================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended March 31, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to ___________.
Commission file number: 1-16027
___________
LANTRONIX, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0362767
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
15353 Barranca Parkway Irvine, California 92618
(Address of principal executive offices and zip code)
___________
(949) 453-3990
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(D) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
As of May 31, 2002, 54,218,020 shares of the Registrant's common stock were
outstanding.
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LANTRONIX, INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2002
INDEX
Page
----
PART I. FINANCIAL INFORMATION ........................................................................................ 3
Item 1. Financial Statements ......................................................................................... 3
Condensed Consolidated Balance Sheets at March 31, 2002 (unaudited) and June 30, 2001 (restated) ............. 3
Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months Ended
March 31, 2002 and 2001 (restated) ........................................................................ 4
Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended
March 31, 2002 and 2001 (restated) ........................................................................ 5
Notes to Unaudited Condensed Consolidated Financial Statements ............................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ........................ 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk ................................................... 33
PART II. OTHER INFORMATION ............................................................................................ 34
Item 1. Legal Proceedings ............................................................................................ 34
Item 2. Changes in Securities and Use of Proceeds .................................................................... 34
Item 3. Defaults Upon Senior Securities .............................................................................. 35
Item 4. Submission of Matters to a Vote of Security Holders .......................................................... 35
Item 5. Other Information ............................................................................................ 35
Item 6. Exhibits and Reports on Form 8-K ............................................................................. 35
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
LANTRONIX, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
March 31, June 30,
2002 2001
---- ----
(Restated
(Unaudited) -Note 2)
ASSETS
------
Current assets:
Cash and cash equivalents ...................................................................... $ 30,937 $ 15,367
Short-term investments ......................................................................... 9,925 1,973
Accounts receivable, net ....................................................................... 7,863 9,134
Inventories .................................................................................... 14,118 13,560
Deferred income taxes .......................................................................... 4,846 3,621
Prepaid income taxes ........................................................................... 2,416 973
Prepaid expenses and other current assets ...................................................... 5,245 3,805
-------- --------
Total current assets ....................................................................... 75,350 48,433
Property and equipment, net ......................................................................... 6,020 5,492
Long-term investments ............................................................................... 9,305 2,424
Goodwill, net ....................................................................................... 67,089 42,273
Purchased intangible assets, net .................................................................... 20,105 13,328
Officer loans. ...................................................................................... 3,999 4,131
Other assets ........................................................................................ 1,187 780
-------- --------
Total assets ............................................................................... $183,055 $116,861
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable ............................................................................... $ 4,681 $ 5,698
Accrued payroll and related expenses ........................................................... 1,949 1,243
Due to related party ........................................................................... 205 787
Other current liabilities ...................................................................... 3,746 3,742
-------- --------
Total current liabilities .................................................................. 10,581 11,470
Deferred income taxes ............................................................................... 9,855 5,895
Stockholders' equity:
Common stock 5 4
Additional paid-in capital. .................................................................... 182,267 109,871
Employee notes receivable ...................................................................... (277) (790)
Deferred compensation .......................................................................... (7,032) (10,020)
Retained earnings (accumulated deficit) ........................................................ (12,343) 582
Accumulated other comprehensive loss ........................................................... (1) (151)
-------- --------
Total stockholders' equity ................................................................. 162,619 99,496
-------- --------
Total liabilities and stockholders' equity ................................................. $183,055 $116,861
======== ========
See accompanying notes.
3
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
Three Months Ended Nine Months Ended
March 31, March 31,
--------- ---------
2002 2001 2002 2001
---- ---- ---- ----
(Restated (Restated
-Note 2) -Note 2)
Net revenues (A) ................................................................... $ 14,580 $ 12,530 $ 46,137 $ 36,210
Cost of revenues (B) ............................................................... 10,374 5,848 25,451 16,650
-------- -------- -------- --------
Gross profit ....................................................................... 4,206 6,682 20,686 19,560
-------- -------- -------- --------
Operating expenses:
Selling, general and administrative (C) ....................................... 9,206 5,905 24,478 16,877
Research and development (C) .................................................. 2,225 1,171 6,273 3,244
Stock-based compensation (B) (C) .............................................. 707 837 2,660 2,149
Amortization of purchased intangible assets ................................... 579 307 1,388 713
Restructuring charges ......................................................... 2,810 -- 2,810 --
-------- -------- -------- --------
Total operating expenses ........................................................... 15,527 8,220 37,609 22,983
-------- -------- -------- --------
Loss from operations ............................................................... (11,321) (1,538) (16,923) (3,423)
Interest income (expense), net ..................................................... 289 538 1,304 1,706
Other income (expense), net ........................................................ (185) (71) (989) (66)
-------- -------- -------- --------
Loss before income taxes and cumulative effect of accounting change ................ (11,217) (1,071) (16,608) (1,783)
Benefit for income taxes ........................................................... (2,487) (220) (3,683) (366)
-------- -------- -------- --------
Loss before cumulative effect of accounting change ................................. (8,730) (851) (12,925) (1,417)
Cumulative effect of accounting change, net of income taxes of $176 (Note 2) ....... -- -- -- (597)
-------- -------- -------- --------
Net loss ........................................................................... $ (8,730) $ (851) $(12,925) $ (2,014)
======== ======== ======== ========
Basic and diluted loss per share before cumulative effect of
accounting change ............................................................... $ (0.16) $ (0.02) $ (0.25) $ (0.04)
Cumulative effect of accounting change per share ................................... -- -- -- (0.02)
-------- -------- -------- --------
Basic and diluted net loss per share ............................................... $ (0.16) $ (0.02) $ (0.25) $ (0.06)
======== ======== ======== ========
Weighted average shares (basic and diluted) ........................................ 53,305 37,974 50,700 36,015
======== ======== ======== ========
(A) Includes net revenues from related parties ..................................... $ 587 $ 1,322 $ 1,683 $ 3,411
======== ======== ======== ========
(B) Cost of revenues includes the following:
Amortization of purchased intangible assets ................................ $ 612 $ -- $ 1,510 $ --
Stock-based compensation ................................................... 21 11 97 36
-------- -------- -------- --------
$ 633 $ 11 $ 1,607 $ 36
======== ======== ======== ========
(C) Stock-based compensation is excluded from the following:
Selling, general and administrative expenses ............................... $ 579 $ 748 $ 2,088 $ 1,897
Research and development expenses .......................................... 128 89 572 252
-------- -------- -------- --------
$ 707 $ 837 $ 2,660 $ 2,149
======== ======== ======== ========
See accompanying notes.
4
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months Ended
March 31,
---------
2002 2001
---- ----
(Restated
-Note 2)
Cash flows from operating activities:
Net loss ................................................................................ $(12,925) $ (2,014)
Adjustments to reconcile net loss to net cash used in operating activities:
Cumulative effect of accounting change ............................................... -- 597
Depreciation ......................................................................... 1,884 648
Amortization of purchased intangible assets .......................................... 2,898 713
Stock-based compensation ............................................................. 2,757 2,185
Provision for doubtful accounts ...................................................... 970 184
Deferred income taxes ................................................................ (1,707) (367)
Revaluation of strategic investment .................................................. 500 --
Loss on disposal of asset ............................................................ -- 25
Write-off of intellectual property ................................................... 665 --
Equity losses from unconsolidated businesses ......................................... 713 --
Restructuring charges ................................................................ 2,810 --
Changes in operating assets and liabilities, net of effect from acquisitions:
Accounts receivable ................................................................ 1,730 (1,363)
Inventories ........................................................................ (392) (2,697)
Prepaid expenses and other current assets .......................................... (3,027) (478)
Other assets ....................................................................... (998) (2,205)
Accounts payable ................................................................... (4,054) (986)
Other current liabilities .......................................................... (644) 570
-------- --------
Net cash used in operating activities ................................................... (8,820) (5,188)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment, net .............................................. (2,936) (3,200)
Purchase of minority investments, net ................................................ (7,243) --
Acquisition of businesses, net of cash acquired ...................................... (4,801) (2,879)
Purchase of held-to-maturity investments ............................................. (12,237) (22,681)
Proceeds from sale of held-to-maturity investments ................................... 1,975 --
-------- --------
Net cash used in investing activities ................................................... (25,242) (28,760)
-------- --------
Cash flows from financing activities:
Net proceeds from underwritten offerings of common stock ............................. 47,085 53,707
Net proceeds from other issuances of common stock .................................... 2,520 377
-------- --------
Net cash provided by financing activities ............................................... 49,605 54,084
Effect of exchange rates on cash ........................................................ 27 (7)
-------- --------
Increase in cash and cash equivalents ................................................... 15,570 20,129
Cash and cash equivalents at beginning of period ........................................ 15,367 1,988
-------- --------
Cash and cash equivalents at end of period .............................................. $ 30,937 $ 22,117
======== ========
See accompanying notes.
5
LANTRONIX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2002
1. Basis of Presentation
The condensed consolidated financial statements included herein are
unaudited. They contain all normal recurring accruals and adjustments which, in
the opinion of management, are necessary to present fairly the consolidated
financial position of Lantronix, Inc. and its subsidiaries (collectively, the
"Company") at March 31, 2002, the consolidated results of its operations for the
three and nine months ended March 31, 2002 and 2001, and its cash flows for the
nine months ended March 31, 2002 and 2001. All intercompany accounts and
transactions have been eliminated. It should be understood that accounting
measurements at interim dates inherently involve greater reliance on estimates
than at year-end. The results of operations for the three and nine months ended
March 31, 2002 are not necessarily indicative of the results to be expected for
the full year or any future interim periods.
These financial statements do not include certain footnotes and
financial presentations normally required under generally accepted accounting
principles. Therefore, they should be read in conjunction with the audited
consolidated financial statements and notes thereto for the year ended June 30,
2001, included in the Company's Annual Report on Form 10-K/A filed with the
Securities and Exchange Commission ("SEC") in June 2002.
In May 2002, the Company undertook a special investigation of its
accounting and determined that certain sales to distributors and others made in
fiscal 2001 and 2002 did not qualify for recognition as revenue upon shipment.
As a result, the Company has restated its condensed consolidated financial
statements contained herein for the nine months ended March 31, 2001, as well as
all other interim and annual financial statements for periods within fiscal 2001
and the first six months of fiscal 2002 (July 1, 2000 through December 31, 2001)
as further described in Note 2. The Company has filed a Form 10-K/A for the
fiscal year ended June 30, 2001, and Form 10-Q/A for the fiscal quarters ended
September 30, 2001 and December 31, 2001 to reflect the restatement.
Also, effective July 1, 2001, the Company elected to early adopt
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets" ("SFAS No. 142"). As a result, the Company will no
longer amortize goodwill and certain intangible assets deemed to have indefinite
lives (Note 3).
2. Accounting Change and Restatement of Financial Statements
In originally preparing the condensed consolidated financial
statements at December 31, 2001, the Company changed its accounting method for
recognizing revenue on sales to distributors effective as of July 1, 2001, the
beginning of fiscal 2002. Under the new accounting method, the recognition of
revenue and related gross profit on sales to distributors is deferred until the
distributor resells the product to an end customer. Formerly, the Company
recognized revenue from these transactions upon shipment of product to the
distributor, net of estimates for possible returns and allowances.
In May 2002, the Company undertook a special investigation of its
accounting, which revealed that beginning in the third and fourth quarters of
fiscal 2001 certain shipments made to distributors and recorded as revenues in
fiscal 2001 and 2002 did not qualify for revenue recognition upon shipment due
to terms present in agreements with the distributors that were not considered in
the Company's original accounting decisions. As a result, the Company's new
method of accounting for distributor sales, which is based on recognizing
revenue and related gross profit on sales to distributors only as the
distributor resells the product to end customers, has been adopted effective as
of July 1, 2000, the beginning of fiscal 2001, or one year earlier. This manner
of correcting the errors in sales recognition made in previously issued
financial statements for fiscal 2001 is deemed to be preferable in the
circumstances because (1) it eliminates from revenue any effect of shipping
excessive levels of inventory to the distributors; (2) all revenue from
distributor sales in fiscal 2001 and 2002 will be recognized on a common basis;
and (3) there is assurance that any additional agreements with distributors that
may have existed with respect to specific orders but are presently unknown will
not have an impact on amounts reported as revenue after the restatement. The
restatement for the year ended June 30, 2001, results in a reduction in revenue
of approximately $6.2 million and an increase in the loss before cumulative
effect of accounting change of $2.9 million or $0.07 per share. The cumulative
effect of the accounting change recorded as of July 1, 2000 was a charge of
$597,000 (net of income tax benefit of $176,000) or $0.02 per share.
6
Management believes that the new accounting method better reflects the
substance of the transactions considering the Company's recent entry into the
semiconductor marketplace and the changing business environment; is consistent
with other companies in the Company's industry thereby providing greater
comparability in the presentation of financial results among the Company and its
peers, and better focuses the Company on end customer sales.
In the special investigation conducted in May 2002, the Company also
discovered (i) that the terms and circumstances of certain sales made in the
first six months of fiscal 2002 to customers who were not distributors also
preclude revenue from being recognized upon shipment, as originally reported and
(ii) that certain amounts initially reported as other comprehensive income
(loss) should be accounted for as elements of net loss. Accordingly, in the
restated condensed consolidated financial statements for the three months ended
September 30, 2001 and December 31, 2001, the Company has made corrections to
defer the recognition of such sales as revenue until all revenue recognition
criteria have been met and to reclassify to other expense the amounts improperly
charged to other comprehensive income (loss). These corrections result in a
reduction in revenue of approximately $1.2 million and an increase in the loss
before cumulative effect of accounting change of $869,000 or $0.02 per share
for the six months ended December 31, 2001.
The effects of these error corrections on net revenues; loss before
cumulative effect of accounting change, net of income tax benefit; cumulative
effect of accounting change; net loss; and related per share amounts for the
interim periods of fiscal 2001 are shown in the tables below (in thousands,
except per share amounts):
Three Months Nine Months
Ended Ended
March 31, March 31,
2001 2001
---- ----
As originally reported:
Net revenues ................................................................ $ 14,125 $ 38,627
======== ========
Loss before cumulative effect of accounting change .......................... $ (99) $ (173)
Cumulative effect of accounting change ...................................... -- --
-------- --------
Net loss .................................................................... $ (99) $ (173)
======== ========
Loss per share before cumulative effect of accounting change ................ $ (0.00) $ (0.00)
Cumulative effect of accounting change per share ............................ -- --
-------- --------
Basic and diluted net loss per share ........................................ $ (0.00) $ (0.00)
======== ========
As restated:
Net revenues ................................................................ $ 14,125 $ 38,627
Corrections ................................................................. (1,595) (2,417)
-------- --------
Net revenues, as restated ................................................... $ 12,530 $ 36,210
======== ========
Loss before cumulative effect of accounting change .......................... $ (99) $ (173)
Corrections, net of tax ..................................................... (752) (1,244)
-------- --------
Loss before cumulative effect of accounting change, as restated ............. (851) (1,417)
Cumulative effect of accounting change, net of income tax benefit of $176, as
restated ................................................................. -- (597)
-------- --------
Net loss, as restated ....................................................... $ (851) $ (2,014)
======== ========
Loss per share before cumulative effect of accounting change, as restated ... $ (0.02) $ (0.04)
Cumulative effect of accounting change per share, as restated ............... -- 0.02)
-------- --------
Basic and diluted net loss per share, as restated ........................... $ (0.02) $ (0.06)
======== ========
3. Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 141, "Business Combinations" ("SFAS No. 141"), effective for
acquisitions consummated after June 30, 2001, and SFAS No. 142, effective for
fiscal years beginning after December 15, 2001. Under the new rules, goodwill
and certain intangible assets deemed to have indefinite lives will no longer be
amortized but will be subject to annual impairment tests. Other intangible
assets will continue to be amortized over their useful lives.
7
The Company has elected to early adopt the rules set forth in SFAS No.
142 on accounting for goodwill and other intangibles effective as of July 1,
2001. For the nine months ended March 31, 2002, early adoption resulted in
non-amortization of goodwill of $5.6 million or $0.11 per share based on the
weighted average shares outstanding for the nine months ended March 31, 2002.
The following table presents the impact of SFAS No. 142 on net loss and
net loss per share had SFAS No. 142 been in effect for the three and nine months
ended March 31, 2001 (in thousands, except per share data):
Three Months Nine Months
Ended Ended
March 31, March 31,
2001 2001
---- ----
Net loss as reported ............................................................... $ (851) $ (2,014)
Adjustments:
Amortization of goodwill .................................................... 228 228
------------ -----------
Net adjustments ............................................................. 228 228
------------ -----------
Net loss as adjusted ............................................................... $ (623) $ (1,786)
============ ===========
Basic and diluted net loss per share - as reported ................................. $ (0.02) $ (0.05)
============ ===========
Basic and diluted net loss per share - as adjusted ................................. $ (0.02) $ (0.05)
============ ===========
The transition provisions of SFAS No. 142 require that the Company
complete its assessment of whether impairment may exist as of the date of
adoption by December 31, 2001 and complete its determination of the amount of
any impairment as of the date of adoption by June 30, 2002. Any impairment that
is required to be recognized when adopting SFAS No. 142 will be reflected as the
cumulative effect of a change in accounting principle as of July 1, 2001. The
Company has completed its initial assessment and concluded that goodwill arising
from the acquisition of United States Software Corporation ("USSC"), having a
carrying amount of approximately $5.4 million as of July 1, 2001, may be
impaired. The Company expects to complete its determination of the amount of the
impairment charge, if any, to be reflected as a cumulative effect of a change in
accounting principle during the fourth fiscal quarter ending June 30, 2002.
The Company intends to perform the first of the required annual
impairment tests of goodwill under the guidelines of SFAS No. 142 effective as
of April 1, 2002. The Company has not yet determined the effect, if any, that
this test will have on its consolidated statement of operations or financial
position; however, indicators of impairment are present given the decline in the
market capitalization of the Company in the fourth quarter of fiscal 2002. An
impairment charge, if any, identified as a result of completing the Company's
annual impairment test will be reflected as an operating expense in the fourth
quarter of fiscal 2002.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," ("SFAS No. 144") which supersedes
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" ("SFAS No. 121") and the accounting and
reporting provisions of Accounting Principles Board Opinion No. 30, "Reporting
the Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." This statement retains certain requirements of SFAS No. 121
relating to the recognition and measurement of impairment of long-lived assets
to be held and used. Additionally, this statement results in one accounting
model, based on the framework established in SFAS No. 121, for long-lived assets
to be disposed of by sales and also addresses certain implementation issues
related to SFAS No. 121, including the removal of goodwill from its scope due to
the issuance of SFAS No. 142. SFAS No. 144 is effective for fiscal years
beginning after December 15, 2001, and interim periods within those fiscal
years. The Company has not yet determined the effect, if any, on the carrying
value of its long-lived assets resulting from the adoption of SFAS No. 144.
4. Business Combinations
On October 18, 2001, the Company completed the acquisition of
Synergetic Micro Systems, Inc. ("Synergetic"). On January 11, 2002, the Company
completed the acquisition of Premise Systems, Inc. ("Premise"). These
acquisitions have been accounted for under the purchase method of accounting.
The condensed consolidated financial statements include the results of
operations of the acquisitions of Synergetic and Premise after their dates of
acquisition. The acquisition of Synergetics provides the Company with
high-performance embedded network communications to complement its external
device products. The acquisition of Premise and its advanced SYS(TM) software
suite complements the Company's Device Networking products by providing
management and control capabilities for devices that have been network and
internet-enabled.
8
A summary of the transactions are outlined below:
Shares Total Shares
Date Shares Reserved For Issued or Cash
Company Acquired Acquired Business Issued Options Assumed Reserved Consideration
- ---------------- -------- -------- ------ --------------- -------- -------------
Synergetic. .............. Oct. 2001 Embedded network 2,234,715 615,705 2,850,420 $2.7 million
communications
solutions
provider
Premise .................. Jan. 2002 Developer of 1,063,371 875,000 1,938,371 --
client-side
software
applications
The share issuances were exempt from registration pursuant to section
3(a)(10) or 4(2) of the Securities Act of 1933, as amended. Portions of the cash
consideration and shares issued will be held in escrow pursuant to the terms of
the acquisition agreements.
The Premise agreement required the Company to issue 1,150,000 shares of
common stock in exchange for all remaining shares of Premise. Prior to the
acquisition, the Company held shares of Premise representing 19.9% ownership
and, in addition, held convertible promissory notes of $1.2 million with
interest accrued thereon at the rate of 9.0%. The convertible promissory notes
were converted into equity securities of Premise at the closing of the
transaction. The Company issued an aggregate of 1,063,371 shares of its common
stock in exchange for all remaining outstanding shares of Premise common stock
and reserved 875,000 additional shares of common stock for issuance upon
exercise of outstanding employee stock options and other rights of Premise.
Pursuant to the acquisition agreement, 106,337 shares will be held in escrow to
secure certain indemnification obligations, and 531,686 of such shares will be
held in escrow pending achievement of certain performance obligations.
Allocation of Purchase Consideration
The Company is in the process of obtaining independent appraisals of
the fair value of the tangible and intangible assets acquired related to the
acquisitions of Synergetic and Premise in order to allocate the purchase price
in accordance with SFAS No. 141. The Company does not expect that the final
allocation of purchase price will produce materially different results from
those reflected herein, as it relates to the Synergetic acquisition. The
preliminary purchase price of the Synergetic acquisition was allocated as
follows based upon management's best estimate of the tangible and intangible
assets (in thousands):
Net
Tangible Deferred
Assets Purchased Deferred Tax Total
Company Acquired Acquired Goodwill Intangibles Compensation Liabilities Consideration
- ---------------- -------- -------- ----------- ------------ ----------- -------------
Synergetic ................ $178 $13,608 $11,100 $203 $(5,213) $19,876
The consideration for the purchase transaction was calculated as
follows: a) common shares issued were valued based upon the Company's stock
price for a short period just before and after the companies reached agreement
and the proposed transactions were announced and b) employee stock options were
valued in accordance with FASB Interpretations No. 44, "Accounting for Certain
Transactions involving Stock Compensation." Net tangible assets acquired in
connection with the purchase transactions include the acquisition costs incurred
by the Company. Additionally, the net tangible assets of Synergetic reflect an
outstanding note payable and credit facility aggregating $626,000, which was
paid in full by the Company in connection with the terms of the merger
agreement.
The acquisition of Premise resulted in total consideration of $9.8
million, which has been preliminarily allocated principally to goodwill, pending
an initial valuation of the Premise tangible and intangible assets acquired.
9
Pro Forma Data
The pro forma statements of operations data of the Company set forth
below gives effect to the acquisitions of Synergetic and Premise as if they had
occurred at the beginning of fiscal 2001. The following unaudited pro forma
statements of operations data includes the amortization of purchased intangible
assets and stock-based compensation. This pro forma data is presented for
informational purposes only and does not purport to be indicative of the results
of future operations of the Company or the results that would have actually
occurred had the acquisitions taken place at the beginning of fiscal 2001 (in
thousands, except per share data):
Three Months Ended Nine Months Ended
March 31, March 31,
--------- ---------
2002 2001 2002 2001
---- ---- ---- ----
Net revenues ....................................................................... $ 14,579 $ 13,405 $ 47,270 $ 38,317
======== ======== ======== ========
Loss before cumulative effect of accounting change ................................. $ (8,801) $ (2,458) $(15,634) $ (5,320)
Cumulative effect of accounting change, net of income tax benefit of $176 .......... -- -- -- (597)
-------- -------- -------- --------
Net loss ........................................................................... $ (8,801) $ (2,458) $(15,634) $ (5,917)
======== ======== ======== ========
Loss per share before cumulative effect of accounting change ....................... $ (0.16) $ (0.06) $ (0.30) $ (0.13)
Cumulative effect of accounting change per share ................................... -- -- -- (0.02)
-------- -------- -------- --------
Basic and diluted net loss per share ............................................... $ (0.16) $ (0.06) $ (0.30) $ (0.15)
======== ======== ======== ========
5. Net Loss per Share
Basic net loss per share is calculated by dividing net loss by the
weighted average number of common shares outstanding during the period. Diluted
net loss per share is calculated by adjusting outstanding shares assuming any
dilutive effects of options. However, for periods in which the Company incurred
a net loss, these shares are excluded because their effect would be to reduce
recorded net loss per share. The following table sets forth the computation of
net loss per share (in thousands, except per share amounts):
Three Months Ended Nine Months Ended
March 31, March 31,
--------- ---------
2002 2001 2002 2001
---- ---- ---- ----
(Restated) (Restated)
Numerator:
Loss before cumulative effect of accounting change ................................... $ (8,730) $ (851) $(12,925) $ (1,417)
Cumulative effect of accounting change ............................................... -- -- -- (597)
-------- ------- -------- --------
Net loss ............................................................................. $ (8,730) $ (851) $(12,925) $ (2,014)
======== ======= ======== ========
Denominator:
Weighted-average shares outstanding .................................................. 53,836 37,974 51,231 36,015
Less: non-vested common shares outstanding ........................................... (531) -- (531) --
-------- ------- -------- --------
Denominator for basic and diluted loss per share ..................................... 53,305 37,974 50,700 36,015
======== ======= ======== ========
Loss per share before cumulative effect of accounting change ......................... $ (0.16) $ (0.02) $ (0.25) $ (0.04)
Cumulative effect of accounting change per share ..................................... -- -- -- (0.02)
-------- ------- -------- --------
Basic and diluted net loss per share ................................................. $ (0.16) $ (0.02) $ (0.25) $ (0.06)
======== ======= ======== ========
6. Inventories
Inventories are stated at the lower of cost (first-in, first-out) or
market and consist of the following (in thousands):
March 31, June 30,
2002 2001
---- ----
(Restated)
Raw materials .................................................... $ 5,186 $ 6,752
Finished goods ................................................... 11,336 6,526
Inventory at distributors ........................................ 1,419 2,772
-------- --------
17,941 16,050
Reserve for excess and obsolete inventory ........................ (3,823) (2,490)
-------- --------
$ 14,118 $ 13,560
======== ========
10
7. Goodwill and Purchased Intangible Assets
Goodwill
The changes in the carrying amount of goodwill for the nine months ended
March 31, 2002, are as follows (in thousands):
Balance as of July 1, 2001 ........................................................................ $ 43,025
Goodwill acquired during the period (based, in part, on preliminary allocations) .................. 23,394
Reclassification of assembled workforce in connection with adoption of SFAS No. 142 at July 1,
2001 ......................................................................................... 1,458
---------
67,877
Less: accumulated amortization ................................................................. (788)
---------
Balance as of March 31, 2002 .................................................................... $ 67,089
=========
Purchased Intangible Assets
The composition of purchased intangible assets is as follows (in
thousands):
March 31, 2002 June 30, 2001
-------------- -------------
Useful Accumulated Accumulated
Lives Gross Amortization Net Gross Amortization Net
----- ----- ------------ --- ----- ------------ ---
Existing technology ........... 5 years $ 12,245 $ (1,731) $ 10,514 $ 6,745 $ (188) $ 6,557
Customer agreements ........... 5 3,800 (344) 3,456 -- -- --
Customer lists ................ 5 3,500 (569) 2,931 3,500 (44) 3,456
Patent/core technology......... 5 1,600 (312) 1,288 299 (150) 149
Tradename/trademark ........... 5 1,258 (248) 1,010 1,162 (65) 1,097
Assembled workforce ........... 5 -- -- -- 1,458 (68) 1,390
Distribution network .......... 5 755 (189) 566 755 (76) 679
Non-compete agreements......... 3 400 (60) 340 -- -- --
-------- -------- -------- -------- -------- --------
Total $ 23,558 $ (3,453) $ 20,105 $ 13,919 $ (591) $ 13,328
======== ======== ======== ======== ======== ========
As required by SFAS No. 142, assembled workforce was reclassified as
goodwill effective July 1, 2001.
The amortization expense for purchased intangible assets for the nine
months ended March 31, 2002 was $2.9 million, of which $1.5 million was
amortized to cost of revenues and $1.4 million was amortized to operating
expenses. The estimated amortization expense for the remainder of fiscal 2002
and the next five years are as follows:
Cost of Operating
Fiscal year ending June 30: Revenues Expenses Total
-------- -------- -----
2002 ...................... $ 612 $ 580 $ 1,192
2003 ...................... 2,449 2,316 4,765
2004 ...................... 2,449 2,286 4,735
2005 ...................... 2,449 2,162 4,611
2006 ...................... 2,228 1,938 4,166
2007 ...................... 327 309 636
-------- ------- --------
Total ..................... $ 10,514 $ 9,591 $ 20,105
======== ======= ========
8. Long-term Investments
In September and October 2001, the Company paid an aggregate of $3.0
million to Xanboo Inc. ("Xanboo") for convertible promissory notes, which
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 currently holds an 18.7% ownership interest in
Xanboo. The Company is accounting for this investment 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.
11
The Company periodically reviews its investments for which fair value is
less than cost to determine if the decline in value is other than temporary. If
the decline in value is judged to be other than temporary, the cost basis of the
security is written down to fair value. During the nine months ended March 31,
2002, the Company recorded a $500,000 revaluation of a non-marketable equity
investment resulting from an other-than-temporary decline in its value. This
amount is included within the condensed consolidated statements of operations as
other expense.
9. Restructuring Charges
On February 6, 2002, the Company announced a restructuring plan to
prioritize its initiatives around the growth areas of its business, focus on
profit contribution, reduce expenses, and improve operating efficiency. This
restructuring plan includes a worldwide workforce reduction, consolidation of
excess facilities and other charges. As of March 31, 2002, the Company recorded
restructuring costs totaling $2.8 million, which are classified as operating
expenses. The Company's new management team anticipates recording further
restructuring costs in the fourth quarter of fiscal 2002 as it continues to
implement this plan and explores additional restructuring alternatives.
A summary of the activity in the restructuring liability account is as
follows (in thousands):
Charges Against Liability
-------------------------
Restructuring Balance at
Liability Non-Cash Cash March 31, 2002
--------- -------- ---- --------------
Workforce reductions ................................ $ 1,762 $ (595) $ (821) $ 346
Property, equipment and other assets ................ 1,048 (1,048) -- --
------- -------- ------ -----
Total ............................................... $ 2,810 $ (1,643) $ (821) $ 346
======= ======== ====== =====
Through March 31, 2002, the restructuring plan had resulted in the
reduction of approximately 50 regular employees worldwide. In addition, the
number of temporary and contract workers employed by the Company was also
reduced. Included in the workforce reduction charge is a non-cash stock-based
compensation charge in the amount of $595,000 associated with the modification
of stock options that were outstanding at the termination date. Property,
equipment and other assets that were disposed of or removed from operations
consisted primarily of computer software and related equipment, production,
engineering and office equipment, and furniture and fixtures.
10. Line of Credit
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 is required to pay a $100,000 facility fee of which $50,000
was paid upon the closing and $50,000 is to be paid in January 2003. The Company
is also required to pay a quarterly unused line fee of .125% of the unused line
of credit balance. The line of credit contains customary affirmative and
negative covenants. To date, the Company has not borrowed against this line of
credit. The Company is not in compliance with the financial covenants of the
line of credit at March 31, 2002.
11. Stockholders' Equity
In July 2001, the Company completed a public offering of 8,534,000 shares
of its common stock, including an underwriter's over-allotment option to
purchase an additional 534,000 shares, at an offering price of $8.00 per share.
The Company sold 6,000,000 shares and selling stockholders sold 2,000,000 shares
of the primary offering. Additionally, the Company sold 400,500 shares and
selling stockholders sold 133,500 shares of the over-allotment option. The
Company received net proceeds of approximately $47.1 million in connection with
this offering.
12
12. Comprehensive Loss
SFAS No. 130, "Reporting Comprehensive Income (Loss)," establishes
standards for reporting and displaying comprehensive income (loss) and its
components in the condensed consolidated financial statements. The components of
comprehensive loss are as follows (in thousands):
Three Months ended Nine Months ended
March 31, March 31,
--------- ---------
2002 2001 2002 2001
---- ---- ---- ----
(restated) (restated)
Net loss ......................................................................... $ (8,730) $ (851) $(12,925) $ (2,014)
Other comprehensive loss:
Change in net unrealized loss on investment ................................... -- -- 134 --
Change in accumulated translation adjustments.................................. (8) (14) 17 (7)
-------- -------- -------- --------
Total comprehensive loss ......................................................... $ (8,738) $ (865) $(12,774) $ (2,021)
======== ======== ======== ========
13. Litigation
Patent Infringement Suit
From time to time, the Company has received letters claiming that their
products infringe upon patents or other intellectual property of third-parties.
On July 3, 2001, Digi International, Inc., filed a complaint in the United
States District Court for the district of Minnesota claiming patent infringement
and alleging that Lantronix directly and/or indirectly infringes upon Digi's
U.S. Patent No. 6,047,319 by making, using, selling and or offering for sale
certain of Lantronix's Multiport device servers, including the ETS line of
products, coupled with a device driver called the Comm Port Redirector Software.
Digi alleges that the Company has willfully and intentionally infringed Digi's
patent, and its complaint seeks injunctive relief as well as unspecified
damages, treble damages, attorney's fees, interest and costs. On August 17,
2001, the Company filed its answer to the complaint, asserting affirmative
defenses, and counterclaiming for a declaratory judgment that the patent in
issue is invalid. The case is in the discovery stage, and the Court has
tentatively set the matter for trial in June 2003. Based on the facts known to
date, the Company believes that the claims are without merit and intends to
vigorously defend the suit.
Securities Suits
On May 15, 2002, a class action complaint entitled Bachman v.
Lantronix, Inc., et al. was filed in the U.S. District Court for the Central
District of California against the Company and certain of its current and former
officers and directors alleging violations of the Securities Exchange Act of
1934, as amended (the "1934 Act"). Subsequently, two similar actions were filed
in the same court: Fitzgearl v. Lantronix, Inc., et al. and Anderson v.
Lantronix, Inc., et al. Each of the complaints purports to be a class action
lawsuit brought on behalf of persons who purchased or otherwise acquired the
Company's common stock during the period of April 25, 2001 through May 30, 2002,
inclusive.
The complaints allege that the defendants caused the Company to
improperly recognize revenue and made false and misleading statements about the
Company's business. Plaintiffs further allege that the Company materially
overstated its reported financial results, thereby inflating the Company's stock
price during its Secondary Offering in July 2001, as well facilitating the use
of the Company's stock as consideration in acquisitions. The complaints do not
specify the amount of damages sought. The Company is currently investigating the
allegations in the complaints. There has been no discovery to date, and no trial
date has been established. An adverse judgment or settlement of these lawsuits
could have a significant impact on the Company's future financial condition or
results of operations. The Company anticipates that all of these actions will
ultimately be consolidated into one action and that a consolidated amended
complaint will be filed after the appointment of Lead Plaintiff(s). The Company
has not yet responded to any of the complaints, and discovery has not commenced.
Employment Litigation
Cathy Vicari ("Vicari") claims damages in the approximate amount of
$850,000. Vicari asserts claims of Sex and Medical Leave Disability
Discrimination, Intentional Infliction of Emotional Distress, Negligence, Breach
of employment Contract, and Wrongful termination in Violation of Public Policy.
The Company filed a Motion for Summary Judgment, which was argued on April 1,
2002. The Company and its counsel believe Vicari's claims to be groundless, and
continue to vigorously defend each of them.
The Company is also involved in other legal proceedings, claims and
litigation arising in the ordinary course of business.
13
The pending lawsuits involve complex questions of fact and law and
likely will require the expenditure of significant funds and the diversion of
other resources to defend. Although management currently believes the outcome of
outstanding legal proceedings, claims and litigation involving the Company or
its subsidiaries will not 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 an adverse outcome is at
least reasonably possible. The Company is unable to estimate the range of
possible loss from outstanding litigation, and no amounts have been provided for
such matters in the unaudited condensed consolidated financial statements.
14. Subsequent Events
Executive Transitions and Restatement of Financial Reports
On May 3, 2002, the Board of Directors (the "Board") terminated the
employment of Steven V. Cotton, Chief Operating Officer and Chief Financial
Officer. On May 6, 2002, the Board appointed James Kerrigan as Interim Chief
Financial Officer, and eliminated the position of Chief Operating Officer.
On May 29, 2002, Board Chairman Bernhard Bruscha tendered his
resignation from the Board. CEO and President Fred Thiel also tendered his
resignation from the Board, and from his position as CEO and President. The
Board accepted all of the resignations. Mr. Thiel accepted the new position of
Chief Technology and Strategy Officer. The Board subsequently elected Mr. Marc
H. Nussbaum to the position of Interim CEO and President.
On May 30, 2002, the Company announced the Board and CEO changes, along
with its decision to restate its consolidated financial statements for the
fiscal year ended June 30, 2001 and for the quarters ended September 30, 2001
and December 31, 2001 of fiscal 2002 (Note 2).
Officer Loans
At the discretion of the Board of Directors, the Company may make
secured loans to option holders in amounts up to the exercise price of their
options plus related taxes or permit the option holder to pay the exercise price
in installments over a determined period. The Company had outstanding loans of
$277,000 and $790,000 to officers for the exercise of options at March 31, 2002
and June 30, 2001, respectively. These notes are full-recourse, are secured by
the shares of stock issued upon exercise, are interest bearing at rates ranging
from 5.06% to 7.50% per annum, and are due three years from the exercise date.
The Company also had outstanding loans of $3,999,000 and $4,131,000 at March 31,
2002 and June 30, 2001, respectively, related to taxes on exercised stock
options. These notes are non-recourse, are secured by 2,496,344 shares of 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.
Due to the decrease in the trading price of the Company's common stock,
the aggregate value of the collateral related to the non-recourse loans is
approximately $2.5 million (based on the quoted market price on May 31, 2002),
which is below the amount owed on the notes. One of the noteholders is the
former Chief Executive Officer of the Company, who assumed the role of Chief
Technology and Strategy Officer of the Company effective May 30, 2002. One of
the noteholders is one of the Company's outside directors and one of the
noteholders is the former Chief Operating/Chief Financial Officer who was
terminated by the Company on May 3, 2002. The Company will consider the value of
the collateral securing the notes and the ability of the noteholders to honor
their obligations in determining the appropriate carrying value of the notes in
its fourth fiscal quarter ending June 30, 2002. An impairment charge, if any,
identified as a result of this review will be reflected as an operating expense
in the fourth fiscal quarter.
Potential Delisting By Nasdaq
The Company received a notification from Nasdaq on May 23, 2002 that it
does not meet the filing requirements for continued listing on the Nasdaq
National Market and is therefore subject to delisting. The Company requested a
hearing before a Nasdaq listing qualifications panel to review the Staff
Determination. The hearing has been scheduled for June 20, 2002. The notice from
Nasdaq was sent as a result of the Company's current non-compliance with
Marketplace Rule 4310(c)(14), which requires timely filing of the Company's
Quarterly Report on Form 10-Q. Concurrently with the filing of this 10-Q, the
Company has notified Nasdaq that it is in compliance with Rule 4310(c)(14), and
it has requested that Nasdaq discontinue delisting proceedings with respect to
the Company's stock. There can be no assurance the Panel will grant the
Company's request for continued listing.
14
New Intellectual Property Agreement with Gordian
The Company announced on May 30, 2002 that it has signed a new
intellectual property agreement with Gordian, Inc., the Company's long-time
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 Company will pay Gordian $6.0 million to acquire an interest in the
Gordian intellectual property, which will be paid in three installments. The
Company paid $3.0 million concurrent with the signing of the agreement and is
obligated to pay $2.0 million on July 1, 2002 and $1.0 million on July 1, 2003.
The Company will also purchase $1.5 million of engineering and support services
from Gordian over the next 18 months. The Company intends to amortize the
intellectual property rights over three to four years.
Intent To Acquire Stallion Technologies, PTY, LTD.
On May 9, 2002, the Company signed a Letter of Intent to acquire
Stallion Technologies PTY., LTD ("Stallion"), a provider of terminal servers and
multiport products. In connection with the proposed acquisition, the Company
intends to pay cash consideration of $867,000, issue an aggregate of 866,667
shares of its common stock, based upon the fair market value of the Company's
common stock at June 14, 2002, and issue a two-year note of $867,000 convertible
into the Company's common stock at a $5.00 conversion price. The Company is
required to establish a cash escrow account in the amount of $800,000 at the
acquisition date to be used in lieu of the Company's common stock in the event
that such securities are not freely traded. In addition, the Company will pay
approximately $150,000 for legal and professional fees related to the
acquisition. At the time of the execution of the Letter of Intent, the Company
paid to Stallion $200,000 in earnest money, to be credited against the cash
portion of the consideration.
Claim Regarding Certain Unregistered Shares
The Company has received an informal notice from several holders of the
Company's unregistered shares of common stock that were issued in connection
with the acquisition of Lightwave. The shares were issued to the holders in a
private transaction not registered under the Securities Act of 1933, and
therefore could not be sold by the stockholders without a valid registration
statement. The stockholders allege that the Company failed to honor their rights
to have the shares registered and that they were therefore precluded from
selling the shares. The stockholders are seeking compensation of up to $2.1
million, based on the proceeds they might have received had they been able to
sell their shares into the market when the market price of the Company's common
stock was higher.
15
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
You should read the following discussion and analysis in conjunction
with the Unaudited Condensed Consolidated Financial Statements and related Notes
thereto contained elsewhere in this Report. The information in this Quarterly
Report on Form 10-Q is not a complete description of our business or the risks
associated with an investment in our common stock. We urge you to carefully
review and consider the various disclosures made by us in this Report and in
other reports filed with the SEC, including our restated Annual Report on Form
10-K/A for the fiscal year ended June 30, 2001, Form 10-Q/A's for the fiscal
quarters ended September 30, 2001 and December 31, 2001, and our subsequent
reports on Form 8-K that discuss our business in greater detail.
We have restated our consolidated financial statements for our fiscal
year ended June 30, 2001 and each fiscal quarter therein and our condensed
consolidated financial statements for the fiscal quarters ended September 30,
2001 and December 31, 2001. To the extent that the following discussion and
analysis refers to data from our consolidated financial statements for such
periods, such references are to the data as restated.
The section entitled "Risk Factors" set forth below, and similar
discussions in our other SEC filings, discuss some of the important factors that
may affect our business, results of operations and financial condition. You
should carefully consider those factors, in addition to the other information in
this Report and in our other filings with the SEC, before deciding to invest in
our company or to maintain or increase your investment.
This report contains forward-looking statements which include, but are
not limited to, statements concerning projected net revenues, expenses, gross
profit and income (loss), the need for additional capital, market acceptance of
our products, our ability to consummate acquisitions and integrate their
operations successfully, our ability to achieve further product integration, the
status of evolving technologies and their growth potential and our production
capacity. These forward-looking statements are based on our current
expectations, estimates and projections about our industry, management's
beliefs, and certain assumptions made by us. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "seeks," "estimates," "may," "will"
and variations of these words or similar expressions are intended to identify
forward-looking statements. In addition, any statements that refer to
expectations, projections or other characterizations of future events or
circumstances, including any underlying assumptions, are forward-looking
statements. These statements are not guarantees of future performance and are
subject to certain risks, uncertainties and assumptions that are difficult to
predict. Therefore, our actual results could differ materially and adversely
from those expressed in any forward-looking statements as a result of various
factors. We undertake no obligation to revise or update publicly any
forward-looking statements for any reason.
Accounting Change and Restatement of Financial Statements
In originally preparing the condensed consolidated financial statements
at December 31, 2001, we changed our accounting method for recognizing revenue
on sales to distributors effective as of July 1, 2001, the beginning of fiscal
2002. Under the new accounting method, the recognition of revenue and related
gross profit on sales to distributors is deferred until the distributor resells
the product to an end customer. Formerly, we had recognized revenue from these
transactions upon shipment of product to the distributor, net of estimates for
possible returns and allowances.
In May 2002, we undertook a special investigation of our accounting,
which revealed that beginning in the third and fourth quarters of fiscal 2001
certain shipments made to distributors and recorded as revenues in fiscal 2001
and 2002 did not qualify for revenue recognition upon shipment due to terms
present in agreements with the distributors that were not considered in our
original accounting decisions. As a result, our new method of accounting for
distributor sales, which is based on recognizing revenue and related gross
profit on sales to distributors only as the distributor resells the product to
end customers, has been adopted effective as of July 1, 2000, the beginning of
fiscal 2001, or one year earlier. This manner of correcting the errors in sales
recognition made in previously issued financial statements for fiscal 2001 is
deemed to be preferable in the circumstances because (1) it eliminates from
revenue any effect of shipping excessive levels of inventory to the
distributors; (2) all revenue from distributor sales in fiscal 2001 and 2002
will be recognized on a common basis; and (3) there is assurance that any
additional agreements with distributors that may have existed with respect to
specific orders but are presently unknown will not have an impact on amounts
reported as revenue after the restatement. The restatement for the year ended
June 30, 2001, results in a reduction in net revenue of approximately $6.2
million and an increase in the loss before cumulative effect of accounting
change of $2.9 million or $0.07 per share. The cumulative effect of the
accounting change recorded as of July 1, 2000 was a charge of $597,000 (net of
income tax benefit of $176,000) or $0.02 per share.
We believe that the new accounting method better reflects the substance
of the transactions considering our recent entry in the semiconductor
marketplace and the changing business environment; is consistent with other
companies in our industry
16
thereby providing greater comparability in the presentation of financial results
among our peers, and better focuses us on end customer sales.
In the special investigation conducted in May 2002, we also discovered
(i) that the terms and circumstances of certain sales made in the first six
months of fiscal 2002 to customers who were not distributors also preclude
revenue from being recognized upon shipment, as originally reported and (ii)
that certain amounts initially reported as other comprehensive income (loss)
should be accounted for as elements of net loss. Accordingly, in the restated
condensed consolidated financial statements for the three months ended September
30, 2001 and December 31, 2001, we have made error corrections to defer the
recognition of such sales as revenue until all revenue recognition criteria have
been met and to reclassify to other expense the amounts improperly charged to
other comprehensive income (loss). These error corrections result in a reduction
in revenue of approximately $1.2 million and an increase in the loss before
cumulative effect of accounting change of $869,000 or $0.02 per share for
the six months ended December 31, 2001.
The effects of these error corrections on net revenues; loss before
cumulative effect of accounting change, net of income tax benefit; cumulative
effect of accounting change; net loss; and related per share amounts for the
interim periods of fiscal 2002 are shown in the tables below (in thousands,
except per share amounts):
Three Months Nine Months
Ended Ended
March 31, March 31,
2001 2001
---- ----
As originally reported:
Net revenues ..................................................................... $ 14,125 $ 38,627
======== ========
Loss before cumulative effect of accounting change ............................... $ (99) $ (173)
Cumulative effect of accounting change ........................................... -- --
-------- --------
Net loss ......................................................................... $ (99) $ (173)
======== ========
Loss per share before cumulative effect of accounting change ..................... $ (0.00) $ (0.00)
Cumulative effect of accounting change per share ................................. -- --
-------- --------
Basic and diluted net loss per share ............................................. $ (0.00) $ (0.00)
======== ========
As restated:
Net revenues ..................................................................... $ 14,125 $ 38,627
Corrections ...................................................................... (1,595) (2,417)
-------- --------
Net revenues, as restated ........................................................ $ 12,530 $ 36,210
======== ========
Loss before cumulative effect of accounting change ............................... $ (99) $ (173)
Correction, net of tax ........................................................... (752) (1,244)
-------- --------
Loss before cumulative effect of accounting change, as restated .................. (851) (1,417)
Cumulative effect of accounting change, net of income tax benefit of $176, as
restated ...................................................................... -- (597)
-------- --------
Net loss, as restated ............................................................ $ (851) $ (2,014)
======== ========
Loss per share before cumulative effect of accounting change, as restated ........ $ (0.02) $ (0.04)
Cumulative effect of accounting change per share, as restated .................... -- (0.02)
-------- --------
Basic and diluted net loss per share, as restated ................................ $ (0.02) $ (0.06)
======== ========
Under the leadership of our new management, we are actively working to
strengthen our policies, procedures, personnel, controls and internal
communications in response to the circumstances that led to the restatement.
17
Overview
Lantronix designs network-enabling and system management solutions
consisting of hardware and software that permit almost any electronic device to
be accessed, managed, controlled over the Internet, intranets or other networks.
Since our inception in 1989, we have developed an array of network-enabling
products including external Device Servers, embedded Device Servers, Multiport
Device Servers, Print Servers and other products. Beginning in fiscal year 1999,
we began to experience an increase in sales of our Device Servers reflecting our
focus on this higher margin product line. At the same time, we began to
experience a decline in sales of Print Server and other products as we shifted
resources to our Device Server business, which we believe represents a greater
opportunity for long-term growth. However, since the acquisition of Lightwave
Communications, Inc. ("Lightwave") in June 2001 we have experienced a
significant growth in our Multiport Device Server product lines. We believe
sales in our Device Server business will continue to represent an increasing
percentage of our net revenues in the future. Our strategy for continuing to
increase sales of our Device Server product line involves a two-fold approach.
First, we have and intend to continue to substantially increase our research and
development expenditures to enhance our Device Server product line and develop
new products. Second, we intend to grow our Device Server business through
strategic acquisitions, investments and partnerships, which we believe will
support our product lines and allow us to secure additional intellectual
property, increase our customer base and provide access to new markets.
Our products are sold to original equipment manufacturers (OEMs), value
added resellers (VARs), systems integrators and distributors, as well as
directly to end-users. One of our distributors, Tech Data, accounted for 10.6%
of our net revenues for the nine months ended March 31, 2002, compared to 10.0%
for the nine months ended March 31, 2001. Another distributor, Ingram Micro,
accounted for 12.5% of our net revenues for the nine months ended March 31,
2002, compared to 12.7% for the nine months ended March 31, 2001. transtec AG,
an international distributor and related party due to common ownership by our
major stockholder and former Chairman of the Board, accounted for 4.6% of our
net revenues for the nine months ended March 31, 2002, compared to 9.4% for the
nine months ended March 31, 2001. There was no outstanding accounts receivable
balance due from transtec AG at March 31, 2002.
In July 2001, we completed a public offering of 8,534,000 shares of our
common stock, including an underwriter's over-allotment option to purchase an
additional 534,000 shares, at an offering price of $8.00 per share. We sold
6,000,000 shares and selling stockholders sold 2,000,000 shares of the primary
offering. Additionally, we sold 400,500 shares and selling stockholders sold
133,500 shares of the over-allotment option. We received net proceeds of
approximately $47.1 million in connection with this offering.
On October 18, 2001, we completed the acquisition of Synergetic Micro
Systems, Inc. ("Synergetic"), a provider of high performance embedded network
communication solutions that complement our external device products. In
connection with the acquisition, we paid cash consideration of $2.7 million and
issued an aggregate of 2,234,715 shares of our common stock in exchange for all
outstanding shares of Synergetic common stock and reserved 615,705 additional
shares of common stock for issuance upon exercise of outstanding employee stock
options and other rights of Synergetic. Portions of the cash consideration and
shares issued will be held in escrow pursuant to the terms of the acquisition
agreement.
On January 11, 2002, we completed the acquisition of Premise Systems,
Inc. ("Premise"), a developer of client-side software applications that
complement our device networking products by providing superior management and
control capabilities for devices that have been network and internet enabled.
Prior to the acquisition, we held shares of Premise representing 19.9% ownership
and, in addition, held convertible promissory notes of $1.2 million with
interest accrued there-on at the rate of 9.0%. The convertible promissory notes
were converted into equity securities of Premise at the closing of the
transaction. We issued an aggregate of 1,063,371 shares of our common stock in
exchange for all remaining outstanding shares of Premise common stock and
reserved 875,000 additional shares of common stock for issuance upon exercise of
outstanding employee stock options and other rights of Premise. Pursuant to the
acquisition agreement, 106,337 shares will be held in escrow to secure certain
indemnification obligations, and 531,686 of such shares will be held in escrow
pending achievement of certain performance obligations. In connection with the
acquisition, we expect to record a one-time charge for purchased in-process
research and development expenses related to the acquisition in our fourth
fiscal quarter ending June 30, 2002.
In September and October 2001, we paid an aggregate of $3.0 million to
Xanboo Inc. ("Xanboo") for convertible promissory notes, which converted in
January 2002, in accordance with their terms, into Xanboo preferred stock. In
addition, we purchased $4.0 million of Xanboo preferred stock in January 2002.
We currently hold an 18.7% ownership interest in Xanboo. Our investment in
Xanboo is accounted for using the equity method of accounting based on our
ability through representation on Xanboo's board of directors to exercise
significant influence over its operations.
Stock-based compensation primarily relates to deferred compensation
recorded in connection with the grant of stock options to employees where the
option exercise price is less than the estimated fair value of the underlying
shares of common
18
stock as determined for financial reporting purposes, as well as the fair market
value (determined using the Black-Scholes option pricing model) of the vested
portion of non-employee stock options determined. Deferred compensation also
includes the value of employee stock options assumed in connection with
acquisitions of businesses calculated in accordance with current accounting
guidelines. Deferred compensation is presented as a reduction to stockholders'
equity and is amortized over the vesting period of the related stock options,
which is generally four years. At March 31, 2002, a deferred compensation
balance of $7.0 million remains and will be amortized as follows: $737,000 in
the remainder of fiscal 2002, $2.7 million in fiscal 2003, $2.2 million in
fiscal 2004, $1.2 million in fiscal 2005 and $170,000 in fiscal 2006. The amount
of stock-based compensation in future periods will increase if we grant stock
options where the exercise price is less than the quoted market price of the
underlying shares or if we assume employee stock options in connection with
additional acquisitions of businesses. The amount of stock-based compensation
actually recognized in future periods could decrease if options for which
deferred compensation has been recorded are forfeited.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires us to make 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 revenue 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 reserves, 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 unaudited
condensed consolidated financial statements:
Net Revenues, Receivables and Inventory.
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. Commencing July 1, 2000, recognition
of revenue and related gross profit from sales to distributors are deferred
until the distributor resells the product to provide assurance that all revenue
recognition criteria are met at or prior to the point at which revenue is
recognized. Revenues from product sales to original equipment manufacturers,
end-user customers, other resellers and from sales to distributors prior to July
1, 2000 generally are or have been recognized upon product shipment, but may be
deferred to a later date if all revenue recognition criteria are not met at the
date of shipment. 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. Net revenue from certain smaller distributors for which point-of-sale
information is not available, is recognized one month after the shipment date.
This estimate approximates the timing of the sale of the product by the
distributor to the end user. Should actual product returns or pricing
adjustments exceed our estimates, additional reductions to revenues would
result. 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 we have vendor-specific objective evidence of the fair
value of each element of the software offering and collectibility is probable.
Revenue from post-contract customer support and any other future deliverables,
which comprised approximately one-half of one per cent of net revenues for the
year ended June 30, 2001, is deferred and recognized over the support period or
as contract elements are delivered. Our products typically carry a one to three
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. We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of customers to make required payments. If the
financial condition of our customers was to deteriorate, additional allowances
could be required. We write down our inventory for estimated obsolescence or
unmarketable inventory equal to the difference between the cost of inventory and
the estimated realizable value based upon assumptions about future demand and
market conditions. If actual market conditions are less favorable than those
projected by management, additional inventory write-downs could be required.
Prior to July 1, 2000, the effective date of the change in accounting method for
recognizing revenue for sales to distributors, we recorded an estimated
allowance for future product returns for sales to distributors based on
historical returns experience when the related revenue was recorded and provided
for appropriate price protection reserves when pricing adjustments were
approved. As indicated above, recognition of revenue and related gross profit on
sales to distributors is now deferred until the distributor resells the product.
Goodwill and Purchased Intangible Assets.
19
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, or IPR&D. Goodwill and intangible assets
deemed to have indefinite lives are no longer amortized but are subject to
annual impairment tests. The amounts and useful lives assigned to intangible
assets impact future amortization and the amount assigned to IPR&D is expensed
immediately. 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. The Company is still awaiting a preliminary analysis
of the Premise valuation of tangible and intangible assets acquired. As a
result, the excess of the purchase price over the net assets acquired of Premise
of approximately $9.8 million is included in goodwill and, accordingly, not
being amortized.
Impairment of Long-Lived Assets.
We evaluate long-lived assets used in operations 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 assets are impaired based on 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 these assets. In
that event, additional impairment charges or shortened useful lives of certain
long-lived assets could be required. We have completed our initial assessment
and concluded that goodwill arising from the acquisition of United States
Software Corporation (USSC) having a carrying amount of approximately $5.4
million as of July 1, 2001 may be impaired. We expect to complete our
determination of the amount of the impairment charge, if any, to be reflected as
a cumulative effect of a change in accounting principle during the fourth fiscal
quarter ending June 30, 2002. We intend to perform the first of the required
annual impairment tests of goodwill under the guidelines of Statement of
Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets" ("SFAS No. 142"), effective as of April 1, 2002. We have not yet
determined the effect, if any, that this test will have on our consolidated
statement of operations or financial position; however, indicators of impairment
are present given our decline in market capitalization in the fourth quarter of
fiscal 2002. An impairment charge, if any, identified as a result of completing
our annual impairment test will be reflected as an operating expense in the
fourth quarter of fiscal 2002.
Results of Operations
The following table sets forth certain statement of operations data expressed as
a percentage of total net revenues:
Three Months Ended Nine Months Ended
March 31, March 31,
--------- ---------
2002 2001 2002 2001
---- ---- ---- ----
(Restated) (Restated)
Net revenues ................................................................... 100.0% 100.0% 100.0% 100.0%
Cost of revenues ............................................................... 71.1 46.7 55.2 46.0
----- ----- ----- -----
Gross profit ................................................................... 28.9 53.3 44.8 54.0
----- ----- ----- -----
Operating expenses:
Selling, general and administrative ......................................... 63.1 47.1 53.1 45.7
Research and development .................................................... 15.3 9.3 13.6 9.0
Stock based-compensation .................................................... 4.8 6.7 5.8 5.9
Amortization of purchased intangible assets ................................. 4.0 2.5 3.0 2.9
Restructuring charges ....................................................... 19.3 (--) 6.1 (--)
----- ----- ----- -----
Total operating expenses ....................................................... 106.5 65.6 81.5 63.5
----- ----- ----- -----
Loss from operations ........................................................... (77.6) (12.3) (36.7) (9.5)
Interest income (expense), net ................................................. 2.0 4.3 2.8 4.7
Other income (expense), net .................................................... (1.3) (0.6) (2.1) (0.2)
----- ----- ----- -----
Loss before income taxes and cumulative effect of accounting change ............ (76.9) (8.6) (36.0) (4.9)
Benefit for income taxes ....................................................... (17.1) (1.8) (8.0) (1.0)
----- ----- ----- -----
Loss before cumulative effect of accounting change ............................. (59.8) (6.8) (28.0) (3.9)
Cumulative effect of accounting change, net of income taxes of $176 ............ -- -- -- (1.6)
----- ----- ----- -----
Net loss ....................................................................... (59.8)% (6.8)% (28.0)% (5.6)%
===== ===== ===== =====
Net Revenues
Net revenues increased $2.1 million, or 16.4%, to $14.6 million for the
three months ended March 31, 2002 from $12.5 million for the three months ended
March 31, 2001. Net revenues increased $9.9 million, or 27.4%, to $46.1 million
for the nine months ended March 31, 2002 from $36.2 million for the nine months
ended March 31, 2001. The increase for the three months
20
ended March 31, 2002 was primarily attributable to an increase in net revenues
of our Multiport Device Server products, offset by a decline in our Device
Server products. The increase for the nine months ended March 31, 2002 was
primarily attributable to an increase in net revenues of our Multiport Device
Server products and a slight increase in our Device Server products, offset by a
decline in our Print Server and other products. Multiport Device Server net
revenues increased $2.4 million, or 68.1%, to $6.0 million, or 41.0% of net
revenues, for the three months ended March 31, 2002 from $3.6 million, or 28.4%
of net revenues, for the three months ended March 31, 2001. Multiport Device
Server net revenues increased $10.6 million, or 113.6%, to $19.9 million, or
43.0% of net revenues, for the nine months ended March 31, 2002 from $9.3
million, or 25.7% of net revenues, for the nine months ended March 31, 2001. The
increase in our Multiport Device Server net revenues is primarily attributable
to the acquisition of Lightwave. Device Server net revenues decreased $539,000,
or 6.7%, to $7.5 million, or 51.6% of net revenues, for the three months ended
March 31, 2002 from $8.1 million, or 64.3% of net revenues, for the three months
ended March 31, 2001. Device Server net revenues increased $35,000, or 0.1%, to
$24.1 million, or 52.2% of net revenues, for the nine months ended March 31,
2002 from $24.1 million, or 66.4% of net revenues, for the nine months ended
March 31, 2001. Device Server net revenues for the three months ended March 31,
2002 and 2001 includes $251,000 and $658,000, respectively, of software revenue
generated from USSC. Device Server net revenues for the nine months ended March
31, 2002 and 2001 includes $1.2 million and $896,000, respectively, of software
revenue generated from USSC. In addition, Device Server net revenue for the
three and nine months ended March 31, 2002 includes $0 and $259,000 of Destiny
LX-1 chip revenue, respectively. No Destiny LX-1 chip revenue was recorded for
the three and nine months ended March 31, 2001. Print Server and other net
revenues increased $166,000, or 18.1%, to $1.1 million, or 7.4% of net revenues,
for the three months ended March 31, 2002 from $915,000, or 7.3% of net
revenues, for the three months ended March 31, 2001. Print Server and other net
revenues decreased $668,000, or 23.4%, to $2.2 million, or 4.7% of net revenues,
for the nine months ended March 31, 2002 from $2.9 million, or 7.9% of net
revenues, for the nine months ended March 31, 2001. The decrease in our Print
Server and other products net revenues for the nine months ended March 31, 2002
is due to a more rapid transition to our Multiport Device Server and Device
Server products. The slight increase in our Print Server and other products net
revenues for the three months ended March 31, 2002 is due to a one-time specific
customer order.
Net revenues generated from sales in the Americas increased $4.5 million,
or 55.0%, to $12.6 million, or 86.3% of net revenues, for the three months ended
March 31, 2002 from $8.1 million, or 64.8% of net revenues, for the three months
ended March 31, 2001. Net revenues generated from sales in the Americas
increased $14.4 million, or 58.7%, to $38.8 million, or 84.1% of net revenues,
for the nine months ended March 31, 2002 from $24.4 million, or 67.5% of net
revenues, for the nine months ended March 31, 2001. Our net revenues derived
from customers located in the Americas as a percentage of total net revenues
increased due to the acquisition of Lightwave, which primarily sells to
customers in the Americas, as well as reduced European distributor sales. Our
net revenues derived from customers located in Europe decreased $2.5 million, or
60.6%, to $1.6 million, or 10.9% of net revenues, for the three months ended
March 31, 2002 from $4.0 million, or 32.3% of net revenues, for the three months
ended March 31, 2001. Our net revenues derived from customers located in Europe
decreased $4.2 million, or 40.7%, to $6.0 million, or 13.1% of net revenues, for
the nine months ended March 31, 2002 from $10.2 million, or 28.2% of net
revenues, for the nine months ended March 31, 2001. Our net revenues derived
from customers located in Europe as a percentage of total net revenues decreased
due to the acquisition of Lightwave, which primarily sells in the Americas as
well as a reduction in European distributor sales. Our net revenues derived from
customers located in other geographic areas increased slightly to $407,000, or
2.8% of net revenues, for the three months ended March 31, 2002 from $368,000,
or 2.9% of net revenues, for the three months ended March 31, 2001. Our net
revenues derived from customers located in other geographic areas decreased to
$1.3 million, or 2.8% of net revenues, for the nine months ended March 31, 2002
from $1.6 million, or 4.4% of net revenues, for the nine months ended March 31,
2001.
We have experienced sequential net revenue growth in our overall business
during the fiscal years ended June 30, 2000 and June 30, 2001. During this time,
we successfully transitioned from our printer server business into our Device
Server business. We have maintained a steady net revenue growth throughout each
quarter. During the first quarter of fiscal 2002 we experienced our largest
quarter over quarter growth of approximately 24%. Historically our sequential
quarter over quarter growth has not exceeded 5%. We primarily attribute the
growth in the first quarter of fiscal 2002 to net revenues generated from our
acquisition of Lightwave. The Lightwave acquisition has resulted in a
significant increase in our Multiport Device Server product net revenues. In the
second quarter of fiscal 2002, our net revenues were slightly lower than in the
first quarter of fiscal 2002. Our net revenues declined approximately 7% in the
third quarter of fiscal 2002. The decrease in net revenues for the third fiscal
quarter of 2002 is primarily attributable to an overall weakness in the economy
both domestically and internationally.
Gross Profit
Gross profit represents net revenues less cost of revenues. Cost of
revenues consists primarily of the cost of raw material components, subcontract
labor assembly from outside manufacturers and associated overhead costs.
Additionally, cost of revenues for the three and nine months ended March 31,
2002 consisted of $612,000 and $1.5 million, respectively, of non-cash
amortization of purchased intangible assets. No similar charges were recorded
for the three and nine months ended March 31, 2001. We pay Gordian, Inc., an
outside research and development firm, a royalty based on the sale of certain of
our products. As a
21
result, a royalty charge is included in cost of revenues and is calculated based
on the related products sold. Gross profit decreased by $2.5 million, or 37.0%,
to $4.2 million, or 28.9% of net revenues, for the three months ended March 31,
2002 from $6.7 million, or 53.3% of net revenues, for the three months ended
March 31, 2001. Gross profit increased by $1.1 million, or 5.8%, to $20.7
million, or 44.8% of net revenues, for the nine months ended March 31, 2002 from
$19.6 million, or 54.0% of net revenues, for the nine months ended March 31,
2001. For the three months ended March 31, 2002 and 2001, Gordian royalties were
$199,000 and $591,000, respectively. For the nine months ended March 31, 2002
and 2001, Gordian royalties were $1.0 million and $1.6 million, respectively.
The decrease in gross profit in absolute dollars for the three months ended
March 31, 2002 was mainly attributable to an increase in our inventory reserve
of $1.8 million and the write-off of intellectual property totaling $665,000.
The increase in gross profit in absolute dollars for the nine months ended March
31, 2002 was mainly attributable to the significant increase in the sale of our
Multiport Device Server products, which carry a higher gross margin, offset by
the increase in our inventory reserve and write-off of intellectual property.
The decrease in gross profit as a percentage of net revenues for the three and
nine months ended March 31, 2002 is primarily attributable to the increase in
our inventory reserves, write-off of intellectual property, non-cash
amortization of purchased intangible assets, volume-pricing agreements and
competitive pricing strategies.
Selling, General and Administrative
Selling, general and administrative expenses consist primarily of
personnel-related expenses including salaries and commissions, facility
expenses, information technology, trade show expenses, advertising, and
professional fees. Selling, general and administrative expenses increased $3.3
million, or 55.9%, to $9.2 million, or 63.1% of net revenues, for the three
months ended March 31, 2002 from $5.9 million, or 47.1% of net revenues, for the
three months ended March 31, 2001. Selling, general and administrative expenses
increased $7.9 million, or 47.8%, to $24.5 million, or 53.1% of net revenues,
for the nine months ended March 31, 2002 from $16.6 million, or 45.7% of net
revenues, for the nine months ended March 31, 2001. This increase is due
primarily to increased depreciation of fixed assets, increased personnel-related
costs and facilities costs from the acquisitions of USSC, Lightwave and
Synergetic, as well as hiring of sales personnel, bonuses paid to our executive
officers, the allowance for doubtful accounts related to the Lightwave
receivables, and increased legal and other professional fees. We expect selling,
general and administrative expenses in absolute dollars will decrease in the
foreseeable future as a result of our restructuring plan and decrease as a
percentage of net revenues.
Research and Development
Research and development expenses consist primarily of salaries and the
related costs of employees, as well as expenditures to third-party vendors for
research and development activities. Research and development expenses increased
$1.1 million, or 90.0%, to $2.2 million, or 15.3% of net revenues, for the three
months ended March 31, 2002 from $1.2 million, or 9.3% of net revenues, for the
three months ended March 31, 2001. Research and development expenses increased
$3.0 million, or 93.4%, to $6.3 million, or 13.6% of net revenues, for the nine
months ended March 31, 2002 from $3.2 million, or 9.0% of net revenues, for the
nine months ended March 31, 2001. This increase resulted primarily from
increased personnel-related costs due to the acquisition of USSC, Lightwave,
Synergetic and Premise, as well as hiring a senior engineering executive and
expenses related to new product development.
Stock-based Compensation
Stock-based compensation generally represents the amortization of deferred
compensation. We recorded approximately $362,000 of deferred compensation, net
of forfeitures, for the nine months ended March 31, 2002. Deferred compensation
represents the difference between the fair value of the underlying common stock
for accounting purposes and the exercise price of the stock options at the date
of grant. Deferred compensation is presented as a reduction of stockholders'
equity and is amortized ratably over the respective vesting periods of the
applicable options, which is generally four years. Included in cost of revenues
is stock-based compensation of $21,000 and $11,000 for the three months ended
March 31, 2002 and 2001, respectively, and $97,000 and $36,000 for the nine
months ended March 31, 2002 and 2001, respectively. Stock-based compensation
decreased $130,000, or 15.5%, to $707,000, or 4.8% of net revenues, for the
three months ended March 31, 2002 from $837,000, or 6.7% of net revenues, for
the three months ended March 31, 2001. Stock-based compensation increased
$511,000, or 23.8%, to $2.7 million, or 5.8% of net revenues, for the nine
months ended March 31, 2002 from $2.1 million, or 5.9% of net revenues, for the
nine months ended March 31, 2001. The decrease in stock-based compensation for
the three months ended March 31, 2002 is primarily attributable to the
restructuring plan whereby options for which deferred compensation has been
recorded are forfeited. Additionally, stock-based compensation in the amount of
$595,000 was charged to restructuring due to the fact that it was associated
with the extension of the exercise period for stock options that were vested at
the termination date. The increase in stock-based compensation for the nine
months ended March 31, 2002 primarily reflects stock options assumed in three
purchase transactions that were accounted for in accordance with Financial
Accounting Standards Board ("FASB") Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation-An Interpretation of APB
Opinion No. 25". We expect to incur additional stock-based compensation in
future periods as a result of the continued amortization of deferred
compensation
22
related to these and other stock option grants.
Amortization of Purchased Intangible Assets
In connection with the two purchase transactions completed during fiscal
2001 and the two purchase transactions completed during fiscal 2002, we recorded
approximately $12.1 million and $11.1 million, of identified purchased
intangible assets, respectively. Goodwill is recorded as the difference, if any,
between the aggregate consideration paid for an acquisition and the fair value
of the net tangible and intangible assets acquired. Generally, we obtain
independent appraisals of the fair value of tangible and intangible assets
acquired in order to allocate the purchase price. We are in the process of
obtaining independent appraisals of the fair value of the tangible and
intangible assets acquired related to the acquisitions of Synergetic and Premise
in order to allocate the purchase price in accordance with SFAS No. 141,
"Business Combinations" ("SFAS No. 141"). We do not expect that the final
allocation of purchase price will produce materially different results from
those reflected herein, as it relates to the Synergetic acquisition. The Company
is still awaiting a preliminary analysis of the Premise valuation of tangible
and intangible assets acquired. As a result, the excess of the purchase price
over the net assets acquired of Premise of approximately $9.8 million is
included in goodwill and, accordingly, not being amortized. Purchased intangible
assets are amortized on a straight-line basis over the economic lives of the
respective assets, generally three to five years. The amortization of purchased
intangible assets increased $272,000, or 88.6%, to $579,000, or 4.0% of net
revenues, for the three months ended March 31, 2002 from $307,000, or 2.5% of
net revenues, for the three months ended March 31, 2001. The amortization of
purchased intangible assets increased $355,000, or 34.4%, to $1.4 million, or
3.0% of net revenues, for the nine months ended March 31, 2002 from $1.0
million, or 2.9% of net revenues, for the nine months ended March 31, 2001. In
addition, approximately $612,000 and $1.5 million of amortization of purchased
intangible assets has been classified as cost of revenues for the three and nine
months ended March 31, 2002, respectively. No comparable amortization of
purchased intangible assets was classified as cost of revenues for the three and
nine months ended March 31, 2001. The increase in amortization of purchased
intangible assets is due to the acquisitions of USSC and Lightwave in fiscal
2001 and Synergetics in fiscal 2002.
Restructuring Charges
On February 6, 2002, we announced a restructuring plan to prioritize our
initiatives around the high-growth areas of our business, focus on profit
contribution, reduce expenses, and improve operating efficiency. This
restructuring plan includes a worldwide workforce reduction and consolidation of
excess facilities and other charges. As of March 31, 2002, we recorded
restructuring costs totaling $2.8 million, which are classified as operating
expenses. We anticipate recording further restructuring costs in the fourth
quarter of fiscal 2002 as we continue to implement this plan and explore
additional restructuring alternatives.
Through March 31, 2002, the restructuring plan had resulted in the
reduction of approximately 50 regular employees worldwide. We recorded a
worldwide workforce reduction charge of approximately $1.8 million related to
severance and fringe benefits. Included in this amount is a stock-based
compensation charge in the amount of $595,000 associated with the extension of
the exercise period for stock options that were vested at the termination date.
In addition, the number of temporary and contract workers employed by us was
also reduced. Property and equipment that was disposed or removed from
operations resulted in a charge of $1.0 million and consisted primarily of
computer software and related equipment, production, engineering and office
equipment and furniture and fixtures.
Interest Income (Expense), Net
Interest income (expense), net consists primarily of interest earned on
cash, cash equivalents and short and long-term investments. Interest income
(expense), net was $289,000 and $538,000 for the three months ended March 31,
2002 and 2001, respectively. Interest income (expense), net was $1.3 million and
$1.7 million for the nine months ended March 31, 2002 and 2001, respectively.
The decrease is primarily due to lower average investment balances and interest
rates for the three and nine months ended March 31, 2002 compared to March 31,
2001, as a result of the acquisitions of Lightwave, Synergetic and Premise, as
well as our investment in Xanboo.
Other Income (Expense), Net
Other income (expense), net was $(186,000) and $(71,000) for the three
months ended March 31, 2002 and 2001, respectively. Other income (expense), net
was $(989,000) and $(65,000) for the nine months ended March 31, 2002 and 2001,
respectively. The increase in other expense is primarily attributable to our
share of the losses of equity investments of approximately $713,000, and a
$500,000 revaluation in the carrying amount of a strategic investment, offset by
gains on foreign currency translation.
23
Provision for Income Taxes - Effective Tax Rate
We utilize the liability method of accounting for income taxes as set forth
in SFAS No. 109, "Accounting for Income Taxes." Our effective tax rate was 22%
for the nine months ended March 31, 2002, and 21% for the nine months ended
March 31, 2001. The federal statutory rate was 34% for both periods. Our
effective tax rate associated with the income tax benefit for the nine months
ended March 31, 2002, was lower than the federal statutory rate primarily due to
foreign losses and amortization of stock-based compensation for which no current
year tax benefit was provided. Our effective tax rate associated with the income
tax benefit for the nine months ended March 31, 2001, was lower than the
statutory rate primarily due to the nondeductible goodwill amortization,
amortization of stock-based compensation for which no benefit was provided, and
the effects of an unfavorable foreign tax rate variance.
Impact of Adoption of New Accounting Standards
In June 2001, the FASB issued SFAS No. 141, effective for acquisitions
consummated after June 30, 2001, and SFAS No. 142, effective for fiscal years
beginning after December 15, 2001. Under the new rules, goodwill and certain
intangible assets deemed to have indefinite lives will no longer be amortized
but will be subject to annual impairment tests. Other intangible assets will
continue to be amortized over their useful lives.
We have elected to early adopt the rules set forth in SFAS No. 142 on
accounting for goodwill and other intangibles effective as of July 1, 2001. For
the nine months ended March 31, 2002, early adoption resulted in
non-amortization of goodwill of $5.6 million or $0.11 per share based on the
weighted average shares outstanding for the nine months ended March 31, 2002.
The following table presents the impact of SFAS No. 142 on net loss and net
loss per share had SFAS No. 142 been in effect for the three and nine months
ended March 31, 2001 (in thousands, except per share data):
Three Months Nine Months
Ended Ended
March 31, March 31,
2001 2001
---- ----
Net loss as reported ................................................ $ (851) $ (2,014)
Adjustments:
Amortization of goodwill ..................................... 228 228
----------- -----------
Net adjustments .............................................. 228 228
----------- -----------
Net loss as adjusted ................................................ $ (623) $ (1,786)
=========== ===========
Basic and diluted net loss per share - as reported .................. $ (0.02) $ (0.05)
=========== ===========
Basic and diluted net loss per share - as adjusted .................. $ (0.02) $ (0.05)
=========== ===========
The transition provisions of SFAS No. 142 require that we complete our
assessment of whether impairment may exist as of the date of adoption by
December 31, 2001 and complete our determination of the amount of any impairment
as of the date of adoption by June 30, 2002. Any impairment that is required to
be recognized when adopting SFAS 142 will be reflected as the cumulative effect
of a change in accounting principle as of July 1, 2001. We have completed our
initial assessment and concluded that goodwill arising from the acquisition of
United States Software Corporation (USSC) having a carrying amount of
approximately $5.4 million as of July 1, 2001 may be impaired. We expect to
complete our determination of the amount of the impairment charge, if any, to be
reflected as a cumulative effect of a change in accounting principle during the
fourth fiscal quarter ending June 30, 2002.
We intend to perform the first of the required annual impairment tests of
goodwill under the guidelines of SFAS 142 effective as of April 1, 2002. We have
not yet determined the effect, if any, that this test will have on our
consolidated statement of operations or financial position; however, indicators
of impairment are present given our decline in market capitalization in the
fourth quarter of fiscal 2002. An impairment charge, if any, identified as a
result of completing our annual impairment test will be reflected as an
operating expense in the fourth quarter of fiscal 2002.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," ("SFAS No. 144") which supersedes
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" ("SFAS No. 121") and the accounting and
reporting provisions of Accounting Principles Board Opinion No. 30, "Reporting
the Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." This statement retains certain requirements of SFAS No. 121
relating to the recognition and measurement of impairment of long-lived assets
to be held and used. Additionally, this statement results in one accounting
model, based on the framework established in SFAS No. 121, for long-lived assets
to be
24
disposed of by sales and also addresses certain implementation issues related to
SFAS No. 121, including the removal of goodwill from its scope due to the
issuance of SFAS No. 142. SFAS No. 144 is effective for fiscal years beginning
after December 15, 2001, and interim periods within those fiscal years. We have
not yet determined the effect, if any, on the carrying value of our long-lived
assets resulting from the adoption of SFAS No. 144.
Liquidity and Capital Resources
Since inception, we have financed our operations through the issuance of
common stock and through net cash generated from operations. We consider all
highly liquid investments purchased with original maturities of 90 days or less
to be cash equivalents. Cash and cash equivalents consisting of money-market
funds and commercial paper totaled $30.9 million at March 31, 2002. Short-term
investments consist of investments maturing in twelve months or less and totaled
$9.9 million at March 31, 2002. Long-term investments consist of investments in
equity securities of a privately held company, Xanboo, and other investments
maturing in more than twelve months. Long-term investments totaled $9.3 million
at March 31, 2002.
Our operating activities used cash of $8.8 million for the nine months
ended March 31, 2002. We incurred a net loss of $12.9 million, which includes
depreciation of $1.9 million, amortization of purchased intangible assets of
$2.9 million, amortization of stock-based compensation of $2.8 million, the
revaluation of a strategic investment of $500,000, a restructuring charge of
$2.8 million, the write-off of intellectual property of $665,000, deferred
income tax benefit of $1.7 million, and provision for doubtful accounts of
$970,000, and our share of losses from our equity investments of $713,000. This
was reduced by increased other assets of $1.0 million, decreased accounts
payable of $3.5 million, decreased other current liabilities of $1.2 million and
increased prepaid expenses and other current assets of $3.0 million, offset by a
reduction in accounts receivable of $1.7 million. The increase in other assets
is primarily due to the purchase of intellectual property. The decrease in
accounts payable and other current liabilities was primarily due to a reduction
of Synergetic liabilities subsequent to the acquisition. The increase in prepaid
expenses and other current assets is primarily due to increased receivables from
our contract manufacturers. The reduction in accounts receivable is primarily
due to improved collections from our distributors and European customers.
Our investing activities used $25.2 million of cash for the nine months
ended March 31, 2002 compared with $28.8 million for the nine months ended March
31, 2001. We used $4.8 million, net of cash acquired, to acquire Synergetic in
October 2001 and Premise in January 2002. We used $12.2 million to invest in
held-to-maturity investments in debt securities and received $2.0 million in
proceeds from the sales of securities. We used $7.2 million to purchase
preferred stock in Xanboo. We also used $2.9 million to purchase property and
equipment, primarily computer hardware and software pertaining to Oracle
software enhancements, support of our international operations and a software
package to support our sales force.
Cash provided by financing activities was $49.6 million for the nine months
ended March 31, 2002, primarily related to the net proceeds from our secondary
public offering completed in July 2001. Cash provided by financing activities
was $54.1 million for the nine months ended March 31, 2001, primarily related to
the net proceeds from our initial public offering in August 2000.
In January 2002, we entered into a two-year line of credit with a bank in
an amount not to exceed $20.0 million. Borrowings under the line of credit bear
interest at either (i) the prime rate or (ii) the LIBOR rate plus 2.0%. We are
required to pay a $100,000 facility fee of which $50,000 was paid and $50,000 is
to be paid in January 2003. We are also required to pay a quarterly unused line
fee of .125% of the unused line of credit balance. The line of credit contains
customary affirmative and negative covenants. To date we have not borrowed
against this line of credit. We are not in compliance with the financial
covenants of the line of credit at March 31, 2002.
The following table summarizes our contractual payment obligations and
commitments:
Three Months
Ended June 30, Fiscal Years
-------------------------------------------------
2002 2003 2004 2005 2006 Thereafter Total
---- ---- ---- ---- ---- ---------- -----
Operating leases $ 818 $ 3,237 $ 2,993 $ 2,856 $ 1,741 $ 2,888 $14,533
Other contractual
obligations 21 142 76 23 1 -- 263
------- ------- ------- ------- ------- ------- -------
Total $ 839 $ 3,379 $ 3,069 $ 2,879 $ 1,742 $ 2,888 $14,796
======= ======= ======= ======= ======= ======= =======
We believe that our existing cash, cash equivalents and short-term
investments and any available borrowings under our line of credit facility will
be adequate to meet our anticipated cash needs through at least the next 12
months. Our future capital requirements will depend on many factors, including
the timing and amount of our net revenues and research and development
25
and infrastructure investments as well as our intentions to make strategic
acquisitions or investments in other companies, which will affect our ability to
generate additional cash. If cash generated from operations and financing
activities is insufficient to satisfy our working capital requirements, we may
need to borrow funds through bank loans, sales of securities or other means.
There can be no assurance that we will be able to raise any such capital on
terms acceptable to us, if at all. If we are unable to secure additional
financing, we may not be able to develop or enhance our products, take advantage
of future opportunities, respond to competition or continue to operate our
business.
Risk Factors
You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only ones facing our company. Our business operations may be impaired by
additional risks and uncertainties that we do not know of or that we currently
consider immaterial.
Our business, results of operations or cash flows may be adversely affected
if any of the following risks actually occur. In such case, the trading price of
our common stock could decline, and you may lose all or part of your investment.
We have recently restated our consolidated financial statements for the year
ended June 30, 2001 and the six months ended December 31, 2001.
On May 30, 2002, we announced that, based upon the results of an internal
investigation conducted by the Audit Committee of our Board of Directors, we
would restate our financial statements for fiscal year ended June 30, 2001 and
for the quarters ended September 30, 2001 and December 31, 2001. We have filed
amended reports on Form 10-K/A and 10-Q/A with the Securities and Exchange
Commission to reflect the restatement.
We have received a notice of delisting from Nasdaq for failure to timely file
this Form 10-Q.
On May 23, 2002, we were notified by the Nasdaq Listing Qualifications
Department that we were subject to Nasdaq delisting procedures as a result of
our failure to timely file this quarterly report on Form 10-Q. This report was
not filed in a timely fashion due to the previously discussed internal
investigation of certain transactions. Since May 28, 2002, our trading symbol
has been appended with an "E," and we are trading under the symbol "LTRXE." We
are working cooperatively with the Nasdaq staff and have obtained an oral
hearing with the Nasdaq Listing Qualifications Panel to be held on June 20,
2002. At the hearing, we will need to demonstrate to the satisfaction of the
panel our ability to sustain long-term compliance with all of the Nasdaq listing
criteria, including the timely filing of annual and quarterly reports. There can
be no assurance the Panel will grant our request for continued listing. Removal
of our common stock from listing on the Nasdaq National Market would have an
adverse impact on the trading price and liquidity of our common stock.
If our common stock continues to trade below $1.00, we may subject to delisting
from Nasdaq notwithstanding the filing of this Form 10-Q.
One of the requirements for continued listing on the Nasdaq National Market
is maintaining a minimum bid price of $1.00 per share. The highest bid price for
our common stock on June 14, 2002 was $0.95. If the bid price per share for our
common stock is less than $1.00 for a period of 30 consecutive business days,
our shares may be subject to delisting from the Nasdaq National Market following
a 90 day notice period during which we may avoid delisting by maintaining a
minimum closing bid price per share of $1.00 or above for a minimum period of 10
consecutive business days. Removal of our common stock from listing on the
Nasdaq National Market would have an adverse impact on the trading price and
liquidity of our common stock.
We have recently experienced substantial changes in our management team, and
there is no guarantee that the new management team will be able to successfully
manage our business.
On May 3, 2002, the Board terminated the employment of Steven V. Cotton,
our former Chief Operating Officer and Chief Financial Officer. On May 6, 2002,
the Board appointed James Kerrigan as Interim Chief Financial Officer, and
eliminated the position of Chief Operating Officer. On May 29, 2002, Fred Thiel,
our former President and Chief Executive Officer, and Bernhard Bruscha, our
former Chairman, tendered their resignations to the Board. The Board accepted
the resignations. Mr. Thiel was offered, and he accepted, a newly created
position of Chief Technology and Strategy Officer. The Board subsequently
elected Mr. Marc H. Nussbaum to the position of Interim CEO and President. The
new management team may lack the experience with Lantronix, our industry and our
products to be able to quickly return Lantronix to the path of profitability.
Due to the decrease in our stock price, changes in management and related
matters, it may be difficult for us to retain our key employees or hire any
additional skilled personnel necessary to grow our business.
26
The growth of our business and our financial performance depends
substantially on the performance of our executive officers and key employees. We
are dependent in particular on Marc H. Nussbaum, who serves as our Interim
President and Chief Executive Officer, and James Kerrigan, who serves as our
Interim Chief Financial Officer. We are also dependent upon our technical
personnel, due to the specialized technical nature of our business.
Equity incentives in the form of stock options have been an important tool
for us in retaining key personnel. However, due to the decrease in the market
price for common stock over the past several months, many of our employees hold
stock options with exercise prices well above our current trading price. These
"out-of-the-money" options may currently be perceived by our employees as having
little value. In addition, given the recent management changes and other
matters, key employees may determine that better opportunities exist elsewhere.
If we lose the services of any of our key personnel and are not able to find
replacements in a timely manner, our business could be disrupted, other key
personnel might decide to leave, and we might incur increased operating expenses
associated with finding and compensating replacements.
Variations in quarterly operating results, due to factors including changes in
demand for our products and changes in our mix of net revenues, could cause our
stock price to decline.
Our quarterly net revenues, expenses and operating results have varied in
the past and might vary significantly from quarter to quarter in the future. We
therefore believe that quarter-to-quarter comparisons of our operating results
are not a good indication of our future performance, and you should not rely on
them to predict our future performance or the future performance of our stock
price. Our short-term expense levels are relatively fixed and are based on our
expectations of future net revenues. If we were to experience a reduction in net
revenues in a quarter, we would likely be unable to adjust our short-term
expenditures. If this were to occur, our operating results for that quarter
would be harmed. If our operating results in future quarters fall below the
expectations of market analysts and investors, the price of our common stock
would likely fall. Other factors that might cause our operating results to
fluctuate on a quarterly basis include:
. changes in the mix of net revenues attributable to higher-margin and
lower-margin products;
. customers' decisions to defer or accelerate orders;
. variations in the size or timing of orders for our products;
. short-term fluctuations in the cost or availability of our critical
components, such as flash memory;
. changes in demand for our products generally;
. loss or gain of significant customers;
. announcements or introductions of new products by our competitors;
. defects and other product quality problems; and
. changes in demand for devices that incorporate our connectivity
products.
If we make unprofitable acquisitions or are unable to successfully integrate any
future acquisitions, our business could suffer.
We have in the past and intend to continue in the future to acquire
businesses, client lists, products or technologies that we believe complement or
expand our existing business. In October 1998, we acquired ProNet GmbH, a German
supplier of industrial application Device Server technology. In December 2000,
we acquired USSC, a company that provides software solutions for use in embedded
technology applications. In June 2001, we acquired Lightwave, a company that
provides console management solutions. In October 2001, we acquired Synergetic,
a provider of embedded network communication solutions. In January 2002, we
acquired Premise, a developer of client-side software applications. We have just
signed a Letter of Intent to acquire Stallion Technologies, a provider of
terminal server and multiport products. These acquisitions have, and future
acquisitions will, present us with a number of difficulties, not all of which we
can successfully address. These difficulties include:
. assimilating the operations and employees of acquired companies;
. diversion of our management's attention from ongoing business
concerns;
. our inability to maximize our financial and strategic position through
the successful incorporation of acquired technology and rights into
our products and services;
. additional expense associated with amortization of acquired assets;
. maintenance of uniform standards, controls, procedures and policies;
27
. impairment of existing relationships with employees, suppliers and
customers as a result of the integration of new management employees;
and
. disputes with former owners of acquired companies.
Any acquisition or investment could result in the incurrence of debt and
the loss of key employees. Moreover, we often assume specified liabilities of
the companies we acquire. Some of these liabilities, such as environmental and
tort liabilities, are difficult or impossible to quantify. If we do not receive
adequate indemnification for these liabilities our business may be harmed. In
addition, acquisitions are likely to result in a dilutive issuance of equity
securities. For example, we issued common stock and assumed options to acquire
our common stock in connection with our acquisitions of USSC, Lightwave,
Synergetic and Premise. We cannot assure you that any acquisitions or acquired
businesses, client lists, products or technologies associated therewith will
generate sufficient net revenues to offset the associated costs of the
acquisitions or will not result in other adverse effects. Moreover, from time to
time we may enter into negotiations for the acquisition of businesses, client
lists, products or technologies, but be unable or unwilling to consummate the
acquisition under consideration. This could cause significant diversion of
managerial attention and out of pocket expenses to us. We could also be exposed
to litigation as a result of an unconsummated acquisition, including claims that
we failed to negotiate in good faith, misappropriated confidential information
or other claims.
In addition, from time to time we intend to invest in businesses that we
believe present attractive investment opportunities, or provide other synergetic
benefits. In September and October 2001, we paid an aggregate of $3.0 million to
Xanboo for convertible promissory notes, which have converted, in accordance
with their terms, into Xanboo preferred stock. In addition, the Company
purchased an additional $4.0 million of preferred stock of Xanboo. The Company
currently holds an 18.7% ownership interest in Xanboo. These investments are
speculative in nature, and there is a significant chance we will lose part or
all of our investments.
Certain holders of our common stock have demanded that we compensate them for an
alleged failure on our part to honor their registration rights with respect to
their shares.
We have received an informal notice from several holders of our common
shares stock that were issued in connection with our acquisition of Lightwave.
The shares were issued to the holders in a private transaction not registered
under the Securities Act of 1933, and therefore could not be sold by the
stockholders without a valid registration statement. The stockholders allege
that we failed to honor their rights to have the shares registered and that they
were therefore precluded from selling the shares. The stockholders are seeking
compensation of up to $2.1 million, based on the proceeds they might have
received had they been able to sell their shares into the market when the market
price of our common stock was higher.
We primarily depend on a small number of third-party manufacturers to
manufacture all of our products, which reduces our control over the
manufacturing process. If these manufacturers are unable or unwilling to
manufacture our products at the quality and quantity we request, our business
could be harmed and our stock price could decline.
We primarily outsource our Systems Management product manufacturing to
three third-party manufacturers, APW, Inc., Irvine Electronics and Uniprecision.
We outsource all of our chip manufacturing to Atmel. Our reliance on these
third-party manufacturers exposes us to a number of significant risks,
including:
. reduced control over delivery schedules, quality assurance,
manufacturing yields and production costs;
. lack of guaranteed production capacity or product supply; and
. reliance on third-party manufacturers to maintain competitive
manufacturing technologies, which may result in increased risk of
product defects.
Our agreements with these manufacturers provide for services on a
purchase-order basis. If our manufacturers were to become unable or unwilling to
continue to manufacture our products in required volumes, at acceptable quality,
quantity, yields and costs, or in a timely manner, our business would be
seriously harmed. We may also experience unforeseen problems as we attempt to
transition a significant portion of our manufacturing requirements to
Uniprecision, a company located in the People's Republic of China. We do not
have a significant operating history with this entity and if this entity is
unable to provide us with satisfactory service, or we are unable to successfully
complete the transition, our operations could be interrupted. As discussed
above, we have experienced manufacturing problems with Atmel, and while we
believe that those problems have now been resolved, we could experience other
chip fabrication problems.
As a result of any or all of the foregoing, we would have to attempt to
identify and qualify substitute manufacturers, which could be time consuming and
difficult, and might result in unforeseen manufacturing and operations problems.
In addition, a natural disaster could disrupt our manufacturers' facilities and
could inhibit our manufacturers' ability to provide us with
28
manufacturing capacity on a timely basis, or at all. If this were to occur, we
likely would be unable to fill customers' existing orders or accept new orders
for our products. The resulting decline in net revenues would harm our business.
In addition, we are responsible for forecasting the demand for our individual
products by regional location. These forecasts are used by our contract
manufacturers to procure raw materials and manufacture our finished goods. If we
forecast demand too high, we may invest too much cash in inventory and we may be
forced to take a write-down of our inventory balance, which would reduce our
earnings. If our forecast is too low for one or more products, we may be
required to pay expedite charges which would increase our cost of sales or we
may be unable to fulfill customer orders thus reducing net revenues and
therefore earnings.
We are dependent on a small number of customers and distributors for a large
portion of our sales. If a major customer or distributor were to discontinue its
relationship or cancel or reduce its purchases, our business would be adversely
affected.
Our top five customers accounted for 37.1% and our top ten customers
accounted for 44.0% of our net revenues for the nine months ended March 31,
2002. Sales by Tech Data and Ingram Micro, domestic distributors, accounted for
10.9% and 12.8% of our net revenues for the nine months ended March 31, 2002,
respectively. The number and timing of sales by our distributors have been
difficult for us to predict. We have in the past, and might in the future, lose
one or more major customers. If we fail to continue to sell to our major
customers in the quantities we anticipate, or if any of these customers
terminate our relationship, our reputation, the perception of our products and
technology in the marketplace and the growth of our business could be harmed.
Our future success also depends on our ability to attract new customers,
which often involves an extended process. The sale of our products often
involves a significant technical evaluation, and we often face delays because of
our customers' internal procedures used to evaluate and deploy new technologies.
For these and other reasons, the sales cycle associated with our products is
typically lengthy, often lasting six to nine months and sometimes longer.
Therefore, if we were to lose a major customer, we might not be able to replace
the customer on a timely basis or at all. This would cause our net revenues to
decrease and could cause the price of our stock to decline.
The average selling prices of our products may decrease, which could reduce our
gross margins.
In the past, we have experienced some reduction in the average selling
prices and gross margins of products and we expect that this will continue for
our products as they mature. In the future, we expect competition to increase,
and we anticipate this could result in additional pressure on our pricing. In
addition, our average selling prices for our products might decline as a result
of other reasons, including promotional programs and customers who negotiate
price reductions in exchange for longer-term purchase commitments. In addition,
we might not be able to increase the price of our products in the event that the
price of components or our overhead costs increase. If this were to occur, our
gross margins would decline.
Net revenues from our legacy products, which include our print servers,
switches, hubs and other products, have decreased significantly and we expect
that net revenues from these lines of products will continue to decline in the
future as we focus our efforts on the development of other product lines.
Since 1993, net revenues from our legacy products have accounted for a
significant portion of our net revenues but have declined significantly
recently. For example, revenues from our legacy products were approximately $2.2
million or 4.7% of our net revenues, compared to $2.9 million or 7.9% of our
total net revenues for the nine months ended March 31, 2002 and 2001,
respectively. We anticipate that net revenues from our legacy products will
continue to decline in the future as we plan to continue to focus on the
development of our current Device Server and Multiport Device Server product
lines. We do not know if this transition in product development will be
successful. We do not know whether our new product lines will be accepted by our
current and future target markets to the extent we anticipate. If the expected
decline in net revenues attributable to our legacy products is not offset by
increases in net revenues from our Device Server and Multiport Device Server
lines of product, our business could be harmed.
New product introductions and pricing strategies by our competitors could
adversely affect our ability to sell our products and could reduce our market
share or result in pressure to reduce the price of our products.
The market for our products is intensely competitive, subject to rapid
change and is significantly affected by new product introductions and pricing
strategies of our competitors. We face competition primarily from companies that
network-enable devices, companies in the automation industry and companies with
significant networking expertise and research and development resources. Our
competitors might offer new products with features or functionality that are
equal to or better than our products. In addition, since we offer an open
architecture, our customers could develop products based on our technology that
compete with our offerings. We might not have sufficient engineering staff or
other required resources to modify our products to match our competitors.
Similarly, competitive pressure could force us to reduce the price of our
products. In each case, we could
29
lose new and existing customers to our competition. If this were to occur, our
net revenues could decline and our business could be harmed.
Inability or delays in deliveries from our component suppliers could damage our
reputation and could cause our net revenues to decline and harm our results of
operations.
Our contract manufacturers and we are responsible for procuring raw
materials for our products. Our products incorporate components or technologies
that are only available from single or limited sources of supply. In particular,
some of our integrated circuits are available from a single source. From time to
time in the past, integrated circuits we use in our products have been phased
out of production. When this happens, we attempt to purchase sufficient
inventory to meet our needs until a substitute component can be incorporated
into our products. Nonetheless, we might be unable to purchase sufficient
components to meet our demands, or we might incorrectly forecast our demands,
and purchase too many or too few components. In addition, our products use
components that have in the past been subject to market shortages and
substantial price fluctuations. From time to time, we have been unable to meet
our orders because we were unable to purchase necessary components for our
products. We rely on a number of different component suppliers. Because we do
not have long-term supply arrangements with any vendor to obtain necessary
components or technology for our products, if we are unable to purchase
components from these suppliers, product shipments could be prevented or
delayed, which could result in a loss of sales. If we are unable to meet
existing orders or to enter into new orders because of a shortage in components,
we will likely lose net revenues and risk losing customers and harming our
reputation in the marketplace.
Our intellectual property protection may be limited.
We have only recently begun to rely on patents to protect our proprietary
rights. We have traditionally relied on a combination of other laws, such as
copyright, trademark and trade secret laws, and contractual restrictions, such
as confidentiality agreements and licenses, to establish and protect our
proprietary rights. Despite any precautions that we have taken:
. laws and contractual restrictions might not be sufficient to prevent
misappropriation of our technology or deter others from developing
similar technologies;
. other companies might claim common law trademark rights based upon
use that precede the registration of our marks;
. policing unauthorized use of our products and trademarks is difficult,
expensive and time-consuming, and we might be unable to determine the
extent of this unauthorized use;
. current federal laws that prohibit software copying provide only
limited protection from software pirates; and
. the companies we acquire may not have taken similar precautions to
protect their proprietary rights.
Also, the laws of other countries in which we market our products might
offer little or no effective protection of our proprietary technology. Reverse
engineering, unauthorized copying or other misappropriation of our proprietary
technology could enable third parties to benefit from our technology without
paying us for it, which could significantly harm our business.
We are currently involved in litigation over proprietary rights, which could be
costly and time consuming.
Substantial litigation regarding intellectual property rights exists in
our industry. There is a risk that third-parties, including current and
potential competitors, current developers of our intellectual property, our
manufacturing partners, or parties with which we have contemplated a business
combination will claim that our products, or our customers' products, infringe
on their intellectual property rights or that we have misappropriated their
intellectual property. In addition, software, business processes and other
property rights in our industry might be increasingly subject to third-party
infringement claims as the number of competitors grows and the functionality of
products in different industry segments overlaps. Other parties might currently
have, or might eventually be issued, patents that infringe on the proprietary
rights we use. Any of these third parties might make a claim of infringement
against us.
We have in the past received letters claiming that our products infringe
upon patents or other intellectual property of third parties, and we may receive
more such claims in the future. On July 3, 2001, Digi International, Inc. filed
a complaint in the United States District Court for the district of Minnesota
claiming patent infringement and alleging that Lantronix directly and/or
indirectly infringes upon Digi's U.S. Patent No. 6,047,319 by making, using,
selling, and/or offering for sale certain of Lantronix's Multiport device
servers, including the ETS line of products, coupled with a device driver called
the Comm Port Redirector Software. Digi alleges that Lantronix has willfully and
intentionally infringed Digi's patent, and its complaint seeks injunctive relief
as well as unspecified damages, treble damages, attorneys fees, interest and
costs. On August 17, 2001, Lantronix filed its answer to the complaint,
asserting affirmative defenses, and counterclaiming for a declaratory judgment
that the patent in issue is invalid. The case is in the discovery stage, and the
Court has tentatively set the matter for trial in June 2003.
30
The litigation process is inherently uncertain and we may not prevail.
Moreover, patent litigation is particularly complex and can extend for a
protracted time, which can substantially increase the cost of such litigation.
In the event the Digi litigation is not resolved at a preliminary stage, the
cost of defending the claim will be substantial. In addition, the Digi
litigation will likely divert the efforts and attention of some of our key
management and technical personnel. Should the outcome of the litigation be
adverse to us, we would be required to pay monetary damages to Digi and we could
be enjoined from selling those of our products found to infringe Digi's patent
unless and until we are able to negotiate a license from Digi which may not be
available on acceptable terms or at all. If we are required to pay significant
monetary damages, are enjoined from selling any of our products or are required
to make substantial royalty payments pursuant to any such license agreement, our
business would be harmed. This litigation, or other similar litigation brought
by us or others, could result in the expenditure of significant financial
resources and the diversion of management's time and efforts.
In addition, from time to time we could encounter other disputes over
rights and obligations concerning intellectual property. We cannot assume that
we will prevail in intellectual property disputes regarding infringement,
misappropriation or other disputes. Litigation in which we are accused of
infringement or misappropriation might cause a delay in the introduction of new
products, require us to develop non-infringing technology, require us to enter
into royalty or license agreements, which might not be available on acceptable
terms, or at all, or require us to pay substantial damages, including treble
damages if we are held to have willfully infringed. In addition, we have
obligations to indemnify certain of our customers under some circumstances for
infringement of third-party intellectual property rights. If any claims from
third parties were to require us to indemnify customers under our agreements,
the costs could be substantial, and our business could be harmed. If a
successful claim of infringement were made against us and we could not develop
non-infringing technology or license the infringed or similar technology on a
timely and cost-effective basis, our business could be significantly harmed.
There is a risk that our OEM customers will develop their own internal expertise
in network-enabling products, which could result in reduced sales of our
products.
For most of our existence we primarily sold our products to VARs, system
integrators and OEMs. Although we intend to continue to use all of these sales
channels, we have begun to focus more heavily on selling our products to OEMs.
Selling products to OEMs involves unique risks, including the risk that OEMs
will develop internal expertise in network-enabling products or will otherwise
provide network functionality to their products without using our Device Server
Technology. If this were to occur, our stock price could decline in value and
you could lose part or all of your investment.
Terrorist attacks or threats of attacks, and business interruptions caused by
such attacks, natural disasters and electrical blackouts in the state of
California could adversely affect our business.
Interruptions in business, a decline in demand in our products, or a
general economic decline resulting from actual or threatened terrorist attacks
or military action could harm our business. Adverse effects could include, but
are not limited to, physical damage to our facilities, and disruptions caused by
trade restrictions imposed by the United States or foreign governments. In
addition, a general economic downturn in any of our target markets or general
disruption of the financial markets caused by such attacks could substantially
harm our business. Moreover, our operations are vulnerable to interruption by
fire, earthquake, power loss, telecommunications failure and other events beyond
our control. We do not have a detailed disaster recovery plan. Our facilities in
the State of California may be subject to electrical blackouts as a consequence
of a shortage of available electrical power. In the event these blackouts
continue or increase in severity, they could disrupt the operations of our
affected facilities.
We intend to continue to devote significant resources to our research and
development, which, if not successful, could cause a decline in our revenues and
could harm our business.
We intend to continue to devote significant resources to research and
development in the coming years to enhance and develop additional products. For
the nine months ended March 31, 2002, research and development expenses
comprised 13.6% of our net revenues. If we are unable to develop new products as
a result of this effort, or if the products we develop are not successful, our
business could be harmed. Even if we do develop new products that are accepted
by our target markets, we do not know whether the net revenue from these
products will be sufficient to justify our investment in research and
development.
Stock-based compensation will negatively affect our future reported operating
results.
We have recorded deferred compensation in connection with the grant of
stock options to employees where the option exercise price is less than the
estimated fair value of the underlying shares of common stock as determined for
financial reporting purposes. We have recorded deferred compensation net of
forfeitures within stockholders' equity of $362,000 for the nine months ended
March 31, 2002 and a total of $14.2 million of deferred compensation through
fiscal 2001, which is being amortized over
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the vesting period of the related stock options, which is generally four years.
A balance of $7.0 million remains at March 31, 2002 and will be amortized as
follows: $737,000 in the remainder of fiscal 2002, $2.7 million in fiscal 2003,
$2.2 million in fiscal 2004, $1.2 million in fiscal 2005, and $170,000 in fiscal
2006.
The amount of stock-based compensation in future periods will increase if
we grant stock options where the exercise price is less than the quoted market
price of the underlying shares. The amount of stock-based compensation
amortization in future periods could decrease if options for which accrued, but
unvested deferred compensation has been recorded are forfeited.
Because we are dependent on international sales for a substantial amount of our
sales, we face the risks of international business and associated currency
fluctuations, which might adversely affect our operating results.
Net revenues from international sales represented 15.9% and 32.6% of net
revenues for the nine months ended March 31, 2002 and 2001, respectively. Net
revenues from Europe represented 13.1% and 28.2% of our net revenues for the
nine months ended March 30, 2002 and 2001, respectively.
We expect that international revenues will increase as a percentage of
our net revenues in the foreseeable future. Doing business internationally
involves greater expense and many additional risks. 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. For example, because
the products we sell abroad and the products and services we buy abroad are
priced in foreign currencies, we are affected by fluctuating exchange rates. In
the past, we have from time to time lost money because of these fluctuations. We
might not successfully protect ourselves against currency rate fluctuations, and
our financial performance could be harmed as a result. In addition, we face
other risks of doing business internationally, including:
. unexpected changes in regulatory requirements, taxes, trade laws and
tariffs;
. reduced protection for intellectual property rights in some countries;
. differing labor regulations;
. compliance with a wide variety of complex regulatory requirements;
. changes in a country's or region's political or economic conditions;
. greater difficulty in staffing and managing foreign operations; and
. increased financial accounting and reporting burdens and complexities.
The market for our products is new and rapidly evolving. If we are not able to
develop or enhance our products to respond to changing market conditions, our
business will suffer.
Our future success depends in large part on our ability to continue to
enhance existing products, lower product cost and develop new products that
maintain technological competitiveness. The demand for network-enabled products
is relatively new and can change as a result of innovations or changes. For
example, industry segments might adopt new or different standards, giving rise
to new customer requirements. Any failure by us to develop and introduce new
products or enhancements directed at new industry standards could harm our
business, financial condition and results of operations. These customer
requirements might or might not be compatible with our current or future product
offerings. We might not be successful in modifying our products and services to
address these requirements and standards. For example, our competitors might
develop competing technologies based on Internet Protocols, Ethernet Protocols
or other protocols that might have advantages over our products. If this were to
happen, our net revenue might not grow at the rate we anticipate, or could
decline.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk. Our exposure to interest rate risk is limited to the
exposure related to our cash, cash equivalents, short-term investments and our
credit facilities, which are tied to market interest rates. As of March 31,
2002, we had cash, cash equivalents and short-term investments of $40.9 million,
which consisted of both domestic and foreign cash, cash equivalents and
short-term investments. We believe our cash equivalents and short-term
investments would decline in value by only insignificant amounts if interest
rates increase, and therefore, such change in value would not have a material
effect on our consolidated financial condition or results of operations.
Foreign Currency Risk. We buy and sell products internationally. As a
result, our financial results could be harmed by factors such as changes in
foreign currency exchange rates or weak economic conditions in foreign markets.
Investment Risk. At March 31, 2002, our investment in a privately held
development stage company totaled $7.0 million. This investment is inherently
risky as the market for the technologies or products under development are
typically in the early stages and may never materialize. We could lose our
entire initial investment in this company.
33
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Patent Infringement Suit
From time to time, we have received letters claiming that their products
infringe upon patents or other intellectual property of third-parties. On July
3, 2001, Digi International, Inc., filed a complaint in the United States
District Court for the district of Minnesota claiming patent infringement and
alleging that Lantronix directly and/or indirectly infringes upon Digi's U.S.
Patent No. 6,047,319 by making, using, selling and or offering for sale certain
of Lantronix's Multiport device servers, including the ETS line of products,
coupled with a device driver called the Comm Port Redirector Software. Digi
alleges that we have willfully and intentionally infringed Digi's patent, and
our complaint seeks injunctive relief as well as unspecified damages, treble
damages, attorney's fees, interest and costs. On August 17, 2001, we filed our
answer to the complaint, asserting affirmative defenses, and counterclaiming for
a declaratory judgment that the patent in issue is invalid. The case is in the
discovery stage, and the Court has tentatively set the matter for trial in June
2003. Based on the facts known to date, we believe that the claims are without
merit and intend to vigorously defend the suit.
Securities Suits
On May 15, 2002, a class action complaint entitled Bachman v. Lantronix,
Inc., et al. was filed in the U.S. District Court for the Central District of
California against the Company and certain of its current and former officers
and directors alleging violations of the Securities Exchange Act of 1934, as
amended (the "1934 Act"). Subsequently, two similar actions were filed in the
same court: Fitzgearl v. Lantronix, Inc., et al. and Anderson v. Lantronix,
Inc., et al. Each of the complaints purports to be a class action lawsuit
brought on behalf of persons who purchased or otherwise acquired our common
stock during the period of April 25, 2001 through May 30, 2002, inclusive.
The complaints allege that the defendants caused us to improperly
recognize revenue and made false and misleading statements about our business.
Plaintiffs further allege that we materially overstated our reported financial
results, thereby inflating the our stock price during its Secondary Offering in
July 2001, as well facilitating the use of our stock as consideration in
acquisitions. The complaints do not specify the amount of damages sought. We are
currently investigating the allegations in the complaints. There has been no
discovery to date, and no trial date has been established. An adverse judgment
or settlement of these lawsuits could have a significant impact on our future
financial condition or results of operations. We anticipate that all of these
actions will ultimately be consolidated into one action and that a consolidated
amended complaint will be filed after the appointment of Lead Plaintiff(s). We
have not yet responded to any of the complaints, and discovery has not
commenced.
Employment Litigation
Cathy Vicari ("Vicari") claims damages in the approximate amount of
$850,000. Vicari asserts claims of Sex and Medical Leave Disability
Discrimination, Intentional Infliction of Emotional Distress, Negligence, Breach
of employment Contract, and Wrongful termination in Violation of Public Policy.
We filed a Motion for Summary Judgment, which was argued on April 1, 2002. We
and our counsel believe Vicari's claims to be groundless, and continue to
vigorously defend each of them.
We are also involved in other legal proceedings, claims and litigation
arising in the ordinary course of business.
The pending lawsuits involve complex questions of fact and law and
likely will require the expenditure of significant funds and the diversion of
other resources to defend. Although we currently believe the outcome of
outstanding legal proceedings, claims and litigation we are involved in will not
have a material adverse effect on our business, results of operations and
financial condition taken as a whole, the results of litigation are inherently
uncertain, and an adverse outcome is at least reasonably possible. We are unable
to estimate the range of possible loss from outstanding litigation, and no
amounts have been provided for such matters in the unaudited condensed
consolidated financial statements.
Item 2. Changes in Securities and Use of Proceeds
On January 11, 2002, we completed the acquisition of Premise, a
developer of client--side software applications. Prior to the acquisition we
held shares of Premise representing 19.9% ownership and in addition held notes
receivable of $1.2 million. We agreed to issue an aggregate of 1,063,371 shares
of its common stock in exchange for all remaining outstanding shares of Premise
common stock and reserved 875,000 additional shares of common stock for issuance
upon exercise of outstanding employee stock options and other rights of Premise.
Pursuant to the acquisition agreement, 106,337 of such shares will be held in
34
escrow to secure certain indemnification obligations, and 531,686 of such shares
will be held in escrow pending achievement of certain performance obligations.
We intend to issue these shares on or around February 18, 2002. The transaction
was exempt from registration pursuant to section 4 (2) of the Securities Act of
1933, as amended. In connection with the acquisition, we expect to record a
one-time charge for purchased in-process research and development expenses
related to the acquisition in our fourth fiscal quarter ending June 30, 2002.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description of Document
- ------ -----------------------
2.1 Agreement and Plan of Reorganization dated March 21, 2001, as
amended and restated on January 7, 2002 by and among Lantronix, Inc.,
Premise Acquisition Corporation, Premise Systems, Inc. and the other
parties thereto (incorporated by reference to Exhibit 2.1 to the
Report on Form 8-K filed January 25, 2002).
(b) Reports on Form 8-K
Date Items Reported On
- ---- -----------------
June 7, 2002 Management changes update on internal review,
agreement with Gordian, Inc., and shareholder
lawsuits filed against Lantronix.
May 7, 2002 Termination of former Chief Operating Officer/
Chief Financial Officer.
January 25, 2002 Acquisition of Premise Systems, Inc.
35
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, as amended,
Lantronix has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Irvine, State of
California, on the 24th day of June, 2002.
LANTRONIX, INC.
By: /s/ James Kerrigan
---------------------------------------
James Kerrigan
Interim Chief Financial Officer
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