SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED OCTOBER 31, 2004
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 No. 0-8419
SBE, INC.
(Exact name of Registrant as specified in its charter)
Delaware 94-1517641
(State or other jurisdiction of (IRS Employer Identification
incorporation or organization) Number)
2305 Camino Ramon, Suite 200, San Ramon, California 94583
(Address of principal executive offices and Zip Code)
(925) 355-2000
(Registrant's Telephone Number, including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock
(Title of Class)
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 such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. |X|
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Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes |_| No |X|
The approximate aggregate market value of the common stock of the
registrant held by non-affiliates of the registrant, based on the closing price
for the registrant's common stock on April 30, 2004 as reported on the Nasdaq
SmallCap Market, was $19,487,267. Shares of Common Stock held by each executive
officer, director and stockholder whose ownership exceeds five percent of Common
Stock outstanding have been excluded because such persons may be deemed to be
affiliates of the registrant. This determination of affiliate status for
purposes of the foregoing calculation is not necessarily a conclusive
determination of affiliate status for other purposes.
The number of shares of the registrant's common stock outstanding as of
December 31, 2004 was 5,159,722.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for the
registrant's Annual Meeting of Stockholders, scheduled for March 22, 2005, have
been incorporated by reference into Part III of this Annual Report on Form 10-K.
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SBE, INC.
FORM 10-K
TABLE OF CONTENTS
PART I
Item 1 Business 4
Item 2 Properties 19
Item 3 Legal Proceedings 19
Item 4 Submission of Matters to a Vote of Security Holders 19
PART II
Item 5 Market for Registrant's Common Equity
and Related Stockholder Matters 21
Item 6 Selected Financial Data 22
Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations 23
Item 7A Quantitative and Qualitative Disclosures about Market Risk 35
Item 8 Financial Statements and Supplementary Data 36
Item 9 Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 36
Item 9A Controls and Procedures 36
PART III
Item 10 Directors and Executive Officers of the Registrant 37
Item 11 Executive Compensation 37
Item 12 Security Ownership of Certain Beneficial Owners
and Management 37
Item 13 Certain Relationships and Related Transactions 37
Item 15 Exhibits, Financial Statement Schedules
and Reports on Form 8-K 38
SIGNATURES 42
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SPECIAL NOTE ON FORWARD LOOKING STATEMENTS
Certain statements set forth in or incorporated by reference in this Annual
Report on Form 10-K constitute "forward-looking statements" within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. These statements include, without limitation, our
expectations regarding our sales to The Hewlett-Packard Company, our
expectations regarding the market for client server networking products, the
adequacy of anticipated sources of cash, planned capital expenditures, the
effect of interest rate increases, and trends or expectations regarding our
operations. Words such as "may," "will," "should," "believes," "anticipates,"
"expects," "intends," "plans," "estimates" and similar expressions are intended
to identify forward-looking statements, but are not the exclusive means of
identifying such statements. Such statements are based on currently available
operating, financial and competitive information and are subject to various
risks and uncertainties. Readers are cautioned that the forward-looking
statements reflect management's estimates only as of the date hereof, and we
assume no obligation to update these statements, even if new information becomes
available or other events occur in the future. Actual future results, events and
trends may differ materially from those expressed in or implied by such
statements depending on a variety of factors, including, but not limited to
those set forth under "Item 1 - Business -- Risk Factors" on page 15 and
elsewhere in this Form 10-K.
PART I
ITEM 1. BUSINESS
OVERVIEW
SBE, Inc. develops and provides network communications and storage solutions for
original equipment manufacturers ("OEM") in the embedded systems marketplace.
Embedded networking technology is hardware or software that serves as a
component within a larger networking or storage device or system such as a
Gigabit Ethernet or a T-1/T-3 input/output ("I/O") network interface card
("NIC") that plugs into an expansion slot in a high-end computer or storage
system. Embedded networking solutions enable the functionality of many commonly
used devices or equipment, such as products and solutions for basic telephone
and internet services, mobile phones, medical equipment and storage networks.
We deliver a product portfolio comprised of standards-based wide area networking
("WAN"), local area networking ("LAN") and storage area network ("SAN") network
interface and intelligent communications controller cards. All of our products
are coupled with enabling Linux or Solaris software drivers. Our products are
designed to be functionally compatible with each other and, since we use
industry standard form factors and technologies, our products are also
compatible with third party standards-based products. This standard scalability
and modularity offers our customers greater flexibility to develop solutions for
unique product configurations and applications.
Our products are developed based on industry standard form factors including
those known as Peripheral Component Interconnect ("PCI"), CompactPCI,
VersaModule Eurocard ("VME"), PCI Mezzanine Card ("PMC"), and PCI Telecom
Mezzanine Card ("PTMC"). Form factors are the shape and size of interface cards
used to expand the functionality of standard computer bus architectures. For
example, a PCI system includes a 32 or 64-bit local bus architecture used to
transfer data from a computer's main microprocessor to peripherals such as hard
disks and video adapter. CompactPCI is an adaptation of the standard PCI on a
larger rugged design and expands the number of available slots for peripheral
devices from four to eight, improves a computer's ability to withstand adverse
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conditions such as extreme vibration and offers "hot swap" capability - allowing
the user to insert and take out the board without turning off the system. A PMC
card plugs on to a standard PCI, CompactPCI, VME or the new AdvancedTCA ("ACTA")
card enabling it to provide differing input/output or computing functions. A
PTMC is a PMC card designed specifically for telecommunication applications.
Our solutions have been integrated into a wide spectrum of applications to
enable network and storage connectivity, including Voice over Internet Protocol
("VoIP"), Wi-Fi, Enhanced 911, enterprise servers, data storage, data messaging,
process control, media gateways, routers, internet access devices, medical
imaging, CAE/automated test equipment, government/military defense systems and
telecommunications networks. We distribute our products worldwide through a
direct sales force, distributors, independent manufacturers' representatives and
value-added resellers.
SBE was incorporated in 1961 as Linear Systems, Inc. In 1976, we completed our
initial public offering. In July 2000, we acquired LAN Media Corporation
("LMC"), a privately held company, to complement and grow our WAN adapter
product line from both a hardware and software perspective. In August 2003, we
acquired the products and technologies of Antares Microsystems to increase the
functionality of our PCI product line. We continue to operate under a single
business unit.
BUSINESS STRATEGY
Our objective is to be a leading provider of high-performance network
communications solutions by delivering reliable, flexible, cost-efficient
products in a timely manner to our customers, thus allowing them to focus on
their core competencies.
During fiscal 2004, we made noteworthy steps in achieving this objective,
including:
o Making our commitment to existing customers our number one priority
As a proponent of continuous improvement, we are always identifying new ways to
better serve our customers. Over the past year, to ensure that we fulfill our
commitments to our customers, we strengthened our operations team, including the
addition of resources in the manufacturing, technical support and quality
departments. In addition, we have implemented a "WebCall" system on our web site
which allows customers to address technical product issues with us at their
convenience, 24 hours a day. Upon implementation of this system in the third
quarter of 2004, the average time to resolution for technical issues has
improved by 50% from one quarter to the next.
o New Product Introductions
In order to meet the ever-changing requirements of the industry and our
customers, we believe it is important to maintain a strong and flexible
portfolio of products designed for easy and quick deployment into a variety of
unique applications.
- TCP/IP Offload Engine ("TOE"). As Ethernet speeds continue to
increase, a progressively higher load is placed on the CPU to
process the messaging traffic and deal with the interface protocol,
leaving little computing power left for user applications. SBE's TOE
board is designed to offload the interface protocol ("TCP/IP stack")
and manage messaging traffic normally processed by the Central
Processing Unit ("CPU"). This interface protocol offloading
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increases user application performance and alleviates networking
bottlenecks. We expect that demand for TOE will continue to increase
as network bandwidth requirements escalate.
- ISCSI (Internet Small Computer System Interface). A new market is
emerging using Ethernet infrastructure allowing "virtual storage"
flexibility and lower costs. Our Internet Protocol ("IP") management
solution bundles our dual port Gigabit Ethernet TOE board with PyX's
enterprise level, high availability iSCSI software protocol. Fully
compliant with IETF iSCSI standards, this iSCSI solution delivers
multi-path migration and Error Recovery Level Two (ERL2)
functionality. Our iSCSI product ensures that there is no single
point of failure on the storage transport layer between any two
iSCSI nodes while simultaneously offloading the network protocol
processing from the CPU.
- Security Offload Engine. In September 2004, we announced the first
in a growing series of board-level encryption solutions designed to
accelerate SSL and IPsec cryptographic operations. These are the two
most common encryption solutions used to provide electronic security
in use today. Our securePMC-L is a PMC-based security offload engine
using Cavium Networks' NITROX Lite security processor, and designed
to meet the United States federal government's mandated security
FIPS 140-2 Level 3 requirements to be used in all government
security related applications.
- Channelized T3 PMC Adapter. We launched the wanPMC-C1T3 WAN adapter
in the first quarter of fiscal 2004. Designed to enable advanced
voice and data applications, such as VoIP, video-on-demand, voice
conferencing, Internet routing, and SAN pipes, our wanPMC-C1T3
integrates a fully channelized, single port T3 interface with an
HDLC/transparent controller on a PMC slot.
- Channelized 24-port T1/E1: In August 2004, we introduced the
wanPTMC-24TE1, a fully channelized 24-port T1/E1 PCI Telecom
Mezzanine Card (PTMC) and Rear Transition Module (RTM) board set.
This solution is designed for high density applications, such as
VoIP gateways, computer telephony softswitches, TDM switches/PBX,
and voice conferencing systems.
- Linux "On Demand". Recognizing the value to our customers, we
continue developing Linux software drivers for SBE products using
internal resources and those from partnering software companies. In
addition to standard enterprise level drivers, we offer products
with "real-time" enhancements.
o Strategic Alliances and Investments
We are committed to expanding our product offerings by entering into strategic
business agreements where we combine our products with those of our partners to
present a cost-effective, completely integrated solution to our customers.
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o PYX TECHNOLOGIES: PyX provides enterprise level iSCSI software
protocol with Error Recovery Level 2 ("ERL2") functionality, tuned
to operate with our TCP/IP Offload Engine card. ERL2 functionality
is required to provide seamless guaranteed delivery of critical data
whenever storage data is transmitted over the Internet.
o TIMESYS: In a collaborative effort, SBE and TimeSys, a pioneer and
leader in Embedded Linux and Java development technologies, continue
to team to provide the high-performance and modularity of SBE's WAN
modules and HighWire carrier-class core processing platforms bundled
with the scalable computing power of TimeSys Linux GPL and
cross-platform development tools.
o CAVIUM NETWORKS: SBE teamed with Cavium to provide board-level
encryption solutions designed to accelerate SSLand IPsec
cryptographic operations and significantly improve secure data
transmissions for Linux and other applications.
o NCOMM: SBE and NComm formed an alliance to provide comprehensive WAN
solutions coupling our WAN hardware interfaces with NComm's
intelligent top-level software drivers and tools. This joint
solution results in significant cost savings for OEMs and speeds up
time-to-market by 6-12 months.
ATCA PARTNER PROGRAM. This is our program to align our PMC and PTMC
interface products with AdvancedTCA ("ATCA") system providers to provide
powerful telecommunications networking solutions. The ACTA products are
based on a new standard industry form factor that has been developed for
use by the telecommunications industry. This form factor allows for greater
flexibility and network transmission speeds.
o DIVERSIFIED TECHNOLOGIES, INC ("DTI"): DTI is integrating multiple
SBE network interface cards with the Diversified Technologies ATCA
system level platforms to build powerful ATCA platforms for service
providers in the telecommunications and networking marketplace.
o GNP: GNP will complement its product mix by bundling SBE's portfolio
of network interface cards into its ready-to-deploy ATCA and
CompactPCI system solutions for its customer base of network
equipment manufacturers and large systems integrators.
o CONCURRENT TECHNOLOGIES, INC ("CONCURRENT"): SBE and Concurrent have
entered into an agreement to merge our PMC-based modules with
Concurrent's ATCA system solutions. This new alliance is expected to
result in expanded market coverage for our products.
In fiscal 2005, we plan to further build on the momentum that has been generated
over the past two years by turning our technology investments into strong,
customer-driven product solutions, continuing to diversify our customer base,
and actively seeking out new market opportunities. Specifically, our key focus
areas for the upcoming year include:
o Build and Strengthen Awareness of Expanded Product Portfolio and
Capabilities within Target Markets
With the recent release of the TOE, Encryption and iSCSI products, we will
present our customers with an enhanced line of board-level I/O choices. We have
launched an aggressive sales and marketing campaign to develop and enhance
awareness of our portfolio of products and capabilities to target audiences. Our
marketing initiatives include print/online advertising, direct marketing, joint
partner marketing, public relations, industry tradeshow presence, and web
marketing.
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o Broaden Market and Customer Diversification
With the expansion of our products, we intend to further penetrate existing
territories and capture opportunities in new markets and applications. In
addition, we evaluate and reinforce our distribution channels to broaden
coverage both domestically and internationally and allow for a wider set of
application and market targets.
o Continue to Invest in New Products and Technologies
Continued investment in new products and technologies is critical in driving the
long-term growth and success of the business. Areas of technological focus over
the next year include:
o Voice over IP ("VoIP") PTMC Solution. Recognizing the opportunities
in the VoIP marketplace, we are engaged in the conceptual research
and planning for a VoIP media gateway solution. In the coming year,
we plan to aggressively execute on our VoIP strategy which leverages
compatibility with current product offerings.
o Expansion of HighWire Line of Intelligent Communications
Controllers. We are in the process of completing development on the
next generation HighWire CompactPCI controller with Intelligent
Platform Management Interface ("IPMI") to the backplane, Ethernet
switch, and dual PTMC support. As with our currently available
platforms, SBE's future processors will be designed to provide
embedded Linux with the intent to offer complete interoperability
with a broad selection of WAN, LAN, and Storage PMCs.
o ATCA Mezzanine Card ("AMC"). ATCA is a new platform that is gaining
significant momentum in the marketplace. It is touted to offer OEMs
in the telecommunications space many benefits, including new levels
of scalability and performance. Our wide range of PMC/PTMC-based WAN
and LAN I/O boards are available for integration into today's ATCA
deployments. When the AMC specification has been ratified, it will
be a natural progression for us to evolve our PMC and PTMC modules
to AMC.
PRODUCTS
We design and provide network interface cards and communication controllers
serving the embedded markets. With the exception of the TOE products, our
network interface adapters are open standards interface adapter cards that
generally do not have a microprocessor onboard ("state machine products"). They
are designed to provide developers of networking and data communications
equipment a simple and cost effective way to integrate WAN, LAN, SCSI, iSCSI,
and/or Fibre Channel interfaces into their systems. All of our products are
supported by communications software developed by SBE and a select group of
third party partners.
Although SBE continues to sell and manufacture products such as Multibus,
VMEbus, and ISA, we emphasize six principal lines of products: WAN adapters,
LAN/Ethernet adapters, storage network interface cards ("NICs"), intelligent
communications controllers, iSCSI software and custom and specialty I/O and CPU
processing protocol offload products such as TOE and Encryption cards.
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WIDE AREA NETWORKING ADAPTERS
A wide area network is a computer network that spans a relatively large
geographical area. Computers connected to a WAN are often connected through
dedicated networks, such as the telephone system, leased lines or satellites.
Our series of WAN adapter products is designed to address the need for WAN
interfaces in data communication products such as those used in internet and
other communications routers, security firewalls, virtual private network
("VPN") servers and VoIP gateways. We provide a broad range of interfaces,
including synchronous serial, T1/E1, High Speed Serial Interface ("HSSI") and T3
in PCI, PMC, and PTMC industry standard form factors.
LOCAL AREA NETWORKING ADAPTERS
A local area network is a computer network spanning a relatively small
geographical area. Often confined to a single building or group of buildings,
most LANs connect workstations and personal computers. Each computer in the LAN
is able to access data and devices, such as printers, located anywhere on the
LAN. There are many different types of LANs but Ethernet is the most common.
Ethernet LAN connectivity is utilized by virtually every market segment in both
the embedded and enterprise space.
Our LAN adapter products are focused on LAN connectivity using high speed
Ethernet technology. We offer single, dual or quad port LAN adapter PCI and PMC
modules that feature connectivity speeds of up to 10 Mb/second, 100 Mb/second or
1000 Mb/second. Our Gigabit Ethernet NICs include trunking and failover. These
features allow our customers' systems to take advantage of static load balancing
and failure recovery within a user-defined communications trunk. It is designed
to distribute traffic across the aggregated links, detects port failures, and
increases throughput. In the event of a link failure, the software will
automatically redistribute outgoing loads across the remaining links.
STORAGE NETWORK INTERFACE CARDS
Our storage NICs are comprised of SCSI and Fibre Channel products. SCSI is a
parallel interface standard used by personal computers and many UNIX systems for
attaching peripheral devices, such as printers and disk drives, to computers.
SCSI interfaces are designed to allow for faster transmission rates than
standard serial ports, which transfer data one bit at a time, and parallel
ports, which simultaneously transfer data more than one bit at a time. Our
series of SCSI host bus adapters are specifically designed for the enterprise
Sun UNIX market. With transfer rates ranging from 40 Megabyte ("MB")/sec to 320
MB/sec, our SCSI adapters have been utilized in data centers and enterprise
environments within the financial, government, manufacturing, and healthcare
sectors. These SCSI boards are also utilized in UNIX-based SCSI tape backup
systems.
Fibre Channel is a serial data transfer architecture developed by a consortium
of computer and mass storage device manufacturers and is now being standardized
by the American National Standards Institute ("ANSI"). Our Fibre Channel host
bus adapters are available in single or dual port, 1-Gigabit or 2-Gigabit
versions with copper and/or optical Gigabit transceivers.
iSCSI STORAGE MANAGEMENT SOLUTIONS
iSCSI is an Internet Protocol based storage networking standard for linking data
storage facilities which was developed by the Internet Engineering Task Force
(IETF). By carrying SCSI commands over IP networks, iSCSI is used to facilitate
data transfers over LAN intranets and to manage storage over long distances
(internet). The iSCSI protocol is among the key technologies expected to help
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further the rapid development of the SAN market space by dramatically increasing
the capabilities and performance of storage data transmission at a fraction of
the cost of current SANs. Because of the ubiquity of IP networks, iSCSI can be
used to transmit data over LANs, WANs, or the Internet and can enable location
independent data storage and retrieval.
Our iSCSI storage management solution bundles SBE's dual port Gigabit Ethernet
TOE board with PyX Technologies' enterprise level, high availability, uniform
iSCSI software protocol. Fully compliant with IETF iSCSI standards, this iSCSI
product delivers multi-path migration and ERL2 functionality. The SBE/PyX
solution uses active/active trunking providing seamless connectivity migration
which supports uninterrupted data flow and aggregation of bandwidth. This means
that requests from a failed communication path can be automatically re-assigned
to active communication paths, allowing iSCSI data to continue to flow
uninterrupted. As a result, the solution ensures that there is no single point
of failure on the storage transport layer between any two iSCSI nodes while
simultaneously offloading the network protocol processing from the CPU.
CPU OFFLOAD ENGINES
o TCP/IP OFFLOAD ENGINE
Today's modern networks incorporate packet communications for a wide
variety of applications linking WANs, LANs, and SANs. TCP/IP is the common
thread throughout and the de-facto packet standard that was developed for
the internet. Ironically, TCP/IP has also become the major bottleneck in
high speed networks.
A TOE is a highly specialized TCP/IP protocol accelerator. Typically, in
the form of a NIC, it is designed to reduce the amount of host CPU cycles
required for TCP/IP processing and maximize Ethernet throughput. This is
accomplished by offloading TCP/IP protocol processing from the host
processor to the hardware on the TOE.
Our dual port Gigabit Ethernet controller with full TCP/IP offload
capabilities for maximizing the performance of demanding TCP-based
applications is designed to reduce the amount of CPU cycles required for
TCP/IP processing while optimizing the Ethernet throughput. Our TOE
solution processes TCP/IP at network speeds, provides full segmentation
and reassembly, terminates multiple simultaneous sessions, and minimizes
transaction latency - all without host intervention.
o SECURITY OFFLOAD ENGINE
The rapid changes of the information age have put increasing security
demands on enterprise networks, such as VPNs, portals and corporate web
sites over the last few years. With the expansion of network boundaries
come the inevitable need for effective solutions to secure these
enterprise connections. In September 2004, we introduced the first in a
growing series of security offload solutions for integration into
Linux-based systems. Based on Cavium Networks' Nitrox Lite, our new
encryption board is designed to accelerate SSL, WLAN and IPsec
cryptographic operations and significantly improve security, performance,
and availability of Linux and other embedded applications.
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INTELLIGENT COMMUNICATIONS CONTROLLERS
The HighWire products are "intelligent," containing their own microprocessors
and memory. This architecture allows our communications controllers to offload
many of the lower-level communications tasks that would typically be performed
by the host platform.
In the telecommunications market, the HighWire series of communications
controller products provide high bandwidth intelligent connectivity to servers
designed to act as gateways and signaling points within communication networks
and network devices. The HighWire co-processing controllers enable operators of
wireline and wireless networks to deliver Intelligent Network ("IN") and
Advanced Intelligent Network ("AIN") services such as Caller ID, voice
messaging, personal number calling, Service Provider Local Number Portability,
and customized routing and billing, as well as digital wireless services such as
Personal Communications Systems ("PCS") and Global System for Mobile
Telecommunications ("GSM"). The HighWire products are designed for integration
with standard server platforms that enable traditional carriers and new telecom
entrants to pursue cost-reduced and performance-enhanced network architectures
based on Internet Protocol ("IP"), broadband or other "packet" technologies.
We offer embedded Linux operating system software that enables several HighWire
products to be combined with any of our WAN and LAN PMC products or other third
party PMC form factor products to provide core computing and connectivity
solutions to the communications, military/government, medical and industrial
control markets. Utilizing our HighWire products in conjunction with other
available PMC modules, such as A-to-D converters or video capture PMC modules,
opens up new opportunities to market the products for factory/process control or
video surveillance applications.
VMEBUS
Our line of legacy VMEbus products continues to be sold to government, military
and industrial customers. Our VME products are intelligent communications
controllers used to provide connectivity between a system such as a
mini-computer or bridge/router and a local or wide area network. Our VMEbus
communications products target four major protocol communications technologies:
Fiber Distributed Data Interface ("FDDI"), Token Ring, Ethernet and high-speed
serial communications.
The following table shows sales by major product type as a percentage of net
sales for fiscal 2004, 2003 and 2002:
Year Ended October 31,
2004 2003 2002
------------------------------------------------
(percentage of net sales)
VME 43% 53% 56%
WAN Adapter 34 30 31
LAN Adapter 8 5 0
Storage NIC 4 2 0
HighWire 11 10 13
------------------------------------------------
100% 100% 100%
================================================
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DISTRIBUTION, SALES, AND MARKETING
We market our WAN, LAN, storage, intelligent communication controller, specialty
I/O and protocol processing offload products to OEMs, distributors and systems
integrators. We sell our products both domestically and internationally, using a
direct sales force as well as independent manufacturers' representatives,
resellers, and distributors. We believe that our direct sales force is well
suited to communicate and promote our products and how they differentiate from
those of our competitors. Since our products represent a complex and technical
sale, our sales force is supported by application engineers who provide
customers with pre-sale technical assistance.
Our internal sales and marketing organization supports our channel marketing
partners by providing sales collateral, such as product data sheets,
presentations, and other sales/marketing resource tools. Our sales staff
solicits prospective customers, provides technical advice with respect to our
products, and works closely with marketing partners to train and educate their
staffs on how to sell, install, and support our product lines.
We have focused our sales and marketing efforts in North America, Europe and
Asia. All of our international sales are negotiated in U.S. dollars.
International sales constituted 12%, 12% and 13% of net sales in fiscal 2004,
2003 and 2002, respectively. International sales are executed in U.S. dollars
and are principally transacted in Europe.
Our direct sales force is based in three locations in the United States and we
conduct our marketing activities from our principal office in San Ramon,
California.
RESEARCH AND DEVELOPMENT
We believe that continued research and development in current and emerging
technologies is critical to maintaining our competitive position in the embedded
and enterprise markets. Many factors are involved in determining the strategic
direction of our product development focus, including trends and developments in
the marketplace, competitive analyses, and feedback from our customers and
strategic partners. We actively support and contribute to standards development
organizations and trade groups, which define and promote existing and emerging
technologies for both the embedded and enterprise arenas. We belong to several
influential industry associations, including VME International Trade Association
("VITA") and PCI Industrial Computers Manufacturers Group ("PICMG").
Our product development efforts are focused principally on our strategic product
lines, providing high bandwidth connectivity and computing solutions that serve
a wide range of networking applications. Leveraging our experience in high-speed
data communications and telecommunications enables us to develop integrated
communications solutions for our customers. We believe that the development of
new internetworking products, high-performance communications controllers and
enabling communications software is essential to expanding our customer base,
penetrating new markets, and retaining existing customers.
During the past four years, we have developed communications products based on
PCI, CompactPCI, PMC, PTMC, and HyperTransport architectures. We have also
redesigned and upgraded certain communications products to take advantage of new
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technologies offering improved product performance and lower costs. In addition,
we have acquired or licensed certain hardware products that have been integrated
principally through the addition of software into our product line.
During fiscal 2004, we continued to focus on further expansion of our line of
standards-based WAN adapters, upgrading/enhancing software drivers, developing
new products based on emerging technologies, such as TCP/IP Offload, Encryption,
and iSCSI. These hardware and software design efforts have enabled us to more
effectively target existing and emerging markets in areas such as VoIP, VPN,
security routers, telecommunications, military/government, medical and
industrial control
During fiscal 2004, 2003 and 2002, we incurred $2.4 million, $1.3 million and
$3.0 million, respectively, in product research and development expenses.
COMMITMENT TO QUALITY
We have been an ISO certified supplier of communications products since 1991. In
December 2001, we achieved certification to the internationally recognized
ISO9001: 2000 Standard. As part of our ongoing commitment to quality, we are
regularly inspected by an audit team from Bureau Veritas Quality International
(NA) Inc. ("BVQI"). These audits ensure that our internal quality system meets
internationally recognized quality management systems standards. We believe that
our customers' success depends on the delivery of high-quality products and
services. Our adherence to ISO standards and resulting quality practices is our
way of guaranteeing that customer expectations are met and exceeded.
MANUFACTURING
We do not engage in any manufacturing activities. Instead, we utilize third
party manufacturers to build our products. We currently have non-exclusive
manufacturing agreements with ProWorks, Inc. and Sonic Manufacturing Technology.
We believe that ProWorks and Sonic are equipped to provide more cost-efficient
and timely product delivery than could otherwise be obtained if we manufactured
our product internally. The use of external manufacturing partners allows us to
better respond to fluctuations in customer demand.
COMPETITION
The market for networking and communications interface products is highly
competitive. Many of our competitors have greater financial resources and are
well established in the space. Competition within the communications market is
fragmented principally by application segment. Our HighWire products compete
with offerings from Radisys Corp, Performance Technologies, Interphase Corp,
Artesyn Technologies, and Adax, along with various other platform and controller
product providers. Our VMEbus, WAN adapter and LAN adapter products compete
primarily with products from Performance Technologies, Motorola, Interphase
Corp., Themis Computers, SBS Technologies and various other companies on a
product-by-product basis. Our SCSI products compete with LSI Logic, Adaptec,
Qlogic and Sun Microsystems. Our Fibre Channel products compete with products
from QLogic Corp and Emulex Corp. Our TOE products compete with QLogic and
-13-
Adaptec. Our encryption solutions compete with Extreme Engineering, Layer N
Networks, and InterfaceMasters. To compete and differentiate ourselves in our
markets, we emphasize the functionality, engineering support, quality and price
of our product in relation to our competitors, as well as our ability to
customize the product to meet the customer's specific application needs.
Additionally, we compete with the internal engineering resources of our
customers. As our customers become successful with their products, they examine
methods to reduce costs and integrate functions. To compete with the internal
engineering resources of our customers, we work jointly with their engineering
staffs to understand each customer's specific system requirements and to
anticipate new product needs versus time-to-market decisions.
INTELLECTUAL PROPERTY
We believe that our ability to innovate in product engineering, sales,
marketing, support, and customer relations, and then to protect this proprietary
technology and knowledge impacts our future success. We rely on a combination of
copyright, trademark, trade secret laws and contractual provisions to establish
and protect our proprietary rights in our products. We currently hold four
patents. We typically enter into confidentiality agreements with our employees,
strategic partners, channel partners and suppliers, and enforce strict
limitations and the access to our proprietary information.
BACKLOG
On October 31, 2004, we had a sales backlog of product orders of approximately
$2.5 million, including $1.0 million in orders from HP, compared to a sales
backlog of product orders of approximately $4.1 million, including $2.0 million
in orders from HP, one year ago. Because customer purchase orders are subject to
changes in customer delivery schedules, cancellation, or price changes, our
backlog as of any particular date may not be representative of actual sales for
any succeeding fiscal period. We do not anticipate any problems in filling our
current backlog.
EMPLOYEES
On December 31, 2004, we had 36 employees. None of our employees is represented
by a labor union. We have experienced no work stoppages. We believe our employee
relations are positive.
We believe that our future success will depend, in part, on our ability to
attract and retain qualified technical (particularly engineering), marketing and
management personnel. Such experienced personnel are in great demand, and we
must compete for their services with other firms, many of which have greater
financial resources.
-14-
RISK FACTORS
Our business is subject to, but not limited to, the risks and uncertainties
described below.
RISKS RELATED TO OUR BUSINESS
WE DEPEND UPON A SMALL NUMBER OF OEM CUSTOMERS. THE LOSS OF ANY OF THESE
CUSTOMERS, OR THEIR FAILURE TO SELL THEIR PRODUCTS, WOULD LIMIT OUR ABILITY TO
GENERATE REVENUES.
In fiscal 2004, most of our sales were derived from a limited number of OEM
customers. In fiscal 2004, 2003 and 2002, sales of VME products to The
Hewlett-Packard Company (previously Compaq Computer) ("HP") accounted for 45%,
45% and 30%, 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 will ship the remaining $1.0
million of the last order for VME products to HP in the first fiscal quarter of
fiscal 2005. 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.
Orders by our OEM customers are affected by factors such as new product
introductions, product life cycles, inventory levels, manufacturing strategies,
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. In addition, we anticipate a significant
portion of future sales will be dependent on a few new OEM customers, and there
can be no assurance that we will become a qualified supplier with new OEM
customers or that we will remain a qualified supplier with existing OEM
customers.
THE COMMUNICATIONS AND STORAGE PRODUCTS MARKET IS INTENSELY COMPETITIVE, AND OUR
FAILURE TO COMPETE EFFECTIVELY COULD REDUCE OUR REVENUES AND MARGINS.
We compete directly with traditional vendors of terminal servers, modems, remote
control software, terminal emulation software and application-specific
communications and storage solutions. We also compete with suppliers of routers,
hubs, network interface cards and other data communications and storage
products. In the future, we expect competition from companies offering
client/server access solutions based on emerging technologies such as switched
digital telephone services, iSCSI, SCSI, TOE and other technologies. In
addition, we may encounter increased competition from operating system and
network operating system vendors to the extent such vendors include full
communications and storage 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
-15-
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.
WE HAVE INCURRED OPERATING LOSSES IN THE PAST AND MAY NOT BE PROFITABLE IN THE
FUTURE.
The consolidated financial statements contemplate the realization of assets and
the satisfaction of liabilities in the normal course of business. Although we
had a net loss of $1.7 million for fiscal 2004, we did have net income of
$563,000 for fiscal 2003 and had eight consecutive profitable quarters prior to
the loss in our fourth quarter of fiscal 2004. We generated negative cash flows
from operations of $140,000, $84,000 and $2.7 million for fiscal 2004, 2003 and
2002, respectively We believe our existing cash plus additional cash from our
line of credit and continuing operations will provide sufficient cash flows to
fund our operations through October 31, 2005. However, these our cash flows from
future operations is dependent on 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. In addition, we must
successfully sell and distribute for our new TOE and iSCSI products. If the
projected sales do not materialize, we will need to reduce expenses further and
potentially 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 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 timing of significant orders from
OEM customers, fluctuating market demand for, and declines in the 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 revenue 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, our
OEM telecommunications customers may hold excess inventory of our products. A
result of the economic downturn and slowness in recovery of the
telecommunications market 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.
-16-
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 revenue 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 VoIP"), 3G Wireless ("Third
Generation Wireless Services") SATA ("Serial ATA"), SAS (Serial Attached SCSI")
iSCSI , Gigabit Ethernet, 10 Gigabit Ethernet and TOE. 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 have focused a significant portion of our research and development, marketing
and sales efforts on HighWire, WAN and LAN adapters, Encryption, iSCSI and TOE
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 TOE, iSCSI, 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.
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 employee 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
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 or in the case of the TOE products from LeWiz Communications, Inc.. 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
-17-
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 OR USE OUR
EXISTING CREDIT LINE WITH A BANK.
The engineering development and marketing of our products is capital-intensive.
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. Declines in our sales or a
failure to keep expenses in line with revenues could require us to seek
additional financing or force us to draw down on our existing line of credit
with a Bank in fiscal 2005. Due to the net loss in our fourth quarter of fiscal
2004, we are not in compliance with our Bank line of credit debt covenants and
may not be able to use that credit line unless the Bank agrees to waive the
covenant violation. 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. There can be no assurance that additional financing, if
required, will be available on reasonable terms or at all. To the extent that
additional capital is raised through the sale of additional equity or
convertible debt securities, the issuance of such securities could result in
additional dilution to our stockholders.
WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WHICH COULD REDUCE ANY
COMPETITIVE ADVANTAGE WE HAVE.
Since 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 currently hold two patents and two patent
applications, and also rely on a combination of copyright, trademark, trade
secret laws and contractual provisions to establish and protect proprietary
rights of 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 IS 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
price of $1.00 and minimum stockholders' equity of $2.5 million. Our
stockholders' equity as of October 31, 2004 was $4.3 million. The closing bid
price for our common stock has been below $1.00 for short periods of time in the
past. If the closing bid price of our common stock is below $1.00 for a period
of 30 consecutive trading days, our common stock could be subject to 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
-18-
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.
ITEM 2. PROPERTIES
In December 2001, we relocated our engineering and administrative headquarters
to 15,000 square feet of leased space located in San Ramon, California. The
lease expires in 2006. We expect the facility to satisfy our anticipated needs
for the foreseeable future. In conjunction with the relocation to the new
building, we assigned the lease related to our former 63,000 square foot
engineering and administrative headquarters to a third party. The third party
has assumed payment of the remaining lease payments through the termination of
the original lease term in 2006 and we are a secondary guarantor.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any pending legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of our stockholders in the fourth
quarter of 2004.
-19-
IDENTIFICATION OF EXECUTIVE OFFICERS
Our executive officers and their respective ages and positions as of October 31,
2004 are set forth in the following table. Our Board of Directors accepted the
retirement of Mr. William Heye, Jr. as President and Chief Executive Officer
effective December 31, 2004 and appointed Mr. Dan Grey as his replacement
effective January 1, 2005. Mr. Grey will continue to serve as the Senior vice
President, Sales and Marketing. Executive officers serve at the discretion of
the board of directors. There are no familial relationships between our
directors or our executive officers and any other director or executive officer.
Name Age Position
- --------------------------------------------------------------------------------
William B. Heye, Jr. 66 President and Chief Executive Officer
David W. Brunton 54 Vice President, Finance, Chief Financial
Officer, Treasurer and Secretary
Dan Grey 49 Senior Vice President, Sales and Marketing
Carl Munio 54 Vice President, Engineering
Kirk Anderson 45 Vice President, Operations
Yee-Ling Chin 29 Vice President, Marketing
Mr. Heye joined us in November 1991 as President, Chief Executive Officer and
member of the Board of Directors. Mr. Heye will retire from active management
effective December 31, 2004. From 1989 to November 1991, he served as Executive
Vice President of Ampex Corporation, a manufacturer of high-performance scanning
recording systems, and President of Ampex Video Systems Corporation, a
wholly-owned subsidiary of Ampex Corporation and a manufacturer of professional
video recorders and editing systems for the television industry. From 1986 to
1989, Mr. Heye served as Executive Vice President of Airborn, Inc., a
manufacturer of components for the aerospace and military markets. Prior to
1986, Mr. Heye served in various senior management positions at Texas
Instruments, Inc. in the United States and overseas, including Vice President
and General Manager of Consumer Products and President of Texas Instruments
Asia, Ltd., with headquarters in Tokyo, Japan.
Mr. Brunton joined us in November 2001 as Vice President, Finance, Chief
Financial Officer, Secretary and Treasurer. From 2000 to 2001 he was the Chief
Financial Officer for NetStream, Inc., a telephony broadband network service
provider. From 1997 to 2000, Mr. Brunton was the Chief Financial Officer and
Senior Vice President - Operations for ReSourcePhoenix.com, a financial services
outsource provider. From 1987 to 1997, Mr. Brunton was the Corporate Controller
for the Phoenix American Companies, an equipment leasing, cable TV,
telecommunications and software development company. Mr. Brunton is a certified
public accountant who prior to 1987 was with Arthur Andersen & Co.
Mr. Grey has served as Senior Vice President Sales and Marketing since May 2001.
For the 18 months prior to SBE, he was the Senior Vice President of Sales for
SBS Technologies. From 1999 to 2000, Mr. Grey was Vice President of Sales for
-20-
LAN Media Corporation, a company later acquired by SBE. Mr. Grey was the Western
Regional Sales Manager from 1996 to 1999 for Performance Technologies, Inc. From
1989 to 1996, Mr. Grey served as the Director of Western Sales for SBE. Mr. Grey
will assume the additional positions of President and Chief Executive Officer
effective January 1, 2005.
Mr. Munio joined SBE in August 2003 following SBE's acquisition of Antares
Microsystems. From 1996 to August 2003, Mr. Munio served as CTO for Antares,
where he drove product developments in emerging and existing technologies. Prior
to joining Antares, he was Director of Operations Product Engineering at Sun
Microsystems for over 11 years, and served in a variety of management positions
during a 12-year tenure at Hewlett-Packard.
Mr. Anderson has served as Vice President, Operations since October 2001. He
joined us as Manager of Operations in 1997 and was promoted to Director,
Operations in 1999. Prior to joining us Mr. Anderson was the Manager, Marketing
Logistics for Wesley Jessen from 1994 to 1997 where he was responsible for
logistical planning and manufacturing budgeting and control. Prior to 1994 he
held various management positions in operations, finance and marketing for
several high-tech companies in Silicon Valley, including Vitalink
Communications, a pioneer in internetworking products.
Ms. Chin joined us in July 2003 as Vice President, Marketing. From 1998 to 2003,
she served as Director of Marketing Communications for SBS Technologies.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
Our common stock is quoted on the Nasdaq SmallCap Market under the symbol SBEI.
The following table presents quarterly information on the price range of our
common stock, indicating the high and low bid prices reported by the Nasdaq
SmallCap Market. These prices do not include retail markups, markdowns or
commissions. As of December 31, 2004, there were approximately 394 holders of
record of our common stock.
There are no restrictions on our ability to pay dividends; however, it is
currently the intention of our Board of Directors to retain all earnings, if
any, for use in our business and we do not anticipate paying cash dividends in
the foreseeable future. Any future determination as to the payment of dividends
will depend, among other factors, upon our earnings, capital requirements,
operating results and financial condition.
Fiscal quarter ended
---------------------------------------------------------
Fiscal 2004 January 31 April 30 July 31 October 31
- -----------------------------------------------------------------------------
High $8.49 $7.34 $4.08 $3.19
Low 4.76 3.90 2.81 2.68
Fiscal 2003
High $1.26 $0.95 $2.99 $6.00
Low 0.56 0.64 0.77 2.42
-21-
The following table includes information regarding our equity incentive plans as
of the end of fiscal 2004.
Equity Compensation Plan Information
Number of securities
remaining available for
Number of securities to Weighted-average exercise future issuance under
be issued upon exercise price of outstanding equity compensation plans
of outstanding options, options, warrants (excluding securities
Plan category warrants and rights and rights reflected in column (a))
- ------------- ------------------- ---------- ------------------------
(a) (b) (c)
Equity compensation plans
approved by security
holders 1,319,666 $3.75 1,091,266
Equity compensation plans
not approved by security
holders 617,453 $2.53 26,250
---------- ----- ----------
Total 1,937,119 $3.36 1,117,516
---------- ----- ----------
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and the Notes thereto
included elsewhere in this Form 10-K.
For years ended October 31,
and at October 31 2004 2003 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------
(in thousands, except for per share amounts and number of employees)
Net sales $11,066 $ 7,456 $ 6,898 $ 7,726 $ 29,178
Net income (loss) $(1,679) $ 563 $ (1,731) $(9,896) $ 3,970
Net income (loss) per share - basic $( 0.33) $ 0.13 $ (0.46) $ (2.92) $ 1.24
Net income (loss) per share - diluted $ 1.04 $ (0.33) $ 0.12 $ (0.46) $ (2.92)
Product research and development $ 2,411 $ 1,330 $ 3,027 $ 5,652 $ 5,635
Expenses
Working capital $ 3,970 $ 3,945 $ 2,985 $ 7,595 $ 11,793
Total assets $ 6,173 $ 6,975 $ 5,321 $10,690 $ 17,427
Long-term liabilities $ 139 $ 217 $ 10 $ 4,870 $ 288
Stockholders' equity $ 4,303 $ 5,387 $ 3,696 $ 4,119 $ 13,829
Number of employees 36 32 24 47 87
-22-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SBE, Inc. architects and provides network communications and storage solutions
to the original equipment manufacturers ("OEM") in the embedded computing and
storage markets. Our solutions enable data communications, telecommunications
and storage solution companies in addition to enterprise class high-end server
clients to rapidly deliver advanced networking and storage products and
services. Our products include wide area network ("WAN"), local area network
("LAN"), Internet Small Computer System Interface ("iSCSI") software, SCSI,
Fibre Channel, intelligent carrier cards, Encryption and TCP/IP Offload Engine
("TOE") cards. These products perform critical computing, processing offload,
Input/Output ("I/O") and storage tasks across both the enterprise server and
embedded markets such as high-end enterprise level servers, Linux super
computing clusters, workstations, media gateways, routers, internet access
devices, home location registers, data messaging applications, network attached
storage ("NAS") and remote storage devices and networks. Our products are
distributed worldwide through a direct sales force, distributors, independent
manufacturers' representatives and value-added resellers. Our business falls
primarily within one industry segment.
Our business is characterized by a concentration of sales to a small number of
OEMs and distributors who provide products and services to the datacom and
telecommunications markets in addition to OEM's and system integrators in the
storage and high-end server markets. Consequently, the timing of significant
orders from major customers and their product cycles cause fluctuation in our
operating results. The Hewlett Packard Company ("HP") is the largest of our
customers and represented 45%, 45% and 30% of net sales in fiscal 2004, 2003 and
2002, respectively. We will ship the remaining $1.0 million of the last order
for VME products to HP in the first fiscal quarter of fiscal 2005. We do not
expect to receive any future purchase orders from HP for our VME products. If
any of our major customers reduces orders for our products, we could lose
revenues and suffer damage to our business reputation. Orders by our OEM
customers are affected by factors such as new product introductions, product
life cycles, inventory levels, manufacturing strategy, contract awards,
competitive conditions and general economic conditions.
During fiscal 2004, we introduced new TOE, iSCSI, Encryption, WAN, and LAN
products that are targeted at large growing enterprise markets such as super
computing clusters, network storage clusters, VPN, security and other
communications devices. Our HighWire products have been focused primarily on the
telecommunications market and the communications activities that are driven by
the convergence of traditional telephony applications with the Internet with
applications like VoIP. While we believe the market for our TOE, iSCSI,
Encryption, HighWire, Adapter and Storage NIC's and software product families is
large, there can be no assurance that we will be able to succeed in penetrating
these markets and diversifying our sales.
Since the fourth quarter of fiscal 2001 we have 24 new design wins, including
two in fiscal 2004, 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 the basis for future sales growth. 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
-23-
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.
On October 31, 2004, we had a sales backlog of product orders of approximately
$2.5 million compared to a sales backlog of product orders of approximately $4.1
million one year ago. Included in these backlogs are orders from HP of $1.0
million and $2.0 million, respectively.
The market environment for our products is extremely competitive and we have
limited visibility into customer activity. In spite of this uncertain market, we
have been successful in increasing our adapter revenues 53% and revenues from
our HighWire products 77% during fiscal 2004. 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 that will be left after we process our final shipment of VME
products to HP in the first quarter of fiscal 2005.
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
revenues 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:
Our policy is to recognize revenue for product sales upon shipment of our
products to our customers provided that no significant obligation remains and
collection of the receivable is considered probable. Shipping terms are
generally FOB shipping point.. We defer and recognize service revenue over the
contractual period or as services are rendered. We estimate expected sales
returns and record the amount as a reduction of revenue and cost of goods
("COGS") at the time of shipment. Our policy complies with the guidance provided
by Staff Accounting Bulletin No. 104, Revenue Recognition in Financial
Statements, issued by the Securities and Exchange Commission. Judgments are
required in evaluating the credit worthiness of our customers. Credit is not
extended to customers and revenue is not recognized until we have determined
that collectibility is reasonably assured. Our sales transactions are
denominated in U.S. dollars. The software component of our products is
considered incidental to our products. We, therefore do not recognize software
revenue separately from the product sale.
Our agreements with OEMs, such as HP and Nortel Networks Corp, typically
incorporate clauses reflecting the following understandings:
-24-
- all prices are fixed and determinable at the time of sale;
- title and risk of loss pass at the time of shipment (FOB shipping
point);
- collectibility of the sales price 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 will 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 assist in the resale of the product by the OEMs; and
- there is no contractual right of return other than for defective
products.
Our agreements with our distributors include certain product rotation and price
protection rights. All distributors have the right to rotate slow moving
products once each fiscal quarter. The maximum dollar value of inventory
eligible for rotation is equal to twenty-five percent of our products purchased
by the distributor during the previous quarter. In order to take advantage of
their product rotation rights, the distributors must order and take delivery of
additional SBE products equal to at least the dollar value of the products that
they want to rotate.
Each distributor is also allowed certain price protection rights. If and when we
reduce or plan to reduce the price of any of our products and the distributor is
holding any of the affected products in inventory, we will credit the
distributor the difference in price when it places its next order with us. We
record an allowance for price protection reducing our net sales and accounts
receivable. The allowance is based on the price difference of the inventory held
by our stocking distributors at the time we expect to reduce selling prices.
Reserves for the right of return and restocking are established based on the
requirements of SFAS 48, Revenue Recognition when Right of Return Exists because
we have visibility into our distributor's inventory and have sufficient history
to estimate returns.
During the year ended October 31, 2004 and 2003, $873,000, or 8% of sales and
$191,000 or 3% of our sales were sold to distributors, respectively.
Allowance for Doubtful Accounts:
Our policy is to maintain allowances for estimated losses resulting from the
inability of our customers to make required payments. Credit limits are
established through a process of reviewing the financial history and stability
of each customer. Where appropriate, we obtain credit rating reports and
financial statements of the customer when determining or modifying their credit
limits. We regularly evaluate the collectibility of our trade receivable
balances based on a combination of factors. When a customer's account balance
becomes past due, we initiate dialogue with the customer to determine the cause.
If it is determined that the customer will be unable to meet its financial
obligation to us, such as in the case of a bankruptcy filing, deterioration in
the customer's operating results or financial position or other material events
impacting its business, we record a specific allowance to reduce the related
receivable to the amount we expect to recover.
We also record an allowance for all customers based on certain other factors
including the length of time the receivables are past due and historical
collection experience with customers. We believe our reported allowances are
adequate. If the financial conditions of those customers were to deteriorate,
however, resulting in their inability to make payments, we may need to record
additional allowances which would result in additional general and
-25-
administrative expenses being recorded for the period in which such
determination was made.
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.
Because 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. 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:
We are exposed to a number of economic and industry factors that could result in
portions of our inventory becoming either obsolete or in excess of anticipated
usage, or subject to lower of cost or market issues. These factors include, but
are not limited to, technological changes in our markets, our ability to meet
changing customer requirements, competitive pressures in products and prices,
and the availability of key components from our suppliers. Our policy is to
establish inventory reserves when conditions exist that suggest that our
inventory may be in excess of anticipated demand or is obsolete based upon our
assumptions about future demand for our products and market conditions. We
regularly evaluate our ability to realize the value of our inventory based on a
combination of factors including the following: historical usage rates,
forecasted sales or usage, product end-of-life dates, estimated current and
future market values and new product introductions. Purchasing practices and
alternative usage avenues are explored within these processes to mitigate
inventory exposure. When recorded, our reserves are intended to reduce the
carrying value of our inventory to its net realizable value. If actual demand
for our products deteriorates, or market conditions are less favorable than
those that we project, additional inventory reserves may be required. In the
fourth quarter of 2004, we reviewed our inventory balances and increased our
reserves on specific products by $547,000.
Inventories are stated at the lower of cost, using the first-in, first-out
method, or market value.
Acquisitions:
All business acquisitions have been accounted for using the purchase method of
accounting and, accordingly, the statements of income include the results of
each acquired business since the date of acquisition. The assets acquired and
liabilities assumed are recorded at estimates of fair values as determined by
management based on information available. Management considers a number of
factors, including third-party valuations or appraisals, when making these
determinations. We finalize the allocation of purchase price to the fair value
of the assets acquired and liabilities assumed when we obtain information
sufficient to complete the allocation, but in any case, within one year after
acquisition. Our acquisition of Antares in fiscal year ended October 31, 2003
resulted in intangible assets of approximately $1.2 million. These assets were
fully written off in the current year.
-26-
Intangible Assets:
We adopted the Financial Accounting Standards Board ("FASB") Statements of
Financial Accounting Standards ("SFAS") No. 141, Business Combinations and SFAS
No. 142, Goodwill and Other Intangible Assets on accounting for business
combinations and goodwill as of the beginning of fiscal year 2002. Accordingly,
we do not amortize goodwill from acquisitions, but continue to amortize other
acquisition-related intangibles and costs. All of the intangible assets that we
currently own are intellectual property acquired in the Antares acquisition.
For identifiable intangible assets, we amortize the cost over the estimated
useful life and assess any impairment by estimating the future cash flow from
the associated asset in accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. If the estimated undiscounted cash
flow related to these assets decreases in the future or the useful life is
shorter than originally estimated, we may incur charges for impairment of these
assets. The impairment is based on the estimated discounted cash flow associated
with the asset. An impairment could result if the underlying technology fails to
gain market acceptance, we fail to deliver new products related to these
technology assets, the products fail to gain expected market acceptance or if
market conditions are unfavorable.
Intellectual property costs consist of the allocation of costs associated with
the purchase of current and the design of future products from Antares
Microsystems on August 7, 2003. As required by these rules, we perform an
impairment review annually, or earlier if indicators of potential impairment
exist. The impairment analysis requires significant judgment to identify events
or circumstances that would likely have a significant adverse effect on the fair
value of the intangible asset. Our annual impairment review was completed during
the fourth quarter of fiscal 2004, and we determined that there was considerable
doubt that the remaining unamortized balance of $713,000 of the intangible asset
at October 31, 2004 would be recoverable. The indicators we used to identify
those events and circumstances included: revenue and earnings trends relative to
predefined milestones and overall business prospects; the technological
feasibility of the Antares products; and technologies and the general market
conditions in the market for SUN Microsystems compatible products with which
Antares products compete. Our impairment review was based on a discounted cash
flow approach that uses estimates of future market share and revenues and costs
for the Antares products as well as appropriate discount rates. The estimates
used are consistent with the plans and estimates that we use to manage the
underlying business. We determined that the estimated fair market value of the
balance of the intangible asset related to the Antares acquisition was nominal
and as a result, we recorded an impairment charge of $713,000, during the fourth
fiscal quarter ended October 31, 2004, thus writing off the remaining value of
the intellectual property asset.
The non-cash expense related to the amortization and write-down of the
intellectual property in fiscal 2004 was $1.1 million and consists of $408,000
of regularly scheduled annual amortization expense plus $713,000 write down
related to the impairment valuation analysis. This write-down plus the regularly
scheduled amortization is included in our cost of goods sold. The amortization
expense for the one quarter that we owned Antares in fiscal 2003 was
approximately $102,000.
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Deferred Taxes:
We record a valuation allowance to reduce our deferred taxes to the amount that
is more likely than not to be realized. Based on the uncertainty of future
pre-tax income, we have fully reserved our deferred tax assets as of October 31,
2004. In the event we were to determine that we would be able to realize our
deferred tax assets in the future, an adjustment to the deferred tax asset would
increase income in the period such determination was made.
New Accounting Pronouncements:
In December 2004, the FASB issued SFAS No. 123R that amends SFAS No. 123
Accounting for Stock-Based Compensation, to require public entities (other than
those filing as small business issuers) to report stock-based employee
compensation in their financial statements. Unless modified, we will be required
to comply with the provisions of SFAS No. 123R as of the first interim period
that begins after June 15, 2005 (August 1, 2005 for us). We currently do not
record compensation expense related to our stock-based employee compensation
plans in our financial statements.
RESULTS OF OPERATIONS
The following table sets forth, as a percentage of net sales, certain
consolidated statements of operations data for the fiscal years ended October
31, 2004, 2003 and 2002. These operating results are not necessarily indicative
of our operating results for any future period.
YEAR ENDED OCTOBER 31,
---------------------------------
2004 2003 2002
----- ----- ------
Net sales 100% 100% 100%
Cost of sales 60 37 46
----- ----- ------
Gross profit 40 63 54
Operating expenses:
Product research and development 22 18 44
Sales and marketing 19 20 31
General and administrative 16 23 34
Loan reserve (benefit) (2) (3) 7
Restructuring costs (benefit) -- (2) 6
----- ----- ------
Total operating expenses 55 56 (122)
----- ----- ------
Operating income (loss) (15) 7 (68)
Forfeited deposit, net -- -- 39
Interest and other income -- -- 2
----- ------ ------
Income (loss) before income taxes (15) 7 (27)
Income tax benefit -- -- 2
----- ------ ------
Net income (loss) (15)% 7% (25)%
===== ====== ======
NET SALES
Net sales for fiscal 2003 were $11.1 million, a 48% increase from $7.5 million
for fiscal 2003. Net sales for fiscal 2003 were $7.5 million, an 8% decrease
from $6.9 million in fiscal 2002. The increase in fiscal 2004 as compared to
-28-
fiscal 2003 was primarily attributable to an increase in sales to numerous
customers including our largest, HP. Net sales to HP were $4.9 million in fiscal
2004 as compared to $3.4 million for fiscal 2003 and $2.1 million in fiscal
2002. Sales to HP, primarily of VMEBus products, represented 45% of net sales
for fiscal 2004, compared to 45% during fiscal 2003 and 30% in fiscal 2002. 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
have one remaining order with HP for $1.0 million of VME products that will be
shipped in the first quarter of fiscal 2005. At this time, we do not expect to
receive any future orders for VME products from HP. Nortel Networks was the only
other customer that represented greater than 10% of our sales, accounting for
13% of our sales in fiscal 2004. For fiscal 2003 and 2002, Lockheed Martin was
the only other customer representing 10% or more of our sales, accounting for
11% of net sales in fiscal 2002. In fiscal 2004 after one complete year of
operations, we derived $1.2 million in sales from products we acquired from
Antares compared to $459,000 in Antares product sales from acquisition date,
August 7, 2003 through October 31, 2003.
Sales of our adapter products were $4.9 million for fiscal 2004, as compared to
$2.6 million in fiscal 2003 and $2.1 million in fiscal 2002. Sales of our
HighWire products were $1.3 million in fiscal 2004, as compared to $0.8 million
in fiscal 2003 and $1.0 million in fiscal 2002. Our adapter products are used
primarily in edge-of-the-network applications such as VPN and other routers,
VoIP gateways and security devices, whereas our HighWire products are primarily
targeted at core-of-the-network applications used primarily by
telecommunications central offices. In the future, we expect our net sales to be
generated predominantly by sales of our adapter and encryption products with
Linux and Solaris software, followed by our recently released TOE products and
storage products, primarily iSCSI. We expect to see a continued steady increase
in the sale of our Highwire products due to the recent adoption and release of
OEM products that have incorporated our Highwire series of intelligent carrier
cards. All of our design wins and new customers are for applications using these
product families. In addition, we will continue to sell and support our older
VME products, but expect them to become a declining portion of our future net
sales.
We anticipate that our net sales for fiscal 2005 will increase when compared
with fiscal 2004, as certain of our design wins from the last two year to go
into production and that our customers will increase the rate of product rollout
such as edge of the network routers, VoIP gateways and WiFi applications. As a
result of these design wins moving to production stage, sales of our Adapter
products increased 53% and sales of our Highwire products increase 77% in fiscal
2004 as compared to fiscal 2003. One of our major challenges on a long term
basis continues to be replacement of the net sales of VME products previously
provided to HP. HP (including its predecessors, Tandem Computer and Compaq
Computer), has accounted for a substantial portion of our net sales for the past
five years. We expect to continue to increase the sales of our Adapter and
Highwire products and that these increases as a percentage of total revenue will
replace the sales to HP. Even though the market environment for our customers'
activities continues to be uncertain we have been successful in extending our
reach with new customers. We have been successful in increasing our network of
distributors and value-added resellers in the United States and Europe and have
rolled out some new products such as high density multi-ported adapter cards,
Encryption cards, the TOE product and iSCSI storage software. We have also
entered into some new strategic partnerships that will expand the reach of our
products to a new base of customers using AdvanceTCA ("ATCA") products. We have
-29-
continued to add new customers and design wins over the course of fiscal 2004
and we believe the combination of new customers and past design wins beginning
to go into production will provide future growth in net sales in the
communications, computing and storage marketplaces.
Our sales backlog at October 31, 2004 was $2.5 million, including $1.0 million
from HP, compared to $4.1 million, including $2.0 million from HP, at October
31, 2003. While we anticipate an increase in our sales volume in our Adapter and
Highwire products over the course of fiscal 2005 as certain of our design wins
from the last two year to go into production and our customers gradually return
to new product design and product rollout, there can be no assurances that such
increase will occur. Our customers typically operate on 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.
International sales constituted 12%, 12% and 13% of net sales in fiscal 2004,
2003 and 2002, respectively. International sales are executed in U.S. dollars
and are principally transacted in Europe.
GROSS PROFIT
Gross profit as a percentage of net sales was 40%, 63% and 54% in fiscal 2004,
2003 and 2002, respectively. Gross profit as a percentage of sales increased in
fiscal 2003 primarily as a result of sales of $409,000 of inventory to HP that
had been fully written down in fiscal 2002 when HP placed its final order for
end-of-life VME products under its then-existing contract. Our gross profit
would have been 58% after excluding the effect of the HP inventory write-down.
The decrease in our gross profit margin in fiscal 2004 is due primarily to lower
than expected gross margins from the Antares product, the addition of $547,000
expense related to the valuation adjustment for slow moving and obsolete
inventory and the inclusion of $408,000 of amortization and $713,000 of
impairment charges relating to the August 2003 intellectual property purchased
with Antares. We expect our gross profit to range between 50% and 53% for fiscal
2005 based on our current product sales prices and cost to manufacture those
products. However, if market and economic conditions, particularly in the
telecommunications sector, deteriorate or fail to recover as expected, gross
profit as a percentage of net sales may decline from the current level.
PRODUCT RESEARCH AND DEVELOPMENT
Product research and development expenses were $2.4 million in fiscal 2004, $1.3
million in fiscal 2003, and $3.0 million in fiscal 2002, representing 22%, 18%
and 44% of net sales, respectively. The increase in fiscal 2004 as compared to
fiscal 2003 is primarily the result of three factors:
o the inclusion of three personnel hired in conjunction with the
Antares acquisition;
o the addition of five additional design engineers hired during the
year;
o a 160% increase in expenditures for new product development.
-30-
The decrease in research and development expense as a percentage of revenue from
fiscal 2002 to fiscal 2003 was the direct result of headcount reductions of
fifteen full-time equivalent personnel combined with other project-related cost
containment measures During fiscal 2004, we began the development of the next
generation of our Highwire products, designed and released several new WAN and
LAN products including three new encryption products, continued development and
released our new TOE product and integrated our TOE product with a partners
enterprise based iSCSI software. We also continued to port our products to new
versions of Linux and Solaris software expanding their market reach. These
hardware and software design efforts have enabled us to more effectively target
enterprise markets such as Internet based storage, TCP offload, VoIP, VPN and
security routers, as well as expand market coverage within the
telecommunications, military/government, medical and industrial control markets.
We expect overall spending for our product research and development to range
between 15% and 18% of net sales in fiscal 2005 as we remain committed to the
development and enhancement of new and existing products. We did not capitalize
any internal software development costs in fiscal 2004, 2003 or 2002.
SALES AND MARKETING
Sales and marketing expenses for fiscal 2004 were $2.2 million, a 47% increase
over fiscal 2003. This increase is primarily related to higher headcount in the
sales and marketing departments for the majority of the year increasing by three
people plus an increases in travel and product marketing activities. We
increased our marketing expenditures by 142% in fiscal 2004 as we attended more
industry trade shows and increased our advertising in industry relevant
magazines. Fiscal 2003 expense was $1.5 million, a 31% decrease over fiscal
2002. The decrease in fiscal 2003 as compared to 2002 is the direct result of
headcount reductions in our sales and marketing departments combined with a
reduction in our overall marketing programs. Sales and marketing programs are
focused on design wins with new customers and, therefore, as new customer sales
increase, sales and marketing expenses will increase. New customers' product
design sales cycles may span over periods as long as twenty-four months. We
expect our sales and marketing expenses to range between 15% and 17% of net
sales in fiscal 2005 as we continue our product marketing efforts, especially
for the TOE and iSCSI products, and attend an increasing number of industry
specific trade shows.
GENERAL AND ADMINISTRATIVE
General and administrative expenses for fiscal 2004 remained constant at $1.8
million as compared to fiscal 2003. Fiscal 2004 includes $259,000 in
compensation expense related to the severance package provide to the company's
retiring president and chief executive officer. Fiscal 2003 expenses decreased
to $1.8 million from $2.4 million in fiscal 2002 or, 26%. The decrease was due
to headcount from eight to five individuals and expense containment measures,
primarily rent and depreciation, put into place in the fourth quarter of fiscal
2002, with the cost savings fully realized in fiscal 2003 and 2004. We expect
general and administrative expense for fiscal 2005 to increase from fiscal 2004
levels partly due to the increase in insurance and expenses related to
compliance with the Sarbanes-Oxley Act. General and administrative expenses are
expected to range between 12% and 15% of sales for fiscal 2005.
-31-
LOAN RESERVE (BENEFIT)
On November 6, 1998, we made a loan to our retiring President and CEO which was
used by him to exercise an option to purchase 139,400 shares of our common stock
and related taxes. The loan, as amended, was collateralized by shares of our
common stock, bore interest at a rate of 2.48% per annum and was due on December
14, 2003.
On October 31, 2002, we determined that it was probable that we would 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 against the loan at
October 31, 2002.
During the fourth quarter of fiscal 2003, the officer repaid $362,800 of the
loan and as a result, we recognized a benefit of $235,000 related to the
reversal of the loan impairment charge taken by us in fiscal 2002. During the
first quarter of fiscal 2004, the officer repaid the remaining loan balance in
full and as a result, we recorded a benefit of $239,000 relating to the reversal
of the remaining loan impairment charge.
RESTRUCTURING COSTS(BENEFIT)
In response to the economic slowdown, we implemented restructuring plans in
fiscal 2002 and recorded restructuring charges of $446,000. Restructuring costs
for fiscal 2002 were comprised of severance costs associated with staff
reductions totaling $115,000, leasehold improvements and equipment write-downs
related to the abandonment of our Madison, Wisconsin office of $185,000 and
estimated losses related to future rents, net of estimated future recoveries
from potential sublease, of $146,000. We reduced our headcount from 47 employees
to 24 employees during fiscal 2002.
In the third quarter of fiscal 2003, we recognized a restructuring benefit of
$154,000 after the final settlement of costs associated with prior real estate
and equipment leases.
As of October 31, 2004 and 2003, $21,000 and $58,000 of the restructuring costs
were included in other current liabilities, respectively.
INTEREST AND OTHER INCOME
Interest and other income in fiscal 2004 decreased slightly from 2003 due to
lower average cash balances in fiscal 2004 coupled with lower average interest
rates. Fiscal 2003 income decreased slightly from fiscal 2002 due to lower
average cash balances in fiscal 2003 coupled with lower average interest rates.
A refundable deposit associated with a multi-year supply agreement with HP of
$4.9 million was received in April 2001. This deposit was refundable as we
delivered certain quantities of products to HP over a four year period ending in
2005. The supply contact was restructured in fiscal 2002 to include a final
purchase order for $1.6 million of our products to be shipped to HP in the first
two quarters of fiscal 2003 and the forfeiture by HP of $4.4 million of the $4.9
million refundable deposit. Under the agreement, we are required to retain for
future production or repair all VCOM finished goods and spare parts inventory
through October 31, 2005 unless notified otherwise by HP. Concurrent with the
forfeiture of the $4.4 million refundable deposit, we recorded a reserve of $1.7
million related to the potentially obsolete inventory we held at October 31,
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2002. The $2.7 million of forfeiture of the refundable deposit net of inventory
reserve is presented under "Forfeited deposit, net" on the fiscal 2002
Consolidated Statements of Operations.
INCOME TAXES
On March 9, 2002, the Job Creation and Workers Assistance Act of 2002 extended
the net operating loss carryback from two to five years for losses generated in
tax years ending in 2001 and 2002. As a result, we recorded a benefit for income
taxes of $22,000 in the second quarter of fiscal 2003 and a tax benefit of
$91,000 in fiscal 2002 due to refunds of federal income taxes related to this
Act. The net benefit recorded for the 2003 and 2002 periods were $17,000 and
$177,000, respectively. In fiscal 2002 we also filed amended federal and state
tax returns to claim $86,000 in research and development credits related to LAN
Media Corporation ("LMC"), a company we acquired in July 2000. Our effective tax
rate was 0%, 0% and (8)% in fiscal 2004, 2003 and 2002, respectively. We
recorded valuation allowances in fiscal 2004 and 2003 for deferred tax assets
due to the uncertainty of realization. In the event of future taxable income,
our effective income tax rate in future periods could be lower than the
statutory rate as such tax assets are realized.
NET INCOME (LOSS)
As a result of the factors discussed above, we recorded a net loss of $1.7
million in fiscal 2004 compared to net income of $563,000 in fiscal 2003 and a
net loss of $1.7 million in fiscal 2002.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following table sets forth a summary of our material contractual obligations
and commercial commitments as of October 31, 2004:
Payments due by period (Dollars in thousands)
---------------------------------------------------
Less than 1-3 3-5 More than
Contractual Obligations Total 1 year Years Years 5 Years
------- ------- ------- ------- -------
Building leases $ 1,649 $ 963 $ 686 $ -- $ --
Reimbursements from lease
assignment (902) (637) (265) -- --
------- ------- ------- ------- -------
Total net lease payments $ 747 $ 326 $ 421 $ -- $ --
======= ======= ======= ======= =======
In connection with the acquisition of Antares, we committed to issue 98,945
shares of our Common Stock in 10,000 and 20,000 share increments beginning
January 2004 and ending March 2005 to a selling shareholder of Antares. During
fiscal 2004, we issued 30,000 shares of our Common Stock of a committed 98,945
to an employee who was one of the owners of Antares Microsystems, Inc. pursuant
to the original purchase agreement. We will issue the remaining 68,945 during
fiscal 2005. The value of the Common Stock issued in fiscal 2004 under this
commitment was $85,600.
In connection with the retirement of Mr. William Heye, Jr. as the company's
President and Chief Executive Officer, the Company will pay Mr. Heye $250,000 at
the rate of $20,833 each month for the period January 1, 2005 through December
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31, 2005. The commitment to pay $250,000 has been accrued as of October 31, 2004
and is included in General and Administrative expense and Accrued Payroll and
Employee Benefits liability.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any transactions, arrangements, or other relationships with
unconsolidated entities that are reasonably likely to affect our liquidity or
capital resources other than the operating leases noted above. We have no
special purpose or limited purpose entities that provide off-balance sheet
financing, liquidity, or market or credit risk support; or engage in leasing,
hedging, research and development services, or other relationships that expose
us to liability that is not reflected on the face of the financial statements.
LIQUIDITY AND CAPITAL RESOURCES
Our liquidity is dependent on many factors, including sales volume, operating
profit and the efficiency of asset use and turnover. Our future liquidity will
be affected by, among other things:
- actual versus anticipated sales of our products;
- our actual versus anticipated operating expenses and results of
ongoing cost control actions;
- the timing of product shipments, which occur primarily during the
last month of each quarter;
- our actual versus anticipated gross profit margin;
- our ability to raise additional capital, if necessary; and
- our ability to secure credit facilities, if necessary.
We had cash and cash equivalents of $1.8 million and $1.4 million on October 31,
2004 and October 31, 2003, respectively. In fiscal 2004, $140,000 of cash was
used by operating activities, primarily as a result of net losses, the reversal
of a valuation allowance on a loan from an officer and an increase in inventory.
The cash receipt from the repayment of the loan is included in the financing
activities section of the cash flow statement. Cash was provided by the
inclusion of $1.1 million of amortization expense and the write-down of the
intellectual property plus $420,000 of amortization and depreciation expense
related to property and equipment and capitalized software included in the $1.7
million net loss. Cash flow was also provided by a $150,000 decrease in our
accounts receivable. Working capital (current assets less current liabilities)
at October 31, 2004 was $3.9 million, as compared to $4.0 million at October 31,
2003.
In fiscal 2004, we purchased $87,000 of fixed assets, consisting primarily of
computers and engineering equipment. Purchased software costs amounting to
$136,000 were capitalized in fiscal 2004. We expect to slightly increase our
levels of capital expenditures in fiscal 2005 in order to purchase test and
design equipment upgrades.
We received $18,000 in fiscal 2004 from payments related to common stock
purchases made by employees pursuant to the employee stock purchase plan and
$233,000 from proceeds related the exercise of employee stock options, for a
total of $251,000.
-34-
On December 19, 2003 we received cash proceeds of $116,000 from Puglisi & Co.
for the purchase of 70,000 shares of our Common Stock pursuant to a warrant they
received in conjunction with a private placement of common stock transaction
that was completed in fiscal 2003.
During the fourth quarter of fiscal 2003, our retiring president and CEO sold
139,400 shares of our common stock and used the proceeds from the stock sale to
repay $362,800 of an outstanding $743,800 loan we made to the officer. In
November 2003 the loan was repaid in full when we received an additional loan
payment of $381,000 from proceeds from the sale of stock.
On May 13, 2004, we renewed our working capital line of credit for twelve months
until May 14, 2005. 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
4.75%, at October 31, 2004, plus 1.50%. Draw-downs on the credit line are based
on a formula equal to 80% of our domestic accounts receivable. As of October 31,
2004, due to the net loss for our fourth fiscal quarter of 2004, we are not in
compliance with all the covenants of our credit line. The Bank agreed to waive
the non-compliance with this covenant. We have not drawn down on this line of
credit and have no amounts payable at October 31, 2004.
We believe the projected revenue during fiscal 2005 will generate sufficient
cash flows to fund our operations through October 31, 2005 and beyond. Our
projected future quarterly operational cash flow breakeven point is expected to
be $2.7 million to $2.8 million in net sales at an expected 50% to 53% gross
margin. Our current year's sales to HP of $4.9 million at a gross margin of 73%
are expected to significantly decline. Our projected sales are based on a
combination of increasing demand for existing products and market acceptance of
recently released products 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 the 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 our 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.
ITEM 7A. 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 October
31, 2004 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 income (loss) related to our financial
instruments would be immaterial. We hold no assets or liabilities denominated in
a foreign currency.
-35-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required under Item 8 are
provided under Item 15.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
An evaluation as of October 31, 2004 was carried out under the
supervision of and with the participation of the Company's management, including
the Company's Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of the Company's "disclosure controls
and procedures," which are defined under SEC rules as controls and other
procedures of a company that are designed to ensure that information required to
be disclosed by a company in the reports that it files under the Securities
Exchange Act of 1934 (the "Exchange Act") is recorded, processed, summarized and
reported within required time periods. Based upon that evaluation, the Company's
Chief Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures were effective.
(b) Changes in Internal Controls over Financial Reporting
The Company's management, including the Company's Chief Executive
Officer and Chief Financial Officer, has evaluated any changes in the company's
internal control over financial reporting that occurred during the quarter ended
October 31, 2004, and has concluded that there was no change during such quarter
that has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
-36-
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Identification of Directors; Audit Committee Financial Expert; Section 16(a)
Beneficial Ownership Reporting Compliance; Code of Ethics
The information required by Item 10 concerning our executive officers is set
forth in the section entitled "Identification of Executive Officers" appearing
in Part I of this annual report. The information required by Item 10 concerning
our directors is incorporated by reference from the information in the section
entitled "Election of Directors" appearing in our definitive Proxy Statement to
be filed with the Securities and Exchange Commission for the Annual Meeting of
Stockholders scheduled for March 22, 2005 (the "2005 Proxy Statement"). The
information required by Item 10 concerning the compliance of certain persons
with the beneficial ownership reporting requirements of Section 16(a) of the Act
is incorporated by reference from the information in the section entitled
"Compliance with Section 16(a) of the Securities and Exchange Act of 1934"
appearing in the 2005 Proxy Statement. The information required by Item 10
concerning the disclosure of the existence of an audit committee financial
expert sitting on the Audit Committee is incorporated by reference from the
information in the section entitled "Audit Committee Financial Expert" appearing
in the 2005 Proxy Statement. The information required by Item 10 concerning the
adoption of a code of ethics is incorporated by reference from the information
in the section entitled "Code of Ethics" appearing in the 2005 Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated by reference from the
information in the section entitled "Executive Compensation" appearing in the
2005 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by Item 12 is found under the heading "Equity
Compensation Plan Information" in Item 5 of this report and otherwise is
incorporated by reference from the information in the section entitled "Security
Ownership of Certain Beneficial Owners and Management" appearing in the 2005
Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated by reference from the
information in the sections entitled "Certain Transactions" and "Executive
Compensation" appearing in the 2005 Proxy Statement.
-37-
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
The following documents are filed as part of this Report:
(a)(1) Financial Statements
Page
-----
Report of Independent Registered Public Accounting Firm 44
Report of Independent Registered Public Accounting Firm 45
Consolidated Balance Sheets at October 31, 2004 and 2003 46
Consolidated Statements of Operations for fiscal years 2004, 2003
and 2002 47
Consolidated Statements of Stockholders' Equity for fiscal
years 2004, 2003 and 2002 48
Consolidated Statements of Cash Flows for fiscal years 2004, 2003
and 2002 49
Notes to Consolidated Financial Statements 50
(a)(2) Financial Statement Schedule
Schedule II -- Valuation and Qualifying Accounts 70
All other schedules are omitted as the required information is not
applicable or has been included in the consolidated financial
statements or the notes thereto.
(a)(3) List of Exhibits
Exhibit
Number Description
------- -----------
2.1 (1) Asset Purchase Agreement dated August 8, 2003, by and
between D.R. Barthol & Company and SBE, Inc.
3.1(2) Certificate of Incorporation, as amended through
December 15, 1997.
3.2(3) Bylaws, as amended through December 8, 1998.
10.1(4)* 1996 Stock Option Plan, as amended.
-38-
10.2(4)* 1991 Non-Employee Directors' Stock Option Plan, as
amended.
10.3(4) 1992 Employee Stock Purchase Plan, as amended.
10.4(4) 1998 Non-Officer Stock Option Plan as amended.
10.5(5) Lease for 4550 Norris Canyon Road, San Ramon, California
dated November 2, 1992 between the Company and PacTel
Properties.
10.6(6) Amendment dated June 6, 1995 to lease for 4550 Norris
Canyon Road, San Ramon, California, between the Company
and CalProp L.P. (assignee of PacTel Properties).
10.7(4)* Full Recourse Promissory Note executed by William B.
Heye, Jr. in favor of the Company dated November 6,
1998, as amended and restated on December 14, 2001.
10.8(4)+ Letter Agreement, dated October 30, 2001, amending (i)
Amendment No. S/M018-4 dated April 3, 2001, and (ii)
Purchase Agreement dated May 6, 1991, each between SBE,
Inc. and Compaq Computer Corporation
10.9(7) Stock subscription agreement and warrant to purchase
111,111 of SBE, Inc. Common Stock dated April 30, 2002
between SBE, Inc. and Stonestreet Limited Partnership.
10.10(8) Amendment dated August 22, 2002 to stock subscription
agreement dated April 20, 2002 between SBE, Inc. and
Stonestreet LP.
10.11(9) Securities Purchase Agreement, dated July 27, 2003,
between SBE, Inc. and purchasers of SBE's common stock
thereunder, including form of warrant issued thereunder
10.12(9) Form of warrant issued to associates of Puglisi & Co.
($1.50 exercise price)
10.13(9) Form of warrant issued to associates of Puglisi & Co.
($1.75 and $2.00 exercise price)
23.1 Consent of BDO Seidman LLP, Independent
Registered Public Accounting Firm
23.2 Consent of PricewaterhouseCoopers LLP, Independent
Registered Public Accounting Firm
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
-39-
32.1 Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
* Indicates management contract or compensation plans or
arrangements filed pursuant to Item 601(b)(10) of
Regulation SK.
+ Certain confidential information has been deleted from
this exhibit pursuant to a confidential treatment order
that has been granted.
(1) Filed as an exhibit to Current Report on Form 8-K, dated
April 30, 2002 and incorporated herein by reference.
(2) Filed as an exhibit to Annual Report on Form 10-K for
the year ended October 31, 1997 and incorporated herein
by reference.
(3) Filed as an exhibit to Annual Report on Form 10-K for
the year ended October 31, 1998 and incorporated herein
by reference.
(4) Filed as an exhibit to Annual Report on Form 10-K for
the year ended October 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, 1993 and incorporated herein
by reference.
(6) Filed as an exhibit to Annual Report on Form 10-K for
the year ended October 31, 1995 and incorporated herein
by reference.
(7) Filed as an exhibit to Registration Statement on Form
S-3 dated May 23, 2002 and incorporated herein by
reference.
(8) Filed as an exhibit to Quarterly Report on Form 10-Q for
the quarter ended July 31, 2002 and incorporated herein
by reference.
(9) Filed as an exhibit to Registration Statement on Form
S-3 dated July 11, 2003 and incorporated herein by
reference.
-40-
(b) REPORTS ON FORM 8-K
On August 25, 2004, we filed a Form 8-K to report our earnings for the three and
nine months ended July 31, 2004.
(c) EXHIBITS REQUIRED BY ITEM 601
Please refer to Part IV, Item 15(a)(3).
(d) FINANCIAL STATEMENTS
Please refer to Part IV, Item 15(a)(2).
-41-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
SBE, Inc.
Date: January 14, 2005 By: /s/ William B. Heye, Jr.
--------------------------
William B. Heye, Jr.
Chief Executive Officer and
President
(Principal Executive Officer)
Date: January 14, 2005 By: /s/ David W. Brunton
--------------------------
David W. Brunton
Chief Financial Officer,
Vice President, Finance
and Secretary
(Principal Financial and
Accounting Officer)
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each of the undersigned
officers and directors of the registrant constitutes and appoints, jointly and
severally, William B. Heye, Jr. and David W. Brunton, and each of them, as
lawful attorneys-in-fact and agents for the undersigned and for each of them,
each with full power of substitution and resubstitution, for and in the name,
place and stead of each of the undersigned officers and directors, in any and
all capacities, to sign any and all amendments to this report, and to file the
same, with all exhibits thereto and all other documents in connection therewith,
with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing necessary or appropriate to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that each of said
attorneys-in-fact or any of them, or any of their substitutes, may lawfully do
or cause to be done by virtue hereof.
Pursuant to the requirements for the Securities Exchange Act of 1934,
this report has been signed by the following persons in the capacities
indicated, as of January 14, 2005.
-42-
Signature Title
--------- -----
/s/ William B. Heye, Jr. Chief Executive Officer and President
- ------------------------ (Principal Executive Officer)
William B. Heye Jr.
/s/ David W. Brunton Chief Financial Officer, Vice President,
- ------------------------ Finance and Secretary (Principal Financial
David W. Brunton and Accounting Officer)
/s/ Ronald J. Ritchie Director, Chairman of the Board
- ------------------------
Ronald J. Ritchie
/s/ John Reardon Director
- ------------------------
John Reardon
/s/ Marion M. Stuckey Director
- ------------------------
Marion M. Stuckey
-43-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
SBE, Inc.
San Ramon, California
We have audited the accompanying consolidated balance sheets of SBE, Inc. as of
October 31, 2004 and 2003 and the related consolidated statements of operations,
stockholders' equity, and cash flows for the years then ended. We have also
audited the schedule listed in the accompanying index. These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audit.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States of America). Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements and schedule. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall presentation of the financial statements and schedule.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of SBE, Inc. as of
October 31, 2004 and 2003, and the results of its operations and its cash flows
for the years then ended in conformity with accounting principles generally
accepted in the United States of America.
Also, in our opinion, the schedule presents fairly, in all material respects,
the information relating to the years ended October 31, 2004 and 2003 as set
forth therein.
/s/ BDO Seidman, LLP
December 10, 2004 San Francisco, California
-44-
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of SBE, Inc.:
In our opinion, the consolidated statements of operations, of changes in
stockholders' equity and of cash flows for the year ended October 31, 2002
(appearing on pages 47 through 49 of the SBE, Inc. Annual Report on Form 10-K)
present fairly, in all material respects, the results of operations and cash
flows of SBE, Inc. and its subsidiaries for the year ended October 31, 2002, in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedule listed in
the index appearing under Item 15(a)(2) on page 38 presents fairly, in all
material respects, the information relating to the year ended October 31, 2002
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audit. We conducted our audit of these statements in
accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has suffered recurring losses
from operations and has generated negative cash flows from operations that raise
substantial doubt about its ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note 1. The consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ PricewaterhouseCoopers LLP
San Francisco, California
January 13, 2003
-45-
SBE, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
October 31 2004 2003
- ------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 1,849 $ 1,378
Trade accounts receivable, net of allowance for
doubtful accounts of $42 and $90 1,668 1,818
Inventories 1,926 1,880
Other 227 240
----------- -----------
Total current assets 5,670 5,316
Property and equipment, net 427 389
Capitalized software costs, net 48 120
Intellectual property, net -- 1,122
Other 28 28
----------- -----------
Total assets $ 6,173 $ 6,975
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 856 $ 696
Accrued payroll and employee benefits 391 184
Capital lease obligations - current portion 25 --
Other 459 491
----------- -----------
Total current liabilities 1,701 1,371
Capital lease obligations and long term liabilities,
net of current portion 139 217
----------- -----------
Total liabilities 1,870 1,588
----------- -----------
Commitments (Notes 7 and 8)
Stockholders' equity:
Convertible preferred stock:
($0.001 par value) authorized 2,000,000 shares; none
outstanding -- --
Common stock and additional paid-in capital
($0.001 par value); authorized 25,000,000 and 10,000,000
shares; issued and outstanding 5,094,118 and 4,808,650 15,755 15,302
Note receivable from stockholder -- (142)
Accumulated deficit (11,452) (9,773)
----------- -----------
Total stockholders' equity 4,303 5,387
----------- -----------
Total liabilities and stockholders' equity $ 6,173 $ 6,975
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
-46-
SBE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
For the years ended October 31, 2004 2003 2002
- ------------------------------------------------------------------------------------------
Net sales $ 11,066 $ 7,456 $ 6,898
Cost of sales 6,646 2,749 3,170
------------ ------------ ------------
Gross profit 4,420 4,707 3,728
------------ ------------ ------------
Product research and development 2,411 1,330 3,027
Sales and marketing 2,177 1,484 2,151
General and administrative 1,755 1,752 2,364
Shareholder note valuation (benefit) (239) (235) 474
Restructuring costs (benefit) -- (154) 446
------------ ------------ ------------
Total operating expenses 6,104 4,177 8,462
------------ ------------ ------------
Operating income (loss) (1,684) 530 (4,734)
Interest income 5 26 51
Forfeited deposit, net -- -- 2,712
Other income (expense) -- (10) 63
------------ ------------ ------------
Income (loss) before income taxes (1,679) 546 (1,908)
Income tax benefit -- 17 177
------------ ------------ ------------
Net income (loss) $ (1,679) $ 563 $ (1,731)
============ ============ ============
Basic earnings (loss) per common share $ (0.33) $ 0.13 $ (0.46)
============ ============ ============
Diluted earnings (loss) per common share $ (0.33) $ 0.12 $ (0.46)
============ ============ ============
Basic - Shares used in per share
computations 5,022 4,259 3,759
============ ============ ============
Diluted - Shares used in per share
computations 5,022 4,709 3,759
============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
-47-
SBE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except shares)
Notes
Common Stock and Receivable
Additional Paid-in Capital from Treasury Stock
Shares Amount Stockholder Shares Amount
---------- ---------- ---------- --------- -------
Balance, October 31, 2001 3,521,035 $ 13,877 $ (744) 79,500 $ (409)
Stock issued in connection with stock purchase plan 47,596 31 -- -- --
Stock and warrant issued in connection with private placement 555,556 782 -- -- --
Stock issued to Directors in lieu of cash payments 13,425 21 -- -- --
Valuation allowance on note receivable from officer -- -- 474 -- --
Net loss -- -- -- -- --
---------------------------------------------------------------
Balance, October 31, 2002 4,137,612 14,711 (270) 79,500 (409)
---------------------------------------------------------------
Stock issued in connection with stock purchase plan 11,012 12 -- -- --
Stock and warrant issued in connection with private placement 500,000 464 -- -- --
Stock issued to Directors in lieu of cash payments 37,787 43 -- -- --
Stock issued in connection with the acquisition of Antares 90,628 259 -- -- --
Stock issued in connection with warrant exercise 111,111 222 -- -- --
Retirement of treasury stock (79,500) (409) -- (79,500) 409
Reversal of valuation allowance on note receivable from officer -- -- 128 -- --
Net income -- -- -- -- --
---------------------------------------------------------------
Balance, October 31, 2003 4,808,650 15,302 (142) -- --
---------------------------------------------------------------
Stock issued in connection with stock purchase plan 9,903 18 -- -- --
Stock issued in connection with Stock Option Plans 164,136 233 -- -- --
Stock issued in connection with warrant exercise 81,429 116 -- -- --
Stock issued in connection with the acquisition of Antares 30,000 86 -- -- --
Reversal of valuation allowance on note receivable from officer -- -- (239) -- --
Collection of note receivable from officer 381 381
Net loss -- -- -- -- --
---------------------------------------------------------------
Balance, October 31, 2004 5,094,118 $ 15,755 $ -- -- $ --
===============================================================
Retained
Earnings
(Accumulated
deficit) Total
---------- --------
Balance, October 31, 2001 $ (8,605) $ 4,119
Stock issued in connection with stock purchase plan -- 31
Stock and warrant issued in connection with private placement -- 782
Stock issued to Directors in lieu of cash payments -- 21
Valuation allowance on note receivable from officer -- 474
Net loss (1,731) (1,731)
-----------------------
Balance, October 31, 2002 (10,336) 3,696
-----------------------
Stock issued in connection with stock purchase plan -- 12
Stock and warrant issued in connection with private placement -- 464
Stock issued to Directors in lieu of cash payments -- 43
Stock issued in connection with the acquisition of Antares -- 259
Stock issued in connection with warrant exercise -- 222
Retirement of treasury stock -- --
Reversal of valuation allowance on note receivable from officer -- 128
Net income 563 563
-----------------------
Balance, October 31, 2003 (9,773) 5,387
-----------------------
Stock issued in connection with stock purchase plan -- 18
Stock issued in connection with Stock Option Plans -- 233
Stock issued in connection with warrant exercise -- 116
Stock issued in connection with the acquisition of Antares -- 86
Reversal of valuation allowance on note receivable from officer -- (239)
Collection of note receivable from officer
Net loss (1,679) (1,679)
-----------------------
Balance, October 31, 2004 $ (11,452) $ 4,303
=======================
The accompanying notes are an integral part of these consolidated financial
statements.
-48-
SBE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the years ended October 31 2004 2003 2002
- -------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss) $(1,679) $ 563 $(1,731)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 829 443 730
Impairment of intellectual property 713 -- --
Non-cash restructuring (benefit) -- (154) 185
Stock-based compensation expense 21
-- 43
Non-cash valuation allowance (recovery) on loan from (240) (142) 474
officer
Effect of re-measured warrant -- -- (83)
Loss on sale of assets -- 13 19
Changes in operating assets and liabilities:
Trade accounts receivable 150 (930) (128)
Inventories (46) 30 2,518
Other assets 13 30 238
Trade accounts payable 208 (57)
160
Other current liabilities (41) (184)
(29)
Non-current liabilities -- (4) (4,860)
------- ------- -------
Net cash used in operating activities (140) (84) (2,703)
------- ------- -------
Cash flows from investing activities:
Purchases of property and equipment (87) (172) (149)
Cash payments related to purchase of Antares assets
and related costs -- (868) --
Purchased software (136) (48) (105)
------- ------- -------
Net cash used in investing activities (223) (1,088) (254)
------- ------- -------
Cash flows from financing activities:
Proceeds from stock plans 251 12 31
Proceeds from issuance of common stock and warrants 202 686 864
Proceeds from repayment of shareholder note 382 270 --
------- ------- -------
Net cash provided by financing activities 834 968 895
------- ------- -------
Net increase (decrease) in cash and cash 471 (204) (2,062)
Cash and cash equivalents at beginning of year 1,378 1,582 3,644
------- ------- -------
Cash and cash equivalents at end of year $ 1,849 $ 1,378 $ 1,582
======= ======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ -- $ -- $ --
======= ======= =======
Income taxes $ 1 $ 1 $ 1
======= ======= =======
SUPPLEMENTAL SCHEDULE OF NON CASH INVESTING AND FINANCING
ACTIVITIES
Assets acquired under capital leases $ 164 $ -- $ --
======= ======= =======
Non-cash stock portion of Antares purchase price $ -- $ 542 $ --
======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
-49-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company and Basis of Presentation:
SBE, Inc., headquartered in San Ramon, California, architects and provides
network communications and storage solutions to the original equipment
manufacturers ("OEM") in the embedded computing and storage markets. Our
solutions enable both data communications and telecommunications companies in
addition to enterprise class high-end server clients to rapidly deliver advanced
networking and storage products and services. Our products include wide area
network ("WAN"), local area network ("LAN"), Internet Small Computer System
Interface ("iSCSI"), SCSI, Fibre Channel, intelligent carrier cards, Encryption
and TCP/IP Offload Engine ("TOE") cards. These products perform critical
computing, Input/Output ("I/O") and storage tasks across both the enterprise
server and embedded markets such as high-end enterprise level servers, Linux
super computing clusters, workstations, media gateways, routers, internet access
devices, home location registers, data messaging applications network attached
storage ("NAS") and remote storage devices. Our products are distributed
worldwide through a direct sales force, distributors, independent manufacturers'
representatives and value-added resellers. Our business falls within one
industry segment and product group.
Liquidity
We had a net loss of $1.7 million in fiscal 2004. The net loss includes the
following expenses:
o $1.1 million of amortization and impairment charges of the
intellectual property associated with the acquisition of Antares
MicroSystems, Inc. on August 7, 2003;
o $259,000 accrual for severance pay for the retirement of the
Company's president and CEO;
o $421,000 of depreciation and amortization expense and $547,000 in
inventory valuation charges.
We believe our existing cash plus additional cash from our line of credit and
continuing operations will provide sufficient cash flows to fund our operations.
Principles of Consolidation:
The consolidated financial statements include the accounts of SBE, Inc. and its
wholly-owned subsidiaries. All intercompany balances and transactions have been
eliminated in consolidation.
Use of Estimates:
The preparation of consolidated 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 revenues and
expenses during the reporting period. Such estimates include levels of reserves
-50-
for doubtful accounts, obsolete inventory, warranty costs and deferred tax
assets. Actual results could differ from those estimates.
Fair Value of Financial Instruments:
The fair value of our cash and cash equivalents, accounts receivable, accounts
payable and accrued liabilities approximate their carrying value due to the
short-term maturity rate structure of those instruments.
Cash and Cash Equivalents:
We consider all highly liquid investments readily convertible into cash with an
original maturity of three months or less to be cash equivalents. Substantially
all of our cash and cash equivalents are held with one large financial
institution and may at times be above insured limits.
Inventories:
We are exposed to a number of economic and industry factors that could result in
portions of our inventory becoming either obsolete or in excess of anticipated
usage, or subject to lower of cost or market issues. These factors include, but
are not limited to, technological changes in our markets, our ability to meet
changing customer requirements, competitive pressures in products and prices,
and the availability of key components from our suppliers. Our policy is to
establish inventory reserves when conditions exist that suggest that our
inventory may be in excess of anticipated demand or is obsolete based upon our
assumptions about future demand for our products and market conditions. We
regularly evaluate our ability to realize the value of our inventory based on a
combination of factors including the following: historical usage rates,
forecasted sales or usage, product end-of-life dates, estimated current and
future market values and new product introductions. Purchasing practices and
alternative usage avenues are explored within these processes to mitigate
inventory exposure. When recorded, our reserves are intended to reduce the
carrying value of our inventory to its net realizable value. If actual demand
for our products deteriorates, or market conditions are less favorable than
those that we project, additional inventory reserves may be required. In the
fourth quarter of fiscal 2004, we reviewed our inventory balances and increased
our reserves on specific products by $547,000.
Inventories are stated at the lower of cost, using the first-in, first-out
method, or market value.
Property and Equipment:
Property and equipment are carried at cost. We record depreciation charges on a
straight-line basis over the assets' estimated useful lives of three years for
computers and related equipment to eight years for manufacturing equipment.
Leasehold improvements are amortized over the lesser of their useful lives or
the remaining term of the related leases.
When assets are sold or otherwise disposed of, the cost and accumulated
depreciation are removed from the accounts and any gain or loss on sale or
disposal is recognized in operations. Maintenance, repairs and minor renewals
are charged to expense as incurred. Expenditures which substantially increase an
asset's useful life are capitalized.
-51-
We review property and equipment for impairment whenever events or changes in
circumstances indicate the carrying value of an asset may not be recoverable. In
performing the review for recoverability, we would estimate the future gross
cash flows expected to result from the use of the asset and its eventual
disposition. If such gross cash flows are less than the carrying amount of the
asset, the asset is considered impaired. The amount of the impairment loss, if
any, would then be calculated based on the excess of the carrying amount of the
asset over its fair value.
Intangible Assets:
We adopted the Financial Accounting Standards Board ("FASB") Statements of
Financial Accounting Standards ("SFAS") No. 141, Business Combinations and SFAS
No. 142, Goodwill and Other Intangible Assets on accounting for business
combinations and goodwill as of the beginning of fiscal year 2002. Accordingly,
we do not amortize goodwill from acquisitions, but amortize other
acquisition-related intangibles and costs. All of the intangible assets that we
currently own are intellectual property acquired in the Antares acquisition.
For identifiable intangible assets, we amortize the cost over the estimated
useful life and assess any impairment by estimating the future cash flow from
the associated asset in accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. If the estimated undiscounted cash
flow related to these assets decreases in the future or the useful life is
shorter than originally estimated, we may incur charges for impairment of these
assets. The impairment is based on the estimated discounted cash flow associated
with the asset. An impairment could result if the underlying technology fails to
gain market acceptance, we fail to deliver new products related to these
technology assets, the products fail to gain expected market acceptance or if
market conditions are unfavorable.
Intellectual property costs consist of the allocation of costs associated with
the purchase of current and the design of future products from Antares
Microsystems on August 7, 2003. As required by these rules, we perform an
impairment review annually, or earlier if indicators of potential impairment
exist. The impairment analysis requires significant judgment to identify events
or circumstances that would likely have a significant adverse effect on the fair
value of the intangible asset. Our annual impairment review was completed during
the fourth quarter of fiscal 2004, and we determined that there was considerable
doubt that the unamortized balance of $713,000 of the intangible asset at
October 31, 2004 would be recoverable. The indicators we used to identify those
events and circumstances include revenue and earnings trends relative to
predefined milestones and overall business prospects; the technological
feasibility of the Antares products and technologies and the general market
conditions in the market for SUN Microsystems compatible products with which
Antares product compete. Our impairment review is based on a discounted cash
flow approach that uses estimates of future market share and revenues and costs
for the Antares products as well as appropriate discount rates. The estimates
used are consistent with the plans and estimates that we use to manage the
underlying business. We determined that the estimated fair market value of the
balance of the intangible asset related to the Antares acquisition was nominal
and as a result, we recorded an impairment charge of $713,000 during the quarter
ended October 31, 2004 thus writing off the remaining value of the intellectual
property asset.
The non-cash amortization expense related to the intellectual property in fiscal
2004 was $1.1 million and consists of $408,000 of regularly scheduled annual
amortization expense plus $713,000 write down related to impairment valuation
-52-
analysis. This write-down plus the regularly scheduled amortization is included
as an expense item in our cost of goods sold. The amortization expense for the
one quarter that we owned Antares in fiscal 2003 was approximately $102,000.
Acquisitions:
All business acquisitions have been accounted for using the purchase method of
accounting and, accordingly, the consolidated statements of operations include
the results of each acquired business since the date of acquisition. The assets
acquired and liabilities assumed are recorded at estimates of fair values as
determined by management based on information available we consider a number of
factors, including third-party valuations or appraisals, when making these
determinations. We finalize the allocation of purchase price to the fair value
of the assets acquired and liabilities assumed when we obtain information
sufficient to complete the allocation, but in any case, within one year after
acquisition.
Revenue Recognition:
Our policy is to recognize revenue for product sales upon shipment of our
products to our customers provided that no significant obligations remain and
collection of the receivable is considered probable. Shipping terms are
generally FOB shipping point. We defer and recognize service revenue over the
contractual period or as services are rendered. Service revenue has not been
significant in any period. We estimate expected sales returns and record the
amount as a reduction of revenue at the time of shipment. Our policies comply
with the guidance provided by Staff Accounting Bulletin No. 104, Revenue
Recognition in Financial Statements, issued by the Securities and Exchange
Commission. Judgments are required in evaluating the credit worthiness of our
customers. Credit is not extended to customers and revenue is not recognized
until we have determined that the collectibility is reasonably assured. Our
sales transactions are generally denominated in U.S. dollars.
Our agreements with our distributors include certain product rotation and price
protection rights. All distributors have the right to rotate slow moving
products once each fiscal quarter. The maximum dollar value of inventory
eligible for rotation is equal to twenty-five percent of our products purchased
by the distributor during the previous quarter. In order to take advantage of
their product rotation rights, the distributors must order and take delivery of
additional SBE products equal to at least the dollar value of the products that
they want to rotate.
Each distributor is also allowed certain price protection rights. If and when we
reduce the price of any of our products and the distributor is holding any of
the affected products in inventory, we will credit the distributor the
difference in price when it places its next order with us. We record an
allowance for price protection reducing our net sales and accounts receivable.
The allowance is based on the price difference of the inventory held by our
distributors at the time we expect to reduce selling prices. Reserves for the
right of return and restocking are established based on the requirements of SFAS
48, Revenue Recognition when Right of Return Exists because we have visibility
into our distributor's inventory and have significant history to estimate
returns.
During the year ended October 31, 2004, $874,000 or 8% of our sales were to
distributors compared to $191,000 or 3% in fiscal 2003.
-53-
Product Warranty:
Our products are sold with warranty provisions that require us to remedy
deficiencies in quality or performance of our products over a specified period
of time, generally 12 months, at no cost to our customers. Our policy is to
establish warranty reserves at levels that represent our estimate of the costs
that will be incurred to fulfill those warranty requirements at the time that
revenue is recognized. We believe that our recorded liabilities are adequate to
cover our future cost of materials, labor and overhead for the servicing of our
products sold through that date. If actual product failures, or material or
service delivery costs differ from our estimates, our warranty liability would
need to be revised accordingly.
Allowance for Doubtful Accounts:
Our policy is to maintain allowances for estimated losses resulting from the
inability of our customers to make required payments. Credit limits are
established through a process of reviewing the financial history and stability
of each customer. Where appropriate, we obtain credit rating reports and
financial statements of the customer when determining or modifying their credit
limits. We regularly evaluate the collectibility of our trade receivable
balances based on a combination of factors. When a customer's account balance
becomes past due, we initiate dialogue with the customer to determine the cause.
If it is determined that the customer will be unable to meet its financial
obligation to us, such as in the case of a bankruptcy filing, significant
deterioration in the customer's operating results or financial position or other
material events impacting its business, we record a specific allowance to reduce
the related receivable to the amount we expect to recover.
We also record an allowance for all customers based on certain other factors
including the length of time the receivables are past due and historical
collection experience with customers. We believe our reported allowances are
adequate. If the financial conditions of those customers were to deteriorate,
however, resulting in their inability to make payments, we may need to record
additional allowances which would result in additional general and
administrative expenses being recorded for the period in which such
determination is made.
Product Research and Development Expenditures:
Product research and development ("R&D") expenditures, other than certain
software development costs, are charged to expense as incurred. Contractual
reimbursements for R&D expenditures under joint R&D contracts with customers are
accounted for as revenue when received.
Capitalized software costs consist of costs to purchase software and costs to
internally develop software. Capitalization of software costs begins upon the
establishment of technological feasibility. All capitalized software costs are
amortized as related sales are recorded on a per-unit basis with a minimum
amortization to cost of goods sold based on a straight-line method over a
two-year estimated useful life. We evaluate the estimated net realizable value
of each software product and record provisions to the asset value of each
product for which the net book value is in excess of the net realizable value.
No internal software development costs were capitalized in the years ended
October 31, 2004, 2003 and 2002.
-54-
Refundable Deposit:
A refundable deposit associated with a multi-year supply agreement with HP of
$4.9 million was received in April 2001. This deposit was refundable to HP as we
delivered certain quantities of products to HP over a four year period ending in
2005. The supply contract was restructured in fiscal 2002 to include a purchase
order for $1.6 million of our products that was shipped to HP in the first two
quarters of fiscal 2003 and the forfeiture by HP of $4.4 million of the $4.9
million refundable deposit. Under the agreement, we are required to retain for
future production or repair all VME finished goods and spare parts inventory
through October 31, 2005 unless notified otherwise by HP. Concurrent with the
forfeiture of the $4.4 million refundable deposit, we recorded a reserve of $1.7
million related to certain HP specific inventory we held at October 31, 2002 but
may not be able to sell. The $2.7 million of forfeiture of refundable deposit
net of inventory reserve is presented under Forfeited deposit, net on the
Consolidated Statements of Operations. The remaining $447,000 of the deposit was
repaid to HP in the third quarter of fiscal 2003.
Stock-based Compensation:
We account for stock-based employee compensation arrangements in accordance with
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, ("APB 25") and comply with the disclosure provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based
Compensation and SFAS No. 148, Accounting for Stock Based Compensation -
Transition and Disclosure. Under APB 25, compensation expense is based on the
difference, if any, on the date of the grant between the fair value of our stock
and the exercise price of the option. We account for equity instruments issued
to non-employees in accordance with SFAS No. 123 and Emerging Issues Task Force
("EITF") 96-18, Accounting for Equity Instruments that are Issued to Other than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services,
which require that such equity instruments be recorded at their fair value.
Had compensation cost for these plans been determined pursuant to the provisions
of SFAS No. 123, our pro forma net income (loss) would have been as follows (in
thousands):
For the Year Ended October 31,
-----------------------------------
2004 2003 2002
--------- --------- ---------
Net income (loss) - as reported .......... $ (1,679) $ 563 $ (1,731)
Stock based employee compensation
(recovery) expense included in reported
net loss, net of related tax effects ... -- -- --
Less total stock based employee
compensation expense determined
under fair value based method for
all awards, net of related tax
effects ................................ (1,177) (231) (721)
--------- --------- ---------
Pro forma net income (loss) .............. $ (2,856) $ 332 $ (2,452)
========= ========= =========
Income (loss) per share:
Basic - as reported ...................... $ (0.33) $ 0.13 $ (0.46)
Basic - pro forma ........................ $ (0.57) $ 0.08 $ (0.65)
Diluted - as reported .................... $ (0.33) $ 0.12 $ (0.46)
Diluted - pro forma ...................... $ (0.57) $ 0.07 $ (0.65)
-55-
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:
Options granted in years ended October 31 2004 2003 2002
- ------------------------------------------------------------------------------
Expected life (in years) 4.00 5.00 5.00
Risk-free interest rate 3.29% 2.00% 2.00%
Volatility 120.20% 126.00% 148.00%
Dividend yield 0.00% 0.00% 0.00%
The weighted average fair value of options granted during 2004, 2003, and 2002
was $2.93, $1.79 and $0.92 per option, respectively.
Advertising Costs:
Advertising expenditures are expensed as incurred. Advertising costs were
$204,000 in fiscal 2004 and $79,000 in fiscal 2003.
Income Taxes:
We account for income taxes in accordance with SFAS No. 109, Accounting for
Income Taxes. SFAS No. 109 requires recognition of deferred tax liabilities and
assets for the expected future tax consequences of items that have been included
in the consolidated financial statements or tax returns. Deferred income taxes
represent the future net tax effects resulting from temporary differences
between the financial statement and tax bases of assets and liabilities, using
enacted tax rates in effect for the year in which the differences are expected
to reverse. Valuation allowances are recorded against net deferred tax assets
where, in our opinion, realization is uncertain. The provision for income taxes
represents the net change in deferred tax amounts, plus income taxes payable for
the current period.
Net Earnings (Loss) Per Common Share:
Basic earnings per common share is computed by dividing net income (loss) by the
weighted average number of shares of common stock outstanding. Diluted earnings
per common share is computed by dividing net income (loss) by the weighted
average number of shares of common stock and common stock equivalents
outstanding. Common stock equivalents relate to stock options and warrants
include:
o 397,000 employee options to purchase common stock;
o 23,000 shares of common stock; and
o 30,000 warrants to purchase common stock for the year ended October
31, 2003.
Common stock equivalents of approximately 792,000 and 809,000 options are
excluded from the diluted earnings per share calculation for fiscal 2004 and
2002, respectively, due to their anti-dilutive effect.
-56-
Comprehensive Income:
Comprehensive income is defined as the change in equity of a business enterprise
during a period from transactions and other events and circumstances from
non-owner sources. Through October 31, 2004, we have not had any transactions
that were required to be reported in other comprehensive income and,
accordingly, comprehensive income (loss) is the same as net income (loss).
New Accounting Pronouncements:
In December 2004, the FASB issued SFAS No. 123R that amends SFAS No. 123
Accounting for Stock-Based Compensation, to require public entities (other than
those filing as small business issuers) to report stock-based employee
compensation in their financial statements. SFAS No. 123R will require us to
expense the fair value of unvested options and future grants of options over the
remaining vesting period. Unless modified, we will be required to comply with
the provisions of SFAS No. 123R as of the first interim period that begins after
June 15, 2005 (August 1, 2005 for us). We currently do not record compensation
expense related to our stock-based employee compensation plans in our financial
statements.
Reclassifications:
Certain reclassifications have been made to the financial statements to conform
to the prior presentation with no effect on net income (loss) or stockholders'
equity as previously reported.
2. INVENTORIES
Inventories at October 31, comprise the following (in thousands):
2004 2003
- -------------------------------------------------------------------------
Finished goods $ 1,343 $ 726
Parts and materials 583 1,154
------------ ------------
Total inventory $ 1,926 $ 1,880
============ ============
3. PROPERTY AND EQUIPMENT
Property and equipment at October 31, are comprised of the following (in
thousands):
2004 2003
- -------------------------------------------------------------------------
Machinery and equipment $ 4,708 $ 4,482
Furniture and fixtures 284 278
Leasehold improvements 118 118
------------ ------------
5,110 4,878
Less accumulated depreciation
and amortization (4,683) (4,489)
------------ ------------
$ 427 $ 389
============ ============
-57-
Depreciation and amortization expense totaled $213,000, $303,000 and $649,000
for the years ended October 31, 2004, 2003 and 2002, respectively. There was no
deprecation expense on capital leases in 2004.
The following is a schedule by years of future minimum lease payments under
capital leases together with the present value of the net minimum lease payments
as of October 31, 2004: (in thousands)
Year ending October 31:
2005 $ 44
2006 44
2007 44
2008 44
2009 43
Total minimum lease payments 219
Less: Amount representing interest(1) (55)
----
Present value of net minimum lease payments(2) $164
====
----------
(1) Amount necessary to reduce net minimum lease payments to present
value calculated at the actual lease interest rate at the inception
of the leases.
(2) Reflected in the balance sheet as other current liabilities and
other long-term liabilities of $25,000 and $139,000, respectively.
4. CAPITALIZED SOFTWARE COSTS
Capitalized software costs at October 31, 2004 and 2003 comprise the following
(in thousands):
2004 2003
- --------------------------------------------------------------------------
Purchased software $ 1,065 $ 929
Less accumulated amortization (1,017) (809)
----------- -----------
$ 48 $ 120
========== ==========
We capitalized $136,000, $48,000 and $105,000 of purchased software costs in
2004, 2003, and 2002 respectively. Amortization of capitalized software costs
totaled $208,000, $38,000, and $81,000 for the years ended October 31, 2004,
2003, and 2002, respectively. Included in the $208,000 software amortization
expense for fiscal 2004 is $126,000 related to write-downs of capitalized
software during the fourth quarter of fiscal 2004.
-58-
5. STOCKHOLDERS' EQUITY
In May 1999, our Board of Directors authorized us to repurchase up to 100,000
shares of our issued and outstanding Common Stock. During fiscal 1999 and 2000,
we repurchased 79,500 shares of our Common Stock in the open market for an
aggregate purchase price of approximately $409,000. We retired the 79,500 shares
of our Common Stock that we purchased under this repurchase program on October
16, 2003.
On April 30, 2002, we completed a private placement of 555,556 shares of Common
Stock at $1.80 per share plus a warrant to purchase 111,111 shares of common
stock, resulting in net cash proceeds of approximately $0.8 million. The warrant
has a term of three years and is exercisable at $2.00 per share. The equity
investment was made by Stonestreet L.P., of Ontario, Canada. The shares of
Common Stock and the shares of Common Stock associated with the warrants were
registered with the Securities and Exchange Commission and the registration
statement was declared effective on June 14, 2002. Stonestreet L.P. exercised
its warrant to purchase 111,111 shares of our Common Stock on October 9, 2003
for cash consideration of $222,222.
The fair value of the Stonestreet L.P. warrant of $164,000 on its issue date was
computed using the Black-Scholes option pricing model and was recorded as a
liability pursuant to EITF No. 00-19, Determination of Whether Share Settlement
is Within the Control of the Issuer for Purposes of Applying Issue 96-3, as cash
penalties could have been payable to Stonestreet LP in the event a registration
statement related to the private placement was not declared effective and
maintained. The registration statement was declared effective on June 14, 2002.
On August 22, 2002, the private placement subscription agreement was amended
such that no cash penalties are now payable with respect to the warrant.
Accordingly, as of August 22, 2002, the warrant was reclassified from
liabilities to equity at its fair value of $81,000, resulting in $83,000 of
other income.
In connection with the private placement we paid Vintage Partners a finder's fee
of $60,000 and warrants to purchase 21,429 shares of Common Stock. The warrants
have a three year term and are exercisable at $3.50 per share. During fiscal
2004, Vintage Partners exercised a portion of their warrants and purchased
11,429 shares of common stock for a total purchase price of $40,001.
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 $464,000.
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 paid Puglisi & Co. and its
associates a placement 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 value of approximately $225,000. This value was derived using the
"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. During fiscal 2004, Puglisi exercised a portion of their warrants and
purchased 70,000 shares of common stock for a total purchase price of $116,000.
-59-
During fiscal 2003, we issued 37,787 shares of our Common Stock to the
non-employee members of our Board of Directors in lieu of 50% of their cash
compensation. The value of the Common Stock of $43,000 was recorded as a general
and administrative expense.
During fiscal 2003, we issued 90,628 shares of our Common Stock to one of the
owners of Antares Microsystems, Inc. pursuant to the original purchase
agreement. The value of the Common Stock of $259,000
During fiscal 2004, we issued 30,000 shares of our Common Stock to an employee
who was one of the owners of Antares Microsystems, Inc. pursuant to the original
purchase agreement. The value of the Common Stock of $85,600.
In fiscal year 2004 and 2003 9,903 and11,012 shares of Common Stock were issued
under the Employee Stock Purchase Plan, respectively.
6. INCOME TAXES
The components of the benefit for income taxes for the years ended October 31,
2004, 2003 and 2002, comprise the following:
2004 2003 2002
- --------------------------------------------------------------------------------
Federal:
Current $ -- $ (18) $ (161)
Deferred -- -- --
State:
Current -- 1 (16)
Deferred -- -- --
------ ------ ------
Total benefit for income taxes $ -- $ (17) $ (177)
====== ====== ======
We recorded a tax benefit of $18,000 and $91,000 in fiscal 2003 and 2002,
respectively, due to refunds of federal income taxes related to the Job Creation
and Workers Assistance Act of 2002 which extends the net operating loss
carryback period from two to five years for losses generated in tax years ending
in 2002. We also filed amended federal and state tax returns to claim $86,000 in
research and development credits related to LMC in fiscal 2002. As of October
31, 2003, we received all of these tax refunds.
The effective income tax rate differs from the statutory federal income tax rate
for the following reasons:
2004 2003 2002
- ------------------------------------------------------------------------------
Statutory federal income tax rate (34.0)% (34.0)% (34.0)%
Change in valuation allowance 34.0 34.0 25.0
Other -- -- 1.0
------ ------ ------
(0)% (0)% (8.0)%
====== ====== ======
-60-
Significant components of our deferred tax balances as of October 31, 2004 and
2003 are as follows:
2004 2003
- --------------------------------------------------------------------------------
Deferred tax assets:
Current
Accrued employee benefits $ 25 $ 36
Inventory allowances 924 828
Allowance for doubtful accounts 17 39
Distributor reserves 8 --
Noncurrent
R&D credit carryforward 2,663 2,871
Net operating loss carryforwards 4,569 4,619
Refundable deposit -- 191
Reserve on shareholder note receivable 313 103
Depreciation and amortization, net 416 --
Restructuring costs 9 (25)
--------- ---------
Total deferred tax assets 8,944 8,662
--------- ---------
Deferred tax liabilities:
Deferred tax asset valuation allowance (8,944) (8,662)
--------- ---------
Net deferred tax assets $ -- $ --
========= =========
Valuation allowances are recorded to offset certain deferred tax assets due to
management's uncertainty of realizing the benefit of these items. The valuation
allowance increased by $282,000 in fiscal 2004 primarily as a result of
increases in inventory allowances, depreciation and amortization expense and a
reduction in the reserve on shareholder note receivable. These were have been
partially offset by decreases in net operating loss carryforwards and research
and development credit carryforwards. At October 31, 2004, we have research and
experimentation tax credit carryforwards of $1.8 million and $1.2 million for
federal and state tax purposes, respectively. These carryforwards expire in the
periods ending 2011 through 2024. The State R&D tax credits do not expire. We
have net operating loss carryforwards for federal and state income tax purposes
of approximately $12.7 million and $5.7 million, respectively, which expire in
periods ending 2005 through 2024.
Under the Tax Reform Act of 1986, the amounts of benefits from net operating
loss carryforwards may be impaired or limited as we have incurred a cumulative
ownership change of more than 50%, as defined, over a three-year period.
7. WARRANTY OBLIGATIONS AND OTHER GUARANTEES:
The following is a summary of our agreements that we have determined are within
the scope of FIN 45, ("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.
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
-61-
those claims, the warranty accrual will increase, resulting in decreased gross
margin.
The following table sets forth an analysis of our warranty reserve at October 31
(in thousands):
2004 2003
---- ----
Warranty reserve at beginning of period $ 53 $ 55
Less: Cost to service warranty obligations (33) (13)
Plus: Increases to reserves -- 11
---- ----
Total warranty reserve included in other accrued
expenses $ 20 $ 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 October 31, 2004 and 2003, respectively.
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 October 31, 2004 and 2003, respectively.
As discussed below, we are the secondary guarantor on the sublease of our
previous headquarters. We believe we will have no liabilities on this guarantee
and have not recorded a liability at October 31, 2004.
8. COMMITMENTS
We lease our buildings under noncancelable operating leases which expire at
various dates through the year 2007. Additionally, we have acquired assets with
capital lease obligations. Future minimum lease payments under noncancelable
operating leases and capital leases, are as follows (in thousands):
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Operating Capital
--------- -------
Year ending October 31:
2005 $ 963 $ 44
2006 626 44
2007 60 44
2008 -- 44
2009 and thereafter -- 43
------- -------
1,649 219
Less: total expected reimbursements
from sublease or interest (902) (55)
------- -------
Total minimum lease payments $ 747 $ 164
======= =======
In November 2001, we entered into a facilities lease for our engineering and
administrative headquarters located in San Ramon, California. The lease expires
in 2006. We expect our current facility to satisfy our anticipated needs through
the foreseeable future. Additionally, we assigned the lease related to our
former 63,000 square foot engineering and administrative headquarters facility
to a third-party corporation. The third party has assumed payment of the
remaining lease payments though the termination of the original lease in 2006
and we are a secondary guarantor.
Our rent expense under all operating leases, net of reimbursements for
subleases, for the years ended October 31, 2004, 2003 and 2002 totaled $384,000,
$434,000 and $549,000, respectively. We had reimbursements of sublease proceeds
of $637,000, $713,000 and $158,000 for the years ended October 31, 2004, 2003
and 2002, respectively.
In connection with the acquisition of Antares, we committed to issue 98,945
shares of our Common Stock in 20,000 share increments beginning January 2004 and
ending March 2005 to a selling shareholder of Antares. During fiscal 2004, we
issued 30,000 shares of our Common Stock of a committed 98,945 to an employee
who was one of the owners of Antares Microsystems, Inc. pursuant to the original
purchase agreement. We will issue the remaining 68,945 during fiscal 2005. The
value of the Common Stock issued in fiscal 2004 under this commitment was
$85,600.
In connection with the retirement of Mr. William Heye, Jr. as the company's
President and Chief Executive Officer, the Company will pay Mr. Heye $250,000 at
the rate of $20,833 each month for the period January 1, 2005 through December
31, 2005. The commitment to pay $250,000 has been accrued as of October 31, 2004
and is included in General and Administrative expense and Accrued Payroll and
Employee Benefits liability.
On May 13, 2004, we renewed our working capital line of credit for twelve months
until May 14, 2005. 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
4.75%, at October 31, 2004, plus 1.50%. Draw-downs on the credit line are based
on a formula equal to 80% of our domestic accounts receivable. As of October 31,
2004, due to the net loss for our fourth fiscal quarter of 2004, we are not in
compliance with all the covenants of our credit line. The Bank agreed to waive
the non-compliance with this covenant. We have not drawn down on this line of
credit and have no amounts payable at October 31, 2004.
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At October 31, 2004, we have two stock-based employee compensation plans, as
more fully described in note 9. We account for these plans under the recognition
and measurement principles of APB No. 25, Accounting for Stock Issued to
Employees and related interpretations. Stock-based employee compensation costs
are not reflected in net income when options granted under the plan had an
exercise price equal to the market value of the underlying common stock on the
date of grant. During the periods ending October 31, 2004, 2003 and 2002, we
recorded no compensation expense related to our stock-based employee
compensation plans. As discussed earlier, should we have determined compensation
cost utilizing the fair value approach, recorded stock compensation expense
would have been approximately $1.2 million, $200,000 and $700,000 in each of the
years ended October 31, 2004, 2003, and 2002, respectively.
9. STOCK OPTION AND STOCK PURCHASE PLANS
We sponsor two employee stock option plans, the 1996 Stock Option Plan (the
"1996 Plan") and the 1998 Non-Officer Stock Option Plan (the "1998 Plan"). A
total of 2,730,000 shares of Common Stock were reserved under the 1996 Plan at
October 31, 2003. A total of 650,000 shares of Common Stock are reserved under
the 1998 Plan. Stock options granted under the 1996 and 1998 Plans are
exercisable over a maximum term of ten years from the date of grant, vest in
various installments over a one to four-year period and have exercise prices
reflecting the market value of the shares of Common Stock on the date of grant.
Additionally, in 1991, stockholders approved a Non-Employee Director Stock
Option Plan (the "Director Plan"). A total of 340,000 shares of Common Stock are
reserved for issuance under the Director Plan. Options granted under the
Director Plan vest over a one to four-year period, expire five to seven years
after the date of grant and have exercise prices reflecting market value at the
date of grant.
At October 31, 2004 and 2003, 903,516 and 273,964 shares of Common Stock,
respectively, were available for grant under the 1996 Plan. A total of 26,250
and 3,939 shares of Common Stock were available for grant under the 1998 Plan at
October 31, 2004 and 2003, respectively. A total of 187,750 and 42,750 shares of
Common Stock were available for grant under the Director Plan at October 31,
2004 and 2003, respectively.
A summary of the combined activity under all of the stock option plans is set
forth below:
Weighted
Average
Number of Price Per Exercise
Shares Share Price
- -------------------------------------------------------------------------------
Outstanding at
October 31, 2001 1,419,003 $0.51 - $23.50 $ 6.18
Granted 809,000 $0.90--$1.80 $ 0.92
Cancelled or expired (458,730) $0.51--$23.50 $ 7.94
---------------------------------------------
Outstanding at
October 31, 2002 1,769,273 $0.90--$19.81 $ 3.32
Granted 140,500 $0.70--$2.86 $ 1.90
Cancelled or expired (285,238) $0.51--$19.81 $ 5.13
---------------------------------------------
Outstanding at
October 31, 2003 1,624,505 $0.70--$19.41 $ 2.90
Granted 422,500 $2.86--$7.13 $ 4.99
Cancelled or expired (50,750) $2.86--$7.00 $ 3.98
Exercised (182,012) $0.90--$5.13 $ 1.69
---------------------------------------------
Outstanding at
October 31, 2004 1,797,119 $0.70--$19.41 $ 3.48
=============================================
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The following table summarizes information with respect to all options to
purchase shares of Common Stock outstanding under the 1996 Plan, the 1998 Plan,
the Director Plan and the LMC Plan at October 31, 2004:
Options Outstanding Options Exercisable
=======================================================================================================
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
Range of Outstanding Contractual Life Exercise Exercisable Exercise
Exercise Price at 10/31/04 (years) Price at 10/31/04 Price
-------------- -------------- ---------------- ----------- ------------- ---------
$ 0.00 - $ 1.00 683,742 4.8 $ 0.91 653,666 $ 0.91
$ 1.01 - $ 2.50 144,376 4.5 $ 1.61 109,748 $ 1.70
$ 2.51 - $ 3.50 222,000 4.0 $ 2.73 179,557 $ 2.68
$ 3.51 - $ 5.50 479,802 4.8 $ 4.80 183,650 $ 5.09
$ 5.51 - $ 7.50 88,000 6.0 $ 7.01 2,000 $ 6.63
$ 7.51 - $ 9.50 107,699 1.5 $ 8.23 107,699 $ 8.23
$ 9.51 - $ 14.50 65,000 0.2 $ 13.23 65,000 $ 13.23
$ 14.51 - $ 19.85 6,500 2.6 $ 18.27 6,500 $ 18.27
--------- ---------
1,797,119 1,307,820
========= =========
We sponsor an Employee Stock Purchase Plan (the "Purchase Plan") under which
300,000 shares of Common Stock were reserved for issuance at October 31, 2004.
The Purchase Plan allows participating employees to purchase, through payroll
deductions, shares of our Common Stock at 85 percent of the fair market value of
the shares at specified dates. At October 31, 2004, 32 employees were eligible
to participate in the Purchase Plan and 58,559 shares were available for
issuance. In fiscal year 2004, 2003 and 2002, 9,903, 11,012 and 47,596 shares of
Common Stock were issued under the Purchase Plan, respectively.
10. NET INCOME (LOSS) PER SHARE:
Basic net income (loss) per common share for the years ended October 31, 2004,
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 years ended October 31, 2004 and 2002 have been
excluded from shares used in calculating diluted net loss per share because the
effect would have been anti-dilutive.
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YEARS ENDED OCTOBER 31
--------------------------------
2004 2003 2002
--------------------------------
BASIC EARNINGS PER SHARE:
Net income (loss) $(1,679) $ 563 $(1,731)
Number of shares for computation of
earnings per share 5,022 4,259 3,759
================================
Basic earnings (loss) per share $ (0.33) $ 0.13 $ (0.46)
================================
DILUTED EARNINGS PER SHARE:
Weighted average number of common
shares outstanding during the year 5,022 4,259 3,759
Assumed issuance of stock under warrant
plus stock issued the employee and
non-employee stock option plans (a) 450 (a)
--------------------------------
Number of shares for computation of
earnings per share 5,022 4,709 3,759
================================
Diluted earnings (loss) per share $ (0.33) $ 0.12 $ (0.46)
================================
- ---------
(a) In loss periods, common share equivalents would have an anti-dilutive
effect on net loss per share and therefore have been excluded.
11. EMPLOYEE SAVINGS AND INVESTMENT PLAN
We contribute a percentage of income before income taxes into an employee
savings and investment plan. The percentage is determined annually by the Board
of Directors. These contributions are payable annually, vest over five years,
and cover substantially all employees who have been employed by us at least one
year. Additionally, we make matching payments to the employee savings and
investment plan of 50% of each employee's contribution up to three percent of
employees' earnings.
For the years ended October 31, 2004, 2003 and 2002, total expense under the
employee savings and investment plan was $90,099, $61,730 and $99,471,
respectively.
12. CONCENTRATION OF CREDIT AND BUSINESS RISKS
Our trade accounts receivable are concentrated among a small number of
customers, principally located in the United States. Two customers accounted for
61% of our outstanding accounts receivable at October 31, 2004 compared to three
customers who accounted for more than 62% of total accounts receivable at
October 31, 2003. Ongoing credit evaluations of customers' financial condition
are performed and, generally, no collateral is required. We maintain an
allowance for doubtful accounts for potential credit losses. Actual bad debt
losses have not been material and have not exceeded our expectations. Trade
accounts receivable are recorded net of an allowance for doubtful accounts of
$42,000 and $90,000 at October 31, 2004 and 2003, respectively.
Sales to individual customers in excess of 10% of net sales for the year ended
October 31, 2004 included sales to HP of $4.9 million, or 45% and Nortel of $1.5
million or 13% of net sales compared to sales to HP in fiscal 2003 of $3.1
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million, or 45%, and sales to HP of $2.1 million, or 30%, and Lockheed Martin of
$0.8 million, or 12% of net sales, in fiscal 2002. International sales accounted
for 12%, 12% and 13% of total sales during fiscal 2004, 2003 and 2002,
respectively.
We depend on a limited number of customers for substantially all revenue to
date. Failure to anticipate or respond adequately to technological developments
in our industry, changes in customer or supplier requirements or changes in
regulatory requirements or industry standards, or any significant delays in the
development or introduction of products or services, could have a material
adverse effect on our business, operating results and cash flows.
Substantially all of our manufacturing process is subcontracted to two
independent companies. 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, could have a material adverse effect on our
business, operating results, financial condition and cash flows.
13. ACQUISITION OF ANTARES MICROSYSTEMS, INC.
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"). The acquisition enabled us to obtain intellectual property
such as the TCP/IP Offload Engine ("TOE") and other intellectual property which
we consider to be complementary to our business. While this product has reached
technological feasibility and is being capitalized as an intangible asset, we
continue to customize it to meet SBE's specific customer needs. We acquired
Antares for a purchase price of $75,000 in cash plus $582,000 in costs
associated with the payment of certain loan guarantees, legal fees, accounting
fees, broker fees, contract transfer fees and moving expenses and $211,000 in
cash to the selling shareholders of Antares. We also issued 90,628 shares of our
Common Stock with a market value at the time of issuance of $259,000 to one of
the selling shareholders and committed to issue 98,945 shares of our Common
Stock valued at $283,000 in 10,000 and 20,000 share increments beginning January
2004 and ending March 2005 to a selling shareholder of Antares.
A summary of the assets acquired and consideration paid is as follows:
Tangible assets acquired $ 187,000
Intellectual property 1,223,000
----------
Total assets acquired 1,410,000
Liabilities assumed --
----------
Net assets acquired $1,410,000
==========
Cash consideration or costs paid or to be paid $ 868,000
Fair value of stock provided 542,000
----------
Total consideration $1,410,000
==========
We used the purchase method of accounting for the acquisition and combined
Antares results of operations beginning August 7, 2003. We allocated the
purchase price to the tangible assets based on fair market value at the time of
the acquisition and to intellectual property based on future expected cash flows
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to be derived from the acquired product lines in addition to new products that
have reach technological feasibility, but have not gone into production.
The unaudited pro forma results are provided for comparative purposes only and
are not necessarily indicative of what actual results would have been had the
Antares acquisition, and the private equity offering transactions been
consummated on such dates, nor do they give effect to the synergies, cost
savings and other changes expected to result from the acquisitions. Accordingly,
the pro forma financial results do not purport to be indicative of results of
operations as of the date hereof or for any period ended on the date hereof or
for any other future date or period. Had we acquired Antares at the beginning
the prior period, our results of operations for would have been as follows:
For the Years ended October 31, 2003 2002
---- ----
Revenues $8,845 $10,702
Net loss (1,173) (2,665)
Basic loss per common share (0.28) (0.67)
Diluted earnings per common (0.25) (0.67)
We did not assume any of the liabilities associated with Antares. In connection
with the acquisition, we hired certain employees of Antares in order to continue
the development of the Antares TOE technology, which is not yet to market, and
other products of Antares. The TOE base technology is being readied for
commercial development. 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 5. 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.
We planned to amortize the intellectual property acquired in the Antares
acquisition to expense over 36 months which was the estimated useful life at the
time of acquisition. In the fourth quarter of fiscal 2004, after our annual
asset impairment review (see Intangible Assets in our Significant Accounting
Policies section of this report), we are behind in our roll-out of the new
product and with the change in market competition, we determined that there
exists considerable doubt that we would recover the remaining $713,000 balance
of the intellectual property asset that would have been on our balance sheet as
of October 31, 2004. As a result of this evaluation and determination we wrote
off the remaining balance. Including the normally scheduled amortization of the
intellectual property of $408,000 and the $713,00 write-down, the total non-cash
amortization expense included in our cost of goods for fiscal 2004 is $1.1
million. We recorded approximately $102,000 in amortization in fiscal 2003.
14. RESTRUCTURING COSTS
In response to the economic slowdown, we implemented restructuring plans in
fiscal 2002 and recorded restructuring charges of $446,000. Restructuring costs
for fiscal 2002 are comprised of severance costs associated with staff
reductions totaling $115,000 (we reduced our headcount from 47 employees to 24
employees during fiscal 2002), leasehold improvements and equipment write-downs
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related to the abandonment of our Madison, Wisconsin office of $185,000 and
accrued lease and brokerage costs totaling $146,000. We reached agreement with
the property owner to terminate the Madison office lease releasing us from
further obligations effective December 31, 2002.
As of October 31, 2004 and 2003 $21,000 and $58,000 of the restructuring costs
was included in other current liabilities, respectively.
In our third quarter of fiscal 2003, we recognized a restructuring benefit of
$154,000 after the final settlement of costs associated with prior real estate
and equipment leases.
The following table sets forth an analysis of the components of the
restructuring reserve and the payments made against it through October 31, 2004
(in thousands):
Restructuring accrual at October 31, 2003 $ 58
Less:
Cash paid and adjustment for accrued lease costs (37)
-------
Total restructuring costs included in liabilities $ 21
=======
15. LOAN TO OFFICER
On November 6, 1998, we made a loan to our retiring president and CEO which was
used by him to exercise an option to purchase 139,400 shares of our common stock
and related taxes. The loan, as amended, was collateralized by shares of our
common stock, bore interest at a rate of 2.48% per annum, due on December 14,
2003.
On October 31, 2002, we determined that it was probable that we would 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 against the loan at
October 31, 2002.
During the fourth quarter of fiscal 2003, the officer repaid $362,800 of the
loan and as a result, we recognized a benefit of $235,000 related to the
reversal of the loan impairment charge taken by us in fiscal 2002. During the
first quarter of fiscal 2004, the officer repaid the remaining loan balance in
full and as a result, we recorded a benefit of $239,000 relating to the reversal
of the remaining loan impairment charge.
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QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
(in thousands except First Second Third Fourth
per share amounts) Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------------
2004: Net sales $ 2,970 $ 2,977 $ 2,899 $ 2,220
Gross profit 1,645 1,560 1,540 (325)
Net income (loss) 527 54 79 (2,339)
Basic income (loss) per
common share $ 0.11 $ 0.01 $ 0.02 $ (0.47)
Diluted income (loss) per
common share $ 0.09 $ 0.01 $ 0.01 $ (0.47)
2003: Net sales $ 1,861 $ 1,767 $ 1,621 $ 2,207
Gross profit 1,128 1,088 1,062 1,429
Net income 91 51 141 280
Basic income per
common share $ 0.02 $ 0.01 $ 0.03 $ 0.07
Diluted income per
common share $ 0.02 $ 0.01 $ 0.03 $ 0.06
SBE, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED OCTOBER 31, 2004, 2003 AND 2002
(AMOUNTS IN THOUSANDS)
Column A Column B Column C Column D Column E
-------- -------- -------- -------- --------
Balance at Additions Balance
Beginning charged to costs End of
Description of Period and expenses Deductions Period
- ------------------------------------------------------------------------------------------
YEAR ENDED OCTOBER 31, 2004
Allowance for Doubtful Accounts
and sales programs $ 90 $ -- $ (48) $ 42
Allowance for Warranty Claims 53 -- (33) 20
Allowance for Deferred Tax Assets 8,662 295 -- 8,957
Allowance for Stockholder Loan 239 -- (239) --
YEAR ENDED OCTOBER 31, 2003
Allowance for Doubtful Accounts
and sales programs $ 93 $ 11 $ (14) $ 90
Allowance for Warranty Claims 55 11 (13) 53
Allowance for Deferred Tax Assets 8,593 69 -- 8,662
Allowance for Stockholder Loan 474 -- (235) 239
YEAR ENDED OCTOBER 31, 2002
Allowance for Doubtful Accounts
and sales programs $ 225 $ -- $ (132) $ 93
Allowance for Warranty Claims 56 -- (1) 55
Allowance for Deferred Tax Assets 8,080 513 -- 8,593
Allowance for Stockholder Loan -- 474 -- 474
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