UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark one)
[X] Quarterly report pursuant to section 13 or 15(d)
of the Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED JULY 31, 2003
[ ] Transition report pursuant to section 13 or 15(d) of the
Securities and Exchange Act of 1934
For the transition period from _______ to ________
Commission file number 0-8419
SBE, INC.
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(Exact name of registrant as specified in its charter)
Delaware 94-1517641
- --------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2305 Camino Ramon, Suite 200, San Ramon, California 94583
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(Address of principal executive offices and zip code)
(925) 355-2000
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(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 Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
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The number of shares of Registrant's common stock outstanding as of August 31,
2003 was 4,684,411.
SBE, INC.
INDEX TO JULY 31, 2003 FORM 10-Q
PART I FINANCIAL INFORMATION
ITEM 1 Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of
July 31, 2003 and October 31, 2002....................................3
Condensed Consolidated Statements of Operations for the
three and nine months ended July 31, 2003 and 2002....................4
Condensed Consolidated Statements of Cash Flows for the
nine months ended July 31, 2003 and 2002..............................5
Notes to Condensed Consolidated Financial Statements.....................6
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations........................13
ITEM 3 Quantitative and Qualitative Disclosures about
Market Risk................................................26
ITEM 4 Controls and Procedures....................................26
PART II OTHER INFORMATION
ITEM 2 Changes in Securities and Use of Proceeds..................26
ITEM 6 Exhibits and Reports on Form 8-K...........................27
SIGNATURES...................................................................29
EXHIBITS.....................................................................30
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SBE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
July 31, October 31,
2003 2002
----------- -----------
(Unaudited)
Current assets:
Cash and cash equivalents $ 1,990 $ 1,582
Trade accounts receivable, net 1,005 888
Inventories 1,603 1,910
Other 281 220
----------- -----------
Total current assets 4,879 4,600
Property, plant and equipment, net 343 533
Capitalized software costs, net 93 110
Other 79 78
----------- -----------
Total assets $ 5,394 $ 5,321
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 305 $ 488
Accrued payroll and employee benefits 129 159
Other accrued expenses and deferred revenue 435 531
Refundable deposit --- 447
----------- -----------
Total liabilities 869 1,625
----------- -----------
Stockholders' equity:
Common stock 15,232 14,711
Treasury stock (409) (409)
Note receivable from stockholder (245) (270)
Accumulated deficit (10,053) (10,336)
------------ ------------
Total stockholders' equity 4,525 3,696
----------- -----------
Total liabilities and stockholders' equity $ 5,394 $ 5,321
=========== ===========
See notes to condensed consolidated financial statements.
3
SBE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
Three months ended Nine months ended
July 31, July 31,
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net sales $ 1,621 $ 2,786 $ 5,249 $ 5,793
Cost of sales 559 1,091 1,971 2,488
----------- ----------- ----------- -----------
Gross profit 1,062 1,695 3,278 3,305
----------- ----------- ----------- -----------
Product research and development 334 770 913 2,335
Sales and marketing 361 501 1,004 1,609
General and administrative 381 673 1,259 1,810
Restructuring costs (benefit) (154) --- (154) ---
------------ ----------- ------------ -----------
Total operating expenses 922 1,944 3,022 5,754
----------- ----------- ----------- -----------
Operating income (loss) 140 (249) 256 (2,449)
Interest income 6 11 21 44
Other income (expense) (4) 27 (10) 16
------------ ----------- ------------ -----------
Net income (loss) before income
taxes 142 (211) 267 (2,389)
Provision (benefit) for income taxes 1 (33) (17) (33)
----------- ------------ ------------ ------------
Net income (loss) $ 141 $ (178) $ 284 $ (2,356)
=========== ============ ============ ===========
Basic income (loss) per share $ 0.03 $ (0.04) $ 0.07 $ (0.64)
=========== =========== =========== ===========
Diluted income (loss) per share $ 0.03 $ (0.04) $ 0.07 $ (0.64)
=========== =========== =========== ===========
Basic - shares used
in per share computations 4,288 4,042 4,145 3,659
=========== =========== =========== ===========
Diluted - shares used
in per share computations 4,614 4,042 4,276 3,659
=========== =========== =========== ===========
See notes to condensed consolidated financial statements.
4
SBE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine months ended
July 31,
---------------------------------
2003 2002
----------- -----------
Cash flows from operating activities:
Net income (loss) $ 284 $ (2,356)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Effect of remeasured warrant -- (63)
Depreciation and amortization:
Property and equipment 254 514
Software 26 65
Loss on abandonment of equipment 13 15
Changes in operating assets and liabilities:
Accounts and other receivables (117) (1,687)
Inventories 307 865
Other assets (62) (40)
Trade accounts payable (183) 518
Other current liabilities (573) (635)
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Net cash used in operating activities (51) (2,804)
------------ ------------
Cash flows from investing activities:
Purchases of property and equipment (77) (143)
Capitalized software costs (10) (141)
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Net cash used in investing activities (87) (284)
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Cash flows from financing activities:
Net proceeds from sale of common stock and warrants 478 891
Repayment of shareholder note 25 ---
Proceeds from stock plans 43 16
----------- -----------
Net cash provided by financing activities 546 907
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Net increase (decrease) in cash and cash equivalents 408 (2,181)
Cash and cash equivalents at beginning of period 1,582 3,644
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Cash and cash equivalents at end of period $ 1,990 $ 1,463
=========== ===========
See notes to condensed consolidated financial statements.
5
SBE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. INTERIM PERIOD REPORTING:
These condensed consolidated financial statements of SBE, Inc. are unaudited and
include all adjustments, consisting of normal recurring adjustments, that are,
in the opinion of management, necessary for a fair presentation of the financial
position and results of operations and cash flows for the interim periods. The
results of operations for the three and nine months ended July 31, 2003 are not
necessarily indicative of expected results for the full 2003 fiscal year.
Certain information and footnote disclosures normally contained in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These condensed consolidated financial
statements should be read in conjunction with the financial statements and notes
contained in our Annual Report on Form 10-K for the year ended October 31, 2002.
We incurred substantial losses and negative cash flows from operations during
the year ended October 31, 2002. Our auditors stated in their opinion at October
31, 2002 that these losses and negative cash flows raise substantial doubt about
our ability to continue as a going concern. Our operations produced net income
for the first nine months of fiscal 2003 as we began to realize the full effect
of our cost containment program due to reductions of our headcount, real estate
obligations and certain non-essential spending. In addition, on June 27, 2003,
we completed a private placement of 500,000 shares of common stock plus warrants
to purchase 50,000 shares of common stock, resulting in net cash proceeds to the
company of approximately $478,000. We used substantially all of the net cash
proceeds from the private placement to purchase the assets of Antares
Microsystems. See footnotes 8 and 10.
Our sales are to a limited number of original equipment manufacturer ("OEM")
customers and are based on internal and customer-provided estimates of future
demand, not firm customer orders. If our projected sales do not materialize, we
will need to reduce expenses further and raise additional capital through
customer prepayments or debt or equity financing. If additional funds are raised
through the issuance of securities or debt, these securities could have rights,
privileges or preferences senior to those of common stock, and debt covenants
could impose restrictions on our operations. The sale of equity or debt
securities could result in additional dilution to current stockholders.
Financing may not be available to us on acceptable terms, if at all.
MANAGEMENT ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of net sales and expenses
during the reporting period. Actual results could differ from these estimates.
6
Significant estimates and judgments made by us include matters such as
collectibility of accounts receivable, realizability of inventories and
recoverability of capitalized software and deferred tax assets. SFAS 148 now
requires the SFAS 123 reconciliation quarterly.
2. INVENTORIES:
Inventories comprise the following (in thousands):
July 31, October 31,
2003 2002
---------- ---------
(unaudited)
Finished goods $ 792 $ 985
Parts and materials 811 925
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$ 1,603 $ 1,910
========== =========
3. RESTRUCTURING COSTS:
The following table sets forth an analysis of the restructuring accrual as of
October 31, 2002 and the payments and adjustments made against it during the
nine months ended July 31, 2003 (in thousands):
Restructuring accrual at October 31, 2002 $ 249
Less: Cash paid and adjustments for accrued lease costs (188)
------
Total restructuring accrual included in other accrued expenses $ 61
======
In the quarter ended July 31, 2003, we recognized a restructuring benefit of
$154,000 after the final settlement of costs associated with prior real estate
and equipment leases.
4. NET INCOME (LOSS) PER SHARE:
Basic net income (loss) per common share for the three and nine months ended
July 31, 2003 and 2002 was computed by dividing the net income (loss) for the
relevant period by the weighted average number of shares of common stock
outstanding. Common stock equivalents for the three months and nine months ended
July 31, 2003 were 325,711 and 131,110 and have been included in the calculation
of diluted net income per share. Common stock equivalents for the three and nine
months ended July 31, 2002 were 44,705 and 45,967 have been excluded from shares
used in calculating diluted net loss per share because the effect would have
been anti-dilutive.
Three months ended Nine months ended
July 31, July 31,
--------------------------- ---------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
BASIC
Weighted average number of
common shares outstanding 4,288 4,042 4,145 3,659
----------- ----------- ----------- -----------
Number of shares for computation of
net income (loss) per share 4,288 4,042 4,145 3,659
=========== =========== =========== ===========
Net income (loss) $ 141 $ (178) $ 284 $ (2,356)
=========== ============ =========== ============
Net income (loss) per share $ 0.03 $ (0.04) $ 0.07 $ (0.64)
=========== =========== =========== ===========
7
DILUTED
Weighted average number of
common shares outstanding 4,288 4,042 4,145 3,659
Shares issuable pursuant to options granted
under stock option plans and warrants granted,
less assumed repurchase at the average fair
market value for the period 326 (a) 131 (a)
----------- ----------- ----------- -----------
Number of shares for computation of
net income (loss) per share 4,614 4,042 4,276 3,659
=========== =========== =========== ===========
Net income (loss) $ 141 $ (178) $ 284 $ (2,356)
=========== ============ =========== ============
Net income (loss) per share $ 0.03 $ (0.04) $ 0.07 $ (0.64)
=========== =========== =========== ===========
(a) In loss periods, common share equivalents would have an anti-dilutive
effect on net loss per share and therefore have been excluded.
5. STOCK BASED COMPENSATION:
At July 31, 2003, we had two stock-based employee compensation plans and one
stock-based directors compensation plan. We account for these plans under the
recognition and measurement principles of Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," and related interpretations.
Accordingly, no stock-based employee compensation cost has been recognized in
net income for the stock option plans. Had compensation cost for our stock
option plans been determined based on the fair value recognition provisions of
SFAS No. 123, "Accounting for Stock-Based Compensation, "our net income (loss)
and income (loss) per share would have been as follows (in thousands):
Three Months Nine Months
Ended July 31, Ended July 31,
-------------- --------------
2003 2002 2003 2002
---- ---- ---- ----
Net income (loss), as reported $ 141 $ (178) $ 284 $ (2,356)
Add: Total stock-based compensation
expense (benefit) included in the net loss
determined under the recognition and
measurement principles of APB Opinion 25 - - - -
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (43) (87) (43) (103)
-------- ---------- ------ ---------
8
Pro forma net income (loss) $ 98 $ (265) $ 241 $ (2,459)
======== ========== ====== =========
Net income (loss) per share:
Basic - as reported $ 0.03 $ ( 0.04) $ 0.07 $ (0.64)
======== ========== ====== =========
Basic - pro forma $ 0.02 $ (0.04) $ 0.06 $ (0.64)
======== ========== ====== =========
Diluted - as reported $ 0.03 $ (0.04) $ 0.06 $ (0.64)
======== ========== ====== =========
Diluted - pro forma $ 0.02 $ (0.04) $ 0.06 $ (0.64)
======== ========== ====== =========
Options to purchase 52,500 shares of common stock were granted in the quarter
ended July 31, 2003. The assumptions regarding the annual vesting of stock
options were 25% per year for options granted in 2003. The fair value of each
option grant is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions used for
grants in 2003: Dividend yield of 0%; expected volatility of 50%; risk-free
interest rate of 3.0%; and expected life of four years.
6. CONCENTRATION OF RISK:
In the three and nine months ended July 31, 2003 and 2002, most of our sales
were attributable to sales of communications products and were derived from a
limited number of OEM customers. Sales to the Hewlett-Packard Company ("HP")
accounted for 50% and 45% of net sales during the third quarter of fiscal 2003
and 2002, respectively, and 52% and 34% of our net sales in the first nine
months of fiscal 2003 and 2002, respectively. There were no other customer with
accounting for 10% or more of our net sales for the third quarter of fiscal
2003, compared to two customers in the third quarter of fiscal 2002 (Lockheed
Martin - 15% and Nortel - 15%). For the nine months ended July 31, 2002, the
only other customer accounting for more than 10% of net sales was Lockheed
Martin - (14%). HP accounted for 30% and 43% of our accounts receivable as of
July 31, 2003 and 2002, respectively. Under a restructured product supply
agreement entered into on October 31, 2002, HP submitted an end-of-life
product-discontinuation non-cancelable purchase order for approximately $1.6
million of our VME products, all of which shipped in the first two quarters of
fiscal 2003. Subsequently, we received additional orders for approximately $1.0
million of VME products. Of this amount, $0.2 million was shipped in the second
quarter of fiscal 2003 and the remaining amount was shipped in the third quarter
of fiscal 2003. In September 2003, HP notified us that they would purchase an
additional $2.6 million of VME products with deliveries scheduled for our fourth
fiscal quarter of 2003 and the first two fiscal quarters of fiscal 2004. We
expect to continue to sell our adapter products to HP but in small volumes. A
significant reduction in orders from any of our OEM customers or failure to
replace the net sales previously earned from product shipments to HP could have
a material adverse effect on our business, operating results, financial
condition and cash flows.
9
7. WARRANTY OBLIGATIONS AND OTHER GUARANTEES:
In November 2002, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation ("FIN") No. 45 "Guarantor's Accounting and Disclosure
Requirements for Guarantees, including Indirect Guarantees of Indebtedness of
Others -- an interpretation of FASB Statements No. 5, 57 and 107 and rescission
of FIN 34." The following is a summary of our agreements that we have determined
are within the scope of FIN 45.
We accrue the estimated costs to be incurred in performing warranty services at
the time of revenue recognition and shipment of the products to our customers.
Our estimate of costs to service our warranty obligations is based on historical
experience and expectation of future conditions. To the extent we experience
increased warranty claim activity or increased costs associated with servicing
those claims, the warranty accrual will increase, resulting in decreased gross
margin.
The following table sets forth an analysis of our warranty reserve at July 31,
2003 (in thousands):
Warranty reserve at October 31, 2002 $ 55
Less: Cost to service warranty obligations (13)
Plus: Warranty accrual 11
-----
Total warranty reserve included in other accrued expenses $ 53
=====
We have agreed to indemnify each of our executive officers and directors for
certain events or occurrences arising as a result of the officer or director
serving in such capacity. The term of the indemnification period is for the
officer's or director's lifetime. The maximum potential amount of future
payments we could be required to make under these indemnification agreements is
unlimited. However, we have a directors' and officers' liability insurance
policy that should enable us to recover a portion of future amounts paid. As a
result of our insurance policy coverage, we believe the estimated fair value of
these indemnification agreements is minimal and have no liabilities recorded for
these agreements as of July 31, 2003 and October 31, 2002.
We enter into indemnification provisions under our agreements with other
companies in the ordinary course of business, typically with business partners,
contractors, customers and landlords. Under these provisions we generally
indemnify and hold harmless the indemnified party for losses suffered or
incurred by the indemnified party as a result of our activities or, in some
cases, as a result of the indemnified party's activities under the agreement.
These indemnification provisions often include indemnifications relating to
representations made by us with regard to intellectual property rights. These
indemnification provisions generally survive termination of the underlying
agreement. The maximum potential amount of future payments we could be required
to make under these indemnification provisions is unlimited. We have not
incurred material costs to defend lawsuits or settle claims related to these
indemnification agreements. As a result, we believe the estimated fair value of
these agreements is minimal. Accordingly, we have no liabilities recorded for
these agreements as of July 31, 2003 and October 31, 2002.
10
8. SALE OF COMMON STOCK AND WARRANTS:
On June 27, 2003, we completed a private placement of 500,000 shares of common
stock plus a warrant to purchase 50,000 shares of common stock, resulting in
gross cash proceeds of $550,000 and net cash proceeds of approximately $478,000.
The warrant has a term of five years and bears an exercise price of $1.50 per
share subject to certain adjustment provisions.
In connection with the private placement, we retained the services of Puglisi &
Co. as placement agent, and in connection therewith paid Puglisi & Co. and its
associates a fee of $33,000 and warrants to purchase 150,000 shares of common
stock. The warrants have a five-year term and bear exercise prices between $1.50
and $2.00 per share, subject to certain adjustment provisions. The warrants to
purchase a total of 200,000 shares of common stock have a calculated fair market
value of approximately $225,000. This value was derived using a "Black-Scholes"
pricing model. We registered for resale all of the shares of common stock sold
in this offering and the shares subject to sale pursuant to the exercise of the
warrants with the Securities and Exchange Commission on Form S-3.
9. LOAN TO OFFICER:
On November 6, 1998, we made a loan to an officer and stockholder in the amount
of $622,800 under a two-year recourse promissory note bearing an interest rate
of 4.47% and collateralized by 145,313 shares of our common stock. The loan was
used to pay for the exercise of an option to purchase 139,400 shares of our
common stock and related taxes. On April 16, 1999, the loan was increased to
$743,800. The loan was extended for a one-year term under the same terms and
conditions on November 6, 2000. On December 14, 2001, the note was amended,
restated and consolidated to extend the term to December 2003 and to require
certain mandatory repayments of principal of at least $25,000 and up to $100,000
a year while the note is outstanding. On December 14, 2002, $25,000 in principal
was repaid pursuant to the note. The loan bears interest at a rate of 2.48% per
annum, with interest due annually and the entire amount of the principal due on
December 14, 2003. At July 31, 2003 all interest payments were current.
While the officer is current on his payments on the loan and we plan on pursuing
all available courses of action to collect the amounts ultimately due on the
loan, on October 31, 2002 we determined that it was probable that we will be
unable to fully recover the balance of the loan on its due date of December 14,
2003. Accordingly, a valuation allowance of $474,000 was recorded based
generally on the fair value of the common stock collateralizing the note at
October 31, 2002 and the amount of the officer's personal assets considered
likely to be available to settle the note in December 2003. This valuation
allowance is subject to adjustment in the future based on changes in the fair
value of the common stock and personal assets collateralizing the loan. At July
31, 2003, we believe this valuation allowance is sufficient to cover unexpected
losses.
11
10. SUBSEQUENT EVENT:
Effective as of August 7, 2003, we purchased substantially all of the assets of
Antares Microsystems, Inc., a California corporation ("Antares"), excluding cash
and accounts receivable, from the Assignee for the Benefit of Creditors of
Antares ("Assignee") for a purchase price of $75,000 in cash plus $465,000 in
costs associated with the payment of certain loan guarantees, legal fees,
accounting fees, broker fees, contract transfer fees and moving expenses. We did
not assume any of the liabilities associated with Antares. In connection the
acquisition, we hired certain employees of Antares in order to continue the
development of the Antares TCP/IP Offload Engine ("TOE") technology, which is in
the developmental stage. In the event TOE is successfully completed and
commercialized, we have committed to make certain payments of cash and/or stock
as bonuses to certain of these employees, as sales of the TOE products occur.
The amount of consideration paid in connection with the asset acquisition was
determined by extensive "arms-length" negotiation among the parties. We funded
the acquisition of the assets in cash from our working capital plus proceeds
from the sale of our common stock as described in Note 8. There was no material
relationship between Assignee or Antares and us or any of our affiliates, any of
our directors or officers, or any associate of any such director or officer.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD LOOKING STATEMENTS
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements that involve risks and
uncertainties. Words such as "believes," "anticipates," "expects," "intends" and
similar expressions are intended to identify forward-looking statements, but are
not the exclusive means of identifying such statements. Readers are cautioned
that the forward-looking statements reflect our analysis only as of the date
hereof, and we assume no obligation to update these statements. Actual events or
results may differ materially from the results discussed in or implied by the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those risks and uncertainties set forth under the
caption "Risk Factors" below.
The following discussion should be read in conjunction with the Financial
Statements and the Notes thereto included in Item 1 of this Quarterly Report on
Form 10-Q and in our Form 10-K for the fiscal year ended October 31, 2002.
RISK FACTORS
In addition to the other information in this Periodic Report on Form 10-Q,
stockholders or prospective investors should carefully consider the following
risk factors:
RISKS RELATED TO OUR BUSINESS
OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO REPLACE NET SALES PREVIOUSLY
GENERATED BY SALES OF VME PRODUCTS TO HP.
In the first three quarters of fiscal 2003 and 2002, sales of Versa Module
Europa ("VME") products to The Hewlett-Packard Company (previously Compaq
Computer) ("HP") accounted for 52% and 34%, respectively, of our net sales. A
substantial portion of such sales were attributable to sales of VME products
pursuant to a long-term supply agreement with HP that is no longer in effect. We
shipped $1.6 million of VME products to HP over the first two quarters of fiscal
2003 pursuant to an end-of-life product discontinuation purchase order under
such contract. After termination of the contract, we received additional orders
for $1.0 million, which orders were shipped in the second and third quarters of
fiscal 2003. In September 2003, HP notified us that they would purchase an
additional $2.6 million of VME products with deliveries scheduled for our fourth
fiscal quarter of 2003 and the first two fiscal quarters of fiscal 2004. We can
provide no assurance that we will succeed in obtaining new orders from existing
or new customers sufficient to replace or exceed the net sales previously
attributable to HP.
WE SELL OUR PRODUCTS TO A SMALL NUMBER OF OEM CUSTOMERS, AND THE LOSS OF ANY OF
THEM, OR THEIR FAILURE TO SELL THEIR PRODUCTS, WOULD LIMIT OUR ABILITY TO
GENERATE NET SALES.
In fiscal 2002 and the first three quarters of fiscal 2003, most of our sales
were derived from a limited number of OEM customers, primarily HP. We expect
that we will always derive most our net sales from sales to a limited number of
OEM customers. Orders by our OEM customers are affected by factors such as new
13
product introductions, product life cycles, inventory levels, manufacturing
strategy, contract awards, competitive conditions and general economic
conditions. Our sales to any single OEM customer are also subject to significant
variability from quarter to quarter. Such fluctuations may have a material
adverse effect on our operating results. A significant reduction in orders from
any of our OEM customers would have a material adverse effect on our operating
results, financial condition and cash flows of our customers is bound by a
long-term purchase contract. Thus, we cannot provide any assurance that we will
continue to sell our products at existing levels, if at all, to our existing OEM
customers.
IF WE FAIL TO DEVELOP AND PRODUCE NEW HIGHWIRE AND ADAPTER PRODUCTS, WE MAY LOSE
SALES AND OUR REPUTATION MAY BE HARMED.
Since late 1998, we have focused a significant portion of our research and
development, marketing and sales efforts on our HighWire and Adapter products.
The success of these products is dependent on several factors, including timely
completion of new product designs, achievement of acceptable manufacturing
quality and yields, introduction of competitive products by other companies and
market acceptance of our products. If the HighWire and Adapter products or other
new products developed by us do not gain market acceptance, our business,
operating results, financial condition and cash flows would be materially
adversely affected.
THE COMMUNICATIONS PRODUCTS MARKET IS INTENSELY COMPETITIVE, AND OUR FAILURE TO
COMPETE EFFECTIVELY COULD REDUCE OUR NET SALES AND MARGINS.
We compete directly with vendors of terminal servers, modems, remote control
software, terminal emulation software and application-specific communications
solutions. We also compete with suppliers of routers, hubs, network interface
cards and other data communications products. In the future, we expect
competition from companies offering client/server access solutions based on
emerging technologies such as switched digital telephone services. In addition,
we may encounter increased competition from operating system and network
operating system vendors to the extent such vendors include full communications
capabilities in their products. We may also encounter future competition from
telephony service providers (such as AT&T or the regional Bell operating
companies) that may offer communications services through their telephone
networks.
Increased competition with respect to any of our products could result in price
reductions and loss of market share, which would adversely affect our business,
operating results, financial condition and cash flows. Many of our current and
potential competitors have greater financial, marketing, technical and other
resources than we do. There can be no assurance that we will be able to compete
successfully with our existing competitors or will be able to compete
successfully with new competitors.
OUR OPERATING RESULTS IN FUTURE PERIODS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY
AND MAY FAIL TO MEET THE EXPECTATIONS OF SECURITIES ANALYSTS OR INVESTORS,
CAUSING OUR STOCK PRICE TO FALL.
Our quarterly operating results have fluctuated significantly in the past and
are likely to fluctuate significantly in the future due to several factors, some
of which are outside our control, including existence or absence of significant
orders from OEM customers, fluctuating market demand for, and declines in the
14
average selling prices of, our products, delays in the introduction of our new
products, competitive product introductions, the mix of products sold, changes
in our distribution network, the failure to anticipate changing customer product
requirements, the cost and availability of components and general economic
conditions. We generally do not operate with a significant order backlog, and a
substantial portion of our net sales in any quarter is derived from orders
booked in that quarter. Accordingly, our sales expectations are based almost
entirely on our internal estimates of future demand and not on firm customer
orders.
Due to the adverse economic conditions in the telecommunications industry, many
of our customers may hold excess inventory of our products. A result of the
economic downturn is that certain of our customers have cancelled or delayed
many of their new design projects and new product rollouts that included our
products. Due to the current economic uncertainty, our customers now typically
require a "just-in-time" ordering and delivery cycle where they will place a
purchase order with us after they receive an order from their customer. This
"just-in-time" inventory purchase cycle by our customers has made forecasting of
our future sales volumes very difficult.
Based on the foregoing, we believe that quarterly operating results are likely
to vary significantly in the future and that period-to-period comparisons of our
results of operations are not necessarily meaningful and should not be relied
upon as indications of future performance. Further, it is likely that in some
future quarter our net sales or operating results will be below the expectations
of public market analysts and investors. In such event, the price of our common
stock is likely to fall.
IF WE ARE UNABLE TO KEEP UP WITH THE RAPID TECHNOLOGICAL CHANGES THAT
CHARACTERIZE OUR INDUSTRY, OUR BUSINESS WOULD SUFFER.
The markets for our products are characterized by rapidly changing technologies,
evolving industry standards and frequent new product introductions. Our future
success will depend on our ability to enhance our existing products and to
introduce new products and features to meet and adapt to changing customer
requirements and emerging technologies such as Frame Relay, DSL ("Digital
Subscriber Line"), ATM ("Asynchronous Transfer Mode"), VoIP ("Voice over
Internet Protocol") and 3G Wireless ("Third Generation Wireless Services").
There can be no assurance that we will be successful in identifying, developing,
manufacturing and marketing new products or enhancing our existing products. In
addition, there can be no assurance that services, products or technologies
developed by others will not render our products noncompetitive or obsolete.
WE DEPEND ON OUR KEY PERSONNEL. IF WE ARE UNABLE TO RETAIN OUR CURRENT PERSONNEL
AND HIRE ADDITIONAL QUALIFIED PERSONNEL AS NEEDED, OUR BUSINESS WOULD BE HARMED.
We are highly dependent on the technical, management, marketing and sales skills
of a limited number of key employees. We do not have employment agreements with,
or life insurance on the lives of, any of our key employees. The loss of the
services of any key employees could adversely affect our business and operating
results. Our future success will depend on our ability to continue to attract
and retain highly talented personnel to the extent our business grows.
Competition for qualified personnel in the networking industry, and in the San
Francisco Bay Area, is intense. There can be no assurance that we will be
15
successful in retaining our key employees or that we can attract or retain
additional skilled personnel as required.
BECAUSE OF OUR DEPENDENCE ON SINGLE SUPPLIERS FOR SOME COMPONENTS, WE MAY BE
UNABLE TO OBTAIN AN ADEQUATE SUPPLY OF SUCH COMPONENTS, OR WE MAY BE REQUIRED TO
PAY HIGHER PRICES OR TO PURCHASE COMPONENTS OF LESSER QUALITY.
The chipsets used in most of our products are currently available only from
Motorola. In addition, certain other components are currently available only
from single suppliers. The inability to obtain sufficient key components as
required, or to develop alternative sources if and as required in the future,
could result in delays or reductions in product shipments or margins that, in
turn, would have a material adverse effect on our business, operating results,
financial condition and cash flows.
OUR FUTURE CAPITAL NEEDS MAY EXCEED OUR ABILITY TO RAISE CAPITAL.
We did not generate positive cash flow from operations in fiscal 2002 or the
first three quarters of fiscal 2003. As a result, while we believe that our
existing cash balances and our anticipated cash flow from operations will
satisfy our working capital needs for the next twelve months, we cannot assure
that this will be the case. Further declines in our sales or a failure to keep
expenses in line with net sales could require us to seek additional financing in
the future. In addition, should we experience a significant growth in customer
orders, we may be required to seek additional capital to meet our working
capital needs. If additional funds are raised through the issuance of securities
or debt, these securities could have rights, privileges or preferences senior to
those of common stock, and debt covenants could impose restrictions on our
operations. The sale of equity or debt securities could result in additional
dilution to current stockholders. Financing may not be available to us on
acceptable terms, if at all.
WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WHICH COULD REDUCE ANY
COMPETITIVE ADVANTAGE WE HAVE.
Although we believe that our future success will depend primarily on continuing
innovation, sales, marketing and technical expertise, the quality of product
support and customer relations, we must also protect the proprietary technology
contained in our products. We do not currently hold any patents and rely on a
combination of copyright, trademark, trade secret laws and contractual
provisions to establish and protect proprietary rights in our products. There
can be no assurance that steps taken by us in this regard will be adequate to
deter misappropriation or independent third-party development of our technology.
Although we believe that our products and technology do not infringe on the
proprietary rights of others, there can be no assurance that third parties will
not assert infringement claims against us.
RISKS ASSOCIATED WITH OWNERSHIP OF OUR COMMON STOCK
OUR COMMON STOCK HAS BEEN AT RISK FOR DELISTING FROM THE NASDAQ SMALLCAP MARKET.
IF IT IS DELISTED, OUR STOCK PRICE AND YOUR LIQUIDITY MAY BE IMPACTED.
Our common stock is currently listed on the Nasdaq SmallCap Market. Nasdaq has
requirements that a company must meet in order to remain listed on the Nasdaq
SmallCap Market. These requirements include maintaining a minimum closing bid
16
price of $1.00 and minimum stockholders' equity of $2.5 million. The closing bid
price for our common stock has been below $1.00 for more than 30 consecutive
trading days during portions of fiscal 2003. Although we currently meet all the
minimum continued listing requirements for the Nasdaq SmallCap Market, should
our stock price again decline we could be subjected to potential delisting from
the Nasdaq SmallCap Market.
If we fail to maintain the standards necessary to be quoted on the Nasdaq
SmallCap Market and our common stock is delisted, trading in our common stock
would be conducted on the OTC Bulletin Board as long as we continue to file
reports required by the Securities and Exchange Commission. The OTC Bulletin
Board is generally considered to be a less efficient market than the Nasdaq
SmallCap Market, and our stock price, as well as the liquidity of our common
stock, may be adversely impacted as a result.
THE MARKET PRICE OF OUR COMMON STOCK IS LIKELY TO CONTINUE TO BE VOLATILE. YOU
MAY NOT BE ABLE TO RESELL YOUR SHARES AT OR ABOVE THE PRICE AT WHICH YOU
PURCHASED SUCH SHARES.
The trading price of our common stock is subject to wide fluctuations in
response to quarter-to-quarter fluctuations in operating results, the failure to
meet analyst estimates, announcements of technological innovations or new
products by us or our competitors, general conditions in the computer and
communications industries and other events or factors. In addition, stock
markets have experienced extreme price and trading volume volatility in recent
years. This volatility has had a substantial effect on the market prices of
securities of many high technology companies for reasons frequently unrelated to
the operating performance of the specific companies. These broad market
fluctuations may adversely affect the market price of our common stock.
OUR CERTIFICATE OF INCORPORATION AND BYLAWS AND THE DELAWARE GENERAL CORPORATION
LAW CONTAIN PROVISIONS THAT COULD DELAY OR PREVENT A CHANGE IN CONTROL.
Our board of directors has the authority to issue up to 2,000,000 shares of
preferred stock and to determine the price, rights, preferences and privileges
of those shares without any further vote or action by the stockholders. The
rights of the holders of common stock will be subject to, and may be materially
adversely affected by, the rights of the holders of any preferred stock that may
be issued in the future. The issuance of preferred stock could have the effect
of making it more difficult for a third party to acquire a majority of our
outstanding voting stock. Furthermore, certain other provisions of our
certificate of incorporation and bylaws may have the effect of delaying or
preventing changes in control or management, which could adversely affect the
market price of our common stock. In addition, we are subject to the provisions
of Section 203 of the Delaware General Corporation Law, an anti-takeover law.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OVERVIEW
SBE, Inc. designs, markets, sells and supports network communications and
storage controller solutions for original equipment manufacturers and enterprise
class computing systems in the global networking and enterprise level
information technology ("IT") marketplace. Our solutions enable both data
communications and telecommunications companies in addition to enterprise class
17
high-end server clients to rapidly deliver advanced networking and storage
products and services. The addition of the Antares product line in August 2003
enables us to introduce an impressive collection of WAN, LAN, SCSI, Fibre
Channel, and carrier cards across both the enterprise server and embedded
markets. Our products with Linux and Solaris drivers and software now include
wide area network ("WAN") and local area network ("LAN") interface adapters,
storage products such as SCSI and Fibre Channel and high performance intelligent
communications controllers for high-end enterprise level servers, workstations,
media gateways, routers, internet access devices, home location registers and
data messaging applications. Our products are distributed worldwide through a
direct sales force, stocking distributors, independent manufacturers'
representatives and value-added resellers.
With the addition of Antares, we now offer an increased portfolio of
field-tested products of Ethernet, SCSI, Fibre Channel, and specialty I/O boards
for the Enterprise Sun and Linux markets. The Antares products have been
integrated into a variety of applications, including storage area networks and
mission-critical data centers. We continue to operate under a single segment.
Our business is characterized by a concentration of sales to a small number of
OEM and stocking distributors and, consequently, the timing of significant
orders from major customers and their product cycles causes fluctuation in our
operating results. With the addition of Antares, we have extended the reach of
our product offerings to the enterprise level IT marketplace and are no longer
wholly dependent on the OEM datacom marketplace. HP is the largest of our
customers. Sales to HP accounted for 50% and 52% of our net sales in the three
and nine months ended July 31, 2003, respectively and 45% and 34% for the same
periods in fiscal 2002, respectively. In the three months ended July 31, 2002,
Nortel accounted for 15% of our net sales. In the nine months ended July 31,
2002, sales to Lockheed Martin constituted 14% of net sales. No other customer
accounted for greater than 10% of net sales in the three or nine months ended
July 31, 2003 or 2002. HP accounted for 30% and 43% of our accounts receivable
as of July 31, 2003 and July 31, 2002, respectively. No other customers
accounted for more than 10% of our accounts receivable as of July 31, 2003 or
2002, respectively.
We shipped $1.6 million of VME products to HP over the first two quarters of
fiscal 2003 pursuant to an end-of-life purchase order under such contract. After
termination of the contract, we received additional orders for $1.0 million.
These orders were shipped in the second and third quarter of fiscal 2003. In
September 2003, HP notified us that they would purchase an additional $2.6
million of VME products with deliveries scheduled for our fourth fiscal quarter
of 2003 and the first two fiscal quarters of fiscal 2004. We also signed a three
year product support agreement with HP with an annual fee of $135,000, effective
May 1, 2003, which stipulates that we will provide ongoing engineering and
product warranty support for the VME products sold under the HP product supply
contract. We expect to continue to sell our Adapter products to HP in small
volumes.
We have taken aggressive steps to reduce overall operating costs over the past
two years, including reducing headcount, relocating our engineering and
headquarters facilities and closing our office in Madison, Wisconsin. We
continue to focus on cost containment and cash preservation and monitor our
expense levels very closely.
The market environment for our products is extremely competitive and we have
18
limited visibility into customer activity due to the downturn in the
communications equipment marketplace. In spite of this uncertain market, we have
been successful in selling and shipping our Adapter and HighWire products to 40
new customers during the first nine months of fiscal 2003. One of our primary
sales goals is to diversify our customer base and at the same time provide
sources of net sales to fill the gap left by the HP end-of-life purchase of our
VME products.
In the quarter ended July 31, 2003 we had four new design wins. Since the fourth
quarter of fiscal 2001 we have 21 new "design wins" and have added a substantial
number of new customers to our growing base of customers. A design win is
defined as a program with an OEM customer that will generate at least $400,000
in recurring annual net sales typically within 12 to 18 months after the
customer accepts and confirms the use of our product in their platform. We
believe the combination of new customers and design wins will provide future
sales growth once there is a discernable recovery in the communications
equipment marketplace. A variety of risks such as schedule delays, cancellations
and changes in customer markets and economic conditions can adversely affect a
design win before or after production is reached. With the current economic
climate in the communications equipment marketplace, design activity has slowed
and reaching production volumes is proving to be elusive for those products that
have been designed. In these difficult economic times, poor customer visibility
is causing ordering delays. These factors often result in a substantial portion
of our net sales being derived from orders placed within the quarter and shipped
in the final month of the quarter.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
net sales and expenses during the reporting period. Such estimates include
levels of reserves for doubtful accounts, obsolete inventory, warranty costs and
deferred tax assets. Actual results could differ from those estimates.
Our critical accounting policies and estimates include the following:
Revenue Recognition
We record product sales at the time of product shipment. Our sales transactions
are negotiated in U.S. dollars. Our agreements with OEMs such as HP and Lockheed
Martin typically incorporate clauses reflecting the following understandings:
- all prices are fixed and determinable at the time of sale;
- title and risk of loss pass at the time of shipment;
- collectibility of the sales prices is probable. The OEM is
obligated to pay and such obligation is not contingent on the
ultimate sale of the OEM's integrated solution;
- the OEM's obligation to us would not be changed in the event
of theft or physical destruction or damage of the product;
- we do not have significant obligations for future performance
to directly bring about resale of the product by the OEMs; and
- there is no contractual right of return other than for
defective products; we can reasonably estimate such returns
and record a warranty reserve at the point of shipment.
19
Maintenance Revenues
We record deferred revenues upon receipt of a non-cancelable purchase order or
maintenance contract for extended maintenance and warranty services. We record
the revenues to the income statement as the services are delivered or over the
contract period.
Non-Recurring Engineering Expenses
Contractual reimbursements for research and development ("R&D") expenditures
under joint R&D contracts of purchase orders with customers are accounted for as
reductions of related expenses as incurred.
Warranty Reserves
We accrue the estimated costs to be incurred in performing warranty services at
the time of revenue recognition and shipment of the products to the OEMs. Our
estimate of costs to service our warranty obligations is based on historical
experience and expectation of future conditions. To the extent we experience
increased warranty claim activity or increased costs associated with servicing
those claims, the warranty accrual will increase, resulting in decreased gross
margin.
Inventories
Inventories are stated at the lower of cost, using the first-in, first-out
method, or market value. Our inventories include high-technology parts that may
be subject to rapid technological obsolescence. We consider technological
obsolescence in estimating required reserves to reduce recorded amounts to
market values. Such estimates could change in the future and have a material
adverse impact on our financial position and results of operations.
RESULTS OF OPERATIONS
The following table sets forth, as a percentage of net sales, consolidated
statements of operations data for the three and nine months ended July 31, 2003
and 2002. These operating results are not necessarily indicative of our
operating results for any future period.
20
THREE MONTHS ENDED NINE MONTHS ENDED
------------------ -----------------
JULY 31, JULY 31,
-------- --------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Net sales 100% 100% 100% 100%
Cost of sales 34 39 38 43
----------- ----------- ----------- -----------
Gross profit 66 61 62 57
----------- ----------- ----------- -----------
Product research and development 21 28 17 40
Sales and marketing 22 18 19 28
General and administrative 24 24 24 31
Restructuring (benefit) (10) --- (3) ---
------------ ----------- ------------ -----------
Total operating expenses 57 70 57 99
----------- ----------- ----------- -----------
Operating income (loss) 9 (9) 5 (42)
Interest and other income --- 3 --- 2
Income tax benefit --- --- --- ---
----------- ----------- ----------- -----------
Net income (loss) 9% (6)% 5% (40)%
=========== ============ =========== ============
NET SALES
Net sales for the third quarter of fiscal 2003 were $1.6 million, a 42% decrease
from the third quarter of fiscal 2002. This decrease for the comparable quarters
was primarily attributable a reduction in shipments of our VME products to HP
and Lockheed Martin in addition to reductions in shipments of our Adapter
products to Nortel. Sales to HP were $804,000 in the three months ended July 31,
2003, compared to $1.1 million for the same period in fiscal 2002, a 27%
decrease. We also had a decrease in our sales to Lockheed Martin. In the third
quarter of fiscal 2002, we shipped $415,000 in VME products to Lockheed Martin
for FAA control tower color display systems compared to $39,000 this quarter, a
91% decrease. Lockheed continues to deploy the systems but the velocity of the
deployment has slowed considerably. Our sales of adapter products to Nortel for
the comparable quarterly periods decreased from $414,000 to $180,000, a 57%
decrease, due to a slowness of in demand for the Nortel products in which our
adapter products are incorporated.
For the first nine months of fiscal 2003, net sales were $5.2 million, which
represented a 9% decrease over the same period in fiscal 2002. For the
comparable nine-month periods, Sales to HP were $2.7 million in the nine months
ended July 31, 2003, compared to $2.0 million for the same period in fiscal
2002, a 23% increase. This increase is primarily due to an end-of-life purchase
order for $1.6 million, all of which shipped in the first two quarters of fiscal
2003. In September 2003, HP notified us that they would purchase an additional
$2.6 million of VME products with deliveries scheduled for our fourth fiscal
quarter of 2003 and the first two fiscal quarters of fiscal 2004. We do not
expect sales of VME products to HP to continue beyond the order fulfilled in the
second quarter of fiscal 2004.
We continue to see an overall slowdown in demand from our telecommunications
customers due to adverse industry-wide economic conditions. Sales of our Adapter
products were $423,000 for the three months ended July 31, 2003 compared to
$683,000 for the three months ended July 31, 2002. Sales of our HighWire
products were $165,000 for the quarter ended July 31, 2003 compared to $301,000
for the same quarter last year. For the nine months ended July 31, 2003, sales
of our Adapter products was $1.4 million compared to $1.6 million for the same
nine-month period in fiscal 2002. Sales of our HighWire products were $799,000
for the nine months just ended compared to $799,000 for the same period last
21
year. In the future, we expect our net sales to be generated predominantly by
sales of our Adapter products followed by the Antares products. We expect to see
a continued slowness in the sale of our Highwire products due to the continued
downturn in the communications equipment markets All of our design wins and new
customer adds are for applications using these product families. We will
continue to sell and support our older VME products, but expect them to become a
declining portion of our future net sales.
Due to the adverse economic conditions in the communications equipment industry,
our customers have cancelled or delayed many of their new design projects and
new product rollouts that included our products. We anticipate that our net
sales over the last quarter of fiscal 2003 will remain flat when compared with
the first three quarters of fiscal 2003, as we expect our customers to slowly
deploy existing inventory and gradually return to new product design and product
rollout. One of our major challenges is the replacement of the net sales
previously provided by HP. HP (including its predecessors, Tandem Computer and
Compaq Computer), has accounted for the majority of our net sales for the past
five years. The market environment for our products is extremely competitive and
we have limited visibility into customer activity due to the downturn in the
communications equipment marketplace. In spite of this uncertain market, we have
been successful in selling and shipping our Adapter and HighWire products to 40
new customers during the first nine months of fiscal 2003. Many of these new
customers are in the beginning stages of the product development but with their
addition we have increased our base of customers to an all time high. In
addition, since the fourth quarter of fiscal 2001 we have added 21 new "design
wins." We believe the combination of new customers and design wins will provide
future growth in net sales once there is a discernable recovery in the
communications equipment marketplace.
Due to the current economic uncertainty, our customers typically require a
"just-in-time" ordering and delivery cycle where they will place a purchase
order with us after they receive an order from their customer. This
"just-in-time" inventory purchase cycle by our customers has made forecasting of
our future sales volumes very difficult. Because our sales are generally
concentrated with a small group of OEM customers, we could experience
significant fluctuations in our quarterly sales volumes due to fluctuating
demand from any major customer or delay in the rollout of any significant new
product by a major customer.
GROSS MARGIN
Gross margin as a percentage of net sales in the third quarter of fiscal 2003
was 66% compared to 61% during the third quarter of fiscal 2002. For the first
nine months of fiscal 2003, the gross margin percentage was 62%, as compared to
57% during the same period of fiscal 2002. The increase in the gross margin in
fiscal 2003 as compared to fiscal 2002 was primarily attributable to lower
materials and manufacturing costs combined with a more profitable product mix in
fiscal 2003 and sales of previously written-down inventory used by HP. Excluding
sales to Hp, our gross margin would have been 57% for fiscal 2003. We expect our
gross margin to range between 60% and 65% for our fourth quarter of fiscal 2003.
As our product mix of our net sales moves from VME to Adapter products and we
integrate Antares' product into our product lines and sales force, we expect to
see our future gross margin to decrease to approximately 55%. The market for
Adapter products is extremely competitive and as a result, at production
volumes, there is a greater downward price pressure than with our VME and
22
Highwire products. However, if market and economic conditions, particularly in
the telecommunications sector, deteriorate or fail to recover, gross margin may
be lower than projected.
PRODUCT RESEARCH AND DEVELOPMENT
Product research and development expenses for the three and nine month periods
ending July 31, 2003 were $334,000 and $913,000, respectively, a decrease from
$770,000 and $2.3 million for the same periods of fiscal 2002. The decrease
resulted primarily from staff reductions and the closing of our Madison,
Wisconsin facility during the fourth quarter of fiscal 2002. We continue to
maintain the engineering capability to develop new products and upgrade existing
products. During the first nine months of fiscal 2003, we developed and released
to production our new lanAdapter high-speed Gigabit Ethernet product family
including single, dual and 4-port copper and fiber ports. We also developed and
release a new Gigabit Ethernet product incorporating HyperTransport technology.
We will continue to pursue a targeted program of product development and with
the acquisition of the Antares assets we hired a Vice President of Engineering
and three design engineers to enhance our product development and support
activities. We expect our quarterly product research and development expenses to
increase by 30% to 40% during the last quarter of fiscal 2003 and into fiscal
2004.
SALES AND MARKETING
Sales and marketing expenses for the three and nine month periods ending July
31, 2003 were $361,000 and $1.0 million, respectively, a decrease from $501,000
and $1.6 million for the same periods of fiscal 2002. The decrease is primarily
due to lower marketing program spending for products in addition to the effect
of headcount reductions during the fourth quarter of fiscal 2002. We recently
hired a product manager associated and technical support engineer with the
acquisition of the Antares assets in addition to a Vice President of Marketing
and expect our quarterly sales and marketing expenses to increase by 10% to 20%
during the last quarter of fiscal 2003 and the first two quarters of fiscal 2004
as we begin to renew our product marketing efforts and attend an increasing
number of industry specific trade shows.
GENERAL AND ADMINISTRATIVE
General and administrative expenses for the three and nine month periods ending
July 31, 2003 were $381,000 and $1.2 million, respectively, a decrease from
$673,000 and $1.8 million for the same periods of fiscal 2002. This decrease was
due to the effect of reduced headcount and a reduction in facility related
spending. We expect our quarterly general and administrative expenses to remain
at this level for the remainder of fiscal 2003. In the quarter ended July 31,
2003, we recognized a restructuring benefit of $154,000 after the final
settlement of costs associated with prior real estate and equipment leases.
INTEREST INCOME
Interest income decreased in the nine months of fiscal 2003 from the same period
in fiscal 2002 due to lower average interest earning cash balances coupled with
lower average interest rates.
23
INCOME TAXES
We recorded a benefit for income taxes of $22,000 in the second quarter of
fiscal 2003 related to the Job Creation and Workers Assistance Act of 2002
signed into law by the President of the United States on March 9, 2002, which
extended the net operating loss carryback from two to five years for losses
generated in tax years ending in 2001 and 2002. As of July 31, 2003, we
collected all of the tax refunds we recorded associated with the Job Creation
and Workers Assistance Act of 2002. We have approximately $8.6 million of income
tax loss carryforwards that are expected to be utilized to offset future taxable
income. The deferred tax assets associated with these benefits have been fully
reserved in prior periods.
NET INCOME (LOSS)
As a result of the factors discussed above, we recorded net income of $141,000
and $284,000 in the three and nine months ended July 31, 2003, as compared to a
net loss of $178,000 and $2.4 million in the same periods of fiscal 2002.
LIQUIDITY AND CAPITAL RESOURCES
Our liquidity is dependent on many factors, including sales volume, operating
expenses and the efficiency of inventory use and turnover and efficient
collection of our accounts receivable. Our future liquidity will be affected by,
among other things:
- the actual versus anticipated increase in sales of our
products;
- ongoing cost control actions and expenses, including for
example, research and development and capital expenditures;
- timing of product shipments, which occur primarily during the
last month of the quarter;
- gross profit margin;
- the ability to raise additional capital, if necessary; and
- the ability to secure credit facilities, if necessary.
At July 31, 2003, we had cash and cash equivalents of $2.0 million, as compared
to $1.6 million at October 31, 2002. In the first nine months of fiscal 2003,
$51,000 of cash was used by operating activities, primarily as a result of a
reduction in liabilities and other current assets. The decrease in other current
liabilities was primarily the result of the $447,000 payment to HP related to
the long-term product supply agreement cancellation. The decrease in inventory
is reflective of our focus on just-in-time inventory practices where we place
orders with our contract manufacturers as we receive purchase orders from our
customers. Working capital (current assets less current liabilities) at July 31,
2003 was $4.0 million, as compared to $3.0 million at October 31, 2002.
In the first nine months of fiscal 2003, we purchased $77,000 of fixed assets,
consisting primarily of computer and engineering equipment and $10,000 in
software primarily for engineering and product design activities. Capital
expenditures for the remaining quarter of fiscal 2003 are expected to range from
$25,000 to $30,000.
24
Cash provided by financing activities in the first nine months of fiscal 2003
was the results of $43,000 received in the first nine months of fiscal 2003 from
payments related to common stock purchases made by employees pursuant to our
employee stock purchase plan and a required $25,000 principal payment on a loan
made to our Chief Executive Officer in 1998. On June 27, 2003, we completed a
private placement of 500,000 shares of common stock at $1.10 per share plus a
warrant to purchase 50,000 shares of common stock, resulting in gross cash
proceeds of approximately $550,000 and net proceeds after offering expenses of
approximately $478,000.
On May 14, 2002, we secured a twelve-month revolving $1.0 million working
capital line of credit with a bank. On May 13, 2003, we renewed our working
capital line of credit for twelve months until May 14, 2004. The credit line is
secured by a first lien on all our assets and carries a floating annual interest
rate equal to the bank's prime rate of 4.00%, at July 31, 2003, plus 1.50%.
Draw-downs on the credit line are based on a formula equal to 80% of our
domestic accounts receivable. As of July 31, 2003, we are in compliance with all
the covenants of our credit line and have not drawn down on this line of credit.
Effective as of August 7, 2003, we purchased substantially all of the assets of
Antares Microsystems, Inc., a California corporation ("Antares"), excluding cash
and accounts receivable, from the Assignee for the Benefit of Creditors of
Antares ("Assignee") for a purchase price of $75,000 in cash plus $465,000 in
costs associated with the payment of certain loan guarantees, legal fees,
accounting fees, broker fees, contract transfer fees and moving expenses. We did
not assume any of the liabilities associated with Antares. In connection the
acquisition, we hired certain employees of Antares in order to continue the
development of the Antares TCP/IP Offload Engine ("TOE") technology, which is in
the developmental stage. In the event TOE is successfully completed and
commercialized, we have committed to make certain payments of cash and/or stock
as bonuses to certain of these employees, as sales of the TOE products occur.
We realized significant reductions in our operating expenses due to our
implementation of a program of controlled spending and headcount reduction
initially instituted in mid-fiscal 2001 and continued throughout fiscal 2003.
With these reductions and the addition of the ongoing operational costs
associated with the purchase of the Antares assets, our future quarterly
operational cash flow breakeven point is expected to be $2.2 million to $2.5
million in net sales at an expected 55% gross margin. Our projected sales are to
a limited number of new and existing OEM customers and are based on internal and
customer-provided estimates of future demand, not firm customer orders. If our
projected sales do not materialize, we will need to reduce expenses further and
raise additional capital through customer prepayments or the issuance of debt or
equity securities. If additional funds are raised through the issuance of
preferred stock or debt, these securities could have rights, privileges or
preferences senior to those of common stock, and debt covenants could impose
restrictions on our operations. The sale of equity or debt could result in
additional dilution to current stockholders, and such financing may not be
available to us on acceptable terms, if at all.
Our only significant contractual obligations and commitments relate to certain
real estate operating leases for development and headquarters facilities and our
supply agreement with HP.
25
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our cash and cash equivalents are subject to interest rate risk. We invest
primarily on a short-term basis. Our financial instrument holdings at July 31,
2003 were analyzed to determine their sensitivity to interest rate changes. The
fair values of these instruments were determined by net present values. In our
sensitivity analysis, the same change in interest rate was used for all
maturities and all other factors were held constant. If interest rates increased
by 10%, the expected effect on net loss related to our financial instruments
would be immaterial.
ITEM 4. CONTROLS AND PROCEDURES
Our chief executive officer and our chief financial officer, after evaluating
the effectiveness of our "disclosure controls and procedures" (as defined in the
Securities Exchange Act of 1934 (the "Exchange Act") Rules 13a-14(c) and
15d-14(c)) as of July 31, 2003, have concluded that our disclosure controls and
procedures are effective to ensure that information required to be disclosed by
us in reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms. There were no significant
changes in our internal controls over financial reporting that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting subsequent to the date of such evaluation. There were
no significant deficiencies or material weaknesses, and therefore there were no
corrective actions taken.
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On June 27, 2003, we issued 500,000 shares of common stock plus a warrant to
purchase 50,000 shares of common stock, resulting in gross cash proceeds of
approximately $550,000 and net cash proceeds of approximately $478,000. The
warrant has a term of five years and bears an exercise price of $1.50 per share,
subject to certain adjustment provisions. The securities were sold to accredited
investors. In connection with the private placement, we retained the services of
Puglisi & Co. as placement agent, and paid Puglisi & Co. and its associates a
fee of $33,000 and warrants to purchase 150,000 shares of common stock, subject
to certain adjustment provisions. These warrants have a five-year term and bear
exercise prices between $1.50 and $2.00 per share. The issuances of stock and
warrants were exempt from registration under the Securities Act of 1933, as
amended (the "Securities Act"), pursuant to Rule 506 of Regulation D promulgated
under Section 4(2) of the Securities Act. This exemption was claimed because the
securities were issued only to accredited investors and the offering otherwise
met the requirements for the Rule 506 exemption. The proceeds were used to
purchase the assets of Antares Microsystems as described elsewhere in this
report.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit Index:
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------ -----------------------
3.1 Certificate of Incorporation, as amended through December 15,
1997. (1)
3.2 Bylaws, as amended through December 8, 1998. (2)
4.1 Stock subscription agreement, dated April 30, 2002, between
Stonestreet L.P. and SBE, Inc. (3)
4.2 Warrant dated April 30, 2002, to purchase 111,111 shares of
common stock of SBE, Inc. in favor of Stonestreet L.P. (3)
4.3 Warrant dated April 30, 2002, to purchase 11,429 shares of
common stock of SBE, Inc. in favor of Vintage Partners L.L.C.
(3)
4.4 Amendment dated August 22, 2002 to stock subscription
agreement dated April 30, 2002 between SBE, Inc. and
Stonestreet L.P. (4)
4.5 Securities Purchase Agreement, dated July 27, 2003, between
SBE, Inc. and purchasers of SBE's common stock thereunder,
including form of warrant issued thereunder (10)
4.6 Form of warrant issued to associates of Puglisi & Co. ($1.50
exercise price) (10)
4.7 Form of warrant issued to associates of Puglisi & Co. ($1.75
and $2.00 exercise price) (10)
10.1 1996 Stock Option Plan, as amended. (5)
10.2 1991 Non-Employee Directors' Stock Option Plan, as amended.
(5)
10.3 1992 Employee Stock Purchase Plan, as amended. (5)
10.4 1998 Non-Officer Stock Option Plan, as amended. (5)
10.5 Lease for 4550 Norris Canyon Road, San Ramon, California,
dated June 6, 1995 between SBE, Inc. and PacTel Properties.
(6)
10.6 Amendment dated June 6, 1995 to lease for 4550 Norris Road,
San Ramon, California, between SBE, Inc. and CalProp (assignee
of PacTel Properties).(7)
10.7 Full Recourse Promissory Note executed by William B. Heye, Jr.
in favor of SBE, Inc., dated November 6, 1998, amended
December 14, 2001. (2)
10.8 Amendment No. S/M018-4 dated April 3, 2001, to the Purchase
Agreement dated May 6, 1991, between SBE, Inc. and Compaq
Computer Corporation, as amended October 30, 2002. (8)
10.9 Loan and security agreement dated May 13, 2002 between SBE,
Inc. and Silicon Valley Bank. (9)
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10.10 Amendment to the Full Recourse Promissory Note executed by
William Heye, Jr. in favor of SBE, Inc., dated December 14,
2001. (5)
31.1 Certification by Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification by Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification by Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification by Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
(1) Filed as an exhibit to Annual Report on Form 10-K for
the year ended October 31, 1997 and incorporated
herein by reference.
(2) Filed as an exhibit to Annual Report on Form 10-K for
the year ended October 31, 1998 and incorporated
herein by reference.
(3) Filed as an exhibit to Form S-3 dated May 23, 2002
and incorporated herein by reference.
(4) Filed as an exhibit to Quarterly Report on Form 10-Q
for the quarter ended July 31, 2002 and incorporated
herein by reference.
(5) Filed as an exhibit to Annual Report on Form 10-K for
the year ended October 31, 2002 and incorporated
herein by reference.
(6) Filed as an exhibit to Form S-8 dated October 16,
1998 and incorporated herein by reference.
(7) Filed as an exhibit to Annual Report on Form 10-K for
the year ended October 31, 1995 and incorporated
herein by reference.
(8) Filed as an exhibit to Quarterly Report on Form 10-Q
for the quarter ended April 30, 2001 and incorporated
herein by reference. (Certain confidential
information has been deleted from this exhibit
pursuant to a confidential treatment order that has
been granted.)
(9) Filed as an exhibit to Quarterly Report on Form 10-Q
for the quarter ended April 30, 2002 and incorporated
herein by reference.
(10) Filed as an exhibit to Form S-3 dated July 10, 2003
and incorporated herein by reference.
(b) Reports on Form 8-K:
A report on Form 8-K was filed with the Securities and Exchange Commission on
May 21, 2003. The report furnished our press release announcing our financial
results for the quarter ended April 30, 2003
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, on September 11, 2003.
SBE, INC.
Registrant
Date: September 11, 2003 By: /s/ William B. Heye, Jr.
--------------------------
William B. Heye, Jr.
Chief Executive Officer and
President
(Principal Executive Officer)
Date: September 11, 2003 By: /s/ David W. Brunton
---------------------------
David W. Brunton
Chief Financial Officer,
Vice President, Finance
and Secretary
(Principal Financial and
AccountingOfficer)
29