September 14, 2005, there were 58,925,433 shares of the
Registrant's common stock outstanding.
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1
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the Lantronix, Inc.
Annual Meeting of Stockholders scheduled to be held on November 15, 2005 are
incorporated by reference into Part III of this Form 10-K.
LANTRONIX, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED JUNE 30, 2005
TABLE OF CONTENTS
Page
----
PART I
ITEM 1. Business............................................................................................................4
ITEM 2. Properties.........................................................................................................11
ITEM 3. Legal Proceedings..................................................................................................12
ITEM 4. Submission of Matters to a Vote of Security Holders................................................................12
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters and Issuer Purchases of Securities...........13
ITEM 6. Selected Financial Data............................................................................................14
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..............................15
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk.........................................................40
ITEM 8. Financial Statements and Supplementary Data........................................................................40
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...............................41
ITEM 9A. Controls and Procedures............................................................................................41
ITEM 9B. Other Information..................................................................................................43
PART III
ITEM 10. Directors and Executive Officers of the Registrant.................................................................44
ITEM 11. Executive Compensation.............................................................................................44
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.....................44
ITEM 13. Certain Relationships and Related Transactions.....................................................................44
ITEM 14. Principal Accountant Fees and Services.............................................................................44
PART IV
ITEM 15. Exhibits and Financial Statement Schedules ........................................................................45
Signatures.......................................................................................................II-3
2
FORWARD-LOOKING STATEMENTS
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
THE FEDERAL SECURITIES LAWS. STATEMENTS THAT ARE NOT PURELY HISTORICAL SHOULD BE
CONSIDERED FORWARD-LOOKING STATEMENTS. OFTEN THEY CAN BE IDENTIFIED BY THE USE
OF FORWARD-LOOKING WORDS AND PHRASES, SUCH AS "INTEND," "MAY," "WILL," "COULD,"
"PROJECT," "ANTICIPATE," "EXPECT," "ESTIMATE," "CONTINUE," "POTENTIAL," "PLAN,"
"FORECASTS," AND THE LIKE. STATEMENTS CONCERNING CURRENT CONDITIONS MAY ALSO BE
FORWARD-LOOKING IF THEY IMPLY A CONTINUATION OF CURRENT CONDITIONS. EXAMPLES OF
FORWARD-LOOKING STATEMENTS INCLUDE, BUT ARE NOT LIMITED TO, STATEMENTS
CONCERNING INDUSTRY TRENDS, ANTICIPATED DEMAND FOR OUR PRODUCTS, THE IMPACT OF
PENDING LITIGATION, OUR OVERALL BUSINESS STRATEGY, MARKET ACCEPTANCE OF NEW
PRODUCTS, FUTURE CUSTOMER AND SALES DEVELOPMENTS, MANUFACTURING FORECASTS,
INCLUDING THE POTENTIAL BENEFITS OF OUR CONTRACT MANUFACTURERS SOURCING AND
SUPPLYING RAW MATERIALS, THE SIGNIFICANT ROLE OF ORIGINAL EQUIPMENT
MANUFACTURERS IN OUR BUSINESS, THE FUTURE COST AND POTENTIAL BENEFITS OF OUR
RESEARCH AND DEVELOPMENT EFFORTS AND LIQUIDITY AND CASH RESOURCES FORECASTS.
FORWARD-LOOKING STATEMENTS ARE SUBJECT TO RISKS AND UNCERTAINTIES THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN THE
FORWARD-LOOKING STATEMENTS. READERS ARE URGED TO CAREFULLY REVIEW THE CAUTIONARY
STATEMENTS MADE BY THE COMPANY IN THIS REPORT CONCERNING RISKS AND OTHER FACTORS
THAT MAY AFFECT THE COMPANY'S BUSINESS AND OPERATING RESULTS, INCLUDING THOSE
MADE IN THIS REPORT UNDER THE CAPTION "RISK FACTORS," AS WELL AS THE COMPANY'S
OTHER REPORTS FILED WITH THE SEC. WE MAY FROM TIME TO TIME MAKE ADDITIONAL
FORWARD-LOOKING STATEMENTS IN OUR FILINGS WITH THE SEC, IN OUR REPORTS TO OUR
STOCKHOLDERS, AND ELSEWHERE. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE
ON THESE FORWARD-LOOKING STATEMENTS. WE DO NOT UNDERTAKE ANY OBLIGATION TO
UPDATE ANY FORWARD-LOOKING STATEMENT THAT MAY BE MADE FROM TIME TO TIME BY US OR
ON OUR BEHALF.
3
PART I
ITEM 1. BUSINESS
OVERVIEW
Lantronix, Inc. ("Lantronix" or "the Company") designs, develops and
markets devices that make it possible to access, manage, control and configure
electronic products over the Internet or other networks. We are a leader in
providing innovative networking solutions. We were initially formed as
"Lantronix," a California corporation, in June 1989. We reincorporated as
"Lantronix, Inc.," a Delaware corporation in May 2000.
We have a history of providing devices that enable information
technology ("IT") equipment to network using standard protocols for
connectivity, including fiber optic, Ethernet and wireless. Our first device was
a terminal server that allowed "dumb" terminals to connect to a network.
Building on the success of our terminal servers, in 1991 we introduced a
complete line of print servers that enabled users to inexpensively share
printers over a network. Since then, we have continually refined our core
technology and have developed additional innovative networking solutions that
expand upon the business of providing our customers network connectivity. With
the expansion of networking and the Internet, our technology focus has been
increasingly broader and has expanded beyond IT equipment, so that our device
solutions provide a product manufacturer with the ability to network its
products within the industrial, service and consumer markets.
We provide three broad categories of products: "device networking
solutions" that enable electronic products to be connected to a network; "IT
management solutions" that enable multiple pieces of equipment, usually
IT-related network hardware such as servers, routers, switches and similar
pieces of equipment to be managed over a network; and "non-core" products and
services that include visualization solutions, legacy print servers and other
miscellaneous products. The expansion of our business in the future is directed
at the first two of these categories, which comprise our "core" businesses of
device networking and IT management solutions.
Today, our solutions include fully integrated hardware and software
devices, as well as software tools, to develop related customer applications.
Because we deal with network connectivity, we provide solutions to extremely
broad market segments, including industrial, retail, medical, commercial,
financial, governmental, building automation, and many more. Our technology is
used to provide networking capabilities to products such as medical equipment,
manufacturing equipment, bar code scanners, building heating ventilation and air
conditioning systems, elevators, process control equipment, vending machines,
thermostats, security cameras, temperature sensors, card readers, point of sale
terminals, time clocks, and virtually any product that has some form of standard
data control capability.
We sell our products through a global network of distributors, systems
integrators, value-added resellers ("VARs"), manufacturers' representatives and
original equipment manufacturers ("OEMs"). In addition, we sell directly to
selected accounts.
Our common stock is currently traded on The NASDAQ Capital Market
under the symbol LTRX.
Our worldwide headquarters is located in Irvine, California, and we
have offices worldwide, including France and Hong Kong. We also have employees
working from home offices in other areas of the world, including Germany, United
Kingdom, France, Japan and the Netherlands. In September 2003, we closed our
European administrative operations handled by our Switzerland office. Since
then, European operations have been managed from our Irvine, California
facility.
We provide information regarding our company and our products on our
Internet website, www.lantronix.com.
4
OUR STRATEGY
Our business strategy is based on our proven capability to develop
fully integrated networking solutions that increase the value of our customers'
products by making it easy to take advantage of features that can be made
available when these products are network-enabled. This strategy is accomplished
by providing our customers with hardware and software that connects products and
systems to a network and intelligently manages and controls them. With our 16
years of networking expertise, knowledge of industry trends and our capability
to develop solutions based on open industry standards, we have been able to
anticipate our customers' networking technology requirements and offer solutions
that enable them to achieve their connectivity objectives. By providing a
complete solution of hardware and integrated software, we have been able to
provide "turnkey" solutions, eliminating the need for our customers to build
expensive design and manufacturing expertise in-house. This results in savings
to the customer both in terms of financial investment and time.
Our solutions have enabled us to become a technology and industry
leader. We focus on the following key areas:
o Device Networking Solutions - We offer an array of embedded
and external device networking solutions that enable
integrators and manufacturers of electronic and
electro-mechanical products to add network connectivity,
manageability and control. Our customers' products originate
from a wide variety of applications within the
machine-to-machine ("M2M") market, from blood analyzers that
relay critical patient information directly to a hospital's
information system, to simple devices such as time clocks or
audiovisual equipment, allowing the user to obtain information
from these products and to improve how they are managed and
controlled.
o IT Management Solutions - We offer off-the-shelf appliances
that enable IT professionals to remotely manage network
infrastructure equipment and large groups of servers. Our
terminal and console management products provide for the
remote command and control of today's network infrastructure.
o Non-core Businesses - Over the years, we have innovated or
acquired various product lines that are no longer part of our
primary, core markets described above. In general, these
non-core businesses represent decreasing markets and we
minimize research and development in these product lines.
Included in this category are visualization solutions, legacy
print servers, software and other miscellaneous products.
Our strategy is to drive the product development and revenues of our
core areas, device networking solutions and IT management solutions.
PRODUCTS
DEVICE NETWORKING SOLUTIONS
Device networking is the technology that enables connectivity within
the broad market of M2M networking. We provide manufacturers, integrators and
users with complete device networking solutions that include the technology
required for products to be connected, managed and controlled over networks
using standard protocols for connectivity, including fiber optic, Ethernet and
wireless. As common, everyday products such as lighting, security and
audiovisual systems leverage the power of network connectivity, manufacturers
and users are realizing the benefits of networking. Our device networking
solutions dramatically shorten a manufacturer's development time to implement
network connectivity, provide competitive advantages with new features, and
greatly reduce engineering and marketing risks. Our hardware solutions include
large scale integration ("LSI") chips, embedded modules (completed circuit
boards or intelligent connectors with electronic components and the necessary
connectors and software that is mounted within a customer's product), and
external hardware modules with single, multi- or wireless ports that can be
connected to the customer's products typically by cables. Embedded and external
hardware modules incorporate a real-time operating system and application
software required to make the devices effective. We also offer application- and
industry-specific solutions such as industrial device servers.
5
Our device servers allow a wide range of equipment to be quickly
network-enabled without the need for intermediary gateways, workstations or PCs.
This distributed computing approach significantly improves reliability and
up-time. Our device servers also eliminate the high cost of ownership associated
with networking, which frequently would otherwise require using PCs and
workstations to perform connectivity and remote management functions. Our device
servers contain high-performance processors capable of not only controlling the
attached device, but also of accumulating data and status. The accumulated data
can then be formatted by the device server and presented to users via the built
in web server, SNMP or e-mail. Device servers have a built-in HTTP server,
making them easy to manage using any standard Web browser.
In 2003, we introduced our XPort device server, which represents an
improvement in technology and a reduction in physical size and price for this
type of functionality. The thumb-sized XPort is a self-contained network
communications server and miniaturized web server enclosed within a rugged RJ-45
connector package, which can be embedded in virtually any electronic product.
Products incorporating XPort have their own IP address on a network and can be
accessed from any web browser, including a wireless PC or Internet-enabled cell
phone, from anywhere in the world. The XPort can serve up Internet-standard web
pages, initiate e-mails for notifications or alerts, and run other applications
as defined by the product manufacturer. XPort makes it simple for a product
manufacturer to create network connectivity, because the XPort device includes a
complete, integrated solution with a 10/100 Base-T Ethernet connection, a
reliable and proven operating system, an embedded web server, flexible firmware,
a full TCP/IP protocol stack, and optional 256-bit standards-based ("AES")
encryption. The relatively low price of the XPort, and the speed and ease with
which a manufacturer can design the device into its products, can make many
products more attractive by cost-effectively providing network connectivity.
In March 2004, we introduced WiPort, a wireless (and wired) embedded
device server with substantially the same functionality as XPort, but with an
802.11 standard wireless configuration for embedded application in products and
situations where a wired Ethernet environment is not available or practical. In
August 2004, we introduced WiBox, an external wireless device server.
IT MANAGEMENT SOLUTIONS
Our IT management solutions provide IT professionals with the tools
they need to remotely manage computers and associated systems. These solutions
include console servers, digital remote keyboard, video, mouse ("KVM") servers,
managed power distribution products and terminal servers.
IT professionals use our solutions to monitor and run their systems to
ensure the performance and availability of critical business information
systems, network infrastructure and telecommunications equipment. The equipment
our solutions manage includes routers, switches, servers, phone switches and
public branch exchanges that are often located in remote or inaccessible
locations.
Our console servers provide system administrators and network managers
a way to connect with their remote equipment through a universal interface
called a console port, helping them work more efficiently without having to
leave their desks or office. With remote access and system downtime, its impact
on business is minimized. Our console servers provide IT professionals with
peace-of-mind through extensive security features, and in some cases, provisions
for dial-in access via modem. These solutions are provided in various
configurations and can manage up to 48 devices from one console server. Our
remote KVM products provide customers with the ability to extend traditional
server keyboard, video, and mouse controls over long distances using standard IP
networks.
NON-CORE BUSINESSES: VISUALIZATION SOLUTIONS, PRINT SERVERS AND OTHER
LEGACY PRODUCTS
We offer visualization solutions that provide switching and optical
extension of high performance video, audio, keyboard and mouse over long
distances within a building or campus environment. Products include video
display extenders, analog KVM extension systems and matrix hubs. Our analog
remote KVM products provide a valuable solution for extending and sharing audio,
video, keyboard and mouse signals among many users and over optical cable
without loss of resolution. KVM products enable a single keyboard, monitor and
mouse to be switched between multiple computers, providing immediate access and
control from a single location. The customers for these devices typically are
companies that need to isolate users from the core computing center for security
reasons, or require high speed video sources to be shared among many users. Our
visualization solutions can be found in government agencies and at customers
involved with large scale simulation and display applications.
6
Early in our business history, we provided external print servers that
connect various printers to a network for shared printing tasks. Over the years,
we have updated and continue to provide print servers that work with a myriad of
operating systems and network configurations. The requirement for external print
servers is decreasing, as printer manufacturers have incorporated networking
hardware and software as part of many printers.
We acquired a line of low-cost products which we market under the
"Stallion" brand. Stallion products include a variety of network servers and a
range of multi-port serial I/O cards. Various other small categories of our
legacy business are included in this category, such as software revenues and
other product lines we have discontinued or that are being de-emphasized.
The following are approximate revenues for these product families for
the periods indicated. Definitions of these families have been modified slightly
from time to time, and the data has been revised to conform to the current
definitions:
PRODUCT FAMILY PRIMARY PRODUCT FUNCTION NET REVENUES FOR THE YEARS ENDED JUNE 30,
-------------- ------------------------ -----------------------------------------
2005 2004 2003
---- ---- ----
Device networking solutions Enable electronic products to $ 30.0 $ 27.5 $ 24.5
become network enabled.
IT management solutions Allow the user to control $ 12.3 $ 12.6 $ 13.1
equipment by way of a network
using a wide range of protocols.
This category includes console
servers and remote digital KVM.
Non-core products Includes visualization solutions, $ 6.2 $ 8.8 $ 11.8
legacy print servers, software
and other miscellaneous products.
Financial Accounting Standards Board ("FASB") Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information,"
establishes standards for disclosures about operating segments in annual
consolidated financial statements. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
We operate in one segment, networking and Internet connectivity.
CUSTOMERS
DISTRIBUTORS
Our principal customers are our distributors, which account for the
largest percentage of our net revenues. Distributors resell our products to a
wide variety of end customers, including consumers, corporate customers and
VARs. We sell to a group of ten major distributors, some of which operate from
multiple warehouses. Our major distributors in the U.S. include: Ingram Micro,
Tech Data, KMJ Communications, Symmetry Electronics and Arrow Electronics, Inc.
In Europe, we distribute to the following major distributors: transtec AG (a
related party due to common ownership by our largest stockholder), Sphinx
Computer Vertriebs GmbH, Jade Communications, LTD, Astradis Elecktronik GmbH and
Atlantik Systems GmbH.
OEM MANUFACTURERS
We have established a broad range of OEM customers in various
industries, such as industrial automation, medical, security, building
automation, consumer and audiovisual. Our OEM customers typically lack the
expertise or resources to develop hardware and software required to introduce
network solutions to their end users in a timely manner. To shorten the
development cycle and add network connectivity to a product, OEMs can use our
external devices to network-enable their installed base of products, while
board-level embedded modules are typically used in new product designs. Our
capabilities and solutions enable OEMs to focus on their core competencies,
resulting in reduced research and development costs, fewer integration problems
and faster time to market.
7
END USER BUSINESSES
We have a broad range of end user customers in various vertical markets
such as retail, universities/education, manufacturing, healthcare/hospitals and
financial/banking. End user businesses require solutions that are simple to
install, set up and operate, and can provide immediate results. Generally, these
customers need to connect to a diverse range of products and equipment, without
modifying existing software and systems.
Our external device solutions enable end users to quickly, securely and
easily connect their devices and equipment to networks, extending the life of
existing investments. We provide a number of support services including
telephone-based sales and technical support as well as a wide array of
Internet-based resources. In many cases, the customer simply has to call in to
obtain assistance in identifying which networking device would be most
appropriate for their need. After buying the devices from us or one of our
distributors, a customer often only has to plug a cable from their device to our
external device, and then plug our device into their network.
SALES AND MARKETING
We maintain both an inside and a field sales force to provide
management and support to our worldwide network of selling partners. Over the
past several years, we have transitioned to and continued to expand to an
indirect sales model, using manufacturers' representatives, VARs and other
resellers throughout the world. We develop marketing programs, products, tools
and services specifically geared to meet the needs of our targeted customers.
Our sales and marketing force consisted of the following numbers of employees at
the end of the periods indicated:
Years Ended June 30,
2005 2004 2003
---- ---- ----
Sales and marketing 56 82 83
========== ========== ===========
We believe that our multi-channel approach provides several advantages.
We can engage the customers and end users through their channel of choice,
making our solutions available from a variety of sources.
Our device networking solutions are principally sold to manufacturers
by our worldwide OEM sales force and our group of manufacturers'
representatives. We have continued to expand our use of manufacturers'
representatives and other resellers, leveraging their established relationships
to bring our device networking solutions to a greater number of customers within
the OEM market.
We market and sell our IT management solutions and select external
device networking solutions through information technology resellers,
industry-specific system integrators, VARs and directly to end user
organizations. Resellers and integrators will often obtain our products through
distributors. These distributors supply our products to a broad range of VARs,
system integrators, direct marketers, government resellers and e-commerce
resellers. In turn, these distributor customers market, sell, install and, in
most cases, support our solutions to the end users. We are continuing to expand
our use of cost-effective, indirect sales channels.
Net revenues generated from sales in the Americas, Europe and other
geographic areas including Asia and Japan for the periods indicated were as
follows (in thousands):
Years Ended June 30,
2005 2004 2003
---- ---- ----
Americas $ 31,162 64.3% $ 33,847 69.3% $ 37,391 75.7%
Europe 13,213 27.2% 11,252 23.0% 10,366 21.0%
Other 4,127 8.5% 3,786 7.7% 1,632 3.3%
----------- ------------ ----------- ----------- ----------- ------------
Total net revenues $ 48,502 100% $ 48,885 100% $ 49,389 100%
=========== ============ =========== =========== =========== ============
8
Information concerning our sales by geographic region can be found in
Part IV, Item 15 of this Form 10-K and is presented in footnote 15. Please see
"Risk Factors" below for a discussion of the risks associated with foreign
sales.
MANUFACTURING
A key element of our operations strategy is to outsource manufacturing
to produce reliable, high quality products at competitive prices and to achieve
on-time delivery to our customers. This practice enables us to concentrate our
resources on design, engineering and marketing.
We utilize contract manufacturers located in the U.S., China, Malaysia
and Taiwan. Our contract manufacturers source raw materials, components and
integrated circuits, in accordance with our pre-determined specifications and
forecasts, and perform printed circuit board assembly, final assembly,
functional testing and quality control. We believe this arrangement decreases
our working capital requirements and provides better raw material and component
pricing, enhancing our gross margins and operating margins. Please see "Risk
Factors" below for a discussion of the risks associated with contract
manufacturing.
RESEARCH AND DEVELOPMENT
Our research and development efforts are focused on the development of
technology and products that will enhance our competitive position in the
markets we serve. Products are developed in-house and through outside research
and development resources. Our number of employees at the end of the periods
indicated and expenses in our research and development organization for the
periods indicated were as follows:
Years Ended June 30,
(in thousands except number of employees)
2005 2004 2003
---- ---- ----
Number of employees 37 60 27
=========== =========== ===========
Research and development expenses $ 6,314 $ 7,813 $ 9,430
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INDUSTRY PARTNERS
In keeping with our business strategy, we have engaged or participated,
with a portfolio of partners, consortia and standards committees in an effort to
provide the most complete networking solutions to our customers.
DEVELOPER RELATIONS
Recruiting, informing and participating with third-party developers is
an integral part of our ongoing strategy. We encourage, enable and support
others in the development of vertical applications using our hardware, firmware
and software products. With their help and investment in creating additional
applications and markets for our products, we improve our ability to secure a
defensible market position and loyal customers.
COMPETITION
The markets in which we compete are dynamic and highly competitive. As
these markets grow and develop, we expect competition to intensify. Our current
and potential competitors include the following:
o companies with network-enabling technologies, such as Avocent,
Echelon, Moxa, Digi International, Cyclades, Freescale
Semiconductor (a spin-off of Motorola), Quatech, Wind River,
Rabbit (acquired by Digi International in May 2005), MRV
(formerly known as iTouch), Rose Electronics, Raritan, Equinox
and Zilog;
o companies with equipment for IT management solutions, such as
Cyclades, Moxa, Digi International, Sena, Logical Solutions,
Cisco Systems, MRV, DPAC Technologies, Open Gear and Perle;
o companies with significant networking expertise and research
and development resources, including Cisco Systems, IBM and
Lucent Technologies.
9
The principal competitive factors that affect the market for our
products are:
o product quality, technological innovation, compatibility with
standards and protocols, reliability, functionality, ease of
use and compatibility;
o product pricing; and
o potential customers' awareness and perception of our products
and of network-enabling technologies.
INTELLECTUAL PROPERTY RIGHTS
We have developed proprietary methodologies, tools, processes and
software in connection with delivering our services. We have not historically
relied on patents to protect our proprietary rights, although we have recently
begun to build a patent portfolio. We have historically relied on a combination
of copyright, trademark, trade secret laws and contractual restrictions, such as
confidentiality agreements and licenses, to establish and protect our
proprietary rights.
Gordian, Inc. ("Gordian") developed certain intellectual property used
in our micro serial server line of products. These products represented and
continue to represent a significant portion of our net revenues. An agreement
with Gordian gives us joint ownership of the Gordian intellectual property that
is embodied in the products Gordian designed for us.
UNITED STATES AND FOREIGN GOVERNMENT REGULATION
Many of our products and the industries in which they are used are
subject to federal, state or local regulation in the U.S. In addition, our
products are exported worldwide. Therefore, we are subject to the regulation of
foreign governments. For example, wireless communication is highly regulated in
both the U.S. and elsewhere. Some of our products employ encryption technology;
the export of some encryption software is restricted. At this time our
activities comply with existing laws, but we cannot determine whether future,
more restrictive laws, if enacted, would adversely affect us. Please see "Risk
Factors" below for risks associated with foreign operations.
EMPLOYEES
We have never experienced a work stoppage, none of our employees are
currently represented by a labor union, and we consider our employee relations
to be good. The functional distribution of the number of part-and full-time
employees that we had as of June 30, 2005 was as follows:
Year Ended June 30,
2005
-------------
Research and development 37
Sales and marketing 56
Operations 24
General and administrative 27
-------------
Total 144
=============
BACKLOG
Normally, we manufacture our products in advance of receiving firm
product orders from our customers based upon our forecasts of worldwide customer
demand. Most customer orders are placed on an as-needed basis and may be
canceled or rescheduled by the customer without significant penalty.
Accordingly, backlog as of any particular date is not necessarily indicative of
our future sales. Because most of our business is on an as-needed basis and
varies slightly, only because of short-term customer requests, we do not rely on
backlog as a metric of our operations. We have no customer orders extending more
than several months into the future.
10
AVAILABLE INFORMATION
Our annual report on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K and amendments to reports filed or furnished
pursuant to Section 13(a) and 15(d) of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), are available free of charge on our website at
www.lantronix.com shortly after we electronically file such material with, or
furnish it to, the SEC. The public may read and copy any materials we file with
the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC
20549. The public may obtain information on the operation of the Public
Reference Room by calling 1-800-SEC-0330. The SEC also maintains a website at
www.sec.gov that contains reports, proxy and information statements, and other
information regarding issuers that file electronically. We assume no obligation
to update or revise forward looking statements in this annual report, whether as
a result of new information, future events or otherwise, unless we are required
to do so by law.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table lists the names, ages and positions held by all our
executive officers as of August 31, 2005. There are no family relationships
between any director or executive officer and any other director or executive
officer of Lantronix. Executive officers serve at the discretion of the Board of
Directors.
Name Age Position
- ---- --- --------
Marc Nussbaum 49 President and Chief Executive Officer
James Kerrigan 69 Chief Financial Officer and Secretary
MARC NUSSBAUM has served as our President and Chief Executive Officer
since May 2002 (on an Interim basis until February 2003). From April 2000 to
March 2002, Mr. Nussbaum served as Senior Vice President and Chief Technical
Officer for MTI Technology Corporation, a developer of enterprise storage
solutions. From April 1981 to November 1998, Mr. Nussbaum served in various
positions at Western Digital Corporation, a manufacturer of PC components,
communication controllers, storage controllers and hard drives. Mr. Nussbaum
lead business development, strategic planning and product development
activities, serving as Western Digital's Senior Vice President, Chief Technical
Officer from 1995 to 1998 and Vice President, Storage Technology and Product
Development from 1988 through 1995. Mr. Nussbaum holds a BA degree in physics
from the State University of New York.
JAMES KERRIGAN has served as our Chief Financial Officer since May 2002
(on an Interim basis until February 2003) and as Secretary since July 2005. From
March 2000 to October 2000, he was Chief Financial Officer of Motiva, a
privately-owned company that developed, marketed and sold collaboration software
systems. From January 1998 to February 1999, he was Chief Financial Officer of
Who?Vision Systems, Inc., an incubator company that developed biometric
fingerprint devices and software. From April 1995 to March 1997, Mr. Kerrigan
was Chief Financial Officer of Artios, Inc., a privately-owned company that
designs, manufactures, and sells prototyping hardware and software to the
packaging industry. Previously, Mr. Kerrigan has served as chief financial
officer for other larger, public companies. He has a BS degree in engineering
and a MBA degree from Northwestern University.
ITEM 2. PROPERTIES
We lease a building in Irvine, California, that comprises our corporate
headquarters and includes administration, sales, marketing, research and
development, warehouse and order fulfillment functions. We have smaller sales
offices in France and Hong Kong. Our leased facilities comprise an aggregate of
approximately 55,000 square feet of which our Irvine facility represents the
majority.
11
During the fiscal year ended June 30, 2005, we closed and vacated
leased, sales offices in Milford, Connecticut; Munich, Germany; and Tokyo,
Japan. We also negotiated and extended our lease for our Irvine facility until
July 2010. During fiscal 2004, we completed facility and organizational
restructuring activities that we began in fiscal 2003. In September 2003, we
ceased operational activities in Cham, Switzerland, the headquarters of
Lantronix International AG, which is our wholly owned subsidiary. We now support
international sales and shipping from our Irvine, California headquarters. In
March 2004, we sold our Premise software unit and closed our Redmond,
Washington, facility. We continue to make payments on our lease obligations for
facilities we no longer occupy, including our facilities located in Naperville,
Illinois (lease terminating February 2007); Hillsboro, Oregon (lease terminated
August 2005); and Ames, Iowa (lease terminating February 2007). The remaining
liability for these lease obligations is included in our restructuring reserve
at June 30, 2005.
We believe our existing facilities are adequate to meet our needs. If
additional space is needed in the future, we believe that suitable space will be
available on commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
The legal proceedings as required by this item are incorporated by
reference from Part IV, Item 15 of this Form 10-K and are presented under
footnote 12 to our notes to consolidated financial statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during the
fourth fiscal quarter for the year ended June 30, 2005.
12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF SECURITIES
PRICE RANGE OF COMMON STOCK
Our common stock was traded on The NASDAQ National Market under the
symbol "LTRX" from our initial public offering on August 4, 2000 through October
22, 2002. On October 23, 2002 our listing was changed to The NASDAQ Capital
Market. The number of holders of record of our common stock as of August 15,
2005 was approximately 87. The following table sets forth, for the periods
indicated, the high and low per share closing prices for our common stock:
Fiscal Year 2004 High Low
- ---------------- ---- ---
First Quarter $1.41 $0.78
Second Quarter 1.32 0.89
Third Quarter 1.86 1.06
Fourth Quarter 2.09 1.18
Fiscal Year 2005 High Low
- ---------------- ---- ---
First Quarter $1.25 $0.99
Second Quarter 1.24 0.85
Third Quarter 1.85 1.08
Fourth Quarter 1.80 1.24
We believe that a number of factors, including but not limited to
quarterly fluctuations in results of operations, may cause the market price of
our common stock to fluctuate significantly. See Part II, Item 7 of this Form
10-K.
DIVIDEND POLICY
We have never declared or paid cash dividends on our common stock. We
do not anticipate paying any cash dividends on our common stock in the
foreseeable future, and we intend to retain any future earnings for use in the
expansion of our business and for general corporate purposes.
EQUITY COMPENSATION PLANS
The information required by this item regarding equity compensation
plans is incorporated by reference to the information set forth in Item 12 of
this Annual Report on Form 10-K. Item 12 of this Annual Report on Form 10-K
incorporates by reference the information contained in the sections captioned
"Election of Directors" and "Security Ownership of Certain Beneficial Owners and
Management" in the Lantronix definitive Proxy Statement for the Annual Meeting
of Stockholders to be held November 15, 2005 (the "Proxy Statement"), a copy of
which will be filed with the Securities and Exchange Commission within 120 days
after June 30, 2005.
RECENT SALES OF UNREGISTERED SECURITIES
We have not issued unregistered securities since July 1, 2003. Also, we
did not repurchase any of our common stock during the fourth fiscal quarter of
2005.
13
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included below. In March 2004, we completed the sale of our Premise
business unit that was originally purchased in January 2002. Accordingly, the
information set forth in the table below reflects the Premise business unit as a
discontinued operation. The consolidated statements of operations data for the
fiscal years ended June 30, 2005, 2004 and 2003 and the balance sheet data as of
June 30, 2005 and 2004, are derived from the audited consolidated financial
statements included elsewhere in this report. The consolidated statements of
operations data for the fiscal years ended June 30, 2002 and 2001, and the
balance sheet data as of June 30, 2003, 2002 and 2001, are derived from the
audited consolidated financial statements not included elsewhere in this report.
The historical results are not necessarily indicative of results to be expected
for future periods.
YEARS ENDED JUNE 30,
--------------------
2005 2004 2003 2002 2001
--------- --------- --------- --------- ---------
Net revenues $ 48,502 $ 48,885 $ 49,389 $ 57,591 $ 48,972
Cost of revenues 24,326 25,026 36,264 40,281 24,530
--------- --------- --------- --------- ---------
Gross profit 24,176 23,859 13,125 17,310 24,442
--------- --------- --------- --------- ---------
Operating expenses:
Selling, general and administrative 24,610 23,293 28,660 40,538 23,998
Research and development 6,314 7,813 9,430 8,680 4,478
Stock-based compensation 171 347 1,453 2,863 3,019
Amortization of purchased intangible assets 65 148 602 960 1,490
Impairment of goodwill and purchased intangible assets -- -- 2,353 50,445 --
Restructuring (recovery) charges -- (2,093) 5,600 3,473 --
Litigation settlement costs -- -- 1,533 1,912 --
In-process research and development -- -- -- -- 2,596
--------- --------- --------- --------- ---------
Total operating expenses 31,160 29,508 49,631 108,871 35,581
Loss from operations (6,984) (5,649) (36,506) (91,561) (11,139)
Interest income (expense), net (20) 50 248 1,548 2,182
Other income (expense), net 173 (5,333) (926) (760) (167)
--------- --------- --------- --------- ---------
Loss before income taxes and cumulative
effect of accounting changes (6,831) (10,932) (37,184) (90,773) (9,124)
Provision (benefit) for income taxes 229 (325) 250 (6,665) (1,876)
--------- --------- --------- --------- ---------
Loss from continuing operations (7,060) (10,607) (37,434) (84,108) (7,248)
Income (loss) from discontinued operations 56 (5,047) (10,115) (3,444) --
--------- --------- --------- --------- ---------
Loss before cumulative effect of accounting changes (7,004) (15,654) (47,549) (87,552) (7,248)
Cumulative effect of accounting changes
Change in revenue recognition policy,
net of income tax benefit of $176 -- -- -- -- (597)
Adoption of new accounting standard SFAS No. 142 -- -- -- (5,905) --
--------- --------- --------- --------- ---------
Net loss $ (7,004) $ (15,654) $ (47,549) $ (93,457) $ (7,845)
========= ========= ========= ========= =========
Basic and diluted loss per share from continuing
operations before cumulative effect of accounting changes $ (0.12) $ (0.19) $ (0.69) $ (1.63) $ (0.19)
Income (loss) from discontinued operations -- (0.09) (0.19) (0.07) --
--------- --------- --------- --------- ---------
Loss before cumulative effect of accounting changes (0.12) (0.28) (0.88) (1.70) (0.19)
Cumulative effect of accounting changes per share
Change in revenue recognition policy,
net of income tax benefit of $176 -- -- -- -- (0.02)
Adoption of new accounting standard SFAS No. 142 -- -- -- (0.12) --
--------- --------- --------- --------- ---------
Basic and diluted net loss per share $ (0.12) $ (0.28) $ (0.88) $ (1.82) $ (0.21)
========= ========= ========= ========= =========
Weighted average shares (basic and diluted) 58,202 56,862 54,329 51,403 36,946
========= ========= ========= ========= =========
AS OF JUNE 30,
CONSOLIDATED BALANCE SHEET DATA 2005 2004 2003 2002 2001
--------- --------- --------- --------- ---------
Cash and cash equivalents $ 6,690 $ 9,128 $ 7,328 $ 26,491 $ 15,367
Marketable securities 85 3,050 6,750 6,963 1,973
Working capital 7,693 12,087 17,312 40,317 36,963
Goodwill, net 9,488 9,488 9,488 7,218 42,273
Purchased intangible assets, net 559 2,056 4,275 11,891 13,328
Total assets 30,117 37,250 54,947 103,812 116,861
Long-term obligations 51 -- 867 1,000 --
(Accumulated deficit) retained earnings (163,082) (156,078) (140,242) (92,875) 582
Total stockholders' equity 18,468 24,791 37,717 82,157 99,496
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with our consolidated
financial statements and related notes thereto included elsewhere in this
report. In addition to historical information, the discussion in this report
contains forward-looking statements that involve risks and uncertainties. Actual
results could differ materially from those anticipated by these forward-looking
statements due to factors including, but not limited to, those factors set forth
under "Risk Factors" and elsewhere in this report.
OVERVIEW
We design, develop and market devices that make it possible to access,
manage, control and configure electronic devices over the Internet and other
networks. We are a leader in providing innovative networking solutions. We were
initially formed as "Lantronix," a California corporation, in June 1989. We
reincorporated as "Lantronix, Inc.," a Delaware corporation in May 2000. Our
products are sold to distributors, OEMs, VARs, and systems integrators, as well
as directly to end users.
CHANGES TO PREVIOUSLY ANNOUNCED FISCAL 2005 FOURTH QUARTER AND ANNUAL RESULTS
AND PREVIOUSLY REPORTED FIRST, SECOND AND THIRD QUARTERS OF FISCAL 2005
Subsequent to the September 8, 2005 announcement of our preliminary
fourth quarter and full fiscal year results for 2005, we have made certain
adjustments to our announced results. Having fully reviewed the impact of
accounting adjustments recorded in fiscal 2005, we have restated our
consolidated financial statements for the first, second and third quarters of
fiscal 2005 to (i) reduce our accrued professional fees and other accrued
liabilities by reducing selling, general and administrative expenses and (ii)
reduce amounts previously recorded as stock-based compensation related to a
stock option grant to a terminated employee. The effect of these and other
adjustments modifies the net loss of $15,000 announced on September 8, 2005 for
the fourth fiscal quarter of 2005, to a net loss of $549,000 for that quarter.
The impact of these adjustments is reflected in Note 16, "Quarterly Financial
Data (Unaudited)," to our consolidated financial statements. We have determined
that the effect of these adjustments on the first, second and third fiscal
quarter of 2005 is immaterial and we do not intend to file amended Forms 10-Q
for these periods. The adjustments had an immaterial effect on our consolidated
balance sheets at the end of each of the adjusted periods and had no impact on
net revenues or operating cash flows for those periods. In addition, we
evaluated whether any of the adjustments impacted our prior year consolidated
financial statements and determined that they (i) did not impact the prior year
periods or (ii) were immaterial to the prior year periods.
Further information on the nature and impact of these adjustments to
fiscal year 2005 as well as the impact to our quarterly financial information
for fiscal 2005 is provided in Note 16, "Quarterly Financial Data (Unaudited),"
to our consolidated financial statements and Item 9A "Controls and Procedures".
FISCAL YEAR 2005 FINANCIAL HIGHLIGHTS AND OTHER INFORMATION
In March 2004, we sold substantially all of the net assets of our
Premise business unit. The Company's consolidated financial statements have been
presented to reflect Premise as a discontinued operation for all periods
presented.
A summary of the key factors and significant events which impacted our
financial performance during the fiscal year ended June 30, 2005 are as follows:
o Net revenues of $48.5 million for the fiscal year ended June
30, 2005 decreased by $383,000 or 0.8%, from the $48.9 million
reported during the fiscal year ended June 30, 2004. While
fiscal 2005 revenues decreased by 1.7% and 30.1% in our IT
management and non-core product lines, respectively, revenues
increased 9.1% in our device networking product line.
o Gross profit as a percentage of net revenues was 49.8% for the
fiscal year ended June 30 2005, increasing 1.0% from the 48.8%
reported in the fiscal year ended June 30, 2004. The
improvement in gross profit is primarily due to a decrease in
the amortization of purchased intangible assets and a
reduction in product warranty reserves to reflect a decrease
in our product return rates.
o Loss from operations as a percentage of net revenues was 14.4%
for the fiscal year ended June 30, 2005 compared to 11.6% in
the fiscal year ended June 30, 2004.
15
o Net loss of $7.0 million, or $0.12 per diluted share in the
fiscal year ended June 30, 2005, improved from a loss of $15.7
million, or $0.28 per diluted share, in the fiscal year ended
June 30, 2004.
o Cash, cash equivalents and marketable securities declined from
$12.2 million as of June 30, 2004, to $6.8 million as of June
30, 2005. Cash decreased primarily to fund operations for the
fiscal year ended June 30, 2005 and to repay notes that became
due during the fiscal year. Notable for the fiscal year was
that for the fourth fiscal quarter ended June 30, 2005, the
net balance for cash, cash equivalents and marketable
securities increased by $200,000 from the beginning of that
period.
o Accounts receivable was $2.6 million as of June 30, 2005,
compared to $3.2 million at June 30, 2004. Days sales
outstanding (DSO) in receivables as of June 30, 2005 decreased
to 22.2 days from 26.4 days as of June 30, 2004. Our accounts
receivable and DSO are primarily affected by the linearity of
shipments within the year, our collections performance and the
fact that revenues are recognized on a sell-through basis
(upon shipment from distributor inventories rather than as
goods are shipped to distributors). There can be no assurance
that we will be able to maintain our DSO ratios consistent
with historical trends and DSO ratios may increase in the
future.
o Inventories were $6.8 million as of June 30, 2005, compared to
$6.7 million as of June 30, 2004. Our annualized inventory
turns in fiscal 2005 of 3.6 turns declined from the 3.9 turns
in fiscal 2004.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements and related disclosures in
accordance with accounting principles generally accepted in the U.S. requires us
to make judgments, estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements and the reported
amounts of net revenues and expenses during the reporting period. We regularly
evaluate our estimates and assumptions related to net revenues, allowances for
doubtful accounts, sales returns and allowances, inventory valuation, valuation
of deferred income taxes, goodwill and purchased intangible asset valuations,
warranty reserves, restructuring costs, litigation and other contingencies. We
base our estimates and assumptions on historical experience and on various other
factors that we believe to be reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. To the extent
there are material differences between our estimates and the actual results, our
future results of operations will be affected.
We believe the following critical accounting policies require us to
make significant judgments and estimates in the preparation of our consolidated
financial statements:
REVENUE RECOGNITION
We do not recognize revenue until all of the following criteria are
met: persuasive evidence of an arrangement exists; delivery has occurred or
services have been rendered; our price to the buyer is fixed or determinable;
and collectibility is reasonably assured. However, a significant portion of our
sales are made to distributors under agreements which contain a limited right to
return unsold product and price protection provisions. Recognition of revenue
and related cost of revenues from sales to distributors are deferred until the
distributor resells the product. Net revenue from certain smaller distributors
for which point-of-sale information is not available, is recognized
approximately one month after the shipment date. This estimate approximates the
timing of the sale of the product by the distributor to the end user.
When product sales revenue is recognized, we establish an estimated
allowance for future product returns based on historical returns experience;
when price reductions are approved, we establish an estimated liability for
price protection payable on inventories owned by product resellers. Should
actual product returns or pricing adjustments exceed our estimates, additional
reductions to revenues would result.
16
Our products typically carry a one-to two-year warranty. In addition,
certain products that were sold prior to August 2003 carry a five-year warranty.
Although we engage in extensive product quality programs and processes, our
warranty obligation is affected by product failure rates, use of materials or
service delivery costs that differ from our estimates. As a result, additional
warranty reserves could be required, which could reduce gross margins.
Additionally, we sell extended warranty services, which extend the warranty
period for an additional one to three years, depending upon the product.
Warranty revenue is recognized evenly over the warranty service period.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. Our
allowance for doubtful accounts is based on our assessment of the collectibility
of specific customer accounts, the aging of accounts receivable, our history of
bad debts and the general condition of the industry. If a major customer's
credit worthiness deteriorates, or our customers' actual defaults exceed our
historical experience, our estimates could change and impact our reported
results.
We also maintain a reserve for uncertainties relative to the collection
of officer notes receivable. Factors considered in determining the level of this
reserve include the value of the collateral securing the notes, our ability to
effectively enforce collection rights and the ability of the former officers to
honor their obligations.
INVENTORY VALUATION
Our policy is to value inventories at the lower of cost or market on a
part-by-part basis. This policy requires us to make estimates regarding the
market value of our inventories, including an assessment of excess and obsolete
inventories. We determine excess and obsolete inventories based on an estimate
of the future sales demand for our products within a specified time horizon,
generally three to twelve months. The estimates we use for demand are also used
for near-term capacity planning and inventory purchasing and are consistent with
our revenue forecasts. In addition, specific reserves are recorded to cover
risks in the area of end of life products, inventory located at our contract
manufacturers, deferred inventory in our sales channel and warranty replacement
stock.
If our sales forecast is less than the inventory we have on hand at the
end of an accounting period, we may be required to take excess and obsolete
inventory charges, which will decrease gross margin and net operating results
for that period.
VALUATION OF DEFERRED INCOME TAXES
We have recorded a valuation allowance to reduce our net deferred tax
assets to zero, primarily due to historical net operating losses and uncertainty
of generating future taxable income. We consider estimated future taxable income
and ongoing prudent and feasible tax planning strategies in assessing the need
for a valuation allowance. If we determine that it is more likely than not that
we will realize a deferred tax asset, which currently has a valuation allowance,
we would be required to reverse the valuation allowance that would be reflected
as an income tax benefit at that time.
GOODWILL AND PURCHASED INTANGIBLE ASSETS
The purchase method of accounting for acquisitions requires extensive
use of accounting estimates and judgments to allocate the purchase price to the
fair value of the net tangible and intangible assets acquired, including
in-process research and development. The amounts and useful lives assigned to
intangible assets impact future amortization. If the assumptions and estimates
used to allocate the purchase price are not correct, purchase price adjustments
or future asset impairment charges could be required.
We perform goodwill impairment tests on an annual basis, and more
frequently if events occur or circumstances change that would more likely than
not reduce the fair value of a reporting unit below its carrying amount.
Goodwill impairment testing requires us to compare the fair value of each
reporting unit to its carrying amount, including goodwill, and record an
impairment charge if the carrying amount of a reporting unit exceeds its
estimated fair value. The determination of a reporting unit's fair value
requires significant judgment and is based on management's best estimate, which
generally considers the unit's expected future earnings. If actual results are
not consistent with our assumptions and judgments used in estimating fair value,
we may be exposed to additional goodwill impairment losses. As of June 30, 2005,
we have $9.5 million of goodwill reflected in our consolidated balance sheet.
17
We evaluate purchased intangible assets when indicators of impairment,
such as reductions in demand or significant economic slowdowns, are present.
Reviews are performed to determine whether the carrying values of these assets
are impaired based on a comparison to the undiscounted expected future cash
flows. If the comparison indicates that there is impairment, the expected future
cash flows using a discount rate based upon our weighted average cost of capital
is used to estimate the fair value of the assets. Impairment is based on the
excess of the carrying amount over the fair value of those assets. Significant
management judgment is required in the forecast of future operating results that
is used in the preparation of expected discounted cash flows. It is reasonably
possible that the estimates of anticipated future net revenue, the remaining
estimated economic lives of the products and technologies, or both, could differ
from those used to assess the recoverability of our purchased intangible assets.
In the event they are lower, additional impairment charges or shortened useful
lives of certain purchased intangible assets could be required. As of June 30,
2005, we have approximately $559,000 of purchased intangible assets reflected in
our consolidated balance sheet.
SETTLEMENT COSTS
From time to time, we are involved in legal actions arising in the
ordinary course of business. We cannot assure you that these actions or other
third party assertions against us will be resolved without costly litigation, or
in a manner that is not adverse to our financial position, results of operations
or cash flows. As facts concerning contingencies become known, we reassess our
position and make appropriate adjustments to the financial statements. There are
many uncertainties associated with any litigation. If our initial assessments
regarding the merits of a claim prove to be wrong, our results of operations and
financial condition could be materially and adversely affected. In addition, if
further information becomes available that causes us to determine a loss in any
of our pending litigation, it is probable and we can reasonably estimate a range
of loss associated with such litigation, then we would record at least the
minimum estimated liability. However, the actual liability in any such
litigation may be materially different from our estimates, which could result in
the need to record additional costs or recover amounts previously recorded.
Generally, legal expenses billed directly to us are expensed as incurred. Legal
expenses covered by an insurance policy have been recorded and paid as incurred;
reimbursement of legal expenses from insurance or other sources are recorded
upon receipt. This practice was modified in May 2005, when a new insurance
carrier became responsible for certain legal expenses related to our stockholder
lawsuits. Since May 2005, the new insurance carrier receives invoices from
attorneys and reviews and pays these invoices on our behalf directly. Invoices
related to stockholder litigation that are unpaid as of June 30, 2005 have been
recorded as a liability, with a receivable from insurance to offset that
liability. Litigation settlement costs have generally been recognized as a
liability, with a receivable from insurance to offset that liability until the
settlement is paid by the insurance company.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - An
Amendment of ARB 43, Chapter 4" ("SFAS 151"). This new standard is the result of
a broader effort by the FASB to improve financial reporting by eliminating
differences between Generally Accepted Accounting Principles ("GAAP") in the
U.S. and accounting principles developed by the International Accounting
Standards Board ("IASB"). As part of this effort, the FASB and the IASB
identified opportunities to improve financial reporting by eliminating certain
narrow differences between their existing accounting standards. SFAS 151
clarifies that abnormal amounts of idle facility expense, freight handling costs
and spoilage costs should be expensed as incurred and not included in overhead.
Further, SFAS 151 requires that allocation of fixed production overheads to
conversion costs should be based on normal capacity of the production
facilities. The provisions in SFAS 151 are effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. Companies must apply
the standard prospectively. Management does not expect the adoption of SFAS 151
to have a material impact on our financial position, results of operations or
cash flows.
18
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment," ("SFAS 123R"), which is a revision to SFAS No. 123
Accounting for Stock-Based Compensation ("SFAS 123"), and which supersedes
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees" ("APB 25"), and its related implementation guidance. SFAS 123R
establishes standards for the accounting for transactions in which an entity
exchanges equity instruments for goods or services. It also addresses
transactions in which an entity incurs liabilities in exchange for goods or
services that are based on the fair value of the entity's equity instruments or
that may be settled by the issuance of those equity instruments. SFAS 123R
established the accounting treatment for transactions in which an entity obtains
employee services in share-based payment transactions. SFAS 123R requires
companies to recognize in the statement of operations the grant-date fair value
of stock options and other equity-based compensation issued to employees. SFAS
123R requires the Company to value the share-based compensation based on the
classification of the share-based award. If the share-based award is to be
classified as a liability, the Company must re-measure the award at each balance
sheet date until the award is settled. If the share-based award is to be
classified as equity, the Company will measure the value of the share-based
award on the date of grant but the award will not be re-measured at each balance
sheet date. SFAS 123R does not change the accounting guidance for share-based
payment transactions with parties other than employees provided in SFAS 123 as
originally issued and Emerging Issues Task Force ("EITF") Issue No. 96-18,
"Accounting for Equity Instruments That Are Issued to Other Than Employees for
Acquiring, or in Conjunction with, Selling Goods or Services". SFAS 123R is
effective for public companies that do not file as small business issuers no
later than the beginning of the first fiscal year beginning after June 15, 2005.
All public companies must use either the modified prospective or modified
retrospective transition method. Under the modified prospective method, awards
that are granted, modified, or settled after the date of adoption should be
measured and accounted for in accordance with SFAS 123R. Unvested equity
classified awards that were granted prior to the effective date should continue
to be accounted for in accordance to SFAS 123 except that the amounts must be
recognized in the statement of operations. Under the modified retrospective
method, the previously reported amounts are restated (either to the beginning of
the year of adoption or for all periods presented) to reflect SFAS 123 amounts
in the statement of operations. We expect to adopt SFAS 123R under the modified
prospective method. The adoption of SFAS 123R will have a significant impact on
our reported results of operations, although it will not have a significant
impact on our overall financial position. The impact of adoption of SFAS 123R
cannot be predicted at this time because that will depend on the fair value and
number of share-based payments granted in the future. However, had we adopted
SFAS 123R in prior periods, the magnitude of the impact of that standard would
have approximated the impact of SFAS 123 assuming the application of the
Black-Scholes model as described in the disclosure of pro forma net loss and pro
forma loss per share in Part IV, Item 15 of this Form 10-K and are presented
under footnote 1.
In May 2005, FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections" ("SFAS 154"). SFAS 154 requires retroactive application of a
voluntary change in accounting principle to prior period financial statements
unless it is impracticable. SFAS 154 also requires that a change in method of
depreciation, amortization, or depletion for long-lived, non-financial assets be
accounted for as a change in accounting estimate that is affected by a change in
accounting principle. SFAS 154 replaces APB Opinion 20, "Accounting Changes,"
and SFAS 3, "Reporting Accounting Changes in Interim Financial Statements." We
will adopt the provisions of SFAS 154 in fiscal 2007 consolidated financial
statements. Management currently believes that adoption of the provisions of
SFAS 154 will not have a material impact on our consolidated financial
statements.
Other recent accounting pronouncements issued by the FASB (including
its Emerging Issues Task Force), the American Institute of Certified Public
Accountants and the Securities and Exchange Commission did not or are not
believed by management to have a material impact on our present or future
consolidated financial statements.
The following discussion of results of operations includes discussion
of continuing operations only. Certain amounts in the 2004 and 2003 consolidated
financial statements have been reclassified to conform with current year
presentation.
19
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the
percentage of net revenues represented by each item in our consolidated
statements of operations:
YEARS ENDED JUNE 30,
2005 2004 2003
----------- ------------- -------------
Net revenues 100.0% 100.0% 100.0%
Cost of revenues 50.2% 51.2% 73.4%
----------- ------------- -------------
Gross Profit 49.8% 48.8% 26.6%
----------- ------------- -------------
Operating Expenses:
Selling, general and adminstrative 50.7% 47.6% 58.0%
Research and development 13.0% 16.0% 19.1%
Stock-based compensation 0.4% 0.7% 2.9%
Amortization of purchased intangible assets 0.1% 0.3% 1.2%
Impairment of goodwill and purchased intangible assets 0.0% 0.0% 4.8%
Restructuring (recovery) charges 0.0% (4.3%) 11.3%
Litigation settlement costs 0.0% 0.0% 3.1%
----------- ------------- -------------
Total operating expenses 64.2% 60.4% 100.5%
----------- ------------- -------------
Loss from operations (14.4%) (11.6%) (73.9%)
Interest income (expense), net 0.0% 0.1% 0.5%
Other income (expense), net 0.4% (10.9%) (1.9%)
----------- ------------- -------------
Loss before income taxes (14.0%) (22.4%) (75.3%)
Provision (benefit) for income taxes 0.5% (0.7%) 0.5%
----------- ------------- -------------
Loss from continuing operations (14.5%) (21.7%) (75.8%)
----------- ------------- -------------
Income (loss) from discontinued operations 0.1% (10.3%) (20.5%)
----------- ------------- -------------
Net loss (14.4%) (32.0%) (96.3%)
=========== ============= =============
COMPARISON OF THE FISCAL YEARS ENDED JUNE 30, 2005 AND 2004
NET REVENUES BY PRODUCT CATEGORY (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
PRODUCT CATEGORIES 2005 REVENUE 2004 REVENUE VARIANCE VARIANCE
- ------------------ ------------ ------------ ------------- ------------ ------------ -----------
Device networking $ 29,979 61.9% $ 27,481 56.2% $ 2,498 9.1%
IT management 12,341 25.4% 12,555 25.7% (214) (1.7%)
Non-core 6,182 12.7% 8,849 18.1% (2,667) (30.1%)
------------ ------------ ------------- ------------ ------------ -----------
Total $ 48,502 100.0% $ 48,885 100.0% $ (383) (0.8%)
============ ============ ============= ============ ============ ===========
The decrease for the fiscal year ended June 30, 2005, is primarily
attributable to a decrease in net revenue from our non-core products and, to a
lesser extent, our IT management, offset by an increase in our device networking
products. Our increase in device networking products is primarily due to volume
increases. The decrease in our non-core product net revenues is primarily due to
a decrease in our print server, visualization and other products. We are no
longer investing in the development of these product lines and expect net
revenues related to these products to continue to decline in the future as we
focus our investment in device networking and IT management products.
20
NET REVENUES BY REGION (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
GEOGRAPHIC REGION 2005 REVENUE 2004 REVENUE VARIANCE VARIANCE
- ----------------- ---- ------- ---- ------- -------- --------
Americas $ 31,162 64.3% $ 33,847 69.3% $ (2,685) (7.9%)
Europe 13,213 27.2% 11,252 23.0% 1,961 17.4%
Other 4,127 8.5% 3,786 7.7% 341 9.0%
------------ ------------ ------------- ------------ ------------ -----------
Total $ 48,502 100.0% $ 48,885 100.0% $ (383) (0.8%)
============ ============ ============= ============ ============ ===========
The overall decrease in net revenues for the fiscal year ended June 30,
2005 is primarily due to a decrease in the Americas region offset by an increase
in Europe and, to a lesser extent, Other. The decrease in net revenues in the
Americas region is primarily attributable to lower sales of non-core products.
We are no longer investing in the development of these non-core product lines
and expect net revenues related to these product lines, primarily our print
server, visualization and other product lines, to continue to decline in the
future as we focus our investment on device networking and IT management
products. The increase in the European region is primarily due to growth in our
device networking business.
NET REVENUES BY SIGNIFICANT CUSTOMER
YEARS ENDED JUNE 30,
CUSTOMER 2005 2004
- -------- ---- ----
Ingram Micro 16.0% 14.0%
Tech Data 11.0% 9.0%
Related party 2.0% 3.0%
An international customer, transtec AG, is a related party due to
common ownership by our largest stockholder, Bernhard Bruscha.
GROSS PROFIT (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
2005 REVENUE 2004 REVENUE VARIANCE VARIANCE
---- ------- ---- ------- -------- --------
Gross profit $ 24,176 49.8% $ 23,859 48.8% $ 317 1.3%
========= ========= ========= ======== ======== ========
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, amortization of purchased intangible
assets, establishing or relieving inventory reserves for excess and obsolete
products or raw materials, overhead, warranty costs and royalty payments. The
improvement in profit margins is primarily due to a decrease in the amortization
of purchased intangible assets and a reduction in product warranty reserves to
reflect a decrease in our product return rates. Cost of revenues for the fiscal
years ended June 30, 2005 and 2004 included $1.4 million and $2.1 million of
amortization of purchased intangible assets, respectively. At June 30, 2005, the
unamortized balance of purchased intangible assets that will be amortized to
future cost of revenues was approximately $557,000, which will be amortized in
fiscal 2006.
SELLING, GENERAL AND ADMINISTRATIVE (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
2005 REVENUE 2004 REVENUE VARIANCE VARIANCE
---- ------- ---- ------- -------- --------
Selling, general and administrative $ 24,610 50.7% $ 23,293 47.6% $ 1,317 5.7%
======== ======== ======== ======== ======== ========
21
Selling, general and administrative expenses consist primarily of
personnel-related expenses including salaries and commissions, facility
expenses, information technology, trade show expenses, advertising, insurance
reimbursements, purchased patents, and professional legal and accounting fees.
The increase in selling, general and administrative expense for the fiscal year
ended June 30, 2005 is primarily due to increased marketing expenses for new
product introductions and existing products and an increase in channel marketing
programs, increased severance, and increased legal fees, offset by the recovery
of accrued professional fees and decreased depreciation. Legal fees incurred in
defense of the stockholder suits are reimbursable to the extent provided in our
directors and officers liability insurance policies, and subject to the coverage
limitations and exclusions contained in such policies. For the fiscal years
ended June 30, 2005 and 2004, we were reimbursed approximately $767,000 and $3
million, respectively.
RESEARCH AND DEVELOPMENT (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
2005 REVENUE 2004 REVENUE VARIANCE VARIANCE
---- ------- ---- ------- -------- --------
Research and development $ 6,314 13.0% $ 7,813 16.0% $ (1,499) (19.2%)
======= ======= ======== ======= ========= ========
Research and development expenses consist primarily of
personnel-related costs of employees, as well as expenditures to third-party
vendors for research and development activities. The decrease in research and
development expenses for the fiscal year ended June 30, 2005 is primarily due to
a reduction in headcount and outside services.
STOCK-BASED COMPENSATION (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
2005 REVENUE 2004 REVENUE VARIANCE VARIANCE
---- ------- ---- ------- -------- --------
Stock-based compensation $ 171 0.4% $ 347 0.7% $ (176) (50.7%)
======= ======= ======= ======= ======== ========
Stock-based compensation generally represents the amortization of
deferred compensation. We recorded no deferred compensation or deferred
compensation forfeitures for the fiscal year ended June 30, 2005. Deferred
compensation represents the difference between the fair value of the underlying
common stock for accounting purposes and the exercise price of the stock options
at the date of grant. Deferred compensation also includes the value of employee
stock options assumed in connection with our acquisitions calculated in
accordance with current accounting guidelines. Deferred compensation is
presented as a reduction of stockholders' equity and is amortized ratably over
the respective vesting periods of the applicable options, which is generally
four years.
At June 30, 2005, a balance of approximately $17,000 remains. The
remaining $17,000 will be amortized in fiscal 2006. In addition, included in
cost of revenues is stock-based compensation of $48,000 for the fiscal year
ended June 30, 2004. No similar amounts were recorded in cost of revenues for
the fiscal year ended June 30, 2005.
AMORTIZATION OF PURCHASED INTANGIBLE ASSETS (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
2005 REVENUE 2004 REVENUE VARIANCE VARIANCE
---- ------- ---- ------- -------- --------
Amortization of
purchased intangible assets $ 65 0.1% $ 148 0.3% $ (83) (56.1%)
======= ======= ======= ======= ======== ========
22
Purchased intangible assets primarily include existing technology,
patents and non-compete agreements which are amortized on a straight-line basis
over the estimated useful lives of the respective assets, ranging from one to
five years. The decrease in amortization of purchased intangible assets is
primarily due to assets becoming fully amortized. Approximately $1.4 million and
$2.1 million of amortization of purchased intangible assets have been classified
as cost of revenues for the fiscal years ended June 30, 2005 and 2004,
respectively. During the fourth fiscal quarter of 2005, we completed our annual
impairment assessment and determined that no impairment was indicated as the
estimated fair values exceeded their respective carrying values. The unamortized
balance of purchased intangible assets as of June 30, 2005 will be amortized
during fiscal 2006 as follows (in thousands):
COST OF OPERATING
REVENUES EXPENSES TOTAL
-------- -------- -----
Fiscal year ending June 30, 2006 $ 557 $ 2 $ 559
======== ======== =====
RESTRUCTURING (RECOVERY) CHARGES
From the fiscal quarter ended March 31, 2002 through the fiscal quarter
ended March 31, 2003, we implemented plans to restructure our operations to
prioritize our initiatives around the growth area of our business, focus on
profit contribution, reduce expenses and improve operating efficiency. These
restructuring plans included a worldwide workforce reduction, consolidation of
excess facilities and other charges. During the fiscal years ended June 30, 2004
and 2003, approximately 58 and 50 employees, respectively, were terminated
across all of our business functions and geographic regions in connection with
the restructuring plans. No additional restructuring plans were entered into
during the fiscal year ended June 30, 2005.
During the fiscal year ended June 30, 2004, approximately $2.1 million
of restructuring charges were recovered related to a favorable settlement of a
contractual obligation, consolidation of excess facilities and workforce
reductions, which were previously accrued for in fiscal 2003. No similar
recovery occurred during the fiscal year ended June 30, 2005. The remaining
restructuring reserve is related to facility closures in Naperville, Illinois;
Hillsboro, Oregon; Redmond, Washington and Ames, Iowa. Payments under the lease
obligations will end in fiscal 2007.
INTEREST INCOME (EXPENSE), NET (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
2005 REVENUE 2004 REVENUE VARIANCE VARIANCE
---- ------- ---- ------- -------- --------
Interest income (expense), net $ (20) 0.0% $ 50 0.1% $ - N/A
====== ======= ==== ======= ======== ========
Interest income of $58,000 and $94,000 for the years ended June 30,
2005 and 2004, respectively, consists primarily of interest earned on cash, cash
equivalents and marketable securities. The decrease is primarily due to lower
average investment balances. Interest expense of $78,000 and $44,000 for the
years ended June 30, 2005 and 2004, respectively, consists primarily of interest
expense related to our line of credit.
OTHER INCOME (EXPENSE), NET (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
2005 REVENUE 2004 REVENUE VARIANCE VARIANCE
---- ------- ---- ------- -------- --------
Other income (expense), net $ 173 0.4% $ (5,333) (10.9%) $ - N/A
====== ======= ======== ======= ======== ========
23
The decrease in other expense is due to the write-off of our long-term
investment in Xanboo in 2004. On the basis of events occurring during the fiscal
quarter ended June 30, 2004, we performed an analysis and recorded a charge in
the amount of $5.0 million, representing a write-off of all remaining value of
this non-marketable equity security. This charge is included within the
consolidated statements of operations as other expense. No similar write-off
occurred during the fiscal year ended June 30, 2005.
PROVISION (BENEFIT) FOR INCOME TAXES
We utilize the liability method of accounting for income taxes as set
forth in SFAS No. 109, "Accounting for Income Taxes." Our effective tax rate was
3.0% and 3.0% for the fiscal years ended June 30, 2005 and 2004, respectively.
The federal statutory rate was 34% for both periods. The difference between our
effective tax rate and the federal statutory rate resulted primarily from the
effect of foreign earnings taxed at rates differing from the federal statutory
rate, as well as the effect of our domestic losses recorded without a tax
benefit. We record net deferred tax assets to the extent we believe these assets
will more likely than not be realized. As a result of our cumulative losses, we
provided a full valuation allowance against our net deferred tax assets in
fiscal 2005 and 2004. In 2003, the Internal Revenue Service completed its audit
of our federal income tax returns for the fiscal years ended June 30, 1999, 2000
and 2001. As a result, we paid tax and interest to the IRS and the California
Franchise Tax Board of approximately $222,000, $441,000 and $114,000 in fiscal
quarters ended March 31, 2004, June 30, 2004 and September 30, 2004,
respectively.
We had discussions with the Swiss Federal Tax Authorities ("SFTA")
regarding the inability of our Swiss subsidiary, Lantronix International AG, to
meet certain guidelines as set within a tax ruling that was obtained in May
2001. The ruling provided for reduced Swiss tax rates. The subsidiary was unable
to meet the guidelines set forth in the ruling due to slower than planned growth
and has since converted to a holding company. The SFTA has ruled on this matter,
resulting in a tax liability to the SFTA of approximately $50,000 plus interest
which was paid in the fiscal quarter ending June 30, 2005.
COMPARISON OF THE FISCAL YEARS ENDED JUNE 30, 2004 AND 2003
NET REVENUES BY PRODUCT CATEGORY (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
PRODUCT CATEGORIES 2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
- ------------------ ---- ------- ---- ------- -------- --------
Device networking $ 27,481 56.2% $ 24,523 49.6% $ 2,958 12.1%
IT management 12,555 25.7% 13,034 26.4% (479) (3.7%)
Non-core 8,849 18.1% 11,832 24.0% (2,983) (25.2%)
----------- ------------ ------------ ------------ ------------ -----------
Total $ 48,885 100.0% $ 49,389 100.0% $ (504) (1.0%)
=========== ============ ============ ============ ============ ===========
The overall decrease in net revenues was primarily attributable to a
decrease in net revenues of our non-core and IT management product lines, offset
by an increase in our device networking product line. Our increase in device
networking products included increases from our newly introduced XPort product.
The decrease in our IT management product line is primarily due to delays in
introducing certain new products. During the fourth fiscal quarter of 2004, we
introduced a new line of console servers and we have substantially increased our
marketing and sales efforts in our IT management solutions product family. The
decrease in our non-core product line was primarily attributable to a decrease
in our legacy print server, industrial controller board and Stallion product
lines. We are no longer investing in the development of these product lines and
expect net revenues related to these product lines to continue to decline in the
future as we focus our investment on device networking and IT management
products.
24
NET REVENUES BY REGION (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
GEOGRAPHIC REGION 2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
- ----------------- ---- ------- ---- ------- -------- --------
Americas $ 33,847 69.3% $ 37,391 75.7% $ (3,544) (9.5%)
Europe 11,252 23.0% 10,366 21.0% 886 8.5%
Other 3,786 7.7% 1,632 3.3% 2,154 132.0%
----------- ------------ ------------ ------------ ------------ -----------
Total $ 48,885 100.0% $ 49,389 100.0% $ (504) (1.0%)
=========== ============ ============ ============ ============ ===========
The overall decrease in net revenues is primarily due to a decrease in
the Americas region. The decrease in net revenues in the Americas region is
primarily attributable to our exit of the industrial controller board product
line, which was sold entirely in the Americas as well as our decrease in the IT
management product family net revenues. The increase in Europe is primarily due
to the addition of new customers, including three new distributors and several
channel customers. The increase in Other is primarily due to the signing of
several new customers and our increased sales efforts in the Asia Pacific
region.
GROSS PROFIT (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
---- ------- ---- ------- -------- --------
Gross profit $ 23,859 48.8% $ 13,125 26.6% $ 10,734 81.8%
======== ======= ======== ======= ======== ========
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, amortization of purchased intangible
assets, impairment of purchased intangible assets, establishing or relieving
inventory reserves for excess and obsolete products or raw materials, overhead
and warranty costs. Cost of revenues for the fiscal years ended June 30, 2004
and 2003 included $2.1 million and $3.6 million of amortization of purchased
intangible assets, respectively. Cost of revenues for the fiscal year ended June
30, 2003 includes a $3.1 million impairment charge of purchased intangible
assets, in accordance with SFAS 144. No impairment charge was recorded for the
fiscal year ended June 30, 2004. At June 30, 2004, the unamortized balance of
purchased intangible assets that will be amortized to future cost of revenues
was $2.0 million.
In May 2002, we signed a new agreement with Gordian to acquire a joint
interest in the intellectual property that is evident in our products designed
by Gordian and to extinguish our obligation to pay royalties on future sales of
our products. We paid $6.0 million for this intellectual property and are
amortizing this asset to cost of revenues over the remaining life of our
products designed by Gordian, or approximately three years. Effective May 30,
2002, upon the signing of the new agreement, royalty expenses have been replaced
by an amortization of the prepaid royalties and entitlement to the intellectual
property that was part of the agreement. Amortization expense related to the new
Gordian agreement, included in amortization of purchased intangible assets of
$2.1 million, totaled $1.8 million for the fiscal year ended June 30, 2004.
Amortization expense related to the new Gordian agreement, included in
amortization of purchased intangible assets of $3.6 million, totaled $2.5
million for the fiscal year ended June 30, 2003. The increase in gross profit is
primarily attributable to a lower inventory reserve provision in fiscal 2004
compared to fiscal 2003, an overall reduction in payroll and payroll related
costs due to the closing of our Milford, Connecticut, facility in February 2003,
an increase in our capitalized inventory overhead and a decrease in the
amortization of purchased intangible assets due to the impairment write-down of
$3.1 million during the fourth fiscal quarter of 2003. These decreases were
offset by an increase in our warranty expense.
25
SELLING, GENERAL AND ADMINISTRATIVE (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
---- ------- ---- ------- -------- --------
Selling, general and administrative $ 23,293 47.6% $ 28,660 58.0% $ (5,367) (18.7%)
======== ======= ======== ======= ======== ========
Selling, general and administrative expenses consist primarily of
personnel-related expenses including salaries and commissions, facility
expenses, information technology, trade show expenses, advertising, insurance
proceeds, and professional legal and accounting fees. Selling, general and
administrative expense decreased primarily due to reductions in headcount and
facility costs as a result of our fiscal 2003 restructurings, decrease in legal
and other professional fees, improvement in our accounts receivable resulting in
a reduction of our allowance for doubtful accounts, offset by an increase in our
directors and officers liability insurance. The legal fees primarily relate to
our defense of the stockholder and various other lawsuits and the SEC
investigation. Legal fees incurred in defense of the stockholder suits are
reimbursable to the extent provided in our directors and officers liability
insurance policies, and subject to the coverage limitations and exclusions
contained in such policies. For the fiscal years ended June 30, 2004 and 2003,
we have been reimbursed $3.0 million and $1.4 million of these expenses.
RESEARCH AND DEVELOPMENT (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
---- ------- ---- ------- -------- --------
Research and development $ 7,813 16.0% $ 9,430 19.1% $ (1,617) (17.1%)
======== ======= ======== ======= ======== ========
Research and development expenses consist primarily of
personnel-related costs of employees, as well as expenditures to third-party
vendors for research and development activities. Research and development
expenses decreased primarily due to our fiscal 2003 restructurings which
resulted in the consolidation of our research and development activities
primarily to our Irvine, California, facility.
STOCK-BASED COMPENSATION (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
---- ------- ---- ------- -------- --------
Stock-based compensation $ 347 0.7% $ 1,453 2.9% $ (1,106) (76.1%)
======== ======= ======== ======= ======== ========
Stock-based compensation expense generally represents the amortization
of deferred compensation. We recorded no deferred compensation for the fiscal
year ended June 30, 2004 and recorded a reduction to deferred compensation as a
result of employee stock option forfeitures in the amount of $197,000. Deferred
compensation represents the difference between the fair value of the underlying
common stock for accounting purposes and the exercise price of the stock options
at the date of grant as well as the fair market value of the vested portion of
non-employee stock options utilizing the Black-Scholes option pricing model.
Deferred compensation also includes the value of employee stock options assumed
in connection with our acquisitions calculated in accordance with current
accounting guidelines. Deferred compensation is presented as a reduction of
stockholders' equity and is amortized ratably over the respective vesting
periods of the applicable options, which is generally four years.
26
Included in cost of revenues is stock-based compensation of $48,000 and
$89,000 for the fiscal years ended June 30, 2004 and 2003, respectively.
Stock-based compensation decreased primarily due to the restructuring plan
whereby options for which deferred compensation has been recorded were forfeited
by terminated employees. Additionally, the decrease is due to the acceleration
of approximately $239,000 of stock-based compensation in January 2003 as a
result of our completion of a stock option exchange program whereby employees
holding options to purchase our common stock were given the opportunity to
cancel certain of their existing options in exchange for the opportunity to
receive new options. At June 30, 2004, a balance of $103,000 remained.
AMORTIZATION OF PURCHASED INTANGIBLE ASSETS (IN THOUSANDS EXCEPT
PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
---- ------- ---- ------- -------- --------
Amortization of
purchased intangible assets $ 148 0.3% $ 602 1.2% $ (454) 75.4%
======== ======= ======== ======= ======== ========
Purchased intangible assets primarily include existing technology,
patents and non-compete agreements and are amortized on a straight-line basis
over the estimated useful lives of the respective assets, ranging from one to
five years. We obtained independent appraisals of the fair value of tangible and
intangible assets acquired in order to allocate the purchase price. In addition,
approximately $2.1 million and $3.6 million of amortization of purchased
intangible assets have been classified as cost of revenues for the fiscal years
ended June 30, 2004 and 2003, respectively. During the fourth fiscal quarter of
2004, we completed our annual impairment assessment and determined that no
impairment was indicated as the estimated fair values exceeded their respective
carrying values. The overall decrease is primarily due to the impairment charge
of $2.4 million recorded during the fiscal year ended June 30, 2003. At June 30,
2004, the unamortized balance of purchased intangible assets that will be
amortized to future operating expense was $67,000.
IMPAIRMENT OF GOODWILL AND PURCHASED INTANGIBLE ASSETS
During the fourth fiscal quarter of 2003, we performed an assessment
of the value of our purchased intangible assets in accordance with SFAS 144. As
a result of industry conditions, continued lower market valuations and reduced
estimates in information technology capital equipment spending in the future and
other factors impacting expected future cash flows, we determined that there
were indicators of impairment to the carrying value of our purchased intangible
assets recorded as part of our acquisitions. We engaged an independent valuation
company to perform a review of the value of our purchased intangible assets. In
accordance with SFAS 144, we utilized a cash flow estimation approach, comparing
the discounted expected future cash flows to the carrying value of the subject
assets. Based on the independent valuations, during the fourth fiscal quarter of
2003 we recorded a $5.4 million impairment charge of which $2.4 million and $3.1
million were charged to operating expenses and cost of revenues, respectively.
RESTRUCTURING (RECOVERY) CHARGES
On September 12, 2002 and again on March 14, 2003, we announced a
restructuring plan to prioritize our initiatives around the growth areas of our
business, focus on profit contribution, reduce expenses and improve operating
efficiency. These restructuring plans included a worldwide workforce reduction,
consolidation of excess facilities and other charges. We recorded restructuring
costs totaling $5.6 million which were classified as operating expenses in the
consolidated statements of operations for the fiscal year ended June 30, 2003.
The restructuring plans resulted in the reduction of approximately 58 regular
employees worldwide. We recorded workforce reduction charges of approximately
$1.2 million related to severance and fringe benefits for the terminated
employees. We recorded charges of approximately $4.4 million related to
consolidation of excess facilities, relating primarily to lease terminations,
non-cancelable lease costs, write-off of leasehold improvements and termination
of a contractual obligation.
During the fiscal year ended June 30, 2004, approximately $2.1 million
of restructuring charges were recovered related to a favorable settlement of a
contractual obligation, consolidation of excess facilities and workforce
reductions which were previously accrued for in fiscal 2003. The remaining
restructuring reserve is related to facility closures in Naperville, Illinois;
Hillsboro, Oregon; Redmond, Washington; and Ames, Iowa. Payments under the lease
obligations will end in fiscal 2007.
27
LITIGATION SETTLEMENT COSTS
On August 23, 2002, a complaint entitled Dunstan v. Lantronix, Inc., et
al., was filed in the Circuit Court of the State of Oregon, County of Multnomah,
against us and certain of our current and former officers and directors by the
co-founders of United States Software Corporation ("USSC"). The parties
participated in mediation on June 30, 2003, and subsequently reached an
agreement to settle the dispute. The agreement called for us to release to the
plaintiffs approximately $400,000 in cash and 49,038 shares of our common stock
that had been held in an escrow since December 2000 as part of the acquisition
of USSC. The agreement also called for us to issue to the plaintiffs additional
shares of our common stock worth approximately $1.5 million, which was recorded
in our results of operations as litigation settlement costs for the fiscal year
ended June 30, 2003. Accordingly, 1,726,703 shares were issued following a
fairness determination by the state court in Oregon. In exchange, the plaintiffs
released all claims against all defendants. No litigation settlement costs
related to this matter were incurred during the fiscal year ended June 30, 2004.
INTEREST INCOME (EXPENSE), NET (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
---- ------- ---- ------- -------- --------
Interest income (expense), net $ 50 0.1% $ 248 0.5% $ (198) (79.8%)
======== ======= ======== ======= ======== ========
Interest income (expense), net consists primarily of interest earned on
cash, cash equivalents and marketable securities. The decrease is primarily due
to lower average investment balances and interest rates. Additionally, the
decrease in the average investment balance is due to increased legal and other
professional fees, settlement of litigation and contractual obligations, cash
portions of settlements with prior owners of some of the businesses we have
acquired, the settlement of the Milford lease obligation included in our
restructuring charge, the purchase of a joint interest in intellectual property
from Gordian, our acquisition of Stallion Technologies PTY, LTD ("Stallion") and
to fund current operations.
OTHER INCOME (EXPENSE), NET (IN THOUSANDS EXCEPT PERCENTAGES)
YEARS ENDED JUNE 30,
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
---- ------- ---- ------- -------- --------
Other income (expense), net $ (5,333) (10.9%) $ (926) (1.9%) $ (4,407) (475.9%)
======== ======= ======== ======= ======== ========
The increase in other expense is due to our decision to write-off our
long-term investment in Xanboo. We periodically review our investments for which
fair value is less than cost to determine if the decline in value is other than
temporary. If the decline in value is judged to be other than temporary, the
cost basis of the security is written down to fair value. We generally believe
an other-than-temporary decline has occurred when the fair value of the
investment is below the carrying value for two consecutive fiscal quarters,
absent evidence to the contrary. On the basis of events occurring during the
fiscal quarter ended June 30, 2004, we performed an analysis and recorded a
charge in the amount of $5.0 million, representing a write-off of all remaining
value of this non-marketable equity security. This charge is included within the
consolidated statements of operations as other expense.
28
PROVISION (BENEFIT) FOR INCOME TAXES
We utilize the liability method of accounting for income taxes as set
forth in FASB Statement No. 109, "Accounting for Income Taxes." Our effective
tax rate was 0% for the fiscal year ended June 30, 2003, and 7% for the fiscal
year ended June 30, 2002. The federal statutory rate was 34% for both periods.
Our effective tax rate associated with the income tax expense for the fiscal
year ended June 30, 2003 was lower than the federal statutory rate primarily due
to the increase in valuation allowance, as well as the amortization of
stock-based compensation for which no current year tax benefit was provided. Our
effective tax rate associated with the income tax benefit for the fiscal year
ended June 30, 2002 was lower than the federal statutory rate primarily due to
foreign losses and amortization of stock-based compensation for which no benefit
was provided.
LIQUIDITY AND CAPITAL RESOURCES
Since inception through fiscal 2005, 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, cash equivalents and
marketable securities consisting of cash and publicly traded equity securities
totaled approximately $6.8 million at June 30, 2005.
The following table summarizes the major components of the consolidated
statement of cash flows (in thousands):
YEARS ENDED JUNE 30,
CONSOLIDATED CASH FLOW DATA: 2005 2004 2003
- ---------------------------- -------- -------- --------
Net cash provided by (used in):
Net loss $ (7,004) $(15,654) $(47,549)
Non-cash operating expenses, net 2,626 7,885 25,711
Changes in operating assets and liabilities 8 4,832 4,268
-------- -------- --------
Net cash used in operating activities (4,370) (2,937) (17,570)
Net cash provided by (used in) investing activities 2,926 3,459 (2,086)
Net cash (used in) provided by financing activities (910) 1,226 345
Effect of foreign exchange rate changes on cash (84) 52 148
-------- -------- --------
Increase (decrease) in cash and cash equivalents $ (2,438) $ 1,800 $(19,163)
======== ======== ========
Operating activities used cash for the fiscal year ended June 30, 2005.
This was primarily the result of the net loss offset by non-cash operating
expenses. Non-cash items that had a significant impact on net loss included
depreciation, amortization of purchased intangible assets, stock-based
compensation expense, provision for doubtful accounts and provision for
inventory reserve.
Operating activities used cash for the fiscal year ended June 30, 2004.
This was primarily the result of the net loss offset by net cash provided from
changes in operating assets and liabilities and non-cash operating expenses.
Non-cash items that had a significant impact on net loss included depreciation,
amortization of purchased intangible assets, stock-based compensation expense,
deferred income taxes, provision for doubtful accounts, provision for inventory
reserve, equity losses from unconsolidated business, restructuring recovery and
revaluation of strategic investment.
Investing activities provided cash for the fiscal year ended June 30,
2005. We received $4.1 million in proceeds from the sale of marketable
securities. We used $1.0 million to purchase marketable securities We also used
$124,000 to purchase property and equipment.
Financing activities used cash for the fiscal year ended June 30, 2005.
We received $468,000 related to the purchase of common shares through option
exercises and purchases through the Employee Stock Purchase Plan. We used
$867,000 to pay the convertible note payable from the acquisition of Stallion.
We used $500,000 to pay off our bank line of credit.
29
In January 2002, we entered into a two-year line of credit with a bank
in an amount not to exceed $20.0 million. Borrowings under the line of credit
bear interest at either: (i) the prime rate or (ii) the LIBOR rate plus 2.0%. We
were required to pay a $100,000 facility fee which was reduced to $62,500 and
was paid. We were also required to pay a quarterly unused line fee of .125% of
the unused line of credit balance. Since establishing the line of credit, we
have twice reduced the amount of the line, modified customary financial
covenants, and adjusted the interest rate to be charged on borrowings to the
prime rate plus .50% and eliminated the LIBOR option. Effective July 25, 2003,
we further modified this line of credit, reducing the revolving line to $5.0
million, and adjusting the customary affirmative and negative covenants. We are
also required to maintain certain financial ratios as defined in the agreement.
The agreement has an annual revolving maturity date that renews on the effective
date. The agreement was renewed on July 24, 2004, with an amendment to a
financial ratio, and again on February 15, 2005 with an amendment to a covenant.
We paid $12,500 and $1,000 in facility fees, respectively, for the renewals. Our
revolving credit line at June 30, 2005 was $3.0 million. As of June 30, 2005, we
had no borrowings against this line of credit. Additionally, we have used
letters of credit available under the line of credit totaling approximately
$480,000 in place of cash to fund deposits on leases, tax account deposits and
security deposits. As a result, our available line of credit at June 30, 2005
was $2.5 million. Pursuant to the line of credit, we are restricted from paying
any dividends. As of June 30, 2005, we were not in compliance with the quick
ratio covenant as defined in the agreement. A waiver was granted by the bank
during August 2005. The line of credit expired July 22, 2005. We are in the
process of obtaining a new line of credit.
The following table summarizes our contractual payment obligations and
commitments (in thousands):
YEARS ENDED JUNE 30,
2006 2007 2008 2009 2010 Thereafter Total
------ ------ ------ ------ ------ ------
Purchase obligations $5,500 $ -- $ -- $ -- $ -- $ -- $5,500
Minimum royalty commitment 103 103 -- -- -- -- 206
Capital leases 178 51 -- -- -- -- 229
Operating leases 835 664 577 605 636 53 3,370
------ ------ ------ ------ ------ ------ ------
Total $6,616 $ 818 $ 577 $ 605 $ 636 $ 53 $9,305
====== ====== ====== ====== ====== ====== ======
Purchase obligations primarily represent open purchase orders for
inventory and other commitments in the ordinary course of business as of June
30, 2005.
As of June 30, 2005, approximately $2.5 million of our tangible assets
(primarily cash held in foreign subsidiary bank accounts) were held by
subsidiaries outside the U.S. Such assets are unrestricted with regard to
foreign liquidity needs, however, our ability to utilize a portion of such
assets to satisfy liquidity needs outside of such foreign locations are subject
to approval by the foreign location board of directors.
We refer to the sum of the following components as "cash" for the
purposes of discussing our cash balance and liquidity (in thousands):
YEARS ENDED JUNE 30,
2005 2004 CHANGE
-------- -------- --------
Cash and cash equivalents $ 6,690 $ 9,128 $ (2,438)
Marketable securities 85 3,050 (2,965)
-------- -------- --------
$ 6,775 $ 12,178 $ (5,403)
======== ======== ========
30
Our cash balance decreased by $3.0 million in the first fiscal quarter,
which included payments for increased marketing and sales expenses to launch new
product programs, repayment of a note of $867,000 related to the Stallion
acquisition, audit payments and other costs. Our cash balance decreased by an
additional $1.0 million in the second fiscal quarter. Throughout the fiscal
quarter ended December 31, 2004, we reduced expenses from the levels of the
first fiscal quarter, as part of a planned program. These activities have been
ongoing, and in January 2005, we further cut back our staff to reduce operating
costs. In the process, we realigned our international sales operations and have
reduced our fixed costs in Japan and Europe. We also closed a small sales office
in Milford, Connecticut. Our cash balance decreased by an additional $1.6
million from $8.2 million at December 31, 2004 to $6.6 million at March 31,
2005. As a result of our cost reduction activities and cash management, our cash
balances increased by $200,000 from $6.6 at March 31, 2005 to $6.8 million at
June 30, 2005.
The cumulative effect of the reductions initiated in October 2004
through January 2005 is that we have been lowering our operating costs to
streamline operations and lower our cash breakeven point from the earlier
revenue range of $14.0 to $15.0 million in quarterly revenues as an operating
model, to approximately $13.0 million per fiscal quarter. This target is based
upon a financial model, and we expect that actual expenses may vary in any
fiscal quarter and, thus, so would financial results impacting cash usage or
profitability. Also, uses of cash to fund inventories, receivables and payables,
will cause results to vary from the financial model.
We believe that our existing cash, cash equivalents and marketable
securities will be adequate to meet our anticipated cash needs through at least
the next twelve months. Our future capital requirements will depend on many
factors, including the timing and amount of our net revenues, research and
development and infrastructure investments, and expenses related to ongoing
government investigations and pending litigation, which will affect our ability
to generate additional cash. If cash generated from operations and financing
activities is insufficient to satisfy our working capital requirements, we may
need to borrow funds through bank loans, sales of securities or other means. We
are in the process of negotiating a new bank line of credit. There can be no
assurance that we will be able to raise any such capital on terms acceptable to
us, if at all. If we are unable to secure additional financing, we may not be
able to develop or enhance our products, take advantage of future opportunities,
respond to competition or continue to operate our business.
RISK FACTORS
BEFORE DECIDING TO PURCHASE, HOLD OR SELL OUR COMMON STOCK, YOU SHOULD
CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW, IN ADDITION TO THE OTHER
CAUTIONARY STATEMENTS AND RISKS DESCRIBED ELSEWHERE AND THE OTHER INFORMATION
CONTAINED IN THIS REPORT AND IN OUR OTHER FILINGS WITH THE SEC, INCLUDING OUR
SUBSEQUENT REPORTS ON FORMS 10-Q AND 8-K. THE RISKS AND UNCERTAINTIES DESCRIBED
BELOW ARE NOT THE ONLY ONES WE FACE. ADDITIONAL RISKS AND UNCERTAINTIES NOT
PRESENTLY KNOWN TO US OR THAT WE CURRENTLY DEEM IMMATERIAL MAY ALSO AFFECT OUR
BUSINESS. IF ANY OF THESE KNOWN OR UNKNOWN RISKS OR UNCERTAINTIES ACTUALLY
OCCURS WITH MATERIAL ADVERSE EFFECTS ON LANTRONIX, OUR BUSINESS, FINANCIAL
CONDITION AND RESULTS OF OPERATIONS COULD BE SERIOUSLY HARMED. IN THAT EVENT,
THE MARKET PRICE FOR OUR COMMON STOCK COULD DECLINE AND YOU MAY LOSE ALL OR PART
OF YOUR INVESTMENT.
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE, WHICH COULD CAUSE OUR
STOCK TO DECLINE.
We have experienced, and expect to continue to experience, significant
fluctuations in revenues, expenses and operating results from quarter to
quarter. 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. Our short-term expense levels for ongoing operations
are relatively fixed and are based on our expectations of future net revenues.
If we were to experience a reduction in 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 fiscal quarter would be harmed. If our operating
results in future fiscal quarters fall below the expectations of market analysts
and investors, the price of our common stock would likely fall. Other factors
that might cause our operating results to fluctuate on a quarterly basis
include:
o changes in the mix of net revenues attributable to
higher-margin and lower-margin products;
o customers' decisions to defer or accelerate orders;
31
o variations in the size or timing of orders for our products;
o changes in demand for our products;
o defects and other product quality problems;
o loss or gain of significant customers;
o short-term fluctuations in the cost or availability of our
critical components;
o announcements or introductions of new products by our
competitors;
o effects of terrorist attacks in the U.S. and abroad; and
o changes in demand for devices that incorporate our products.
CURRENT OR FUTURE LITIGATION COULD ADVERSELY AFFECT US.
We are currently involved in significant litigation, including multiple
security class action lawsuits, a state derivative lawsuit and litigation with a
former executive officer. The pending lawsuits involve complex questions of fact
and law and will likely continue to require the expenditure of significant funds
and the diversion of other resources. We do not know what the outcome of
outstanding legal proceedings will be and cannot determine the extent to which
these resolutions might have a material adverse effect on our business,
financial condition or results of operations. The results of litigation are
inherently uncertain, and adverse outcomes are possible. For a more detailed
description of pending litigation, see Note 12 to our notes to consolidated
financial statements.
From time to time, we are subject to other legal proceedings and
claims. Litigation can involve complex factual and legal questions and its
outcome is uncertain. Any claim that is successfully asserted against us may
cause us to pay substantial damages. Even if we were to prevail, any litigation
could be costly and time-consuming and would divert the attention of our
management and key personnel from our business operations, which could have a
material adverse effect on us.
CURRENT OR FUTURE LITIGATION OVER PROPRIETARY RIGHTS COULD ADVERSELY
AFFECT US.
Substantial litigation regarding intellectual property rights exists in
our industry. For example, Digi International ("Digi") has filed a lawsuit
against us alleging that we infringe one of their patents, and we have filed
three suits against Digi alleging that they infringe patents that we own or
license. These pending lawsuits involve complex questions of fact and law and
will likely continue to require the expenditure of significant funds and the
diversion of other resources. We do not know what the outcome of these legal
proceedings will be and cannot determine the extent to which resolutions of
these disputes might have a material adverse effect on our business, financial
condition or results of operations. The results of litigation are inherently
uncertain, and adverse outcomes are possible. For a more detailed description of
pending litigation, see Note 12 to our notes to consolidated financial
statements.
There is a risk that other third parties will claim that our products,
or our customers' products, infringe on their intellectual property rights or
that we have misappropriated their intellectual property. In addition, software,
business processes and other property rights in our industry might be
increasingly subject to third-party infringement claims as the number of
competitors grows and the functionality of products in different industry
segments overlaps. Other parties might currently have, or might eventually be
issued, patents that pertain to the proprietary rights we use. Any of these
third parties might make a claim of infringement against us. The results of
litigation are inherently uncertain, and adverse outcomes are possible.
Responding to any infringement claim, regardless of its validity, could:
o be time-consuming, costly and/or result in litigation;
o divert management's time and attention from developing our
business;
32
o require us to pay monetary damages, including treble damages
if we are held to have willfully infringed;
o require us to enter into royalty and licensing agreements that
we would not normally find acceptable;
o require us to stop selling or to redesign certain of our
products; or
o require us to satisfy indemnification obligations to our
customers.
If any of these occur, our business, financial condition or results of
operations could be adversely affected.
OUR USE OF CONTRACT MANUFACTURERS IN CHINA AND TAIWAN INVOLVES RISKS
THAT COULD ADVERSELY AFFECT US.
We use contract manufacturers based in China and Taiwan. There are
significant risks of doing business in these locations including the following:
o These locations do not afford the same level of protection to
intellectual property as do domestic or many foreign
countries. If our products were reverse-engineered or our
intellectual property were otherwise pirated (reproduced and
duplicated without our knowledge or approval), our revenues
would be reduced;
o Delivery times are extended due to the distances involved,
requiring more lead-time in ordering and increasing the risk
of excess inventories;
o We could incur ocean freight delays because of labor problems,
weather delays or expediting and customs problems; and
o U.S. foreign relations with these locations have,
historically, been subject to change. Political considerations
and actions could interrupt our expected supply of products
from these locations.
DELAYS IN DELIVERIES OR QUALITY PROBLEMS WITH OUR COMPONENT SUPPLIERS
COULD DAMAGE OUR REPUTATION AND COULD CAUSE OUR NET REVENUES TO DECLINE AND HARM
OUR RESULTS OF OPERATIONS.
We and our contract manufacturers are responsible for procuring raw
materials for our products. Our products incorporate components or technologies
that are only available from single or limited sources of supply. In particular,
some of our integrated circuits are available from a single source and in some
cases are no longer being manufactured. From time to time, integrated circuits
used in our products will be phased out of production. When this happens, we
attempt to purchase sufficient inventory to meet our needs until a substitute
component can be incorporated into our products. Nonetheless, we might be unable
to purchase sufficient components to meet our demands, or we might incorrectly
forecast our demands, and purchase too many or too few components. In addition,
our products use components that have, in the past, been subject to market
shortages and substantial price fluctuations. From time to time, we have been
unable to meet our orders because we were unable to purchase necessary
components for our products. We do not have long-term supply arrangements with
many of our vendors to obtain necessary components or technology for our
products. If we are unable to purchase components from these suppliers, product
shipments could be prevented or delayed, which could result in a loss of sales.
If we are unable to meet existing orders or to enter into new orders because of
a shortage in components, we will likely lose net revenues and risk losing
customers and harming our reputation in the marketplace.
IF WE LOSE THE SERVICES OF ANY OF OUR CONTRACT MANUFACTURERS OR
SUPPLIERS, WE MAY NOT BE ABLE TO OBTAIN ALTERNATE SOURCES IN A TIMELY MANNER,
WHICH COULD HARM OUR CUSTOMER RELATIONS AND ADVERSELY AFFECT OUR NET REVENUES
AND OUR OPERATING RESULTS.
33
We do not have long-term agreements with our contract manufacturers or
suppliers. If any of these subcontractors or suppliers ceased doing business
with us, we may not be able to obtain alternative sources in a timely or
cost-effective manner. Due to the amount of time that it usually takes us to
qualify contract manufacturers and suppliers, we could experience delays in
product shipments if we are required to find alternative subcontractors and
suppliers. Some of our suppliers have or provide technology or trade secrets,
the loss of which could be disruptive to our procurement and supply processes.
If a competitor should acquire one of our contract manufacturers or suppliers,
we could be subjected to more difficulties in maintaining or developing
alternative supply of some components or products. Any problems that we may
encounter with the delivery, quality or cost of our products could damage our
customer relationships and materially and adversely affect our results of
operations.
IF OUR RESEARCH AND DEVELOPMENT EFFORTS ARE NOT SUCCESSFUL, OUR NET
REVENUES COULD DECLINE AND OUR BUSINESS COULD BE HARMED.
If we are unable to develop new products as a result of our research
and development efforts, or if the products we develop are not successful, our
business could be harmed. Even if we do develop new products that are accepted
by our target markets, we do not know whether the net revenue from these
products will be sufficient to justify our investment in research and
development. In addition, if we do not invest sufficiently in research and
development, we may be unable to maintain our competitive position. The
following table shows our research and development expenditures and percentages
of net revenue for the number of research and development employees at the end
of the indicated periods. The engineering headcount excludes approximately six
former employees contributing to us as consultants in 2005. (amounts in
thousands except percentages and employees) for the periods indicated:
YEARS ENDED JUNE 30,
2005 2004
------- -------
Research and development expenses $ 6,314 $ 7,813
Research and development as a percent of net revenue 13% 16%
Number of employees 37 60
IF A MAJOR CUSTOMER CANCELS, REDUCES, OR DELAYS PURCHASES, OUR NET
REVENUES MIGHT DECLINE AND OUR BUSINESS COULD BE ADVERSELY AFFECTED.
The number and timing of sales to our distributors have been difficult
for us to predict. While our distributors are customers in the sense they buy
our products, they are also part of our product distribution system. To some
extent, any business lost from a distributor would likely be replaced by sales
to other customer/distributors in a reasonable period, rather than a total loss
of that business such as from a customer who used our products in their
business. Some of our distributors could be acquired by a competitor and stop
buying product from us. The following table presents our largest customers as a
percentage of net revenue for the periods indicated:
YEARS ENDED JUNE 30,
2005 2004 2003
---- ---- ----
Top five customers 42.0% 38.0% 34.0%
Ingram Micro 16.0% 14.0% 11.0%
Tech Data 11.0% 9.0% 10.0%
Below is a table of our two largest customers as a percentage of
accounts receivable for the periods indicated:
YEARS ENDED JUNE 30,
2005 2004
---- ----
Ingram Micro and Tech Data 24.0% 13.0%
The loss or deferral of one or more significant sales in a quarter
could harm our operating results. We have in the past, and might in the future,
lose one or more major customers. If we fail to continue to sell to our major
customers in the quantities we anticipate, or if any of these customers
terminate our relationship, our reputation, the perception of our products and
technology in the marketplace we 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
networking solutions technology. Our sales are usually completed on a purchase
order basis and we have few long-term purchase commitments from our customers.
34
Our future success also depends on our ability to attract new
customers, which often involves an extended selling process. The sale of our
products often involves a significant technical evaluation, and we often face
delays because of our customers' internal procedures for evaluating and
deploying 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.
IF WE FAIL TO DEVELOP OR ENHANCE OUR PRODUCTS TO RESPOND TO CHANGING
MARKET CONDITIONS AND GOVERNMENT AND INDUSTRY STANDARDS, OUR COMPETITIVE
POSITION WILL SUFFER AND OUR BUSINESS WILL BE ADVERSELY AFFECTED.
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 and meet government and industry
standards. The demand for network-enabled products is relatively new and can
change as a result of innovations, changes, or new government and industry
standards. For example, industry segments might adopt new or different
standards, giving rise to new customer requirements. On January 27, 2003, the
European Parliament and the Council of the European Union authorized Directive
2002/95/EC on the restriction of the use of certain hazardous substances in
electrical and electronic equipment. This new directive, also referred to as
RoHS, requires that manufacturers reduce usage of six hazardous substances to
minimum acceptable levels by July of 2006. Any failure by us to develop and
introduce new products or enhancements in response to new government and
industry standards could harm our business, financial condition and results of
operations. These requirements might or might not be compatible with our current
or future product offerings. We might not be successful in modifying our
products and services to address these requirements and standards. For example,
our competitors might develop competing technologies based on Internet
Protocols, Ethernet Protocols or other protocols that might have advantages over
our products. If this were to happen, our net revenue might not grow at the rate
we anticipate, or could decline.
WE EXPECT THE AVERAGE SELLING PRICES OF OUR PRODUCTS TO DECLINE, WHICH
COULD REDUCE OUR NET REVENUES, GROSS MARGINS AND PROFITABILITY.
In the past, we have experienced some reduction in the average selling
prices and gross margins of products, and we expect that this will continue for
our products as they mature. We expect competition to continue to increase, and
we anticipate this could result in additional pressure on our pricing. 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. We also may not be
able to increase the price of our products if the prices of components or our
overhead costs increase. We may be unable to adjust our prices in response to
currency exchange rate fluctuations resulting in lower gross margins. If these
were to occur, our gross margins would decline. In addition, we may not be able
to reduce the cost to manufacture our products to keep up with the decline in
prices.
IF THE SEC SHOULD LEVY FINES AGAINST US, OR DECLARE US TO BE OUT OF
COMPLIANCE WITH THE RULES REGARDING OFFERING SECURITIES TO THE PUBLIC, IT COULD
DAMAGE OUR REPUTATION WITH CUSTOMERS AND VENDORS AND ADVERSELY AFFECT OUR STOCK
PRICE.
The SEC is investigating the events surrounding the restatement of our
financial statements filed on June 25, 2002 for the fiscal year ended June 30,
2001 and for the six months ended December 31, 2002. The SEC could conclude that
we violated the rules of the Securities Act of 1933, as amended or the Exchange
Act. In either event, the SEC might levy civil fines against us, or might
conclude that we lack sufficient internal controls to warrant our being allowed
to continue offering our shares to the public. This investigation involves
substantial cost. These costs, and the cost of any fines imposed by the SEC, are
not covered by insurance. In addition to sanctions imposed by the SEC, an
adverse determination could significantly damage our reputation with customers
and vendors, and harm our employees' morale.
IF SOFTWARE THAT WE LICENSE OR ACQUIRE FROM THE OPEN SOURCE SOFTWARE
COMMUNITY AND INCORPORATE INTO OUR PRODUCTS WERE TO BECOME UNAVAILABLE OR NO
LONGER AVAILABLE ON COMMERCIALLY REASONABLE TERMS, IT COULD ADVERSELY AFFECT
SALES OF OUR PRODUCTS, WHICH COULD DISRUPT OUR BUSINESS AND HARM OUR FINANCIAL
RESULTS.
35
Certain of our products contain components developed and maintained by
third-party software vendors or are available through the "open source" software
community. We also expect that we may incorporate software from third-party
vendors and open source software in our future products. Our business would be
disrupted if this software, or functional equivalents of this software, were
either no longer available to us or no longer offered to us on commercially
reasonable terms. In either case, we would be required to either redesign our
products to function with alternate third-party software or open source
software, or develop these components ourselves, which would result in increased
costs and could result in delays in our product shipments. Furthermore, we might
be forced to limit the features available in our current or future product
offerings. We are presently developing products for use on the Linux platform.
The SCO Group ("SCO") has filed and threatened to file lawsuits against
companies that operate Linux for commercial purposes, alleging that such use of
Linux infringes SCO's rights. These allegations may adversely affect the demand
for the Linux platform and, consequently, the sales of our Linux-based products.
OUR PRODUCTS MAY CONTAIN UNDETECTED SOFTWARE OR HARDWARE ERRORS OR
DEFECTS THAT COULD LEAD TO AN INCREASE IN OUR COSTS, REDUCE OUR NET REVENUES OR
DAMAGE OUR REPUTATION.
We currently offer warranties ranging from one to two years on each of
our products. Our products could contain undetected errors or defects. If there
is a product failure, we might have to replace all affected products without
being able to book revenue for replacement units, or we may have to refund the
purchase price for the units. We do not have a long history with which to assess
the risks of unexpected product failures or defects for our device server
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.
IF OUR CONTRACT MANUFACTURERS ARE UNABLE OR UNWILLING TO MANUFACTURE
OUR PRODUCTS AT THE QUALITY AND QUANTITY WE REQUEST, OUR BUSINESS COULD BE
HARMED.
We outsource substantially all of our manufacturing to three
manufacturers: Venture Electronics Services, Uni Precision Industrial Ltd., and
Universal Scientific Industrial Company, LTD. Our reliance on these third-party
manufacturers exposes us to a number of significant risks, including:
o reduced control over delivery schedules, quality assurance,
manufacturing yields and production costs;
o lack of guaranteed production capacity or product supply; and
o reliance on these manufacturers to maintain competitive
manufacturing technologies.
Our agreements with these manufacturers provide for services on a
purchase order basis. If our manufacturers were to become unable or unwilling to
continue to manufacture our products at requested 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, which could be time consuming and difficult, and might result in
unforeseen manufacturing and operations problems. For example, Jabil Circuit,
Inc. acquired Varian, Inc. in March 2005 and closed the facility that currently
manufactures our product. We transferred this production to another contract
manufacturer. Moreover, as we shift products among third-party manufacturers, we
may incur substantial expenses, risk material delays, or encounter other
unexpected issues. For example, in the third fiscal quarter of 2003 we
encountered product shortages related to the transition to a third-party
manufacturer. This product shortage contributed to our net revenues falling
below our publicly announced estimates.
In addition, a natural disaster could disrupt our manufacturers'
facilities and could inhibit our manufacturers' ability to provide us with
manufacturing capacity on a timely basis, or at all. If this were to occur, we
likely would be unable to fill customers' existing orders or accept new orders
for our products. The resulting decline in net revenues would harm our business.
We also are responsible for forecasting the demand for our individual products.
These forecasts are used by our contract manufacturers to procure raw materials
and manufacture our finished goods. If we forecast demand too high, we may
invest too much cash in inventory, and we may be forced to take a write-down of
our inventory balance, which would reduce our earnings. If our forecast is too
low for one or more products, we may be required to pay charges which would
increase our cost of revenues or we may be unable to fulfill customer orders,
thus reducing net revenues and therefore earnings.
36
BECAUSE WE DEPEND ON INTERNATIONAL SALES FOR A SUBSTANTIAL AMOUNT OF
OUR NET REVENUES, WE ARE SUBJECT TO INTERNATIONAL ECONOMIC, REGULATORY,
POLITICAL AND OTHER RISKS THAT COULD HARM OUR BUSINESS, FINANCIAL CONDITION OR
RESULTS OF OPERATIONS.
The following table presents the amount of revenue derived from
international sources (amounts in thousands except percentages) for the periods
indicated:
YEARS ENDED JUNE 30,
2005 2004 2003
------------ ------------ -----------
Americas $ 31,162 64.3% $ 33,847 69.3% $ 37,391 75.7%
Europe 13,213 27.2% 11,252 23.0% 10,366 21.0%
Other 4,127 8.5% 3,786 7.7% 1,632 3.3%
------------ ------------ ------------ ----------- ------------ ------------
Total net revenues $ 48,502 100% $ 48,885 100% $ 49,389 100%
============ ============ ============ =========== ============ ============
We expect that international revenues will continue to represent a
significant portion of our net revenues in the foreseeable future. Doing
business internationally involves greater expense and many 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:
o unexpected changes in regulatory requirements, taxes, trade
laws and tariffs;
o reduced protection for intellectual property rights in some
countries;
o differing labor regulations;
o compliance with a wide variety of complex regulatory
requirements;
o changes in a country's or region's political or economic
conditions;
o effects of terrorist attacks in the U.S. and abroad;
o greater difficulty in staffing and managing foreign
operations; and
o 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.
IF WE ARE UNABLE TO SELL OUR INVENTORY IN A TIMELY MANNER IT COULD
BECOME OBSOLETE, WHICH COULD REQUIRE US TO INCREASE OUR RESERVES AND HARM OUR
OPERATING RESULTS.
At any time, competitive products may be introduced with more
attractive features or at lower prices than ours. There is a risk that we may be
unable to sell our inventory in a timely manner to avoid it becoming obsolete.
The following table shows our inventory and excess and obsolete inventory
reserve (in thousands) for the periods indicated:
JUNE 30,
--------
2005 2004
-------- --------
Raw materials $ 3,973 $ 4,047
Finished goods 7,277 7,368
Inventory at distributors 1,181 1,291
-------- --------
12,431 12,706
Reserve for excess and obsolete inventory (5,603) (6,029)
-------- --------
$ 6,828 $ 6,677
======== ========
37
In the event we are required to substantially discount our inventory or
are unable to sell our inventory in a timely manner, we would be required to
increase our reserves and our operating results could be substantially harmed.
IF WE ARE UNABLE TO ATTRACT, RETAIN OR MOTIVATE KEY SENIOR MANAGEMENT
AND TECHNICAL PERSONNEL, IT COULD SERIOUSLY HARM OUR BUSINESS.
Our financial performance depends substantially on the performance of
our executive officers and key technical employees. We are dependent in
particular on Marc Nussbaum, our President and Chief Executive Officer, and
James Kerrigan, our Chief Financial Officer and Secretary. We have no employment
contracts with these executives. We are also dependent upon our technical
personnel, due to the specialized technical nature of our business. If we lose
the services of Mr. Nussbaum, Mr. Kerrigan or any of our key technical 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.
IF OUR OEM CUSTOMERS DEVELOP THEIR OWN EXPERTISE IN NETWORK-ENABLING
PRODUCTS, IT COULD RESULT IN REDUCED SALES OF OUR PRODUCTS AND HARM OUR
OPERATING RESULTS.
We sell to both resellers and OEMs. Selling products to OEMs involves
unique risks, including the risk that OEMs will develop internal expertise in
network-enabling products or will otherwise incorporate network functionality in
their products without using our device networking solutions. If this were to
occur, our sales to OEMs would likely decline, which could reduce our net
revenue and harm our operating results.
NEW PRODUCT INTRODUCTIONS AND PRICING STRATEGIES BY OUR COMPETITORS
COULD REDUCE OUR MARKET SHARE OR CAUSE US TO REDUCE THE PRICES OF OUR PRODUCTS,
WHICH WOULD REDUCE OUR NET REVENUES AND GROSS MARGINS.
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, semiconductor companies, companies in the automation
industry and companies with significant networking expertise and research and
development resources. Our competitors might offer new products with features or
functionality that are equal to or better than our products. In addition, since
we work with open standards, our customers could develop products based on our
technology that compete with our offerings. We might not have sufficient
engineering staff or other required resources to modify our products to match
our competitors. Similarly, competitive pressure could force us to reduce the
price of our products. In each case, we could lose new and existing customers to
our competition. If this were to occur, our net revenues could decline and our
business could be harmed.
WE MAY NOT BE ABLE TO ADEQUATELY PROTECT OR ENFORCE OUR INTELLECTUAL
PROPERTY RIGHTS, WHICH COULD HARM OUR COMPETITIVE POSITION.
We have not historically relied on patents to protect our proprietary
rights, although we are now building a patent portfolio. We rely primarily 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:
o laws and contractual restrictions might not be sufficient to
prevent misappropriation of our technology or deter others
from developing similar technologies;
o other companies might claim common law trademark rights based
upon use that precedes the registration of our marks;
o other companies might assert other rights to market products
using our trademarks;
o 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;
o courts may determine that our software programs use open
source software in such a way that deprives the entire
programs of intellectual property protection; and
38
o current federal laws that prohibit software copying provide
only limited protection from software pirates.
Also, the laws of other countries in which we market and manufacture
our products might offer little or no effective protection of our proprietary
technology. Reverse engineering, unauthorized copying or other misappropriation
of our proprietary technology could enable third-parties to benefit from our
technology without paying us for it, which could significantly harm our
business.
BUSINESS INTERRUPTIONS COULD ADVERSELY AFFECT OUR BUSINESS.
Our operations and those of our suppliers are vulnerable to
interruption by fire, earthquake, power loss, telecommunications failure,
terrorist attacks and other events beyond our control. A substantial portion of
our facilities, including our corporate headquarters and other critical business
operations, are located near major earthquake faults, and therefore, may be more
susceptible to damage if an earthquake occurs. We do not carry earthquake
insurance for direct earthquake-related losses. In addition, we do not carry
business interruption insurance for, nor do we carry financial reserves against,
business interruptions arising from earthquakes or certain other events. If a
business interruption occurs, our business could be materially and adversely
affected.
IF WE FAIL TO MAINTAIN AN EFFECTIVE SYSTEM OF DISCLOSURE CONTROLS OR
INTERNAL CONTROLS OVER FINANCIAL REPORTING, OUR BUSINESS AND STOCK PRICE COULD
BE ADVERSELY AFFECTED.
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate
periodically the effectiveness of its internal controls over financial
reporting, and to include a management report assessing the effectiveness of its
internal controls as of the end of each fiscal year. Current SEC rules will
require that our first management report on the effectiveness of our internal
controls to be in our Annual Report on Form 10-K for our fiscal year ending June
30, 2008. These rules will also require our independent public accountant to
attest to, and report on, management's assessment of our internal controls over
financial reporting.
Our management does not expect that our internal controls over
financial reporting will prevent all errors or frauds. A control system, no
matter how well designed and operated, can provide only reasonable, not
absolute, assurance that the control system's objectives will be met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and instances
of fraud, if any, involving us have been, or will be, detected. These inherent
limitations include the realities that judgments in decision-making can be
faulty and that breakdowns can occur because of simple errors or mistakes.
Controls can also be circumvented by individual acts of a person, or by
collusion among two or more people, or by management override of the controls.
The design of any system of controls is based in part on certain assumptions
about the likelihood of future events, and we cannot assure you that any design
will succeed in achieving its stated goals under all potential future
conditions. Over time, controls may become inadequate because of changes in
conditions or deterioration in the degree of compliance with policies and
procedures. Because of the inherent limitations in a cost-effective control
system, misstatements due to errors or frauds may occur and not be detected.
In connection with our fiscal 2005 audit, we determined and informed
our Audit Committee that we had incorrectly accounted for (i) the accrual of
professional fees and other accrued liabilities and (ii) amounts previously
recorded as stock-based compensation related to a stock option grant to a
terminated employee, which resulted in the adjustment to amounts as originally
reported in our first, second and third fiscal quarter of 2005 consolidated
financial statements. In addition, we determined and concluded that there were
other significant deficiencies in our financial statement close process. We have
concluded that these conditions are a material weakness in our internal controls
over financial reporting. Included in this Annual Report on Form 10-K in Item
9A, Part II is a more detailed discussion of the material weakness that has been
identified. We have taken steps to remediate the material weakness in our
internal controls over financial reporting and the ineffectiveness of our
disclosure controls. Our failure to adequately remediate our material weakness
could have a material adverse effect on our business, results of operations and
financial condition.
39
We cannot assure you that we or our independent registered public
accounting firm will not identify a material weakness in our disclosure controls
and internal controls over financial reporting in the future. If our internal
control over financial reporting are not considered adequate, we may experience
a loss of public confidence, which could have an adverse effect on our business
and our stock price.
CHANGES IN THE ACCOUNTING TREATMENT OF STOCK OPTIONS WILL ADVERSELY
AFFECT OUR RESULTS OF OPERATIONS.
In December 2004, the FASB issued SFAS 123R, which is a revision of
SFAS 123. SFAS 123R requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the financial statements
based on their fair values and does not permit pro forma disclosure as an
alternative to financial statement recognition. SFAS 123R is scheduled to be
effective for us beginning in the first quarter of fiscal 2006. The adoption of
the SFAS 123R fair value method will have a significant adverse impact on our
reported results of operations because the stock-based compensation expense will
be charged directly against our reported earnings. The impact of our adoption of
SFAS 123R cannot be quantified at this time because that will depend on the
future fair values and number of share-based payments granted in the future.
However, had we adopted SFAS 123 in prior periods, the magnitude of the impact
of that standard would have approximated the impact of SFAS 123R assuming the
application of the Black-Scholes model as described in the disclosure of pro
forma net loss and pro forma loss per share in Part IV, Item 15 of this Form
10-K and are presented under Footnote 1.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates
primarily to our investment portfolio. We do not use derivative financial
instruments for speculative or trading purposes. We place our investments in
instruments that meet high credit quality standards, as specified in our
investment policy. Information relating to quantitative and qualitative
disclosure about market risk is set forth below and in "Management's Discussion
and Analysis of Financial Condition and Results of Operations-Liquidity and
Capital Resources."
INTEREST RATE RISK
Our exposure to interest rate risk is limited to the exposure related
to our cash, cash equivalents, marketable securities and our credit facilities,
which is tied to market interest rates. We had the following cash and cash
equivalents and marketable securities consisting of publicly traded equity
securities and municipal government notes and bonds (in thousands) for the
periods indicated:
JUNE 30,
--------
2005 2004
------- -------
Cash and cash equivalents $ 6,690 $ 9,128
Marketable securities 85 3,050
------- -------
Total $ 6,775 $12,178
======= =======
We believe our marketable securities would not decline in value by a
significant 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by this item
are incorporated by reference from Part IV, Item 15 of this Form 10-K and are
presented beginning on page F-1.
40
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On a Form 8-K filed with the Securities and Exchange Commission on
January 21, 2005, as amended on February 18, 2005, we previously reported our
decision to dismiss our former independent registered public accounting firm,
Ernst & Young LLP, effective January 17, 2005, and appoint McGladrey & Pullen,
LLP as our new independent registered public accounting firm, to perform
auditing services beginning with the second fiscal quarter ended December 31,
2004.
During our most recent two fiscal years and from July 1, 2004 through
January 17, 2005, there were no "reportable events" as such term is described in
Item 304(a)(1)(v) of Regulation S-K under the Securities Exchange Act of 1934,
as amended; however, we were advised by Ernst & Young LLP that there were
control deficiencies related to our financial statement close process which
contributed to the errors in the initial filing of our Annual Report on Form
10-K for the fiscal year ended June 30, 2004, which errors had been corrected by
us in Form 10-K/A amendments. These control deficiencies included a lack of
secondary review within Lantronix and the failure to incorporate final changes
prior to filing. Ernst & Young LLP further advised that our processes to
document contract manufacturer inventory and purchase order transactions
contributed to significant errors in reconciling our records. These conditions
were determined to be reportable conditions under the standards established by
the American Institute of Certified Public Accountants.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
We carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and our
Chief Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934 (the "Exchange Act")) as of the end of
our fiscal year. This evaluation included consideration of the controls,
processes and procedures that comprise our internal control over financial
reporting. Based upon that evaluation, our Chief Executive Officer and our Chief
Financial Officer concluded that, as of June 30, 2005, as a result of the
material weakness in our internal controls over financial reporting discussed
below, our disclosure controls and procedures were not effective in ensuring
that information required to be disclosed by us in the reports that we file
under the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms and that
such information is accumulated and communicated to our management as
appropriate to allow timely decisions regarding required disclosure. A material
weakness is a control deficiency, or combination of control deficiencies, that
results in more than a remote likelihood that a material misstatement of the
annual or interim financial statements will not be prevented or detected.
DISCUSSION OF MATERIAL WEAKNESS IN INTERNAL CONTROL
During fiscal 2005, the Company experienced personnel changes within
its accounting and finance department. As a result of numerous adjustments
identified during our financial statement close process and audit adjustments,
we underwent a process to review our significant accounting practices, improve
accounting accuracy and identify process improvements. We anticipate
implementing these and other process improvements as we begin our readiness to
implement the provisions of Section 404 of Sarbanes-Oxley Act of 2002. As a
result of the numerous entries recorded in connection with the fiscal 2005 audit
and financial statement close process, we determined that there was a material
weakness in our internal controls over financial reporting. The following
discussion sets forth the basis for concluding that the significant deficiencies
described below aggregate to a material weakness:
1. As of June 30, 2005, the Company did not maintain effective
controls over the accrual of certain liabilities. With respect
to this, we:
41
a. Accrued for our audit and tax professional fees based
upon the expected cost of the fiscal 2005 financial
statement audit and tax returns as opposed to
accounting for such costs on an as incurred basis.
For example, audit and tax professional fees were
accrued based upon estimates of annual audit and tax
services related to the current fiscal year's
activities, ratably during the fiscal year. During
the fiscal 2005 audit, we became aware of guidance
from the American Institute of Certified Public
Accountants ("AICPA"), which suggests that fees for
audit work or tax services should be accrued as
incurred instead of recorded based upon the expected
cost of the services for that fiscal year. Since a
significant portion of our external auditor's audit
procedures occurred subsequent to June 30, 2005, the
Company over-accrued its audit fees.
b. Accrued for general liabilities for which we were
unable to substantiate with specific liabilities.
Although previously amounts were accrued to
reasonably provide for unknown and unspecific events,
current accounting trends discourage the use of
general reserves, limiting reserves to only amounts
that can be specifically estimated, or for which a
liability is more certain and can be determined.
During the fourth fiscal quarter of 2005, we
eliminated our general reserve, which had previously
provided for events that might arise subsequent to
the end of the accounting period, including minor
accounting adjustments prior to filing our financial
reports, or thereafter.
c. Under accrued our legal fee liability at year-end. As
part of our financial statement close process, we
contact all attorneys serving us, asking them to
describe their services, and to include a statement
of their outstanding legal fees unpaid by us as of
June 30, 2005. Our attorneys complied with our
request and initially provided a balance that
included, in part, unbilled legal fees, which total
balance we included in our consolidated financial
statements. Subsequently, certain attorneys provided
a new, higher balance, requiring an adjustment.
Specifically, this control deficiency resulted in an adjustment to
reduce selling, general and administrative expenses as originally
reported in our first, second and third fiscal quarter of 2005
consolidated financial statements by $106,000, $107,000 and $116,000,
respectively.
2. As of June 30, 2005, we did not maintain sufficient accounting
expertise to allow for the proper application of generally accepted
accounting principles for a certain complex transaction. Specifically,
we concluded that an agreement with a terminated employee included a
modification of an employee stock option grant and a charge to
stock-based compensation was recorded. Upon further review it was
determined that the terms of the grant were defined under the original
employment agreement and, as such, a stock option modification did not
occur at the time of termination. Specifically, this control deficiency
resulted in an adjustment to reduce stock-based compensation expense as
originally reported in our first, second and third fiscal quarter of
2005 consolidated financial statements by $118,000, $10,000 and
$30,000, respectively.
42
3. As of June 30, 2005, our internal controls over financial reporting
intended to ensure adequate control over end-user computing
spreadsheets were not designed properly. The use of large and complex
Excel spreadsheets contributed to an error in calculating our year end
fiscal 2005 reserve for excess and obsolete inventory. This control
deficiency did not result in an adjustment to amounts as originally
reported in our consolidated financial statements.
(b) Changes in internal controls.
There have been no changes in our internal controls over financial
reporting identified during the fiscal quarter that ended June 30, 2005 that
have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.
PLAN FOR REMEDIATION OF MATERIAL WEAKNESS
However, we are in the process of completing remediation efforts
relating to the material weakness, which is described above. Management has
reviewed with the Audit Committee of the Board of Directors the internal control
deficiencies that constitute significant deficiencies and a material weakness in
our internals control over financial reporting as of June 30, 2005. Management
has adopted, with the Audit Committee's concurrence, certain remedial measures
that are designed to improve our control environment. These remedial measures
include, but are not limited to, the following:
o Implement a process whereby a centralized accounts payable
function receives all incoming invoices and accrues for such
invoices upon receipt.
o Update the Company's accounting policies and procedures to
ensure the proper accrual of professional fees and other
liabilities.
o Implement a process whereby the Company's accounting
conclusions on complex transactions are reviewed by an
external consultant that is considered a GAAP expert.
o The review, revision or establishment of new policies and
procedures to ensure the proper accounting and documentation
for accounting conclusions reached during the preparation of
significant accounting estimates and reserves and for
recording complex transactions.
o For significant accounting processes that use complex
spreadsheets, identify and implement alternative computing
solutions that are designed with appropriate internal controls
or put in place controls over existing end-user computing
spreadsheets.
ITEM 9B. OTHER INFORMATION
Subsequent to the September 8, 2005 announcement of our preliminary
fourth quarter and full fiscal year results for 2005, we have made certain
adjustments to our announced results. During the fourth fiscal quarter,
adjustments were identified which pertained to our unaudited first, second and
third fiscal 2005 quarters. The unaudited quarterly financial information for
those fiscal 2005 quarters has been restated to reflect adjustments to net loss
from continuing operations and net loss, and to properly (i) accrue professional
fees and other accrued liabilities by reducing selling, general and
administrative expenses as originally reported in the Company's first, second
and third fiscal quarter 2005 consolidated financial statements by $106,000,
$107,000 and $116,000, respectively, and (ii) account for a stock option grant
by reducing stock-based compensation expense as originally reported in our
first, second and third fiscal 2005 quarters consolidated financial statements
by $118,000, $10,000 and $30,000, respectively. The effect of these and other
adjustments modifies the net loss of $15,000 announced on September 8, 2005 for
the fourth fiscal quarter of 2005, to a net loss of $549,000 for that quarter.
The determination to restate our unaudited first, second and third fiscal 2005
quarters as described above was made by our management in consultation with our
Audit Committee on September 26, 2005. We have determined that the effect of
these adjustments on the first, second and third fiscal quarter of 2005 is
immaterial and we do not intend to file amended Forms 10-Q for these periods.
The adjustments had an immaterial effect on our consolidated balance sheets at
the end of each of the adjusted periods and had no impact on net revenues or
operating cash flows for those periods. In addition, we evaluated whether any of
the adjustments impacted our prior year consolidated financial statements and
determined that they (i) did not impact the prior year periods or (ii) were
immaterial to the prior year periods.
43
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The names of our executive officers and their ages, titles and biographies as of
the date hereof are set forth in Part I, Item 1 above, and are incorporated
herein by reference.
The following information is included in our Proxy Statement for the 2005 Annual
Meeting of Shareholders to be filed within 120 days after our fiscal year ended
June 30, 2005 (the "Proxy Statement") and is incorporated herein by reference:
o Information regarding our directors who are standing for
reelection is set forth under "Election of Directors"
o Information regarding our Audit Committee and designated
"audit committee financial experts" is set forth under
"Election of Directors -- Audit Committee"
o Information on our code of business conduct and ethics for
directors, officers and employees is set forth under "Code of
Ethics and Complaint Procedure,"
o Information regarding Section 16(a) beneficial ownership
reporting compliance is set forth under "Section 16(a)
Beneficial Ownership Reporting Compliance"
ITEM 11. EXECUTIVE COMPENSATION
Information regarding compensation of our named executive officers is
set forth under "Executive Compensation and Related Information" in the Proxy
Statement and is incorporated herein by reference. Information regarding
compensation of our directors is set forth under "Director Compensation" in the
Proxy Statement and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Information regarding security ownership of certain beneficial owners,
directors and executive officers is set forth under "Election of Directors" and
"Security Ownership of Certain Beneficial Owners and Management" in the Proxy
Statement and is incorporated herein by reference. Information regarding our
equity compensation plans is set forth under "Equity Compensation Plan
Information" in the Proxy Statement and is incorporated by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions is
set forth under "Related Party Transactions" in the Proxy Statement and is
incorporated by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information regarding principal auditor fees and services is set forth
under "Ratification of Appointment of Independent Registered Public Accountants"
in the Proxy Statement and is incorporated herein by reference.
44
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) 1. CONSOLIDATED FINANCIAL STATEMENTS
The following financial statement schedule of the Company and related
Report of Independent Registered Public Accounting Firm is filed as part of this
Form 10-K.
PAGE
----
Report of Independent Registered Public Accounting Firm, McGladrey & Pullen, LLP........................... F-1
Report of Independent Registered Public Accounting Firm, Ernst & Young LLP................................. F-2
Consolidated Balance Sheets as of June 30, 2005 and 2004................................................... F-3
Consolidated Statements of Operations for the fiscal years ended June 30, 2005, 2004 and 2003.............. F-4
Consolidated Statements of Stockholders' Equity for the fiscal years ended June 30, 2005, 2004 and 2003.... F-5
Consolidated Statements of Cash Flows for the fiscal years ended June 30, 2005, 2004 and 2003 ............. F-6
Notes to Consolidated Financial Statements.............................................................. F-7 - F-30
2. FINANCIAL STATEMENT SCHEDULE
The following financial statement schedule of the Company and related
Report of Independent Registered Public Accounting Firm is filed as part of this
Form 10-K.
PAGE
----
(1) Report of Independent Registered Public Accounting Firm on
Financial Statement Schedule. S-1
(2) Schedule II-Consolidated Valuation and Qualifying Accounts S-2
All other financial statement schedules have been omitted because they
are not applicable, not required, or the information is included in the
consolidated financial statements or notes thereto.
3. EXHIBITS
The exhibits listed on the accompanying index to exhibits immediately
following the financial statements are filed as part of, or hereby incorporated
by reference into, this Form 10-K.
45
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Lantronix, Inc.
Irvine, California
We have audited the consolidated balance sheet of Lantronix, Inc. as of
June 30, 2005, and the related consolidated statement of operations,
stockholders' equity and cash flows for the year then ended. Our audit also
included the 2005 financial statement schedule listed at Item 15. These
financial statements and the schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Lantronix,
Inc. as of June 30, 2005, and the results of its operations and its cash flows
for the year then ended, in conformity with U.S. generally accepted accounting
principles. Also, in our opinion, such financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.
/s/ MCGLADREY & PULLEN, LLP
Irvine, California
September 20, 2005
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Lantronix, Inc.
We have audited the accompanying consolidated balance sheet of
Lantronix, Inc. as of June 30, 2004, and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the two fiscal
years in the period ended June 30, 2004. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. We were not engaged to
perform an audit of the Company's internal control over financial reporting. Our
audits included consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the circumstances,
but not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we express no
such opinion. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Lantronix, Inc. at June 30, 2004, and the consolidated results of its operations
and its cash flows for each of the two fiscal years in the period ended June 30,
2004, in conformity with U.S. generally accepted accounting principles.
/S/ ERNST & YOUNG LLP
ORANGE COUNTY, CALIFORNIA
SEPTEMBER 10, 2004
F-2
LANTRONIX, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
JUNE 30, JUNE 30,
ASSETS 2005 2004
------ ------------ ------------
Current Assets:
Cash and cash equivalents $ 6,690 $ 9,128
Marketable securities 85 3,050
Accounts receivable, (net of allowance for doubtful accounts of
$158 and $177 at June 30, 2005 and 2004, respectively) 2,646 3,242
Inventories 6,828 6,677
Contract manufacturers' receivable, (net of allowance of
$22 and $38 at June 30, 2005 and 2004, respectively) 711 999
Settlements receivable 1,200 --
Prepaid expenses and other current assets 1,055 1,450
------------ ------------
Total current assets 19,215 24,546
Property and equipment, net 674 865
Goodwill 9,488 9,488
Purchased intangible assets, net 559 2,056
Officer loans (net of allowance of $4,470
at June 30, 2005 and 2004, respectively) 116 110
Other assets 65 185
------------ ------------
Total assets $ 30,117 $ 37,250
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable $ 4,702 $ 4,049
Accrued payroll and related expenses 1,296 1,599
Warranty reserve 1,248 1,770
Restructuring reserve 264 752
Accrued settlements 1,200 --
Other current liabilities 2,812 2,922
Bank line of credit -- 500
Convertible note payable -- 867
------------ ------------
Total current liabilities 11,522 12,459
Other long-term liabilities 76 --
Long-term capital lease obligations 51 --
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.0001 par value; 5,000,000 shares authorized;
none issued and outstanding -- --
Common stock, $0.0001 par value; 200,000,000 shares authorized;
58,790,413 and 58,154,747 shares issued and outstanding at
June 30, 2005 and 2004, respectively 6 6
Additional paid-in capital 181,264 180,712
Deferred compensation (17) (103)
Accumulated deficit (163,082) (156,078)
Accumulated other comprehensive income 297 254
------------ ------------
Total stockholders' equity 18,468 24,791
------------ ------------
Total liabilities and stockholders' equity $ 30,117 $ 37,250
============ ============
See accompanying notes
F-3
LANTRONIX, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED JUNE 30,
--------------------
2005 2004 2003
-------- -------- --------
Net revenues (A) $ 48,502 $ 48,885 $ 49,389
Cost of revenues (B) 24,326 25,026 36,264
-------- -------- --------
Gross profit 24,176 23,859 13,125
-------- -------- --------
Operating expenses:
Selling, general and adminstrative (C) 24,610 23,293 28,660
Research and development (C) 6,314 7,813 9,430
Stock-based compensation (B) (C) 171 347 1,453
Amortization of purchased intangible assets 65 148 602
Impairment of purchased intangible assets -- -- 2,353
Restructuring (recovery) charges -- (2,093) 5,600
Litigation settlement costs -- -- 1,533
-------- -------- --------
Total operating expenses 31,160 29,508 49,631
Loss from operations (6,984) (5,649) (36,506)
Interest income (expense), net (20) 50 248
Other income (expense), net 173 (5,333) (926)
-------- -------- --------
Loss before income taxes (6,831) (10,932) (37,184)
Provision (benefit) for income taxes 229 (325) 250
-------- -------- --------
Loss from continuing operations (7,060) (10,607) (37,434)
Income (loss) from discontinued operations 56 (5,047) (10,115)
-------- -------- --------
Net loss $ (7,004) $(15,654) $(47,549)
======== ======== ========
Basic and diluted loss per share:
Loss from continuing operations $ (0.12) $ (0.19) $ (0.69)
Income (loss) from discontinued operations -- (0.09) (0.19)
-------- -------- --------
Basic and diluted net loss per share $ (0.12) $ (0.28) $ (0.88)
======== ======== ========
Weighted average shares (basic and diluted) 58,202 56,862 54,329
======== ======== ========
(A) Includes net revenues from related party $ 1,136 $ 1,416 $ 1,845
======== ======== ========
(B) Cost of revenues includes the following:
Amortization of purchased intangible assets $ 1,432 $ 2,071 $ 3,619
Impairment of purchased intangible assets -- -- 3,082
Stock-based compensation -- 48 89
-------- -------- --------
$ 1,432 $ 2,119 $ 6,790
======== ======== ========
(C) Stock-based compensation is excluded from the following:
Selling, general and administrative expenses $ 160 $ 306 $ 1,074
Research and development expenses 11 41 379
-------- -------- --------
$ 171 $ 347 $ 1,453
======== ======== ========
See accompanying notes
F-4
LANTRONIX, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
NOTES ACCUMULATED TOTAL
ADDITIONAL RECEIVABLE OTHER STOCK-
COMON STOCK PAID-IN FROM DEFERRED ACCUMULATED COMPREHENSIVE HOLDERS'
SHARES AMOUNT CAPITAL OFFICERS COMPENSATION DEFICIT INCOME (LOSS) EQUITY
----------- ------- ----------- -------- ------------ ----------- ----------- ---------
Balance at
June 30, 2002 54,252,528 $ 5 $ 179,547 $ (28) $ (4,546) $ (92,875) $ 54 $ 82,157
Stock options
exercised 152,004 -- 37 -- -- -- -- 37
Repurchase of
common stock (448,335) -- -- -- -- -- -- --
Employee stock
purchase plan 406,205 -- 280 -- -- -- -- 280
Deferred
compensation
net -- -- (2,310) -- 2,548 -- -- 238
Stock-based
compensation -- -- -- -- 1,303 -- -- 1,303
Repayment of
notes
receivable -- -- -- 28 -- -- -- 28
Premise
settlement 1,063,372 1 1,074 -- -- -- -- 1,075
Components of
comprehensive
loss:
Translation
adjustment -- -- -- -- -- -- 148 148
Net loss -- -- -- -- -- (47,549) -- (47,549)
---------
Comprehensive
loss -- -- -- -- -- -- -- (47,401)
----------- ------- ----------- -------- ------------ ----------- ----------- ---------
Balance at
June 30, 2003 55,425,774 6 178,628 -- (695) (140,424) 202 37,717
Stock options
exercised 496,335 -- 359 -- -- -- -- 359
Employee stock
purchase plan 505,935 -- 369 -- -- -- -- 369
Deferred
compensation
net -- -- (197) -- 197 -- -- --
Stock-based
compensation -- -- -- -- 395 -- -- 395
Dunstan
settlement 1,726,703 -- 1,553 -- -- -- -- 1,553
Components of
comprehensive
loss:
Translation
adjustment -- -- -- -- -- -- 52 52
Net loss -- -- -- -- -- (15,654) -- (15,654)
---------
Comprehensive
loss -- -- -- -- -- -- -- (15,602)
----------- ------- ----------- -------- ------------ ----------- ----------- ---------
Balance at
June 30, 2004 58,154,747 6 180,712 -- (103) (156,078) 254 24,791
Stock options
exercised 281,862 -- 193 -- -- -- -- 193
Employee stock
purchase plan 353,804 -- 275 -- -- -- -- 275
Stock-based
compensation -- -- 84 -- 86 -- -- 170
Components of
comprehensive
loss:
Translation
adjustment -- -- -- -- -- -- (42) (42)
Change in net
unrealized
income on
investment -- -- -- -- -- -- 85 85
Net loss -- -- -- -- -- (7,004) -- (7,004)
---------
Comprehensive loss -- -- -- -- -- -- -- (6,961)
----------- ------- ----------- -------- ------------ ----------- ----------- ---------
Balance at
June 30, 2005 58,790,413 $ 6 $ 181,264 $ -- $ (17) $ (163,082) $ 297 $ 18,468
=========== ======= =========== ======== ============ =========== =========== =========
See accompanying notes.
F-5
LANTRONIX, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEARS ENDED JUNE 30,
--------------------
Cash flows from operating activities: 2005 2004 2003
-------- -------- --------
Net loss from continuing operations $ (7,060) $(10,607) $(37,434)
Net income (loss) from discontinued operations 56 (5,047) (10,115)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 611 1,742 2,361
Amortization of purchased intangible assets 1,497 2,219 4,221
Impairment of goodwill and purchased intangible assets -- -- 5,435
Stock-based compensation 171 395 1,542
Deferred income taxes -- (600) --
Provision for doubtful accounts 140 (164) (473)
Provision for inventory reserve 163 368 4,189
Loss on disposal of fixed assets 22 25 --
Equity losses from unconsolidated business -- 413 1,303
Loss on sale of long-term investment -- 31 --
Restructuring (recovery) charges (56) (1,551) 5,600
Litigation settlement costs -- -- 1,533
Revaluation of strategic investment -- 5,007 --
Foreign currency transaction gain 78 -- --
Changes in operating assets and liabilities:
Accounts receivable 456 708 2,875
Inventories (315) 199 581
Contract manufacturers' receivable 289 777 (154)
Prepaid expenses and other current assets 843 1,173 1,729
Other assets 112 (28) 148
Accounts payable 650 (725) 195
Due to related party -- -- (246)
Due to Gordian -- (1,000) (2,000)
Accrued settlements -- -- (2,004)
Warranty reserve (522) 577 714
Restructuring reserve (432) (932) (2,772)
Other current liabilities (1,073) 732 (1,906)
Net assets of discontinued operations -- 3,351 7,108
-------- -------- --------
Net cash used in operating activities (4,370) (2,937) (17,570)
-------- -------- --------
Cash flows from investing activities:
Purchases of property and equipment (124) (248) (222)
Purchases of marketable securities (1,000) (552) (11,000)
Proceeds from sale of long-term investment -- 7 --
Proceeds from sale of marketable securities 4,050 4,252 11,250
Acquisition of business, net of cash acquired -- -- (2,114)
-------- -------- --------
Net cash provided by (used in) investing activities 2,926 3,459 (2,086)
-------- -------- --------
Cash flows from financing activities
Net proceeds from issuances of common stock 468 726 317
Payment of convertible note payable (867) -- --
Proceeds from repayment of notes receivable from officers -- -- 28
(Payment) borrowing of line of credit (500) 500 --
Payment on capital lease obligations (11) -- --
-------- -------- --------
Net cash (used in) provided by financing activities (910) 1,226 345
-------- -------- --------
Effect of foreign exchange rate changes on cash (84) 52 148
-------- -------- --------
Increase (decrease) in cash and cash equivalents (2,438) 1,800 (19,163)
Cash and cash equivalents at beginning of period 9,128 7,328 26,491
-------- -------- --------
Cash and cash equivalents at end of period $ 6,690 $ 9,128 $ 7,328
======== ======== ========
Supplemental disclosure of cash flow information:
Interest paid $ 85 $ 43 $ 13
Income taxes paid $ 179 $ 708 $ 49
See accompanying notes
F-6
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2005
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
THE COMPANY
Lantronix, Inc. (the "Company"), incorporated in California in June
1989 and re-incorporated in the State of Delaware in May 2000, is engaged
primarily in the design and distribution of networking and Internet connectivity
products on a worldwide basis. The actual assembly and a portion of the
engineering of the Company's products are outsourced to third parties.
The Company has incurred losses from operations and has reported
negative operating cash flows. As of June 30, 2005, the Company had an
accumulated deficit of $163.1 million and cash and cash equivalents and
marketable securities of $6.8 million. The Company has no material financial
commitments other than operating lease agreements and inventory purchase orders.
The Company believes that its existing cash and cash equivalents, and any cash
generated from operations, will be sufficient to fund its working capital
requirements, capital expenditures and other obligations through the next twelve
months. Long term the Company may face significant risks associated with the
successful execution of its business strategy and may need to raise additional
capital in order to fund more rapid expansion, to expand its marketing
activities, to develop new or enhance existing services or products, and to
respond to competitive pressures or to acquire complementary services,
businesses, or technologies. If the Company is not successful in generating
sufficient cash flow from operations, it may need to raise additional capital
through public or private financing, strategic relationships, or other
arrangements.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation. At June 30,
2005, approximately $2.5 million of the Company's net tangible assets (primarily
cash held in foreign bank accounts) were located outside the U.S. Such assets
are unrestricted with regard to foreign liquidity needs, however, the ability of
the Company to utilize such assets to satisfy liquidity needs outside of such
foreign locations are subject to approval by the foreign location board of
directors.
In March 2004, the Company completed the sale of substantially all of
the net assets of Premise Systems, Inc. ("Premise") (Note 8). The Company's
consolidated financial statements have been presented to reflect Premise as a
discontinued operation for all periods presented.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. The industry in which the Company
operates is characterized by rapid technological change and short product life
cycles. As a result, estimates made in preparing the consolidated financial
statements include the allowance for doubtful accounts, sales returns and
allowances, inventory reserves, allowance for officer loans, strategic
investments, goodwill and purchased intangible asset valuations, deferred income
tax asset valuation allowances, warranty reserves, restructuring costs,
litigation and other contingencies. To the extent there are material differences
between estimates and the actual results, future results of operations will be
affected.
REVENUE RECOGNITION
The Company does not recognize revenue until all of the following
criteria are met: persuasive evidence of an arrangement exists; delivery has
occurred or services have been rendered; the Company's price to the buyer is
fixed or determinable; and collectibility is reasonably assured. However, a
significant portion of our sales are made to distributors under agreements which
contain a limited right to return unsold product and price protection provisions
The recognition of revenue and related cost of revenues from sales to
distributors are deferred until the distributor resells the product. Net revenue
from certain smaller distributors, for which point-of-sale information is not
available, is recognized approximately one month after the shipment date. This
estimate approximates the timing of the sale of the product by the distributor
to the end user.
When product sales revenue is recognized, the Company establishes an
estimated allowance for future product returns based on historical returns
experience; when price reductions are approved, it establishes an estimated
liability for price protection payable on inventories owned by product
resellers. Should actual product returns or pricing adjustments exceed the
Company's estimates, additional reductions to revenues would result.
F-7
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
Revenue from the licensing of software is recognized at the time of
shipment (or at the time of resale in the case of software products sold through
distributors), provided the Company has vendor-specific objective evidence of
the fair value of each element of the software offering and collectibility is
probable. Additionally, the Company sells extended warranty services which
extend the warranty period for an additional one to three years, depending upon
the product. Warranty revenue is recognized ratably over the warranty service
period.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company maintains an allowance for doubtful accounts for estimated
losses resulting from the inability of its customers to make required payments.
The Company's allowance for doubtful accounts is based on its assessment of the
collectibility of specific customer accounts, the aging of accounts receivable,
the Company's history of bad debts and the general condition of the industry.
Accounts that are deemed uncollectible are written off against the allowance for
doubtful accounts. If a major customer's creditworthiness deteriorates, or the
Company's customers' actual defaults exceed its historical experience, its
estimates could change and impact their reported results. The Company also
maintains a reserve for uncertainties relative to the collection of officer
notes receivable. Factors considered in determining the level of this reserve
include the value of the collateral securing the notes, our ability to
effectively enforce collection rights and the ability of the former officers to
honor their obligations.
CONCENTRATION OF CREDIT RISK
The Company's accounts receivable are derived from revenues earned from
customers located throughout North America, Europe and Asia. The Company
performs ongoing credit evaluations of its customers' financial condition and
maintains allowances for potential credit losses. Credit losses have
historically been within management's expectations. The Company generally does
not require collateral or other security from its customers. The Company invests
its excess cash in deposits with major banks, in U.S. Government agencies,
state, municipal and county government notes and bonds.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's financial instruments consist principally of cash, cash
equivalents, marketable securities, accounts receivable, notes receivable,
contract manufacturers' receivable, accounts payable, convertible note payable,
bank line of credit and accrued liabilities. The Company believes all of the
financial instruments' recorded values approximate current values because of the
nature and short duration of these instruments.
FOREIGN CURRENCY TRANSLATION
The financial statements of foreign subsidiaries whose functional
currency is not the U.S. dollar have been translated to U.S. dollars in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 52,
"Foreign Currency Translation." Foreign currency assets and liabilities are
valued in U.S. dollars at the end-of-period exchange rates. Revenues and
expenses are translated at average exchange rates in effect during each period.
Exchange gains and losses from foreign currency translations are reported as a
component of accumulated other comprehensive income (loss) within stockholders'
equity. Exchange gains and losses from foreign currency transactions are
recognized in the consolidated statement of operations and historically have not
been material.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and short-term investments
with original maturities of 90 days or less.
F-8
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
INVESTMENTS
AVAILABLE-FOR-SALE INVESTMENTS
The Company accounts for its investments in debt and equity securities
with readily determinable fair values that are not accounted for under the
equity method of accounting under SFAS 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. The Company
classifies its marketable securities as available-for-sale under SFAS 115.
Marketable securities consist of equity securities and obligations of municipal
government notes and bonds which can be readily converted to cash. Debt
securities are adjusted for amortization of premiums and discounts to maturity
and such amortization is included in interest income. The specific
identification method is used to determine the cost basis of securities disposed
of. Unrealized gains and losses on the marketable securities are included as a
separate component of accumulated comprehensive income, net of tax.
LONG-TERM INVESTMENTS
The Company is accounting for its long-term investment in Xanboo Inc.
("Xanboo") under the equity method based upon the Company's ability, through
representation on Xanboo's board of directors, to exercise significant influence
over its operations. Under the equity method of accounting, the Company's
proportionate share of income or losses from the long-term investment, and any
gain or loss on disposal, are recorded in other expense, net.
IMPAIRMENT OF INVESTMENTS
The Company periodically reviews its investments for which fair value
is less than cost to determine if the decline in value is other-than-temporary.
Additionally, the Company monitors its long-term investment for impairment and
makes appropriate reductions in the carrying value if the Company determines
that an impairment charge is required based primarily on the financial condition
and near-term prospects of the investment. If the decline in value is judged to
be other-than-temporary, the cost basis of the security is written down to fair
value. The Company generally believes an other-than-temporary decline has
occurred when the fair value of the investment is below the carrying value for
two consecutive fiscal quarters, absent evidence to the contrary.
INVENTORIES
Inventories are stated at the lower of cost (on a first-in, first-out
basis) or market. The Company provides reserves for excess and obsolete
inventories determined primarily based upon estimates of future demand for the
Company's products. Shipping and handling costs are classified as a component of
cost of revenues in the consolidated statements of operations.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost. Depreciation is provided
using the straight-line method over the assets' estimated useful lives ranging
from three to five years. Depreciation and amortization of leasehold
improvements are computed using the shorter of the remaining lease term or five
years. Major renewals and betterments are capitalized, while replacements,
maintenance and repairs, which do not improve or extend the lives of the
respective assets, are expensed as incurred.
CAPITALIZED INTERNAL USE SOFTWARE COSTS
The Company capitalizes the costs of computer software developed or
obtained for internal use in accordance with AICPA Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." Capitalized computer software costs consist of purchased software
licenses and implementation costs. As of June 30, 2005 and 2004, $11,000 and
$75,000, respectively, are included in computer and office equipment in the
accompanying consolidated balance sheets. The capitalized software costs are
being amortized on a straight-line basis over a period of three years.
Amortization for the fiscal years ended June 30, 2005, 2004 and 2003 totaled
$64,000, $659,000 and $776,000, respectively. Capitalized internal use software
with a net carrying amount of approximately $107,000 was written off for the
fiscal year ended June 30, 2003 as a result of the Company's fiscal 2003
restructuring plan (Note 7). No similar write-offs were recorded for the fiscal
years ended June 30, 2005 and June 30, 2004.
F-9
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
GOODWILL AND PURCHASED INTANGIBLE ASSETS
Goodwill is recorded as the difference, if any, between the aggregate
consideration paid for an acquisition and the fair value of the net tangible and
intangible assets acquired. In accordance with SFAS No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"), the Company tests goodwill for impairment at
the reporting unit level (operating segment or one level below an operating
segment) on an annual basis in the fourth fiscal quarter or more frequently if
the Company believes indicators of impairment exist. The performance of the test
involves a two-step process. The first step of the impairment test involves
comparing the fair values of the applicable reporting units with their aggregate
carrying value, including goodwill. The Company generally determines the fair
value of its reporting units using the market or income approach methodology of
valuation that includes comparing to market values of similar companies, the
discounted cash flow method as well as other generally accepted valuation
methodologies. If the carrying amount of a reporting unit exceeds the reporting
unit's fair value, the Company performs the second step of the goodwill
impairment test to determine the amount of impairment loss. The second step of
the goodwill impairment test involves comparing the implied fair value of the
affected reporting unit's goodwill with the carrying value of that goodwill.
The Company accounts for long-lived assets, including other purchased
intangible assets, in accordance with SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), which requires
impairment losses to be recorded on long-lived assets used in operations when
indicators of impairment are present. Reviews are performed to determine whether
the carrying value of an asset is impaired, based on comparisons to undiscounted
expected future cash flows. If this comparison indicates that there is
impairment, the impaired asset is written down to fair value, which is typically
calculated using (i) quoted market prices and/or (ii) discounted expected future
cash flows utilizing a discount rate consistent with the guidance provided in
FASB Concepts Statement No. 7, "Using Cash Flow Information and Present Value in
Accounting Measurements." Impairment is based on the excess of the carrying
amount over the fair value of those assets.
DISCONTINUED OPERATIONS
In accordance with SFAS 144, all of the assets and liabilities within a
separate business segment or reporting unit that has been disposed of through
closure or sale, or are classified as held for sale, are disclosed separately as
assets or liabilities within discontinued operations in the consolidated balance
sheets for all periods presented. The assets and liabilities are deemed to be
held for sale upon management's approval and commitment to a plan to dispose of
or sell the business segment or reporting unit. Also, the revenues and expenses
associated with these business segments or reporting units are included within
loss from discontinued operations, net of tax, in the consolidated statements of
operations for all periods presented.
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 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. A valuation allowance is
recorded when it is more likely than not that some of the deferred tax assets
will not be realized.
STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to employees in accordance
with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB 25"), and related interpretations, and has adopted
the disclosure-only alternative of SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), and SFAS No. 148, "Accounting for Stock-Based
Compensation Transition and Disclosure" ("SFAS 148"). Options granted to
non-employees, as defined, have been accounted for at fair market value in
accordance with SFAS 123.
F-10
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
The Company also complies with Financial Accounting Standards Board
("FASB") Interpretation No. 44, "Accounting for Certain Transactions Involving
Stock Compensation - An Interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44
clarifies the definition of an employee for purposes of applying APB 25, the
criteria for determining whether a plan qualifies as a non-compensatory plan,
the accounting consequence of various modifications to the terms of a previously
fixed stock option or award, and the accounting for an exchange of stock
compensation awards in a business combination. The rules require that the
intrinsic value of unvested options be allocated to deferred compensation and
recognized as stock-based compensation expense ratably over the remaining future
vesting period. In the event that a holder does not fully vest in the unvested
options, the unamortized portion of deferred compensation is eliminated.
For stock option grants to non-employees who are consultants to the
Company, the Company complies with the provisions of Emerging Issues Task Force
("EITF") Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to
Other Than Employees for Acquiring, or in Conjunction with, Selling Goods or
Services" ("EITF 96-18"). EITF 96-18 requires variable plan accounting with
respect to such non-employee stock options, whereby compensation associated with
such options is measured on the date such options vest, and incorporates the
then-current fair market value of the Company's common stock into the option
valuation model.
Pro forma information regarding net income loss per share is required
by SFAS 123 and has been determined as if the Company had accounted for its
employee stock options under the fair value method of SFAS 123.
The value of the Company's stock-based awards granted to employees
prior to the Company's initial public offering in August 2000 was estimated
using the minimum value method, which does not consider stock price volatility.
Stock-based awards granted subsequent to the initial public offering have been
valued using the Black-Scholes option pricing model. Among other things, the
Black-Scholes model considers the expected volatility of the Company's stock
price, determined in accordance with SFAS 123, in arriving at an option
valuation. Estimates and other assumptions necessary to apply the Black-Scholes
model may differ significantly from assumptions used in calculating the value of
options granted prior to the initial public offering under the minimum value
method.
The fair value of options granted to employees after the initial
public offering were estimated using the following weighted average assumptions
(in thousands except per share data):
YEARS ENDED JUNE 30,
2005 2004 2003
---- ---- ----
Expected life (in years) 4.00 4.00 4.00
Volatility 0.97 1.24 1.28
Risk-free interest rate 3.57% 3.60% 1.90%
Dividend yield 0.00% 0.00% 0.00%
Weighted average fair value $ 0.80 $ 1.09 $ 0.68
For pro forma purposes, the estimated value of the Company's
stock-based awards to employees is amortized over the vesting period of the
underlying instruments. The results of applying SFAS 123 to the Company's
stock-based awards to employees would approximate the following (in thousands
except per share data):
F-11
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
YEARS ENDED JUNE 30,
--------------------
2005 2004 2003
-------- -------- --------
Net loss as reported $ (7,004) $(15,654) $(47,549)
Add: Stock-based employee compensation expense included
in net loss - as reported, net of related tax effects 171 395 1,542
Deduct: Stock-based employee compensation expense determined
under fair value method, net of related tax effects (1,186) (3,092) (6,304)
-------- -------- --------
Net loss - pro forma $ (8,019) $(18,351) $(52,311)
======== ======== ========
Net loss per share (basic and diluted) - as reported $ (0.12) $ (0.28) $ (0.88)
======== ======== ========
Net loss per share (basic and diluted) - pro forma $ (0.14) $ (0.32) $ (0.96)
======== ======== ========
LOSS PER SHARE
Basic and diluted loss per share is calculated by dividing net loss by
the weighted average number of common shares outstanding during the year.
The following table presents the computation of net loss per share (in
thousands except per share data).
YEARS ENDED JUNE 30,
Numerator 2005 2004 2003
-------- -------- --------
Loss from continuing operations $ (7,060) $(10,607) $(37,434)
Income (loss) from discontinued operations 56 (5,047) (10,115)
-------- -------- --------
Net Loss $ (7,004) $(15,654) $(47,549)
======== ======== ========
Denominator
Weighted-average shares outstanding 58,534 57,194 54,661
Less: Unvested common shares outstanding (332) (332) (332)
-------- -------- --------
Denominator for basic and diluted loss per share 58,202 56,862 54,329
======== ======== ========
Basic and diluted loss per share from continuing operations $ (0.12) $ (0.19) $ (0.69)
Basic and diluted income (loss) from discontinued operations 0.00 (0.09) (0.19)
-------- -------- --------
Basic and diluted net loss per share $ (0.12) $ (0.28) $ (0.88)
======== ======== ========
Common stock equivalents of 2,297,323, 1,126,503 and 453,053 have been
excluded from the diluted net loss per share calculation for the fiscal years
ended June 30, 2005, 2004 and 2003, respectively, because they were
anti-dilutive as of such dates. These excluded common stock equivalents could be
dilutive in the future.
RESEARCH AND DEVELOPMENT COSTS
Costs incurred in the research and development of new products and
enhancements to existing products are expensed as incurred. The Company believes
its current process for developing products is essentially completed
concurrently with the establishment of technological feasibility. Software
development costs incurred after the establishment of technological feasibility
have not been material and, therefore, have been expensed as incurred.
WARRANTY
Upon shipment to its customers, the Company provides for the estimated
cost to repair or replace products to be returned under warranty. The Company's
products typically carry a one-to two-year warranty. In addition, certain
products that were sold prior to August 2003 carry a five-year warranty.
F-12
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
Although the Company engages in extensive product quality programs and
processes, its warranty obligation is affected by product failure rates, use of
materials or service delivery costs that differ from our estimates. As a result,
additional warranty reserves could be required, which could reduce gross
margins. Additionally, the Company sells extended warranty services, which
extend the warranty period for an additional one to three years depending upon
the product.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. Advertising expense
was approximately $1.1 million, $392,000, and $336,000 for the fiscal years
ended June 30, 2005, 2004 and 2003, respectively.
COMPREHENSIVE INCOME
SFAS No. 130, "Reporting Comprehensive Income," establishes standards
for reporting and displaying comprehensive income (loss) and its components in
the consolidated financial statements. Other accumulated comprehensive loss
includes foreign currency translation adjustments and unrealized gains on
investments.
SEGMENT INFORMATION
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," establishes standards for the way companies report information
about operating segments in annual financial statements. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. The Company has only one reportable segment, networking and
internet connectivity.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2004, the FASB issued SFAS No. 151, "Inventory Costs - An
Amendment of ARB 43, Chapter 4" ("SFAS 151"). This new standard is the result of
a broader effort by the FASB to improve financial reporting by eliminating
differences between Generally Accepted Accounting Principles ("GAAP") in the
U.S. and accounting principles developed by the International Accounting
Standards Board ("IASB"). As part of this effort, the FASB and the IASB
identified opportunities to improve financial reporting by eliminating certain
narrow differences between their existing accounting standards. SFAS 151
clarifies that abnormal amounts of idle facility expense, freight handling costs
and spoilage costs should be expensed as incurred and not included in overhead.
Further, SFAS 151 requires that allocation of fixed production overheads to
conversion costs should be based on normal capacity of the production
facilities. The provisions in SFAS 151 are effective for inventory costs
incurred during fiscal years beginning after June 15, 2005. Companies must apply
the standard prospectively. Management does not expect the adoption of SFAS 151
to have a material impact on the Company's financial position, results of
operations or cash flows.
In December 2004, the FASB issued SFAS No. 123 (revised 2004),
"Share-Based Payment," ("SFAS 123R"), which is a revision to SFAS 123 and which
supersedes APB 25 and its related implementation guidance. SFAS 123R establishes
standards for the accounting for transactions in which an entity exchanges
equity instruments for goods or services. It also addresses transactions in
which an entity incurs liabilities in exchange for goods or services that are
based on the fair value of the entity's equity instruments or that may be
settled by the issuance of those equity instruments. SFAS 123R established the
accounting treatment for transactions in which an entity obtains employee
services in share-based payment transactions. SFAS 123R requires companies to
recognize in the statement of operations the grant-date fair value of stock
options and other equity-based compensation issued to employees. SFAS 123R
requires the Company to value the share-based compensation based on the
classification of the share-based award. If the share-based award is to be
classified as a liability, the Company must re-measure the award at each balance
sheet date until the award is settled. If the share-based award is to be
classified as equity, the Company will measure the value of the share-based
award on the date of grant but the award will not be re-measured at each balance
sheet date. SFAS 123R does not change the accounting guidance for share-based
payment transactions with parties other than employees provided in SFAS 123 as
F-13
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
originally issued and EITF 96-18. SFAS 123R is effective for public companies
that do not file as small business issuers no later than the beginning of the
first fiscal year beginning after June 15, 2005. All public companies must use
either the modified prospective or modified retrospective transition method.
Under the modified prospective method, awards that are granted, modified, or
settled after the date of adoption should be measured and accounted for in
accordance with SFAS 123R. Unvested equity classified awards that were granted
prior to the effective date should continue to be accounted for in accordance to
SFAS 123 except that the amounts must be recognized in the statement of
operations. Under the modified retrospective method, the previously reported
amounts are restated (either to the beginning of the year of adoption or for all
periods presented) to reflect SFAS 123 amounts in the statement of operations.
The Company expects to adopt SFAS 123R under the modified prospective method.
The adoption of SFAS 123R will have a significant impact on the Company's
reported results of operations, although it will not have a significant impact
on the overall financial position. The impact of adoption of SFAS 123R cannot be
predicted at this time because that will depend on the fair value and number of
share-based payments granted in the future. However, had the Company adopted
SFAS 123R in prior periods, the magnitude of the impact of that standard would
have approximated the impact of SFAS 123, assuming the application of the
Black-Scholes model as described in the above stock-based compensation
disclosure of pro forma net loss and pro forma loss per share.
In May 2005, FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections" ("SFAS 154"). SFAS 154 requires retroactive application of a
voluntary change in accounting principle to prior period financial statements
unless it is impracticable. SFAS 154 also requires that a change in method of
depreciation, amortization, or depletion for long-lived, non-financial assets be
accounted for as a change in accounting estimate that is affected by a change in
accounting principle. SFAS 154 replaces APB Opinion 20, "Accounting Changes",
and SFAS 3, "Reporting Accounting Changes in Interim Financial Statements." The
Company will adopt the provisions of SFAS 154 in fiscal 2007 consolidated
financial statements. Management currently believes that adoption of the
provisions of SFAS 154 will not have a material impact on the Company's
consolidated financial statements.
Other recent accounting pronouncements issued by the FASB (including
its Emerging Issues Task Force), the American Institute of Certified Public
Accountants, and the Securities and Exchange Commission did not or are not
believed by management to have a material impact on the Company's present or
future consolidated financial statements.
2. BUSINESS COMBINATIONS
During August 2002, the Company completed the acquisition of Stallion
Technologies PTY, LTD ("Stallion"). This acquisition was accounted for under the
purchase method of accounting. The consolidated financial statements include the
results of operations of this acquisition commencing as of its acquisition date.
The acquisition of Stallion complemented the Company's existing multi-port and
terminal server product lines.
The Stallion agreement required the Company to pay $1.2 million in cash
consideration and establish a cash escrow account in the amount of $867,000 at
the acquisition date to be used in lieu of the Company's common stock in the
event that the Company was unable to issue registered shares by October 31,
2002. The Company was not able to issue registered shares by October 31, 2002 in
accordance with the terms of the acquisition agreement, and the cash escrow of
$867,000 was released on November 1, 2002. In addition, the Company issued a
two-year convertible note payable in the principal amount of $867,000, which was
due and paid in August 2004 (Note 9). The Company relied on the exemption in
Section 4 (2) of the Securities Act of 1933, in that the offering of the
convertible note payable was not a public offering.
ALLOCATION OF PURCHASE CONSIDERATION
The Company obtained an independent appraisal of the fair value of the
tangible and intangible assets acquired in order to allocate the purchase price.
Based upon the appraisal, the purchase price was allocated as follows (in
thousands):
NET DEFERRED
LIABILITIES PURCHASED TAX TOTAL
COMPANY ACQUIRED ACQUIRED GOODWILL INTANGIBLES LIABILITIES CONSIDERATION
- ---------------- -------- -------- ----------- ----------- -------------
Stallion $ (93) (1) $ 2,270 $ 1,500 $ (600) $ 3,077
=========== ========= =========== =========== =============
(1) Net tangible assets acquired in connection with the purchase
transaction include the acquisition costs incurred by the Company.
F-14
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
3. SUPPLEMENTARY FINANCIAL INFORMATION
INVENTORIES (IN THOUSANDS)
JUNE 30,
--------
2005 2004
-------- --------
Raw materials $ 3,973 $ 4,047
Finished goods 7,277 7,368
Inventory at distributors 1,181 1,291
-------- --------
12,431 12,706
Reserve for excess and obsolete inventory (5,603) (6,029)
-------- --------
$ 6,828 $ 6,677
======== ========
PROPERTY AND EQUIPMENT (IN THOUSANDS)
JUNE 30,
--------
2005 2004
------- -------
Computer and office equipment $ 6,171 $ 5,873
Furniture and fixtures 1,082 978
Production and warehouse equipment 582 599
Transportation equipment -- 27
------- -------
7,835 7,477
Accumulated depreciation (7,161) (6,612)
------- -------
$ 674 $ 865
======= =======
As of June 30, 2005, property and equipment includes $203,000, net of
$11,000 of accumulated amortization, of office equipment recorded in connection
with capital lease obligations.
WARRANTY RESERVE (IN THOUSANDS):
JUNE 30,
--------
2005 2004
------- -------
Beginning balance $ 1,770 $ 1,193
Charged to cost of revenues (88) 1,168
Usage (434) (591)
------- -------
Ending balance $ 1,248 $ 1,770
======= =======
SUPPLEMENTARY CASH FLOW INFORMATION
The following table sets forth certain non-cash transactions excluded
from the consolidated statement of cash flows (in thousands):
2005 2004 2003
---- ---- ----
Acquisition of equipment through capital leases $ 214 $ -- $ --
Litigation settlement and legal expenses paid
by insurance carrier 1,671 -- --
Tenant leasehold improvements 98 -- --
F-15
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
4. INVESTMENTS
MARKETABLE SECURITIES
The Company's available-for-sale investments, which are classified as
marketable securities in the consolidated balance sheets, are as follows (in
thousands):
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ------
JUNE 30, 2005
Publicly traded equity securities $ -- $ 85 $ -- $ 85
========= ========== ========== ======
JUNE 30, 2004
Municipal government notes and bonds $ 3,050 $ -- $ -- $3,050
========= ========== ========== ======
There were no gross realized gains and losses related to the Company's
available-for-sale investments during the fiscal years ended June 30, 2005 and
2004.
LONG-TERM INVESTMENTS
In September and October 2001, the Company paid an aggregate of $3.0
million to Xanboo Inc. for convertible promissory notes, which converted in
January 2002, in accordance with their terms, into Xanboo preferred stock. In
addition, the Company purchased $4.0 million of Xanboo preferred stock in
January 2002. The Company's ownership interest in Xanboo was 14.4% and 14.9% at
June 30, 2005 and 2004, respectively. On the basis of events occurring during
the fiscal quarter ended June 30, 2004, the Company performed an analysis and
recorded a charge in the amount of $5.0 million, representing a write-off of all
remaining value of this non-marketable equity security. This charge was included
within the consolidated statements of operations as other expense. The Company's
interest in the losses of Xanboo aggregating $413,000 and $1.3 million during
the fiscal years ended June 30, 2004 and 2003, respectively, were recognized as
other expense in the accompanying consolidated statement of operations. As of
June 30, 2005 and 2004, the carrying value of our long-term investment in Xanboo
was zero.
5. OFFICER LOANS
The Company had net outstanding notes receivable from officers of
$116,000 and $110,000 (net of allowance of $4.5 million) at June 30, 2005 and
2004, respectively, primarily related to taxes on exercised stock options. These
notes are non-recourse, are secured by 2,573,394 shares of common stock, and are
interest bearing at rates ranging from 5.19% to 7.50% per annum. Principal and
any unpaid interest are due upon any transfer or disposition of the common
stock. One of the note holders is the former Chief Executive Officer who assumed
the role of Chief Technology and Strategy Officer of the Company effective May
30, 2002 and resigned from the Company effective September 1, 2002. One of the
note holders is one of the Company's outside directors and one of the note
holders is the former Chief Operating/Chief Financial Officer who was terminated
by the Company on May 3, 2002. The Company reduced the carrying amount of the
officer loans by $4.5 million by establishing a reserve for uncertainties
relative to collection of the related receivables. Factors considered in
determining the level of this reserve include the value of the collateral
securing the notes, the ability of the Company to effectively enforce its
collection rights and the ability of the former officers to honor their
obligations to the Company. As of June 30, 2005, no impairment has been recorded
as it relates to the note receivable from the outside director.
F-16
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
6. GOODWILL AND PURCHASED INTANGIBLE ASSETS
GOODWILL
The change in the carrying amount of goodwill is as follows (in
thousands):
JUNE 30,
2005 2004 2003
------ ------ ------
Beginning balance $9,488 $9,488 $7,218
Goodwill acquired during the period -- -- 2,270
------ ------ ------
Ending balance $9,488 $9,488 $9,488
====== ====== ======
The above table excludes goodwill impairments as they relate to the
sale of the Company's Premise business unit as more fully disclosed in Note 8.
PURCHASED INTANGIBLE ASSETS
The composition of purchased intangible assets is as follows (in
thousands):
JUNE 30, 2005 JUNE 30, 2004
------------- -------------
USEFUL ACCUMULATED ACCUMULATED
LIVES GROSS AMORTIZATION NET GROSS AMORTIZATION NET
----- ----- ------------ --- ----- ------------ ---
Existing technology 1 - 5 years $ 7,090 $ (6,533) $ 557 $ 7,090 $ (5,101) $ 1,989
Patent/core technology 5 405 (405) -- 405 (365) 40
Tradename/trademark 5 32 (30) 2 32 (24) 8
Non-compete agreements 2 - 3 140 (140) -- 140 (121) 19
------- ----------- ------- ------- ------------ -------
Total $ 7,667 $ (7,108) $ 559 $ 7,667 $ (5,611) $ 2,056
======= =========== ======= ======= ============ =======
The unamortized balance of purchased intangible assets as of June 30,
2005 will be amortized during fiscal 2006 as follows (in thousands):
COST OF OPERATING
REVENUES EXPENSES TOTAL
-------- --------- -----
Fiscal year ending June 30, 2006 $ 557 $ 2 $ 559
======== ========= =====
IMPAIRMENT OF GOODWILL AND PURCHASED INTANGIBLE ASSETS
During the fiscal quarter ended June 30, 2003, the Company performed an
assessment of the value of its purchased intangible assets in accordance with
SFAS 144. As a result of industry conditions, continued lower market valuations,
reduced estimates in information technology capital equipment spending in the
future, and other factors impacting expected future cash flows, the Company
determined that there were indicators of impairment to the carrying value of its
purchased intangible assets recorded as part of its acquisitions. The Company
engaged an independent valuation company to perform a review of the value of its
purchased intangible assets. Based on the independent valuations, during the
fiscal quarter ended June 30, 2003, the Company recorded a $5.4 million
impairment charge of which $2.3 million and $3.1 million were charged to
operating expenses and cost of revenues, respectively. No such impairments were
recorded for the fiscal years ended June 30, 2005 and 2004.
F-17
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
During the fiscal quarters ended June 30, 2005, 2004 and 2003, the
Company completed its annual goodwill impairment tests in accordance with SFAS
142 and determined that no impairment was indicated as the estimated fair values
exceeded their respective carrying values.
GORDIAN INTELLECTUAL PROPERTY AGREEMENT
The Company announced on May 30, 2002 that it had signed a new
intellectual property agreement with Gordian, Inc., the Company's provider of
product designs and engineering services. The agreement gives the Company joint
ownership of the Gordian intellectual property that is embodied in the products
Gordian has designed for the Company since 1989. The agreement provides that the
Company will be able to use the intellectual property to support, maintain and
enhance its products. The agreement extinguishes the Company's obligations to
pay royalties for each unit of a Gordian-designed product that it sells.
The intellectual property agreement required the Company to pay Gordian
$6.0 million in order to acquire an interest in the Gordian intellectual
property, which was paid in three installments. The Company paid $3.0 million
concurrent with the signing of the agreement, $2.0 million on July 1, 2002 and
the remaining $1.0 million on July 1, 2003. The Company agreed to purchase $1.5
million of engineering and support services from Gordian over the next 18
months. The Company is amortizing the intellectual property rights over the
remaining life cycles of the products designed by Gordian, or approximately
three years. The Company recorded $1.1 million, $1.8 million and $2.5 million of
amortization expense included in cost of revenues for the fiscal years ended
June 30, 2005, 2004 and 2003, respectively.
7. RESTRUCTURING CHARGES
From the fiscal quarter ended March 31, 2002 through the fiscal quarter
ended March 31, 2003, the Company implemented plans to restructure its
operations to prioritize its initiatives around the growth area of its business,
focus on profit contribution, reduce expenses, and improve operating efficiency.
These restructuring plans included a worldwide workforce reduction,
consolidation of excess facilities and other charges. During the fiscal years
ended June 30, 2004 and 2003, approximately 58 and 50 employees, respectively,
were terminated across all of the Company's business functions and geographic
regions in connection with the restructuring plans.
During the fiscal year ended June 30, 2004, the Company completed the
sale of its Premise business unit as more fully disclosed in Note 8. As a
result, the Company recorded approximately $670,000 of restructuring charges
which are included in loss from discontinued operations in the consolidated
statement of operations of which $633,000 related to certain future lease
obligations and $37,000 related to workforce reductions of three Premise
employees that were not transferred to the buyer.
During the fiscal year ended June 30, 2004, approximately $2.1 million
of restructuring charges were recovered related to a favorable settlement of a
contractual obligation, consolidation of excess facilities and workforce
reductions which were previously accrued for during the fiscal year ended June
30, 2003. No similar recovery occurred during the fiscal year ended June 30,
2005. The remaining restructuring reserve is related to facility closures in
Naperville, Illinois; Hillsboro, Oregon; and Ames, Iowa. Payments under the
lease obligations will end in fiscal 2007.
F-18
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
A summary of the activity in the restructuring liability account is as
follows (in thousands):
RESTRUCTURING RESERVE
CONSOLIDATION
WORKFORCE OF EXCESS CONTRACTUAL
REDUCTIONS FACILITIES OBLIGATIONS TOTAL
--------- --------- ----------- -------
Restructuring liabilities at June 30, 2003 $ 260 $ 975 $ 2,000 $ 3,235
Restructuring recovery (183) (360) (1,550) (2,093)
Restructuring activity included in discontinued operations 21 521 -- 542
Cash payments (98) (384) (450) (932)
--------- --------- ----------- -------
Restructuring liabilities at June 30, 2004 -- 752 -- 752
Restructuring activity included in discontinued operations -- (56) -- (56)
Cash payments -- (432) -- (432)
--------- --------- ----------- -------
Restructuring liabilities at June 30, 2005 $ -- $ 264 $ -- $ 264
========= ========= =========== =======
8. DISCONTINUED OPERATIONS
In March 2004, the Company completed the sale of substantially all of
the net assets of its Premise business unit for $1.0 million. Additionally, the
Company incurred $383,000 of disposal costs.
The net revenues and loss from discontinued operations are as follows
(in thousands):
YEARS ENDED JUNE 30,
2005 2004 2003
-------- -------- --------
Net revenues $ -- $ 86 $ 120
======== ======== ========
Gain (Loss) from discontinued operations $ 56 $ (5,639) $(10,115)
Gain on sale of assets of discontinued operations -- 592 --
-------- -------- --------
Loss from discontinued operations, net of income taxes of $0 $ 56 $ (5,047) $(10,115)
======== ======== ========
The Company performed its annual impairment tests under the guidelines
of SFAS 142 as of April 1, 2003. The Company compared the carrying value of each
reporting unit to its estimated fair value calculated with the assistance of an
independent valuation company. An impairment loss was recognized for reporting
units where the carrying value of their goodwill exceeded the implied fair value
of goodwill. Based on this assessment, the Company recorded a charge of $4.4
million during the fiscal year ended June 30, 2003 to write down the value of
goodwill related to the Premise acquisition. The impairment of the Premise
goodwill is included in the loss from discontinued operations in the
consolidated statements of operations for the fiscal year ended June 30, 2003.
During the fiscal quarter ended December 31, 2003, the Company
identified indicators of an other than temporary impairment as it related to its
Premise acquisition of goodwill and purchased intangible assets. The Company
performed an assessment of the value of its goodwill and purchased intangible
assets related to the Premise acquisition in accordance with SFAS 142 and SFAS
144. The Company identified certain conditions including continued losses and
the inability to achieve significant revenues from the existing home automation
and media management software markets as indicators of asset impairment. These
conditions led to operating results and forecasted future results that were
substantially less than had been anticipated. The Company revised its
projections and determined that the projected results utilizing a discounted
cash flow valuation technique would not fully support the carrying values of the
goodwill and purchased intangible assets associated with the Premise
acquisition. Based on this assessment, the Company recorded an impairment charge
of $2.2 million during the fiscal quarter ended December 31, 2003 to write-off
F-19
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
the value of the Premise goodwill. Additionally, the Company recorded a $790,000
impairment charge for the Premise-purchased intangible assets. The impairment of
Premise goodwill and purchased intangibles are included in the loss from
discontinued operations in the consolidated statements of operations for the
fiscal year ended June 30, 2004.
9. BANK LINE OF CREDIT AND DEBT
In January 2002, the Company entered into a two-year line of credit
with a bank in an amount not to exceed $20.0 million. Borrowings under the line
of credit bear interest at either, (i) the prime rate or (ii) the LIBOR rate
plus 2.0%. The Company was required to pay a $100,000 facility fee which was
reduced to $62,500 and was paid. The Company was also required to pay a
quarterly unused line fee of .125% of the unused line of credit balance. Since
establishing the line of credit, the Company has twice reduced the amount of the
line, modified customary financial covenants, and adjusted the interest rate to
be charged on borrowings to the prime rate plus .50% and eliminated the LIBOR
option. Effective July 25, 2003, the Company further modified this line of
credit, reducing the revolving line to $5.0 million and adjusting the customary
affirmative and negative covenants. The Company is also required to maintain
certain financial ratios as defined in the agreement. The agreement has an
annual revolving maturity date that renews on the effective date. The agreement
was renewed on July 24, 2004, with an amendment to a financial ratio, and again
on February 15, 2005 with an amendment to a covenant. The Company paid $12,500
and $1,000 in facility fees, respectively, for the renewals. The Company's
revolving credit line at June 30, 2005 was $3.0 million. As of June 30, 2005,
the Company had no borrowings against this line of credit. As of June 30, 2004,
the Company had $500,000 in borrowings against this line of credit.
Additionally, at June 30, 2005, the Company has used letters of credit available
under its line of credit totaling approximately $480,000 in place of cash to
fund deposits on leases, tax account deposits and security deposits. As a
result, the Company's available line of credit at June 30, 2005 was $2.5
million. Pursuant to the line of credit, the Company was restricted from paying
any dividends. As of June 30, 2005, the Company was not in compliance with the
quick ratio covenant as defined in the agreement. A waiver was granted by the
bank during August 2005. The line of credit expired July 22, 2005. The Company
is in the process of obtaining a new line of credit.
The Company issued a two-year note in the principal amount of $867,000
as a result of its acquisition of Stallion, accruing interest at a rate of 2.5%
per annum. Interest expense related to the note totaled approximately $3,000 and
$22,000 for the fiscal years ended June 30, 2005 and 2004, respectively. The
notes were convertible into the Company's common stock at any time, at the
election of the holders, at a $5.00 conversion price. The notes were due and
paid in August 2004 as the holders elected not to convert the notes into the
Company's common stock.
The Company had interest expense of $78,000, $44,000 and $76,000 for
the fiscal years ended June 30, 2005, 2004 and 2003, respectively.
10. STOCKHOLDERS' EQUITY
STOCK OPTION PLANS
The Company has in effect several stock-based plans under which
non-qualified and incentive stock options have been granted to employees,
non-employees and board members. The Company also has an employee stock purchase
plan for all eligible employees. The Board of Directors determines eligibility,
vesting schedules and exercise prices for options granted under the plans.
Options generally have a term of 10 years and vest and become exercisable, over
a four-year period.
A summary of the shares reserved for grant and options available for
grant under each plan is as follows:
F-20
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
SHARES SHARES
RESERVED AVAILABLE
FOR GRANT FOR GRANT
---------- ----------
1993 Incentive Stock Option Plan ("1993 Plan") 4,000,000 --
1994 Non-statutory Stock Option Plan ("1994 Plan") 10,000,000 --
2000 Stock Plan ("2000 Plan") 10,000,000 4,236,510
2000 Employee Stock Purchase plan ("ESPP") 2,250,000 654,138
---------- ----------
26,250,000 4,890,648
========== ==========
Under the 2000 Plan, the number of shares available for issuance
increases by 2,000,000 shares annually commencing in calendar year 2002. Each
outside director is automatically granted an option to purchase 25,000 shares of
common stock annually, subject to certain eligibility requirements. As a result
of the Company's acquisitions, the Company assumed stock options granted under
stock option plans established by each acquired company; no additional options
will be granted under those plans.
A summary of all stock option activity under the plans is as follows:
YEARS ENDED JUNE 30,
------------------------------------------------------------------------------
2005 2004 2003
------------------------------------------------------------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------ ----- ------ ----- ------ -----
Outstanding at beginning of period 5,573,986 1.81 4,198,049 2.10 5,978,366 5.14
Granted 1,225,690 1.14 2,814,899 1.09 1,985,361 0.67
Cancelled (1,433,704) 2.61 (942,627) 1.52 (3,613,674) 6.42
Exercised (281,862) 0.69 (496,335) 0.72 (152,004) 0.24
------------- ------------ -------------
Outstanding at end of period 5,084,110 1.49 5,573,986 1.81 4,198,049 2.10
============= ============ =============
Options exercisable at end of period 2,787,120 2,669,069 2,338,610
============= ============ =============
The weighted average exercise price of options outstanding and of options exercisable as of June 30, 2005 were as
follows:
OUTSTANDING EXERCISABLE
------------------------------------------ -------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
NUMBER OF REMAINING AVERAGE AVERAGE
OPTIONS CONTRACTUAL EXERCISE OPTIONS EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
- ------------------------ ------------- ------------ -------- ----------- --------
$0 to $0.62 834,559 6.55 $ 0.49 684,602 $ 0.48
$0.63 to $1.06 1,072,816 7.54 0.80 692,166 0.78
$1.07 to $2.59 2,788,045 8.32 1.42 1,027,555 1.76
$2.60 to $5.89 162,357 6.27 5.44 161,568 5.44
$5.90 to $14.00 226,333 5.82 6.41 221,229 6.40
------------- ------------ -------- ----------- --------
5,084,110 7.69 $ 1.49 2,787,120 $ 1.78
============= ============ ======== =========== ========
F-21
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
EXERCISABLE UNEXERCISABLE TOTAL
------------------------ ------------- -----------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
SHARES PRICE SHARES SHARES PRICE
---------- -------- ---------- ---------- --------
In-the-money 1,812,005 $ 0.77 2,095,561 3,907,566 $ 0.93
Out-of-the-money 975,115 3.66 201,429 1,176,544 3.33
---------- -------- ---------- ---------- --------
Total options outstanding 2,787,120 $ 1.78 2,296,990 5,084,110 $ 1.49
========== ======== ========== ========== ========
In-the-money options are options with an exercise price lower than the
$1.31 closing price of our common stock on June 30, 2005. Out-of-the-money
options are options with an exercise price greater than the $1.31 closing price
of our common stock on June 30, 2005.
2005 2004 2003
------- ------- ------
Weighted average exercise price of in-
the-money options granted $ -- $ -- $ 0.50
======= ======= ======
Weighted average grant day fair value
of in-the-money options granted $ -- $ -- $ 0.65
======= ======= ======
During the year ended June 30, 2003, the Company recorded deferred
compensation for in-the-money stock options granted to employees based upon the
intrinsic value of the option grants. The Company did not grant any in-the-money
options during the fiscal years ended June 30, 2005 and 2004.
Certain of the Company's employees hold options that were assumed by
the Company in connection with its acquisitions of the businesses that
previously employed those individuals. The Company has recorded deferred
compensation based upon the intrinsic value of the assumed unvested options.
Net deferred compensation is presented as a reduction of stockholders'
equity and is amortized ratably over the shorter of the period in which the
employee provides services or the respective vesting period of the applicable
option. For the fiscal years ended June 30, 2005, 2004 and 2003, stock-based
compensation was approximately $171,000, $395,000 and $1.5 million,
respectively. Deferred compensation is decreased in the period of forfeiture
arising from the early termination of an option holder's services. The Company
has recorded net deferred compensation forfeitures of $197,000 and $2.5 million,
for the fiscal years ended June 30, 2004 and 2003, respectively. There were no
net deferred compensation forfeitures during the fiscal year ended June 30,
2005.
STOCK OPTION EXCHANGE OFFER
On January 24, 2003, the Company completed an offering to employees
whereby employees holding options to purchase the Company's common stock with
exercise prices at or above $3.01 per share were given the opportunity to cancel
certain of their existing options in exchange for the opportunity to receive new
options to purchase the Company's common stock. Each new option represented 0.75
of the underlying shares of the options cancelled. Approximately 1,378,124
options with a weighted average exercise price of $9.01 were tendered. On
January 27, 2003, the tendered options were cancelled by the Company. The new
options were granted six months and one day after acceptance of the old options
for exchange and cancellation and were only granted to those exchange
participants who remained as employees at the time of the new grant. On July 28,
2003, the Company granted replacement options to purchase 1,033,593 shares of
its common stock to employees who tendered options under the stock option
exchange offer, at an exercise price of $0.81 per share. The exercise price of
the new options was determined based upon the last reported trading price of the
Company's common stock on the grant date.
F-22
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
EMPLOYEE STOCK PURCHASE PLAN
In May 2000, the Board of Directors approved the ESPP effective upon
the completion of the initial public offering. The number of shares available
for issuance is increased 150,000 annually pursuant to the ESPP. The ESPP
permits participants to purchase common stock at six-month intervals through
payroll deductions of up to 15% of the participant's compensation, as defined.
Amounts deducted and accumulated by the participants are to be used to purchase
shares of common stock at the end of each offering period, as defined, at 85% of
the lower of the fair market value of the common stock at the beginning or end
of the offering period.
In November 2004, the Company's stockholders authorized 750,000
additional shares to be available pursuant to the ESPP.
A summary of the ESPP is as follows:
2005 2004 2003
-------- -------- --------
Beginning shares available for issuance 107,942 463,877 720,082
Shares reserved for issuance 900,000 150,000 150,000
ESPP shares issued (353,804) (505,935) (406,205)
-------- -------- --------
Ending shares available for future issuance 654,138 107,942 463,877
======== ======== ========
Average purchase price of common shares $ 0.78 $ 0.73 $ 0.69
======== ======== ========
ACCUMULATED OTHER COMPREHENSIVE INCOME
The components of accumulated other comprehensive income are as follows (in
thousands):
2005 2004
-------- --------
Accumulated unrealized gain on investments $ 85 $ --
Accumulated translation adjustment 212 254
-------- --------
Total accumulated other comprehensive income $ 297 $ 254
======== ========
11. 401(K) PLAN
The Company has a savings plan (the "Plan") which is qualified under
Section 401(k) of the Internal Revenue Code. Eligible employees may elect to
make contributions to the Plan through salary deferrals up to 15% of their base
pay, subject to limitations. The Company's contributions are discretionary and
are subject to limitations. For the fiscal years ended June 30, 2005, 2004 and
2003, the Company contributed $0.50 for each $1.00 of employee salary deferral
contributions up to a maximum of 6% of the employee's annual gross wages,
subject to limitations. Selling, general and administrative expenses include
401(k) matching contributions as follows (in thousands):
2005 2004 2003
-------- -------- --------
401(k) matching contributions $ 270 $ 166 $ 192
======== ======== ========
12. LITIGATION
GOVERNMENT INVESTIGATION
The Securities and Exchange Commission is conducting a formal
investigation of the events leading up to the Company's restatement of its
financial statements on June 25, 2002. The Department of Justice is also
conducting an investigation concerning events related to the restatement.
F-23
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
CLASS ACTION LAWSUITS
Beginning on May 15, 2002, a number of securities class actions were
filed against the Company and certain of its current and former directors and
former officers alleging violations of the federal securities laws. These
actions were consolidated into a single action pending in the United States
District Court for the Central District of California and entitled: In RE
LANTRONIX, INC. Securities Litigation, Case No. CV 02-3899 GPS (JTLx). After the
Court appointed a lead plaintiff, amended complaints were filed by the
plaintiff, and the defendants filed various motions to dismiss directed at
particular allegations. Through that process, certain of the allegations were
dismissed by the Court.
On October 18, 2004, the plaintiff filed the third amended complaint,
which is now the operative complaint in the action. The Complaint alleges
violations of Sections 11 and 15 of the Securities Act of 1933 and violations of
Sections 10(b) and 20(a) and Rule 10b-5 of the Securities Exchange Act of 1934.
The 1933 Act claims are brought on behalf of all persons who purchased common
stock of Lantronix pursuant or traceable to the Company's August 4, 2000 initial
public offering ("IPO"). The 1934 Act claims are based on alleged misstatements
related to the Company's financial results that were contained in the
Registration Statement and Prospectus for the IPO. The claims brought under the
1934 Act are brought on behalf of all persons and entities that purchased or
acquired Lantronix securities from November 1, 2000 through May 30, 2002 (the
"Class Period"). The Complaint alleges that defendants issued false and
misleading statements concerning the business and financial condition in order
to allegedly inflate the value of the Company's securities during the Class
Period. The complaint alleges that during the Class Period, Lantronix overstated
financial results through improper revenue recognition and failure to comply
with Generally Accepted Accounting Principles ("GAAP"). Defendants have filed an
answer to the complaint and the case is now in discovery. The Court has set a
trial date in September 2006. While the complaint does not specify the damages
plaintiff may seek on behalf of the purported classes of stockholders, a
recovery by the plaintiff and the plaintiff classes could have a material
adverse impact on the Company.
DERIVATIVE LAWSUIT
On June 9, 2005, the Superior Court of the State of California, County
of Orange, approved the settlement of a stockholder derivative action (entitled
DRAKE V. BRUSCHA, ET AL.) pending against the Company and certain of its current
and former directors and former officers. The settlement involves the adoption
of certain corporate governance measures and payment of attorneys' fees and
expenses to the derivative plaintiff's counsel in the amount of $1.2 million.
The action was dismissed with prejudice as to all parties, including Mr. Steven
Cotton, who was not a party to the settlement agreement and who had objected to
the settlement. As part of the settlement, the Company's insurance carrier has
agreed to pay the $1.2 million after the settlement becomes final, and the
settlement will have no impact on the Company's financial statements or results
of operations. On August 12, 2005, Mr. Cotton appealed the Superior Court's
approval of the settlement, specifically challenging the amount of the $1.2
million fee award. This settlement does not impact the securities class action
or Synergetic Micro Systems securities case.
EMPLOYMENT SUIT BROUGHT BY FORMER CHIEF FINANCIAL OFFICER AND CHIEF OPERATING
OFFICER STEVE COTTON
On September 6, 2002, Steve Cotton, the Company's former CFO and COO,
filed a complaint entitled COTTON V. LANTRONIX, INC., et al., No. 02CC14308, in
the Superior Court of the State of California, County of Orange. The complaint
alleges claims for breach of contract, breach of the covenant of good faith and
fair dealing, wrongful termination, misrepresentation, and defamation. The
complaint seeks unspecified damages, declaratory relief, attorneys' fees and
costs.
The Company filed a motion to dismiss on October 16, 2002, on the
grounds that Mr. Cotton's complaints are subject to the binding arbitration
provisions in Mr. Cotton's employment agreement. On January 13, 2003, the Court
ruled that five of the six counts in Mr. Cotton's complaint are subject to
binding arbitration. The court is staying the sixth count, for declaratory
relief, until the underlying facts are resolved in arbitration. No arbitration
date has been set.
SECURITIES CLAIMS BROUGHT BY FORMER STOCKHOLDERS OF SYNERGETIC MICRO SYSTEMS,
INC. ("SYNERGETIC")
On October 17, 2002, Richard Goldstein and several other former
stockholders of Synergetic filed a complaint entitled GOLDSTEIN, ET AL. V.
LANTRONIX, INC., ET AL. in the Superior Court of the State of California, County
of Orange, against the Company and certain of its former officers and directors.
Plaintiffs filed an amended complaint on January 7, 2003. The amended complaint
alleges fraud, negligent misrepresentation, breach of warranties and covenants,
F-24
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
breach of contract and negligence, all stemming from its acquisition of
Synergetic. The complaint seeks an unspecified amount of damages, interest,
attorneys' fees, costs, expenses, and an unspecified amount of punitive damages.
On May 5, 2003, the Company answered the complaint and generally denied the
allegations in the complaint. Discovery has commenced and the court has
continued the original trial date set in March 2006 to May 2006.
PATENT INFRINGEMENT LITIGATION
On April 13, 2004, Digi International Inc. ("Digi") filed a complaint
against the Company in the U.S. District Court in Minnesota. The complaint
alleges that certain of the Company's products infringe Digi's U.S. Patent No.
6,446,192 ("192 patent"). The complaint seeks both monetary and non-monetary
relief. The Company has filed an answer and counterclaim alleging invalidity of
the patent. The counterclaim seeks both monetary and non-monetary relief.
Discovery is ongoing in the case, and the court has set a trial date in July
2006.
On May 3, 2004, the Company filed a complaint against Digi in the U.S.
District Court for the Central District of California. The complaint alleges
that certain of Digi's products infringe the Company's U.S. Patent No. 6,571,305
("305 patent"). The Complaint seeks both monetary and non-monetary relief. Digi
has filed an answer and counterclaim alleging invalidity of the patent. The
counterclaim seeks both monetary and non-monetary relief. Discovery is ongoing
in the case, and the court has set a trial date in January 2006.
On February 7, 2005, the Company filed a complaint against Digi in the
U.S. District Court for the Eastern District of Texas. The complaint alleges
that certain of Digi's products infringe U.S. Patent No. 4,972,470 ("470
patent"), under which the Company is an exclusive licensee with respect to the
field of use encompassing Digi's accused products. The Complaint seeks both
monetary and non-monetary relief. Digi has filed an answer alleging invalidity
of the patent. The answer seeks both monetary and non-monetary relief. Discovery
has commenced in the case, and the court has set a trial date in July 2006.
On May 12, 2005, the Company filed a patent infringement complaint
against Digi, in the U.S. District Court for the Eastern District of Texas. The
complaint alleges that the Digi Connect ME and certain other Digi device server
products infringe upon the Company's U.S. Patent No. 6,881,096 ("096 patent")
entitled "Compact Serial-to-Ethernet Port." The 096 patent suit is the third
patent infringement suit filed by Lantronix against Digi. Digi has filed an
answer alleging invalidity and unenforceability of the patent. The answer seeks
both monetary and non-monetary relief. Discovery has commenced in the case, and
the Court has set a trial date in September 2006.
OTHER
From time to time, the Company is subject to other legal proceedings
and claims in the ordinary course of business. The Company is currently not
aware of any such legal proceedings or claims that it believes will have,
individually or in the aggregate, a material adverse effect on its business,
prospects, financial position, operating results or cash flows.
The pending lawsuits involve complex questions of fact and law and
likely will continue to require the expenditure of significant funds and the
diversion of other resources to defend. Management is unable to determine the
outcome of its outstanding legal proceedings, claims and litigation involving
the Company, its subsidiaries, directors and officers and cannot determine the
extent to which these results may have a material adverse effect on the
Company's business, results of operations and financial condition taken as a
whole. The results of litigation are inherently uncertain, and adverse outcomes
are possible. The Company is unable to estimate the range of possible loss from
outstanding litigation, and no amounts have been provided for such matters,
except as disclosed above.
F-25
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
13. INCOME TAXES
The income tax provision (benefit) is comprised of the following (in
thousands):
YEARS ENDED JUNE 30,
2005 2004 2003
----- ----- -----
Current
Federal $ -- $ 91 $ 18
State (6) 7 100
Foreign 235 177 132
----- ----- -----
Total current 229 275 250
Deferred
Federal -- (476) --
State -- (124) --
Foreign -- -- --
----- ----- -----
Total deferred -- (600) --
Total income tax provision (benefit) $ 229 $(325) $ 250
===== ===== =====
U.S. and foreign income (loss) from continuing operations before taxes
are as follows (in thousands):
YEARS ENDED JUNE 30,
2005 2004 2003
-------- -------- --------
United States $ (7,047) $(11,716) $(40,404)
Foreign 216 784 3,220
-------- -------- --------
$ (6,831) $(10,932) $(37,184)
======== ======== ========
The tax effects of temporary differences that give rise to deferred
tax assets and liabilities are as follows (in thousands):
YEARS ENDED JUNE 30,
2005 2004
-------- --------
Deferred tax assets:
Reserves not currently deductible $ 4,022 $ 4,620
Inventory capitalization 2,777 2,749
Marketing rights 1,262 1,360
Tax losses and credits 35,436 32,446
Deferred compensation 60 --
-------- --------
43,557 41,175
Valuation allowance (43,434) (38,946)
-------- --------
Total deferred tax assets 123 2,229
-------- --------
Deferred tax liabilities
State taxes (2) --
Identified intangibles (40) (310)
Depreciation (81) (255)
Deferred compensation -- (1,664)
-------- --------
Total deferred tax liabilities (123) (2,229)
-------- --------
Net deferred tax assets (liabilities) $ -- $ --
======== ========
F-26
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
A reconciliation of the income tax provision (benefit) for loss from
continuing operations before discontinued operations and cumulative effect of
accounting changes to taxes computed at the U.S. federal statutory rate is as
follows (in thousands):
YEARS ENDED JUNE 30,
2005 2004 2003
-------- -------- --------
Federal income tax (benefit) at statutory rate $ (2,322) $ (3,717) $(12,642)
State taxes (net of federal tax benefit) (4) (77) 66
Reduction in tax contingency reserve based on IRS exam and other -- (486) 18
Change in valuation allowance 2,897 4,338 12,646
Permanent differences 24 193 10
Research and development credit (444) (570) (596)
Foreign tax rate variances 162 (90) 411
Deferred compenation -- 84 337
Other (84) -- --
-------- -------- --------
$ 229 $ (325) $ 250
======== ======== ========
As of June 30, 2005, the Company has net operating loss carryovers of
$75.5 million and $39.0 million for federal and California income tax purposes,
respectively. The federal and California net operating loss carryovers begin to
expire in fiscal years 2021 and 2013, respectively.
Approximately $2.3 million of the net operating loss carryforwards
resulted from a purchase business combination. Due to uncertainties surrounding
the realization of the deferred tax assets related to the net operating loss
carryforwards, a valuation allowance of approximately $773,000 was established.
If or when realized, a portion of the tax benefit for those items will be
applied to reduce goodwill and acquired intangibles related to the purchase
business combination.
The Company has research and development tax credit carryforwards of
$3.2 million and $3.1 million for federal and California purposes, respectively.
Federal tax credits begin to expire in 2021. California tax credits have no
expiration.
The Company has recorded a valuation allowance against its net deferred
tax assets of $43.4 million. If or when realized, the tax benefits relating to,
and the reversal of, approximately $4.2 million of the valuation allowance will
be accounted for as an increase in additional paid-in capital as a result of tax
deductible compensation arising from stock option exercises. The valuation
allowance was established due to uncertainties surrounding the realization of
the deferred tax assets.
Due to the "change of ownership" provision of the Tax Reform Act of
1986, utilization of the Company's net operating loss carryforwards and tax
credit carryforwards may be subject to an annual limitation against taxable
income in future periods. As a result of the annual limitation, a portion of
these carryforwards may expire before ultimately becoming available to reduce
future income tax liabilities.
In 2003, the Internal Revenue Service completed its audit of the
Company's federal income tax returns for the fiscal years ended June 30, 1999,
2000 and 2001. The Company had accrued for this liability in prior fiscal
periods. Based on the final resolution and related state impact of the IRS
examination, the Company recorded a reduction in its tax contingency reserve of
approximately $500,000 during the fiscal year ended June 30, 2004.
The Company had discussions with the Swiss Federal Tax Authorities
("SFTA") regarding the inability of the Company's Swiss subsidiary, Lantronix
International AG, to meet certain guidelines as set within a tax ruling that was
obtained in May 2001. The ruling provided for reduced Swiss tax rates. The
subsidiary was unable to meet the guidelines set forth in the ruling due to
slower than planned growth and has since converted to a holding company. The
SFTA has ruled on this matter, resulting in tax and interest to the SFTA of
approximately $55,000. This was paid in the fiscal quarter ended June 30, 2005.
F-27
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
14. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases office equipment and its office and warehouse
facilities under non-cancelable capital and operating leases. In 2005, the
Company renewed its office and warehouse facility lease in Irvine, California
commencing in August 2005 and expiring in July 2010.
The following schedule represents minimum lease payments for all
non-cancelable operating and capitalized leases as of June 30, 2005 (in
thousands):
CAPITAL OPERATING
YEARS ENDED JUNE 30, LEASE LEASE TOTAL
- -------------------- -------- -------- --------
2006 $ 178 $ 835 $ 1,013
2007 51 664 715
2008 -- 577 577
2009 -- 605 605
2010 -- 636 636
Thereafter -- 53 53
-------- -------- --------
Total 229 $ 3,370 $ 3,599
======== ======== ========
Amounts representing interest (13)
Executory costs (3)
--------
Present value of net minimum lease payments 213
Less: capital lease obligations, short-term
portion (included in other current liabilities) 162
--------
Capital lease obligations, long-term portion $ 51
========
Facilities rent expense for the fiscal years ended June 30, 2005, 2004,
and 2003 were $1.1 million, $1.3 million and $1.7 million, respectively.
ROYALTY COMMITMENT
In March 2005, the Company entered into an agreement, which requires
the Company to pay a minimum royalty over a two-year period beginning in July
2005. Upon reaching the minimum royalty commitment the Company will continue to
pay royalties on a per unit basis. The following schedule sets forth the minimum
royalty commitment as of June 30, 2005 (in thousands):
YEARS ENDED JUNE 30,
2006 2007 TOTAL
---- ---- -----
Minimum royalty commitment $ 103 $ 103 $ 206
F-28
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
15. GEOGRAPHIC AND SIGNIFICANT CUSTOMER INFORMATION
REVENUE BY GEOGRAPHIC AREA
Net revenue by geographic area is as follows (amounts in thousands):
YEARS ENDED JUNE 30,
2005 2004 2003
---- ---- ----
Americas $ 31,162 64.3% $ 33,847 69.3% $ 37,391 75.7%
Europe 13,213 27.2% 11,252 23.0% 10,366 21.0%
Other 4,127 8.5% 3,786 7.7% 1,632 3.3%
-------- ------- -------- ------- -------- ------
Total net revenues $ 48,502 100% $ 48,885 100% $ 49,389 100%
======== ======= ======== ======= ======== ======
SIGNIFICANT CUSTOMER INFORMATION
Sales to the Company's significant customers and a related party as a
percentage of net revenue are as follows:
YEARS ENDED JUNE 30,
CUSTOMER 2005 2004 2003
- -------- ---- ---- ----
Ingram Micro 16.0% 14.0% 11.0%
Tech Data 11.0% 9.0% 10.0%
Related party 2.0% 3.0% 4.0%
No other customer represented more than 10% of the Company's annual net
revenue during these years.
Significant customers as a percentage of accounts receivable are as
follows:
YEARS ENDED JUNE 30,
2005 2004
---- ----
Ingram Micro and Tech Data 24.0% 13.0%
F-29
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
JUNE 30, 2005
16. QUARTERLY FINANCIAL DATA (UNAUDITED)
During the fourth fiscal quarter, adjustments were identified which
pertained to the Company's unaudited first, second and third fiscal 2005
quarters. The unaudited quarterly financial information presented below for
fiscal 2005 has been restated to reflect these adjustments and to (i) accrued
professional fees and other accrued liabilities by reducing selling, general and
administrative expenses as originally reported in the Company's first, second
and third fiscal quarter of 2005 consolidated financial statements by $106,000,
$107,000 and $116,000, respectively, and (ii) reduce amounts previously recorded
as stock-based compensation related to a stock option grant to a terminated
employee as originally reported in the Company's first, second and third fiscal
quarter of 2005 consolidated financial statements by $118,000, $10,000 and
$30,000, respectively. In addition, we evaluated whether any of the adjustments
impacted our prior year consolidated financial statements and determined that
they (i) did not impact the prior year periods or (ii) were immaterial to the
prior year periods. In our opinion, all adjustments necessary to present fairly
the information for such quarters have been reflected. The following table
presents unaudited quarterly data (in thousands except per share amounts):
AS ANNOUNCED
AS ORIGINALLY REPORTED SEPTEMBER 8, 2005
------------------------------------ ----------------------
FISCAL QUARTER ENDED 2005 SEPT 30, DEC 31, MAR 31, JUNE 30, TOTAL
-------- -------- -------- -------- --------
Net revenues $ 11,045 $ 12,908 $ 12,303 $ 12,246 (5) $ 48,502
Gross profit $ 5,557 $ 6,256 $ 5,689 $ 6,674 (1) $ 24,176
Net loss from continuing operations $ (3,835) $ (1,655) $ (1,508) $ (15)(6) $ (7,013)
Net loss $ (3,779) $ (1,655) $ (1,508) $ (15) $ (6,957)
Basic and diluted loss per share
from continuing operations $ (0.07) $ (0.03) $ (0.03) $ -- $ (0.12)*
Basic and diluted net loss per share $ (0.07) $ (0.03) $ (0.03) $ -- $ (0.12)*
AS ADJUSTED
----------------------------------------------------------------
FISCAL QUARTER ENDED 2005 SEP 30, DEC 31, MAR 31, JUNE 30, TOTAL
-------- -------- -------- -------- --------
Net revenues $ 11,045 $ 12,908 $ 12,303 $ 12,246 (5) $ 48,502
Gross profit $ 5,557 $ 6,256 $ 5,689 $ 6,674 (1) $ 24,176
Net loss from continuing operations $ (3,611) $ (1,538) $ (1,362) $ (549)(6) $ (7,060)
Net loss $ (3,555) $ (1,538) $ (1,362) $ (549) $ (7,004)
Basic and diluted loss per share
from continuing operations $ (0.06) $ (0.03) $ (0.02) $ (0.01) $ (0.12)
Basic and diluted net loss per share $ (0.06) $ (0.03) $ (0.02) $ (0.01) $ (0.12)
AS ORIGINALLY REPORTED
----------------------------------------------------------------
FISCAL QUARTER ENDED 2004 SEPT 30, DEC 31, MAR 31, JUN 30, TOTAL
-------- -------- -------- -------- --------
Net revenues $ 12,201 $ 12,498 $ 12,310 $ 11,876 $ 48,885
Gross profit $ 6,156 $ 5,644 $ 6,917 $ 5,142 $ 23,859
Net (loss) income $ --
from continuing operations $ (2,272) $ (1,516) $ 116 $ (6,935) $(10,607)
Net loss $ (3,049) $ (5,255)(2) $ (553)(3) $ (6,797)(4) $(15,654)
Basic and diluted (loss) income
per share from continuing operations $ (0.04) $ (0.03) $ (0.00) $ (0.12) $ (0.19)
Basic and diluted net loss per share $ (0.05) $ (0.09) $ (0.01) $ (0.12) $ (0.28)*
* Annual per share amounts may not agree to the sum of the quarterly per
share amounts due to differences between average shares outstanding
during the periods.
(1) Includes reduction to warranty reserve of approximately $317,000.
(2) Includes impairment of goodwill and purchased intangible assets of $3.0
million included in net loss from discontinued operations.
(3) Includes a $2.1 million recovery from previously recorded restructuring
reserves.
(4) Includes $5.0 million write-off of the Company's long-term investment
in Xanboo.
(5) Includes $80,000 reduction to the reserve for rebates.
(6) Includes $141,000 reduction to accrued liabilities.
F-30
INDEX TO EXHIBITS
-----------------
- ------------------------------------------------------------------------------------------------------------------------------------
INCORPORATED BY REFERENCE
EXHIBIT ------------------------- FILED
NUMBER EXHIBIT DESCRIPTION FORM FILE NO. EXHIBIT FILING DATE HEREWITH
- ------------------------------------------------------------------------------------------------------------------------------------
3.1 Amended and Restated Certificate of 8 - K 001-16027 99.1 07/29/2005
Incorporation of Lantronix, Inc.
3.2 Amended and restated Bylaws as amended on July 8 - K 001-16027 99.2 07/29/2005
28, 2005
4.1 Form of Registrant's common stock certificate S - 1, 333-37508 06/13/2000
Amend. No. 1
10.1 Form of Indemnification Agreement entered into S - 1, 333-37508 06/13/2000
by registrant with each of its directors and Amend. No. 1
executive officers
10.2 1993 Stock Option Plan and forms of agreements S - 1, 333-37508 06/13/2000
thereunder Amend. No. 1
10.3 1994 Nonstatutory Stock Option Plan and forms S - 1, 333-37508 06/13/2000
of agreements thereunder Amend. No. 1
10.4 2000 Stock Plan and forms of agreement S - 8, 333-103395 02/24/2003
10.5 2000 Stock Plan Amendment I dated as of S-8 333-103395 02/24/2003
January 3, 2003
10.6 2000 Employee Stock Purchase Plan, amended and S - 8, 333-121000 4.1 12/06/2004
restated dated as of November 18, 2004
10.7 Employment Agreement between registrant and S - 1 333-37508 05/19/2000
Fred Thiel
10.8 Employment Agreement between registrant and S - 1 333-37508 05/19/2000
Steve Cotton
10.9 Employment Agreement between registrant and S - 1 333-37508 05/19/2000
Johannes Rietschel
10.10 Lease Agreement between registrant and The S - 1, 333-37508 06/13/2000
Irvine Company Amend. No. 1
10.11 First Amendment to Lease Agreement between S-1 333-37508 06/13/2000
registrant and Irvine Technology Partners III Amend. No. 1
dated as of August 10, 1995
10.12 Second Amendment to Lease Agreement between 10 - K 001-16027 10.03 09/28/2000
registrant and Irvine Technology Partners III
dated as of July 6, 2000
10.13 Third Amendment to Lease Agreement between 8 - K 001-16027 10.04 03/22/2005
Registrant and Irvine Technology Partners
dated as of March 16, 2005
10.14 Research and Development Agreement between S - 1, 333-37508 06/13/2000
registrant and Gordian Amend. No. 1
* CONFIDENTIAL TREATMENT PURSUANT TO RULE 406
10.15 Distributor Contract between registrant and S - 1, 333-37508 06/13/2000
Tech Data Corporation Amend. No. 1
* CONFIDENTIAL TREATMENT PURSUANT TO RULE 406
10.16 Distributor Contract between registrant and S - 1, 333-37508 06/13/2000
Ingram Micro Inc. Amend. No. 1
* CONFIDENTIAL TREATMENT PURSUANT TO RULE 406
10.17 Offer to Exchange Outstanding Options, dated Schedule TO 001-16027 99(a)(1) 12/19/2002
December 19, 2002
10.18 Loan and Security Agreement between registrant 10-Q 001-16027 10.16 02/14/2002
and Silicon Valley Bank dated February 14, 2002
10.19 Amendment to Loan Documents between Lantronix, 8 - K 001-16027 10.17 02/15/2005
Inc. and Silicon Valley Bank dated February
15, 2005
- ------------------------------------------------------------------------------------------------------------------------------------
II-1
- ------------------------------------------------------------------------------------------------------------------------------------
INCORPORATED BY REFERENCE
EXHIBIT ------------------------- FILED
NUMBER EXHIBIT DESCRIPTION FORM FILE NO. EXHIBIT FILING DATE HEREWITH
- ------------------------------------------------------------------------------------------------------------------------------------
10.20 Letter from Ernst & Young LLP, dated January 8 - K 001-16027 16.1 01/21/2005
21, 2005
21.1 Subsidiaries of registrant 10 - K X
23.1 Consent of Independent Registered Public X
Accounting Firm, McGladrey & Pullen, LLP
23.2 Consent of Independent Registered Public X
Accounting Firm, Ernst & Young LLP
24.1 Power of Attorney (see page II-2)
31.1 Certificate of Principal Executive Officer X
Pursuant to Section 302 of the Sarbanes -
Oxley Act of 2002
31.2 Certificate of Principal Financial Officer X
Pursuant to Section 302 of the Sarbanes -
Oxley Act of 2002
32.1 Certification of Chief Executive Officer and X
Chief Financial Officer furnished pursuant to
18 U.S.C. ss. 1350, as adopted pursuant to ss. 906
of Sarbanes Oxley Act of 2002
- ------------------------------------------------------------------------------------------------------------------------------------
99.1 Report of Independent Registered Public X
Accountant on Financial Statement Schedule
99.2 Consolidated Valuation and Qualifying X
Accounts
- ------------------------------------------------------------------------------------------------------------------------------------
II-2
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Lantronix has duly caused this Report on Form 10-K to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of Irvine, State of California, on the 28th day of September, 2005.
LANTRONIX, INC.
By: /s/ JAMES W. KERRIGAN
---------------------
JAMES W. KERRIGAN
CHIEF FINANCIAL OFFICER
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints James Kerrigan, his attorney-in-fact,
with the power of substitution, for him and in his name, place and stead, in any
and all capacities, to sign any and all amendments to this Form 10-K and to file
the same, with all exhibits thereto in all documents in connection therewith,
with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents or any of them, or his or their substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Report on Form 10-K has been signed by the following persons in
the capacities and on the dates indicated:
Signature Title Date
--------- ----- ----
/s/ H. K. DESAI Chairman of the Board 09/28/05
- -------------------------
H. K. DESAI
/s/ MARC H. NUSSBAUM Chief Executive Officer, 09/28/05
- ------------------------- President (Principal
MARC H. NUSSBAUM Executive Officer)
/s/ JAMES W. KERRIGAN Chief Financial Officer 09/28/05
- ------------------------- and Secretary (Principal Financial
JAMES W. KERRIGAN and Accounting Officer)
/s/ THOMAS W. BURTON Director 09/28/05
- -------------------------
THOMAS W. BURTON
/s/ HOWARD T. SLAYEN Director 09/28/05
- -------------------------
HOWARD T. SLAYEN
/s/ KATHRYN B. LEWIS Director 09/28/05
- -------------------------
KATHRYN B. LEWIS
II-3