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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER 1-16027
LANTRONIX, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0362767
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
15353 BARRANCA PARKWAY, IRVINE, CALIFORNIA 92618
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(949) 453-3990
(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:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
COMMON STOCK, $0.0001 PAR VALUE THE NASDAQ SMALLCAP MARKET
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes [ ] No [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
last sold, or the average bid and asked price of such common equity, as of the
last business day of the registrant's most recently completed fiscal year (June
30, 2003), was $18,260,000. Shares of common stock held by each executive
officer, director and each person who beneficially owns 5% or more of the
outstanding common stock have been excluded because such persons may, under
certain circumstances, be deemed to be affiliates. The determination of
affiliate or executive officer status is not necessarily conclusive for other
purposes.
As of August 31, 2003, there were 55,657,903 shares of the Registrant's common
stock outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the Lantronix, Inc. Annual
Meeting of Stockholders scheduled to be held on November 20, 2003 are
incorporated by reference into Part II and Part III of this Form 10-K.
Certain exhibits filed in connection with the Lantronix, Inc. Registration
Statement on Form S-1, originally filed May 19, 2000, and Registration Statement
on Form S-1, originally filed June 13, 2001, are incorporated by reference into
Part IV of this Form 10-K.
LANTRONIX, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED JUNE 30, 2003
TABLE OF CONTENTS
PAGE
----
PART I
ITEM 1. Business 4
ITEM 2. Properties 11
ITEM 3. Legal Proceedings 11
ITEM 4. Submission of Matters to a Vote of Security Holders 13
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters 14
ITEM 6. Selected Consolidated Financial Data 15
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 16
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk 40
ITEM 8. Financial Statements and Supplementary Data 40
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 40
ITEM 9A Controls and Procedures
PART III
ITEM 10. Directors and Executive Officers of the Registrant 41
ITEM 11. Executive Compensation 41
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 41
ITEM 13. Certain Relationships and Related Transactions 41
ITEM 15. Principal Accountant Fees and Services 41
PART IV
ITEM 16. Exhibits, Financial Statements, Schedules and Reports on Form 8-K 42
Officer Certifications II-3
2
FORWARD-LOOKING STATEMENTS
THIS DOCUMENT CONTAINS STATEMENTS THAT ARE NOT HISTORICAL FACTS BUT ARE
FORWARD-LOOKING STATEMENTS RELATING TO SUCH MATTERS AS ANTICIPATED FINANCIAL
PERFORMANCE, BUSINESS PROSPECTS, TECHNOLOGICAL DEVELOPMENTS, NEW PRODUCTS,
ENGINEERING AND DEVELOPMENT ACTIVITIES AND SIMILAR MATTERS. SUCH STATEMENTS ARE
GENERALLY IDENTIFIED BY THE USE OF FORWARD-LOOKING WORDS AND PHRASES, SUCH AS
"INTENDED," "EXPECTS," "ANTICIPATES" AND "IS (OR ARE) EXPECTED (OR
ANTICIPATED)." THESE FORWARD-LOOKING STATEMENTS INCLUDE BUT ARE NOT LIMITED TO
STATEMENTS CONCERNING INDUSTRY TRENDS, ANTICIPATED DEMAND FOR OUR PRODUCTS, THE
IMPACT OF PENDING LITIGATION, OUR STRATEGY, THE FUTURE BENEFITS OF OUR
ACQUISITIONS, INCLUDING THE BENEFITS OF USING THE TECHNOLOGY DEVELOPED BY THE
COMPANIES WE ACQUIRE IN OUR EXISTING PRODUCT LINE AND THE POSSIBLE SALES OF OUR
PRODUCTS TO THE ACQUIRED COMPANIES' EXISTING CUSTOMERS, THE POSSIBILITY OF
FUTURE INVESTMENTS OR ACQUISITIONS, FUTURE CUSTOMER AND SALES DEVELOPMENTS,
MANUFACTURING FORECASTS, INCLUDING THE POTENTIAL BENEFITS OF OUR CONTRACT
MANUFACTURERS SOURCING AND SUPPLYING RAW MATERIALS, COMPONENTS AND INTEGRATED
CIRCUITS, THE POSSIBILITY OF AN EXPANDING ROLE FOR ORIGINAL EQUIPMENT
MANUFACTURERS IN OUR BUSINESS, THE FUTURE COST AND POTENTIAL BENEFITS OF OUR
RESEARCH AND DEVELOPMENT EFFORTS, AND LIQUIDITY AND CASH RESOURCES FORECASTS.
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE DISCUSSED IN SUCH
FORWARD-LOOKING STATEMENTS, AND OUR STOCKHOLDERS SHOULD CAREFULLY REVIEW THE
CAUTIONARY STATEMENTS SET FORTH IN THIS FORM 10-K, INCLUDING FACTORS THAT MAY
AFFECT FUTURE RESULTS. WE MAY FROM TIME TO TIME MAKE ADDITIONAL WRITTEN AND ORAL
FORWARD-LOOKING STATEMENTS, INCLUDING STATEMENTS CONTAINED IN OUR FILINGS WITH
THE SECURITIES AND EXCHANGE COMMISSION AND IN OUR REPORTS TO STOCKHOLDERS. WE DO
NOT UNDERTAKE TO UPDATE ANY FORWARD-LOOKING STATEMENTS THAT MAY BE MADE FROM
TIME TO TIME BY US OR ON OUR BEHALF.
3
PART I
ITEM 1. BUSINESS
OVERVIEW
Lantronix, Inc. ("Lantronix" or "we" or "us") designs, develops and markets
devices and software solutions that make it possible to access, manage, control
and configure almost any electronic product over the Internet or other networks.
We are a leader in providing innovative networking solutions. We were initially
formed as "Lantronix," a California corporation, in June 1989. We reincorporated
as "Lantronix, Inc.," a Delaware corporation in May 2000.
We have a history of providing devices that enable information technology
("IT") equipment to network using standard protocols for connectivity, including
fiber optic, Ethernet and wireless. Our first device was a terminal server that
allowed "dumb" terminals to connect to a network. Building on the success of our
terminal servers, we introduced a complete line of print servers in 1991 that
enabled users to inexpensively share printers over a network. Over the years, we
have continually refined our core technology and have developed additional
innovative networking solutions that expand upon the business of providing our
customers network connectivity. With the expansion of networking and the
Internet, our technology focus is increasingly broader, so that our device
solutions provide a product manufacturer with the ability to network their
products within the industrial, service and consumer markets.
We provide three broad categories of products: "device networking
solutions," that enable almost any electronic product to be connected to a
network; IT management solutions," that enable multiple pieces of hardware,
usually IT-related network hardware such as servers, routers, switches, and
similar pieces of equipment to be managed over a network; and software that is
either embedded in the hardware devices that are mentioned above, or stand-alone
application software.
Today, our solutions include fully integrated hardware and software
devices, as well as software tools to develop related customer applications.
Because we deal with network connectivity, we provide hardware solutions to
extremely broad market segments, including industrial, medical, commercial,
financial, governmental, retail, building and home automation, and many more.
Our technology is used with products such as networking routers, medical
instruments, manufacturing equipment, bar code scanners, building HVAC systems,
elevators, process control equipment, vending machines, thermostats, security
cameras, temperature sensors, card readers, point of sale terminals, time
clocks, and virtually any product that has some form of standard data control
capability. Our current offerings include a wide range of hardware devices of
varying size, packaging and, where appropriate, software solutions that allow
our customers to network-enable virtually any electronic product.
We sell our devices through a global network of distributors, systems
integrators, value-added resellers (VARs), manufacturers' representatives and
original equipment manufacturers (OEMs). In addition, we sell directly to
selected accounts.
Our common stock is currently traded on The Nasdaq SmallCap Market under
the symbol LTRX.
Our worldwide headquarters are located in Irvine, California and we have
offices throughout the U.S. and worldwide, including Redmond, Washington;
Milford, Connecticut; Switzerland; Germany; France; Hong Kong and Japan. We also
have employees working from home offices in other areas of the world including
the UK and Netherlands. During fiscal 2003, we closed or administratively
dissolved the following subsidiaries, integrating their operations into our
operations: Premise Systems, Inc., ("Premise"), Synergetic Micro systems, Inc.,
("Synergetic") and United States Software Corporation ("USSC"). Operations from
our Switzerland facility will cease in October 2003, and thereafter, operations
will be managed from our Irvine, California facility.
OUR STRATEGY
Our business strategy is based on our proven capability to develop fully
integrated networking solutions that increase the value of our customers'
products by making it easy to take advantage of features that can be made
available when these products are network-enabled. This strategy is accomplished
by providing our customers with hardware and software that connects products and
systems to a network, and intelligently manages and controls them. Through our
14 years of networking expertise, knowledge of industry trends, and our
capability to develop solutions based on open industry standards, we have been
able to anticipate our customers' networking technology requirements and offer
solutions that enable them to achieve their connectivity objectives. By
providing a complete solution of hardware and integrated software, we have been
able to provide "turnkey" solutions, eliminating the need for our customers to
build expensive design and manufacturing expertise in-house. This results in
savings to the customer both in terms of financial investment, and in time.
Our fully integrated hardware, software, and application development tools
have enabled us to become a technology and industry leader. While our solutions
could address practically any application, we have focused on the following key
areas:
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- - Device Networking Solutions - We offer an array of embedded and external
device networking solutions that enable manufacturers of electronic and
electro-mechanical products to add network connectivity, manageability, and
control to their products. Our customers' products originate from a wide
variety of applications, such as blood analyzers that relay critical
patient information directly to a hospital's information system, to simple
devices such as timeclocks or audio/visual equipment, to improve how these
products are managed and controlled.
- - IT Management Solutions - We offer off-the-shelf equipment that enables IT
professionals to remotely manage network infrastructure equipment and large
groups of servers. Our terminal and console management systems solutions
provide a comprehensive solution for the command and control of today's
network infrastructure.
- - Residential/Building Automation - Our home and building management
solutions link security, lighting, air conditioning and other systems
together by providing the necessary tools to more efficiently manage an
entire home or building. Our solutions include an entire software platform
that is the basis for much more extensive command and control systems. This
software is currently being adapted specifically to the PC market, to
provide management of music and other media within the home environment.
- - Visualization Solutions - We offer solutions that provide switching and
extension of high performance video, audio, keyboard and mouse over long
distances within a building or campus environment. The customers for these
devices are typically companies needing to isolate users from the core
computing center for security reasons, or have other needs requiring high
speed video sources to be shared among many users. Our visualization
solutions can be found in government agencies and at customers involved
with large scale simulation and display applications.
RECENT ACQUISITIONS AND INVESTMENTS
We have completed a number of acquisitions and investments since our
initial public offering in August 2000, the purpose of which is to expand our
product offerings, increase our technology base and provide a foundation for
future growth. In December 2000, we completed the acquisition of USSC, a
developer of software operating systems, protocol stacks and an application
development environment for embedded technology.
In June 2001, we completed the acquisition of Lightwave Communications,
Inc., ("Lightwave"), a developer of console management products, visualization
(video extension and matrix switches), and keyboard, video and mouse ("KVM")
switches.
In October 2001, we completed the acquisition of Synergetic, a provider of
embedded network communication solutions that complement our device server
products.
In January 2002, we completed the acquisition of Premise, a developer of
client-side software applications that complement our device networking products
by providing management and control capabilities for devices that have been
network and Internet enabled.
In January 2002, we acquired a minority interest in Xanboo Inc. ("Xanboo")
through a cash investment. Xanboo, a privately-held company, develops technology
that allows users to control, command and view their home or business remotely
over the Internet.
In August 2002, we completed the acquisition of Stallion Technologies PTY,
LTD ("Stallion"), an Australian company that provides terminal servers and
multiport board-level products. Stallion products are complementary to our
existing product line.
With the exception of Xanboo, which is a minority investment, these
acquisitions have been integrated into our general product offerings and
operations.
PRODUCTS
DEVICE NETWORKING SOLUTIONS
We provide manufacturers, integrators, and users with complete device
networking solutions that include the technology required for products to be
connected, managed and controlled over networks using standard protocols for
connectivity, including fiber optic, Ethernet and wireless. As common, everyday
products such as lighting, security and audio/visual systems leverage the power
of network connectivity, manufacturers and users are realizing the benefits of
networking. Our device networking solutions dramatically shorten a
manufacturer's development time to implement network connectivity, significantly
5
speed time-to-market with competitive advantages of new features, and greatly
reduce engineering and marketing risks. Our hardware solutions include
integrated circuits (ICs), embedded modules (completed boards or intelligent
connectors with electronic components and the necessary connectors and software
that is mounted within a customer's product), and external hardware modules
(with single, multi- or wireless ports), as well as the related real-time
operating system and application software that is required to make the devices
effective. We also offer application- and industry-specific solutions such as
industrial device servers, network time servers and print servers.
Our device servers allow a wide range of equipment to be quickly
network-enabled without the need for intermediary gateways, workstations, or
PCs. This distributed computing approach significantly improves the reliability
and up-time of the network. Our device servers also eliminate the high cost of
ownership associated with PCs and workstations needed when device server
technology is not used. Our device servers contain high-performance processors
capable of not only controlling the attached device, but are also capable of
accumulating data and status. Such data can then be formatted by the device
server and presented to users via the built in web server, SNMP, e-mail, etc.
Device servers are easy to manage using any standard Web browser, due to a
built-in HTTP server and powerful Java technology.
In February 2003, we announced the release of our XPort device server,
which represents a significant improvement in technology, and a reduction in
physical size and price for this type of functionality. The thumb-sized XPort is
a self-contained network communications server and miniaturized web site
enclosed within a rugged RJ-45 connector package, which can be embedded in
virtually any electronic product. Products incorporating XPort have their own
address on the World Wide Web and can be accessed from any web browser,
including a wireless PC or Internet-enabled cell phone, from anywhere in the
world. The XPort can serve up Internet-standard web pages, initiate e-mails for
notifications or alerts, and run other applications as defined by the product
manufacturer. XPort eliminates the complexity for a product manufacturer to
create network connectivity, because the XPort device includes a complete,
integrated solution with a 10Base-T / 100Base-TX Ethernet connection, a reliable
and proven operating system, an embedded web server, flexible firmware, a full
TCP/IP protocol stack, and optional 256-bit standards-based (AES) encryption. We
believe the relatively low price of the XPort, as well as the speed and ease
with which a manufacturer can design the device into their products, will make a
customer's products more attractive, by providing network connectivity.
IT MANAGEMENT SOLUTIONS
Our IT management solutions provide IT professionals with the tools they
need to remotely manage computer network hardware and software systems. Our
terminal servers provide simple and cost-effective network connectivity.
IT professionals use our multiport device solutions (including our terminal
and console servers) to monitor and run their systems to assure the performance
and availability of critical business information systems, network
infrastructure, and telecommunications equipment. The equipment they manage
includes routers, switches, servers, phone switches and public branch exchanges
(PBXs) that are often located in remote or inaccessible locations.
Our console servers provide system administrators and network managers a
way to connect with their remote equipment through a universal interface called
a console port, helping them work more efficiently without having to leave their
desk or office. With remote access, system downtime, and its impact on business,
is minimized. Our console servers provide IT professionals with peace-of-mind
through extensive security features and provisions for dial-in access via modem
("out of band" connectivity) in case the network is not available. These
solutions are provided in various configurations, and can manage up to 48
devices from one console server.
PRINT SERVERS AND OTHER LEGACY PRODUCTS
We began our business by providing external print servers that connect
various printers to a network for shared printing tasks. Over the years, we have
updated and continue to provide print servers that work with a myriad of
operating systems and network configurations. The requirement for external print
servers is decreasing, as manufacturers have incorporated the networking
hardware and software as part of many printers.
We also design and manufacture visualization products including video
display extenders ("VDE") and FiberLynx (video display extenders), KVM switches,
KVM extension systems and matrix hubs. These products provide a valuable
solution for extending and sharing audio, video, keyboard and mouse signals
among many users and over large distances without loss of resolution. KVM
products enable a single keyboard, monitor and mouse to be switched between
multiple computers, providing immediate access and control from a single
location.
6
SOFTWARE APPLICATION SOLUTIONS
We produce software application solutions targeted at the residential and
building automation markets. These markets are emerging and fragmented, with
numerous providers and a wide range of products and services. Our current
product offering, Premise SYS software, is a PC-based system that controls items
such as audio, video, home theater systems, lighting, motorized drapes, heating
and air conditioning units, closed circuit cameras, security systems, and other
home electronic equipment. Premise SYS can be used to manage and play digital
media. Although this is an emerging market and we have not realized significant
revenues for this software through June 30, 2003, our solution has received
significant recognition in its marketplace. Currently, our software is being
adapted for use in PCs being offered by various manufacturers.
The following are approximate revenues for these categories, the
definitions of which have been modified slightly as of June 30, 2003, and
previous years' data has been modified to conform to the new definitions:
NET REVENUES FOR THE YEARS ENDED JUNE 30,
--------------------------------
PRODUCT FAMILY PRIMARY PRODUCT FUNCTION 2003 2002 2001
- ---------------------------------------- ---------------------------------- ----- ------ -----
Enable almost any electronic
Device networking solutions. . . . . . . product to become network
(including software) . . . . . . . . . . enabled. $26.8 $30.0 $34.3
Allow the user to control equipment
by way of the Internet using a wide
IT management solutions. . . . . . . . . range of network protocols. This
(including software) . . . . . . . . . . category includes console servers. $13.2 $16.5 $14.0
Allow the user to share network
printers. This category also includes
visualization and KVM products, as
well as software and Miscellaneous
Print server and others . . . . . . . older products. $ 9.5 $11.1 $ 4.7
Financial Accounting Standards Board ("FASB") Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information,"
establishes standards for disclosures about operating segments in annual
consolidated financial statements. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
We operate in one segment, networking and Internet connectivity.
CUSTOMERS
Distributors
Our principal customers are our distributors, who are the source of our
highest percentage of net revenues. Distributors resell our products to a wide
variety of customers including consumers, corporate customers, VARs, etc. We
sell to a group of eight major distributors, who operate, in some cases, from
multiple warehouses. Our major distributors in the U.S. include: Ingram Micro,
Tech Data, KMJ Communications and Arrow Electronics, Inc. In Europe, we
distribute directly from a public warehouse located in Belgium which services,
in part, the following major distributors: transtec AG (a related party due to
common ownership by our largest shareholder), Atlantik Systems GmbH, Astradis
Elecktronik GmbH and Lightwave Communications GmbH (not affiliated with
Lantronix).
OEM Manufacturers
We have established a broad range of OEM electro-mechanical manufacturing
customers in various industries such as industrial automation, medical,
security, building automation, consumer and audio/visual. Our OEM customers
typically lack the expertise or resources to develop hardware and software
required to introduce network solutions to their end users in a timely manner.
To shorten the development cycle to add network connectivity to a product, OEMs
can use our external devices to network-enable their installed base of products,
while board-level solutions, chips and embedded software are typically used in
new product designs. Our capabilities and hardware and software solutions enable
OEMs to focus on their core competencies, resulting in reduced research and
development costs, fewer integration problems, and faster time to market.
Our new product Xport, is particularly useful and adaptable by OEM
customers to enable network connectivity to a wide variety of electro-mechanical
products. In addition to the features it provides, the advantage is low cost,
and the fact that the device can be adapted for use in a wide range of products
without the necessity for lengthy engineering processes by the OEM, or the time
delays that activity might introduce.
7
End User Businesses
We have established a broad range of end user customers in various
businesses such as airports, retail, universities/education, manufacturing,
healthcare/hospitals and financial/banking. End user businesses require
solutions that are simple to install, setup, and operate, and can provide
immediate results. Generally, these customers have requirements to connect a
diverse range of products and equipment, without modifying existing software and
systems.
Our external device solutions enable end users to quickly, securely and
easily connect their devices and equipment to networks, extending the life of
existing investments. In support of these customers, we provide a number of
programs including telephone-based sales and technical support as well as a wide
array of Internet-based resources. We maintain a field sales force and network
of VARs and system integrators throughout the world to call on IT departments
and decision-makers within the end user accounts. In many cases, the customer
simply has to call in to obtain assistance in identifying which networking
device would be most appropriate for its need. After buying the devices from us
or one of our distributors, a customer often only has to plug a cable from the
device to be managed to our external device, and then plug our device into their
network.
Consumer Market
We have made a preliminary entry into the consumer networking market. The
networking of consumer products and services will impact the value of broadband
and entertainment services delivered to the home, as well as create demand for
newly emerging classes of computer, networking, and consumer electronics
products.
We believe the consumer networking market will develop very differently
from the enterprise local area network market. We believe the home network will
evolve steadily to encompass entertainment, communications, security,
convenience and control applications. We expect the key applications driving
consumer networking adoption will include PCs, integrated controllers, gateways,
distribution of digital music and video, IP-based telephony, security and the
automation of home appliances. In support of these customer and home integrator
needs, we offer embedded devices and our Premise SYS software.
SALES AND MARKETING
We maintain both an inside and a field sales force. We are also represented
by manufacturers' representatives and VARs throughout the world who call on
engineering design and product management teams. We develop marketing programs,
products, tools and services specifically geared to meet the needs of our
targeted customers. Our sales and marketing force consisted of 83 employees as
of June 30, 2003 and 89 employees as of June 30, 2002.
We believe that our direct distribution and multi-channel approach provides
several advantages. We can engage the customers and end users through their
channel of choice, making our solution available from a variety of sources.
Our device networking solutions are principally sold direct to
manufacturers by our worldwide OEM sales force and through our group of
manufacturers' representatives. We have expanded our use of manufacturers'
representatives and VARs in the past year, leveraging their established
relationships to bring our device networking solutions to a greater number of
customers within the OEM market.
We market and sell our IT management solutions, application software and
select external device networking solutions through information technology
resellers, industry-specific system integrators, VARs and directly to end user
organizations. Resellers and integrators will often obtain our products through
distributors such as Ingram Micro, Tech Data and Atlantik Systems GmbH. These
distributors supply our products to a broad range of VARs, system integrators,
direct marketers, government resellers and e-commerce resellers. In turn, these
distributor customers market, sell, install, and in most cases, support our
solution to the end users. We are continuing to expand our use of
cost-effective, indirect channels for basic offerings and will focus our direct
end user sales force for our more advanced technologies and solution selling.
Net revenues generated from sales in the Americas, Europe and other
geographic areas including Asia and Japan for the year ended June 30, 2003 were
$37.5 million, $10.4 million and $1.6 million, respectively, compared to $47.7
million, $8.2 million and $1.7 million for year ended June 30, 2002,
respectively.
8
MANUFACTURING
Our manufacturing strategy is to produce reliable, high quality products at
competitive prices and to achieve on-time delivery to our customers. To achieve
this strategy, we generally contract with others for the manufacturing of our
products. This practice enables us to concentrate our resources on design,
engineering and marketing where we believe we have greater competitive
advantages.
We have agreements with multiple contract manufacturers. Our contract
manufacturers are located in and around Irvine, California; Sacramento,
California; Durham, Connecticut; and Dongguan, China. Under these agreements,
the manufacturers source and supply most raw materials, components and
integrated circuits in accordance with our pre-determined specifications and
forecasts, and perform final assembly, functional testing and quality control.
We believe that this arrangement decreases our working capital requirements and
provides better raw material and component pricing, enhancing our gross and
operating margins. Please see "Risk Factors" for a discussion of the risks
associated with contract manufacturing.
RESEARCH AND DEVELOPMENT
Our research and development efforts are focused on the development of
technology and products that will enhance our position in our markets. Products
are developed in-house and through outside research and development resources.
We employed 47 employees in our research and development organization as of June
30, 2003, and 67 employees as of June 30, 2002. Our research and development
expenses were $10.4 million, $9.2 million (excluding $1.0 million of acquired
in-process research and development) and $4.5 million (excluding $2.6 million of
acquired in-process research and development) for the years ended June 30, 2003,
2002 and 2001, respectively.
INDUSTRY PARTNERS
In keeping with our business strategy, we have engaged a portfolio of
partners, consortia, and standards committees in an effort to provide the most
complete networking solutions to our customers. We are an active member of many
leading professional and industry associations. Membership in these associations
provides us with a voice in the development of future standards that are vital
to our customers. Industry associations also provide much needed standardization
in specific technology areas and ensure that customers benefit from
interoperable products regardless of vendor. To enhance our software products,
for example, we embrace open standards-based systems, and participate in the
development of these standards.
SOFTWARE DEVELOPER RELATIONS
Recruiting and informing third-party software developers is an integral
part of our ongoing strategy. We encourage, enable, and support programmers to
develop vertical applications using our hardware, firmware and software
products. With their help and investment in creating additional applications and
markets for our products, we secure a defensible market position and loyal
customers in the process.
COMPETITION
The markets in which we compete are dynamic and highly competitive. We
expect competition to intensify in the future. Our current and potential
competitors include the following:
- - companies with network-enabling technologies, such as Avocent, Echelon,
Moxa, Digi International, Cyclades, Quatech, Wind River, Rabbit and Zilog;
- - companies with equipment for IT management solutions, such as Cyclades,
Moxa, Digi International, Sena, Logical Solutions, Cisco and Perle;
- - companies with significant networking expertise and research and
development resources, including Cisco Systems, IBM and Lucent
Technologies.
The principal competitive factors that affect the market for our products
are:
- - product quality, technological innovation, compatibility with standards and
protocols, reliability, functionality, ease of use, and compatibility;
- - prices of the products; and
- - potential customers' awareness and perception of our products and of
network-enabling technologies.
9
Much of our technology can be reproduced by our competitors without
royalties or license fees and could compete with our offerings. In addition,
there is a risk that our customers or new entrants to the market could develop
and market their own solutions without paying a fee to us.
INTELLECTUAL PROPERTY RIGHTS
We have developed proprietary methodologies, tools, processes and software
in connection with delivering our services. We have not historically relied on
patents to protect our proprietary rights, although we have recently begun to
build a patent portfolio. We have historically relied on a combination of
copyright, trademark, trade secret laws, and contractual restrictions, such as
confidentiality agreements and licenses to establish and protect our proprietary
rights. As of June 30, 2003, we owned four United States patents and one patent
issued in Germany.
Trade secret and copyright laws afford us only limited protection. We
cannot be certain that the steps we have taken in this regard will be adequate
to deter misappropriation of our proprietary information or that we will be able
to detect unauthorized use and take appropriate steps to enforce our
intellectual property rights. An adverse change in the laws protecting
intellectual property could harm our business. In addition, we believe that our
success will depend principally upon continuing innovation, technical expertise,
knowledge of networking, storage and applications, and to a lesser extent, on
our ability to protect our proprietary technology. Furthermore, there can be no
assurance that our current or future competitors will not develop technologies
that are substantially equivalent to ours.
In July 2001, Digi International, Inc. ("Digi") filed a lawsuit against us
alleging that our multiport device servers, specifically our ETS line of
products, when coupled with our Comm Port Redirector software, infringe a patent
held by Digi. In November 2002, this and related lawsuits were settled.
In March 2003, we filed a lawsuit against Logical Solutions, Inc.
("Logical"). This company was founded principally by former owners of Lightwave
Communications, Inc., a company we purchased in June 2001. In this lawsuit, we
allege that Logical has failed to honor covenants not to compete that had been
signed by its principals, and Logical has illegally used intellectual property,
trade secrets, and proprietary information to further its business. The
litigation seeks a permanent injunction and damages. Please see "ITEM 3. Legal
Proceedings," for a discussion of this litigation.
LIMITATIONS ON OUR RIGHTS TO INTELLECTUAL PROPERTY
Gordian, Inc. ("Gordian") has developed certain intellectual property used
in our micro serial server line of products. These products represented and
continue to represent a significant portion of our net revenues. Under the terms
of an agreement dated February 29, 1989, Gordian owned the rights to the
intellectual property developed under the agreement and required us to pay
royalties based upon gross margin of products sold under the agreement. For the
years ended June 30, 2002 and 2001, we paid Gordian approximately $1.2 million
and $2.2 million for royalties, respectively. No royalties were paid to Gordian
for the year ended June 30, 2003 as a result of a new Gordian agreement as
described below. Our agreement with Gordian was to terminate at the end of the
sales life of the products.
On May 30, 2002, we signed a new intellectual property agreement with
Gordian. The new agreement gives us joint ownership of the Gordian intellectual
property that is embodied in the products Gordian has designed for us since
1989. This new agreement provides that we will be able to use the intellectual
property to support, maintain and enhance our products. This new agreement
extinguishes our obligations to pay royalties for each unit of a
Gordian-designed product that we sell as of the effective date.
As part of the new agreement, we paid Gordian $6.0 million in three
installments. We paid $3.0 million concurrent with the signing of the new
agreement, $2.0 million on July 1, 2002, and we made the third and final payment
of $1.0 million on July 1, 2003. We also agreed to purchase $1.5 million of
engineering and support services from Gordian over the 18-month period ending
November 2003. We are amortizing the intellectual property rights acquired by
this new agreement over the remaining life cycles of our products designed by
Gordian, or approximately three years. We recorded $2.5 million and $212,000 of
amortization expense in cost of revenues for the years ended June 30, 2003 and
2002, respectively.
UNITED STATES AND FOREIGN GOVERNMENT REGULATION
Many of our products and the industries in which they are used are subject
to federal, state or local regulation in the United States. In addition, our
products are exported worldwide. Therefore, we are subject to the regulation of
foreign governments. For example, wireless communication is highly regulated in
both the United States and elsewhere. Our products currently employ encryption
technology; the export of some encryption software is restricted. We do not know
whether these or other existing or future laws or regulations will adversely
affect us.
10
EMPLOYEES
As of June 30, 2003, we had 181 full-time employees consisting of 47
employees in research and development, 83 in sales and marketing departments, 17
in operations departments, and 34 general and administrative employees. We have
not experienced any work stoppages and we believe that our relationship with our
employees is good. None of our employees are currently represented by a labor
union.
BACKLOG
In many cases, we manufacture our products in advance of receiving firm
product orders from our customers based upon our forecasts of worldwide customer
demand. Generally, orders are placed by the customer on an as-needed basis and
may be canceled or rescheduled by the customer without significant penalty.
Accordingly, backlog as of any particular date is not necessarily indicative of
our future sales. As of June 30, 2003 and June 30, 2002, we had backlog of
approximately $2.3 million and $1.3 million, respectively. We do not have
backlog orders that cannot be filled within the next fiscal year.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table lists the names, ages and positions held by all our
executive officers as of September 29, 2003. There are no family relationships
between any director or executive officer and any other director or executive
officer of Lantronix. Executive officers serve at the discretion of the Board of
Directors.
NAME AGE POSITION
- --------------------- --- ---------------------------------------
Marc H. Nussbaum 47 President and Chief Executive Officer
James W. Kerrigan 67 Chief Financial Officer
Michael Oswald 48 General Counsel and Secretary
MARC H. NUSSBAUM has served as our President and Chief Executive Officer
since May 2002 (on an Interim basis until February 2003). From April 2000 to
March 2002, Mr. Nussbaum served as Senior Vice President and Chief Technical
Officer for MTI Technology Corporation, a developer of enterprise storage
solutions. From April 1981 to November 1998, Mr. Nussbaum served in various
positions at Western Digital Corporation, a manufacturer of PC components,
communication controllers, storage controllers and hard drives. Mr. Nussbaum
lead business development, strategic planning and product development
activities, serving as Western Digital's Senior Vice President, Chief Technical
Officer from 1995 to 1998 and Vice President, Storage Technology and Product
Development from 1988 through 1995. Mr. Nussbaum holds a BA degree in physics
from the State University of New York.
JAMES W. KERRIGAN has served as our Chief Financial Officer since May 2002
(on an Interim basis until February 2003). From March 2000 to October 2000, he
was Chief Financial Officer of Motiva, a privately-owned company that developed,
marketed and sold collaboration software systems. From January 1998 to February
1999, he was Chief Financial Officer of Who?Vision Systems, Inc., an incubator
company that developed biometric fingerprint devices and software. From April
1995 to March 1997, Mr. Kerrigan was Chief Financial Officer of Artios, Inc., a
privately-owned company that designs, manufactures, and sells prototyping
hardware and software to the packaging industry. Previously, Mr. Kerrigan has
served as chief financial officer for other larger, public companies. He has a
BS degree in engineering and a MBA degree from Northwestern University.
MICHAEL OSWALD has served as our General Counsel and Secretary since
December 2001. From June 2001 through December 2001, he provided legal services
for clients, including Lantronix, as an independent consultant. From September
1999 to June 2001, he was General Counsel and Chief Administrative Officer at
NowDocs, Inc., a private start-up Internet-enabled document printing and
delivery company located in Aliso Viejo, California. From December 1996 to
November 1999, he was General Counsel to Acuity Corp., a start-up CRM software
producer in Austin, Texas. Mr. Oswald holds a J.D. from Santa Clara University
School of Law, and a BA from the University of California at Riverside.
11
ITEM 2. PROPERTIES
We lease a building in Irvine, California that comprises our corporate
headquarters and includes administration, sales and marketing, research and
development, warehouse and order fulfillment functions. We also lease an office
in Redmond, Washington that provides some sales, research and development and
administrative functions. We have smaller sales offices in Milford, Connecticut;
Germany; Hong Kong and Japan. The foregoing leases comprise an aggregate of
approximately 70,000 square feet. Our principal facilities have lease terms
expiring between 2005 and 2008.
During the year ended June 30, 2003, we undertook substantial facility and
organizational restructuring activities to simplify and consolidate our
operations, worldwide. We shut down our operational activities in Milford,
Connecticut; Ames, Iowa; Naperville, Illinois; Hillsboro, Oregon; and
Villigen-Schwenningen, Germany. By October 2003, we will cease operational
activities in Cham, Switzerland, the headquarters of Lantronix International AG
Switzerland, which is our wholly owned subsidiary; thereafter, we will support
international sales and shipping from our Irvine, California headquarters. With
each of these facility closures, we have either subleased, listed for rent, or
terminated leases and have recorded a charge against our restructuring reserves
during fiscal 2003.
ITEM 3. LEGAL PROCEEDINGS
Government Investigation
The Securities and Exchange Commission ("SEC") is conducting a formal
investigation of the events leading up to our restatement of our financial
statements on June 25, 2002. The Department of Justice is also conducting an
investigation concerning events related to our restatement of financial results.
Class Action Lawsuits
On May 15, 2002, Stephen Bachman filed a class action complaint entitled
Bachman v. Lantronix, Inc., et al., No. 02-3899, in the U.S. District Court for
the Central District of California against us and certain of our current and
former officers and directors alleging violations of the Securities Exchange Act
of 1934 and seeking unspecified damages. Subsequently, six similar actions were
filed in the same court. Each of the complaints purports to be a class action
lawsuit brought on behalf of persons who purchased or otherwise acquired our
common stock during the period of April 25, 2001 through May 30, 2002,
inclusive. The complaints allege that the defendants caused us to improperly
recognize revenue and make false and misleading statements about our business.
Plaintiffs further allege that the defendants materially overstated our reported
financial results, thereby inflating our stock price during our securities
offering in July 2001, as well as facilitating the use of our common stock as
consideration in acquisitions. The complaints have subsequently been
consolidated into a single action and the court has appointed a lead plaintiff.
The lead plaintiff filed a consolidated amended complaint on January 17, 2003.
The amended complaint now purports to be a class action brought on behalf of
persons who purchased or otherwise acquired our common stock during the period
of August 4, 2000 through May 30, 2002, inclusive. The amended complaint
continues to assert that we and the individual officer and director defendants
violated the 1934 Act, and also includes alleged claims that we and these
officers and directors violated the Securities Act of 1933 arising from our
Initial Public Offering in August 2000. We filed a motion to dismiss the
additional allegations on March 3, 2003. The Court has taken the motion under
submission. We have not yet answered, discovery has not commenced, and no trial
date has been established.
Derivative Lawsuit
On July 26, 2002, Samuel Ivy filed a shareholder derivative complaint
entitled Ivy v. Bernhard Bruscha, et al., No. 02CC00209, in the Superior Court
of the State of California, County of Orange, against certain of our current and
former officers and directors. On January 7, 2003, the plaintiff filed an
amended complaint. The amended complaint alleges causes of action for breach of
fiduciary duty, abuse of control, gross mismanagement, unjust enrichment, and
improper insider stock sales. The complaint seeks unspecified damages against
the individual defendants on our behalf, equitable relief, and attorneys' fees.
We filed a demurrer/motion to dismiss the amended complaint on February 13,
2003. The basis of the demurrer is that the plaintiff does not have standing to
bring this lawsuit since plaintiff has never served a demand on our Board that
our Board take certain actions on our behalf. On April 17, 2003, the Court
overruled our demurrer. Discovery has commenced, but no trial date has been
established.
Securities Claims and Employment Claims Brought by the Co-Founders of
United States Software Corporation
On August 23, 2002, a complaint entitled Dunstan v. Lantronix, Inc., et
al., was filed in the Circuit Court of the State of Oregon, County of Multnomah,
against us and certain of our current and former officers and directors by the
co-founders USSC. The complaint alleged Oregon state law claims for securities
violations, fraud, and
12
negligence. The original complaint sought not less than $3.6 million in damages,
interest, attorneys' fees, costs, expenses, and an unspecified amount of
punitive damages. We moved to compel arbitration in November 2002, and in a
ruling dated February 9, 2003, the court ordered the matter stayed pending
arbitration of all claims. Plaintiffs filed an arbitration demand on or about
February 21, 2003 which included additional claims related to our acquisition of
USSC. The arbitration demand sought more than $14.0 million in damages and an
unspecified amount in attorneys' fees, costs, expenses, and punitive damages.
The parties participated in a mediation on June 30, 2003, and subsequently
reached an agreement to settle the dispute. The agreement called for us to
release to the plaintiffs approximately $400,000 in cash and 49,038 shares of
our common stock that had been held in an escrow since December 2000 as part of
the acquisition of USSC. The agreement also called for us to issue to the
plaintiffs additional shares of our common stock worth approximately $1.5
million. Accordingly, 1,726,703 shares were issued following a fairness
determination by the state court in Oregon. In exchange, the plaintiffs
released all claims against all defendants.
Employment Suit Brought by Former Chief Financial Officer and Chief
Operating Officer Steve Cotton
On September 6, 2002, Steve Cotton, our former CFO and COO, filed a
complaint entitled Cotton v. Lantronix, Inc., et al., No. 02CC14308, in the
Superior Court of the State of California, County of Orange. The complaint
alleges claims for breach of contract, breach of the covenant of good faith and
fair dealing, wrongful termination, misrepresentation, and defamation. The
complaint seeks unspecified damages, declaratory relief, attorneys' fees and
costs. Discovery has not commenced and no trial date has been established.
We filed a motion to dismiss on October 16, 2002, on the grounds that Mr.
Cotton's complaints are subject to the binding arbitration provisions in Mr.
Cotton's employment agreement. On January 13, 2003, the Court ruled that five of
the six counts in Mr. Cotton's complaint are subject to binding arbitration. The
court is staying the sixth count, for declaratory relief, until the underlying
facts are resolved in arbitration. No arbitration date has been set.
Securities Claims Brought by Former Shareholders of Synergetic Micro
Systems, Inc.
On October 17, 2002, Richard Goldstein and several other former
shareholders of Synergetic filed a complaint entitled Goldstein, et al v.
Lantronix, Inc., et al in the Superior Court of the State of California, County
of Orange, against us and certain of our former officers and directors.
Plaintiffs filed an amended complaint on January 7, 2003. The amended complaint
alleges fraud, negligent misrepresentation, breach of warranties and covenants,
breach of contract and negligence, all stemming from our acquisition of
Synergetic. The complaint seeks an unspecified amount of damages, interest,
attorneys' fees, costs, expenses, and an unspecified amount of punitive damages.
On May 5, 2003, we answered the complaint and generally denied the allegations
in the complaint. Discovery has not yet commenced and no trial date has been
established.
Suit filed by Lantronix Against Logical Solutions, Inc.
On March 25, 2003, we filed in Connecticut state court (Judicial District
of New Haven) a complaint entitled Lantronix, Inc. and Lightwave Communications,
Inc. v Logical Solutions, Inc., et. al. This is an action for unfair and
deceptive trade practices, unfair competition, unjust enrichment, conversion,
misappropriation of trade secrets and tortuous interference with contractual
rights and business expectancies. We seek preliminary and permanent injunctive
relief and damages. The individual defendants are all former employees of
Lightwave Communications, a company that we acquired in June 2001. The suit is
pending trial.
Other
From time to time, we are subject to other legal proceedings and claims in
the ordinary course of business. We currently are not aware of any such legal
proceedings or claims that we believe will have, individually or in the
aggregate, a material adverse effect on our business, prospects, financial
position, operating results or cash flows.
The pending lawsuits involve complex questions of fact and law and likely
will continue to require the expenditure of significant funds and the diversion
of other resources to defend. We are unable to determine the outcome of its
outstanding legal proceedings, claims and litigation involving us, our
subsidiaries, directors and officers and cannot determine the extent to which
these results may have a material adverse effect on our business, results of
operations and financial condition taken as a whole. The results of litigation
are inherently uncertain, and adverse outcomes are possible. We are unable to
estimate the range of possible loss from outstanding litigation, and no amounts
have been provided fur such matters in the consolidated financial statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Our common stock was traded on The Nasdaq National Market under the symbol
"LTRX" from our initial public offering on August 4, 2000 through October 22,
2002. On October 23, 2002 our listing was changed to The Nasdaq SmallCap Market.
The number of holders of record of our common stock as of August 31, 2003 was
approximately 120. The following table sets forth, for the period indicated, the
high and low per share closing prices for our common stock:
FISCAL YEAR 2002 HIGH LOW
- ---------------- ------ -----
First Quarter $10.20 $5.57
Second Quarter $ 6.45 $4.85
Third Quarter $ 6.93 $2.02
Fourth Quarter $ 2.85 $0.68
FISCAL YEAR 2003 HIGH LOW
- ---------------- ------ -----
First Quarter $ 1.03 $0.38
Second Quarter $ 0.92 $0.36
Third Quarter $ 1.08 $0.67
Fourth Quarter $ 0.91 $0.49
We believe that a number of factors, including but not limited to quarterly
fluctuations in results of operations, may cause the market price of our common
stock to fluctuate significantly. See "Management's Discussion and Analysis-Risk
Factors."
DIVIDEND POLICY
We have never declared or paid cash dividends on our common stock. We do
not anticipate paying any cash dividends on our common stock in the foreseeable
future, and we intend to retain any future earnings for use in the expansion of
our business and for general corporate purposes. Pursuant to a line of credit we
entered into in January 2002 and have amended on June 30, 2002, February 4, 2003
and July 25, 2003, we are restricted from paying any dividends.
EQUITY COMPENSATION PLANS
The information required by this item regarding equity compensation plans
is incorporated by reference to the information set forth in Item 12 of this
Annual Report on Form 10-K. Item 12 of this Annual Report on Form 10-K
incorporates by reference the information contained in the sections captioned
"Election of Directors" and "Security Ownership of Certain Beneficial Owners and
Management" in the Lantronix's definitive Proxy Statement for the Annual Meeting
of Stockholders to be held November 20, 2003 (the Proxy Statement), a copy of
which will be filed with the Securities and Exchange Commission before the
meeting date.
RECENT SALES OF UNREGISTERED SECURITIES
We have issued the following unregistered securities since July 1, 2002:
In January 2003, we issued an aggregate of 1,063,372 shares of our common
stock to the former stockholders of Premise in connection with our Compromise
Settlement and Mutual Release Agreement with the former stockholders of Premise.
In September 2003, we issued an aggregate of 1,726,703 shares of our common
stock to the former co-founders of USSC in connection with our litigation
settlement.
The issuance of securities in January 2003 were deemed to be exempt from
registration under the Securities Act in reliance on Section 4(2) of the
Securities Act. The securities issued in September 2003 were exempt from
registration under the Securities Act in reliance on Section 3(a)(10) of the
Securities Act. There were no underwritten offerings employed in connection with
any of the transactions set forth above.
14
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included below. The consolidated statements of operations data for
the years ended June 30, 2003, 2002 and 2001 and the balance sheet data as of
June 30, 2003 and 2002, are derived from the audited consolidated financial
statements included elsewhere in this report. The consolidated statements of
operations data for the years ended June 30, 2000 and 1999, and the balance
sheet data as of June 30, 2001, 2000 and 1999, are derived from the audited
consolidated financial statements not included elsewhere in this report. The
historical results are not necessarily indicative of results to be expected for
future periods.
YEARS ENDED JUNE 30,
--------------------
2003 2002 2001 2000 1999
--------- --------- --------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net revenues $ 49,509 $ 57,646 $ 48,972 $44,975 $32,980
Cost of revenues 37,603 40,510 24,530 21,526 16,824
--------- --------- --------- -------- --------
Gross profit 11,906 17,136 24,442 23,449 16,156
--------- --------- --------- -------- --------
Operating expenses:
Selling, general and administrative 30,633 41,575 23,998 16,744 9,173
Research and development 10,413 9,225 4,478 3,186 2,615
Stock-based compensation 1,453 2,863 3,019 1,093 -
Amortization of goodwill and purchased intangible assets 1,002 1,263 1,490 813 595
Impairment of goodwill and purchased intangible assets 6,708 50,828 - - -
Restructuring charges 5,711 3,473 - - -
Litigation settlement costs 2,607 1,912 - - -
In-process research and development - 1,000 2,596 - -
--------- --------- --------- -------- --------
Total operating expenses 58,527 112,139 35,581 21,836 12,383
--------- --------- --------- -------- --------
Income (loss) from operations (46,621) (95,003) (11,139) 1,613 3,773
Minority interest - - - (49) (30)
Interest income (expense), net 248 1,546 2,182 187 151
Other income (expense), net (926) (760) (167) (47) (10)
--------- --------- --------- -------- --------
Income (loss) before income taxes and cumulative effect of
accounting changes (47,299) (94,217) (9,124) 1,704 3,884
Provision (benefit) for income taxes 250 (6,665) (1,876) 649 1,098
--------- --------- --------- -------- --------
Income (loss) before cumulative effect of accounting changes (47,549) (87,552) (7,248) 1,055 2,786
Cumulative effect of accounting changes:
Change in revenue recognition policy, net of income
tax benefit of $176 - - (597) - -
Adoption of new accounting standard, SFAS No. 142 - (5,905) - - -
--------- --------- --------- -------- --------
Net income (loss) $(47,549) $(93,457) $ (7,845) $ 1,055 $ 2,786
========= ========= ========= ======== ========
Basic income (loss) per share before cumulative effect of
accounting changes $ (0.88) $ (1.70) $ (0.19) $ 0.04 $ 0.10
Cumulative effect of accounting changes per share:
Change in revenue recognition policy, net of income
tax benefit of $176 - - (0.02) - -
Adoption of new accounting standard, SFAS No. 142 - (0.12) - - -
--------- --------- --------- -------- --------
Basic net income (loss) per share $ (0.88) $ (1.82) $ (0.21) $ 0.04 $ 0.10
========= ========= ========= ======== ========
Diluted income (loss) per share before cumulative effect of
accounting changes $ (0.88) $ (1.70) $ (0.19) $ 0.03 $ 0.10
Cumulative effect of accounting changes per share:
Change in revenue recognition policy,
net of income tax benefit of $176 - - (0.02) - -
Adoption of new accounting standard, SFAS No. 142 - (0.12) - - -
--------- --------- --------- -------- --------
Diluted net income (loss) per share $ (0.88) $ (1.82) $ (0.21) $ 0.03 $ 0.10
========= ========= ========= ======== ========
Weighted average shares (basic) 54,329 51,403 36,946 29,274 26,977
========= ========= ========= ======== ========
Weighted average shares (diluted) 54,329 51,403 36,946 34,178 28,880
========= ========= ========= ======== ========
15
JUNE 30,
--------------
2003 2002 2001 2000 1999
---------- --------- -------- ------- -------
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents $ 7,328 $ 26,491 $ 15,367 $ 1,988 $ 5,833
Marketable securities 6,750 6,963 1,973 - -
Working capital 21,698 45,423 36,963 11,042 8,109
Goodwill, net 11,726 13,811 42,273 - -
Purchased intangible assets, net 5,394 14,681 13,328 586 1,399
Total assets 62,856 103,812 116,861 20,210 17,292
Convertible note payable 867 - - - -
Retained earnings (accumulated deficit) (140,424) (92,875) 582 8,427 7,372
Total stockholders' equity 37,717 82,157 99,496 12,547 10,312
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with our consolidated
financial statements and related notes included elsewhere in this report. In
addition to historical information, the discussion in this report contains
forward-looking statements that involve risks and uncertainties. Actual results
could differ materially from those anticipated by these forward-looking
statements due to factors including, but not limited to, those factors set forth
under "Risk Factors" and elsewhere in this report.
OVERVIEW
Lantronix designs, develops and markets products and software solutions
that make it possible to access, manage, control and configure almost any
electronic device over the Internet or other networks. We are a leader in
providing innovative networking solutions. We were initially formed as
"Lantronix," a California corporation, in June 1989. We reincorporated as
"Lantronix, Inc.," a Delaware corporation in May 2000.
We have a history of providing devices that enable information technology
IT equipment to network using standard protocols for connectivity, including
fiber optic, Ethernet and wireless. Our first product was a terminal server that
allowed "dumb" terminals to connect to a network. Building on the success of our
terminal servers, we introduced a complete line of print servers in 1991 that
enabled users to inexpensively share printers over a network. Over the years, we
have continually refined our core technology and have developed additional
innovative networking solutions that expand upon the business of providing our
customers network connectivity. We provide three broad categories of products:
"device networking solutions," that enable almost any electronic device to be
connected to a network; "IT management solutions," that enable multiple
devices-usually network computing devices such as servers, routers, switches,
and similar equipment to be managed over a network; and software that is either
embedded in the hardware devices that are mentioned above, or stand-alone
application software.
Today, our solutions include fully integrated hardware and software
products, as well as software tools to develop related customer applications.
Because we deal with network connectivity, we have provided products to
extremely broad market segments, including industrial, medical, commercial,
financial, governmental, retail, building and home automation, and many more.
Our technology is used with devices such as networking routers, medical
instruments, manufacturing equipment, bar code scanners, building HVAC systems,
elevators, process control equipment, vending machines, thermostats, security
cameras, temperature sensors, card readers, point of sale terminals, time
clocks, and virtually any device that has some form of standard data control
capability. Our current product offerings include a wide range of hardware
devices of varying size, packaging and, where appropriate, software solutions
that allow our customers to network-enable virtually any electronic device.
16
Our products are sold to distributors, OEMs, VARs, and systems integrators,
as well as directly to end users. One customer, Ingram Micro Inc., accounted for
approximately 11%, 12% and 14% of our net revenues for the years ended June 30,
2003, 2002 and 2001, respectively. Another customer, Tech Data Corporation,
accounted for approximately 10%, 11% and 10% of our net revenues for the years
ended June 30, 2003, 2002 and 2001, respectively. Accounts receivable
attributable to these two domestic customers accounted for approximately 16% and
21% of total accounts receivable at June 30, 2003 and 2002, respectively.
One international customer, transtec AG, which is a related party due to
common ownership by our largest stockholder and former Chairman of our Board of
Directors, Bernhard Bruscha, accounted for approximately 4%, 5% and 9% of our
net revenues for the years ended June 30, 2003, 2002 and 2001, respectively.
Included in the accompanying consolidated balance sheets is approximately
$246,000 due to this related party at June 30, 2002. No significant amount was
due to or from this related party at June 30, 2003. We also had an agreement
with transtec AG for the provision of technical support services at the rate of
$7,500 per month which has now been terminated. Included in selling, general and
administrative expenses is $0, $90,000 and $90,000 for the years ended June 30,
2003, 2002 and 2001, respectively, for these support services.
In July 2001, we completed a public offering of 8,534,000 shares of our
common stock, including an underwriter's over-allotment option to purchase an
additional 534,000 shares, at an offering price of $8.00 per share. We sold
6,000,000 shares and selling shareholders sold 2,000,000 shares of the primary
offering. Additionally, we sold 400,500 shares and selling stockholders sold
133,500 shares of the over-allotment option. We received net proceeds of
approximately $47.1 million in connection with this offering.
We have completed a number of acquisitions and investments since our
initial public offering in August 2000, the purpose of which is to expand our
product offerings, increase our technology base and provide a foundation for
future growth.
In December 2000, we completed the acquisition of USSC, a developer of a
software operating system, protocol stacks and an application development
environment for embedded technology. The total purchase price consisted of $2.5
million in cash and 653,846 shares of our common stock. In addition, we assumed
existing employee stock and issued new options to acquire 133,333 shares of our
common stock at a weighted average exercise price of $1.00 per share. USSC
provides an open standards-based operating system and supports a variety of
processors. We believe the acquisition of USSC helps expand our product offering
and enables us to provide our customers with an integrated software and hardware
embedded solution. Recently, we released from escrow approximately $400,000 and
49,038 shares of our common stock, and issued to the founders of USSC 1,726,703
shares of our common stock, to settle the lawsuit that they filed against us in
Oregon state court in August of 2002.
17
In June 2001, we completed the acquisition of Lightwave, a developer of
multiport and visualization solutions. The purchase price included 3,428,571
shares of our common stock and $12.0 million in cash. In addition, we assumed
options issued to employees and issued options to acquire 870,513 shares of our
common stock at a weighted average exercise price of $3.67 per share. We also
paid off approximately $6.7 million of debt to a creditor of Lightwave. In July
2002, we paid $2.0 million to the former stockholders of Lightwave to settle a
dispute regarding a registration rights agreement entered into pursuant to this
acquisition and also exchanged 240,000 shares of our common stock held in escrow
and 208,335 additional shares held by the former Lightwave stockholders. The
settlement resulted in a net change to our results of operations of
approximately $1.9 million for the year ended June 30, 2002.
In October 2001, we completed the acquisition of Synergetic, a provider of
high performance embedded network communication solutions that complement our
external device products. In connection with the acquisition, we paid cash
consideration of $2.7 million and issued an aggregate of 2,234,715 shares of our
common stock in exchange for all outstanding shares of Synergetic common stock
and reserved 615,705 additional shares of common stock for issuance upon
exercise of outstanding employee stock options and other rights of Synergetic.
Portions of the cash consideration and shares issued are held in escrow pursuant
to the terms of the acquisition agreement.
In January 2002, we completed the acquisition of Premise, a developer of
client-side software applications that complement our device networking products
by providing superior management and control capabilities for devices that have
been network and internet enabled. Prior to the acquisition, we held shares of
Premise representing 19.9% ownership and, in addition, held convertible
promissory notes of $1.2 million with interest accrued there-on at the rate of
9.0%. The convertible promissory notes were converted into equity securities of
Premise at the closing of the transaction. We issued an aggregate of 1,063,371
shares of our common stock in exchange for all remaining outstanding shares of
Premise common stock and reserved 875,000 additional shares of common stock for
issuance upon exercise of outstanding employee stock options and other rights of
Premise. In connection with the acquisition, we recorded a one-time charge for
purchased in-process research and development ("IPR&D") expenses of $1.0 million
in our fourth fiscal quarter ended June 30, 2002. In January 2003, we issued an
additional 1,063,372 shares of our common stock to the former shareholders of
Premise stock in exchange for a release of all claims relating to the
acquisition. We also accelerated the vesting of options held by certain former
Premise shareholders and released all shares that had been held in the
acquisition escrow.
In August 2002, we completed the acquisition of Stallion, a provider of
terminal servers and multiport products. In connection with the acquisition, we
paid $1.2 million in cash consideration, of which $200,000 was paid upon the
execution of the Letter of Intent dated May 9, 2002, and established a cash
escrow account in the amount of $867,000 at the acquisition date to be used in
lieu of our common stock, in the event that we were unable to issue registered
shares by October 31, 2002. In accordance with the terms of the agreement, we
were not able to issue registered shares by October 31, 2002; accordingly, the
cash escrow amount of $867,000 was released on November 1, 2002. In addition, we
issued a two-year note in the principal amount of $867,000 accruing interest at
a rate of 2.5% per annum. The note is due in August 2004.
In September and October 2001, we made a strategic investment in Xanboo, a
privately-held company that develops technology that allows users to control,
command and view their home or business remotely over the Internet. We paid an
aggregate of $3.0 million for convertible promissory notes, which converted in
January 2002, in accordance with their terms, into Xanboo preferred stock. In
addition, we purchased $4.0 million of Xanboo preferred stock in January 2002.
Our ownership interest in Xanboo was 15.3% and 15.8% at June 30, 2003 and 2002,
respectively. Our investment in Xanboo is accounted for using the equity method
of accounting based on our ability through representation on Xanboo's board of
directors to exercise significant influence over its operations. Our losses in
Xanboo aggregating $1.3 million and $526,000 for the years ended June 30, 2003
and 2002, respectively, have been recognized as other expense in the
accompanying consolidated statement of operations. No similar expense was
recognized for the year ended June 30, 2001.
18
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires us to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of net revenues
and expenses during the reporting period. We regularly evaluate our estimates
and assumptions related to net revenues, allowances for doubtful accounts, sales
returns and allowances, inventory reserves, goodwill and purchased intangible
asset valuations, warranty reserves, restructuring costs, litigation and other
contingencies. We base our estimates and assumptions on historical experience
and on various other factors that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. To the extent there are material differences between our
estimates and the actual results, our future results of operations will be
affected.
We believe the following critical accounting policies require us to make
significant judgments and estimates in the preparation of our consolidated
financial statements:
Revenue Recognition
We do not recognize revenue until all of the following criteria are met:
persuasive evidence of an arrangement exists; delivery has occurred or services
have been rendered; our price to the buyer is fixed or determinable; and
collectibility is reasonably assured. Commencing July 1, 2000, we adopted a new
accounting policy for revenue recognition such that recognition of revenue and
related gross profit from sales to distributors are deferred until the
distributor resells the product. Net revenue from certain smaller distributors
for which point-of-sale information is not available, is recognized one month
after the shipment date. This estimate approximates the timing of the sale of
the product by the distributor to the end user. Revenues from product sales to
OEMs, end user customers, other resellers and from sales to distributors prior
to July 1, 2000 generally were recognized upon product shipment, but may have
been deferred to a later date if all revenue recognition criteria were not met
at the date of shipment. When product sales revenue is recognized, we establish
an estimated allowance for future product returns based on historical returns
experience; when price reductions are approved, we establish an estimated
liability for price protection payable on inventories owned by product
resellers. Should actual product returns or pricing adjustments exceed our
estimates, additional reductions to revenues would result. Revenue from the
licensing of software is recognized at the time of shipment (or at the time of
resale in the case of software products sold through distributors), provided we
have vendor-specific objective evidence of the fair value of each element of the
software offering and collectibility is probable. Revenue from post-contract
customer support and any other future deliverables is deferred and recognized
over the support period or as contract elements are delivered. Our products
typically carry a ninety day to five year warranty. Although we engage in
extensive product quality programs and processes, our warranty obligation is
affected by product failure rates, use of materials or service delivery costs
that differ from our estimates. As a result, additional warranty reserves could
be required, which could reduce gross margins. Prior to July 1, 2000, the
effective date of the change in accounting method for recognizing revenue for
sales to distributors, we recorded an estimated allowance for future product
returns for sales to distributors based on historical returns experience when
the related revenue was recorded and provided for appropriate price protection
reserves when pricing adjustments were approved. As indicated above, recognition
of revenue and related gross profit on sales to distributors is now deferred
until the distributor resells the product.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. Our
allowance for doubtful accounts is based on our assessment of the collectibility
of specific customer accounts, the aging of accounts receivable, our history of
bad debts and the general condition of the industry. If a major customer's
credit worthiness deteriorates, or our customers' actual defaults exceed our
historical experience, our estimates could change and impact our reported
results. We also maintain a reserve for uncertainties relative to the collection
of officer notes receivable. Factors considered in determining the level of this
reserve include the value of the collateral securing the notes, our ability to
effectively enforce collection rights and the ability of the former officers to
honor their obligations.
Inventory Valuation
Our policy is to value inventories at the lower of cost or market on a
part-by-part basis. This policy requires us to make estimates regarding the
market value of our inventories, including an assessment of excess and obsolete
inventories. We determine excess and obsolete inventories based on an estimate
of the future sales demand for our products within a specified time horizon,
generally three to twelve months. The estimates we use for demand are also used
for near-term capacity planning and inventory purchasing and are consistent with
our revenue forecasts. In addition, specific reserves are recorded to cover
risks in the area of end of life products, inventory located at our contract
manufacturers, deferred inventory in our sales channel and warranty replacement
stock.
19
If our sales forecast is less than the inventory we have on hand at the end
of an accounting period, we may be required to take excess and obsolete
inventory charges which will decrease gross margin and net operating results for
that period.
Valuation of Deferred Income Taxes
We have recorded a valuation allowance to reduce our net deferred tax
assets to zero, primarily due to our inability to estimate future taxable
income. We consider estimated future taxable income and ongoing prudent and
feasible tax planning strategies in assessing the need for a valuation
allowance. If we determine that it is more likely than not that we will realize
a deferred tax asset, which currently has a valuation allowance, we would be
required to reverse the valuation allowance which would be reflected as an
income tax benefit at that time.
Goodwill and Purchased Intangible Assets
The purchase method of accounting for acquisitions requires extensive use
of accounting estimates and judgments to allocate the purchase price to the fair
value of the net tangible and intangible assets acquired, including IPR&D.
Goodwill and intangible assets deemed to have indefinite lives are no longer
amortized but are subject to annual impairment tests. The amounts and useful
lives assigned to intangible assets impact future amortization and the amount
assigned to IPR&D is expensed immediately. If the assumptions and estimates used
to allocate the purchase price are not correct, purchase price adjustments or
future asset impairment charges could be required.
Impairment of Long-Lived Assets
We evaluate long-lived assets used in operations when indicators of
impairment, such as reductions in demand or significant economic slowdowns, are
present. Reviews are performed to determine whether the carrying values of
assets are impaired based on comparison to the undiscounted expected future cash
flows. If the comparison indicates that there is impairment, the expected future
cash flows using a discount rate based upon our weighted average cost of capital
is used to estimate the fair value of the assets. Impairment is based on the
excess of the carrying amount over the fair value of those assets. Significant
management judgment is required in the forecast of future operating results that
is used in the preparation of expected discounted cash flows. It is reasonably
possible that the estimates of anticipated future net revenue, the remaining
estimated economic lives of the products and technologies, or both, could differ
from those used to assess the recoverability of these assets. In that event,
additional impairment charges or shortened useful lives of certain long-lived
assets could be required.
Strategic Investments
We have made strategic investments in privately held companies for the
promotion of business and strategic investments. Strategic investments with less
than a 20% voting interest are generally carried at cost. We will use the equity
method to account for strategic investments in which we have a voting interest
of 20% to 50% or in which we otherwise have the ability to exercise significant
influence. Under the equity method, the investment is originally recorded at
cost and adjusted to recognize our share of net earnings or losses of the
investee, limited to the extent of our investment in, advances to and adjusted
to recognize our share of net earnings or losses of the investee. From time to
time we are required to estimate the amount of our losses of the investee. Our
estimates are based on historical experience. The value of non-publicly traded
securities is difficult to determine. We periodically review these investments
for other-than-temporary declines in fair value based on the specific
identification method and write down investments to their fair value when an
other-than-temporary decline has occurred. We generally believe an
other-than-temporary decline has occurred when the fair value of the investment
is below the carrying value for two consecutive quarters, absent evidence to the
contrary. Fair values for investments in privately held companies are estimated
based upon the values of recent rounds of financing. Although we believe our
estimates reasonably reflect the fair value of the non-publicly traded
securities held by us, had there been an active market for the equity
securities, the carrying values might have been materially different than the
amounts reported. Future adverse changes in market conditions or poor operating
results of companies in which we have such investments could result in losses or
an inability to recover the carrying value of the investments that may not be
reflected in an investment's current carrying value and which could require a
future impairment charge.
20
Restructuring Charges
Over the last several quarters we have undertaken, and we may continue to
undertake, significant restructuring initiatives, which have required us to
develop formalized plans for exiting certain business activities. We have had to
record estimated expenses for lease cancellations, long-term asset write-downs,
severance and outplacement costs and other restructuring costs. Given the
significance of, and the timing of the execution of such activities, this
process is complex and involves periodic reassessments of estimates made at the
time the original decisions were made. Through December 31, 2002, the accounting
rules for restructuring costs and asset impairments required us to record
provisions and charges when we had a formal and committed plan. Beginning
January 1, 2003, the accounting rules now require us to record any future
provisions and changes at fair value in the period in which they are incurred.
In calculating the cost to dispose of our excess facilities, we had to estimate
our future space requirements and the timing of exiting excess facilities and
then estimate for each location the future lease and operating costs to be paid
until the lease is terminated and the amount, if any, of sublease income. This
required us to estimate the timing and costs of each lease to be terminated,
including the amount of operating costs and the rate at which we might be able
to sublease the site. To form our estimates for these costs, we performed an
assessment of the affected facilities and considered the current market
conditions for each site. Our assumptions on future space requirements, the
operating costs until termination or the offsetting sublease revenues may turn
out to be incorrect, and our actual costs may be materially different from our
estimates, which could result in the need to record additional costs or to
reverse previously recorded liabilities. Our policies require us to periodically
evaluate the adequacy of the remaining liabilities under our restructuring
initiatives. As management continues to evaluate the business, there may be
additional charges for new restructuring activities as well as changes in
estimates to amounts previously recorded.
Recent Accounting Pronouncements
We did not have any outstanding guarantees that were required to be
recorded upon adoption of FIN No. 45. Our product warranties, which are subject
to the disclosure provisions of FIN No. 45, have been disclosed in the
accompanying consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" ("SFAS No. 148"), which amends
SFAS No. 123. SFAS No. 148 amends the disclosure requirements in SFAS No. 123
for stock-based compensation for annual periods ending after December 15, 2002
and interim periods beginning after December 15, 2002. The disclosure
requirements apply to all companies, including those that continue to recognize
stock-based compensation under APB No. 25. Effective for financial statements
for fiscal years ending after December 15, 2002, SFAS No. 148 also provides
three alternative transition methods for companies that choose to adopt the fair
value measurement provisions of SFAS No. 123.
In January 2003 the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities ("FIN 46"). FIN 46 requires the primary beneficiary
of a variable interest entity ("VIE") to consolidate the entity and also
requires majority and significant variable interest investors to provide certain
disclosures. A VIE is an entity in which the equity investors do not have a
controlling interest, equity investors participate in losses or residual
interests of the entity on a basis that differs from its ownership interest, or
the equity investment at risk is insufficient to finance the entity's activities
without receiving additional subordinated financial support from the other
parties. For arrangements entered into with VIEs created prior to January 31,
2003, the provisions of FIN 46 are required to be adopted at the beginning of
the first interim or annual period beginning after June 15, 2003. We are
currently reviewing our investments and other arrangements to determine whether
any of our investee companies are VIEs. We do not expect to identify any
significant VIEs that would be consolidated, but we may be required to make
additional disclosures.
Impact of Adoption of New Accounting Standard
In June 2001, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 141, "Business Combinations" ("SFAS No. 141"), effective for
acquisitions consummated after June 30, 2001, and SFAS No. 142, "Goodwill and
Other Intangible Assets" ("SFAS No. 142"), effective for fiscal years beginning
after December 15, 2001. Under the new rules, goodwill and certain intangible
assets deemed to have indefinite lives will no longer be amortized but will be
subject to annual impairment tests. Other intangible assets will continue to be
amortized over their useful lives.
The following table presents the impact of SFAS No. 142 on net loss and net
loss per share had SFAS No. 142 been in effect for the year ended June 30, 2001
(in thousands, except per share data):
Net loss as reported $(7,845)
Adjustments:
Amortization of goodwill 752
---------
Net adjustments 752
---------
Net loss as adjusted $ (7,093)
=========
Basic and diluted net loss per share-as reported $ (0.21)
=========
Basic and diluted net loss per share-as adjusted $ (0.19)
=========
Impairment of goodwill and purchased intangible assets
Under the transitional provisions of SFAS No. 142, effective as of July 1,
2002, we completed our initial assessment and concluded that goodwill arising
from the acquisition of USSC, having a carrying amount of approximately $5.9
million as of July 1, 2001, may be impaired. We engaged an independent valuation
company to perform a review of the value of our goodwill related to USSC. Based
on the independent valuation, which utilized a discounted cash flow valuation
technique, we recorded a $5.9 million charge for the impairment of our USSC
goodwill. This amount is reflected as the cumulative effect of adopting the new
accounting standard effective July 1, 2001.
We performed the first of the required annual impairment tests of goodwill
under the guidelines of SFAS No. 142 effective as of June 1, 2002. As a result
of industry conditions, lower market valuations and reduced estimates of
information technology capital equipment spending in the future, we determined
that there were indicators of impairment to the carrying value of goodwill
related to the acquisitions of Lightwave and Synergetic which had carrying
values of $39.7 million and $13.9 million, respectively, as of June 30, 2002.
During the fourth quarter of fiscal 2002, we engaged an independent valuation
company to perform a review of the value of our goodwill and based on the
independent valuation we recorded a $46.4 million impairment charge of our
goodwill of which $32.5 million related to Lightwave and $13.9 million related
to Synergetic.
21
Additionally, during the fourth quarter of 2002, we performed a review of
the value of our purchased intangible assets in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," ("SFAS No.
144"). As a result of industry conditions, lower market valuations and reduced
estimates of information technology capital equipment spending in the future, we
determined that there were indicators of impairment to the carrying value of our
purchased intangible assets related to our acquisitions. During the fourth
quarter of fiscal 2002, we engaged an independent valuation company to perform a
review of the value of our purchased intangible assets and based on the
independent valuation we recorded a $10.2 million impairment charge of which
$969,000, $764,000, $7.6 million and $849,000 related to USSC, Lightwave,
Synergetic and Premise, respectively. Additionally, we recorded an impairment
charge of $665,000 related to intellectual property not associated with an
acquisition.
We performed our annual impairment tests under the guidelines of SFAS No.
142. We compared the carrying value of each reporting unit to our estimated fair
value calculated with the assistance of an independent valuation company. We
estimated the fair value of our reporting units primarily using the income
approach methodology of valuation that includes the discounted cash flow method,
taking into consideration the market approach and certain market multiples as
verification of the values derived using the discounted cash flow methodology.
In addition, publicly available information regarding our market capitalization
was also considered. An impairment loss was recognized for reporting units where
the carrying value of goodwill exceeded the implied fair value of goodwill.
Based on this assessment, we recorded a charge of $4.4 million during the fourth
quarter of fiscal 2003 to write down the value of goodwill. The primary factors
resulting in the impairment charge were the continued significant economic
slowdown in the technology sector affecting both our current operations and
expected future revenue, as well as the decline in valuation of technology
company stocks, including the valuation of our stock.
Additionally, during the fourth quarter of fiscal 2003, we performed an
assessment of the value of our purchased intangible assets in accordance with
SFAS No. 144. As a result of industry conditions, continued lower market
valuations and reduced estimates in information technology capital equipment
spending in the future and other factors impacting expected future cash flows,
we determined that there were indicators of impairment to the carrying value of
our purchased intangible assets recorded as part of our acquisitions. We engaged
an independent valuation company to perform a review of the value of our
purchased intangible assets. In accordance with SFAS No. 144, we utilized a cash
flow estimation approach, comparing the discounted expected future cash flows to
the carrying value of the subject assets. Based on the independent valuations,
during the fourth quarter of fiscal 2003 we recorded a $6.3 million impairment
charge of which $2.4 million and $3.9 million were charged to operating expenses
and cost of revenues, respectively.
Restructuring charges
On September 12, 2002 and again on March 14, 2003, we announced a
restructuring plan to prioritize our initiatives around the growth areas of our
business, focus on profit contribution, reduce expenses and improve operating
efficiency. These restructuring plans included a worldwide workforce reduction,
consolidation of excess facilities and other charges. For the year ended June
30, 2003, we recorded restructuring costs totaling $5.7 million or 11.5% of net
revenues which are classified as operating expenses in the consolidated
statements of operations. The restructuring plans resulted in the reduction of
approximately 58 regular employees worldwide. Through June 30, 2003, we have
incurred actual workforce reduction charges of approximately $1.3 million
related to severance and fringe benefits for the terminated employees
approximately $2.4 million related to consolidation of excess facilities and
$2.0 million for contractual obligations. Property, equipment and other assets
that will be disposed or removed from operations consist primarily of computer
software, services and related equipment, production and office equipment and
furniture and fixtures. The restructuring plan resulted in the closing of the
Milford, Connecticut manufacturing operations, and Ames, Iowa and Singapore
offices.
On February 6, 2002, we announced a restructuring plan to prioritize our
initiatives around areas of our business that we believe represent high-growth
opportunities, focus on profit contribution, reduce expenses, and improve
operating efficiency. This restructuring plan included a worldwide workforce
reduction, consolidation of excess facilities and other charges. As of June 30,
2002, we recorded restructuring costs totaling $3.5 million. Through June 30,
2003, the February 2002 restructuring plan has resulted in the reduction of
approximately 50 regular employees worldwide and we incurred actual worldwide
workforce reduction charge of approximately $1.9 million related to severance
and fringe benefits. Included in this amount is a stock-based compensation
charges in the amount of $595,000 associated with the extension of the exercise
period for stock options that were vested at the termination date. Property and
equipment that was disposed or removed from operations resulted in a charge of
$1.6 million and consisted primarily of computer software and related equipment,
production, engineering and office equipment and furniture and fixtures.
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
of net revenues represented by each item in our consolidated statements of
operations:
YEARS ENDED JUNE 30,
--------------------
2003 2002 2001
------- -------- -------
Net revenues 100.0% 100.0% 100.0%
Cost of revenues 76.0 70.3 50.1
------- -------- -------
Gross profit 24.0 29.7 49.9
------- -------- -------
Operating expenses:
Selling, general and administrative 61.9 72.1 49.0
Research and development 21.0 16.0 9.1
Stock-based compensation 2.9 5.0 6.2
Amortization of goodwill and purchased intangible assets 2.0 2.2 3.0
Impairment of goodwill and purchased intangible assets 13.5 88.2 -
Restructuring charges 11.5 6.0 -
Litigation settlement costs 5.3 3.3 -
In-process research and development - 1.7 5.3
------- -------- -------
Total operating expenses 118.1 194.5 72.6
------- -------- -------
Loss from operations (94.1) (164.8) (22.7)
Interest income (expense), net 0.5 2.7 4.4
Other income (expense), net (1.9) (1.3) (0.3)
------- -------- -------
Loss before income taxes and cumulative effect
of accounting changes (95.5) (163.4) (18.6)
Provision (benefit) for income taxes 0.5 (11.6) (3.8)
------- -------- -------
Loss before cumulative effect of accounting changes (96.0) (151.9) (14.8)
Cumulative effect of accounting changes:
Change in revenue recognition policy, net
of income tax benefit of $176 - - (1.2)
Adoption of new accounting standard, SFAS No. 142 - (10.2) -
------- -------- -------
Net loss (96.0)% (162.1)% (16.0)%
======= ======== =======
22
COMPARISON OF THE YEARS ENDED JUNE 30, 2003 AND 2002
Net Revenues
Net revenues decreased $8.1 million, or 14.1%, to $49.5 million for the
year ended June 30, 2003 from $57.6 million for the year ended June 30, 2002.
The decrease was primarily attributable to a decrease in net revenues of our
device networking solutions, IT management solutions and other products. Device
networking solutions net revenues decreased $3.2 million, or 10.8%, to $26.8
million or 54.1% of net revenues for the year ended June 30, 2003 from $30.0
million or 52.0% of net revenues for the year ended June 30, 2002. IT management
solutions net revenues decreased $3.3 million, or 19.9%, to $13.2 million or
26.7% of net revenues for the year ended June 30, 2003 from $16.5 million or
28.7% of net revenues for the year ended June 30, 2002. Other product net
revenues decreased $1.6 million, or 14.4%, to $9.5 million or 19.2% of net
revenues for the year ended June 30, 2003 from $11.1 million or 19.3% of net
revenues for the year ended June 30, 2002. The overall decrease in net revenues
is primarily attributable to logistical issues surrounding the restructuring of
our Milford, Connecticut operations, whereby we began to outsource our
manufacturing to three contract manufacturers, our discontinuance of certain
product offerings as well as the overall decrease in industry technology
spending year to year.
Net revenues generated from sales in the Americas decreased $10.2 million,
or 21.4%, to $37.5 million or 75.8% of net revenues for the year ended June 30,
2003 from $47.7 million or 82.8% of net revenues for the year ended June 30,
2002. Our net revenues derived from customers located in the Americas decreased
primarily due to logistical issues surrounding the restructuring of our Milford,
Connecticut operations, whereby we began to outsource our manufacturing to three
contract manufacturers, and due to our discontinuance of certain product
offerings as well as the overall decrease in industry technology spending year
to year. Our net revenues derived from customers located in Europe increased
$2.1 million, or 25.7%, to $10.4 million or 20.9% of net revenues for the year
ended June 30, 2003 from $8.2 million or 14.3% of net revenues for the year
ended June 30, 2002. This increase was primarily due to a concentrated effort to
improve European sales through a stronger sales structure. Our net revenues
derived from customers located in other geographic areas decreased slightly to
$1.6 million or 3.3% of net revenues for the year ended June 30, 2003 from $1.7
million or 2.9% of net revenues for the year ended June 30, 2002. We experienced
a slight decline in our quarterly net revenues during fiscal 2003, although we
began to show a year over year quarterly revenue improvement in the fourth
quarter of fiscal 2003.
23
Gross Profit
Gross profit represents net revenues less cost of revenues. Cost of
revenues consists primarily of the cost of raw material components, subcontract
labor assembly from outside manufacturers, amortization of purchased intangible
assets, establishing inventory reserves for excess and obsolete products or raw
materials and overhead costs. As part of an agreement with Gordian, an outside
research and development firm, a royalty charge was included in cost of revenues
and was calculated based on the related products sold. Gordian royalties were
$1.2 million for the year ended June 30, 2002. No royalties were paid for the
year ended June 30, 2003 as a result of a new Gordian agreement as described
below. Cost of revenues for the years ended June 30, 2003 and 2002 consisted of
$4.0 million and $2.4 million of amortization of purchased intangible assets,
respectively. Cost of revenues for the years ended June 30, 2003 and 2002 also
includes a $3.9 million and $6.4 million impairment charge of purchased
intangible assets, respectively, in accordance with SFAS No. 144. At June 30,
2003, the unamortized balance of purchased intangible assets that will be
amortized to future cost of revenues was $5.0 million, of which $2.3 million
will be amortized in fiscal 2004, $1.7 million in fiscal 2005, $816,000 in
fiscal 2006 and $129,000 in fiscal 2007.
In May 2002, we signed a new agreement with Gordian to acquire a joint
interest in the intellectual property that is evident in our products designed
by Gordian and to extinguish our obligation to pay royalties on future sales of
our products. We paid $6.0 million for this intellectual property and are
amortizing this asset to cost of revenues over the remaining life of our
products designed by Gordian, or approximately 3 years. Effective May 30, 2002,
upon the signing of the new agreement, royalty expenses have been replaced by an
amortization of the prepaid royalties and entitlement to the intellectual
property that was part of the agreement. Amortization expense related to the new
Gordian agreement, included in amortization of purchased intangible assets of
$4.0 million totaled $2.5 million for the year ended June 30, 2003. Amortization
expense related to the new Gordian agreement, included in amortization of
purchased intangible assets of $2.4 million totaled $212,000 for the year ended
June 30, 2002.
Gross profit decreased by $5.2 million, or 30.5%, to $11.9 million or 24.0%
of net revenues for the year ended June 30, 2003 from $17.1 million or 29.7% of
net revenues for the year ended June 30, 2002. The overall decrease in gross
profit is primarily attributable to a decrease in net revenues, an increase in
the amortization of purchased intangible assets relating to technology acquired
in our acquisitions, an increase in production expenses related to the closing
of our Milford, Connecticut facility and an increase in our reserves for excess
and obsolete inventory and warranty.
Selling, General and Administrative
Selling, general and administrative expenses consist primarily of
personnel-related expenses including salaries and commissions, facilities
expenses, information technology, trade show expenses, advertising, and
professional legal and accounting fees. Selling, general and administrative
expenses decreased $10.9 million, or 26.2%, to $30.6 million or 61.9% of net
revenues for the year ended June 30, 2003 from $41.6 million or 72.1% of net
revenues for the year ended June 30, 2002. Selling, general and administrative
expense decreased primarily due to reductions in headcount and facility costs as
a result of our restructurings in the second quarter of fiscal 2002 and the
first and third quarters of fiscal 2003, as well as a favorable settlement of a
contractual service obligation and a reduction in our allowance for doubtful
accounts. These decreases are partially offset by increases in legal and other
professional fees. The legal fees primarily relate to our defense of the
shareholder lawsuits, the Securities and Exchange Commission ("SEC")
investigation, and the defense of the intellectual property lawsuit, which was
settled during the second quarter of fiscal 2003. Legal fees incurred in defense
of the shareholder suits are reimbursable to the extent provided in our
directors and officers liability insurance policies, and subject to the coverage
limitations and exclusions contained in such policies. For the year ended June
30, 2003, we have been reimbursed $1.4 million of these expenses. Management
expects to receive an additional reimbursement for legal fees in fiscal 2004.
Research and Development
Research and development expenses consist primarily of personnel-related
costs of employees, as well as expenditures to third-party vendors for research
and development activities. Research and development expenses increased $1.2
million, or 12.9%, to $10.4 million or 21.0% of net revenues for the year ended
June 30, 2003, from $9.2 million or 16.0% of net revenues for the year ended
June 30, 2002. This increase resulted primarily from increased personnel-related
costs due to the acquisitions of Synergetic, Premise and Stallion and
third-party expenses related to new product development.
Stock-based compensation
Stock-based compensation expense generally represents the amortization of
deferred compensation. We recorded approximately $73,000 of deferred
compensation for the year ended June 30, 2003. Additionally, we recorded
deferred compensation forfeitures of $2.6 million for the year ended June 30,
2003. Deferred compensation represents the difference between the fair value of
the underlying common stock for accounting purposes and the exercise price of
the stock options at the date of grant as well as the fair market value of the
vested portion of non-employee stock options utilizing the Black-Scholes option
pricing model. Deferred compensation also includes the value of employee stock
options assumed in connection with our acquisitions calculated in accordance
with current accounting guidelines. Deferred compensation is presented as a
reduction of stockholders' equity and is amortized ratably over the respective
vesting periods of the applicable options, which is generally four years.
24
Included in cost of revenues is stock-based compensation of $89,000 and $117,000
for the years ended June 30, 2003 and 2002, respectively. Stock-based
compensation included in operating expense decreased $1.4 million, or 49.2%, to
$1.5 million or 2.9% of net revenues for the year ended June 30, 2003 from $2.9
million or 5.0% of net revenues for the year ended June 30, 2002. The decrease
in stock-based compensation for the year ended June 30, 2003 is primarily
attributable to the restructuring plan whereby options for which deferred
compensation has been recorded are forfeited for terminated employees. At June
30, 2003, a balance of $695,000 remains and will be amortized as follows:
$562,000 in fiscal 2004, $108,000 in fiscal 2005 and $25,000 in fiscal 2006.
Amortization of purchased intangible assets
Purchased intangible assets primarily include existing technology, customer
agreements, patents and trademarks and are amortized on a straight-line basis
over the estimated useful lives of the respective assets, ranging from one to
five years. We obtained independent appraisals of the fair value of tangible and
intangible assets acquired in order to allocate the purchase price. The
amortization of purchased intangible assets decreased $261,000 or 20.7%, to $1.0
million or 2.0% of net revenues for the year ended June 30, 2003 from $1.3
million or 2.2% of net revenues for the year ended June 30, 2002. The increase
in amortization of purchased intangible assets included in cost of revenues is
primarily due to the amortization of the intellectual property agreement with
Gordian signed in May 2002, and existing technology recorded as part of the
Stallion acquisition in August 2002, offset by the impairment write-down of $6.4
million during the fourth quarter of fiscal 2002 as well as the $3.9 million
impairment during the fourth quarter of fiscal 2003. The decrease in
amortization of purchased intangible assets is primarily due to the impairment
write-down of $4.4 million during the fourth quarter of fiscal 2002 as well as
the $2.4 million impairment write-down during the fourth quarter of fiscal 2003.
At June 30, 2003, the unamortized balance of purchased intangible assets that
will be amortized to future operating expense was $428,000, of which $362,000
will be amortized in fiscal 2004 and $66,000 in fiscal 2005.
Litigation settlement costs
Litigation settlement costs of approximately $2.6 million and $1.9 million
were incurred for the years ended June 30, 2003 and 2002, respectively.
In-process research and development
The amounts allocated to IPR&D were determined through established
valuation techniques used in the high-technology industry and were expensed upon
acquisition as it was determined that the underlying projects had not reached
technological feasibility and no alternative future uses existed. There was no
IPR&D recorded in connection with the 2003 acquisition. IPR&D totaled $1.0
million for the two purchase transactions completed in 2001.
The fair value of the IPR&D for each of the acquisitions was determined
using the income approach. Under the income approach, the expected future cash
flows from each project under development are estimated and discounted to their
net present value at an appropriate risk-adjusted rate of return. Significant
factors considered in the calculation of the rate of return are the
weighted-average cost of capital and return on assets, as well as the risks
inherent in the development process, including the likelihood of achieving
technological success and market acceptance. Each project was analyzed to
determine the unique technological innovations, the existence and reliance upon
core technology, the existence of any alternative future use or current
technological feasibility, and the complexity, cost and time to complete the
remaining development. Future cash flows for each project were estimated based
upon forecasted revenues and costs, taking into account product life cycles, and
market penetration and growth rates.
The IPR&D charge includes only the fair market value of IPR&D performed to
date. The fair value of completed technology is included in identifiable
intangible assets, and the fair values of IPR&D to be completed and future
research and development are included in goodwill. We believe the amounts
recorded as IPR&D, as well as developed technology, represent fair values and
approximate the amounts an independent party would pay for these projects.
As of the closing date of each purchase transaction, development projects
were in process. Although the costs to bring the products from the acquired
companies to technological feasibility are not expected to have a material
impact on our future results of operations or financial condition, the
development of these technologies remains a significant risk due to the
remaining effort to achieve technical viability, rapidly changing customer
markets, uncertain standards for new products and significant competitive
threats from numerous companies. The nature of the efforts to develop the
acquired technologies into commercially viable products consists principally of
planning, designing and testing activities necessary to determine that the
products can meet market expectations, including functionality and technical
requirements. Failure to bring these products to market in a timely manner could
result in loss of market share or a lost opportunity to capitalize on emerging
markets and could have a material and adverse impact on our business and
operating results.
Interest Income (Expense), Net
Interest income (expense), net consists primarily of interest earned on
cash, cash equivalents and marketable securities. Interest income (expense), net
was $248,000 for the year ended June 30, 2003 and $1.5 million for the year
ended June 30, 2002. The decrease is primarily due to lower average investment
balances and interest rates. Additionally, the decrease in the average
investment balance is due to increased expenditures for legal and other
professional fees resulting from our financial statement restatements in fiscal
2002 and defense of our lawsuits. Also, the decrease is due to the settlement of
the Milford lease obligation included in our restructuring charge, the purchase
of a joint interest in intellectual property from Gordian, our acquisition of
Stallion and to fund current operations.
26
Other Income (Expense), Net
Other income (expense), net was $(926,000) and $(760,000) for the years
ended June 30, 2003 and 2002, respectively. The increase for the year ended
June 30, 2003 is primarily attributable to our share of the losses from our
investment in Xanboo.
Provision (Benefit) for Income Taxes
We utilize the liability method of accounting for income taxes as set forth
in FASB Statement No. 109, "Accounting for Income Taxes." Our effective tax rate
was 0% for the year ended June 30, 2003, and 7% for the year ended June 30,
2002. The federal statutory rate was 34% for both periods. Our effective tax
rate associated with the income tax expense for the year ended June 30, 2003,
was lower than the federal statutory rate primarily due to the increase in
valuation allowance, as well as the amortization of stock-based compensation for
which no current year tax benefit was provided. Our effective tax rate
associated with the income tax benefit for the year ended June 30, 2002, was
lower than the federal statutory rate primarily due to foreign losses and
amortization of stock-based compensation for which no benefit was provided. We
have completed an Internal Revenue Service audit of our fiscal 1999, 2000 and
2001 tax returns. The outcome of the audits did not have a material impact on
our financial condition, results of operations or cash balance.
COMPARISON OF THE YEARS ENDED JUNE 30, 2002 AND 2001
Net Revenues
Net revenues increased $8.7 million, or 17.7%, to $57.6 million for the
year ended June 30, 2002 from $49.0 million for the year ended June 30, 2001.
The increase was primarily attributable to an increase in net revenues of our
other product lines and IT management solutions. Other products increased by
$7.0 million, or 149.0%, to $4.1 million or 19.3% of net revenues for the year
ended June 30, 2002, from $4.7 million or 9.6% of net revenues for the year
ended June 30, 2001. This increase is attributable to an increase in the
visualization and KVM sales due to the acquisition of Lightwave in June 2001.
Other products net revenues for the years ended June 30, 2002 and 2001 includes
$1.4 million and $1.5 million of software revenue generated from USSC,
respectively. IT management solutions net revenues increased $2.5 million, or
17.9%, to $16.5 million or 28.7% of net revenues for the year ended June 30,
2002 from $14.0 million or 28.6% of net revenues for the year ended June 30,
2001. The increase in IT management solutions net revenue is primarily
attributable to the acquisition of Lightwave, which offset reductions in older
multiport devices as IT purchases declined industry-wide. Fiscal year 2002 was
the first full year of inclusion of Lightwave revenues, whereas fiscal 2001
included one month of Lightwave revenues. Device networking solutions net
revenues decreased $.3 million, or 1%, to $30.0 million or 52.1%.
Net revenues generated from sales in the Americas increased $14.6 million,
or 44.1%, to $47.7 million or 82.8% of net revenues for the year ended June 30,
2002 from $33.1 million or 67.6% of net revenues for the year ended June 30,
2001. Our net revenues derived from customers located in Europe decreased $5.7
million, or 40.8%, to $8.2 million or 14.3% of net revenues for the year ended
June 30, 2002 from $13.9 million or 28.4% of net revenues for the year ended
June 30, 2001. Our net revenues derived from customers located in other
geographic areas decreased slightly to $1.7 million or 2.9% of net revenues for
the year ended June 30, 2002 from $1.9 million or 3.9% of net revenues for the
year ended June 30, 2001.
Gross Profit
Gross profit represents net revenues less cost of revenues. Cost of
revenues consists primarily of the cost of raw material components, subcontract
labor assembly from outside manufacturers, establishing inventory reserves for
excess and obsolete products or raw materials and associated overhead costs. As
part of our agreement with Gordian, an outside research and development firm, a
royalty charge was included in cost of revenues and was calculated based on the
related products sold. Gordian royalties were $1.2 million and $2.2 million for
the years ended June 30, 2002 and 2001, respectively. Additionally, cost of
revenues for the years ended June 30, 2002 and 2001 consisted of $2.4 million
and $220,000, respectively of amortization of purchased intangible assets. Cost
of revenues for the year ended June 30, 2002 also includes a $6.4 million
impairment charge of purchased intangible assets in accordance with SFAS No.
144. No similar charge was recorded for the year ended June 30, 2001.
Gross profit decreased by $7.3 million, or 29.9%, to $17.1 million or 29.7%
of net revenues for the year ended June 30, 2002 from $24.4 million or 49.9% of
net revenues for the year ended June 30, 2001. The decrease in gross profit in
absolute dollars and as a percentage of net revenues is primarily attributable
to the $6.4 million impairment charge, $2.4 million of amortization of purchased
intangible assets and the increase in our inventory reserve of $3.3 million. We
also used volume pricing agreements and competitive pricing strategies, which,
to a lesser degree, contributed to the decrease in gross profit.
27
In May 2002, we signed a new agreement with Gordian to acquire a joint
interest in the intellectual property that is evident in our products designed
by Gordian and to extinguish our obligation to pay royalties on future sales of
our products. We agreed to pay $6.0 million for this intellectual property and
will amortize this asset to cost of sales over the remaining life cycles of our
products designed by Gordian, or approximately 3 years. Effective May 30, 2002,
upon the signing of the agreement, royalty expenses were replaced by an
amortization of the prepaid royalties and entitlement to the intellectual
property that was part of the agreement. Amortization expense related to the
Gordian agreement totaled $212,000 for the year ended June 30, 2002.
Selling, General and Administrative
Selling, general and administrative expenses consist primarily of
personnel-related expenses including salaries and commissions, facilities
expenses, information technology expenses, trade show expenses, advertising, and
professional fees. Selling, general and administrative expenses increased $19.5
million, or 81.2%, to $43.5 million or 75.4% of net revenues for the year ended
June 30, 2002 from $24.0 million or 49.0% of net revenues for the year ended
June 30, 2001. Selling, general and administrative expense increased primarily
due to increased legal and other professional fees, increased allowance for
doubtful accounts primarily related to Lightwave receivables, an allowance
related to our officer loans, bonuses paid to our former executive officers,
increased personnel-related costs and facilities costs from the acquisitions of
USSC, Lightwave, Synergetic and Premise.
Research and Development
Research and development expenses consist primarily of salaries and the
related costs of employees, as well as expenditures to third-party vendors for
research and development activities. Research and development expenses increased
$4.7 million, or 106.0%, to $9.2 million or 16.0% of net revenues for the year
ended June 30, 2002, from $4.5 million or 9.1% of net revenues for the year
ended June 30, 2001. This increase resulted primarily from increased
personnel-related costs due to the acquisitions of USSC, Lightwave, Synergetic
and Premise, as well as hiring a senior engineering executive and expenses
related to new product development.
Stock-based compensation
Stock-based compensation expense generally represents the amortization of
deferred compensation. We recorded approximately $1.2 million of deferred
compensation for the year ended June 30, 2002. Additionally, we recorded
deferred compensation forfeitures of $3.1 million for the year ended June 30,
2002. Included in cost of revenues is stock-based compensation of $117,000 and
$87,000 for the years ended June 30, 2002 and 2001, respectively. Stock-based
compensation expense decreased $156,000, or 5.2%, to $2.9 million or 5.0% of net
revenues for the year ended June 30, 2002 from $3.0 million or 6.2% of net
revenues for the year ended June 30, 2001. The decrease in stock-based
compensation for the year ended June 30, 2002 is primarily attributable to the
restructuring plan whereby options for which deferred compensation in the amount
of $595,000 was charged to restructuring due to the fact that it was associated
with the extension of the exercise period for stock options that were vested at
the termination date.
Amortization of goodwill and purchased intangible assets
In connection with the two purchase transactions completed during fiscal
2001 and the two purchase transactions completed during fiscal 2002, we recorded
approximately $13.6 million and $14.8 million, of identified purchased
intangible assets, respectively. Goodwill is recorded as the difference, if any,
between the aggregate consideration paid for an acquisition and the fair value
of the net tangible and intangible assets acquired in order to allocate the
purchase price. We obtained independent appraisals of the fair value of tangible
and intangible assets acquired in order to allocate the purchase price.
Purchased intangible assets are amortized on a straight-line basis over the
economic lives of the respective assets, generally two to five years. The
amortization of goodwill and purchased intangible assets decreased $227,000 or
15.2%, to $1.3 million or 2.2% of net revenues for the year ended June 30, 2002
from $1.5 million or 3.0% of net revenues for the year ended June 30, 2001. In
addition, approximately $2.4 million and $220,000 of amortization of purchased
intangible assets has been classified as cost of revenues for the years ended
June 30, 2002 and 2001, respectively. The increase in amortization of purchased
intangible assets is due to the acquisitions of USSC and Lightwave completed in
fiscal 2001 and Synergetic and Premise completed in fiscal 2002.
28
In-process research and development
IPR&D related to acquisitions aggregated $1.0 million and $2.6 million for
the purchase transactions completed during fiscal 2002 and fiscal 2001,
respectively. The amounts allocated to IPR&D were determined through established
valuation techniques in the high-technology industry and were expensed upon
acquisition as it was determined that the underlying projects had not reached
technological feasibility and no alternative future uses existed. The fiscal
2002 IPR&D was related to the Premise acquisition and the fiscal 2001 IPR&D was
related to the USSC and Lightwave acquisitions in the amount of $496,000 and
$2.1 million, respectively.
Interest Income (Expense), Net
Interest income (expense), net consists primarily of interest earned on
cash, cash equivalents and marketable securities. Interest income (expense), net
was $1.5 million for the year ended June 30, 2002 and $2.2 million for the year
ended June 30, 2001. The decrease is primarily due to lower average investment
balances and interest rates for the year ended June 30, 2002.
Benefit for Income Taxes
We utilize the liability method of accounting for income taxes as set forth
in FASB Statement No. 109, Accounting for Income Taxes. Our effective tax rate
was 7% for the year ended June 30, 2002, and 21% for the year ended June 30,
2001. The federal statutory rate was 34% for both periods. Our effective tax
rate associated with the income tax benefit for the year ended June 30, 2002,
was lower than the federal statutory rate primarily due to nondeductible
goodwill amortization and IPR&D costs associated with current year acquisitions,
change in the valuation allowance, as well as the amortization of stock-based
compensation for which no current year tax benefit was provided. Our effective
tax rate associated with the income tax benefit for the year ended June 30,
2001, was lower than the federal statutory rate primarily due to nondeductible
goodwill amortization and in-process research and development costs associated
with current year acquisitions, as well as the amortization of stock-based
compensation for which no current year tax benefit was provided.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our operations through the issuance of
common stock and through net cash generated from operations. We consider all
highly liquid investments purchased with original maturities of 90 days or less
to be cash equivalents. Cash and cash equivalents, consisting of money-market
funds and commercial paper, totaled $7.3 million at June 30, 2003. Marketable
securities are income yielding securities which can be readily converted to
cash. Marketable securities consist of obligations of U.S. Government agencies,
state, municipal and county government notes and bonds and totaled $6.8 million
at June 30, 2003. Long-term investments primarily consist of an equity security
of a privately held company, Xanboo, and totaled $5.4 million at June 30, 2003.
Our operating activities used cash of $17.5 million for the year ended June
30, 2003. We incurred a net loss of $47.5 million, which includes the following
adjustments: impairment of goodwill and purchased intangible assets of $10.6
million, amortization of purchased intangible assets of $5.0 million,
stock-based compensation of $1.5 million, restructuring charges of $3.1 million,
depreciation of $2.5 million, equity losses from unconsolidated businesses of
$1.3 million, provision for inventory reserve of $4.2 million, litigation
settlement costs of $2.6 million, offset by a recovery from allowance for
doubtful accounts of $473,000. The changes in our operating assets consist of a
decrease in accounts receivable of $2.8 million, decrease in inventory of
$584,000, decrease in prepaid expenses and other current assets of $1.6 million,
increase in warranty reserve of $714,000, which was reduced by a decrease in our
liability to Gordian of $2.0 million, decrease in accrued Lightwave settlement
of $2.0 million and a decrease in other current liabilities of $1.9 million. The
reduction in accounts receivable is primarily due to improved collections from
29
our distributors and European customers. The decrease in inventory is primarily
due to an increase in our reserve for excess and obsolete inventory and
competitive pricing strategies of our on hand inventory. The decrease in our
prepaid and other current assets is primarily due to a reserve recorded against
prepaid inventory. The increase in the warranty reserve is primarily due to the
increase in historical actual warranty costs. The decrease in our liability to
Gordian and our accrued Lightwave settlement is due to payments in accordance
with the respective agreements. The decrease in our other current liabilities is
primarily due to payment of various one time liabilities that were outstanding
at June 30, 2002. Our operating activities used cash of $12.8 million for the
year ended June 30, 2002. and 2001,
Our investing activities used $2.1 million of cash for the year ended June
30, 2003 compared with $25.8 million for the year ended June 30, 2002. We used
$2.1 million, net of cash acquired, to acquire Stallion in August 2002. We used
$11.0 million to purchase marketable securities. We received $11.3 million in
proceeds from the sales of marketable securities. We also used $283,000 to
purchase property and equipment. The reduction in property and equipment
purchases is the result of the general consolidation and restructuring
activities during the year.
Cash provided by financing activities was $345,000 for the year ended June
30, 2003. Cash provided by financing activities was $49.7 million for the year
ended June 30, 2002, primarily related to the net proceeds from our secondary
public offering in July 2001.
In January 2002, we entered into a two-year line of credit with a bank in
an amount not to exceed $20.0 million. Borrowings under the line of credit bear
interest at either (i) the prime rate or (ii) the LIBOR rate plus 2.0%. We are
required to pay a $100,000 facility fee of which $50,000 was paid upon the
closing and $50,000 was to be paid. We were also required to pay a quarterly
unused line fee of .125% of the unused line of credit balance. The line of
credit contains customary affirmative and negative covenants. Effective June 30,
2002, we amended our existing line of credit, reducing the revolving line to
$12.0 million, removing the LIBOR rate option and adjusting the customary
affirmative and negative covenants. Effective February 4, 2003, we amended our
existing line of credit reducing the revolving line to $10.0 million, adjusting
the interest to the prime rate plus .50% and adjusted the customary affirmative
and negative covenants. Effective July 25, 2003, we further reduced our existing
line of credit, reducing the revolving line to $5.0 million and adjusted
affirmative and negative covenants. The agreement has an annual revolving
maturity date that renews on the effective date. The remaining $50,000 facility
fee was amended to $12,500 and was paid. Prior to any advances being made under
the line of credit, the bank is required to complete a field examination to
determine its borrowing base. We are also required to maintain certain financial
ratios as defined in the agreement. To date, we have not borrowed against this
line of credit. We were not in compliance with the revised financial covenants
of the February 4, 2003 amended line of credit at June 30, 2003, however, we are
currently in compliance with the revised financial covenants of the July 25,
2003 amended line of credit.
The following table summarizes our contractual payment obligations and
commitments:
FISCAL YEARS
------------
2004 2005 2006 2007 2008 TOTAL
------ ------ ----- ----- ----- ------
Convertible note payable $ - $ 867 $ - $ - $ - $ 867
Operating leases 1,711 1,348 493 336 202 4,090
Other contractual obligations 476 - - - - 476
------ ------ ----- ----- ----- ------
Total $2,187 $2,215 $ 493 $ 336 $ 202 $5,433
====== ====== ===== ===== ===== ======
We believe that our existing cash, cash equivalents and marketable
securities and any available borrowings under our line of credit facility will
be adequate to meet our anticipated cash needs through at least the next twelve
months. Our future capital requirements will depend on many factors, including
the timing and amount of our net revenues, research and development and
infrastructure investments, and expenses related to an on-going Securities and
Exchange Commission investigation and pending litigation, which will affect our
ability to generate additional cash. If cash generated from operations and
financing activities is insufficient to satisfy our working capital
requirements, we may need to borrow funds through bank loans, sales of
securities or other means. There can be no assurance that we will be able to
raise any such capital on terms acceptable to us, if at all. If we are unable to
secure additional financing, we may not be able to develop or enhance our
products, take advantage of future opportunities, respond to competition or
continue to operate our business.
RISK FACTORS
You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only ones facing our company. Our business operations may be impaired by
additional risks and uncertainties of which we are unaware or that we currently
consider immaterial.
Our business, results of operations or cash flows may be adversely affected
if any of the following risks actually occur. In such case, the trading price of
our common stock could decline, and you may lose all or part of your investment.
30
VARIATIONS IN QUARTERLY OPERATING RESULTS, DUE TO FACTORS INCLUDING
CHANGES IN DEMAND FOR OUR PRODUCTS AND CHANGES IN OUR MIX OF NET REVENUES, COULD
CAUSE OUR STOCK PRICE TO DECLINE.
Our quarterly net revenues, expenses and operating results have varied in
the past and might vary significantly from quarter to quarter in the future. We
therefore believe that quarter-to-quarter comparisons of our operating results
are not a good indication of our future performance, and you should not rely on
them to predict our future performance or the future performance of our stock
price. Our short-term expense levels are relatively fixed and are based on our
expectations of future net revenues. If we were to experience a reduction in net
revenues in a quarter, we would likely be unable to adjust our short-term
expenditures. If this were to occur, our operating results for that quarter
would be harmed. If our operating results in future quarters fall below the
expectations of market analysts and investors, the price of our common stock
would likely fall. Other factors that might cause our operating results to
fluctuate on a quarterly basis include:
- - changes in the mix of net revenues attributable to higher-margin and
lower-margin products;
- - customers' decisions to defer or accelerate orders;
- - variations in the size or timing of orders for our products;
- - short-term fluctuations in the cost or availability of our critical
components;
- - changes in demand for our products generally;
- - loss or gain of significant customers;
- - announcements or introductions of new products by our competitors;
- - defects and other product quality problems; and
- - changes in demand for devices that incorporate our products.
WE ARE CURRENTLY ENGAGED IN MULTIPLE SECURITIES CLASS ACTION LAWSUITS, A
STATE DERIVATIVE SUIT, A LAWSUIT BY OUR FORMER CFO AND COO STEVEN V. COTTON, A
LAWSUIT BY FORMER SHAREHOLDERS OF OUR SYNERGETIC SUBSIDIARY, AND A LAWSUIT
AGAINST THE FORMER OWNERS OF OUR LIGHTWAVE COMMUNICATIONS SUBSIDIARY, ANY OF
WHICH, IF IT RESULTS IN AN UNFAVORABLE RESOLUTION, COULD ADVERSELY AFFECT OUR
BUSINESS, RESULTS OF OPERATIONS OR FINANCIAL CONDITION.
Government Investigation
The SEC is conducting a formal investigation of the events leading up to
our restatement of our financial statements on June 25, 2002. The Department of
Justice is also conducting an investigation concerning events related to this
restatement.
Class Action Lawsuits
On May 15, 2002, Stephen Bachman filed a class action complaint entitled
Bachman v. Lantronix, Inc., et al., No. 02-3899, in the U.S. District Court for
the Central District of California against us and certain of our current and
former officers and directors alleging violations of the Securities Exchange Act
of 1934 and seeking unspecified damages. Subsequently, six similar actions were
filed in the same court. Each of the complaints purports to be a class action
lawsuit brought on behalf of persons who purchased or otherwise acquired our
common stock during the period of April 25, 2001 through May 30, 2002,
inclusive. The complaints allege that the defendants caused us to improperly
recognize revenue and make false and misleading statements about our business.
Plaintiffs further allege that the defendants materially overstated our reported
financial results, thereby inflating our stock price during our securities
offering in July 2001, as well as facilitating the use of our common stock as
consideration in acquisitions. The complaints have subsequently been
consolidated into a single action and the court has appointed a lead plaintiff.
The lead plaintiff filed a consolidated amended complaint on January 17, 2003.
The amended complaint now purports to be a class action brought on behalf of
persons who purchased or otherwise acquired our common stock during the period
of August 4, 2000 through May 30, 2002, inclusive. The amended complaint
continues to assert that we and the individual officer and director defendants
violated the 1934 Act, and also includes alleged claims that we and these
officers and directors violated the Securities Act of 1933 arising from our
Initial Public Offering in August 2000. We filed a motion to dismiss the
additional allegations on March 3, 2003. The Court has taken the motion under
submission. We have not yet answered, discovery has not commenced, and no trial
date has been established.
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Derivative Lawsuit
On July 26, 2002, Samuel Ivy filed a shareholder derivative complaint
entitled Ivy v. Bernhard Bruscha, et al., No. 02CC00209, in the Superior Court
of the State of California, County of Orange, against certain of our current and
former officers and directors. On January 7, 2003, the plaintiff filed an
amended complaint. The amended complaint alleges causes of action for breach of
fiduciary duty, abuse of control, gross mismanagement, unjust enrichment, and
improper insider stock sales. The complaint seeks unspecified damages against
the individual defendants on our behalf, equitable relief, and attorneys' fees.
We filed a demurrer/motion to dismiss the amended complaint on February 13,
2003. The basis of the demurrer is that the plaintiff does not have standing to
bring this lawsuit since plaintiff has never served a demand on our Board that
our Board take certain actions on our behalf. On April 17, 2003, the Court
overruled our demurrer. Discovery has commenced, but no trial date has been
established.
Employment Suit Brought by Former Chief Financial Officer and Chief Operating
Officer Steve Cotton
On September 6, 2002, Steve Cotton, our former CFO and COO, filed a
complaint entitled Cotton v. Lantronix, Inc., et al., No. 02CC14308, in the
Superior Court of the State of California, County of Orange. The complaint
alleges claims for breach of contract, breach of the covenant of good faith and
fair dealing, wrongful termination, misrepresentation, and defamation. The
complaint seeks unspecified damages, declaratory relief, attorneys' fees and
costs. Discovery has not commenced and no trial date has been established.
We filed a motion to dismiss on October 16, 2002, on the grounds that Mr.
Cotton's complaints are subject to the binding arbitration provisions in Mr.
Cotton's employment agreement. On January 13, 2003, the Court ruled that five of
the six counts in Mr. Cotton's complaint are subject to binding arbitration. The
court is staying the sixth count, for declaratory relief, until the underlying
facts are resolved in arbitration. No arbitration date has been set.
Securities Claims Brought by Former Shareholders of Synergetic Micro Systems,
Inc.
On October 17, 2002, Richard Goldstein and several other former
shareholders of Synergetic filed a complaint entitled Goldstein, et al v.
Lantronix, Inc., et al in the Superior Court of the State of California, County
of Orange, against us and certain of our former officers and directors.
Plaintiffs filed an amended complaint on January 7, 2003. The amended complaint
alleges fraud, negligent misrepresentation, breach of warranties and covenants,
breach of contract and negligence, all stemming from our acquisition of
Synergetic. The complaint seeks an unspecified amount of damages, interest,
attorneys' fees, costs, expenses, and an unspecified amount of punitive damages.
On May 5, 2003, we answered the complaint and generally denied the allegations
in the complaint. Discovery has not yet commenced and no trial date has been
established.
Suit filed by Lantronix Against Logical Solutions, Inc.
On March 25, 2003, we filed in Connecticut state court (Judicial District
of New Haven) a complaint entitled Lantronix, Inc. and Lightwave Communications,
Inc. v. Logical Solutions, Inc., et. al. This is an action for unfair and
deceptive trade practices, unfair competition, unjust enrichment, conversion,
misappropriation of trade secrets and tortuous interference with contractual
rights and business expectancies. We seek preliminary and permanent injunctive
relief and damages. The individual defendants are all former employees of
Lightwave Communications, a company that we acquired in June 2001. The suit is
pending trial.
Other
From time to time, we are subject to other legal proceedings and claims in
the ordinary course of business. We currently are not aware of any such legal
proceedings or claims that we believe will have, individually or in the
aggregate, a material adverse effect on our business, prospects, financial
position, operating results or cash flows.
The pending lawsuits involve complex questions of fact and law and likely
will continue to require the expenditure of significant funds and the diversion
of other resources to defend. We are unable to determine the outcome of its
outstanding legal proceedings, claims and litigation involving us, our
subsidiaries, directors and officers and cannot determine the extent to which
these results may have a material adverse effect on our business, results of
operations and financial condition taken as a whole. The results of litigation
are inherently uncertain, and adverse outcomes are possible. We are unable to
estimate the range of possible loss from outstanding litigation, and no amounts
have been provided fur such matters in the consolidated financial statements.
THERE IS A RISK THAT THE SEC COULD LEVY FINES AGAINST US, OR DECLARE US TO
BE OUT OF COMPLIANCE WITH THE RULES REGARDING OFFERING SECURITIES TO THE PUBLIC.
32
The SEC is investigating the events surrounding our recent restatement of
our financial statements. The SEC could conclude that we violated the rules of
the Securities Act of 1933 or the Securities and Exchange Act of 1934. In either
event, the SEC might levy civil fines against us, or might conclude that we lack
sufficient internal controls to warrant our being allowed to continue offering
our shares to the public. This investigation involves substantial cost and could
significantly divert the attention of management. These costs, and the cost of
any fines imposed by the SEC, are not covered by insurance. In addition to
sanctions imposed by the SEC, an adverse determination could significantly
damage our reputation with customers and vendors, and harm our employees'
morale.
WE MIGHT BECOME INVOLVED IN LITIGATION OVER PROPRIETARY RIGHTS, WHICH COULD BE
COSTLY AND TIME CONSUMING.
Substantial litigation regarding intellectual property rights exists in our
industry. There is a risk that third-parties, including current and potential
competitors, current developers of our intellectual property, our manufacturing
partners, or parties with which we have contemplated a business combination will
claim that our products, or our customers' products, infringe on their
intellectual property rights or that we have misappropriated their intellectual
property. In addition, software, business processes and other property rights in
our industry might be increasingly subject to third-party infringement claims as
the number of competitors grows and the functionality of products in different
industry segments overlaps. Other parties might currently have, or might
eventually be issued, patents that infringe on the proprietary rights we use.
Any of these third parties might make a claim of infringement against us.
For example, in July 2001, Digi International, Inc., filed a complaint
alleging that we directly and/or indirectly infringed upon a Digi Patent.
Following extensive and costly pre-trial preparation, we settled the matter with
Digi in November 2002. From time to time in the future we could encounter other
disputes over rights and obligations concerning intellectual property. We cannot
assume that we will prevail in intellectual property disputes regarding
infringement, misappropriation or other disputes. Litigation in which we are
accused of infringement or misappropriation might cause a delay in the
introduction of new products, require us to develop non-infringing technology,
require us to enter into royalty or license agreements, which might not be
available on acceptable terms, or at all, or require us to pay substantial
damages, including treble damages if we are held to have willfully infringed. In
addition, we have obligations to indemnify certain of our customers under some
circumstances for infringement of third-party intellectual property rights. If
any claims from third-parties were to require us to indemnify customers under
our agreements, the costs could be substantial, and our business could be
harmed. If a successful claim of infringement were made against us and we could
not develop non-infringing technology or license the infringed or similar
technology on a timely and cost-effective basis, our business could be
significantly harmed.
FOUR OF THE FORMER STOCKHOLDERS OF LIGHTWAVE COMMUNICATIONS ARE OPERATING A
BUSINESS THAT COMPETES WITH US. IF WE ARE UNSUCCESSFUL IN OUR PENDING LITIGATION
AGAINST THIS COMPANY, AND THESE FORMER LIGHTWAVE STOCKHOLDERS, OUR BUSINESS MAY
BE HARMED
In June 2001, we acquired Lightwave Communications. Since that time, four
of the founding stockholders and executive officers of Lightwave, as well as
several other former employees of Lightwave, have begun operating a business
that completes with us. Because these individuals held senior positions at
Lightwave, and were exposed to confidential information about Lightwave, as well
as Lantronix, if we are unsuccessful in our litigation against them, we may
suffer substantial harm.
We filed this suit to protect the value of the assets we bought in the
Lightwave acquisition. If the court refuses to enforce the above agreements, the
former employees will be able to compete against us in our markets for console
servers, KVM and video display extenders.
STOCK-BASED COMPENSATION WILL NEGATIVELY AFFECT OUR OPERATING RESULTS.
We have recorded deferred compensation in connection with the grant of
stock options to employees where the option exercise price is less than the
estimated fair value of the underlying shares of common stock as determined for
financial reporting purposes. We recorded deferred compensation of $73,000 for
the year ended June 30, 2003. Additionally, we recorded deferred compensation
forfeitures of $2.6 million for the year ended June 30, 2003. At June 30, 2003,
a balance of $695,000 remains and will be amortized as follows: $562,000 in
fiscal 2004, $108,000 in fiscal 2005 and $25,000 in fiscal 2006.
The amount of stock-based compensation in future periods will increase if
we grant stock options where the exercise price is less than the quoted market
price of the underlying shares. The amount of stock-based compensation
amortization in future periods could decrease if options for which accrued, but
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unvested deferred compensation has been recorded, are forfeited. Additionally,
as a result of our completing an offer whereby employees holding options to
purchase our common stock were given the opportunity to cancel certain of their
existing options in exchange for the opportunity to receive new options, we
recognized approximately $239,000 of accelerated stock-based compensation for
the year ended June 30, 2003. As a result, this will reduce the amount of
stock-based compensation in future periods.
WE HAVE EXCESS INVENTORIES AND THERE IS A RISK WE MAY BE UNABLE TO DISPOSE
OF THEM.
Our products and therefore our inventories are subject to technological
risk at any time either new products may enter the market or prices of
competitive products may be introduced with more attractive features or at lower
prices than ours. There is a risk that we may be unable to sell our inventory in
a timely manner to avoid their becoming obsolete. As of June 2003, our
inventories including raw materials, finished goods and inventory at
distributors were valued at $14.0 million and we had reserved $8.0 million
against these inventories. As of June 30, 2002, our inventories, including raw
materials, finished goods and inventory at distributors were valued at $16.5
million and we had reserved $5.8 million against these inventories. In the
event we are required to substantially discount our inventory or are unable to
sell our inventory in a timely manner, our operating results could be
substantially harmed.
WE PRIMARILY DEPEND ON FOUR THIRD-PARTY MANUFACTURERS TO MANUFACTURE
SUBSTANTIALLY ALL OF OUR PRODUCTS, WHICH REDUCES OUR CONTROL OVER THE
MANUFACTURING PROCESS. IF THESE MANUFACTURERS ARE UNABLE OR UNWILLING TO
MANUFACTURE OUR PRODUCTS AT THE QUALITY AND QUANTITY WE REQUEST, OUR BUSINESS
COULD BE HARMED AND OUR STOCK PRICE COULD DECLINE.
We outsource substantially all of our manufacturing to four third-party
manufacturers, Varian, Inc., Irvine Electronics, Technical Manufacturing Corp.
and Uni Precision Industrial LtdOur reliance on these third-party manufacturers
exposes us to a number of significant risks, including:
- - reduced control over delivery schedules, quality assurance, manufacturing
yields and production costs;
- - lack of guaranteed production capacity or product supply; and
- - reliance on third-party manufacturers to maintain competitive manufacturing
technologies.
Our agreements with these manufacturers provide for services on a purchase
order basis. If our manufacturers were to become unable or unwilling to continue
to manufacture our products in required volumes, at acceptable quality,
quantity, yields and costs, or in a timely manner, our business would be
seriously harmed. As a result, we would have to attempt to identify and qualify
substitute manufacturers, which could be time consuming and difficult, and might
result in unforeseen manufacturing and operations problems. Moreover, if we
shift products among third-party manufacturers, we may incur substantial
expenses, risk material delays, or encounter other unexpected issues. For
example, in the third quarter of this year we encountered product shortages
related to the transition to a third-party manufacturer. This product shortage
contributed to our net revenues falling below our publicly announced estimates.
In addition, a natural disaster could disrupt our manufacturers' facilities
and could inhibit our manufacturers' ability to provide us with manufacturing
capacity on a timely basis, or at all. If this were to occur, we likely would be
unable to fill customers' existing orders or accept new orders for our products.
The resulting decline in net revenues would harm our business. In addition, we
are responsible for forecasting the demand for our individual products. These
forecasts are used by our contract manufacturers to procure raw materials and
manufacture our finished goods. If we forecast demand too high, we may invest
too much cash in inventory and we may be forced to take a write-down of our
inventory balance, which would reduce our earnings. If our forecast is too low
for one or more products, we may be required to pay expedite charges which would
increase our cost of revenues or we may be unable to fulfill customer orders,
thus reducing net revenues and therefore earnings.
WE HAVE ELECTED TO USE A CONTRACT MANUFACTURER IN CHINA, WHICH INVOLVES
SIGNIFICANT RISKS.
One of our contract manufacturers is based in China. The outbreak of severe
acute respiratory syndrome, or SARS, which is particularly severe in China, may
have a negative impact on our ability to conduct business in China. In addition,
there are other significant risks of doing business in China, including:
34
- - Delivery times are extended due to the distances involved, requiring more
lead-time in ordering and increasing the risk of excess inventories.
- - We could incur ocean freight delays because of labor problems, weather
delays or expediting and customs problems.
- - China does not afford the same level of protection to intellectual property
as domestic or many other foreign countries. If our products were
reverse-engineered or our intellectual property were otherwise
pirated-reproduced and duplicated without our knowledge or approval, our
revenues would be reduced.
- - China and U.S foreign relations have, historically, been subject to change.
Political considerations and actions could interrupt our expected supply of
products from China.
IF WE MAKE UNPROFITABLE ACQUISITIONS OR ARE UNABLE TO SUCCESSFULLY
INTEGRATE OUR ACQUISITIONS, OUR BUSINESS COULD SUFFER.
We have in the past and may continue in the future to acquire businesses,
client lists, products or technologies that we believe complement or expand our
existing business. In December 2000, we acquired USSC, a company that provides
software solutions for use in embedded technology applications. In June 2001, we
acquired Lightwave, a company that provides console management solutions. In
October 2001, we acquired Synergetic, a provider of embedded network
communication solutions. In January 2002, we acquired Premise, a developer of
client-side software applications. In August 2002, we acquired Stallion, an
Australian based provider of solutions that enable Internet access, remote
access and serial connectivity. Acquisitions of this type involve a number of
risks, including:
- - difficulties in assimilating the operations and employees of acquired
companies;
- - diversion of our management's attention from ongoing business concerns;
- - our potential inability to maximize our financial and strategic position
through the successful incorporation of acquired technology and rights into
our products and services;
- - additional expense associated with amortization of acquired assets;
- - maintenance of uniform standards, controls, procedures and policies; and
- - impairment of existing relationships with employees, suppliers and
customers as a result of the integration of new management employees.
Any acquisition or investment could result in the incurrence of debt and
the loss of key employees. Moreover, we often assume specified liabilities of
the companies we acquire. Some of these liabilities, are difficult or impossible
to quantify. If we do not receive adequate indemnification for these liabilities
our business may be harmed. In addition, acquisitions are likely to result in a
dilutive issuance of equity securities. For example, we issued common stock and
assumed options to acquire our common stock in connection with our acquisitions
of USSC, Lightwave, Synergetic and Premise. We cannot assure you that any
acquisitions or acquired businesses, client lists, products or technologies
associated therewith will generate sufficient net revenues to offset the
associated costs of the acquisitions or will not result in other adverse
effects. Moreover, from time to time we may enter into negotiations for the
acquisition of businesses, client lists, products or technologies, but be unable
or unwilling to consummate the acquisition under consideration. This could cause
significant diversion of managerial attention and out of pocket expenses to us.
We could also be exposed to litigation as a result of an unconsummated
acquisition, including claims that we failed to negotiate in good faith,
misappropriated confidential information or other claims.
In addition, from time to time we may invest in businesses that we believe
present attractive investment opportunities, or provide other synergetic
benefits. In September and October 2001, we paid an aggregate of $3.0 million to
Xanboo for convertible promissory notes, which have converted, in accordance
with their terms, into Xanboo preferred stock. In addition, we purchased an
additional $4.0 million of preferred stock in Xanboo. As of June 30, 2003, we
hold a 15.3% ownership interest with a net book value of $5.4 million, in
Xanboo. This investment is speculative in nature, and there is risk that we
could lose part or all of our investment.
35
INABILITY, DELAYS IN DELIVERIES OR QUALITY PROBLEMS FROM OUR COMPONENT
SUPPLIERS COULD DAMAGE OUR REPUTATION AND COULD CAUSE OUR NET REVENUES TO
DECLINE AND HARM OUR RESULTS OF OPERATIONS.
Our contract manufacturers and we are responsible for procuring raw
materials for our products. Our products incorporate components or technologies
that are only available from single or limited sources of supply. In particular,
some of our integrated circuits are available from a single source. From time to
time in the past, integrated circuits we use in our products have been phased
out of production. When this happens, we attempt to purchase sufficient
inventory to meet our needs until a substitute component can be incorporated
into our products. Nonetheless, we might be unable to purchase sufficient
components to meet our demands, or we might incorrectly forecast our demands,
and purchase too many or too few components. In addition, our products use
components that have in the past been subject to market shortages and
substantial price fluctuations. From time to time, we have been unable to meet
our orders because we were unable to purchase necessary components for our
products. We rely on a number of different component suppliers. Because we do
not have long-term supply arrangements with any vendor to obtain necessary
components or technology for our products, if we are unable to purchase
components from these suppliers, product shipments could be prevented or
delayed, which could result in a loss of sales. If we are unable to meet
existing orders or to enter into new orders because of a shortage in components,
we will likely lose net revenues and risk losing customers and harming our
reputation in the marketplace.
OUR EXECUTIVE OFFICERS AND TECHNICAL PERSONNEL ARE CRITICAL TO OUR
BUSINESS, AND WITHOUT THEM WE MIGHT NOT BE ABLE TO EXECUTE OUR BUSINESS
STRATEGY.
Our financial performance depends substantially on the performance of our
executive officers and key employees. We are dependent in particular on Marc
Nussbaum, who serves as our President and Chief Executive Officer, and James
Kerrigan, who serves as our Chief Financial Officer. We have no employment
contracts with those executives who are at-will employees. We are also dependent
upon our technical personnel, due to the specialized technical nature of our
business. If we lose the services of Mr. Nussbaum, Mr. Kerrigan or any of our
key personnel and are not able to find replacements in a timely manner, our
business could be disrupted, other key personnel might decide to leave, and we
might incur increased operating expenses associated with finding and
compensating replacements.
THERE IS A RISK THAT OUR OEM CUSTOMERS WILL DEVELOP THEIR OWN INTERNAL
EXPERTISE IN NETWORK-ENABLING PRODUCTS, WHICH COULD RESULT IN REDUCED SALES OF
OUR PRODUCTS.
For most of our existence, we primarily sold our products to distributors,
VARs and system integrators. Although we intend to continue to use all of these
sales channels, we have begun to focus more heavily on selling our products to
OEMs. Selling products to OEMs involves unique risks, including the risk that
OEMs will develop internal expertise in network-enabling products or will
otherwise provide network functionality to their products without using our
device server technology. If this were to occur, our stock price could decline
in value and you could lose part or all of your investment.
OUR ENTRY INTO, AND INVESTMENT IN, THE HOME NETWORK MARKET HAS RISKS
INHERENT IN RELYING ON ANY EMERGING MARKET FOR FUTURE GROWTH.
The success of our Premise SYS software and our investment in Xanboo are
dependent on the development of a market for home networking. It is possible
this home network market may develop slowly, or not at all, or that others could
enter this market with superior product offerings that would impair our own
success. We could lose some or all of our investment, or be unsuccessful in
achieving significant revenues and therefore profitability, in these
initiatives. If this were to occur, our operating results could be harmed, and
our stock price could decline.
IF OUR RESEARCH AND DEVELOPMENT EFFORTS ARE NOT SUCCESSFUL OUR NET REVENUES
COULD DECLINE AND BUSINESS COULD BE HARMED.
For the year ended June 30, 2003, we incurred $10.4 million in research and
development expenses, which comprised 21.0% of our net revenues. If we are
unable to develop new products as a result of this effort, or if the products we
develop are not successful, our business could be harmed. Even if we do develop
new products that are accepted by our target markets, we do not know whether the
net revenue from these products will be sufficient to justify our investment in
research and development.
IF A MAJOR CUSTOMER CANCELS, REDUCES, OR DELAYS PURCHASES, OUR NET REVENUES
MIGHT DECLINE AND OUR BUSINESS COULD BE ADVERSELY AFFECTED.
36
Our top five customers accounted for 34% of our net revenues for the year
ended June 30, 2003. One customer. Ingram Micro, Inc., accounted for
approximately 11%, 12% and 14% of our net revenues for the years ended June 30,
2003, 2002 and 2001, respectively. Another customer, Tech Data Corporation,
accounted for approximately 10%, 11% and 10% of our net revenues for the years
ended June 30, 2003, 2002 and 2001, respectively. Accounts receivable
attributable to these two domestic customers accounted for approximately 16% and
21% of total accounts receivable at June 30, 2003 and 2002, respectively. The
number and timing of sales to our distributors have been difficult for us to
predict. The loss or deferral of one or more significant sales in a quarter
could harm our operating results. We have in the past, and might in the future,
lose one or more major customers. If we fail to continue to sell to our major
customers in the quantities we anticipate, or if any of these customers
terminate our relationship, our reputation, the perception of our products and
technology in the marketplace and the growth of our business could be harmed.
The demand for our products from our OEM, VAR and systems integrator customers
depends primarily on their ability to successfully sell their products that
incorporate our device server technology. Our sales are usually completed on a
purchase order basis and we have no long-term purchase commitments from our
customers.
Our future success also depends on our ability to attract new customers,
which often involves an extended process. The sale of our products often
involves a significant technical evaluation, and we often face delays because of
our customers' internal procedures used to evaluate and deploy new technologies.
For these and other reasons, the sales cycle associated with our products is
typically lengthy, often lasting six to nine months and sometimes longer.
Therefore, if we were to lose a major customer, we might not be able to replace
the customer on a timely basis or at all. This would cause our net revenues to
decrease and could cause the price of our stock to decline.
WE HAVE ESTABLISHED CONTRACTS AND OBLIGATIONS THAT WERE IMPLEMENTED WHEN WE
ANTICIPATED HIGHER REVENUES AND ACTIVITIES.
We have several agreements that obligate us to facilities or services that
are in excess of our current requirements and are at higher rates than could be
obtained today. It may be necessary that we sublease or otherwise negotiate
settlement of our obligations rather than perform on them as we originally
expected. If we are unable to negotiate a favorable resolution to these
contracts, we may be required to pay the entire cost of our obligations under
the agreement, which could harm our business.
THE AVERAGE SELLING PRICES OF OUR PRODUCTS MIGHT DECREASE, WHICH COULD
REDUCE OUR GROSS MARGINS.
In the past, we have experienced some reduction in the average selling
prices and gross margins of products and we expect that this will continue for
our products as they mature. In the future, we expect competition to increase,
and we anticipate this could result in additional pressure on our pricing. In
addition, our average selling prices for our products might decline as a result
of other reasons, including promotional programs and customers who negotiate
price reductions in exchange for longer-term purchase commitments. In addition,
we might not be able to increase the price of our products in the event that the
prices of components or our overhead costs increase. If this were to occur, our
gross margins would decline. In addition, we may not be able to reduce the cost
to manufacture our products to keep up with the decline in prices.
NEW PRODUCT INTRODUCTIONS AND PRICING STRATEGIES BY OUR COMPETITORS COULD
ADVERSELY AFFECT OUR ABILITY TO SELL OUR PRODUCTS AND COULD REDUCE OUR MARKET
SHARE OR RESULT IN PRESSURE TO REDUCE THE PRICE OF OUR PRODUCTS.
The market for our products is intensely competitive, subject to rapid
change and is significantly affected by new product introductions and pricing
strategies of our competitors. We face competition primarily from companies that
network-enable devices, companies in the automation industry and companies with
significant networking expertise and research and development resources. Our
competitors might offer new products with features or functionality that are
equal to or better than our products. In addition, since we work with open
standards, our customers could develop products based on our technology that
compete with our offerings. We might not have sufficient engineering staff or
other required resources to modify our products to match our competitors.
Similarly, competitive pressure could force us to reduce the price of our
products. In each case, we could lose new and existing customers to our
competition. If this were to occur, our net revenues could decline and our
business could be harmed.
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OUR INTELLECTUAL PROPERTY PROTECTION MIGHT BE LIMITED.
We have not historically relied on patents to protect our proprietary
rights, although we have recently begun to build a patent portfolio. We rely
primarily on a combination of laws, such as copyright, trademark and trade
secret laws, and contractual restrictions, such as confidentiality agreements
and licenses, to establish and protect our proprietary rights. Despite any
precautions that we have taken:
- - laws and contractual restrictions might not be sufficient to prevent
misappropriation of our technology or deter others from developing similar
technologies;
- - other companies might claim common law trademark rights based upon use that
precedes the registration of our marks;
- - policing unauthorized use of our products and trademarks is difficult,
expensive and time-consuming, and we might be unable to determine the
extent of this unauthorized use;
- - current federal laws that prohibit software copying provide only limited
protection from software pirates; and
- - the companies we acquire may not have taken similar precautions to protect
their proprietary rights.
Also, the laws of other countries in which we market and manufacture our
products might offer little or no effective protection of our proprietary
technology. Reverse engineering, unauthorized copying or other misappropriation
of our proprietary technology could enable third parties to benefit from our
technology without paying us for it, which could significantly harm our
business.
UNDETECTED PRODUCT ERRORS OR DEFECTS COULD RESULT IN LOSS OF NET REVENUES,
DELAYED MARKET ACCEPTANCE AND CLAIMS AGAINST US.
We currently offer warranties ranging from ninety days to two years on each
of our products. Our products could contain undetected errors or defects. If
there is a product failure, we might have to replace all affected products
without being able to book revenue for replacement units, or we may have to
refund the purchase price for the units. Because of our recent introduction of
our line of device servers, we do not have a long history with which to assess
the risks of unexpected product failures or defects for this product line.
Regardless of the amount of testing we undertake, some errors might be
discovered only after a product has been installed and used by customers. Any
errors discovered after commercial release could result in loss of net revenues
and claims against us. Significant product warranty claims against us could harm
our business, reputation and financial results and cause the price of our stock
to decline.
BECAUSE WE ARE DEPENDENT ON INTERNATIONAL SALES FOR A SUBSTANTIAL AMOUNT OF
OUR NET REVENUES, WE FACE THE RISKS OF INTERNATIONAL BUSINESS AND ASSOCIATED
CURRENCY FLUCTUATIONS, WHICH MIGHT ADVERSELY AFFECT OUR OPERATING RESULTS.
Net revenues from international sales represented 24%, 17% and 32% of net
revenues for the years ended June 30, 2003, 2002 and 2001, respectively. Net
revenues from Europe represented 21%, 14% and 28% of our net revenues for the
years ended June 30, 2003, 2002 and 2001, respectively.
We expect that international revenues will continue to represent a
significant portion of our net revenues in the foreseeable future. Doing
business internationally involves greater expense and many additional risks. For
example, because the products we sell abroad and the products and services we
buy abroad are priced in foreign currencies, we are affected by fluctuating
exchange rates. In the past, we have from time to time lost money because of
these fluctuations. We might not successfully protect ourselves against currency
rate fluctuations, and our financial performance could be harmed as a result. In
addition, we face other risks of doing business internationally, including:
- - unexpected changes in regulatory requirements, taxes, trade laws and
tariffs;
- - reduced protection for intellectual property rights in some countries;
- - differing labor regulations;
- - compliance with a wide variety of complex regulatory requirements;
- - changes in a country's or region's political or economic conditions;
- - greater difficulty in staffing and managing foreign operations; and
- - increased financial accounting and reporting burdens and complexities.
38
The recent outbreak of SARS that is currently having significant impact in
China, Hong Kong, and Singapore may have a negative impact on our operations.
Our operations may be impacted by a number of SARS-related factors, including,
but not limited to, disruptions at our third-party manufacturer that is located
in China, reduced sales in our international retail channels and increased
supply chain costs. If the number of cases continues to rise or spread to other
areas, our international sales and operations could be harmed.
Our international operations require significant attention from our
management and substantial financial resources. We do not know whether our
investments in other countries will produce desired levels of net revenues or
profitability.
THE MARKET FOR OUR PRODUCTS IS NEW AND RAPIDLY EVOLVING. IF WE ARE NOT ABLE
TO DEVELOP OR ENHANCE OUR PRODUCTS TO RESPOND TO CHANGING MARKET CONDITIONS, OUR
NET REVENUES WILL SUFFER.
Our future success depends in large part on our ability to continue to
enhance existing products, lower product cost and develop new products that
maintain technological competitiveness. The demand for network-enabled products
is relatively new and can change as a result of innovations or changes. For
example, industry segments might adopt new or different standards, giving rise
to new customer requirements. Any failure by us to develop and introduce new
products or enhancements directed at new industry standards could harm our
business, financial condition and results of operations. These customer
requirements might or might not be compatible with our current or future product
offerings. We might not be successful in modifying our products and services to
address these requirements and standards. For example, our competitors might
develop competing technologies based on Internet Protocols, Ethernet Protocols
or other protocols that might have advantages over our products. If this were to
happen, our net revenue might not grow at the rate we anticipate, or could
decline.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates primarily
to our investment portfolio. We do not use derivative financial instruments for
speculative or trading purposes. We place our investments in instruments that
meet high credit quality standards, as specified in our investment policy.
Information relating to quantitative and qualitative disclosure about market
risk is set forth below and in "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital Resources."
INTEREST RATE RISK
Our exposure to interest rate risk is limited to the exposure related to
our cash and cash equivalents, marketable securities and our credit facilities,
which is tied to market interest rates. As of June 30, 2003 and 2002, we had
cash and cash equivalents of $7.3 million and $26.5 million, respectively, which
consisted of cash and short-term investments with original maturities of ninety
days or less, both domestically and internationally. As of June 30, 2003 and
2002, we had marketable securities of $6.8 million and $7.0 million,
respectively consisting of obligations of U.S. Government agencies, state,
municipal and county government notes and bonds. We believe our marketable
securities will decline in value by an insignificant amount if interest rates
increase, and therefore would not have a material effect on our financial
condition or results of operations.
FOREIGN CURRENCY RISK
We sell products internationally. As a result, our financial results could
be harmed by factors such as changes in foreign currency exchange rates or weak
economic conditions in foreign markets.
INVESTMENT RISK
As of June 30, 2003 and 2002, we have a net investment of $5.4 million and
$6.7 million, respectively, in Xanboo, a privately held company which can still
be considered in the start-up or development stages. This investment is
inherently risky as the market for the technologies or products they have under
development are typically in the early stages and may never materialize. There
is a risk that we could lose part or all of our investment.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by this item are
incorporated by reference from Part IV, Item 15 of this Form 10-K and are
presented beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
Our chief executive officer and our chief financial officer, after
evaluating our "disclosure controls and procedures" (as defined in Securities
Exchange Act of 1934 (the "Exchange Act") Rules 13a-14(c) and 15-d-14(c)) as of
a date (the "Evaluation Date") within 90 days before the filing date of this
Annual Report on Form 10-K, have concluded that as of the Evaluation Date, our
disclosure controls and procedures are effective to ensure that information we
are required to disclose in reports that we file or submit under the Exchange
Act is recorded, processed, summarized and reported within the time periods
specified in Securities and Exchange Commission rules and forms.
(b) Changes in internal controls.
Prior to the Evaluation Date, we had identified material weaknesses in our
disclosure controls and procedures and have taken corrective actions. In certain
cases, we have identified disclosure controls and procedural improvements that
have been implemented, and will continue to be implemented after the Evaluation
Date. For example, we have revised our process controls that will facilitate
timely Securities and Exchange Commission filings, and have implemented
additional training. We continue to study, plan, and implement process changes
in anticipation of new requirements related to Sarbanes-Oxley legislation and
SEC and Nasdaq rules.
39
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) The information required by Item 10 of this Annual Report on Form 10-K with
respect to identification of directors is incorporated by reference from
the information contained in the section captioned "Election of Directors"
in Lantronix's definitive Proxy Statement for the Annual Meeting of
Stockholders to be held November 20, 2003 (the Proxy Statement), a copy of
which will be filed with the Securities and Exchange Commission before the
meeting date. For information with respect to the executive officers of
Lantronix, see "Executive Officers of the Registrant" included in Part I of
this report.
(b) The information required by Item 10 of this Annual Report on Form 10-K with
respect to compliance with Section 16 of the Securities Exchange Act of
1934 is incorporated by reference from the information contained in the
section captioned "Compliance with Section 16 of the Securities Exchange
Act of 1934" in the Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 of this Annual Report on Form 10-K is
incorporated by reference from the information contained in the section
captioned "Executive Compensation and Related Information" in the Proxy
Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 of this Annual Report on Form 10-K is
incorporated by reference from the information contained in the sections
captioned "Election of Directors" and "Security Ownership of Certain Beneficial
Owners and Management" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 of this Annual Report on Form 10-K is
incorporated by reference from the information contained in the sections
captioned "Election of Directors" and "Security Ownership of Certain Beneficial
Owners and Management" in the Proxy Statement.
Howard Slayen, a member of our Board of Directors also serves as our
nominee to the Xanboo Board of Directors. Marc Nussbaum our Chief Executive
Officer also served as a nominee to the Xanboo Board of Directors prior to his
resignation from the Xanboo board in August 2003.
One international customer, transtec AG, which is a related party due to
common ownership by our largest stockholder and former Chairman of our Board of
Directors, Bernhard Bruscha, accounted for approximately 4%, 5% and 9% of our
net revenues for the years ended June 30, 2003, 2002 and 2001, respectively.
Included in the accompanying consolidated balance sheets are approximately
$246,000 and $787,000 due to this related party at June 30, 2002 and 2001,
respectively. No significant amount was due to or from this related party at
June 30, 2003. We also had an agreement with transtec AG for the provision of
technical support services at the rate of $7,500 per month, which has now been
terminated. Included in selling, general and administrative expenses are $90,000
for each of the years ended June 30, 2002 and 2001, respectively.
ITEM 15. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Pursuant to SEC Release No. 33-8183 (as corrected by Release No. 33-8183A),
the disclosure requirements of this Item are not effective until the Annual
Report on Form 10-K for the first fiscal year ending after December 15, 2003.
40
PART IV
ITEM 16. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON 8-K.
(a) 1. Consolidated Financial Statements.
The following financial statement schedule of the Company and related
Report of Independent Auditors are filed as part of this Form 10-K.
PAGE
----------
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . F-1
Consolidated Balance Sheets as of June 30, 2003 and 2002 . . . . . . . . . . . . . . . . . . . . F-2
Consolidated Statements of Operations for the years ended June 30, 2003, 2002 and 2001 . . . . . F-3
Consolidated Statements of Stockholders' Equity for the years ended June 30, 2003, 2002 and 2001 F-4
Consolidated Statements of Cash Flows for the years ended June 30, 2003, 2002 and 2001 . . . . . F-5
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . F-6 - F-32
2. Financial Statement Schedule
The following financial statement schedule of the Company and related
Report of Independent Auditors are filed as part of this Form 10-K.
PAGE
-------
(1) Report of Independent Auditors on Financial Statement Schedule S-1
(2) Schedule II-Consolidated Valuation and Qualifying Accounts S-2
All other schedules have been omitted because they are not applicable, not
required, or the information is included in the consolidated financial
statements or notes thereto.
3. Exhibits
The following exhibits immediately follow the financial statements and are
filed as part of, or hereby incorporated by reference into this Form 10-K.
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- --------- ---------------------------------------------------------------------------
3.1* Certificate of Incorporation of registrant.
3.4 Bylaws of the registrant as amended on October 1, 2002.
4.1** Form of registrant's common stock certificate.
10.1** Form of Indemnification Agreement entered into by registrant
with each of its directors and executive officers.
10.2**++ 1993 Stock Option Plan and forms of agreements thereunder.
10.3**++ 1994 Nonstatutory Stock Option Plan and forms of agreements thereunder.
10.4***++ 2000 Stock Plan and forms of agreements thereunder.
10.5**++ 2000 Employee Stock Purchase Plan.
10.6** Form of Warranty.
10.7* Employment Agreement between registrant and Frederick Thiel.
10.8* Employment Agreement between registrant and Steven Cotton.
10.9* Employment Agreement between registrant and Johannes Rietschel.
10.10** Lease Agreement between registrant and The Irvine Company.
41
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- --------- ---------------------------------------------------------------------------
10.11** Loan and Security Agreement between registrant and Silicon Valley Bank.
10.12+** Research and Development Agreement between registrant and Gordian.
10.13+** Distributor Contract between registrant and Tech Data Corporation.
10.14+** Distributor Contract between registrant and Ingram Micro Inc.
10.15***** Offer to Exchange Outstanding Options, dated December 19, 2002.
21.1**** Subsidiaries of registrant.
23.1 Consent of Independent Auditors.
24.1 Power of Attorney (see page II-2).
31.1 Certification of Principal Executive Officer, filed herewith.
31.2 Certification of Principal Financial Officer, filed herewith.
32.1 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, furnished herewith.
* Incorporated by reference to the same numbered exhibit previously filed
with Lantronix's Registration Statement on Form S-1 (SEC file no.
333-37508) originally filed May 19, 2000.
** Incorporated by reference to the same numbered exhibit previously filed
with Lantronix's Registration Statement on Form S-1, Amendment No. 1, (SEC
file no. 333-37508) originally filed June 13, 2000.
*** Incorporated by reference to the same numbered exhibit previously filed
with Lantronix's Registration Statement on Form S-1, Amendment No. 1, (SEC
file no. 333-63030) originally filed June 14, 2001.
**** Incorporated by reference to the same numbered exhibit previously filed
with Lantronix's Annual Report on Form 10-K, originally filed September 28,
2001.
***** Incorporated by reference to Exhibit 99(A)(1) to the schedule TO filed
with the Securities and Exchange Commission on December 19, 2002.
+ Confidential treatment has previously been granted by the SEC for certain
portions of the referenced exhibit pursuant to Rule 406.
++ Designates management contract or compensatory plan arrangements required
to be filed as an exhibit of this Annual Report on Form 10-K pursuant to
Item 15(c).
(1) Report of Independent Auditors on Financial Statement Schedule. . . . . . . S-1
(2) Schedule II- Consolidated Valuation and Qualifying Accounts. . . . . . . . . S-2
(b) Reports on Form 8-K.
The Company filed the following current reports on Form 8-K during the quarter
ended June 30, 2003:
Form 8-K filed on April 21, 2003, updating previous guidance regarding the
Company's third fiscal quarter ended March 31, 2003
Form 8-K filed on May 16, 2003 reporting the results of the Company's third
fiscal quarter ended March 31, 2003, including an unaudited balance sheet and
statement of operations.
42
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Lantronix, Inc.
We have audited the accompanying consolidated balance sheets of Lantronix,
Inc. as of June 30, 2003 and 2002, and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended June 30, 2003. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Lantronix, Inc.
at June 30, 2003 and 2002, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended June 30, 2003, in
conformity with accounting principles generally accepted in the United States.
As discussed in Note 5, effective July 1, 2001, the Company adopted the
provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets."
/s/ ERNST & YOUNG LLP
Orange County, California
September 26, 2003
F-1
LANTRONIX, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30,
--------
2003 2002
---------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 7,328 $ 26,491
Marketable securities 6,750 6,963
Accounts receivable (net of allowance for doubtful accounts of $572
and $1,466 at June 30, 2003 and 2002, respectively) 3,858 6,172
Inventories 6,011 10,743
Deferred income taxes 7,909 5,205
Contract manufacturers receivable (net of allowance of $62 at June 30, 2003) 1,744 1,652
Prepaid expenses and other current assets 3,861 3,647
---------- ---------
Total current assets 37,461 60,873
Property and equipment, net 2,541 5,039
Goodwill 11,726 13,811
Purchased intangible assets, net 5,394 14,681
Long-term investments 5,458 6,761
Officer loans (net of allowance of $4,154 at June 30, 2003 and 2002, respectively) 104 104
Other assets 172 2,543
---------- ---------
Total assets $ 62,856 $103,812
========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,801 $ 4,607
Due to related party - 246
Accrued payroll and related expenses 1,367 1,530
Due to Gordian 1,000 2,000
Accrued litigation settlement 1,533 2,004
Warranty reserve 1,193 479
Restructuring reserve 3,235 407
Other current liabilities 2,634 4,177
---------- ---------
Total current liabilities 15,763 15,450
Deferred income taxes 8,509 5,205
Due to Gordian - 1,000
Convertible note payable 867 -
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.0001 par value; 5,000,000 shares authorized;
none issued and outstanding - -
Common stock, $0.0001 par value; 200,000,000 shares authorized;
55,425,774 and 54,252,528 shares issued and outstanding at
June 30, 2003 and 2002, respectively 6 5
Additional paid-in capital 178,628 179,547
Notes receivable from officers (net of allowance of $249 at
June 30, 2003 and 2002, respectively) - (28)
Deferred compensation (695) (4,546)
Accumulated deficit (140,424) (92,875)
Accumulated other comprehensive gain 202 54
---------- ---------
Total stockholders' equity 37,717 82,157
---------- ---------
Total liabilities and stockholders' equity $ 62,856 $103,812
========== =========
See accompanying notes.
F-2
LANTRONIX, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED JUNE 30,
--------------------
2003 2002 2001
--------- --------- ---------
Net revenues (A) $ 49,509 $ 57,646 $ 48,972
Cost of revenues (B) 37,603 40,510 24,530
--------- --------- ---------
Gross profit 11,906 17,136 24,442
--------- --------- ---------
Operating expenses:
Selling, general and administrative (C) 30,633 41,575 23,998
Research and development (C) 10,413 9,225 4,478
Stock-based compensation (B) (C) 1,453 2,863 3,019
Amortization of goodwill and purchased intangible assets 1,002 1,263 1,490
Impairment of goodwill and purchased intangible assets 6,708 50,828 -
Restructuring charges 5,711 3,473 -
Litigation settlement costs 2,607 1,912 -
In-process research and development - 1,000 2,596
--------- --------- ---------
Total operating expenses 58,527 112,139 35,581
--------- --------- ---------
Loss from operations (46,621) (95,003) (11,139)
Interest income (expense), net 248 1,546 2,182
Other income (expense), net (926) (760) (167)
--------- --------- ---------
Loss before income taxes and cumulative effect of accounting changes (47,299) (94,217) (9,124)
Provision (benefit) for income taxes 250 (6,665) (1,876)
--------- --------- ---------
Loss before cumulative effect of accounting changes (47,549) (87,552) (7,248)
Cumulative effect of accounting changes:
Change in revenue recognition policy, net of income tax benefit of $176 - - (597)
Adoption of new accounting standard, SFAS No. 142 - (5,905) -
--------- --------- ---------
Net loss $(47,549) $(93,457) $ (7,845)
========= ========= =========
Basic and diluted loss per share before cumulative effect of accounting changes $ (0.88) $ (1.70) $ (0.19)
Cumulative effect of accounting changes per share:
Change in revenue recognition policy, net of income tax benefit of $176 - - (0.02)
Adoption of new accounting standard, SFAS No. 142 - (0.12) -
--------- --------- ---------
Basic and diluted net loss per share $ (0.88) $ (1.82) $ (0.21)
========= ========= =========
Weighted average shares (basic and diluted) 54,329 51,403 36,946
========= ========= =========
(A) Includes revenues from related parties $ 1,845 $ 2,644 $ 4,257
========= ========= =========
(B) Cost of revenues includes the following:
Amortization of purchased intangible assets $ 4,042 $ 2,446 $ 220
Impairment of purchased intangible assets 3,929 6,448 -
Stock-based compensation 89 117 87
--------- --------- ---------
$ 8,060 $ 9,011 $ 307
========= ========= =========
(C) Stock-based compensation is excluded from the following:
Selling, general and administrative expenses $ 1,074 $ 2,086 $ 2,589
Research and development expenses 379 777 430
--------- --------- ---------
$ 1,453 $ 2,863 $ 3,019
========= ========= =========
See accompanying notes.
F-3
LANTRONIX, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
NOTES RETAINED ACCUMULATED
ADDITIONAL RECEIVABLE EARNINGS OTHER TOTAL
COMMON STOCK PAID-IN FROM DEFERRED (ACCUMULATED COMPREHENSIVE STOCKHOLDERS'
SHARES AMOUNT CAPITAL OFFICERS COMPENSATION DEFICIT) GAIN(LOSS) EQUITY
---------- ------ ---------- -------- ------------ ------------ ------------- -------------
Balance at June 30, 2000 29,803,232 $ 3 $ 13,221 $ (152) $ (8,942) $ 8,427 $ (10) $ 12,547
Issuance of common stock in
initial public offering 6,000,000 1 53,706 - - - - 53,707
Stock options exercised 1,450,656 - 689 - - - - 689
Deferred compensation, net - - 4,184 - (4,184) - - -
Stock-based compensation - - - - 3,106 - - 3,106
Notes receivable issued to
officers for stock purchase 1,965,498 - 670 (670) - - - -
Purchase transactions 4,082,417 - 37,401 - - - - 37,401
Repayment of notes receivable - - - 32 - - - 32
Components of comprehensive
loss:
Translation adjustment - - - - - - (9) (9)
Change in net unrealized
loss on investment - - - - - - (132) (132)
Net loss - - - - - (7,845) - (7,845)
---------
Comprehensive loss . . . . . . (7,986)
---------- ------ ---------- -------- ------------ ------------ ------------- -------------
Balance at June 30, 2001 43,301,803 4 109,871 (790) (10,020) 582 (151) 99,496
Issuance of common stock
in secondary public offering 6,400,500 1 47,085 - - - - 47,086
Stock options exercised 1,073,452 - 1,619 - - - - 1,619
Employee stock purchase plan 178,687 - 437 - - - - 437
Deferred compensation, net - - (1,899) - 1,899 - - -
Stock-based compensation - - - - 3,575 - - 3,575
Repayment of notes receivable - - - 513 - - - 513
Provision for notes receivable
from officers - - - 249 - - - 249
Purchase transactions 3,298,086 - 22,941 - - - - 22,941
Repurchase of common stock - - (507) - - - - (507)
Components of comprehensive
loss:
Translation adjustment - - - - - - 73 73
Change in net unrealized
loss on investment - - - - - - 132 132
Net loss - - - - - (93,457) - (93,457)
---------
Comprehensive loss . . . . . . (93,252)
---------- ------ ---------- -------- ------------ ------------ ------------- -------------
Balance at June 30, 2002 54,252,528 5 179,547 (28) (4,546) (92,875) 54 82,157
Stock options exercised 152,004 - 37 - - - - 37
Repurchase of common stock (448,335) - - - - - - -
Employee stock purchase plan 406,205 - 280 - - - - 280
Deferred compensation, net - - (2,310) - 2,548 - - 238
Stock-based compensation - - - - 1,303 - - 1,303
Repayment of notes receivable - - - 28 - - - 28
Premise settlement 1,063,372 1 1,074 - - - - 1,075
Components of comprehensive
loss:
Translation adjustment - - - - - - 148 148
Net loss - - - - - (47,549) - (47,549)
---------
Comprehensive loss . . . . . . (47,401)
---------- ------ ---------- -------- ------------ ------------ ------------- -------------
Balance at June 30, 2002 55,425,774 $ 6 $ 178,628 $ (-) $ (695) $ (140,424) $ 202 $ 37,717
=========== ===== =========== ======= ============ =========== =========== =============
See accompanying notes.
F-4
LANTRONIX, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED JUNE 30,
--------------------
2003 2002 2001
--------- --------- ---------
Cash flows from operating activities:
Net loss $(47,549) $(93,457) $ (7,845)
Adjustments to reconcile net loss to net cash used in operating activities:
Cumulative effect of accounting changes:
Change in revenue recognition policy, net of income tax benefit of $176 - - 597
Adoption of new accounting standard, SFAS No. 142 - 5,905 -
Depreciation 2,462 2,510 909
Amortization of goodwill and purchased intangible assets 5,044 3,709 1,710
Impairment of goodwill and purchased intangible assets 10,637 57,276 -
Stock-based compensation 1,542 2,980 3,106
Deferred income taxes - (5,594) (2,232)
Provision for officer loans - 4,403 -
Restructuring charges 3,138 3,473 -
Litigation settlement costs 2,607 1,912 -
Equity losses from unconsolidated businesses 1,303 1,002 -
Provision for doubtful accounts (473) 1,680 108
Provision for inventory reserves 4,189 3,443 2,013
In-process research and development - 1,000 2,596
Revaluation of strategic investment - 500 -
Loss on disposal of assets - - 25
Changes in operating assets and liabilities, net of effect from acquisitions:
Accounts receivable 2,849 2,543 (1,440)
Inventories 584 (459) (4,602)
Contract manufacturers receivable (154) - (1,652)
Prepaid expenses and other current assets 1,442 (1,451) (2,500)
Other assets 148 (2,404) (742)
Accounts payable 194 (3,829) 2,216
Due to related party (246) (541) -
Due to Gordian (2,000) 3,000 -
Accrued Lightwave settlement (2,004) - 17
Warranty reserve 714 (83) -
Other current liabilities (1,936) (348) 513
--------- --------- ---------
Net cash used in operating activities (17,509) (12,830) (4,953)
--------- --------- ---------
Cash flows from investing activities:
Purchases of property and equipment, net (283) (2,750) (4,632)
Purchases of marketable securities (11,000) (9,490) (30,470)
Purchase of intellectual property - (6,000) -
Purchases of minority investments - (7,288) (2,136)
Proceeds from sale of marketable securities 11,250 4,500 28,497
Officer loans - - (4,131)
Acquisition of businesses, net of cash acquired (2,114) (4,746) (16,464)
--------- --------- ---------
Net cash used in investing activities (2,147) (25,774) (29,336)
--------- --------- ---------
Cash flows from financing activities:
Net proceeds from underwritten offerings of common stock - 47,085 53,706
Net proceeds from other issuances of common stock 317 2,057 689
Proceeds from repayment of notes receivable from officers 28 513 32
Payments on debt obligations - - (6,750)
--------- --------- ---------
Net cash provided by financing activities 345 49,655 47,677
Effect of exchange rates on cash 148 73 (9)
--------- --------- ---------
Net increase (decrease) in cash (19,163) 11,124 13,379
Cash and cash equivalents at beginning of year 26,491 15,367 1,988
--------- --------- ---------
Cash and cash equivalents at end of year $ 7,328 $ 26,491 $ 15,367
========= ========= =========
Supplemental disclosure of cash flow information:
Interest paid $ 13 $ 49 $ 8
Income taxes paid $ 49 $ 210 $ 276
See accompanying notes.
F-5
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company
Lantronix, Inc. (the "Company"), incorporated in California in June 1989
and re-incorporated in the State of Delaware in May 2000, is engaged primarily
in the design and distribution of networking and Internet connectivity products
on a worldwide basis. The actual assembly and a significant portion of the
engineering of the Company's products are outsourced to third parties.
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany transactions and
balances have been eliminated in consolidation. Substantially all of the
Company's net tangible assets were located within the United States.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. The industry in which the Company operates is
characterized by rapid technological change and short product life cycles. As a
result, estimates made in preparing the financial statements include the
allowance for doubtful accounts, sales returns and allowances, inventory
reserves, allowance for officer loans, strategic investments, goodwill and
purchased intangible asset valuations, deferred income tax asset valuation
allowances, warranty reserves, restructuring costs, litigation and other
contingencies. To the extent there are material differences between estimates
and the actual results, future results of operations will be affected.
Revenue Recognition
The Company does not recognize revenue until all of the following criteria
are met: persuasive evidence of an arrangement exists; delivery has occurred or
services have been rendered; the Company's price to the buyer is fixed or
determinable; and collectibility is reasonably assured. Commencing July 1, 2000
the Company adopted a new accounting policy for revenue recognition such that
recognition of revenue and related gross profit from sales to distributors are
deferred until the distributor resells the product. Net revenue from certain
smaller distributors, for which point-of-sale information is not available, is
recognized one month after the shipment date. This estimate approximates the
timing of the sale of the product by the distributor to the end user. The
cumulative effect of the accounting change recorded as of July 1, 2000 was a
charge of $597,000 (net of income taxes of $176,000) or $0.02 per share.
Revenues from product sales to original equipment manufacturers, end user
customers, other resellers and from sales to distributors prior to July 1, 2000
generally were recognized upon product shipment, but may have been deferred to a
later date if all revenue recognition criteria were not met at the date of
shipment. When product sales revenue is recognized, the Company establishes an
estimated allowance for future product returns based on historical returns
experience; when price reductions are approved, it establishes an estimated
liability for price protection payable on inventories owned by product
resellers. Should actual product returns or pricing adjustments exceed the
Company's estimates, additional reductions to revenues would result. Revenue
from the licensing of software is recognized at the time of shipment (or at the
time of resale in the case of software products sold through distributors),
provided the Company has vendor-specific objective evidence of the fair value of
each element of the software offering and collectibility is probable. Revenue
from post contract customer support and any other future deliverables is
deferred and recognized over the support period or as contract elements are
delivered.
Concentration of Credit Risk
The Company's accounts receivable are derived from revenues earned from
customers located throughout North America, Europe and Asia. The Company
performs ongoing credit evaluations of its customers' financial condition and
maintains allowances for potential credit losses. Credit losses have
historically been within management's expectations. The Company generally does
not require collateral or other security from its customers. The Company invests
its excess cash in deposits with major banks, in U.S. Government agencies,
state, municipal and county governments notes and bonds.
Fair Value of Financial Instruments
The Company's financial instruments consist principally of cash and cash
equivalents, marketable securities, accounts receivable, notes receivable,
accounts payable, convertible debt and accrued liabilities. The Company believes
all of the financial instruments' recorded values approximate current values
because of the short maturities of these investments.
F-6
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
Marketable Securities
The Company defines marketable securities available for sale as income
yielding securities, which can be readily converted to cash. Marketable
securities consist of obligations of U.S. Government agencies, state, municipal
and county governments notes and bonds.
Foreign Currency Translation
The financial statements of foreign subsidiaries whose functional currency
is not the U.S. dollar have been translated to U.S. dollars in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 52, "Foreign Currency
Translation." Foreign currency assets and liabilities are remeasured into U.S.
dollars at the end-of-period exchange rates. Revenues and expenses are
translated at average exchange rates in effect during each period, except for
those expenses related to balance sheet amounts, which are translated at
historical exchange rates. Exchange gains and losses from foreign currency
translations are reported as a component of accumulated other comprehensive gain
(loss) within stockholders' equity. Exchange gains and losses from foreign
currency transactions are recognized in the consolidated statement of operations
and historically have not been material.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and short-term investments with
original maturities of ninety days or less.
Investments
The Company accounts for its investments in debt and equity securities with
readily determinable fair values that are not accounted for under the equity
method of accounting under SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." Management determines the appropriate
classification of such securities at the time of purchase and reevaluates such
classification as of each balance sheet date. The investments are adjusted for
amortization of premiums and discounts to maturity and such amortization is
included in interest income.
In September and October 2001, the Company paid an aggregate of $3.0
million to Xanboo Inc. ("Xanboo") for convertible promissory notes, which
converted in January 2002, in accordance with their terms, into Xanboo preferred
stock. In addition, the Company purchased $4.0 million of Xanboo preferred stock
in January 2002. The Company's ownership interest in Xanboo was 15.3% and 15.8%
at June 30, 2003 and 2002, respectively. The Company is accounting for this
long-term investment under the equity method based upon the Company's ability,
through representation on Xanboo's board of directors to exercise significant
influence over its operations. The Company's interest in the losses of Xanboo
aggregating $1.3 million and $526,000 during the years ended June 30, 2003 and
2002, respectively, have been recognized as other expense in the accompanying
consolidated statement of operations.
The Company periodically reviews its investments for which fair value is
less than cost to determine if the decline in value is other than temporary. If
the decline in value is judged to be other than temporary, the cost basis of the
security is written down to fair value. The Company generally believes an
other-than-temporary decline has occurred when the fair value of the investment
is below the carrying value for two consecutive quarters, absent evidence to the
contrary. During the year ended June 30, 2002, the Company recorded a $500,000
revaluation of a non-marketable equity investment resulting from an
other-than-temporary decline in its value. This amount is included within the
consolidated statements of operations as other expense.
Inventories
Inventories are stated at the lower of cost (on a first-in, first-out
basis) or market. The Company provides reserves for excess and obsolete
inventories determined primarily based upon estimates of future demand for the
Company's products. Shipping and handling costs are classified as a component of
cost of revenues in the consolidated statements of operations.
Property and Equipment
Property and equipment are carried at cost. Depreciation is provided using
the straight-line method over the assets' estimated useful lives ranging from
three to five years. Depreciation and amortization of leasehold improvements are
computed using the shorter of the remaining lease term or five years. Major
renewals and betterments are capitalized, while replacements, maintenance and
repairs which do not improve or extend the lives of the respective assets are
expensed as incurred.
F-7
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
Long-Lived Assets
Long-lived assets and certain identifiable intangible assets to be held and
used are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of such assets may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the
carrying amount of an asset to future net cash flows expected to be generated by
the asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets.
Capitalized Internal Use Software Costs
The Company capitalizes the costs of computer software developed or
obtained for internal use in accordance with AICPA Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." Capitalized computer software costs consist of purchased software
licenses and implementation costs. At June 30, 2003 and 2002 of $734,000 and
$1.7 million, respectively, are included in computer and office equipment in the
accompanying consolidated balance sheet. The capitalized software costs are
being amortized on a straight-line basis over a period of three years.
Amortization for the years ended June 30, 2003, 2002 and 2001 totaled $776,000,
$999,000 and $221,000, respectively. Capitalized internal use software with a
net carrying amount of approximately $107,000 and $898,000 were written off for
the years ended June 30, 2003 and 2002, respectively, as a result of the
Company's fiscal 2003 and 2002 restructuring plans (Note 6).
Income Taxes
Income taxes are computed under the liability method. This method requires
the recognition of deferred tax assets and liabilities for temporary differences
between the financial reporting basis and the tax basis of the Company's assets
and liabilities. The impact on deferred taxes of changes in tax rates and laws,
if any, are applied to the years during which temporary differences are expected
to be settled and are reflected in the consolidated financial statements in the
period of enactment. A valuation allowance is recorded when it is more likely
than not that some of the deferred tax assets will not be realized.
Stock-Based Compensation
The Company accounts for stock-based awards to employees in accordance with
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees" ("APB 25"), and related interpretations, and has adopted the
disclosure-only alternative of SFAS No. 123, "Accounting for Stock-Based
Compensation ("SFAS No. 123"), and SFAS No. 148, "Accounting for Stock Based
Compensation Transition and Disclosure ("SFAS No. 148"). Options granted to
non-employees, as defined, have been accounted for at fair market value in
accordance with SFAS No. 123.
The Company also complies with Financial Accounting Standards Board
("FASB") Interpretation No. 44, "Accounting for Certain Transactions Involving
Stock Compensation - An Interpretation of APB Opinion No. 25", ("FIN 44"). FIN
44 clarifies the definition of an employee for purposes of applying APB 25, the
criteria for determining whether a plan qualifies as a noncompensatory plan, the
accounting consequence of various modifications to the terms of a previously
fixed stock option or award, and the accounting for an exchange of stock
compensation awards in a business combination.
For stock option grants to non-employees who are consultants to the
Company, the Company complies with the provisions of Emerging Issues Task Force
("EITF") Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to
Other Than Employees for Acquiring, or in Conjunction with, Selling Goods or
Services" ("EITF 96-18"). EITF 96-18 requires variable plan accounting with
respect to such non-employee stock options, whereby compensation associated with
such options is measured on the date such options vest, and incorporates the
then-current fair market value of the Company's common stock into the option
valuation model.
Pro forma information regarding net income loss per share is required by
SFAS No. 123 and has been determined as if the Company had accounted for its
employee stock options under the fair value method of SFAS No. 123.
The value of the Company's stock-based awards granted to employees prior to
the Company's initial public offering in August 2000 was estimated using the
minimum value method, which does not consider stock price volatility.
Stock-based awards granted subsequent to the initial public offering have been
valued using the Black-Scholes option pricing model. Among other things, the
Black-Scholes model considers the expected volatility of the Company's stock
price, determined in accordance with SFAS No. 123, in arriving at an option
valuation. Estimates and other assumptions necessary to apply the Black-Scholes
model may differ significantly from assumptions used in calculating the value of
options granted prior to the initial public offering under the minimum value
method.
The fair value of options granted to employees after the initial public
offering was estimated assuming no expected dividends, a weighted average
expected life of five years, a weighted average risk-free interest rate of 1.9%
and an expected volatility of 128%.
The weighted average fair value of options granted to employees during
2003, 2002 and 2001 was $0.68, $3.81 and $7.32, respectively. For pro forma
purposes, the estimated value of the Company's stock-based awards to employees
is amortized over the vesting period of the underlying instruments. The results
of applying SFAS No. 123 to the Company's stock-based awards to employees would
approximate the following:
YEARS ENDED JUNE 30,
--------------------
2003 2002 2001
--------- --------- ---------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
Net loss:
As reported $(47,549) $(93,457) $ (7,845)
Pro forma (52,311) (97,708) (11,144)
Basic and diluted net loss per share:
As reported $ (0.88) $ (1.82) $ (.21)
Pro forma (0.96) (1.90) (.30)
F-8
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
Loss Per Share
Basic and diluted loss per share is calculated by dividing net loss by the
weighted average number of common shares outstanding during the year.
YEARS ENDED JUNE 30,
--------------------
2003 2002 2001
--------- --------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Numerator:
Loss before cumulative effect of accounting changes $(47,549) $(87,552) $(7,248)
Cumulative effect of accounting changes:
Change in revenue recognition policy, net of income tax benefit of $176 - - (597)
Adoption of new accounting standard, SFAS No. 142 - (5,905) -
--------- --------- --------
Net loss $(47,549) $(93,457) $(7,845)
========= ========= ========
Denominator:
Weighted-average shares outstanding 54,661 51,909 37,227
Less: Non-vested common shares outstanding (332) (506) (281)
--------- --------- --------
Denominator for basic and diluted loss per share 54,329 51,403 36,946
========= ========= ========
Basic and diluted loss per share before cumulative effect of accounting changes $ (0.88) $ (1.70) $ (0.19)
Cumulative effect of accounting changes per share:
Change in revenue recognition policy, net of income tax benefit of $176 - - (0.02)
Adoption of new accounting standard, SFAS No. 142 - (0.12) -
--------- --------- --------
Basic and diluted net loss per share $ (0.88) $ (1.82) $ (0.21)
========= ========= ========
Common share equivalents of 453,053, 359,222 and 2,964,229 have been
excluded from the diluted net loss per share calculation for the years ended
June 30, 2003, 2002 and 2001, respectively, because they were antidilutive as of
such dates. These excluded common stock equivalents could be dilutive in the
future.
Research and Development Costs
Costs incurred in the research and development of new products and
enhancements to existing products are expensed as incurred. The Company believes
its current process for developing products is essentially completed
concurrently with the establishment of technological feasibility. Software
development costs incurred after the establishment of technological feasibility
have not been material and, therefore, have been expensed as incurred.
Warranty
Upon shipment to its customers, the Company provides for the estimated cost
to repair or replace products to be returned under warranty. The Company's
warranty periods generally range from ninety days to five years from the date of
shipment. Effective August 1, 2003, the Company changed its warranty period to
two years on all products for Europe and one year for all other regions.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense was
approximately $336,000, $703,000, and $1.1 million for the years ended June 30,
2003, 2002 and 2001, respectively.
Comprehensive Income
SFAS No. 130, "Reporting Comprehensive Income" establishes standards for
reporting and displaying comprehensive income (loss), and its components in the
consolidated financial statements. Other accumulated comprehensive loss includes
foreign currency translation adjustments and unrealized losses on investments.
Segment Information
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" establishes standards for the way companies report information
about operating segments in annual financial statements. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. The Company has only one reportable segment, networking and
internet connectivity.
Reclassifications
Certain amounts in the 2002 and 2001 consolidated financial statements have
been reclassified to conform with current year presentation.
F-9
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
Recent Accounting Pronouncements
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN No. 45"). This statement requires
that a liability be recorded in the guarantor's balance sheet upon issuance of a
guarantee. In addition, FIN No. 45 requires disclosures about the guarantees
that an entity has issued. The Company did not have any outstanding guarantees
that were required to be recorded upon adoption of Fin No. 45. The Company's
product warranties, which are subject to the disclosure provisions of FIN No.
45, have been disclosed in the accompanying consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" ("SFAS No. 148"), which amends SFAS
No. 123. SFAS No. 148 amends the disclosure requirements in SFAS No. 123 for
stock-based compensation for annual periods ending after December 15, 2002 and
interim periods beginning after December 15, 2002. The disclosure requirements
apply to all companies, including those that continue to recognize stock-based
compensation under APB No. 25. Effective for financial statements for fiscal
years ending after December 15, 2002, SFAS No. 148 also provides three
alternative transition methods for companies that choose to adopt the fair value
measurement provisions of SFAS No. 123.
In January 2003 the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities ("FIN 46"). FIN 46 requires the primary beneficiary
of a variable interest entity ("VIE") to consolidate the entity and also
requires majority and significant variable interest investors to provide certain
disclosures. A VIE is an entity in which the equity investors do not have a
controlling interest, equity investors participate in losses or residual
interests of the entity on a basis that differs from its ownership interest, or
the equity investment at risk is insufficient to finance the entity's activities
without receiving additional subordinated financial support from the other
parties. For arrangements entered into with VIEs created prior to January 31,
2003, the provisions of FIN 46 are required to be adopted at the beginning of
the first interim or annual period beginning after June 15, 2003. The Company is
currently reviewing its investments and other arrangements to determine whether
any of its investee companies are VIEs. The Company does not expect to identify
any significant VIEs that would be consolidated, but may be required to make
additional disclosures.
2. BUSINESS COMBINATIONS
During fiscal year 2001, the Company completed the acquisitions of United
States Software Corporation ("USSC") and Lightwave Communications, Inc.
("Lightwave"). During fiscal year 2002, the Company completed the acquisitions
of Synergetic Micro Systems, Inc. ("Synergetic") and Premise Systems, Inc.
("Premise"). During fiscal year 2003, the Company completed the acquisition of
Stallion. These acquisitions have been accounted for under the purchase method
of accounting. The consolidated financial statements include the results of
operations of these acquisitions after their dates of acquisition. The
acquisition of USSC provides the Company with a software operating system,
protocol stacks and an application development environment for embedded
technology. The acquisition of Lightwave provides the Company with a higher end
console management product. The acquisition of Synergetic provides the Company
with high-performance embedded chips to complement its device networking
products. The acquisition of Premise and its SYS(TM) software suite complements
the Company's Device Networking products by providing management and control
capabilities for devices that have been network and Internet-enabled. The
acquisition of Stallion Technologies PTY, LTD ("Stallion") complements the
Company's existing multiport and terminal server product lines.
A summary of transactions accounted for using the purchase method of
accounting is outlined below:
F-10
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
SHARES
RESERVED TOTAL SHARES
DATE FOR OPTIONS ISSUED OR CASH
COMPANY ACQUIRED ACQUIRED BUSINESS SHARES ISSUED ASSUMED RESERVED CONSIDERATION
- ----------------------------- ------------------ ------------------- ------------- ------- ------------ --------------
Software solutions
USSC Dec. 2000 provider 653,846 133,333 787,179 $ 2.5 million
Developer of console
Lightwave Jun. 2001 management products 3,428,571 870,513 4,299,084 $ 12.0 million
Embedded network
Communications
Synergetic Oct. 2001 solutions provider 2,234,715 615,705 2,850,420 $ 2.7 million
Developer of client
side software
Premise Jan. 2002 applications 1,063,371 875,000 1,938,371 -
Provider of terminal
servers and multiport
Stallion Aug. 2002 products - - - $ 2.1 million
The share issuances were exempt from registration pursuant to section 4(2)
of the Securities Act of 1933, as amended. Portions of the cash consideration
and shares issued will be held in escrow pursuant to the terms of the
acquisition agreements.
The Premise agreement required the Company to issue 1,150,000 shares of
common stock in exchange for all remaining shares of Premise. Prior to the
acquisition, the Company held shares of Premise representing 19.9% ownership
and, in addition, held convertible promissory notes of $1.2 million with
interest accrued thereon at the rate of 9.0%. The convertible promissory notes
were converted into equity securities of Premise at the closing of the
transaction. The Company issued an aggregate of 1,063,371 shares of its common
stock in exchange for all remaining outstanding shares of Premise common stock
and reserved 875,000 additional shares of common stock for issuance upon
exercise of outstanding employee stock options and other rights of Premise.
The Stallion agreement required the Company to pay $1.2 million in cash
consideration and establish a cash escrow account in the amount of $867,000 at
the acquisition date to be used in lieu of the Company's common stock in the
event that the Company was unable to issue registered shares by October 31,
2002. In accordance with the terms of the acquisition agreement, the Company was
not able to issue registered shares by October 31, 2002; accordingly, the cash
escrow amount of $867,000 was released on November 1, 2002. In addition, the
Company issued a two-year note in the principal amount of $867,000, which is due
in August 2004 (note 7). The Company relied on the exemption in Section 4 (2) of
the Securities Act of 1933 in that the offering of the convertible note was not
a public offering.
Allocation of Purchase Consideration
For each of the five purchase transactions, the Company obtained
independent appraisals of the fair value of the tangible and intangible assets
acquired in order to allocate the purchase price. Based upon those appraisals,
the purchase price was allocated as follows (in thousands):
F-11
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
NET TANGIBLE
ASSETS
(LIABILITIES) PURCHASED DEFERRED DEFERRED TAX TOTAL
COMPANY ACQUIRED ACQUIRED GOODWILL INTANGIBLES COMPENSATION LIABILITIES IPR&D CONSIDERATION
- ---------------- ----------- ------------ ----------- ------------ ----------- ----------- -----------
USSC $ (12) $ 5,782 $ 3,084 $ 538 $ (1,117) $ 496 $ 8,771
Lightwave 340 37,243 10,500 3,474 (4,183) 2,100 49,474
Synergetic (233) 13,952 11,100 203 (5,213) -- 19,809
Premise (79) 6,593 3,700 -- (1,480) 1,000 9,734
Stallion (93) 2,270 1,500 -- (600) -- 3,077
The consideration for the purchase transactions was calculated as follows:
a) common shares issued were valued based upon the Company's stock price for a
short period just before and after the companies reached agreement and the
proposed transactions were announced and b) employee stock options were valued
in accordance with FIN 44. Net tangible assets acquired in connection with the
purchase transactions include the acquisition costs incurred by the Company.
Additionally, the net tangible assets of Lightwave and Synergetic reflect an
outstanding note payable and credit facility aggregating $6.7 million and
$626,000, respectively, which was paid in full by the Company in connection with
the terms of the merger agreements.
In-Process Research and Development
In-process research and development ("IPR&D") aggregated $496,000, $2.1
million and $1.0 million for the USSC, Lightwave and Premise purchase
transactions, respectively. No IPR&D charge was identified as part of the
Synergetic and Stallion valuations. The amount allocated to IPR&D was determined
through established valuation techniques in the high-technology industry and
were expensed upon acquisition as it was determined that the projects had not
reached technological feasibility and no alternative future uses existed.
The fair value of the IPR&D was determined using the income approach. Under
the income approach, the expected future cash flows from each project under
development are estimated and discounted to their net present value at an
appropriate risk-adjusted rate of return. Significant factors considered in the
calculation of the rate of return are the weighted-average cost of capital and
return on assets, as well as the risks inherent in the development process,
including the likelihood of achieving technological success and market
acceptance. Each project was analyzed to determine the unique technological
innovations, the existence and reliance upon core technology, the existence of
any alternative future use or current technological feasibility, and the
complexity, cost and time to complete the remaining development. Future cash
flows for each project were estimated based upon forecasted revenues and costs,
taking into account product life cycles, and market penetration and growth
rates.
The IPR&D charge includes only the fair value of IPR&D performed to date.
The fair value of existing technology is included in identifiable intangible
assets, and the fair values of IPR&D to be completed and future research and
development are included in goodwill. The Company believes the amounts recorded
as IPR&D, as well as developed technology, represent fair values and approximate
the amounts an independent party would pay for these projects.
As of the closing date of each purchase transaction, development projects
were in process. Research and development costs to bring the products from the
acquired companies to technological feasibility are not expected to have a
material impact on the Company's future consolidated financial position, results
of operations, or cash flows.
Unaudited Pro Forma Data
The pro forma statements of operations data of the Company set forth below
gives effect to the acquisitions of USSC, Lightwave, Synergetic, Premise and
Stallion as if they had occurred at the beginning of fiscal 2002. The following
unaudited pro forma statement of operations data includes the amortization of
purchased intangible assets and stock-based compensation. However, it excludes
the charge for acquired IPR&D. This pro forma data is presented for
informational purposes only and does not purport to be indicative of the results
of future operations of the Company or the results that would have actually
occurred had the acquisitions taken place at the beginning of fiscal 2002:
F-12
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
YEARS ENDED JUNE 30,
--------------------
2003 2002
--------- ---------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
Net revenues $ 49,832 $ 62,959
========= =========
Loss before cumulative effect of accounting changes $(47,565) $(93,484)
Cumulative effect of accounting changes:
Adoption of new accounting standard, SFAS No. 142 - (5,905)
--------- ---------
Net loss $(47,565) $(99,389)
========= =========
Loss before cumulative effect of accounting change per share $ (0.88) $ (1.82)
Cumulative effect of accounting changes per share:
Adoption of new accounting standard, SFAS No. 142 - (0.11)
--------- ---------
Basic and diluted net loss per share $ (0.88) $ (1.93)
========= =========
3. COMPONENTS OF BALANCE SHEET
Inventories
JUNE 30,
--------
2003 2002
-------- --------
(IN THOUSANDS)
Raw materials $ 5,109 $ 6,389
Finished goods 7,940 9,079
Inventory at distributors 959 1,031
-------- --------
14,008 16,499
Reserve for excess and obsolete inventory (7,997) (5,756)
-------- --------
$ 6,011 $10,743
======== ========
Property and Equipment
JUNE 30,
--------
2003 2002
-------- --------
(IN THOUSANDS)
Computer and office equipment $ 6,188 $ 8,381
Furniture and fixtures 987 1,776
Production and warehouse equipment 472 1,246
Transportation equipment 33 47
-------- --------
7,680 11,450
Accumulated depreciation (5,139) (6,411)
-------- --------
$ 2,541 $ 5,039
======== ========
Warranty Reserve:
JUNE 30,
--------
2003 2002
------------ ------
(IN THOUSANDS)
Beginning balance $ 479 $ 562
Charged to costs and expenses 878 220
Charged to other expense (153) -
Deductions (11) (303)
------------ ------
Ending balance $ 1,193 $ 479
============ ======
F-13
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
4. NOTES RECEIVABLE FROM OFFICERS AND OTHER OFFICER LOANS
NOTES RECEIVABLES FROM OFFICERS
The Company had outstanding notes receivable from officers of $0 and
$28,000 at June 30, 2003 and 2002, respectively (net of allowance of $249,000).
These notes are full-recourse, are secured by the shares of stock issued upon
exercise, are interest bearing at rates ranging from 5.06% to 7.50% per annum,
and are due three years from the exercise date. The Company also had outstanding
loans of $4.3 million at June 30, 2003 and 2002, primarily related to taxes on
exercised stock options. These notes are non-recourse, are secured by 2,573,394
shares of common stock, and are interest bearing at rates ranging from 5.19% to
7.50% per annum. Principal and any unpaid interest are due upon any transfer or
disposition of the common stock.
OTHER OFFICER LOANS
The Company had outstanding $104,000 (net of allowance of $4.2 million) at
June 30, 2003 and 2002. One of the noteholders is the former Chief Executive
Officer who assumed the role of Chief Technology and Strategy Officer of the
Company effective May 30, 2002 and resigned from the Company effective September
1, 2002. One of the noteholders is one of the Company's outside directors and
one of the noteholders is the former Chief Operating/Chief Financial Officer who
was terminated by the Company on May 3, 2002. The Company reduced the carrying
amount of the officer loans by $4.2 million by establishing a reserve for
uncertainties relative to collection of the related receivables. Factors
considered in determining the level of this reserve include the value of the
collateral securing the notes, the ability of the Company to effectively enforce
its collection rights and the ability of the former officers to honor their
obligations to the Company. As of June 30, 2003, no impairment has been recorded
as it relates to the note receivable from the outside director.
5. GOODWILL AND PURCHASED INTANGIBLE ASSETS
Goodwill
The changes in the carrying amount of goodwill is as follows (in
thousands):
YEARS ENDED
JUNE 30,
---------
2003 2002
-------- ---------
Balance as of July 1 $13,811 $ 42,273
Reclassification of certain identified intangibles, net of
related deferred tax liability of $2,229 in connection
with adoption of SFAS No. 142 at July 1, 2001 - 3,329
Goodwill acquired during the period 2,270 20,545
Impairment of goodwill in connection with adoption of
SFAS No. 142 at July 1, 2001 - (5,905)
Impairment of goodwill during the period (4,355) (46,431)
-------- ---------
Balance as of June 30 $11,726 $ 13,811
======== =========
Purchased Intangible Assets
The composition of purchased intangible assets is as follows (in
thousands):
JUNE 30, 2003 JUNE 30, 2002
------------- -------------
USEFUL ACCUMULATED ACCUMULATED
LIVES GROSS AMORTIZATION NET GROSS AMORTIZATION NET
---------- -------- -------------- ------- -------- -------------- -------
Existing technology 1-5 years $ 8,060 $ (3,094 ) $ 4,966 $12,720 $ (522 ) $12,198
Customer agreements 5 - - - 1,130 (143) 987
Patent/core technology 5 405 (283) 122 459 (212) 247
Tradename/trademark 5 32 (18) 14 532 (34) 498
Non-compete agreements 2-3 940 (648) 292 940 (189) 751
-------- -------------- ------- -------- -------------- -------
Total $ 9,437 $ (4,043) $ 5,394 $15,781 $ (1,100) $14,681
======= ============== ======= ======= ============== =======
F-14
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
The amortization expense for purchased intangible assets for the year ended
June 30, 2003 was $5.0 million, of which $4.0 million was amortized to cost of
revenues and $1.0 million was amortized to operating expenses. The estimated
amortization expenses for the next five years are as follows:
COST OF OPERATING
REVENUES EXPENSES TOTAL
--------- --------- ------
Fiscal year ending June 30:
2004 $ 2,330 $ 361 $2,691
2005 1,690 65 1,755
2006 816 2 818
2007 130 - 130
--------- --------- ------
Total $ 4,966 $ 428 $5,394
========= ========= ======
In acquisitions accounted for using the purchase method, goodwill is
recorded as the difference, if any, between the aggregate consideration paid for
an acquisition and the fair value of the net tangible and intangible assets
acquired. Prior to the adoption of SFAS No. 142, effective July 1, 2002,
goodwill was amortized on a straight-line basis over a seven year period.
Purchased intangible assets are amortized on a straight-line basis over periods
ranging from one to five years.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations,"
effective for acquisitions consummated after June 30, 2001, and SFAS No. 142,
"Goodwill and Other Intangible Assets" effective for fiscal years beginning
after December 15, 2001. Under the new rules, goodwill and certain intangible
assets deemed to have indefinite lives are no longer amortized but are subject
to annual impairment tests. Other intangible assets will continue to be
amortized over their useful lives.
The following table presents the impact of SFAS No. 142 on net loss and net
loss per share had SFAS No. 142 been in effect for the year ended June 30, 2001:
Net loss as reported . . . . . . . . . . . . . . $(7,845)
Adjustments:
Amortization of goodwill . . . . . . . . . . . . 752
--------
Net adjustments. . . . . . . . . . . . . . . . . 752
--------
Net loss as adjusted . . . . . . . . . . . . . . $(7,093)
========
Basic and diluted net loss per share-as reported $ (0.21)
========
Basic and diluted net loss per share-as adjusted $ (0.19)
========
In connection with the adoption of SFAS No. 142, the Company completed its
initial assessment and concluded that goodwill arising from the acquisition of
USSC, having a carrying value of approximately $5.9 million as of July 1, 2001,
may be impaired. The Company engaged an independent valuation company to perform
a review of the value of goodwill related to USSC. Based on the independent
valuation, which utilized a discounted cash flow valuation technique, the
Company recorded a $5.9 million charge for the impairment of the USSC goodwill.
This amount is reflected as the cumulative effect of adopting the new accounting
standard effective July 1, 2001.
F-15
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
The Company performed the first of the required annual impairment tests of
goodwill under the guidelines of SFAS No. 142 effective as of June 1, 2002. As a
result of industry conditions, lower market valuations and reduced estimates of
information technology capital equipment spending in the future, the Company
determined that there were indicators of impairment to the carrying value of
goodwill related to the acquisitions of Lightwave and Synergetic which had
carrying values of $39.7 million and $13.9 million, respectively, as of June 30,
2002. During the fourth quarter of fiscal 2002, the Company engaged an
independent valuation company to perform a review of the value of goodwill and
based on the independent valuation the Company recorded a $46.4 million
impairment charge on our goodwill of which $32.5 million related to Lightwave
and $13.9 million related to Synergetic.
Additionally, during the fourth quarter of 2002, the Company performed a
review of the value of its purchased intangible assets in accordance with SFAS
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets,"
("SFAS No. 144"). As a result of industry conditions, lower market valuations
and reduced estimates of information technology capital equipment spending in
the future, the Company determined that there were indicators of impairment to
the carrying value of its purchased intangible assets related to its
acquisitions. During the fourth quarter of fiscal 2002, the Company engaged an
independent valuation company to perform a review of the value of its purchased
intangible assets and based on the independent valuation the Company recorded a
$10.2 million impairment charge of which $969,000, $764,000, $7.6 million and
$849,000 related to USSC, Lightwave, Synergetic and Premise, respectively.
Additionally, the Company recorded an impairment charge of $665,000 related to
intellectual property not associated with an acquisition.
The Company performed its annual impairment tests under the guidelines of
SFAS No. 142 AS OF April 1, 2003. The Company compared the carrying value of
each reporting unit to its estimated fair value calculated with the assistance
of an independent valuation company. An impairment loss was recognized for
reporting units where the carrying value of their goodwill exceeded the implied
fair value of goodwill. Based on this assessment, the Company recorded a charge
of $4.4 million during the fourth quarter of fiscal 2003 to write down the value
of goodwill.
Additionally, during the fourth quarter of fiscal 2003, the Company
performed an assessment of the value of its purchased intangible assets in
accordance with SFAS No. 144. As a result of industry conditions, continued
lower market valuations, reduced estimates in information technology capital
equipment spending in the future and other factors impacting expected future
cash flows, the Company determined that there were indicators of impairment to
the carrying value of its purchased intangible assets recorded as part of its
acquisitions. The Company engaged an independent valuation company to perform a
review of the value of its purchased intangible assets. Based on the independent
valuations, the Company recorded during this fourth quarter of fiscal 2003 a
$6.3 million impairment charge of which $2.4 million and $3.9 million were
charged to operating expenses and cost of revenues, respectively.
The Company announced on May 30, 2002 that it had signed a new intellectual
property agreement with Gordian, Inc., the Company's provider of product designs
and engineering services. The agreement gives the Company joint ownership of the
Gordian intellectual property that is embodied in the products Gordian has
designed for the Company since 1989. The agreement provides that the Company
will be able to use the intellectual property to support, maintain and enhance
its products. The agreement extinguishes the Company's obligations to pay
royalties for each unit of a Gordian-designed product that it sells (Note 12).
F-16
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
The intellectual property agreement required the Company to pay Gordian
$6.0 million in order to acquire an interest in the Gordian intellectual
property, which will be paid in three installments. The Company paid $3.0
million concurrent with the signing of the agreement $2.0 million on July 1,
2002 and the remaining $1.0 million on July 1, 2003. The Company agreed to
purchase $1.5 million of engineering and support services from Gordian over the
next 18 months. The Company is amortizing the intellectual property rights over
the remaining life cycles of the products designed by Gordian, or approximately
three years. The Company recorded $2.5 million and $212,000 of amortization
expense included in cost of revenues for the years ended June 30, 2003 and 2002.
6. RESTRUCTURING CHARGES
On September 12, 2002, the Company announced a restructuring plan to
prioritize its initiatives around the growth areas of its business, focus on
profit contribution, reduce expenses, and improve operating efficiency. This
restructuring plan includes a worldwide workforce reduction, consolidation of
excess facilities and other charges. For the year ended June 30, 2003, the
Company recorded restructuring costs totaling $4.9 million, which are classified
as operating expenses in the Company's consolidated statement of operations.
Included in the restructuring plan was approximately $3.7 million for the
consolidation of excess facilities, relating primarily to lease terminations,
non-cancelable lease costs, write-off of leasehold improvements and termination
of a contractual obligation. Property, equipment and other assets that will be
disposed of or removed from operations consists primarily of computer software,
service and related equipment, production, office equipment and furniture and
fixtures. The restructuring plan resulted in the closing of the Milford,
Connecticut manufacturing operations, and Ames, Iowa and Singapore offices. The
restructuring action also resulted in the reduction of approximately 50 regular
employees worldwide. Through June 30, 2003, the Company incurred actual
workforce reduction charges of approximately $1.2 million related to severance
and fringe benefits for the terminated employees and approximately $1.5 million
related to consolidation of excess facilities. The restructuring costs will be
substantially paid in cash and the plan will be completed within one year of its
announcement.
On March 14, 2003, the Company announced a restructuring plan to further
consolidate its engineering and marketing operations. This restructuring plan
includes a workforce reduction, consolidation of excess facilities and other
charges at the Company's Hillsboro, Oregon, Naperville, Illinois and German
engineering facilities. The Company has recorded approximately $800,000 of
restructuring charges, which are classified as operating expenses in the
Company's consolidated statement of operations. Included in the restructuring
plan was approximately $700,000 relating primarily to lease terminations and
non-cancelable lease costs. The restructuring action also resulted in the
reduction of approximately 8 regular employees worldwide. The Company recorded
actual workforce reduction charges of approximately $120,000 related to
severance and fringe benefits for the terminated employees.
On February 6, 2002, the Company announced a restructuring plan to
prioritize its initiatives around the growth area of its business, focus on
profit contribution, reduce expenses, and improve operating efficiency. This
restructuring plan included a worldwide workforce reduction, consolidation of
excess facilities and other charges. As of June 30, 2002, the Company recorded
restructuring costs totaling $3.5 million. Through June 30, 2003, the February
2002 restructuring plan has resulted in the reduction of approximately 50
regular employees worldwide and the Company incurred actual workforce reduction
charges of approximately $1.9 million related to severance and fringe benefits.
Included in the workforce reduction charge was a non-cash stock-based
compensation charge in the amount of $595,000 associated with the modification
of stock options that were outstanding at the termination date. Property,
equipment and other assets that were disposed of or removed from operations
resulted in a charge of $1.6 million and consisted primarily of computer
software and related equipment, production, engineering and office equipment,
and furniture and fixtures.
A summary of the activity in the restructuring liability account is as
follows (in thousands):
CHARGES AGAINST RESERVE
-----------------------
RESTRUCTURING RESTRUCTURING
RESERVE AT ADDITIONAL RESERVE AT
JUNE 30, RESTRUCTURING JUNE 30,
2002 COSTS NON-CASH CASH 2003
------------- ------------- ---------- -------- -------------
Workforce reductions . . . . . . . $ 281 $1,284 $ - $(1,305) $ 260
Contractual obligations. . . . . . - 2,000 - - 2,000
Consolidation of excess facilities 126 2,427 (309) (1,269) 975
----- ------ ---------- -------- ------------
Total. . . . . . . . . . . . . . . $ 407 $5,711 $ (309) $(2,574) $ 3,235
===== ====== ========== ======== ============
F-17
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
7. BANK LINE OF CREDIT AND DEBT
In January 2002, the Company entered into a two-year line of credit with a
bank in an amount not to exceed $20.0 million. Borrowings under the line of
credit bear interest at either (i) the prime rate or (ii) the LIBOR rate plus
2.0%. The Company was required to pay a $100,000 facility fee of which $50,000
was paid upon the closing and $50,000 was to be paid. The Company is also
required to pay a quarterly unused line fee of .125% of the unused line of
credit balance. The line of credit contains customary affirmative and negative
covenants. Effective June 30, 2002, the Company amended its existing line of
credit reducing the revolving line to $12.0 million, removing the LIBOR rate
option and adjusting the customary affirmative and negative covenants. Effective
February 4, 2003, the Company amended its existing line of credit, reducing the
revolving line to $10.0 million, adjusting the interest to the prime rate plus
..50% and adjusted the customary affirmative and negative covenants. Effective
July 25, 2003, the Company amended its existing line of credit reducing the
revolving line to $5.0 million and adjusted affirmative and negative covenants.
The agreement has an annual revolving maturity date that renews on the effective
date. The remaining $50,000 facility fee was amended to $12,500 and was paid.
Prior to any advances being made under the line of credit, the bank is required
to complete a field examination of the Company to determine its borrowing base.
The Company is also required to maintain certain financial ratios as defined in
the agreement. To date, the Company has not borrowed against this line of
credit. The Company was not in compliance with the revised financial covenants
of the February 4, 2003 amended line of credit at June 30, 2003.
The Company issued a two-year note in the principal amount of $867,000 as a
result of its acquisition of Stallion (note 2) accruing interest at a rate of
2.5% per annum. Interest expense related to the note totaled approximately
$19,000 at June 30, 2003. No similar interest expense was recorded for the years
ended June 30, 2002 and 2001. The note is convertible into the Company's common
stock at any time, at the election of the holders, at a $5.00 conversion price.
The note is due in August 2004.
8. STOCKHOLDERS' EQUITY
Initial Public Offering
On August 4, 2000, the Company completed its initial public offering of
common stock. The Company sold 6,000,000 shares, at a price of $10.00 per share.
The Company received aggregate net proceeds from this offering of $53.7 million.
Secondary Public Offering
In July 2001, the Company completed a public offering of 8,534,000 shares
of its common stock, including an underwriter's over-allotment option to
purchase an additional 534,000 shares, at an offering price of $8.00 per share.
The Company sold 6,000,000 shares and selling stockholders sold 2,000,000 shares
of the primary offering. Additionally, the Company sold 400,500 shares and
selling stockholders sold 133,500 shares of the over-allotment option. The
Company received net proceeds of approximately $47.1 million in connection with
this offering.
Stock Split
The Company effected a 4-for-1 split of its common stock in the form of a
stock dividend, effective upon the filing of a re-incorporation in Delaware in
July 2000. All share numbers and per share amounts contained in these notes and
in the accompanying consolidated financial statements have been retroactively
restated to reflect these changes in the Company's capital structure.
Employee Stock Purchase Plan
In May 2000, the Board of Directors approved the 2000 Employee Stock
Purchase Plan (the "Purchase Plan") effective upon the completion of the initial
public offering. A total of 1,050,000 shares of common stock have been reserved
for issuance under the Purchase Plan. The number of shares available for
issuance pursuant to the Purchase Plan increases annually commencing in fiscal
year 2001. The Purchase Plan permits participants to purchase common stock at
six-month intervals through payroll deductions of up to 15% of the participant's
compensation, as defined. Amounts deducted and accumulated by the participants
are to be used to purchase shares of common stock at the end of each offering
period, as defined, at 85% of the lower of the fair market value of the common
stock at the beginning or end of the offering period. For the years ended June
30, 2003 and 2002, 406,205 and 178,687 shares were issued under the plan at an
average per share price of $0.69 and $2.45, respectively. At June 30, 2003,
465,108 shares were available for future issuances under this plan.
Reverse Stock Split
On November 12, 2002, the Company's shareholders approved a proposal to
effect a 3:1 reverse stock split of the Company's outstanding common stock (a
"Reverse Stock Split") and the authorized the Board of Directors to determine if
and when to effectuate a Reverse Stock Split. This authorization will expire in
November 2003.
Stock Option Plans
The Company has in effect several stock-based plans under which
non-qualified and incentive stock options have been granted to employees,
non-employees and board members.
The Board of Directors determines eligibility, vesting schedules and
exercise prices for options granted under the plans. Options generally have a
term of 10 years and vest and become exercisable, generally over a four-year
period.
Under the Company's 1993 Incentive Stock Option Plan (the "1993 Plan"), the
Company has reserved 4,000,000 shares of common stock for the granting of
options. Such options are to be granted at or above the fair market value of the
Company's common stock on the date of grant. All stock options are to vest over
a period determined by the Board of Directors (generally four years) and expire
F-18
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
not more than ten years from the date of grant. As of June 30, 2003, 1,360,902
options were available for grant under the 1993 Plan.
Under the Company's 1994 Nonstatutory Stock Option Plan (the "1994 Plan"),
the Company has reserved 10,000,000 shares of common stock for grant at prices
and vesting periods to be determined by the Company's Board of Directors. In
certain cases, the Company has granted options, which became fully vested on the
date granted. As of June 30, 2003, 7,275,976 options were available for grant
under the 1994 Plan.
Under the Company's 2000 Stock Plan (the "2000 Plan"), the Company has
reserved 6,000,000 shares of common stock for issuance pursuant to option
grants. The number of shares available for issuance increases by 2,000,000
shares annually commencing in calendar year 2002. Each outside director is
automatically granted an option to purchase 25,000 shares of common stock
annually, subject to certain eligibility requirements. As of June 30, 2003,
2,312,283 options were available for grant under the 2000 Plan.
As a result of the Company's acquisitions, the Company assumed stock
options granted under stock option plans established by each acquired company;
no additional options will be granted under those plans. As of June 30, 2003,
253,242 shares of common stock were reserved for issuance upon exercise of
outstanding options assumed under these stock option plans.
A summary of all stock option activity under the plans is as follows:
NUMBER OF WEIGHTED AVERAGE
OPTIONS EXERCISE PRICE
----------- ----------------
Outstanding at June 30, 2000 5,738,748 $ 1.35
Granted 2,482,436 4.94
Canceled (654,767) 2.10
Exercised (3,416,154) 0.40
-----------
Outstanding at June 30, 2001 4,150,263 4.17
Granted 4,179,668 5.12
Canceled (1,278,113) 5.49
Exercised (1,073,452) 1.51
-----------
Outstanding at June 30, 2002 5,978,366 5.14
Granted 1,985,360 0.67
Canceled (3,613,674) 6.42
Exercised (152,003) 0.24
-----------
Outstanding at June 30, 2003 4,198,049 $ 2.10
===========
Exercisable at June 30, 2001 1,206,839
===========
Exercisable at June 30, 2002 1,823,365
===========
Exercisable at June 30, 2003 2,338,610
===========
F-19
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
The weighted average exercise price of options outstanding and of options
exercisable as of June 30, 2003 were as follows:
OUTSTANDING EXERCISABLE
----------- -----------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
NUMBER OF REMAINING AVERAGE AVERAGE
OPTIONS CONTRACTUAL EXERCISE OPTIONS EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
- ------------------------- ----------- ------------ ------ ----------- ------
0 to $0.29 1,094,461 8.13 $ 0.47 602,818 $ 0.45
0.55 to $1.00 1,133,655 9.36 0.75 344,935 0.75
1.01 to $2.59 1,052,909 6.74 2.21 666,914 2.23
4.00 to $5.89 510,140 4.60 5.07 419,478 5.11
6.00 to $14.00 406,884 5.69 6.28 304,465 6.22
At June 30, 2003, 15,865,560 shares of the Company's common stock are
reserved for issuance pursuant to the employee stock purchase and stock option
plans. Certain of the Company's employees hold options that were assumed by the
Company in connection with its acquisitions of the businesses that previously
employed those individuals; in the business combinations that have been
accounted for as purchases, the Company has recorded deferred compensation with
respect to those options. Additionally, the Company granted stock options to
employees where the option exercise price is less that the estimated fair value
of the underlying shares of common stock as determined for financial reporting
purposes, as well as the fair market value of the vested portion of non-employee
stock options utilizing the Black-Scholes option pricing model. The Company has
recorded net deferred compensation forfeitures of $2.5 million and $1.9 million,
for the years ended June 30, 2003 and 2002 respectively.
The Company is amortizing the deferred compensation over the shorter of the
period in which the employee provides services or the applicable vesting period,
which is generally four years. For the years ended June 30, 2003, 2002 and 2001,
stock-based compensation was approximately $1.5 million, $3.6 million and $3.1
million, respectively. The amount of stock-based compensation in future periods
will increase if we grant stock options where the exercise price is less than
the quoted market price of the underlying shares or if we assume employee stock
options in connection with additional acquisitions of businesses. Deferred
compensation is decreased in the period of forfeiture arising from the early
termination of an option holder's services. No compensation expense related to
stock options that existed for any other period has been recorded. The weighted
average grant date fair value of options granted during the years ended June 30,
2003, 2002 and 2001 was $0.67, $5.12 and $7.32, respectively. The weighted
average grant date fair value of in the money options granted during the years
ended June 30, 2003, 2002 and 2001 was $0.65, $6.77 and $8.48, respectively. The
weighted average exercise price of in the money options granted during the years
ended June 30, 2003, 2002 and 2001 was $0.50, $3.26 and $3.17, respectively.
Stock Option Exchange Offer
On January 24, 2003, the Company completed an offering to employees whereby
employees holding options to purchase the Company's common stock with exercise
prices at or above $3.01 per share were given the opportunity to cancel certain
of their existing options in exchange for the opportunity to receive new options
to purchase the Company's common stock. Each new option shall represent 0.75 of
the underlying shares of the options cancelled. Approximately 1,378,124 options
with a weighted average exercise price of $9.01 were tendered. On January 27,
2003, those options were cancelled by the Company. The new options will not be
granted until at least six months and one day after acceptance of the old
options for exchange and cancellation and will only be granted to those exchange
participants who remain employees at the time of the new grant. The exercise
price of the new options will be the last reported trading price of the
Company's common stock on the grant date. On July 28, 2003, the Company granted
replacement options to purchase 1,033,593 shares of its common stock to
employees who tendered options under the stock option exchange offer, at an
exercise price of $0.81 per share.
F-20
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
9. 401(K) PLAN
The Company has a savings plan (the "Plan") which is qualified under
Section 401(k) of the Internal Revenue Code. Eligible employees may elect to
make contributions to the Plan through salary deferrals up to 15% of their base
pay, subject to limitations. The Company's contributions are discretionary and
are subject to limitations. For the years ended June 30, 2003, 2002 and 2001,
the Company contributed $0.50 for each $1.00 of employee salary deferral
contributions up to a maximum of 6% of the employee's annual gross wages,
subject to limitations. Selling, general and administrative expenses include
contributions of approximately $192,000, $202,000 and $126,000 for the years
ended June 30, 2003, 2002 and 2001, respectively.
F-21
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
10. LITIGATION SETTLEMENTS
Premise Settlement
On January 20, 2003, the Company entered into a Compromise Settlement and
Mutual Release Agreement with Premise. In exchange for a complete release of all
claims relating to the acquisition of Premise and the termination of certain of
the Company's obligations under an Investor Rights Agreement, the Company agreed
to issue to the former shareholders of Premise ("Premise Holders") an aggregate
of 1,063,372 unregistersted shares of its Common Stock. These shares were issued
pursuant to Rule 4(2) of the Securities Act of 1933, as amended. In addition to
these shares, the Company accelerated the vesting of options held by certain
Premise Holders and released to the Premise Holders all shares of the Company's
Common Stock being held in escrow. This settlement aggregating $1.1 million for
the year ended June 30, 2003, has been recognized as litigation settlement costs
in the consolidated statement of operations.
Lightwave Settlement
The Company received an informal notice from several holders of the
Company's unregistered shares of common stock that were issued in connection
with the acquisition of Lightwave. The shares were issued to the holders in a
private transaction not registered under the Securities Act of 1933, and
therefore could not be sold by the stockholders without a valid registration
statement. The stockholders alleged that the Company failed to honor their
rights to have the shares registered and that they were therefore precluded from
selling the shares. Effective July 26, 2002, the Company settled with the
stockholders of Lightwave in the amount of $2.0 million in exchange for 240,000
shares of the Company's common stock held in escrow and 208,335 additional
shares issued to the former owners of Lightwave on the acquisition date. This
settlement resulted in a net charge to the Company's results of operations of
approximately $1.9 million for the year ended June 30, 2002 and has been
recognized as litigation settlement costs.
Securities Claims and Employment Claims Brought by the Co-Founders of
United States Software Corporation
On August 23, 2002, a complaint entitled Dunstan v. Lantronix, Inc., et
al., was filed in the Circuit Court of the State of Oregon, County of Multnomah,
against the Company and certain of its current and former officers and directors
by the co-founders of USSC. The complaint alleged Oregon state law claims for
securities violations, fraud, and negligence. The original complaint sought not
less than $3.6 million in damages, interest, attorneys' fees, costs, expenses,
and an unspecified amount of punitive damages. The Company moved to compel
arbitration in November 2002, and in a ruling dated February 9, 2003, the court
ordered the matter stayed pending arbitration of all claims. The Company filed
an arbitration demand on or about February 21, 2003 which included additional
claims related to the Company's acquisition of USSC. The arbitration demand
sought more than $14.0 million in damages and an unspecified amount in
attorneys' fees, costs, expenses, and punitive damages. The parties participated
in a mediation on June 30, 2003, and subsequently reached an agreement to settle
the dispute. The agreement called for the Company to release to the plaintiffs
approximately $400,000 in cash and 49,038 shares of the Company's common stock
that had been held in an escrow since December 2000 as part of the acquisition
of USSC. The agreement also called for the Company to issue to the plaintiffs
additional shares of its common stock worth approximately $1.5 million, which
was recorded in the Company's results of operations as litigation settlement
costs for the year ended June 30, 2003. Accordingly, 1,726,703 shares were
issued following a fairness determination by the state court in Oregon. In
exchange, the plaintiffs released all claims against all defendants.
11. INCOME TAXES
The income tax provision (benefit) is comprised of the following:
YEARS ENDED JUNE 30,
--------------------
2003 2002 2001
----- -------- --------
(IN THOUSANDS)
Current:
Federal $ 18 $(1,423) $ 140
State 100 - (6)
Foreign 132 352 222
----- -------- --------
Total current 250 (1,071) 356
Deferred:
Federal - (4,127) (2,091)
State - (1,467) (338)
Foreign - - 21
----- -------- --------
Total deferred - (5,594) (2,408)
Less: deferred taxes allocated to cumulative
effect of accounting changes - - 176
----- -------- --------
Total income tax provision (benefit) for loss
before cumulative effect of accounting changes $ 250 $(6,665) $(1,876)
===== ======== ========
F-22
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
The tax effects of temporary differences that give rise to deferred tax assets
and liabilities are as follows:
JUNE 30,
--------
2003 2002
--------- ---------
(IN THOUSANDS)
Deferred tax assets:
Reserves not currently deductible $ 4,790 $ 4,275
Inventory capitalization 3,680 1,899
Depreciation - 118
Tax losses and credits 27,460 14,887
--------- ---------
35,930 21,179
Valuation allowance (33,075) (14,093)
--------- ---------
Total deferred tax assets 2,855 7,086
--------- ---------
Deferred tax liabilities:
State taxes (467) (786)
Identified intangibles (644) (3,835)
Depreciation (671) -
Deferred compensation (1,673) (2,465)
--------- ---------
Total deferred tax liabilities (3,455) (7,086)
--------- ---------
Net deferred tax assets (liabilities) $ (600) $ -
========= =========
F-23
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
A reconciliation of the income tax provision (benefit) for loss before
cumulative effect of accounting changes to taxes computed at the U.S. federal
statutory rate is as follows:
YEARS ENDED JUNE 30,
--------------------
2003 2002 2001
--------- --------- --------
(IN THOUSANDS)
Federal income tax (benefit) at statutory rate $(16,082) $(32,065) $(3,102)
State taxes (net of federal tax benefit) 66 (968) (228)
Non deductible goodwill 1,481 16,176 -
Change in valuation allowance 14,604 8,727 -
Permanent differences 10 403 (43)
Research and development credit (596) (399) (263)
Foreign tax rate variances 963 248 770
Deferred compensation 337 250 156
Acquisition expenses - - 834
In process technology - 340 -
Other (533) 623 -
--------- --------- --------
$ 250 $ (6,665) $(1,876)
========= ========= ========
As of June 30, 2003, the Company has net operating loss carryovers of $61.0
million and $35.7 million for federal and California income tax purposes,
respectively. The federal and California net operating loss carryovers begin to
expire in years 2021 and 2013, respectively.
Approximately $2.3 million of the net operating loss carryforwards resulted
from the Company's acquisition of Synergetic (Note 2). For financial reporting
purposes, a valuation allowance of approximately $773,000 has been recognized to
offset the deferred tax asset related to those carryforwards. If or when
realized, the tax benefit for those items will be applied to reduce goodwill
related to the acquisition of Synergetic.
In addition, the Company has research and development tax credit
carryforwards of $2.2 million and $1.5 million for federal and California
purposes, respectively. Federal tax credits begin to expire in 2020. California
tax credits have no expiration.
During the year ended June 30, 2003, pursuant to the Company's purchase of
Stallion, pretax book income reflects the amortization of goodwill and other
intangibles. The tax effect of intangibles, other than goodwill, increased
deferred liabilities by approximately $600,000.
The Company has recorded a valuation allowance against its net deferred tax
assets of $33.0 million. If or when realized, the tax benefits relating to, and
the reversal of, approximately $3.1 million of the valuation allowance will be
accounted for as an increase in additional paid-in capital. The valuation
allowance was established due to uncertainties surrounding the realization of
the deferred tax assets.
Due to the "change of ownership" provision of the Tax Reform Act of 1986,
utilization of the Company's net operating loss carryforwards may be subject to
an annual limitation against taxable income in future periods. As a result of
the annual limitation, a portion of these carryforwards may expire before
ultimately becoming available to reduce future income tax liabilities.
On September 11, 2002, the Governor of California signed into law new tax
legislation that suspends the use of net operating loss carryforwards into tax
years beginning on or after January 1, 2002 and 2003. Should the Company have
taxable income for the year ending June 30, 2003, it may not look to California
net operating losses generated in prior years to offset taxable income. This
suspension will not apply to tax years ending in 2004 and beyond.
12. COMMITMENTS AND CONTINGENCIES
Leases
The Company leases office equipment and its office and warehouse facilities
under noncancelable operating leases. In July 2000, the Company renewed its
office and warehouse facility lease in Irvine, California commencing in August
2000 and expiring in July 2005.
The following schedule represents minimum lease payments for all
noncancelable-operating leases as of June 30, 2003.
Fiscal year ending June 30 (in thousands):
2004 . . . . . . . . . . . . $1,711
2005 . . . . . . . . . . . . 1,348
2006 . . . . . . . . . . . . 493
2007 . . . . . . . . . . . . 336
2008 . . . . . . . . . . . . 202
------
Total minimum lease payments $4,090
======
Rent expense, including month-to-month rentals, totaled approximately $1.9
million, $2.0 million and $1.2 million for the years ended June 30, 2003, 2002
and 2001, respectively. Sublease income totaled approximately $119,000 for the
year ended June 30, 2001.
F-24
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
Royalties
The Company has historically outsourced a substantial portion of its
engineering and production development activities under contract. Certain
development contracts contain royalty provisions based upon sales and/or margin
activity of the underlying products. Approximately $1.2 million and $2.2 million
is included in cost of sales in the accompanying consolidated statements of
operations for the years ended June 30, 2002 and 2001, respectively, relating to
royalties paid on applicable product sales. As of June 30, 2002, accrued
royalties were approximately $113,000, and are included in other current
liabilities in the accompanying consolidated balance sheets. During the year
ended June 30, 2003 no accrued royalties or royalty expense was recorded.
The Company announced on May 30, 2002, that it had signed a new
intellectual property agreement with Gordian. The agreement extinguishes the
Company's obligation to pay royalties for each unit of a Gordian designed
product that it sells (Note 5).
Marketing Rights
Pursuant to an agreement dated September 27, 1998, the Company purchased
marketing rights from an individual which allows the Company to sell products in
certain geographical regions. Per the terms of the agreement, the Company paid
$1,694,000 for the marketing rights. Additionally, the Company paid a sales
commission to the same individual for sales of certain products made to various
customers through December 31, 2000. The initial payment was amortized over a
period of 27 months. The commission payments are expensed in the period of the
related product sale. Commissions paid and amortization of marketing rights for
the year ended June 30, 2001 were $697,000. For the years ended June 30, 2003
and 2002, there were no commissions paid or amortization recorded related to the
agreement.
13. LITIGATION
Government Investigation
The Securities and Exchange Commission ("SEC") is conducting a formal
investigation of the events leading up to the Company's restatement of its
financial statements on June 25, 2002. The Department of Justice is also
conducting an investigation concerning events related to the restatement.
Class Action Lawsuits
On May 15, 2002, Stephen Bachman filed a class action complaint entitled
Bachman v. Lantronix, Inc., et al., No. 02-3899, in the U.S. District Court for
the Central District of California against the Company and certain of its
current and former officers and directors alleging violations of the Securities
Exchange Act of 1934 and seeking unspecified damages. Subsequently, six similar
actions were filed in the same court. Each of the complaints purports to be a
class action lawsuit brought on behalf of persons who purchased or otherwise
acquired the Company's common stock during the period of April 25, 2001 through
May 30, 2002, inclusive. The complaints allege that the defendants caused the
Company to improperly recognize revenue and make false and misleading statements
about its business. Plaintiffs further allege that the defendants materially
overstated the Company's reported financial results, thereby inflating its stock
price during its securities offering in July 2001, as well as facilitating the
use of its common stock as consideration in acquisitions. The complaints have
subsequently been consolidated into a single action and the court has appointed
a lead plaintiff. The lead plaintiff filed a consolidated amended complaint on
January 17, 2003. The amended complaint now purports to be a class action
brought on behalf of persons who purchased or otherwise acquired the Company's
common stock during the period of August 4, 2000 through May 30, 2002,
inclusive. The amended complaint continues to assert that the Company and the
individual officer and director defendants violated the 1934 Act, and also
includes alleged claims that the Company and its officers and directors violated
the Securities Act of 1933 arising from the Company's Initial Public Offering in
August 2000. The Company has filed a motion to dismiss the additional
allegations on March 3, 2003. The Court has taken the motion under submission.
The Company has not yet answered, discovery has not commenced, and no trial date
has been established.
F-25
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
Derivative Lawsuit
On July 26, 2002, Samuel Ivy filed a shareholder derivative complaint
entitled Ivy v. Bernhard Bruscha, et al., No. 02CC00209, in the Superior Court
of the State of California, County of Orange, against certain of the Company's
current and former officers and directors. On January 7, 2003, the plaintiff
filed an amended complaint. The amended complaint alleges causes of action for
breach of fiduciary duty, abuse of control, gross mismanagement, unjust
enrichment, and improper insider stock sales. The complaint seeks unspecified
damages against the individual defendants on the Company's behalf, equitable
relief, and attorneys' fees.
The Company filed a demurrer/motion to dismiss the amended complaint on
February 13, 2003. The basis of the demurrer is that the plaintiff does not have
standing to bring this lawsuit since plaintiff has never served a demand on the
Company's Board that the Board take certain actions on behalf of the Company. On
April 17, 2003, the Court overruled the Company's demurrer. Discovery has
commenced, but no trial date has been established.
Employment Suit Brought by Former Chief Financial Officer and Chief
Operating Officer Steve Cotton
On September 6, 2002, Steve Cotton, our former CFO and COO, filed a
complaint entitled Cotton v. Lantronix, Inc., et al., No. 02CC14308, in the
Superior Court of the State of California, County of Orange. The complaint
alleges claims for breach of contract, breach of the covenant of good faith and
fair dealing, wrongful termination, misrepresentation, and defamation. The
complaint seeks unspecified damages, declaratory relief, attorneys' fees and
costs. Discovery has not commenced and no trial date has been established.
The Company filed a motion to dismiss on October 16, 2002, on the grounds
that Mr. Cotton's complaints are subject to the binding arbitration provisions
in Mr. Cotton's employment agreement. On January 13, 2003, the Court ruled that
five of the six counts in Mr. Cotton's complaint are subject to binding
arbitration. The court is staying the sixth count, for declaratory relief, until
the underlying facts are resolved in arbitration. No arbitration date has been
set.
Securities Claims Brought by Former Shareholders of Synergetic Micro
Systems, Inc. ("Synergetic")
On October 17, 2002, Richard Goldstein and several other former
shareholders of Synergetic filed a complaint entitled Goldstein, et al v.
Lantronix, Inc., et al in the Superior Court of the State of California, County
of Orange, against the Company and certain of its former officers and directors.
Plaintiffs filed an amended complaint on January 7, 2003. The amended complaint
alleges fraud, negligent misrepresentation, breach of warranties and covenants,
breach of contract and negligence, all stemming from its acquisition of
Synergetic. The complaint seeks an unspecified amount of damages, interest,
attorneys' fees, costs, expenses, and an unspecified amount of punitive damages.
On May 5, 2003, the Company answered the complaint and generally denied the
allegations in the complaint. Discovery has not yet commenced and no trial date
has been established.
Suit filed by Lantronix Against Logical Solutions, Inc. ("Logical")
On March 25, 2003, the Company filed in Connecticut state court (Judicial
District of New Haven) a complaint entitled Lantronix, Inc. and Lightwave
Communications, Inc. v Logical Solutions, Inc., et. al. This is an action for
unfair and deceptive trade practices, unfair competition, unjust enrichment,
conversion, misappropriation of trade secrets and tortuous interference with
contractual rights and business expectancies. The Company seeks preliminary and
permanent injunctive relief and damages. The individual defendants are all
former employees of Lightwave Communications, a company that the Company
acquired in June 2001. The suit is pending trial.
F-26
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
JUNE 30, 2003
Other
From time to time, the Company is subject to other legal proceedings and
claims in the ordinary course of business. The Company is currently not aware of
any such legal proceedings or claims that it believes will have, individually or
in the aggregate, a material adverse effect on its business, prospects,
financial position, operating results or cash flows.
The pending lawsuits involve complex questions of fact and law and likely
will continue to require the expenditure of significant funds and the diversion
of other resources to defend. Management is unable to determine the outcome of
its outstanding legal proceedings, claims and litigation involving the Company,
its subsidiaries, directors and officers and cannot determine the extent to
which these results may have a material adverse effect on the Company's
business, results of operations and financial condition taken as a whole. The
results of litigation are inherently uncertain, and adverse outcomes are
possible. The Company is unable to estimate the range of possible loss from
outstanding litigation, and no amounts have been provided fur such matters in
the consolidated financial statements.
14. GEOGRAPHIC AND SIGNIFICANT CUSTOMER INFORMATION
Revenue by Geographic Area
Net revenue by geographic area is provided below:
YEAR ENDED JUNE 30,
-------------------
2003 2002 2001
-------------- ------------- -------------
(AMOUNTS IN THOUSANDS)
Americas $37,511 76% $47,748 83% $33,143 68%
Europe 10,366 21% 8,247 14% 13,938 28%
Other 1,632 3% 1,651 3% 1,891 4%
------- ----- ------- ---- ------- ----
Total net revenues $49,509 100% $57,646 100% $48,972 100%
======= ===== ======= ==== ======= ====
Accounts receivable attributable to international sales represented
approximately 22% and 33% of total accounts receivable at June 30, 2003 and
2002, respectively.
Significant Customer Information
One customer, Ingram Micro, Inc., accounted for approximately 11%, 12% and
14% of the Company's net revenues for the years ended June 30, 2003, 2002 and
2001, respectively. Another customer, Tech Data Corporation, accounted for
approximately 10%, 11% and 10% of the Company's net revenues for the years ended
June 30, 2003, 2002 and 2001, respectively. Accounts receivable attributable to
these two domestic customers accounted for approximately 16% and 21% of total
accounts receivable at June 30, 2003 and 2002, respectively.
One international customer, a related party due to common ownership by the
Company's major stockholder, accounted for approximately 4%, 5% and 9% of the
Company's net revenues for the years ended June 30, 2003, 2002 and 2001,
respectively. Included in the accompanying consolidated balance sheets is
approximately $246,000 due to this related party at June 30, 2002. No amount was
due to or from this related party at June 30, 2003. The Company also had an
agreement with the same related international customer for the provision of
technical support services to the Company at the rate of $7,500 per month, which
has now been terminated. Included in selling, general and administrative
expenses are $90,000 for each of the years ended June 30, 2002 and 2001, for
these support services, respectively. No amounts were incurred for the year
ended June 30, 2003.
15. QUARTERLY FINANCIAL DATA (UNAUDITED)
Set forth below is summarized unaudited quarterly data for fiscal 2003 and
fiscal 2002:
LOSS BEFORE
CUMULATIVE EFFECT OF
ACCOUNTING CHANGE NET LOSS
----------------- --------------
GROSS DILUTED DILUTED
NET REVENUES PROFIT (LOSS) AMOUNT PER SHARE AMOUNT PER SHARE
------------- -------------- --------- ----------- --------- -----------
(In thousands, except per share data)
Fiscal 2003
First quarter $ 12,681 $ 4,485 $(11,402) $ (0.21) $(11,402)(1) $ (0.21)
Second quarter 12,658 4,971 (7,122) (0.13) (7,122) (0.13)
Third quarter 12,362 2,992 (9,921) (0.18) (9,921)(2) (0.18)
Fourth quarter 11,808 (542) (19,104) (0.33) (19,104)(3) (0.33)
------------- -------------- --------- ----------- --------- -----------
Total $ 49,509 $ 11,906 $(47,549) $ (0.88)* $(47,549) $ (0.88)*
============= ============== ========= =========== ========= ===========
Fiscal 2002
First quarter $ 15,831 $ 8,292 $ (2,278) $ (0.05) $ (8,183) $ (0.17)
Second quarter 15,726 8,188 (1,917) (0.04) (1,917) (0.04)
Third quarter 14,580 4,206 (8,730) (0.16) (8,730)(4) (0.16)
Fourth quarter 11,509 (3,550) (74,627) (1.39) (74,627)(5) (1.39)
------------- -------------- --------- ----------- --------- -----------
Totals $ 57,646 $ 17,136 $(87,552) $ (1.70)* $(93,457) $ (1.82)*
============= ============== ========= =========== ========= ===========
* Annual per share amounts may not agree to the sum of the quarterly per
share amounts due to differences between average shares outstanding during
the periods.
(1) Includes restructuring charges of $4,929.
(2) Includes litigation settlement costs of $1,075 and restructuring charges of
$120.
(3) Includes impairment of goodwill and purchased intangible assets of $10,637,
litigation settlement costs of $1,532 and restructuring charges of $662.
(4) Includes restructuring charges of $2,810.
(5) Includes impairment of goodwill and purchased intangible assets of $57,276,
litigation settlement costs of $1,912, restructuring charges of $663 and
in-process research and development costs of $1,000.
F-27
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
The following Exhibits are attached hereto and incorporated herein by
reference.
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- --------- ----------------------------------------------------------------------
3.1* Certificate of Incorporation of registrant.
3.4 Bylaws of the registrant as amended on October 1, 2002.
4.1** Form of registrant's common stock certificate.
10.1** Form of Indemnification Agreement entered into by registrant
with each of its directors and executive officers.
10.2**++ 1993 Stock Option Plan and forms of agreements thereunder.
10.3**++ 1994 Nonstatutory Stock Option Plan and forms of agreements thereunder.
10.4***++ 2000 Stock Plan and forms of agreements thereunder.
10.5**++ 2000 Employee Stock Purchase Plan.
10.6** Form of Warranty.
10.7* Employment Agreement between registrant and Frederick Thiel.
10.8* Employment Agreement between registrant and Steven Cotton.
10.9* Employment Agreement between registrant and Johannes Rietschel.
10.10** Lease Agreement between registrant and The Irvine Company.
10.11** Loan and Security Agreement between registrant and Silicon Valley Bank.
10.12+** Research and Development Agreement between registrant and Gordian.
10.13+** Distributor Contract between registrant and Tech Data Corporation.
10.14+** Distributor Contract between registrant and Ingram Micro Inc.
10.15***** Offer to Exchange Outstanding Options, dated December 19, 2002.
21.1**** Subsidiaries of registrant.
23.1 Consent of Independent Auditors.
24.1 Power of Attorney (see page II-2).
31.1 Certification of Principal Executive Officer, filed herewith.
31.2 Certification of Principal Financial Officer, filed herewith.
32.1 Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, furnished herewith.
* Incorporated by reference to the same numbered exhibit previously filed
with Lantronix's Registration Statement on Form S-1 (SEC file no.
333-37508) originally filed May 19, 2000.
** Incorporated by reference to the same numbered exhibit previously filed
with Lantronix's Registration Statement on Form S-1, Amendment No. 1, (SEC
file no. 333-37508) originally filed June 13, 2000.
*** Incorporated by reference to the same numbered exhibit previously filed
with Lantronix's Registration Statement on Form S-1, Amendment No. 1, (SEC
file no. 333-63030) originally filed June 14, 2001.
**** Incorporated by reference to the same numbered exhibit previously filed
with Lantronix's Annual Report on Form 10-K, originally filed September 28,
2001.
***** Incorporated by reference to Exhibit 99(a)(1) to the Schedule TO filed
with the Securities and Exchange Commission on December 19, 2002.
+ Confidential treatment has previously been granted by the SEC for certain
portions of the referenced exhibit pursuant to Rule 406.
++ Designates management contract or compensatory plan arrangements required
to be filed as an exhibit of this Annual Report on Form 10-K pursuant to
Item 15(c).
FINANCIAL STATEMENT SCHEDULES
(1) Report of Independent Auditors on Financial Statement Schedule S-1
(2) Schedule II-Valuation and Qualifying Accounts S-2
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended,
Lantronix has duly caused this Registration Statement on Form 10-K to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Irvine, State of California, on the 29th day of September, 2003.
LANTRONIX, INC.
By: /s/ JAMES W. KERRIGAN
--------------------------
JAMES W. KERRIGAN
CHIEF FINANCIAL OFFICER
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints James Kerrigan, his attorney-in-fact,
with the power of substitution, for him and in his name, place and stead, in any
and all capacities, to sign any and all amendments to this Form 10-K and to file
the same, with all exhibits thereto in all documents in connection therewith,
with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents or any of them, or his or their substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, as amended,
this report on Form 10-K has been signed by the following persons in the
capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ H. K. DESAI Chairman of the Board 9/29/03
- ------------------------
H. K. DESAI
/s/ MARC NUSSBAUM Chief Executive Officer, 9/29/03
- ------------------------ President (Principal Executive Officer)
MARC NUSSBAUM
/s/ JAMES KERRIGAN Chief Financial Officer 9/29/03
- ------------------------
JAMES KERRIGAN (Principal Financial and Accounting Officer)
/s/ THOMAS W. BURTON Director 9/29/03
- ------------------------
THOMAS W. BURTON
/s/ HOWARD T. SLAYEN Director 9/29/03
- ------------------------
HOWARD T. SLAYEN
/s/ KATHERINE B. LEWIS Director 9/29/03
- --------------------------
KATHERINE B. LEWIS