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, 2005
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)
4000 Executive Parkway, 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 is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. Yes |_| No |X|
Indicate by check mark whether the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the Act. Yes |_| No |X|
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 |_|
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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|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes |_| No |X|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act. 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, 2005 as reported on the Nasdaq
SmallCap Market, was $11,877,000. 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, 2005 was 9,892,347.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for the
registrant's Annual Meeting of Stockholders, scheduled for March 21, 2006, 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 1A Risk Factors 15
Item 2 Properties 20
Item 3 Legal Proceedings 20
Item 4 Submission of Matters to a Vote of Security Holders 20
PART II
Item 5 Market for Registrant's Common Equity,
Related Stockholder Matters and Issuer
Purchases of Equity Securities 22
Item 6 Selected Financial Data 23
Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations 23
Item 7A Quantitative and Qualitative Disclosures about Market Risk 38
Item 8 Financial Statements and Supplementary Data 38
Item 9 Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 38
Item 9A Controls and Procedures 38
Item 9B Other Information 39
PART III
Item 10 Directors and Executive Officers of the Registrant 40
Item 11 Executive Compensation 40
Item 12 Security Ownership of Certain Beneficial Owners
and Management and Related Stockholder Matters 40
Item 13 Certain Relationships and Related Transactions 40
Item 14 Principal Accountant Fees and Services 40
PART IV
Item 15 Exhibits and Financial Statement Schedules 41
SIGNATURES 44
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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 of iSCSI software, 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 1A
Risk Factors" on page 15 and elsewhere in this Annual Report on Form 10-K.
PART I
ITEM 1. BUSINESS
Overview
SBE, Inc. engineers and provides standards based hardware and software products
to original equipment manufacturers (OEMs) who embed our products into their
systems to provide data storage and network connectivity solutions for the
enterprise storage and telecommunications markets.
Our operations are organized into two business segments: Embedded and Storage
Products. The Embedded Products segment designs and manufactures a broad range
of embedded computing products including Voice over IP (VoIP), T1/T3 adapter
cards and programmable intelligent processing platforms. Revenue from this
business segment in 2005 was $8.1 million, representing 100% of our total sales.
The Storage Products segment develops standards-based Internet Small Computer
System Interface (iSCSI) software for a newly emerging Internet Protocol (IP)
based storage market. The Storage business was purchased in July 2005 and had no
revenues in 2005.
We believe that there is a continuing trend towards the use of IP based software
and hardware solutions for storage and networking applications such as storage
and communications over the Internet. Industry experts in IP storage and VoIP
project growth trends that justify our efforts in these markets. Recent reports
from International Data Corporation (IDC) indicate that the iSCSI based IP
storage area networks (SAN) market will reach $296 million in 2005 and $2.7
billion by 2008. Reports from Infonetics Research indicate that the market for
VoIP products will grow to $5 billion in 2007. In fiscal 2005 we made
significant strategic moves to maximize our opportunities in the IP Storage and
VoIP communications markets. (i)
o We acquired PyX Technologies, Inc. (PyX), a privately-held software
company that developed iSCSI products for the enterprise storage
market. Developed by the Internet Engineering Task Force (IETF),
iSCSI is a storage protocol that offers customers the consolidation,
scalability, and management advantages of a SAN, without requiring
the use of unfamiliar, complex, and expensive Fibre Channel network
infrastructure. The iSCSI protocol is a block Input/Output (I/O)
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protocol implemented on industry standard TCP/IP, typically
Ethernet-based, networks. Among the many features it offers, iSCSI
provides remote access to secure multi-terabyte storage using
desktops, laptops, personal digital assistant (PDA), or other mobile
devices, and offers significant cost savings over existing storage
alternatives. By merging PyX's iSCSI software with SBE's traditional
embedded communications hardware, we believe that we now have the
necessary hardware technology and software to create
high-performance, cost-effective IP-based storage blades for use by
our traditional telecommunications customers as well as by OEMs in
the emerging IP SAN enterprise storage markets.
o We developed our digital signal processor (DSP) adapters that allow
us to leverage our current embedded adapter and intelligent carrier
card products to enable our existing customers to take advantage of
two significant markets: VoIP and Video over IP. A DSP is a
specialized microprocessor uniquely designed to facilitate high
speed audio and video processing. All of our DSP products can be
combined with our intelligent carrier card hardware plus our I/O and
connectivity modules to create a robust gateway on a blade that is a
critical component for building VoIP or Video over IP networks.
Among the primary reasons for the success of IP-based solutions are enhanced
functionality, reduced start-up costs, and lower cost of ownership. IP voice,
data and networked storage solutions are designed to address the expansion of
the virtual workforce, globalization, growth of communications traffic, and the
increased need for business agility by breaking down distance barriers and
enabling new ways to share and store information and collaborate in a global
business environment. Consequently, these new solutions provide businesses a
competitive edge with improved productivity and communication.
Our goal is to deliver exceptional value to our OEM customers by providing
IP-based products and services that set the standard for interoperability,
state-of-the-art functionality and ease of integration. Our unwavering focus on
meeting this goal extends from product design and system operation through
support and business operations. We believe this ultimately results in
significant customer advantages, including:
o Accelerated time-to-deployment. We position ourselves as an extension of
our customers' engineering teams, focusing on satisfying their
price/performance and time-to-market challenges through product
innovation, technological expertise, and comprehensive support. By doing
so, we reinforce the advantages and efficiencies of outsourcing embedded
hardware and software, and allow our customers to focus their resources on
their core competencies and value-added services.
o Full Standards Compliance Solutions. We help ensure rapid application
deployment and smooth integration into our customers' products by
utilizing and supporting industry standards-compliant hardware and
software development. We actively contribute and participate in key
industry organizations, such as the Storage Networking Industry
Association (SNIA), VME International Trade Association (VITA), and PCI
Industrial Computers Manufacturers Group (PICMG). SNIA brings together
vendors, resellers and consumers of data storage and storage networking
products/services to deliver architectures, education, and services that
will propel storage networking solutions into the broader market. VITA is
the champion for open technology in the bus and board market. PICMG is a
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consortium of over 450 companies who collaboratively develop
specifications that adapt Peripheral Component Interconnect, a local
computer bus standard developed by Intel Corporation (PCI), technology for
use in industrial and telecommunications computing applications. We plan
to continue to adopt and design products in compliance with
widely-accepted industry standards as it applies to new technologies,
including 10 Gigabit Ethernet (10G), iSCSI, AdvancedTCA (ATCA) and
AdvancedMC (AMC).
o Linux On Demand. We offer Linux Operating System (OS) support across all
of our board level and storage software products. Many of our customers
have and continue to develop on Linux platforms. Providing OEMs with Linux
drivers and board support packages helps reduce development overhead,
decrease deployment times and ensure successful product integration. We
plan to expand future developments on Linux-based products as well as
other emerging technologies that enable us to be well-positioned for
integration into next generation networking applications.
o Strategic Alliances. Our goal is to deliver superior solutions to our OEM
customers. We believe that partnerships with our OEM customers will
enhance our ability to reduce implementation times, increase application
availability, and provide the highest level of solution support to
customers. Our partners are vital to our success in this area, and we have
significant partner relationships with both hardware and software business
application companies including:
o LSI Logic, Inc. (LSI), a leading provider of application-specific
integrated circuit (ASICs) and storage solutions to bundle our iSCSI
software with their MegaRAID(R) 300-8X SATA RAID storage adapter.
This combined product is sold and marketed under the name iMegaRAID
by LSI.
o Texas Instruments (TI), is a leading provider of DSPs. We partner
with TI to supply the most advanced voice, video, and data
components available for integration into our voice and video over
IP solutions. We are a member of the TI TMS320(TM) third party
program, With more than 650 independent companies and consultants,
this program is one of the most extensive collection of global DSP
development support in the industry. Through our partnership with
TI, we believe that our customers have easy access to a broad range
of application software, development hardware and software and
consulting services.
o HCL Technologies (HCL), is a leading global solutions provider in
information technology (IT), IT infrastructure services and business
process outsourcing (BPO). We believe that our partnership with HCL
allows us to strengthen our ability to rapidly respond to a dynamic
business environment, adapt to changing market conditions, and
optimize technology resources for our storage software products.
o NComm provides comprehensive wide area network (WAN) solutions
coupling our high-performance WAN adapter cards with NComm's
intelligent top-level software drivers. Portable to any of our
customers' operating systems, NComm's Trunk Management Software
(TMS) performs all aspects of connectivity with our adapter
products, including alarming, performance monitoring and signaling.
We believe that this joint solution results in significant cost
savings for our customers and speeds up their time-to-market by 6-12
months.
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o We are collaborating with Signalogic, Inc., a Texas corporation, to
develop our VoIP products featuring TI's programmable DSPs with
Telogy Software(R) and Wintegra's WinPath network processor to
enable integration of voice, data, and fax over IP.
o We are an active member of Sun Microsystems' iForce and Solaris
Ready Partner programs. In addition, we supply a variety of SCSI,
Gigabit Ethernet and I/O adapters to Sun Professional Services and
other Sun-based organizations.
Products & Technologies
Over the past several years we have witnessed a proliferation of new
applications in the networking market relating to IP-based technologies. OEMs
are placing a heavy emphasis on cost-effective, feature-rich, highly
configurable, standards-based solutions that can be seamlessly integrated into
their systems. As the way we do business continues to change and evolve in the
face of new challenges, such as using the Internet for communications and
storage applications, networking infrastructure must change and evolve to
accommodate current business needs. IP technologies, such as iSCSI and VoIP,
have been touted by many as being "disruptive" technologies that will not only
create new industries, but will also change the way of life across the globe.
Our embedded hardware and software solutions enable storage and networking OEMs
to rapidly deploy next generation solutions in the storage, high-end enterprise
class server, data communications, and telecommunications markets. In catering
to both the IP storage and embedded markets, our solutions have been integrated
into a multitude of applications worldwide, including network attached storage
(NAS)/SAN gateways, disaster recovery solutions, virtual private networks
(VPNs), remote access devices, data/voice convergence, voice conferencing, VoIP
gateways, wireless networks, satellite communications, IP SANs, and mission
critical data centers.
Storage Products
iSCSI Storage Software Management Solutions
Developed to extend the reach of SANs by enabling SAN functionality over the IP
network, iSCSI technology uses the SCSI command set over TCP/IP, enabling any
requesting node on the IP network (the initiator) to contact any remote storage
server (the target) and perform block I/O on the target as if it was a local
hard drive. Because of the ubiquity of IP networks, iSCSI can be used to
transmit data over local area networks (LANs), WANs, or the Internet and can
enable location independent data storage and retrieval. iSCSI has no distance
limitations, can utilize existing network infrastructure, does not require
specialized training, and takes advantage of Ethernet's economies of scale. With
the immediate availability of 10G adapters and switches, we believe that iSCSI
SANs can more than double the performance levels of leading-edge Fibre Channel
implementations, while mass adoption continues to drive costs down.
Specifically, the availability of 10G copper-based equipment will make 10G
deployments even more affordable.
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Managing storage is regarded as one of the most burdensome responsibilities of a
company's data center management. In the direct-attached storage (DAS)
environments that most small to mid-sized companies deploy, the process of
managing storage is made more difficult by the number of physical connection
points and the number of storage systems in the organization. Imagine an
environment with ten computers, each with its own storage system. That creates
ten storage systems that need to be managed and maintained, which then equates
to ten times the effort normally required in order to handle storage expansion,
reallocation and repairs. One of the main driving forces behind a transition
from DAS to an IP SAN is often high data growth and the need for operations
efficiency. In these circumstances the legacy DAS environment becomes
increasingly complex, backup/restore operations become increasingly unreliable,
and the storage environment is unable to support the demands of the business. On
top of all that, regulatory compliance pressures, the need to integrate
geographically dispersed data assets, and the availability of effective
information life-cycle management solutions create further issues and serve as
drivers behind the move to IP SANs. Another significant driver behind IP SANs is
the availability of data center staff. Most smaller, regional, and departmental
data centers have to operate with limited staff. Often, the decision to move to
a SAN environment hinges on whether the existing staff can handle it. In these
cases an IP SAN solution becomes a viable alternative, since it can almost
always be more easily managed by existing staff and skill sets.
Designed for virtualizing physical media, iSCSI is ideal for storage
applications serving databases, streaming audio/video servers, as well as
clustered computing. iSCSI with full Error Recovery Level 2 (ERL2) enables
robust disaster recovery, back-up, and replication over remote sites via
existing IP WANs. Given its thin software layer, network administrators can turn
almost any TCP-enabled device into an iSCSI initiator or target, giving near
universal access to a network while preserving existing Ethernet investments.
Our iSCSI solution is scalable from Wi-Fi to 10G for IP SANs and we believe
delivers the same level of reliability, quality of service and system robustness
as alternative solutions, such as Fibre Channel, but at a fraction of the cost.
We believe that the advanced features designed into the architecture of our PyX
iSCSI protocol stack enables highly efficient and cost-effective storage
transport by optimizing bandwidth usage, enabling unlimited storage to be
attached to each target device, and leveraging existing network technologies.
Our iSCSI software provides multipathing I/O functionality for maximum
redundancy and reliability, aggregation of bandwidth to reduce service costs, as
well as multiple connections per session to increase bandwidth efficiency and
data integrity. Enterprise-level quality of service functionality enables
traffic to be consistently classified, prioritized, and queued at line rate. We
believe that the ERL2 featured in our PyX iSCSI protocol stack increases system
reliability, availability and adaptability. ERL2 supports active/active task
migration, which prevents session and data loss. Our iSCSI stack is fully tested
and compliant with IETF RFC-3720 iSCSI standards, including all mandatory and
optional feature sets. Our PyX iSCSI target supports most Linux distributions
and is compatible with any compliant iSCSI initiator under any OS distribution,
including Linux, Windows and Solaris. An additional benefit of using iSCSI
transport is its interoperability with any storage protocol (SCSI, Serial
Attached SCSI (SAS), Serial ATA (SATA), Fiber Channel drives).
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TCP/IP Offload Engine (TOE)
A TOE is a highly specialized TCP/IP protocol accelerator. Typically, in the
form of a network interface card (NIC), it is designed to reduce the amount of
host central processing unit (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 TOE card is
sold individually or bundled with our iSCSI software. It is designed to provide
fast, reliable, and secure access to networked storage devices via the Internet
without seriously impacting the host CPU.
Embedded Products
DSP and VoIP Gateways
DSP products have been used for years, performing accelerated number-crunching
for digital-to-analog and analog-to-digital signal conversion in systems, used
in audio, medical instrumentation, geological, military, and communications
applications. Targeting the next-generation of DSP applications interfacing to
the Internet, SBE recently announced two different products featuring TI's
latest ASICs supporting both VoIP and video over IP. These modules are available
as stand-alone solutions for existing systems or can be attached to our
intelligent processor platform in conjunction with other SBE I/O modules - to
create multifunction gateway "blades".
By building blades that are open-standards based and interoperable with
third-party equipment, we help to minimize network infrastructure costs by
facilitating seamless, multi-vendor environments for both media gateways and
softswitch/media gateway controllers. Additionally, our high-density DSP
products allow our customers to protect and leverage their investments in
existing DSP code, allowing them to reduce the time to market and minimize risk
by leveraging the scalability and programmability of our adapter's DSP farm with
an extensive selection of optimized algorithms.
VoIP Products. VoIP first emerged in the early 1990s as a way to conduct voice
conversations over the Internet without incurring telephone charges. Today, the
capacity, speed and reach of data networks are expanding much faster than
traditional circuit-switched voice networks. Voice over packet solutions, such
as VoIP, leverage those data network resources and contemporary packet-switching
technologies to generate new revenue opportunities and cost savings for both
competitive voice service providers and existing telecommunications carriers.
The result is that telecommunications companies are frantically investing in
VoIP infrastructure equipment. And while proprietary VoIP systems initially
helped establish the market, the trend is clearly toward open and interoperable
VoIP platforms that easily permit equipment makers and carrier customers to add
differentiable value.
Our VoIP module with unparalleled capacity, up to OC3, is based on the PTMC
standard form factor, and supports up to 2304 premium carrier class voice
channels. The TNET3010 DSPs are fully integrated with Telogy Software, the VoIP
industry's most widely deployed VoIP software which supports features for
compression, echo cancellation, voice activity detection, and many wireless
codecs. In telecommunications, codecs (short for coder/decoder) is a device that
encodes or decodes a signal. For example, telephone companies use codecs to
convert binary signals transmitted on their digital networks to analog signals
converted on their analog networks. In addition, a powerful on-board packet
processor, built by Wintegra, converts the DSP packet into an IP-compatible
packet.
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Voice, video, and data. For customers not needing VoIP related software, our
module based on TI's TMS6415 device provides a contemporary "triple play"
solution. Using TI's TMS6415 device, which is the world's first Gigahertz DSP,
translates into a new spectrum of application opportunities ranging from
adaptive antenna arrays to smart cars to artificial vision while increasing the
bandwidth and channel capacity of existing real-time applications, such as
wireless base stations, IP-based video, high-speed broadband networking, medical
diagnostics and radar.
Our 6415 product is based on the standard PTMC form factor, and is available
with up to eight DSP devices per board. TI's 64xx software development tools
allow Code Composer Studio, Chip Support Library and other libraries to operate
with the board.
Network Interface Cards
Wide Area Networking Adapters. A wide area network is a computer or
communications network that spans a relatively large geographical area.
Computers attached 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, VPN servers and VoIP gateways. We provide a broad
range of standards-based interfaces that can be easily integrated into our OEM
customers' products.
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 in an office environment. 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 one that is most commonly deployed.
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 adapters that
feature connectivity speeds of up to 10 Megabits (Mb)/second, 100 Mb/second or
1000 Mb/second. Our Gigabit Ethernet NICs include trunking and failover
features. These features allow our customers' systems to take advantage of
static load balancing and failure recovery within a user-defined communications
trunk. Our Gigabit Ethernet NICs are designed to distribute traffic across the
aggregated links, detect port failures, and increase throughput. In the event of
a system failure, the software will automatically redistribute outgoing loads
across the remaining links.
Storage Network Interface Cards. Our storage NICs are comprised of SCSI
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
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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 Megabytes
(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.
Encryption Adapters. Our securePMC series of high-performance security offload
solutions is designed for integration into Linux-based systems. Advanced
encryption processors accelerate SSL and IPsec cryptographic operations,
significantly improving security, performance, and availability of networking
applications. Designed to enable quick integration by OEMs, Value Added
Resellers (VARs) and end users, our securePMC adapters can be used in a wide
variety of networking equipment, including routers, switches, web servers,
server load balancers, firewalls, SANs and VPN gateways.
Intelligent Communications Controllers
Our 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 and Advanced
Intelligent Network 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 telecommunications entrants to pursue
cost-reduced and performance-enhanced network architectures based on IP,
broadband or other "packet" technologies.
Other
Although we continue to sell and manufacture legacy products such as Multibus,
Versa Module Europa (VME)bus, and ISA, we emphasize four principal lines of
products: iSCSI software, DSP products, WAN/LAN connectivity products, and
carrier platforms (also known as our "HighWire" line).
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The following table shows sales by major product type as a percentage of net
sales for fiscal 2005, 2004 and 2003:
Year Ended October 31,
2005 2004 2003
---------------------------------------------
(percentage of net sales)
VME 20% 43% 53%
WAN Adapter 39 34 30
LAN Adapter 8 8 5
Storage NIC 1 4 2
HighWire 32 11 10
---------------------------------------------
100% 100% 100%
=============================================
Distribution, Sales, and Marketing
We sell and license 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 how our products differ from those of our competitors.
Since our products represent a complex and technical sale, our sales force is
supported by field 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 signed an agreement with LSI to bundle our iSCSI target software product
with their MegaRAID SATA-II adapters, for a product LSI markets as "iMegaRAID".
As the worldwide leader in SATA adapter boards, LSI will sell iMegaRAID directly
and through their manufacturer's representatives. We will continue to support
LSI and its sales channel to identify and cultivate future business
opportunities.
We have focused our sales and marketing efforts in North America, Europe and
Asia. All of our international sales are negotiated and executed in U.S.
dollars. International sales constituted 37%, 12% and 12% of net sales in fiscal
2005, 2004 and 2003, respectively. Our international sales are primarily in
Europe.
Our direct sales force is based in four locations in the United States and we
conduct our marketing activities from our corporate headquarters in San Ramon,
California.
Research and Development
We continue to invest in research and development of current and emerging
technologies that we deem critical to maintaining our competitive position in
the storage and communications markets. Many factors are involved in determining
the strategic direction of our product development focus, including trends and
developments in the marketplace, competitive analyses, market demands, business
conditions, 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 storage
and communications arenas.
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Our product development efforts are focused principally on our strategic product
lines, providing high bandwidth connectivity, computing solutions and advanced
iSCSI software features that serve a wide range of networking and storage
applications. Leveraging our experience in iSCSI storage software and high-speed
communications enables us to develop integrated hardware and software storage
solutions for our customers. We believe that the development of new
internetworking products, high-performance communications controllers and
enabling storage software is essential to expanding our customer base,
penetrating new markets, and retaining existing customers.
During fiscal 2005, we acquired PyX and continued development of the PyX iSCSI
software products to bring a broader spectrum of IP storage solutions to market.
During the year, we also continued to focus on further expanding our line of
standards-based intelligent carrier platforms, two DSP products,
upgrading/enhancing software drivers, and developing new products based on the
emerging AMC form factor.
During fiscal 2005, 2004 and 2003, we incurred $2.7 million, $2.4 million and
$1.3 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. These audits are deigned to 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 one of our many methods for assuring that we meet our customer
expectations.
Manufacturing
We do not engage in any manufacturing operations. Instead, we utilize
third-party manufacturers to build our embedded hardware 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 cost-efficient and timely product delivery, thus allowing us to focus on
our core competencies of product development and technology innovation. The use
of external manufacturing partners allows us to respond more quickly and
effectively to fluctuations in customer demand.
Competition
The market for both storage 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
varies principally by application segment. Our iSCSI storage software product
competes with products designed and/or manufactured by Wasabi Systems,
StringBean Software, FalconStor Software and UNH. Our intelligent communications
-13-
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 WAN/LAN 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, Adaptec, Qlogic
and Sun Microsystems, Inc. Our TOE products compete with Qlogic and Adaptec. To
compete and differentiate ourselves in our markets, we emphasize the
functionality, engineering support, quality and price of our product in relation
to the products of our competitors, as well as our ability to customize our
products to meet the customers' specific application needs.
Additionally, we compete with the internal engineering resources of our
customers. Typically, as our customers become successful with their products,
they seek to reduce costs and integrate functions. To compete with the internal
engineering resources of our customers, we position ourselves as an extension of
our customers' engineering teams, focusing on satisfying their price/performance
and time-to-market challenges through product innovation, technological
expertise, and comprehensive support. By doing so, we emphasize the advantages
and efficiencies of outsourcing embedded hardware and software, and keeping
internal engineering resources focused on their core competencies and
value-added services.
Intellectual Property
We believe that innovation in product engineering, sales, marketing, support,
and customer relations, and protection of 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 typically enter into confidentiality
agreements with our employees, strategic partners, channel partners and
suppliers, and enforce strict limitations and access to our proprietary
information.
Backlog
On October 31, 2005, we had a sales backlog of product orders of approximately
$1.2 million, compared to a sales backlog of product orders of approximately
$2.5 million, including $1.0 million in orders from the Hewlett Packard Company
(HP), as of October 31, 2004. 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 fulfilling
our current backlog.
Employees
Our employees represent one of our most valuable assets. 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. We promote employee-focused programs designed to foster a positive
and productive work environment, including specialized training/development,
in-house seminars, and team-building activities.
-14-
On December 31, 2005, we had 37 employees. None of our employees are represented
by a labor union. We have experienced no work stoppages. We believe our employee
relations are positive.
ITEM 1A. RISK FACTORS
In addition to the other information in this Annual Report on Form 10-K,
stockholders or prospective investors should carefully consider the following
risk factors:
Risks Related to Our Business
We may not realize any anticipated benefits from the acquisition of PyX.
We acquired PyX on July 26, 2005. While we believe that our opportunities are
greater than our opportunities prior to the acquisition and that we will be able
to create substantially more stockholder value, there is substantial risk that
the synergies and benefits sought in the acquisition might not be fully
achieved. There is no assurance that PyX's technology can be successfully
integrated into our existing product platforms or that our financial results
will meet or exceed the financial results that would have been achieved absent
the acquisition. As a result, our operations and financial results may suffer
and the market price of our common stock may decline.
If PyX's products contain undetected errors, we could incur significant
unexpected expenses and experience product returns and lost sales.
The iSCSI software products developed by PyX are highly technical and complex.
While PyX's products have been tested, because of their nature, we can not be
certain of their performance either as stand-alone products or when integrated
with our existing product line. Because of PyX's short operating history, we
have little information on the performance of its products. There can be no
assurance that defects or errors may not arise or be discovered in the future.
Any defects or errors in PyX's products discovered in the future could result in
a loss of customers or decrease in net revenue and market share.
We depend upon a small number of OEM customers. The loss of any of these
customers, or their failure to sell their products, could limit our ability to
generate revenues. In particular, the HP ceased to be a significant customer of
ours in the first quarter of fiscal 2005, and our success depends on being able
to replace net sales previously attributable to HP with sales to other
customers.
In fiscal 2005 and 2004, sales of VME products to HP accounted for 13% and 45%,
respectively, of our net sales. We made our final shipment for $1.0 million of
our VME products to HP in the first quarter of fiscal 2005. Our future success
depends on being able to replace net sales previously attributable to HP with
sales to other customers. 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 or that we will become a
qualified supplier with new OEM customers or remain a qualified supplier with
existing OEM customers.
-15-
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, could have a material adverse effect on our operating results,
financial condition and cash flows.
A failure to collect outstanding accounts receivable from any of our OEM
customers could 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.
The development and marketing of our products is capital-intensive. We believe
that our existing cash balances and our anticipated cash flow from operations
will satisfy our working capital needs for the foreseeable future. Declines in
our sales or a failure to keep expenses in line with revenues could require us
to seek additional financing in fiscal 2006. In addition, should we experience a
significant growth in customer orders or wish to make strategic acquisitions of
a business or assets, 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.
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 chip sets used in some of our products are currently available only from a
single supplier. If these suppliers discontinue or upgrade some of the
components used in our products, we could be required to redesign a product to
incorporate newer or alternative technology. The inability to obtain sufficient
key components as required, or to develop alternative sources if and as required
in the future, could result in delays or reductions in product shipments or
margins that, in turn, would have a material adverse effect on our business,
operating results, financial condition and cash flows. If enough components are
unavailable, we may have to pay a premium in order to meet customer demand.
Paying premiums for parts, building inventories of scarce parts and obsolescence
of existing inventories could lower or eliminate our profit margin, reduce our
cash flow and otherwise harm our business. To offset potential component
shortages, we have in the past, and may in the future, carry an inventory of
these components. As a result, our inventory of components parts may become
obsolete and may result in write-downs.
If we fail to develop and produce new products, we may lose sales and our
reputation may be harmed.
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, third generation wireless
services (3G Wireless), SATA, iSCSI, SAS, Gigabit Ethernet, 10G 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 obsolete.
-16-
We have focused a significant portion of our research and development, marketing
and sales efforts on VoIP, HighWire, WAN and LAN adapters, 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, market acceptance of our products and our ability to sell our
products. If the VoIP, iSCSI, HighWire, TOE 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.
Our iSCSI and VoIP products will require a substantial product development
investment by us and we may not realize any return on our investment.
The development of new or enhanced products is a complex and uncertain process.
As we integrate the PyX iSCSI products into our product line, our customers may
experience design, manufacturing, marketing and other difficulties that could
delay or prevent the development, introduction or marketing of new products and
enhancements, both to our existing product line as well as to the PyX and VoIP
products. Development costs and expenses are incurred before we generate any net
revenue from sales of the products resulting from these efforts. We expect to
incur substantial research and development expenses relating to the iSCSI and
VoIP product lines, which could have a negative impact on our earnings in future
periods.
The storage and embedded products market is intensely competitive, and our
failure to compete effectively could reduce our revenues and margins.
We compete directly with traditional vendors of storage software and hardware
devices, including Fibre Channel SAN products, open source "free" software, TOE
and application-specific storage solutions. We compete with communications
suppliers of routers, switches, gateways, network interface cards and other
products that connect to the Public Switched Telephone Network (PSTN) and the
Internet. In the future, we expect competition from companies offering
client/server access solutions based on emerging technologies such as Fibre
Channel, switched digital telephone services, iSCSI, SAS, TOE, VoIP and other
technologies. In addition, we may encounter increased competition from operating
system and network operating system vendors to the extent that 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) and storage product providers (such as
EMC Corporation, Network Appliance, Inc. and Qlogic Corporation).
Increased competition with respect to any of our products could result in price
reductions and loss of market share, which would adversely affect our business,
operating results, financial condition and cash flows. Many of our current and
potential competitors have greater financial, marketing, technical and other
resources than we do. There can be no assurance that we will be able to compete
successfully with our existing competitors or will be able to compete
successfully with new competitors.
-17-
We depend on our key personnel. If we are unable to retain our current personnel
and hire additional qualified personnel as needed, our business will be harmed.
We are highly dependent on the technical, management, marketing and sales skills
of a limited number of key employees. We do not have employment agreements with,
or life insurance on the lives of, any of our key employees. The loss of the
services of any key employees could adversely affect our business and operating
results. Our future success will depend on our ability to continue to attract
and retain highly talented personnel to the extent our business grows.
Competition for qualified personnel in the networking and software industries,
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.
We may be unable to protect our software, which could reduce any competitive
advantage we have.
Although we believe that our future success will depend primarily on continuing
innovation, sales, marketing and technical expertise and the quality of product
support and customer relations, we must also protect the proprietary technology
contained in our products. We do not currently hold any patents and rely on a
combination of copyright, trademark, trade secret laws and contractual
provisions to establish and protect proprietary rights in our products. There
can be no assurance that steps taken by us in this regard will be adequate to
deter misappropriation or independent third-party development of our technology.
Although we believe that our products and technology do not infringe on the
proprietary rights of others, there can be no assurance that third parties will
not assert infringement claims against us.
Risks Associated with Ownership of Our Common Stock
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 price of the
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
common stock has historically had relatively small trading volumes. As a result,
small transactions in our common stock can have a disproportionately large
impact on the quoted price of our common stock.
If we continue to experiences losses we could experience difficulty meeting our
business plan, and our stock price could be negatively affected.
We may experience operating losses and negative cash flow from operations as we
develop and market the iSCSI software solution acquired in the PyX acquisition.
Any failure to achieve or maintain profitability could negatively impact the
market price of our common stock. Historically, PyX has not been profitable on a
quarterly or annual basis, and we expect that the combined company will incur
net losses for the foreseeable future. We anticipate that we will continue to
-18-
incur significant product development, sales and marketing and administrative
expenses. As a result, we will need to generate significant quarterly revenues
if we are to achieve and maintain profitability. A substantial failure to
achieve profitability could make it difficult or impossible for us to grow our
business. Our business strategy may not be successful, and we may not generate
significant revenues or achieve profitability. Any failure to significantly
increase revenues would also harm our ability to achieve and maintain
profitability. If we do achieve profitability in the future, we may not be able
to sustain or increase profitability on a quarterly or annual basis.
Future sales of our common stock, including shares issued in the PyX acquisition
and the private placement could cause the market price for our common stock to
significantly decline.
Sales of substantial amounts of our common stock in the public market could
cause the market price of our common stock to fall, and could make it more
difficult for us to raise capital through public offerings or other sales of our
capital stock. In addition, the public perception that these sales might occur
could have the same undesirable effects. The PyX shareholders who received
shares of our common stock in the PyX acquisition entered into agreements that
provide, in part, that, with respect to 95% of the shares of our common stock
that the shareholder received in connection with the acquisition, the
shareholder will not sell these shares until one year after the acquisition is
completed. We registered for the resale all of the shares that we issued in the
merger and private placement effective November 14, 2005. The purchasers in the
private placement are not subject to any lockup with respect to the shares they
purchased in the private placement. As a result, sales under the registration
statement will include a very substantial number of shares and percentage of our
common stock. Holders of approximately 46.7% of the outstanding shares of our
common stock will have the right to sell their shares pursuant to these
registration rights and holders of an additional approximately 5.7% of the
outstanding shares of our common stock, assuming no further issuances of shares
of our common stock, will have the right to sell their shares after the one year
period has passed. Such free transferability could materially and adversely
affect the market price of our common stock.
Our common stock has been at risk for delisting from the Nasdaq SmallCap Market.
If it is delisted, our stock price and your liquidity may be impacted.
Our common stock is currently listed on the Nasdaq SmallCap Market. Nasdaq has
requirements that a company must meet in order to remain listed on the Nasdaq
SmallCap Market. These requirements include maintaining a minimum closing bid
price of $1.00 and minimum stockholders' equity of $2.5 million. Our
stockholders' equity as of October 31, 2005 was approximately $17.3 million and
our closing bid price on October 31, 2005 was $2.60. Although we currently meet
all of the minimum continued listing requirements for the Nasdaq SmallCap
Market, should our stock price decline, our common stock could be subject to
potential delisting from the Nasdaq SmallCap Market.
If we fail to maintain the standards necessary to be quoted on the Nasdaq
SmallCap Market and our common stock is delisted, trading in our common stock
would be conducted on the OTC Bulletin Board as long as we continue to file
reports required by the Securities and Exchange Commission. The OTC Bulletin
Board is generally considered to be a less efficient market than the Nasdaq
SmallCap Market, and our stock price, as well as the liquidity of our common
stock, may be adversely impacted as a result.
-19-
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 October 2005, we relocated our engineering and administrative headquarters to
22,000 square feet of leased space located in San Ramon, California. The lease
expires in 2010. We expect the facility to satisfy our anticipated needs for the
foreseeable future. We terminated the lease for our 15,000 square foot
engineering and headquarters that we previously occupied, effective September
2005 without penalty. In December 2001 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 March 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 2005.
IDENTIFICATION OF EXECUTIVE OFFICERS
Our executive officers and their respective ages and positions as of October 31,
2005 are set forth in the following table. There are no familial relationships
between our directors or our executive officers and any other director or
executive officer.
Name Age Position
- --------------------------------------------------------------------------------
Daniel Grey 50 President and Chief Executive Officer
David W. Brunton 55 Vice President, Finance, Chief Financial
Officer, Treasurer and Secretary
Andre Hedrick 39 Chief Technical Officer
Greg Yamamoto 49 Vice President and General Manager, Storage
-20-
Mr. Grey has served as President and Chief Executive Officer since January 1,
2005. He was the Company's Senior Vice President Sales and Marketing from May
2001 through his appointment as President and Chief Executive Officer. For the
18 months prior to joining SBE, Inc. (SBE), he was the Senior Vice President of
Sales for SBS Technologies, Inc., a supplier of embedded systems to OEMs. From
1999 to 2000, Mr. Grey was Vice President of Sales for 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., a supplier of embedded
systems to OEMs. From 1989 to 1996, Mr. Grey served as the Director of Western
Sales for SBE.
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. Hedrick joined SBE in July 2005 as Chief Technical Officer following SBE's
acquisition of PyX Technologies. Prior to co-founding PyX in 2002, Mr. Hedrick
served as Chief Technology Officer with ASL, Inc., a leading Linux-based
workstation and server manufacturer in 2001. From 2000 to 2001 Mr. Hedrick was
Director of Software Development for Atipa Inc.. Hedrick served as a maintainer
of the Linux ATA/ATAPI Subsystem, and has been an active member of several
well-recognized industry organizations, including the National Committee for
Information Technology Standards T13 Technical Committee and the Serial ATA
Working Group.
Mr. Yamamoto joined SBE as Vice President and General Manager of the Storage
Group following the acquisition of PyX Technologies, Inc in July 2005, where he
had served as Chief Executive Officer since January 2005. Prior to PyX, Mr.
Yamamoto was Co-Founder and COO of DataPath Systems, Inc., a developer of
mixed-signal communication integrated circuits, which was acquired by LSI Logic,
Inc. in July 2000. Mr. Yamamoto was Senior Director of Business Development for
the Storage and Communications Division of LSI Logic, Inc. from July 2000 until
December 2004.
-21-
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
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, 2005, there were approximately 394 holders of
record of our common stock.
Fiscal quarter ended
-------------------------------------------------
Fiscal 2005 January 31 April 30 July 31 October 31
- --------------------------------------------------------------------------------
High $ 4.59 $ 3.55 $ 3.65 $ 3.50
Low 3.03 2.30 2.09 2.17
Fiscal 2004
High $ 8.49 $ 7.34 $ 4.08 $ 3.19
Low 4.76 3.90 2.81 2.68
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.
The following table includes information regarding our equity incentive plans as
of the end of fiscal 2005.
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)
Equity compensation plans
approved by security holders 4,871,664 (1) $2.80 509,273
Equity compensation plans
not approved by security
holders 512,040 (2) $2.49 53,429
--------- ----- -------
Total 5,383,704 $2.77 562,702
--------- ----- -------
(1) Includes options to purchase 2,038,950 shares our common stock at $2.17
per share pursuant to the PyX 2005 Employee Stock Option Plan assumed by
us as part of the PyX acquisition.
(2) See Footnote 11 "Stock Option and Stock Purchase Plans " to the SBE, Inc.
financial statements.
-22-
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Financial Statements and the Notes thereto included
elsewhere in this Form 10-K.
For years ended October 31,
and at October 31 2005 2004 2003 2002 2001
- ----------------------------------------------------------------------------------------------------------------
(in thousands, except for per share amounts and number of employees)
Net sales $ 8,056 $ 11,066 $ 7,456 $ 6,898 $ 7,726
Net income (loss) $ (4,230) $ (1,679) $ 563 $ (1,731) $ (9,896)
Net income (loss) per share - basic $ (0.66) $ (0.33) $ 0.13 $ (0.46) $ (2.92)
Net income (loss) per share - diluted $ (0.66) $ (0.33) $ 0.12 $ (0.46) $ (2.92)
Product research and development $ 2,694 $ 2,411 $ 1,330 $ 3,027 $ 5,652
Expenses
Working capital $ 5,520 $ 3,939 $ 3,945 $ 2,985 $ 7,595
Total assets $ 18,832 $ 6,173 $ 6,975 $ 5,321 $ 10,690
Long-term liabilities $ 241 $ 139 $ 217 $ 10 $ 4,870
Stockholders' equity $ 17,348 $ 4,303 $ 5,387 $ 3,696 $ 4,119
Number of employees 37 36 32 24 47
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
We engineer and provide standards-based hardware and software products to OEMs
who embed our products into their systems to provide data storage and network
connectivity solutions for the enterprise storage and telecommunications
markets. Our products include iSCSI storage software, WAN and LAN adapters,
intelligent carrier cards and TOE NICs. These products perform critical IP-based
transport, computing, processing offload, 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, communications network applications, NAS, SAN 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 operations are organized into two business segments: Embedded and Storage
Products. The Embedded Products segment designs and manufactures a broad range
of embedded computing products including VoIP, T1/T3 adapter cards and
programmable intelligent processing platforms. Revenue from this business
segment in 2005 was $8.1 million, representing 100% of our total sales. The
Storage Products segment develops standards based iSCSI software for a newly
emerging IP based storage market. The Storage business was purchased in July
2005 and had no revenues in 2005.
-23-
Our business is characterized by a concentration of sales to a small number of
OEMs and distributors who provide products and services to the communications
and data storage markets. Consequently, the timing of significant orders from
major customers and their product cycles cause fluctuation in our operating
results. Data Connection Limited (DCL) was the largest of our customers
representing 28% of our sales in fiscal 2005. HP has historically been one of
our largest customer and represented 13%, 45% and 45% of net sales in fiscal
2005, 2004 and 2003, respectively. We shipped the last $1.0 million of VME
products to HP in the first quarter of fiscal 2005. We do not expect to receive
any future purchase orders from HP for our VME products.
During the year ended October 31, 2005, 2004 and 2003, $640,000, or 8% of sales,
$874,000, or 8% of sales and $191,000 or 3% of our sales, respectively were sold
to distributors. Our reserves for distributor programs totaled approximately
$22,000 as of October 31, 2005 and 2004, respectively.
In the next few years, we expect our net sales will be generated primarily
through licensing our iSCSI storage software products followed by sales of our
DSP/HighWire VoIP gateway products with Linux software. We have begun to see
market acceptance of our iSCSI software products and have signed software
license contracts with four OEMs in the storage marketplace including LSI Logic,
Inc for integration into their newly introduced iMegaRAID(R) adapter product and
OnStor, Inc for use in their NAS/SAN storage gateway product. To date, our iSCSI
software products have been successfully integrated into solutions serving a
variety of applications, including security surveillance, storage
virtualization, NAS, remote access server (RAS) and SAN storage systems. Our
most recent iSCSI customer is using our iSCSI software in conjunction with our
TOE NIC in a storage gateway switching product.
Although we expect to see sales growth in our iSCSI products as these products
continue to gain market acceptance, there can be no assurance that such an
increase or adoption will occur. We also expect to see continued slowness in the
sale of our adapter products, but are encouraged by the acceptance of our
HighWire products and expect to see continued growth in these high margin
products. In addition, we will continue to sell and support our legacy VME
products, but expect sales for them to decline significantly as the OEM products
in which they are embedded are phased out.
In the future 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.
On October 31, 2005, we had a sales backlog of product orders of approximately
$1.2 million compared to a sales backlog of product orders of approximately $2.5
million as of October 31, 2004. Included in the 2004 backlog are orders from HP
of $1.0 million.
-24-
Critical Accounting Policies and Estimates
The preparation of 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:
Hardware Products
Our policy is to recognize revenue for hardware product sales when title
transfers and risk of loss has passed to the customer, which is generally upon
shipment of our hardware products to our customers. 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 sold (COGS) at the time of shipment. Our policy complies with
the guidance provided by the Securities and Exchange Commission's Staff
Accounting Bulletin (SAB) 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 hardware products is considered
incidental. Therefore, we do not recognize software revenue related to our
hardware products separately from the hardware product sale.
When selling hardware, our agreements with OEMs, such as DCL and Nortel Networks
Corp. (Nortel), typically incorporate clauses reflecting the following
understandings:
- all prices are fixed and determinable at the time of sale;
- title and risk of loss pass at the time of shipment (FOB shipping
point);
- collectibility of the sales price is probable (the OEM is
creditworthy, 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 25% 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 products of ours equal to at least the dollar value of the products
that they want to rotate.
-25-
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 they place their next order with us. We
record an allowance for price protection at the time of the price reduction,
thereby 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. We believe we are able to fully
evaluate potential returns and adjustments and continue to recognize the sale
based on shipment to our distributors. Reserves for the right of return and
restocking are established based on the requirements of Financial Accounting
Standards Board (FASB) Statements of Financial Accounting Standards (SFAS) 48,
Revenue Recognition when Right of Return Exists.
Software Products
With the acquisition of PyX, we will also derive future revenues from the
following sources: (1) software, which includes new iSCSI target and initiator
software licenses and (2) services, which include consulting. We account for the
licensing of software in accordance with SOP 97-2, Software Revenue Recognition.
The application of SOP 97-2 requires judgment, including whether a software
arrangement includes multiple elements, and if so, whether vendor-specific
objective evidence (VSOE) of fair value exists for those elements. Customers
receive certain elements of our products over a period of time. These elements
include free post-delivery telephone support and the right to receive
unspecified upgrades/enhancements of our iSCSI software on a
when-and-if-available basis, the fair value of which is recognized over the
product's estimated life cycle. Changes to the elements in a software
arrangement, the ability to identify VSOE for those elements, the fair value of
the respective elements, and changes to a product's estimated life cycle could
materially impact the amount of earned and unearned revenue. Judgment is also
required to assess whether future releases of certain software represent new
products or upgrades and enhancements to existing products. We will defer all
revenue related to the sale of our software products and amortize the deferred
revenue over its estimated life.
For software license arrangements that do not require significant modification
or customization of the underlying software, we will recognize new software
license revenue when: (1) we enter into a legally binding arrangement with a
customer for the license of software; (2) we deliver the products; (3) customer
payment is deemed fixed or determinable and free of contingencies or significant
uncertainties; and (4) collection is reasonably assured. Substantially, all of
our new software license revenue will be recognized in this manner. No software
license revenue has been recognized to date.
As of October 31, 2005, we have deferred all license revenue related to software
arrangements until the specified upgrade is delivered. Once the specified
upgrade is delivered, revenues for the license will be recognized over the term
of the contract or over the economic life of the product, whichever is shorter..
If there is significant uncertainty about the project completion or receipt of
payment for the services, revenue is deferred until the uncertainty is
sufficiently resolved.
-26-
Certain software arrangements include consulting implementation services sold
separately under consulting engagement contracts. Consulting revenues from these
arrangements are generally accounted for separately from new software license
revenues because the arrangements qualify as service transactions as defined in
SOP 97-2. The more significant factors considered in determining whether the
revenue should be accounted for separately include the nature of services (i.e.,
consideration of whether the services are essential to the functionality of the
licensed product), degree of risk, availability of services from other vendors,
timing of payments and impact of milestones or acceptance criteria on the
realizability of the software license fee.
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 their business, we record a specific allowance to reduce the related
receivable to the amount we expect to recover. Should all efforts fail to
recover the related receivable, we will write-off the account.
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 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:
Inventories are stated at the lower of cost, using the first-in, first-out
method, or market value. We utilize standard cost, which approximates actual
costs for certain indirect costs.
-27-
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.
Income Taxes:
We account for income taxes in accordance with SFAS No. 109, Accounting for
Income Taxes (SFAS 109) . SFAS 109 requires recognition of deferred tax
liabilities and assets for the expected future tax consequences of items that
have been included in the 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. Based on the uncertainty of
future pre-tax income, we fully reserved our deferred tax assets as of October
31, 2005 and 2004, respectively. 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. The provision for income taxes represents the net change in deferred tax
amounts, plus income taxes payable for the current period.
Acquisitions:
All business acquisitions have been accounted for using the purchase method of
accounting and, accordingly, the statements of operations include the results of
each acquired business since the date of acquisition. The assets acquired,
including long-lived assets, 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, including long-lived assets, and
liabilities assumed when we obtain information sufficient to complete the
allocation, but in any case, within one year after acquisition.
Long-lived Assets:
We 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
-28-
estimated, we may incur charges for impairment of these assets. The impairment
is based on the estimated discounted cash flow associated with the asset.
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.
We amortize capitalized software to cost of sales on a straight line basis over
thirty-six months, beginning August 1, 2005, which is the expected useful life
and does not materially differ from the expected cash inflow from the sale of
products related to the acquired PyX product line. It is our belief that no
impairment to the software asset exists as of October 31, 2005.
New Accounting Pronouncements:
In December 2004, the FASB issued SFAS 123R, Share Based Payments (SFAS 123R),
which amends SFAS 123, Accounting for Stock-Based Compensation, and requires
public entities (other than those filing as small business issuers) to report
stock-based employee compensation in their financial statements. As modified in
April 2005, we will be required to comply with the provisions of SFAS 123R as of
the first interim period for the fiscal year beginning on or after June 15,
2005. Thus, we will be required to comply with SFAS 123R beginning with our
quarter ending January 31, 2006. We currently have recorded compensation expense
related to stock options awarded to our retired President and Chief Executive
Officer and certain strategic business advisors. The value of these stock
options were recorded as deferred compensation and are amortized to expense over
the vesting period. We also recorded deferred compensation on the balance sheet
related to the intrinsic value of the unvested stock options assumed in our
acquisition of PyX. We are amortizing this deferred compensation to expense over
the future vesting period of these stock options beginning August 1, 2005. We
currently do not record compensation expense related to our other stock-based
employee compensation plans in our financial statements. However, if we did
record stock option expense pursuant to SFAS 123R, we estimate the total expense
for fiscal 2005 would have been approximately $1.1 million based on our current
analysis of variables used in our Black-Scholes model.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs (SFAS 151). The
provisions of this statement become effective for us in fiscal 2006. SFAS 151
amends the existing guidance on the recognition of inventory costs to clarify
the accounting for abnormal amounts of idle expense, freight, handling costs,
and wasted material (spoilage). Existing rules indicate that under some
circumstances, items such as idle facility expense, excessive spoilage, double
freight, and rehandling costs may be so abnormal as to require treatment as
current period charges. SFAS 151 requires that those items be recognized as
current period charges regardless of whether they meet the criterion of "so
abnormal". In addition, SFAS 151 requires that allocation of fixed production
overheads to the costs of conversion be based on the normal capacity of the
production facilities. The adoption of SFAS 151 is not expected to have a
material impact on the valuation of inventory or operating results.
-29-
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections (SFAS 154). This new standard replaces APB Opinion 20, Accounting
Changes, and FASB No. 3, Reporting Accounting Changes in Interim Financial
Statements. Among other changes, SFAS 154 requires that a voluntary change in
accounting principle to be applied retrospectively with all prior period
financial statements presented using the new accounting principle, unless it is
impracticable to do so. SFAS 154 also provides that (1) a change in method of
depreciating or amortizing a long-lived non-financial asset be accounted for as
a change in estimate (prospectively) that was effected by a change in accounting
principle, and (2) correction of errors in previously issued financial
statements should be termed a "restatement." The new standard is effective for
accounting changes and correction of errors made in fiscal years beginning after
December 15, 2005. We believe the adoption of the provisions of SFAS 154 will
not have a material impact on our results of operations, financial positions or
liquidity.
Results of Operations
The following table sets forth, as a percentage of net sales, certain statements
of operations data for the fiscal years ended October 31, 2005, 2004 and 2003.
These operating results are not necessarily indicative of our operating results
for any future period.
Year Ended October 31,
2005 2004 2003
-------- -------- --------
Net sales 100% 100% 100%
Cost of sales 67 60 37
-------- -------- --------
Gross profit 33 40 63
Operating expenses:
Product research and development 33 22 18
Sales and marketing 28 19 20
General and administrative 24 16 23
Loan reserve (benefit) -- (2) (3)
Restructuring costs (benefit) -- -- (2)
-------- -------- --------
Total operating expenses 85 55 56
-------- -------- --------
Operating income (loss) before income taxes (52) (15) 7
Income tax (provision) benefit -- -- --
-------- -------- --------
Net income (loss) (52)% (15)% 7%
======== ======== ========
-30-
SEGMENT INFORMATION
Year Ended October 31,
2005 2005 2005
-------- -------- --------
Embedded Storage Total
-------- -------- --------
Net sales 100% --% 100%
Cost of sales 54 13 67
-------- -------- --------
Gross profit 46 (13) 33
Operating expenses:
Product research and development 28 5 33
Sales and marketing 24 4 28
General and administrative 19 5 24
-------- -------- --------
Total operating expenses 71 14 85
-------- -------- --------
Operating income (loss) before income taxes (25) (27) (52)
Income tax (provision) benefit -- -- --
-------- -------- --------
Net income (loss) (25)% (27)% (52)%
======== ======== ========
Net Sales
Revenue from our Embedded business segment in 2005 was $8.1 million,
representing 100% of our total sales for the year. The Storage business segment
was purchased in July 2005 and had no revenues in 2005. Our sales for 2005
represents a 27% decrease from $11.1 million in fiscal 2004. Net sales for
fiscal 2004 represented a 48% increase from $7.5 million in fiscal 2003. The
decrease in fiscal 2005 net sales as compared to fiscal 2004 was primarily
attributable to a decrease in sales to what was our largest customer, HP. Sales
to HP were $1.0 million in fiscal 2005 compared to $4.9 million in fiscal 2004.
We shipped our final order for $1.0 million of VME products to HP in the first
quarter of fiscal 2005. The increase in fiscal 2004 as compared to 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. Sales to HP, primarily of VME
products, represented 13% of net sales in fiscal 2005 compared to 45% of net
sales for fiscal 2004 and 45% during fiscal 2003. At this time, we do not expect
to receive any future orders for VME products from HP. Sales to other individual
customers in excess of 10% of net sales for the year ended October 31, 2005
included sales to DCL of $2.2 million, or 28% of net sales and to Nortel of $1.4
million, or 18% of net sales. Sales to Nortel were $1.5 million, or 13% of net
sales in fiscal 2004. HP was the only customer to represent more than 10% of
sales in fiscal 2003.
Sales of our adapter products were $4.0 million for fiscal 2005, as compared to
$4.9 million in fiscal 2004 and $2.6 million in fiscal 2003. Sales of our
HighWire products were $2.5 million in fiscal 2005, as compared to $1.3 million
in fiscal 2004 and $0.8 million in fiscal 2003. 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.
-31-
We acquired PyX on July 26, 2005 and have recorded $138,000 of deferred revenue
related to software licensing agreements. This deferred revenue will be
recognized over the economic life of the customer product once there is no
uncertainty as to the project completion.
In the next few years, we expect our net sales will be generated primarily by
sales of our iSCSI storage software products, followed by sales of our
VoIP/HighWire products with Linux software. We have begun to see market
acceptance of our iSCSI software products and have signed software contracts
with four OEMs in the storage marketplace including LSI for integration into
their newly introduced iMegaRAID(R) adapter product and OnStor for use in their
new NAS/SAN gateway product. To date, our iSCSI software products have been
successfully integrated into solutions serving a variety of applications,
including security surveillance, storage virtualization, NAS, RAS and SAN
storage systems. Our most recent iSCSI customer is using our iSCSI software in
conjunction with our TOE adapter card in a storage gateway switching product.
Although we expect to see sales growth in our iSCSI products as these products
continue to gain market acceptance, there can be no assurance that such an
increase or adoption will occur. We also expect to see continued slowness in the
sale of our adapter products, but are encouraged by the acceptance of our
HighWire products and expect to see continued growth in these high margin
products. In addition, we will continue to sell and support our legacy VME
products, but expect sales for them to decline significantly as the OEM products
in which they are embedded are phased out.
Our sales backlog at October 31, 2005 was $1.2 million compared to $2.5 million,
including $1.0 million from HP, at October 31, 2004. While we anticipate an
increase in our sales volume in our iSCSI, adapter and Highwire products over
the course of fiscal 2006 and beyond as certain of our prior design wins go into
production and we see continued sales growth from our iSCSI software products,
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. In addition, that can be no assurance that our new
iSCSI and VoIP products will gain market acceptance.
International sales constituted 37%, 12% and 12% of net sales in fiscal 2005,
2004 and 2003, respectively. International sales are primarily executed in
Europe with 28% to customers in the United Kingdom. All international sales are
executed in U.S. dollars.
Gross Profit
Gross profit as a percentage of net sales was 33%, 40% and 63% in fiscal 2005,
2004 and 2003, respectively. The decrease in our gross profit margin in fiscal
2005 as compared to 2004 is related to the reduction in sales of 70% gross
margin products to HP. In fiscal 2004 we sold $4.9 million of product to HP and
in fiscal 2005 we sold $1.0 million. Both periods include $1.0 million of
non-cash amortization of intellectual property (IP) or software assets in cost
of goods sold (COGS). In fiscal 2005, this $1.0 million of IP amortization
expense is charged to our Storage business segment. Without this amortization
expense, our gross profit margin in fiscal 2005 would have been 46%, which
represents the gross profit margin for our Embedded business segment, compared
to 55% in fiscal 2004.
-32-
The decrease in our gross profit margin in fiscal 2004 versus 2003 is due
primarily to lower than expected gross margins from products purchased in August
2003 when we purchased Antares Microsystems, Inc. (the Antares products), the
addition of $547,000 expense related to a valuation adjustment for slow moving
and obsolete inventory and the inclusion of $1.1 million of recurring
amortization expense and an impairment charge relating to the Antares IP asset.
Gross profit as a percentage of sales in fiscal 2003 included sales of $409,000
of inventory to HP that had been fully written down in fiscal 2002. Our gross
profit in fiscal 2003 would have been 58% after excluding the effect of the HP
inventory write-down.
We expect our gross profit to increase as a percentage of sales as the
proportion of high margin iSCSI software sales becomes a larger portion of our
product mix. However, if market and economic conditions, particularly in the
newly emerging IP SAN storage market, deteriorate or fail to grow as expected,
gross profit as a percentage of net sales may decline from the current level.
Amortization of Intangible and Long-Lived Assets to COGS
For the fiscal year ended October 31, 2005, amortization of intangible and
long-lived assets was $1.0 million, compared to $1.1 million for fiscal 2004.
Fiscal 2004 amortization expense consisted of $408,000 of regularly scheduled
annual amortization expense plus $713,000 write-down related to the impairment
of intellectual property intangible asset acquired when we purchased Antares
Microsystems, Inc. in August 2003. This write-down plus the regularly scheduled
amortization is included as an expense item in our cost of goods sold and is a
component of our previously discussed gross profit margin. The $12.3 million
software long-lived asset recorded when we acquired PyX is scheduled to be
amortized to cost of goods expense of the Storage business segment over 12
quarters beginning with the fourth quarter of fiscal 2005 at the rate of $1.0
million per quarter.
Product Research and Development
Product research and development (R&D) expenses were $2.7 million in fiscal
2005, $2.4 million in fiscal 2004, and $1.3 million in fiscal 2003, representing
33%, 22% and 18% of net sales, respectively.
R&D expenses were $2.3 million and $0.4 million for our Embedded and Storage
business segments, respectively. The Storage business segment R&D expenses were
for one fiscal quarter.
The increase in R&D in fiscal 2005 as compared to fiscal 2004 is primarily the
result of two factors:
o the inclusion of increases related to our Storage business segment
when we hired seven employees in conjunction with the PyX
acquisition; and
o an increase in engineering design project related expenditures
related to the development of iSCSI software and VoIP/DSP gateway
products.
-33-
The increase in R&D in fiscal 2004 as compared to fiscal 2003 is primarily the
result of three factors:
o the inclusion of three employees hired in conjunction with the
Antares acquisition in late fiscal 2003;
o five additional design engineers hired during the year; and
o a 160% increase in expenditures for new product development.
During fiscal 2005, we continued the development of the next generation of our
Highwire products, further development and release of our new TOE product and
continued development of our PyX iSCSI storage software. We also continued to
port our products to new versions of Linux. These hardware and software design
efforts have enabled us to more effectively provide the software and hardware
building blocks to our OEM customers in the communications and storage markets.
We will continue to see increases in engineering expenses as a result of the PyX
acquisition. As part of the acquisition, we hired seven PyX engineers and will
continue to hire additional engineering resources, particularly software
engineers and engineering support personnel to continue to develop the iSCSI
storage software and VoIP products. We did not capitalize any internal software
development costs in fiscal 2005, 2004 or 2003.
Sales and Marketing
Sales and marketing expenses for fiscal 2005 were $2.3 million, a 5% increase
over fiscal 2004. This increase is primarily related to an increase in headcount
related to the acquisition of PyX and an increase travel and product marketing
activities. We increased our marketing expenditures by 58% in fiscal 2005 as we
attended more industry trade shows and increased our advertising and public
relations efforts to reach our target prospects more effectively.
Sales and marketing expenses were $2.0 million and $0.3 million for our Embedded
and Storage business segments, respectively. The Storage business segment sales
and marketing expenses were for one fiscal quarter.
Fiscal 2004 sales and marketing expense was $2.2 million, a 47% increase over
fiscal 2003. In fiscal 2004 we hired three sales and marketing employees and
increased our participation in industry trade shows and product advertising.
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
continue to increase as we position the company to take advantage of new market
opportunities especially for the VoIP and iSCSI products, and participate in
more sales lead generation and branding initiatives, such as, industry trade
events, public relations and direct marketing.
General and Administrative
General and administrative expenses for fiscal 2005 increased approximately
$150,000 to $1.9 million as compared to fiscal 2004. Fiscal 2004 remained
constant at $1.8 million as compared to fiscal 2003. We assumed the PyX employee
stock option plan as part of our acquisition of PyX and recorded $2,484,000 of
deferred compensation. The amortization expense related to the deferred
-34-
compensation will be included in our general and administrative expense and will
be amortized at the rate of $57,800 per month over the remaining 43 month
vesting period beginning August 2005 and ending February 2009. We expect general
and administrative expense for fiscal 2006 to increase from fiscal 2005 levels
partly due to anticipated increases in our insurance, accounting, the expensing
of employee stock options pursuant to the adoption of SFAS 123R and the addition
of employees to run our expanding business General and administrative expenses
are expected to range between 12% and 15% of sales for fiscal 2006.
Loan Reserve Benefit
On November 6, 1998, we made a loan to our former president and chief executive
offer, who retired as of December 31, 2004. The loan was used by him to exercise
an option to purchase 139,400 shares of our common stock and pay 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 Benefit
In response to the economic slowdown, we implemented restructuring plans in
fiscal 2002 and recorded restructuring charges of $446,000. 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, 2005 and 2004, $6,000 and $21,000 of the restructuring costs
accruals were included in other current liabilities, respectively.
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 $17,000 benefit
for fiscal 2003. Our effective tax rate was 0% in fiscal 2005, 2004 and 2003,
respectively. We recorded valuation allowances in fiscal 2005 and 2004 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.
-35-
Net Income (Loss)
As a result of the factors discussed above, we recorded a net loss of $4.2
million in fiscal 2005 compared to a net loss of $1.7 million in fiscal 2004 and
net income of $563,000 in fiscal 2003.
Contractual Obligations and Commercial Commitments
The following table sets forth a summary of our material contractual obligations
and commercial commitments as of October 31, 2005:
Payments due by period (in thousands)
-------------------------------------------------------------------------
Less than 1-3 3-5 More than
Contractual Obligations Total 1 year Years Years 5 Years
----------- ----------- ----------- ----------- -----------
Building leases $ 2,947 $ 724 $ 1,160 $ 1,063 $ --
Capital leases 177 44 132 1 --
Reimbursements from lease
assignment (265) (265) -- -- --
----------- ----------- ----------- ----------- -----------
Total net lease payments $ 2,859 $ 503 $ 1,292 $ 1,064 $ --
=========== =========== =========== =========== ===========
In connection with the retirement of Mr. William Heye, Jr. as our President and
Chief Executive Officer, we have been paying 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 as of that date. The balance remaining to be paid as of
October 31, 2005 is $42,000 and is included in 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;
-36-
- 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 $3.6 million and $1.8 million on October 31,
2005 and October 31, 2004, respectively. In fiscal 2005, $2.4 million of cash
was used by operating activities, primarily as a result of net losses. Our cash
used was reduced by the inclusion of $1.0 million of amortization expense of the
PyX software plus $194,000 of amortization and depreciation expense related to
property and equipment and capitalized software and $258,000 amortization of
deferred stock based compensation expense that are included in the $4.3 million
net loss but did not require cash. Cash used was also reduced by a $113,000
decrease in our accounts receivable and a $643,000 decrease in our inventory.
The decrease in trade accounts receivable is due to a general decrease in
overall sales activity in fiscal 2005 as compared to the end of fiscal 2004. The
decrease in inventory is due to the shipment of VME products to HP in January
2005 with an inventory cost of approximately $300,000 that was held as inventory
at October 31, 2004. We have also been carefully controlling our spending on
inventory and are actively attempting to reduce our overall level of inventory.
Working capital (current assets less current liabilities) at October 31, 2005
was $5.2 million, as compared to $4.0 million at October 31, 2004.
In fiscal 2005, we purchased $337,000 of fixed assets, consisting primarily of
computers and engineering equipment. Purchased software amounted to $207,000,
primarily for engineering and product design activities and payments related to
the contract to design our VoIP products. We expect to slightly increase our
levels of capital expenditures in fiscal 2006 in order to purchase test and
design equipment upgrades.
We received $130,000 in fiscal 2005 from proceeds associated with the exercise
of employee stock options.
On July 27, 2005, we sold 2,060,000 shares of common stock plus warrants to
purchase 1,030,000 shares of common stock for approximately $5.2 million in a
private placement transaction with AIGH Investment Partners, LLC and other
accredited investors. The net cash proceeds after offering expenses were
approximately $5.0 million.
We did not renew our working capital line of credit with Silicon Valley Bank on
its renewal date of May 14, 2005, because it was no longer necessary for our
business.
In mid-January 2006 we took steps to reduce our cash flow break-even point. We
changed the formula for paying all officers and employees and our Board of
Directors for their services. Beginning with our January 31, 2006 payroll,
officer and employee compensation will be paid 70% in cash and 30% in
non-restricted shares of SBE common stock. Our Board of Directors fees will be
paid 100% in non-restricted SBE common stock. Concurrent with our stock-for-pay
program, we are controlling or eliminating other cash operating expenses. These
cost cutting measures will reduce our quarterly operating cash expenses by
approximately $550,000 and reduced our projected cash break-even point to
approximately $8.5 to $9.5 million from approximately $11.5 million to $12.5
-37-
million in net sales at a gross margin of 75% to 77%. Although our current gross
margin is significantly lower than the mid-70% range, we expect our gross margin
to increase significantly as software sales become the dominant product in our
product sales mix. We do expect to continue to increase our expenditures on
engineering and sales and marketing activities to develop and market new and
existing products, especially in the IP storage and communications markets. We
will have significant non-cash expenses in the coming quarters and years related
to the amortization of the software and deferred compensation recorded as a
result of the PyX acquisition and the adoption of SFAS 123R beginning November
1, 2005. Because of the non-cash expenses related to the PyX acquisition,
expensing of employee stock options and anticipated increases in our expenditure
levels, we expect to generate net losses for the foreseeable future. Our
projected sales are to a limited number of new and existing OEM customers and
are based on internal and customer-provided estimates of future demand, not firm
customer orders. In addition, the markets for IP storage, particularly iSCSI NAS
and SAN storage appliances, is a new market and may not gain acceptance as
quickly as we predict. If our projected sales do not materialize, we may need to
reduce expenses and raise additional capital through customer prepayments or the
issuance of debt or equity securities. If additional funds are raised through
the issuance of preferred stock or debt, these securities could have rights,
privileges or preferences senior to those of common stock, and debt covenants
could impose restrictions on our operations. The sale of equity or debt could
result in additional dilution to current stockholders, and such financing may
not be available to us on acceptable terms, if at all.
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, 2005 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 and all sales are denominated in U.S. dollars.
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
-38-
An evaluation as of October 31, 2005 was carried out under the supervision
of and with the participation of the Company's management, including our 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. In the Company's financial reporting process, the
Company's Chief Financial Officer in discussions with its independent registered
public accounting firm identified a certain "material weakness" (as such term is
defined under Public Company Accounting Oversight Board Auditing Standard No. 2)
in our internal controls. As a result of this material weakness, the Company's
Chief Executive Officer and Chief Financial Officer has determined that the
Company's internal controls are ineffective.
The material weakness identified is related to managements inadequate
technical expertise with respect to income tax accounting and income tax
disclosure in the 2005 financial statements. The lack of technical expertise is
related to the Company's accounting and disclosure of deferred income tax
liability for long-lived assets capitalized in the PyX acquisition. Although the
lack of technical expertise did not result in any net changes to the balance
sheets, statements of operations or cash flows, during 2005 it did result in an
adjustment to the disclosures related to deferred income tax assets and
liability in the notes to the financial statements. The Company will utilize the
assistance of income tax reporting specialists in future periods.
ITEM 9B. OTHER INFORMATION
None.
-39-
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 21, 2006 (the 2006 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 2006 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 2006 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 2006 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
2006 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 2006
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 2006 Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by Item 14 is incorporated by reference from the
information in the section entitled "Ratification Of Selection Of Independent
Auditors" appearing in the 2006 Proxy Statement.
-40-
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES
The following documents are filed as part of this Report:
(a)(1) Financial Statements
Page
Report of Independent Registered Public Accounting Firm 46
Balance Sheets at October 31, 2005 and 2004 47
Statements of Operations for fiscal years 2005, 2004
and 2003 48
Statements of Stockholders' Equity for fiscal years 2005,
2004 and 2003 49
Statements of Cash Flows for fiscal years 2005, 2004
and 2003 50
Notes to Financial Statements 51
(a)(2) Financial Statement Schedule
Schedule II -- Valuation and Qualifying Accounts 74
All other schedules are omitted as the required information is not
applicable or has been included in the financial statements or the
notes thereto.
(a)(3) List of Exhibits
Exhibit
Number Description
3.1(1) Certificate of Incorporation, as amended through
December 15, 1997.
3.2(2) Bylaws, as amended through December 8, 1998.
10.1(3)* 1996 Stock Option Plan, as amended.
10.2(4)* 1991 Non-Employee Directors' Stock Option Plan, as
amended.
10.3(5) 1992 Employee Stock Purchase Plan, as amended.
10.4(5) 1998 Non-Officer Stock Option Plan as amended.
-41-
10.5(6) 2005 PyX Technologies Stock Option Plan .
10.6 Lease for 4000 Executive Parkway, Suite 200 dated July
27, 2005 between the Company and Alexander Properties
Company.
10.7(5)* 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(5)+ 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)
10.14(10) Unit Subscription Agreement, dated May 4, 2005, by and
between SBE, Inc. and the other parties thereto.
10.15(10) Agreement and Plan of Merger and Reorganization, dated
March 28, 2005, by and among SBE, Inc., PyX Acquisition
Sub, LLC, PyX Technologies, Inc. and the parties
identified on Exhibit A thereto.
10.16(10) Investor Rights Agreement, dated July 26, 2005, between
SBE, Inc. and the investors listed on Exhibit A thereto.
10.17(10) Form of warrant issued on July 26, 2005.
23.1 Consent of BDO Seidman, LLP, Independent Registered
Public Accounting Firm
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
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
-42-
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 Annual Report on Form 10-K for the year ended
October 31, 1997 and incorporated herein by reference.
(2) Filed as an exhibit to Annual Report on Form 10-K for the year ended
October 31, 1998 and incorporated herein by reference.
(3) Filed as an exhibit to Annual Report on Form 10-K for the year ended
October 31, 2002 and incorporated herein by reference.
(4) Filed as an exhibit to Annual Report on Form 10-K for the year ended
October 31, 1993 and incorporated herein by reference.
(5) Filed as an exhibit to Annual Report on Form 10-K for the year ended
October 31, 1995 and incorporated herein by reference.
(6) Filed as an exhibit to Registration Statement on Form S-8 dated
September 20, 2005 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.
(10) Filed as an exhibit to Proxy Statement on Form 14A dated June 24,
2005 and incorporated herein by reference.
(b) Exhibits Required by Item 601
Please refer to Part IV, Item 15(a)(3).
(c) Financial Statements
Please refer to Part IV, Item 15(a)(2).
-43-
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 20, 2006 By: /s/ Daniel Grey
------------------
Daniel Grey
Chief Executive Officer and
President
(Principal Executive Officer)
Date: January 20, 2006 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,
Daniel Grey 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 20, 2006.
-44-
Signature Title
--------- -----
/s/ Daniel Grey
- ---------------
Daniel Grey Chief Executive Officer and President
(Principal Executive Officer)
/s/ David W. Brunton
- --------------------
David W. Brunton Chief Financial Officer, Vice President,
Finance and Secretary (Principal
Financial and Accounting Officer)
/s/ Ronald J. Ritchie
- ---------------------
Ronald J. Ritchie Director, Chairman of the Board
/s/ John Reardon
- ----------------
John Reardon Director
/s/ Marion M. Stuckey Director
- ---------------------
Marion M. Stuckey
/s/ William B. Heye, Jr. Director
- ------------------------
William B. Heye, Jr.
-45-
Report of Independent Registered Public Accounting Firm
Board of Directors
SBE, Inc.
San Ramon, California
We have audited the accompanying balance sheets of SBE, Inc. as of October 31,
2005 and 2004 and the related statements of operations, stockholders' equity,
and cash flows for each of the three years in the period ended October 31, 2005.
We have also audited Schedule II - Valuation and Qualifying Accounts (the
Schedule). These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and the Schedule based on our audits.
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. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also 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, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of SBE, Inc. as of October 31,
2005 and 2004, and the results of its operations and its cash flows for each of
the three years in the period ended October 31, 2005 in conformity with
accounting principles generally accepted in the United States of America.
Also, in our opinion, the Schedule presents fairly, in all material effects, the
information set forth therein.
/s/ BDO Seidman, LLP
December 2, 2005, except for Note 18 to the financial statements which is as of
January 12, 2006.
San Francisco, California
-46-
SBE, INC.
BALANCE SHEETS
(in thousands, except share and per share amounts)
October 31 2005 2004
- ------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 3,632 $ 1,849
Trade accounts receivable, net of allowance for
doubtful accounts of $54 and $42 1,555 1,668
Inventories 1,283 1,926
Other 293 227
---------- ----------
Total current assets 6,763 5,670
Property and equipment, net 563 427
Capitalized software costs, net 11,424 48
Other 82 28
---------- ----------
Total assets $ 18,832 $ 6,173
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 743 $ 856
Accrued payroll and employee benefits 155 391
Capital lease obligations - current portion 29 25
Deferred software revenue 138 --
Other 178 459
---------- ----------
Total current liabilities 1,243 1,731
Capital lease obligations and long term liabilities,
net of current portion 241 139
---------- ----------
Total liabilities 1,484 1,870
---------- ----------
Commitments (Notes 9, 10 and 13)
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 shares;
issued and outstanding 9,892,347 and 5,094,118 35,431 15,755
Deferred compensation (2,401) --
Accumulated deficit (15,682) (11,452)
---------- ----------
Total stockholders' equity 17,348 4,303
---------- ----------
Total liabilities and stockholders' equity $ 18,832 $ 6,173
========== ==========
The accompanying notes are an integral part of these financial statements.
-47-
SBE, INC.
STATEMENTS OF OPERATIONS
(in thousands, except for per share amounts)
For the years ended October 31, 2005 2004 2003
- --------------------------------------------------------------------------------------
Net sales $ 8,056 $ 11,066 $ 7,456
Cost of sales 5,404 6,646 2,749
---------- ---------- ----------
Gross profit 2,652 4,420 4,707
---------- ---------- ----------
Product research and development 2,694 2,411 1,330
Sales and marketing 2,293 2,177 1,484
General and administrative 1,906 1,755 1,752
Loan loss recovery -- (239) (235)
Restructuring benefit -- -- (154)
---------- ---------- ----------
Total operating expenses 6,893 6,104 4,177
---------- ---------- ----------
Operating income (loss) (4,241) (1,684) 530
Interest income 22 5 26
Other expense (6) -- (10)
---------- ---------- ----------
Income (loss) before income taxes (4,225) (1,679) 546
Income tax benefit (provision) (5) -- 17
---------- ---------- ----------
Net income (loss) $ (4,230) $ (1,679) $ 563
========== ========== ==========
Basic earnings (loss) per common share $ (0.66) $ (0.33) $ 0.13
========== ========== ==========
Diluted earnings (loss) per common share $ (0.66) $ (0.33) $ 0.12
========== ========== ==========
Basic - Shares used in per share
computations 6,439 5,022 4,259
========== ========== ==========
Diluted - Shares used in per share
computations 6,439 5,022 4,709
========== ========== ==========
The accompanying notes are an integral part of these financial statements.
-48-
SBE, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except shares)
Common Stock Note
and Additional Receivable Treasury
Paid-in Capital from Stock
Stockholder
Shares Amount Shares
-------------------------------------------------------
Balance, October 31, 2002 4,137,612 $ 14,711 $ (270) 79,500
-------------------------------------------------------
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
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 --
Net loss -- -- -- --
-------------------------------------------------------
Balance, October 31, 2004 5,094,118 15,755 -- --
-------------------------------------------------------
Stock issued in connection with Stock Option Plans 108,234 130 -- --
Stock issued in connection with the acquisition of Antares 68,945 197 -- --
Stock issued in connection with the acquisition of PyX 2,561,050 11,714 -- --
Stock issued in connection with private placement 2,060,000 4,975 -- --
financing, net of financing costs of $175
Deferred compensation related to Stock Option Plans -- 2,660 -- --
Deferred compensation expense related to Stock Option Plans -- -- -- --
Net loss -- -- -- --
-------------------------------------------------------
Balance, October 31, 2005 9,892,347 $ 35,431 $ -- --
=======================================================
Treasury Deferred Retained
Stock Compensation Earnings
(Accumulated
Amount deficit) Total
-------------------------------------------------------
Balance, October 31, 2002 $ (409) $ -- $ (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 409 -- -- --
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 -- -- 381
Net loss -- -- (1,679) (1,679)
-------------------------------------------------------
Balance, October 31, 2004 -- -- (11,452) 4,303
-------------------------------------------------------
Stock issued in connection with Stock Option Plans -- -- -- 130
Stock issued in connection with the acquisition of Antares -- -- -- 197
Stock issued in connection with the acquisition of PyX -- -- -- 11,714
Stock issued in connection with private placement -- -- -- 4,975
financing, net of financing costs of $175
Deferred compensation related to Stock Option Plans -- (2,660) -- --
Deferred compensation expense related to Stock Option Plans -- 259 -- 259
Net loss -- -- (4,230) (4,230)
-------------------------------------------------------
Balance, October 31, 2005 $ -- $ (2,401) $ (15,682) $ 17,348
=======================================================
The accompanying notes are an integral part of these financial statements.
-49-
SBE, INC.
STATEMENTS OF CASH FLOWS
(in thousands)
For the years ended October 31 2005 2004 2003
- -----------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss) $ (4,230) $ (1,679) $ 563
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 1,241 829 443
Impairment of intellectual property -- 713 --
Non-cash restructuring (benefit) -- -- (154)
Stock-based compensation expense 259 21 --
Non-cash valuation allowance (recovery) on loan from -- (240) (142)
officer
Loss on sale of assets 6 -- 13
Changes in operating assets and liabilities:
Trade accounts receivable 113 150 (930)
Inventories 643 (46) 30
Other assets (121) 13 30
Trade accounts payable (113) 160 (57)
Other current liabilities (184) (319) (61)
Non-current liabilities 102 -- (4)
---------- ---------- ----------
Net cash used in operating activities (2,419) (140) (84)
---------- ---------- ----------
Cash flows from investing activities:
Purchases of property and equipment (337) (87) (172)
Cash payments related to purchase of PyX, net of cash (359) -- --
received
Cash payments related to purchase of Antares assets -- -- (868)
Purchased software (207) (136) (48)
---------- ---------- ----------
Net cash used in investing activities (903) (223) (1,088)
---------- ---------- ----------
Cash flows from financing activities:
Proceeds from stock plans 130 251 12
Proceeds from issuance of common stock and warrants, net 4,975 202 686
Proceeds from repayment of shareholder note -- 382 270
---------- ---------- ----------
Net cash provided by financing activities 5,105 834 968
---------- ---------- ----------
Net increase (decrease) in cash and cash equivalents 1,783 471 (204)
Cash and cash equivalents at beginning of year 1,849 1,378 1,582
---------- ---------- ----------
Cash and cash equivalents at end of year $ 3,632 $ 1,849 $ 1,378
========== ========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash paid during the year for:
Income taxes $ 5 $ 1 $ 1
========== ========== ==========
SUPPLEMENTAL SCHEDULE OF NON CASH INVESTING AND FINANCING ACTIVITIES
Assets acquired under capital leases $ -- $ 164 $ --
========== ========== ==========
Non-cash stock portion of PyX purchase price $ 11,714 $ -- $ --
========== ========== ==========
Non-cash stock portion of Antares purchase price $ 197 $ 86 $ 542
========== ========== ==========
The accompanying notes are an integral part of these financial statements.
-50-
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company and Basis of Presentation:
SBE, Inc., headquartered in San Ramon, California, engineers and provides
standards based hardware and software products to original equipment
manufacturers (OEMs) who embed our products into their networking or storage
systems to provide network connectivity and data storage solutions for the
telecommunications and enterprise storage markets. Our products include Internet
Small Computer System Interface (iSCSI) software, wide area network (WAN), local
area network (LAN) and storage network interface cards (NICS) and programmable
intelligent carrier cards. These products perform critical storage, computing
and Input/Output (I/O) tasks across both the embedded server and data storage
markets such as high-end enterprise level servers, Linux super computing
clusters, workstations, media gateways, routers, Internet access devices,
network communications applications, network attached storage (NAS) and storage
area networks (SANs). Our products are distributed worldwide through a direct
sales force, distributors, independent manufacturers' representatives and
value-added resellers. Our business falls within two industry segment - embedded
and storage products.
Use of Estimates:
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of 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.
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:
Inventories are stated at the lower of cost, using the first-in, first-out
method, or market value. We utilize standard costs, which approximates actual
cost, for certain indirect costs.
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
-51-
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.
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.
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.
Long-lived Assets:
We 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.
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.
We amortize capitalized software to cost of sales on a straight line basis over
thirty-six months, beginning August 1, 2005, which is the expected useful life
and does not materially differ from the expected cash inflow from the sale of
products related to the acquired PyX product line. It is our belief that no
impairment to the software asset exists as of October 31, 2005.
-52-
Acquisitions:
All business acquisitions have been accounted for using the purchase method of
accounting and, accordingly, the 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:
Hardware Products
Our policy is to recognize revenue for hardware product sales when title
transfers and risk of loss has passed to the customer, which is generally upon
shipment of our hardware products to our customers. 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 sold (COGS) at the time of shipment. Our policy complies with
the guidance provided by the Securities and Exchange Commission Staff Accounting
Bulletin No. 104, Revenue Recognition in Financial Statements (SAB 104), 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 hardware products is considered incidental. therefore,
we do not recognize software revenue related to our hardware products separately
from the hardware product sale.
When selling hardware, our agreements with OEMs, such as Data Connection Limited
(DCL) and Nortel Networks Corp. (Nortel), typically incorporate clauses
reflecting the following understandings:
- all prices are fixed and determinable at the time of sale;
- title and risk of loss pass at the time of shipment (FOB shipping
point);
- collectibility of the sales price is probable (the OEM is
creditworthy, 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 25% of our products purchased by the
-53-
distributor during the previous quarter. In order to take advantage of their
product rotation rights, the distributors must order and take delivery of
additional products of ours 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 they place their next order with us. We
record an allowance for price protection at the time of the price reduction,
thereby 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. We believe we are able to fully
evaluate potential returns and adjustments and continue to recognize the sale
based on shipment to our distributors. Reserves for the right of return and
restocking are established based on the requirements of SFAS 48, Revenue
Recognition when Right of Return Exists.
During the year ended October 31, 2005, $640,000 or 8% of our sales were sold to
distributors compared to $874,000 or 8% and $191,000 or 3% in fiscal 2004 and
2003, respectively. Our reserves for distributor programs total approximately
$22,000 as of October 31, 2005 and 2004, respectively.
Software Products
With the acquisition of PyX, we will also derive future revenues from the
following sources: (1) software, which includes new iSCSI target and initiator
software licenses and (2) services, which include consulting. We account for the
licensing of software in accordance with SOP 97-2, Software Revenue Recognition.
The application of SOP 97-2 requires judgment, including whether a software
arrangement includes multiple elements, and if so, whether vendor-specific
objective evidence (VSOE) of fair value exists for those elements. Customers
receive certain elements of our products over a period of time. These elements
include free post-delivery telephone support and the right to receive
unspecified upgrades/enhancements of our iSCSI software on a
when-and-if-available basis, the fair value of which is recognized over the
product's estimated life cycle. Changes to the elements in a software
arrangement, the ability to identify VSOE for those elements, the fair value of
the respective elements, and changes to a product's estimated life cycle could
materially impact the amount of earned and unearned revenue. Judgment is also
required to assess whether future releases of certain software represent new
products or upgrades and enhancements to existing products. We will defer all
revenue related to the sale of our software products and amortize the deferred
revenue over its estimated life.
For software license arrangements that do not require significant modification
or customization of the underlying software, we will recognize new software
license revenue when: (1) we enter into a legally binding arrangement with a
customer for the license of software; (2) we deliver the products; (3) customer
payment is deemed fixed or determinable and free of contingencies or significant
uncertainties; and (4) collection is reasonably assured. Substantially, all of
our new software license revenue will be recognized in this manner. No software
license revenue has been recognized to date.
As of October 31, 2005, we have deferred all license revenue related to software
arrangements until the specified upgrade is delivered. Once the specifed upgrade
is delivered, revenues for the license will be recognized over the term of the
contract or over the economic life of the product, whichever is shorter.. If
there is significant uncertainty about the project completion or receipt of
payment for the services, revenue is deferred until the uncertainty is
sufficiently resolved.
-54-
Certain software arrangements include consulting implementation services sold
separately under consulting engagement contracts. Consulting revenues from these
arrangements are generally accounted for separately from new software license
revenues because the arrangements qualify as service transactions as defined in
SOP 97-2. The more significant factors considered in determining whether the
revenue should be accounted for separately include the nature of services (i.e.,
consideration of whether the services are essential to the functionality of the
licensed product), degree of risk, availability of services from other vendors,
timing of payments and impact of milestones or acceptance criteria on the
realizability of the software license fee.
Product Warranty:
Our embedded 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 related to
our embedded products 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 embedded 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 and should all
collection efforts fail, will write-off the account.
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.
-55-
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, 2005, 2004 and 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 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.
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,
-------------------------------------------
2005 2004 2003
----------- ----------- -----------
Net income (loss) - as reported ...... $ (4,230) $ (1,679) $ 563
Stock based employee compensation
expense included in reported
net loss, net of related tax effects 168 -- --
Less total stock based employee
compensation expense determined
under fair value based method for
all awards, net of related tax
effects ............................ (1,237) (1,177) (231)
----------- ----------- -----------
Pro forma net income (loss) .......... $ (5,299) $ (2,856) $ 332
=========== =========== ===========
Income (loss) per share:
Basic - as reported .................. $ (0.66) $ (0.33) $ 0.13
Basic - pro forma .................... $ (0.82) $ (0.57) $ 0.08
Diluted - as reported ................ $ (0.66) $ (0.33) $ 0.12
Diluted - pro forma .................. $ (0.82) $ (0.57) $ 0.07
-56-
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 2005 2004 2003
- -------------------------------------------------------------------------------
Expected life (in years) 4.00 4.00 5.00
Risk-free interest rate 4.25% 3.29% 2.00%
Volatility 99.88% 120.20% 126.00%
Dividend yield 0.00% 0.00% 0.00%
The weighted average fair value of options granted during 2005, 2004, and 2003
was $2.91, $2.93 and $1.79 per option, respectively.
Advertising Costs:
Advertising and marketing expenditures are expensed as incurred. Advertising and
marketing costs were $324,000, $204,000 and $79,000 in fiscal 2005, 2004 and
2003, respectively.
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 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.
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, 2005, 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, Share Based Payments (SFAS
123R), which amends SFAS No. 123, Accounting for Stock-Based Compensation, and
requires public entities (other than those filing as small business issuers) to
report stock-based employee compensation in their financial statements. As
modified in April 2004, we will be required to comply with the provisions of
SFAS 123R as of the first interim period for the fiscal year beginning on or
after June 15, 2005. Thus, we will be required to comply with SFAS 123R
beginning with our quarter ending January 31, 2006. We have recorded
compensation expense related to stock options awarded to our retired President
and Chief Executive Officer and to certain strategic business advisors. The
value of these stock options were recorded as deferred compensation, remeasured
quarterly, and are amortized to expense over the vesting period varying from 1
to 4 years. We also recorded deferred compensation on the balance sheet related
-57-
to the fair value of the stock options assumed in the acquisition of PyX. We
amortize this deferred compensation to expense over the future 43 month vesting
period beginning August 1, 2005. We currently do not record compensation expense
related to our other stock-based employee compensation plans in our financial
statements. If we had adopted SFAS 123R, the stock based compensation expense
for fiscal 2005 related to unvested outstanding employee stock options would
have been approximately $1.1 million.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs (SFAS 151). The
provisions of this statement become effective for us in fiscal 2006. SFAS 151
amends the existing guidance on the recognition of inventory costs to clarify
the accounting for abnormal amounts of idle expense, freight, handling costs,
and wasted material (spoilage). Existing rules indicate that under some
circumstances, items such as idle facility expense, excessive spoilage, double
freight, and rehandling costs may be so abnormal as to require treatment as
current period charges. SFAS 151 requires that those items be recognized as
current period charges regardless of whether they meet the criterion of "so
abnormal". In addition, SFAS 151 requires that allocation of fixed production
overheads to the costs of conversion be based on the normal capacity of the
production facilities. The adoption of this Statement is not expected to have a
material impact on the valuation of inventory or operating results.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections (SFAS 154). This new standard replaces APB Opinion 20, Accounting
Changes, and FASB No. 3, Reporting Accounting Changes in Interim Financial
Statements. Among other changes, SFAS 154 requires that a voluntary change in
accounting principle to be applied retrospectively with all prior period
financial statements presented on a new accounting principle, unless it is
impracticable to do so. SFAS 154 also provides that (1) a change in method of
depreciating or amortizing a long-lived non-financial asset be accounted for as
a change in estimate (prospectively) that was effected by a change in accounting
principle, and (2) correction of errors in previously issued financial
statements should be termed a "restatement." The new standard is effective for
accounting changes and correction of errors made in fiscal years beginning after
December 15, 2005. We believe the adoption of the provisions of SFAS 154 will
not have a material impact on our results of operations, financial positions or
liquidity.
2. INVENTORIES
Inventories at October 31, are comprised of the following (in thousands):
2005 2004
- --------------------------------------------------------------------------------
Finished goods $ 815 $ 1,343
Parts and materials 468 583
---------- ----------
Total inventory $ 1,283 $ 1,926
========== ==========
In the fourth quarter of fiscal 2004, we recorded a $547,000 reserve on specific
obsolete and slow moving products. This increase in our inventory reserve is
included in our cost of goods expense. The total reserve for slow moving and
obsolete inventory is $2,313,000 and $2,171,000 at October 31, 2005 and 2004,
respectively.
-58-
3. PROPERTY AND EQUIPMENT
Property and equipment at October 31, are comprised of the following (in
thousands):
2005 2004
- -----------------------------------------------------------------------------
Machinery and equipment $ 3,476 $ 4,708
Furniture and fixtures 226 284
Leasehold improvements 145 118
----------- -----------
3,847 5,110
Less accumulated depreciation
and amortization (3,284) (4,683)
----------- -----------
$ 563 $ 427
=========== ===========
Depreciation and amortization expense totaled $194,000, $213,000 and $303,000
for the years ended October 31, 2005, 2004 and 2003, respectively. Depreciation
expense on capital leases in fiscal 2005 and 2004 was $25,000 and $0,
respectively.
4. CAPITALIZED SOFTWARE COSTS
Capitalized software costs at October 31, 2005 and 2004 comprise the following
(in thousands):
2005 2004
- -----------------------------------------------------------------------------
Purchased software $ 14,177 $ 1,065
Less accumulated amortization (2,753) (1,017)
------------ ------------
$ 11,424 $ 48
============ ============
We capitalized $12,424,000, $136,000 and $48,000 of purchased software costs in
2005, 2004, and 2003 respectively. Amortization of capitalized software costs
totaled $1,048,000, $208,000, and $38,000 for the years ended October 31, 2005,
2004, and 2003, respectively. Capitalized software costs consist of the
allocation of the software relating to current products and the design of future
iSCSI software products acquired in connection with our acquisition of PyX on
July 26, 2005. We amortize capitalized software to cost of sales expense on a
straight line basis over thirty-six months, beginning August 1, 2005, which is
the expected useful life and which does not materially differ from the expected
cash inflow from the sale of products related to the acquired PyX product line.
The amortization expense is included in the Cost of Sales. Included in the
$208,000 software amortization expense for fiscal 2004 is $126,000 related to
valuation write-downs of capitalized software during the fourth quarter of
fiscal 2004.
5. INTANGIBLE ASSETS
Antares
At the end of fiscal 2004 we completed our asset impairment review and we
determined that the estimated fair market value of the balance of the
intellectual property acquired when we purchased certain assets of Antares
Microsystems, Inc. (Antares), a California corporation, was nominal. As a
result, we recorded an impairment charge of $713,000 thus writing off the
remaining value, at October 31, 2004, of the intellectual property asset
recorded when we acquired Antares in August 2003.
-59-
The non-cash amortization expense related to the Antares intellectual property
in fiscal 2004 was $1.1 million and consisted of $408,000 of regularly scheduled
annual amortization expense plus $713,000 write down related to the Antares
impairment valuation analysis. This write-down plus the regularly scheduled
amortization is included as an expense item in our cost of goods sold for fiscal
2004. The amortization expense related to the intellectual property for the one
quarter that we owned Antares in fiscal 2003 was approximately $102,000.
6. 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 equity
investment was made by Stonestreet L.P., of Ontario, Canada. 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.
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. 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. The remaining warrant to purchase 10,000
shares of common stock expires on October 9, 2006.
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 with 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 with 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 based on the following assumptions,1) expected
life: 5 years, 2) risk free interest rate: 3%, 3) volatility: 121.71. 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. 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.
-60-
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 pursuant to the original purchase agreement. The value of the
common stock was $259,000.
During fiscal 2005 and 2004, we issued 68,945 and 30,000 shares of our common
stock, respectively, to an employee who was one of the owners of Antares
pursuant to the original purchase agreement. The value of the common stock was
$282,982.
In fiscal year 2004 and 2003, 9,903 and 11,012 shares of common stock were
issued under the Employee Stock Purchase Plan, respectively.
On July 26, 2005, we closed a private placement with AIGH Investment Partners,
LLC and other accredited investors providing for the sales and issuance of
shares of our common stock and warrants to purchase shares of our common stock,
with gross proceeds to us of $5,150,000. The investors invested $5,150,000 in
purchasing units consisting of one share of our common stock and a warrant to
purchase 0.5 of a share of our common stock. The price per unit was $2.50 with
aggregate proceeds to us of $5,150,000. We issued 2,060,000 shares of our common
stock and warrants to purchase an additional 1,030,000 shares of our common
stock in the future in connection with the private placement.
The warrants issued in connection with the private placement have a term of five
years and are exercisable at $3.33 per share, subject to proportional
adjustments for stock splits, stock dividends, recapitalizations and the like.
The warrants also contain a cashless exercise feature.
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 effective November 14, 2005.
On July 26, 2005, we acquired PyX for a total purchase price of $11,714,000 paid
to the selling shareholders of PyX in the form of shares of our common stock and
the assumption of PyX's employee stock option plan plus cash expenses totaling
$359,000 for legal, accounting and valuation services. A total of 2,561,050
shares of our common stock has been issued in respect of outstanding PyX common
stock. We registered for resale all of the shares of common stock issued to the
selling shareholders of PyX with the Securities and Exchange Commission
effective November 14, 2005 (see Note 15).
7. DEFERRED COMPENSATION
On January 1, 2005, our retiring President and Chief Executive Officer was
awarded options to purchase 75,000 shares of our common stock at a price of
$4.00 per share (closing price on December 31, 2004). The fair value of this
option grant is estimated on the date of grant using the Black-Scholes
option-pricing model and is included as deferred compensation on the balance
sheet. The $120,000 deferred compensation is amortized to general and
administrative expense at the rate of $8,000 per month over the 15 month vesting
period ending March 2006 based on his continued service as a director. As of
October 31, 2005, $80,000 of the deferred compensation has been amortized to
expense and is included in General and Administrative expense.
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We awarded stock option grants to certain non-employee strategic business
advisors as a part of their fee structure. The fair value of these option grants
is estimated on the date of grant using the Black-Scholes option-pricing model
and is included as deferred compensation on the balance sheet. The deferred
compensation balance is recalculated on a quarterly basis based on market price.
The $56,000 deferred compensation is amortized to general and administrative
expense at the rate of $2,000 per month over the vesting period of the grants.
As of October 31, 2005, $6,000 of the deferred compensation has been amortized
to expense and is included in General and Administrative expense.
We assumed the PyX employee stock option plan as part of the July 26, 2005
acquisition of PyX and as a result an additional 2,038,950 shares of our common
stock, with an exercise price of $2.17, will be issuable upon exercise of
assumed stock options. The intrinsic value of the unvested portion of these
option grants is estimated on the date of grant using the Black-Scholes
option-pricing model and is included as deferred compensation on the balance
sheet. The $2,484,000 deferred compensation related to this transaction is
amortized to expense at the rate of $57,800 per month over the 43 month vesting
period beginning August 2005 and ending February 2009. As of October 31, 2005,
$173,000 of the deferred compensation has been amortized to expense and is
included in General and Administrative expense.
The estimated aggregate remaining amortization expense for each of the
succeeding fiscal years is as follows (in thousands):
2006 $ 758
2007 713
2008 698
2009 233
-------
Total $ 2,402
=======
8. INCOME TAXES
The components of the benefit for income taxes for the years ended October 31,
2005, 2004 and 2003, comprised of the following:
2005 2004 2003
- ---------------------------------------------------------------------------------------------
Federal:
Current $ -- $ -- $ (18)
Deferred -- -- --
State:
Current 5 -- 1
Deferred -- -- --
-------- -------- --------
Net income tax (benefit) provision $ 5 $ -- $ (17)
======== ======== ========
We recorded a tax benefit of $18,000 in fiscal 2003 due to refunds of federal
income taxes related to the Job Creation and Workers Assistance Act of 2002
which extended the net operating loss carryback period from two to five years
for losses generated in tax years ending in 2002.
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The effective income tax rate differs from the statutory federal income tax rate
for the following reasons:
2005 2004 2003
- ------------------------------------------------------------------------------------
Statutory federal income tax rate (34.0)% (34.0)% (34.0)%
Basis difference in acquisition 104.5 -- --
Change in valuation allowance (95.3) 34.0 34.0
True-up of prior year and other 24.8 -- --
-------- -------- --------
(0)% (0)% (0)%
======== ======== ========
Significant components of our deferred tax balances as of October 31, 2005 and
2004 are as follows:
2005 2004
- -----------------------------------------------------------------------------------------
Deferred tax assets:
Current
Accrued employee benefits $ 32 $ 25
Inventory allowances 926 924
Allowance for doubtful accounts 21 17
Warranty accruals and other assets 11 --
Distributor reserves 8 8
Stock compensation 103 --
Noncurrent
Deferred rent 87 --
R&D credit carryforward 2,859 2,663
Net operating loss carryforwards 5,437 4,569
Reserve on shareholder note receivable -- 313
Depreciation and amortization, net -- 416
Restructuring costs 10 9
----------- -----------
Total deferred tax assets 9,494 8,944
Less: Deferred tax asset valuation allowance (4,923) (8,944)
----------- -----------
Net deferred tax asset 4,571 --
Deferred tax liability - acquired software (4,461) --
Deferred tax liability - capitalized assets (110) --
----------- -----------
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 decreased by $4.0 million in fiscal 2005 primarily as a result of a
deferred tax liability of $4.5 million recorded in connection with the
amortizable software assets recorded in connection with the acquisition of PyX.
This liability have been partially offset by an increases in inventory
allowances, warranty and other accruals, deferred stock compensation, deferred
rent, R&D tax credit carryforwards and operating loss carryforwards. At October
31, 2005, we have research and experimentation tax credit carryforwards of $2.0
million and $1.4 million for federal and state tax purposes, respectively. These
carryforwards expire in the periods ending 2012 through 2025. The State R&D tax
credits do not expire. We have net operating loss carryforwards for federal and
state income tax purposes of approximately $15.4 million and $4.1 million,
respectively, which expire in periods ending 2006 through 2025.
In connection with the acquisition of PyX in 2005, a deferred tax liability of
approximately $4.5 million and a deferred tax asset of approximately $50,000
were recorded with a full valuation allowance. The deferred tax liability is the
result of the book/tax basis difference on the acquired software. The deferred
tax assets consists of $4.4 million related to acquired software and $0.01
million related to other acquired assets. When recognized, the tax benefits of
such deferred tax asset will be applied, first, to reduce to zero other
non-current assets related to this acquisition; and second, to reduce income tax
expense.
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Under the Tax Reform Act of 1986, the amounts of benefits from net operating
loss carryforwards are limited as we have incurred a cumulative ownership change
of more than 50%, as defined, over a three-year period. Usage of net operating
loss carryforwards is limited based on the Company's capital at the date of
change times a risk-free interest rate.
9. WARRANTY OBLIGATIONS AND OTHER GUARANTEES:
The following is a summary of our agreements that we have determined are within
the scope of FASB Interpretation (FIN) No. 45 Guarantor's Accounting and
Disclosure Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others -- an interpretation of FASB Statements No. 5, 57 and 107
and rescission of FIN 34.
We accrue the estimated costs to be incurred in performing warranty services at
the time of revenue recognition and shipment of the products to our customers.
Our estimate of costs to service our warranty obligations is based on historical
experience and expectation of future conditions. To the extent we experience
increased warranty claim activity or increased costs associated with servicing
those claims, the warranty accrual will increase, resulting in decreased gross
margin.
The following table sets forth an analysis of our warranty reserve at October 31
(in thousands):
2005 2004 2003
-------- -------- --------
Warranty reserve at beginning of period $ 20 $ 53 $ 55
Less: Cost to service warranty obligations (12) (33) (13)
Plus: Increases to reserves 14 -- 11
-------- -------- --------
Total warranty reserve included in other accrued expenses $ 22 $ 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, 2005 and 2004, 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 software rights. These indemnification
provisions generally survive termination of the underlying agreement. The
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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, 2005 and 2004, respectively.
As discussed below, we are the secondary guarantor on the sublease of our
previous headquarters. This lease and related sublease matures March 2006. We
believe we will have no liabilities on this guarantee and have not recorded a
liability at October 31, 2005.
10. COMMITMENTS
We lease our buildings under noncancelable operating leases which expire at
various dates through the year 2010. 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):
Operating Capital
----------- -----------
Year ending October 31:
2006 $ 724 $ 44
2007 580 44
2008 580 44
2009 580 44
2010 and thereafter 483 1
----------- -----------
2,947 177
Less: total expected reimbursements
from sublease or interest (265) (37)
----------- -----------
Total minimum lease payments $ 2,682 $ 140
=========== ===========
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, 2005: (in thousands)
Year ending October 31:
2006 $ 44
2007 44
2008 44
2009 44
2010 1
Total minimum lease payments 177
Less: Amount representing interest(1) (37)
---------
Present value of net minimum lease payments(2) $ 140
=========
(1)Amount necessary to reduce net minimum lease payments to present value
calculated at the actual lease interest rate of 12% per annum at the
inception of the leases.
(2) Reflected in the balance sheet as other current liabilities and other
long-term liabilities of $29,000 and $111,000, respectively.
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In October 2005, we entered into a facilities lease for our engineering and
administrative headquarters located in San Ramon, California. The lease expires
in 2010. 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 March
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, 2005, 2004 and 2003 totaled $381,000,
$384,000 and $434,000, respectively. We had reimbursements of sublease proceeds
of $637,000, $637,000 and $713,000 for the years ended October 31, 2005, 2004
and 2003, respectively.
In connection with the retirement of Mr. William Heye, Jr. as our President and
Chief Executive Officer, we have been paying 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 as of that date. The balance remaining to be paid as of
October 31, 2005 is $42,000 and is included in Accrued Payroll and Employee
Benefits liability.
At October 31, 2005, we have three stock-based employee compensation plans,
including the PyX employee stock option plan assumed as part of the acquisition
of PyX on July 26, 2005, and one stock-based director compensation plan. as more
fully described in Note 11. We account for these plans under the recognition and
measurement principles of APB No. 25 and related interpretations. With the
exception of those instances more fully described in Note 7, 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. As discussed earlier, should we have
determined compensation cost utilizing the fair value approach, recorded stock
compensation expense would have been approximately $1.1 million, $1.2 million
and $231,000 in each of the years ended October 31, 2005, 2004 and 2003,
respectively. During fiscal 2005 we acquired PyX and recorded $2,484,000 of
deferred compensation related to the PyX employee stock option plan that we
assumed, as more fully described in Note 7. During fiscal 2005 we amortized
$173,000 of the deferred compensation related to the PyX stock option plan to
compensation expense.
We awarded stock option grants to certain non-employee strategic business
advisors as a part of their fee structure. The fair value of these option grants
is estimated on the date of grant using the Black-Scholes option-pricing model
and is included as deferred compensation on the balance sheet. The $56,000
deferred compensation is amortized to general and administrative expense at the
rate of $2,000 per month over the vesting period of the grants with quarterly
remeasurements. As of October 31, 2005, $6,000 of the deferred compensation has
been amortized to expense and is included in General and Administrative expense.
11. STOCK OPTION AND STOCK PURCHASE PLANS
We sponsor three employee stock option plans, the 1996 Stock Option Plan (the
1996 Plan), the 1998 Non-Officer Stock Option Plan (the 1998 Plan) and the PyX
2005 Stock Option Plan (the PyX Plan). A total of 2,730,000 shares of Common
Stock were reserved under the 1996 Plan at October 31, 2005. A total of 650,000
shares of Common Stock are reserved under the 1998 Plan and a total of 2,038,950
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shares of Common Stock are reserved under the PyX Plan at October 31, 2005,
respectively. Stock options granted under the 1996, 1998 and PyX 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, 2005 and 2004, 361,523 and 903,516 shares of Common Stock,
respectively, were available for grant under the 1996 Plan. A total of 53,429
and 26,250 shares of Common Stock were available for grant under the 1998 Plan
at October 31, 2005 and 2004, respectively. No shares of Common Stock were
available for grant under the PyX Plan at October 31, 2005. A total of 147,750
and 187,750 shares of Common Stock were available for grant under the Director
Plan at October 31, 2005 and 2004, respectively.
A summary of the combined activity under all of the stock option plans is set
forth below:
Weighted
Average Exercise
Number of Price Per Exercise
Shares Share Price
- --------------------------------------------------------------------------------------------------
Outstanding at
October 31, 2002 1,769,243 $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 (67,874) $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
Granted 856,154 $2.17--$4.00 $ 3.48
PyX Plan assumed 2,038,950 $2.17--$2.17 $ 2.17
Cancelled or expired (301,340) $0.90--$7.13 $ 4.03
Exercised (177,179) $0.70--$2.86 $ 1.84
---------------------------------------------------------
Outstanding at
October 31, 2005 4,213,704 $0.70--$18,38 $ 3.05
=========================================================
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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 PyX Plan and the Director Plan at October 31, 2005:
Options Outstanding Options Exercisable
=====================================================================================================
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
Range of Outstanding Contractual Life Exercise Exercisable Exercise
Exercise Price at 10/31/05 (years) Price at 10/31/05 Price
- -------------- -------------- ---------------- ----------- ------------- -----------
$ 0.00 - $ .90 516,900 4.0 $ 0.90 504,690 $ 0.90
$ .91 - $ 1.50 130,000 3.6 $ 1.11 108,124 $ 1.07
$ 1.51 - $ 2.50 2,137,326 6.2 $ 2.16 73,376 $ 1.65
$ 2.51 - $ 3.50 644,000 5.4 $ 2.86 176,082 $ 2.67
$ 3.51 - $ 4.50 376,000 5.8 $ 4.20 140,045 $ 4.27
$ 4.51 - $ 5.50 219,376 2.2 $ 5.06 219,376 $ 5.06
$ 5.51 - $ 8.50 149,102 1.4 $ 7.49 137,704 $ 7.54
$ 8.51 - $10.50 40,000 1.3 $ 8.63 40,000 $ 8.63
$10.51 - $20.00 1,000 1.4 $ 17.28 1,000 $ 17.28
---------- ----------
4,213,704 1,400,397
========== ==========
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, 2005.
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, 2005, 35 employees were eligible
to participate in the Purchase Plan and 58,559 shares were available for
issuance. In fiscal year 2005, no shares of Common Stock were issued under the
Purchase Plan compared to 9,903 and 11,012 shares of Common Stock issued in
fiscal 2004 and 2003, respectively.
12. NET INCOME (LOSS) PER SHARE:
Basic net income (loss) per common share for the years ended October 31, 2005,
2004 and 2003 was computed by dividing the net income (loss) for the relevant
period 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 included in the calculation of common stock and common stock
equivalents for the year ended October 31, 2003 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.
Common stock equivalents of approximately 937,000 and 792,000 options are
excluded from the diluted earnings per share calculation for fiscal 2005 and
2004, respectively, due to their anti-dilutive effect.
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(in thousands, except per share amou Years ended October 31
-------------------------------------------
2005 2004 2003
---- ---- ----
Basic earnings per share:
Net income (loss) $ (4,230) $ (1,679) $ 563
Number of shares for computation of
earnings per share 6,439 5,022 4,259
===========================================
Basic earnings (loss) per share $ (0.66) $ (0.33) $ 0.13
===========================================
Diluted earnings per share:
Weighted average number of common
shares outstanding during the year 6,439 5,022 4,259
Assumed issuance of stock under warrant
plus stock issued the employee and
non-employee stock option plans (a) (a) 450
-------------------------------------------
Number of shares for computation of
earnings per share 6,439 5,022 4,709
===========================================
Diluted earnings (loss) per share $ (0.66) $ (0.33) $ 0.12
===========================================
(a) In loss periods, common share equivalents would have an anti-dilutive
effect on net loss per share and therefore have been excluded.
13. 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, 2005, 2004 and 2003, total expense under the
employee savings and investment plan was $87,918, $90,099 and $61,730,
respectively.
14. CONCENTRATION OF CREDIT AND BUSINESS RISKS
Our trade accounts receivable are concentrated among a small number of
customers, principally located in the United States and Europe. Two customers
accounted for 41% of our outstanding accounts receivable at October 31, 2005
compared to two customers who accounted for more than 61% of total accounts
receivable at October 31, 2004. 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 $54,000 and $42,000 at October 31, 2005 and 2004, respectively.
-69-
Sales to individual customers in excess of 10% of net sales for the year ended
October 31, 2005 included sales to DCL located in the United Kingdom of $2.2
million, or 28% of net sales, Nortel of $1.4 million, or 18% of net sales and HP
of $1.0 million, or 13% of net sales compared to sales to HP in fiscal 2004 of
$4.9 million, or 45% and Nortel of $1.5 million, or 13% of net sales, and sales
to HP of $3.1 million, or 45% of net sales, in fiscal 2003.
International sales constituted 37%, 12% and 12% of net sales in fiscal 2005,
2004 and 2003, respectively. International sales are primarily executed in
Europe with 28% to customers in the United Kingdom. All international sales are
executed in U.S. dollars.
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 some of our hardware products are
currently available from single source 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.
15. ACQUISITION OF PYX TECHNOLOGIES, INC.
Effective July 26, 2005, we acquired PyX for a total purchase price of
$11,714,000 paid to the selling shareholders of PyX in the form of shares of our
common stock and the assumption of PyX's employee stock option plan, plus cash
expenses totaling $359,000 for legal, accounting and valuation services. A total
of 2,561,050 shares of our common stock has been issued in respect of
outstanding PyX common stock. We registered these shares for resale with the
Securities and Exchange Commission. A total of 95% of the shares issued in
connection with the merger will be subject to a one-year market standoff, such
that only 128,053 of such shares will be available to trade prior to July 26,
2006. An additional 2,038,950 shares of our common stock will be issuable upon
exercise of assumed stock options for services of selling shareholders who
became our employees. The option shares are issuable upon exercise of options,
subject to vesting restrictions that do not begin to lapse until February 2006,
except that if an optionee's employment is terminated without cause or the
optionee resigns for certain specified reasons, the vesting on the option will
accelerate and become fully vested.
The acquisition enabled us to obtain iSCSI software which we consider to be
complementary to our business. While this product has reached technological
feasibility and is being capitalized, we will continue to customize it to meet
our specific customer needs.
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A summary of the assets acquired and consideration paid is as follows:
Tangible assets acquired $ 31,000
Software 12,217,000
------------
Total assets acquired 12,248,000
Liabilities assumed 534,000
------------
Net assets acquired $ 11,714,000
============
Fair value of common stock provided $ 9,040,000
Fair value of stock options assumed 5,158,000
Less: value of deferred compensation
related to stock options (2,484,000)
------------
Total consideration $ 11,714,000
============
We used the purchase method of accounting for the acquisition and combined PyX
results of operations beginning July 26, 2005. The fair value of the common
stock provided to the PyX shareholders was calculated as the value of the
2,561,050 shares of common stock multiplied by the closing price of our common
stock on July 26, 2005 ($3.53 per share). The fair value of the vested portion
of the 2,038,950 PyX stock options assumed by us was calculated using the
Black-Scholes valuation model and included in the purchase price. The intrinsic
value of the unvested portion of the 2,038,950 PyX stock options assumed by us
was recorded as deferred compensation (see Note 7) and is amortized to
compensation expense over the remaining 43 month vesting period. We allocated
the purchase price to the tangible assets and liabilities based on fair market
value at the time of the acquisition and to software based on future expected
cash flows to be derived from the acquired iSCSI software product line.
The unaudited pro forma results are provided for comparison purposes only and
are not necessarily indicative of what actual results would have been had the
PyX acquisition been consummated on such dates, nor do they give effect to the
synergies, cost savings and other changes expected to result from the
acquisition. 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
PyX at the beginning of the prior period, our results of operations would have
been as follows (in thousands, except per share amounts):
For the fiscal years ended October 31,
2005 2004
-------- --------
Revenues $ 8,056 $ 11,066
Net loss (8,721) (7,653)
Basic and diluted loss
per common share $ (0.89) $ (0.79)
We amortize the software acquired in the PyX acquisition to cost of sales
expense over 36 months which is the estimated useful life at the time of
acquisition.
16. SEGMENT FINANCIAL DATA
Our operations are organized into two business segments: Embedded and Storage
Products. The Embedded Products segment designs and manufactures a broad range
of embedded computing products including VoIP, T1/T3 adapter cards and
programmable intelligent processing platforms. Revenue from this business
segment in 2005 was $8.1 million, representing 100% of our total sales. The
Storage Products segment develops standards based iSCSI software for a newly
emerging IP based storage market. The Storage business was purchased in July
2005 and had no revenues in 2005. All software relates to the storage business.
Prior to July 2005, we operated in one segment. Sales of adaptor cards,
high-wire products and all other products represented approximately $4.0
million, $2.5 million and $1.5 million in 2005.
-71-
International sales accounted for 37%, 12% and 12% of total sales during fiscal
2005, 2004 and 2003, respectively. Our international sales are primarily to
customers in Europe with 28% of sales to customers in the United Kingdom.
The following is a discussion of sales to external customers and segment profit
(loss) for each reportable segment. We measure the results of operations for
segments (Segment Profit (Loss)) based on income (loss) before income taxes,
interest income or expense and other income or expense.
Embedded Storage Corporate &
(in thousands) Group Group Unallocated Total
----- ----- ----------- -----
Years ended October 31:
Gross Sales 2005 $ 8,056 -- -- $ 8,056
Interest and other
Income, net 2005 $ -- -- 16 $ 16
Amortization 2005 $ -- 1,014 486 $ 1,500
Segment (loss)
before taxes 2005 $ (1,559) (2,201) (470) $ (4,230)
As of October 31:
Total assets 2005 $ -- 11,199 7,633 $ 18,832
17. LOAN TO OFFICER
On November 6, 1998, we made a loan to our prior 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, due to the market value of the stock collateral, 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 market value of the stock
collateral recovered sufficiently and 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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18. SUBSEQUENT EVENTS
On January 12, 2006 we took steps to reduce our cash flow break-even point. We
changed the formula for paying all officers and employees and our Board of
Directors for their services. Beginning with our January 31, 2006 payroll, all
officer and employee payroll compensation will be paid approximately 70% in cash
and approximately 30% in non-restricted shares of SBE common stock. Our Board of
Directors fees will be paid 100% in non-restricted SBE common stock. The cash
reduction efforts are expected to reduce our quarterly cash use rate by
approximately $550,000 and will result in the issuance of additional shares of
SBE common stock. We will issue a total of approximately 264,000 shares of SBE
common stock to employees and directors during the period January 31, 2006
through March 31, 2006, based on the market price of the common stock on the
date of issue. After that time the Board of Directors will review our financial
position each quarter and make a determination as to the continuation of the
stock-for-pay program and the number of shares of SBE common stock to be issued.
QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
(in thousands except First Second Third Fourth
per share amounts) Quarter Quarter Quarter Quarter
- ----------------------------------------------------------------------------------------------
2005: Net sales $ 2,815 $ 1,706 $ 1,720 $ 1,815
Gross profit 1,585 630 648 (212)
Net income (loss) 177 (936) (945) (2,526)
Basic income (loss) per
common share $ 0.03 $ (0.18) $ (0.17) $ (0.26)
Diluted income (loss) per
common share $ 0.03 $ (0.18) $ (0.17) $ (0.26)
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)
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SBE, Inc.
Schedule II - Valuation and Qualifying Accounts
For the Years Ended October 31, 2005, 2004 and 2003
(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, 2005
Allowance for Doubtful Accounts
and sales programs $ 42 $ 27 $ (15) $ 54
Allowance for Warranty Claims 20 14 (12) 22
Allowance for Deferred Tax Assets 8,944 -- (4,021) 4,923
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 8,662 282 -- 8,944
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
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