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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to ___________.
Commission file number: 1-16027
__________
LANTRONIX, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0362767
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
15353 Barranca Parkway Irvine, California 92618
(Address of principal executive offices and zip code)
__________
(949) 453-3990
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(D) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of October 31, 2002, 54,281,061 shares of the Registrant's common stock
were outstanding.
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1
LANTRONIX, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION 3
Item 1. Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Condensed Consolidated Balance Sheets at September 30, 2002 (unaudited) and June 30, 2002 3
Unaudited Condensed Consolidated Statements of Operations for the Three Months Ended
September 30, 2002 and 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended
September 30, 2002 and 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Notes to Unaudited Condensed Consolidated Financial Statements . . . . . . . . . . . . . . 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. . . 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk . . . . . . . . . . . . . . . . 27
Item 4. Controls and Procedures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
PART II. OTHER INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Item 2. Changes in Securities and Use of Proceeds. . . . . . . . . . . . . . . . . . . . . . . . . 30
Item 3. Defaults Upon Senior Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . . . . . . . . . . . . . . 31
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LANTRONIX, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30, JUNE 30, 2002
2002
--------------- ---------------
(UNAUDITED)
ASSETS
- ------------------------------------------
Current assets:
Cash and cash equivalents . . . . . . . . $ 11,121 $ 26,491
Marketable securities . . . . . . . . . 13,248 6,963
Accounts receivable, net . . . . . . . . . 5,318 6,172
Inventories . . . . . . . . . . . . . . . 11,192 10,743
Deferred income taxes . . . . . . . . . . 5,205 5,205
Prepaid expenses and other current assets. 3,846 5,299
--------------- ---------------
Total current assets . . . . . . . . . . . 49,930 60,873
Property and equipment, net. . . . . . . . 4,639 5,039
Goodwill, net. . . . . . . . . . . . . . . 16,949 13,811
Purchased intangible assets, net . . . . . 13,425 14,681
Long-term investments. . . . . . . . . . . 6,432 6,761
Officer loans. . . . . . . . . . . . . . . 104 104
Other assets . . . . . . . . . . . . . . . 2,625 2,543
--------------- ---------------
Total assets . . . . . . . . . . . . . . . $ 94,104 $ 103,812
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------------
Current liabilities:
Accounts payable . . . . . . . . . . . . . $ 4,496 $ 4,607
Due to related party . . . . . . . . . . . - 246
Accrued payroll and related expenses . . . 1,556 1,530
Due to Gordian . . . . . . . . . . . . . . 1,000 2,000
Accrued Lightwave settlement . . . . . . . - 2,004
Restructure reserve. . . . . . . . . . . . 4,881 407
Other current liabilities. . . . . . . . . 4,848 4,656
--------------- ---------------
Total current liabilities. . . . . . . . . 16,781 15,450
Deferred income taxes. . . . . . . . . . . 5,205 5,205
Due to Gordian . . . . . . . . . . . . . . - 1,000
Convertible note payable . . . . . . . . . 867 -
Stockholders' equity:
Common stock . . . . . . . . . . . . . . . 5 5
Additional paid-in capital . . . . . . . . 177,815 179,547
Employee notes receivable . . . . . . . . (28) (28)
Deferred compensation. . . . . . . . . . . (2,341) (4,546)
Accumulated deficit. . . . . . . . . . . . (104,277) (92,875)
Accumulated other comprehensive loss . . . 77 54
--------------- ---------------
Total stockholders' equity . . . . . . . . 71,251 82,157
--------------- ---------------
Total liabilities and stockholders' equity $ 94,104 $ 103,812
=============== ===============
See accompanying notes.
3
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED
SEPTEMBER 30,
-------------------
2002 2001
--------- --------
Net revenues (A) . . . . . . . . . . . . . . . . . . . . . . . $ 12,681 $15,831
Cost of revenues (B) . . . . . . . . . . . . . . . . . . . . . 8,196 7,539
--------- --------
Gross profit . . . . . . . . . . . . . . . . . . . . . . . . . 4,485 8,292
--------- --------
Operating expenses:
Selling, general and administrative (C). . . . . . . . . . . . 7,871 7,577
Research and development (C) . . . . . . . . . . . . . . . . . 2,430 2,092
Stock-based compensation (B) (C) . . . . . . . . . . . . . . . 445 1,172
Amortization of purchased intangible assets . . . . . . . . . 228 286
Restructuring charges . . . . . . . . . . . . . . . . . . . . 4,929 -
--------- --------
Total operating expenses . . . . . . . . . . . . . . . . . . . 15,903 11,127
--------- --------
Loss from operations . . . . . . . . . . . . . . . . . . . . . (11,418) (2,835)
Interest income (expense), net . . . . . . . . . . . . . . . . 192 536
Other income (expense), net . . . . . . . . . . . . . . . . . (90) (628)
--------- --------
Loss before income taxes . . . . . . . . . . . . . . . . . . . (11,316) (2,927)
Provision (benefit) for income taxes . . . . . . . . . . . . . 86 (649)
--------- --------
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . $(11,402) $(2,278)
========= ========
Basic and diluted net loss per share . . . . . . . . . . . . . $ (0.21) $ (0.05)
========= ========
Weighted average shares (basic and diluted) . . . . . . . . . 53,935 47,500
========= ========
(A) Includes net revenues from related parties. . . . . . . . $ 467 $ 517
========= ========
(B) Cost of revenues includes the following:
Amortization of purchased intangible assets . . . . . . . . . $ 1,028 $ 338
Stock-based compensation . . . . . . . . . . . . . . . . . . . 19 27
--------- --------
$ 1,047 $ 365
========= ========
(C) Stock-based compensation is excluded from the following:
Selling, general and administrative expenses . . . . . . . . $ 363 $ 833
Research and development expenses . . . . . . . . . . . . . . 82 339
--------- --------
$ 445 $ 1,172
========= ========
See accompanying notes.
4
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
THREE MONTHS ENDED
SEPTEMBER 30,
-------------------
2002 2001
--------- --------
Cash flows from operating activities:
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(11,402) $(2,278)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 616 560
Amortization of purchased intangible assets . . . . . . . . . . . . . . . . . 1,256 624
Stock-based compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . 464 1,199
Provision for doubtful accounts . . . . . . . . . . . . . . . . . . . . . . . 231 165
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . - (450)
Revaluation of strategic investment . . . . . . . . . . . . . . . . . . . . . - 500
Equity losses from unconsolidated businesses. . . . . . . . . . . . . . . . . 329 294
Restructuring charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,474 -
Changes in operating assets and liabilities, net of effect from acquisition:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 623 (2,583)
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (408) 388
Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . 1,418 (447)
Other assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (82) -
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (111) 326
Due to related party. . . . . . . . . . . . . . . . . . . . . . . . . . . . . (246) -
Due to Gordian . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,000) -
Accrued Lightwave settlement. . . . . . . . . . . . . . . . . . . . . . . . . (2,004) -
Other current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . 20 36
--------- --------
Net cash used in operating activities . . . . . . . . . . . . . . . . . . . . (6,822) (1,666)
--------- --------
Cash flows from investing activities:
Purchase of property and equipment, net . . . . . . . . . . . . . . . . . . . (216) (1,435)
Purchase of minority investments, net . . . . . . . . . . . . . . . . . . . . - (1,524)
Purchases of marketable securities . . . . . . . . . . . . . . . . . . . . . (9,250) -
Acquisition of business, net of cash acquired . . . . . . . . . . . . . . . . (2,114) -
Proceeds from sale of marketable securities . . . . . . . . . . . . . . . . . 3,000 -
--------- --------
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . . (8,580) (2,959)
--------- --------
Cash flows from financing activities:
Net proceeds from underwritten offerings of common stock. . . . . . . . . . . - 47,113
Net proceeds from other issuances of common stock . . . . . . . . . . . . . . 9 341
--------- --------
Net cash provided by financing activities . . . . . . . . . . . . . . . . . . 9 47,454
Effect of foreign exchange rates on cash. . . . . . . . . . . . . . . . . . . 23 27
--------- --------
Increase (decrease) in cash and cash equivalents. . . . . . . . . . . . . . . (15,370) 42,856
Cash and cash equivalents at beginning of period. . . . . . . . . . . . . . . 26,491 15,367
--------- --------
Cash and cash equivalents at end of period. . . . . . . . . . . . . . . . . . $ 11,121 $58,223
========= ========
See accompanying notes.
5
LANTRONIX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
1. BASIS OF PRESENTATION
The condensed consolidated financial statements included herein are
unaudited. They contain all normal recurring accruals and adjustments which, in
the opinion of management, are necessary to present fairly the consolidated
financial position of Lantronix, Inc. and its subsidiaries (collectively, the
"Company") at September 30, 2002, and the consolidated results of its operations
and its cash flows for the three months ended September 30, 2002 and 2001. All
intercompany accounts and transactions have been eliminated. It should be
understood that accounting measurements at interim dates inherently involve
greater reliance on estimates than at year-end. The results of operations for
the three months ended September 30, 2002 are not necessarily indicative of the
results to be expected for the full year or any future interim periods.
These financial statements do not include certain footnotes and financial
presentations normally required under generally accepted accounting principles.
Therefore, they should be read in conjunction with the audited consolidated
financial statements and notes thereto for the year ended June 30, 2002,
included in the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission ("SEC") on October 8, 2002.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities" ("SFAS No. 146"), which nullifies Emerging Issues Task Force
("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)" ("EITF 94-3"). SFAS No. 146 requires that a liability for a
cost associated with an exit or disposal activity be recognized when the
liability is incurred, whereas EITF 94-3 had recognized the liability at the
commitment date to an exit plan. The Company is required to adopt the provisions
of SFAS No. 146 effective for exit or disposal activities initiated after
December 31, 2002. The Company is currently evaluating the impact of adoption of
this statement.
3. BUSINESS COMBINATIONS
On August 1, 2002, the Company completed the acquisition of Stallion
Technologies PTY, LTD ("Stallion"). This acquisition has been accounted for
under the purchase method of accounting. The condensed consolidated financial
statements include the results of operations of the acquisition of Stallion
after the date of acquisition. The acquisition of Stallion complements the
Company's existing multiport and terminal server product lines.
The Company paid $1.2 million in cash consideration and established 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, and accruing interest at a rate of 2.5% per annum.
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 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
The Company is in the process of obtaining an independent appraisal of the
fair value of the tangible and intangible assets acquired related to the
acquisition of Stallion in order to allocate the purchase price in accordance
with SFAS No. 141 "Business Combinations". The acquisition of Stallion resulted
in total consideration of $3.1 million, which has been preliminarily allocated
principally to goodwill, pending an initial valuation of the Stallion tangible
and intangible assets acquired. Net tangible assets acquired in connection with
the purchase transaction include the acquisition costs incurred by the Company.
6
Pro Forma Data
The pro forma statements of operations data of the Company set forth below
gives effect to the acquisition of Stallion as if it had occurred at the
beginning of fiscal 2002. The following unaudited pro forma statements of
operations data excludes the amortization of purchased intangible assets pending
the results of the independent valuation. 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 acquisition taken place at the beginning of fiscal 2002 (in
thousands, except per share data):
THREE MONTHS ENDED
SEPTEMBER 30,
-------------------
2002 2001
--------- --------
Net revenues $ 13,004 $16,654
========= ========
Net loss $(11,396) $(2,238)
========= ========
Basic and diluted net loss per share $ (0.21) $ (0.05)
========= ========
4. NET LOSS PER SHARE
Basic net loss per share is calculated by dividing net loss by the weighted
average number of common shares outstanding during the period. Diluted net loss
per share is calculated by adjusting outstanding shares assuming any dilutive
effects of options. However, for periods in which the Company incurred a net
loss, these shares are excluded because their effect would be to reduce recorded
net loss per share. The following table sets forth the computation of net loss
per share (in thousands, except per share amounts):
THREE MONTHS ENDED
SEPTEMBER 30,
-------------------
2002 2001
--------- --------
Numerator: Net loss $(11,402) $(2,278)
========= ========
Denominator:
Weighted-average shares outstanding 54,267 48,140
Less: non-vested common shares outstanding (332) (640)
--------- --------
Denominator for basic and diluted loss per share 53,935 47,500
========= ========
Basic and diluted net loss per share $ (0.21) $ (0.05)
========= ========
5. MARKETABLE SECURITIES
The Company defines marketable securities 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. These securities are carried at cost, which approximates fair
value.
6. INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out) or market
and consist of the following (in thousands):
SEPTEMBER 30, JUNE 30,
2002 2002
--------------- ----------
Raw materials . . . . . . . . . . . . . . $ 7,030 $ 6,389
Finished goods. . . . . . . . . . . . . . 9,748 9,079
Inventory at distributors . . . . . . . . 930 1,031
--------------- ----------
17,708 16,499
Reserve for excess and obsolete inventory (6,516) (5,756)
--------------- ----------
$ 11,192 $ 10,743
=============== ==========
7
7. PURCHASED INTANGIBLE ASSETS
The composition of purchased intangible assets is as follows (in
thousands):
SEPTEMBER 30, 2002 JUNE 30, 2002
-------------------------------- --------------------------------
USEFUL ACCUMULATED ACCUMULATED
LIVES GROSS AMORTIZATION NET GROSS AMORTIZATION NET
--------- ------- -------------- ------- ------- -------------- -------
Existing technology. . 3-5 years $12,720 $ (1,550) $11,170 $12,720 $ (522) $12,198
Customer agreements. . 5 1,130 (200) 930 1,130 (143) 987
Patent/core technology 5 459 (237) 222 459 (212) 247
Tradename/trademark. . 5 532 (65) 467 532 (34) 498
Non-compete agreements 2-3 940 (304) 636 940 (189) 751
------- -------------- ------- ------- -------------- -------
Total $15,781 $ (2,356) $13,425 $15,781 $ (1,100) $14,681
======= ============== ======= ======= ============== =======
The amortization expense for purchased intangible assets for the three
months ended September 30, 2002 was $1.3 million, of which $1.0 million was
amortized to cost of revenues and $228,000 was amortized to operating expenses.
The amortization expense for purchased intangible assets for the three months
ended September 30, 2001 was $624,000, of which $338,000 was amortized to cost
of revenues and $286,000 was amortized to operating expenses. The estimated
amortization expense for the remainder of fiscal 2003 and the next four years
are as follows:
COST OF OPERATING
Fiscal year ending June 30: REVENUES EXPENSES TOTAL
--------- ---------- -------
2003. . . . . . . . . $3,021 $684 $3,705
2004. . . . . . . . . 3,330 695 4,025
2005. . . . . . . . . 2,654 412 3,066
2006. . . . . . . . . 1,862 380 2,242
2007. . . . . . . . . 303 84 387
--------- ---------- -------
Total $ 11,170 $ 2,255 $13,425
========= ========== =======
8. LONG-TERM INVESTMENTS
- -----------------------------
Long-term investments consist of a 15.8% ownership interest in Xanboo at
September 30, 2002. 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 $329,000
for the three months ended September 30, 2002 have been recognized as other
expense in the condensed consolidated statement of operations. The Company
recorded no similar loss for the same period last year.
9. 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. As of September 30, 2002, the Company
recorded restructuring costs totaling $4.9 million, which are classified as
operating expenses in the Company's condensed consolidated statements of
operations.
Through September 30, 2002, the restructuring plan had resulted in the
reduction of approximately 50 regular employees worldwide. The Company recorded
workforce reduction charges of approximately $1.2 million related to severance
and fringe benefits for the terminated employees.
In connection with the restructuring plan, the Company recorded charges of
approximately $3.7 million through September 30, 2002 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. The restructuring costs will be substantially paid in
8
cash and the plan will be completed within one year.
A summary of the activity in the restructuring liability account is as
follows (in thousands):
CHARGES AGAINST LIABILITY
-------------------------------------------------------------------
RESTRUCTURING RESTRUCTURING
LIABILITIES AT ADDITIONAL LIABILITIES AT
JUNE 30, RESTRUCTURING SEPTEMBER 30,
2002 COSTS NON-CASH CASH 2002
--------------- -------------- --------- ------ ---------------
Workforce reductions . . . . . . . $ 281 $ 1,187 $ - $(290) $ 1,178
Contractual obligations. . . . . . - 2,000 - - 2,000
Consolidation of excess facilities 126 1,742 - (165) 1,703
--------------- -------------- --------- ------ ---------------
Total $ 407 $ 4,929 $ - $(455) $ 4,881
=============== ============== ========= ====== ===============
10. BANK LINE OF CREDIT
In January 2002, the Company entered into a two-year line of credit with a
bank in an amount not to exceed $20.0 million. Borrowings under the line of
credit bear interest at either (i) the prime rate or (ii) the LIBOR rate plus
2.0%. The Company is required to pay a $100,000 facility fee of which $50,000
was paid upon the closing and $50,000 is to be paid in January 2003. The Company
is also required to pay a quarterly unused line fee of .125% of the unused line
of credit balance. The line of credit contains customary affirmative and
negative covenants. 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. To
date, the Company has not borrowed against this line of credit. The Company is
not in compliance with the revised financial covenants of the amended line of
credit at September 30, 2002.
11. COMPREHENSIVE LOSS
SFAS No. 130, "Reporting Comprehensive Income (Loss)," establishes
standards for reporting and displaying comprehensive income (loss) and its
components in the condensed consolidated financial statements. The components of
comprehensive loss are as follows (in thousands):
THREE MONTHS ENDED
SEPTEMBER 30,
-------------------
2002 2001
--------- --------
Net loss $(11,402) $(2,278)
Other comprehensive loss:
Change in net unrealized loss on investment - 134
Change in accumulated translation adjustments 23 27
--------- --------
Total comprehensive loss $(11,379) $(2,117)
========= ========
12. LITIGATION
INTELLECTUAL PROPERTY
On July 3, 2001, Digi International, Inc., filed a complaint alleging that
the Company directly and/or indirectly infringes upon Digi's U.S. Patent No.
6,047,319 by making, using, selling and or offering for sale certain of the
Company's multiport device servers, including the ETS line of products, when
coupled with a software called the comm port redirector software. Digi alleges
that the Company has willfully and intentionally infringed Digi's patent, and
its complaint seeks injunctive relief as well as unspecified damages, treble
damages, attorney's fees, interest and costs. Moreover, in conjunction with the
Company's acquisition of Stallion, the Company became party to similar
litigation in both the U.S. and Australia, in which Digi International claims
that Stallion's easyserverII and ePipe products, when coupled with software
products called truport and extend, respectively, infringe Digi's U.S. Patent
No. 6,047,319. Digi filed suit in the U.S. District Court for the District of
Minnesota on November 21, 2000, and in the Supreme Court of Queensland,
Australia on August 10, 2001, claiming that the easyserverII and ePipe products
9
when coupled with the truport and extend software, respectively, infringe Digi's
Australian Letters Patent No. 706,132. On November 4, 2002, the Company entered
into a settlement agreement with Digi, to dismiss all of the lawsuits. The
Company and Digi also agreed to cross-license the patents. Neither party was
required to provide consideration for the settlement, other than the
cross-license of its own patent(s).
SEC INVESTIGATION
The SEC is conducting a formal investigation of the events leading up to
the Company's restatement of its financial statements on June 25, 2002.
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 the Company's business. Plaintiffs further allege that the Company
materially overstated its reported financial results, thereby inflating the
Company's stock price during its securities offering in July 2001, as well as
facilitating the use of the Company's stock as consideration in acquisitions.
The complaints have subsequently been consolidated into a single action and the
court has appointed a lead plaintiff. The Company is awaiting the consolidated
amended complaint, which is to be filed by the lead plaintiff. The Company has
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 the Company's
current and former officers and directors. The 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 behalf of the Company,
equitable relief, and attorneys' fees. Discovery has not commenced and no trial
date has been established. The Company filed a demurrer/motion to dismiss the
derivative lawsuit on October 26, 2002, and has requested a hearing on the
demurrer scheduled for January 9, 2003. The basis of the demurrer is that the
plaintiff does not have standing to bring this lawsuit since the plaintiff has
never served a demand on the Company's Board that the Board take actions on
behalf of the corporation.
SECURITIES CLAIMS AND EMPLOYMENT CLAIMS BROUGHT BY THE CO-FOUNDERS OF
UNITED STATES SOFTWARE CORPORATION
On August 23, 2002, Donald and Diane Dunstan, the co-founders of United
States Software Corporation ("USSC"), filed a complaint entitled Dunstan v.
Lantronix, Inc., et al., in the Circuit Court of the State of Oregon, County of
Multnomah. The complaint alleges Oregon state law claims for securities
violations, fraud, and negligence. The complaint seeks not less than $3.6
million in damages, interest, attorneys' fees, costs, expenses, and an
unspecified amount of punitive damages. Discovery has not commenced and no trial
date has been established. In addition, Donald Dunstan has requested arbitration
of certain contract claims, including a claim of entitlement to $9.8 million for
lost earnout opportunities.
EMPLOYMENT SUIT BROUGHT BY FORMER CHIEF FINANCIAL OFFICER AND CHIEF
OPERATING OFFICER STEVE COTTON
On September 6, 2002, Steve Cotton, the Company's 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 the employment suit brought by Mr. Cotton 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. The
Company has requested a hearing be held on November 27, 2002.
10
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., Bernhard Bruscha, Frederick G. Thiel, Steven V. Cotton and
Ernst & Young LLP in the Superior Court of the State of California, County of
Orange. The complaint alleges fraud, negligent misrepresentation, breach of
warranties and covenants, breach of contract and negligence, all stemming from
the Company's acquisition of Synergetic. The complaint seeks an unspecified
amount of damages, interest, attorneys' fees, costs, expenses, and an
unspecified amount of punitive damages. The Company has not yet answered the
complaint.
OTHER
From time to time, the Company is subject to other legal proceedings and
claims in the ordinary course of business. The Company currently is 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.
Although the Company believes that claims or any litigation arising
therefrom will have no material impact on its business, all of the above matters
are in either the pleading stage or the discovery stage, and the Company cannot
predict their outcomes with certainty.
13. SUBSEQUENT EVENTS
On November 12, 2002, at the Company's Annual Meeting of Stockholders, the
stockholders approved a 1:3 reverse stock split in the Common Stock of the
Company, in an endeavor to satisfy requirements for the Company's securities to
be listed on the Nasdaq National Market and to amend the Company's Certificate
of Incorporation accordingly. Although approved, the Board of Directors will
only initiate a reverse split at such time it determines such action is
necessary in order to continue Nasdaq listing requirements that are related to
share price.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with
the Unaudited Condensed Consolidated Financial Statements and related Notes
thereto contained elsewhere in this Report. The information in this Quarterly
Report on Form 10-Q is not a complete description of our business or the risks
associated with an investment in our common stock. We urge you to carefully
review and consider the various disclosures made by us in this Report and in
other reports filed with the SEC, including our Annual Report on Form 10-K for
the fiscal year ended June 30, 2002 and our subsequent reports on Form 8-K that
discuss our business in greater detail.
The section entitled "Risk Factors" set forth below, and similar
discussions in our other SEC filings, discuss some of the important factors that
may affect our business, results of operations and financial condition. You
should carefully consider those factors, in addition to the other information in
this Report and in our other filings with the SEC, before deciding to invest in
our company or to maintain or increase your investment.
This report contains forward-looking statements which include, but are not
limited to, statements concerning projected net revenues, expenses, gross profit
and income (loss), the need for additional capital, market acceptance of our
products, our ability to consummate acquisitions and integrate their operations
successfully, our ability to achieve further product integration, the status of
evolving technologies and their growth potential and our production capacity.
These forward-looking statements are based on our current expectations,
estimates and projections about our industry, our beliefs, and certain
assumptions made by us. Words such as "anticipates," "expects," "intends,"
"plans," "believes," "seeks," "estimates," "may," "will" and variations of these
words or similar expressions are intended to identify forward-looking
statements. In addition, any statements that refer to expectations, projections
or other characterizations of future events or circumstances, including any
underlying assumptions, are forward-looking statements. These statements are not
guarantees of future performance and are subject to certain risks, uncertainties
and assumptions that are difficult to predict. Therefore, our actual results
could differ materially and adversely from those expressed in any
forward-looking statements as a result of various factors. We undertake no
obligation to revise or update publicly any forward-looking statements for any
reason.
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 servers," that enable almost any electronic device to be connected to a
network; "multiport device 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-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 and, where appropriate, software solutions that allow
our customers to network-enable virtually any electronic device.
Our products are sold to original equipment manufacturers (OEMs), value
added resellers (VARs), systems integrators and distributors, as well as
directly to end-users. One customer accounted for approximately 10.5% and 12.6%
of our net revenues for the three months ended September 30, 2002 and 2001,
respectively. Accounts receivable attributable to this domestic customer
accounted for approximately 5.8% and 13.4% of total accounts receivable at
September 30, 2002 and June 30, 2002, respectively.
12
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 3.7% and 3.3% of our
net revenues for the three months ended September 30, 2002 and 2001,
respectively. Included in the accompanying condensed consolidated balance sheets
is approximately $246,000 due to this related party at June 30, 2002. No amount
was due to this related party at September 30, 2002.
In August 2002, we completed the acquisition of Stallion Technologies, PTY,
LTD ("Stallion"), a provider of multiport and terminal server products. The
acquisition of Stallion complements our existing multiport and terminal server
product lines. In connection with the acquisition, we paid $1.2 million in cash
consideration 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 we are
unable to issue registered shares by October 31, 2002. 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, and accruing interest at a rate of
2.5% per annum. The note is convertible into our common stock at any time, at
the election of the holders at a $5.00 conversion price. We 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.
Stock-based compensation relates to deferred compensation recorded in
connection with the grant of stock options to employees where the option
exercise price is less than the estimated fair value of the underlying shares of
common 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. Deferred compensation also includes the
value of employee stock options assumed in connection with acquisitions of
United States Software Corporation ("USSC"), Lightwave Communications, Inc.
("Lightwave") and Synergetic Micro Systems, Inc. ("Synergetic") calculated in
accordance with current accounting guidelines. Deferred compensation is
presented as a reduction to stockholders' equity and is amortized over the
vesting period of the related stock options, which is generally four years. At
September 30, 2002, a balance of $2.3 million remains and will be amortized as
follows: $972,000 in the remainder of fiscal 2003, $1.0 million in fiscal 2004,
$330,000 in fiscal 2005 and $17,000 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 actually recognized in future periods
could decrease if options for which deferred compensation has been recorded are
forfeited.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires us to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of net 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 condensed
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, recognition of
revenue and related gross profit from sales to distributors are deferred until
the distributor resells the product to provide assurance that all revenue
recognition criteria are met at or prior to the point at which revenue is
recognized. 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. 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
13
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.
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.
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 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.
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 in-process research and development (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.
14
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
of net revenues represented by each item in our condensed consolidated statement
of operations:
THREE MONTHS ENDED
SEPTEMBER 30,
------------------
2002 2001
------- -------
Net revenues 100.0% 100.0%
Cost of revenues 64.6 47.6
------- -------
Gross profit 35.4 52.4
------- -------
Operating expenses:
Selling, general and administrative . . . . 62.1 47.9
Research and development. . . . . . . . . . 19.2 13.2
Stock based-compensation. . . . . . . . . . 3.5 7.4
Amortization of purchased intangible assets 1.8 1.8
Restructuring charges . . . . . . . . . . . 38.9 (-)
------- -------
Total operating expenses 125.4 70.3
------- -------
Loss from operations (90.0) (17.9)
Interest income (expense), net 1.5 3.4
Other income (expense), net (0.7) (4.0)
------- -------
Loss before income taxes (89.2) (18.5)
Provision (benefit) for income taxes 0.7 (4.1)
------- -------
Net loss (89.9)% (14.4)%
======= =======
NET REVENUES
Net revenues decreased $3.2 million, or 19.9%, to $12.7 million for the
three months ended September 30, 2002 from $15.8 million for the three months
ended September 30, 2001. The decrease for the three months ended September 30,
2002 was primarily attributable to a decrease in net revenues of our Multiport
Device Solutions. Multiport Device Solutions net revenues decreased $2.9
million, or 36.2%, to $5.1 million, or 40.3% of net revenues, for the three
months ended September 30, 2002 from $8.0 million, or 50.6% of net revenues, for
the three months ended September 30, 2001. Mulitport Device Solutions net
revenues include $954,000 of Stallion net revenues (from the acquisition date)
for the three months ended September 30, 2002. No net revenues from Stallion
were recorded for the same period last year. The decrease in our Multiport
Device Solution net revenues is primarily attributable to the current economic
slowdown and competitive pricing strategies. Device Server net revenues
decreased $504,000, or 7.0%, to $6.7 million, or 52.7% of net revenues, for the
three months ended September 30, 2002 from $7.2 million, or 45.4% of net
revenues, for the three months ended September 30, 2001. Print Server and other
net revenues increased $250,000, or 39.3%, to $886,000, or 7.0% of net revenues,
for the three months ended September 30, 2002 from $636,000, or 4.0% of net
revenues, for the three months ended September 30, 2001.
Net revenues generated from sales in the Americas decreased $4.0 million,
or 29.1%, to $9.8 million, or 77.4% of net revenues, for the three months ended
September 30, 2002 from $13.9 million, or 87.5% of net revenues, for the three
months ended September 30, 2001. Our net revenues derived from customers located
in the Americas as a percentage of total net revenues decreased due to the
current economic slowdown and competitive pricing strategies. Our net revenues
derived from customers located in Europe increased $821,000, or 52.8%, to $2.4
million, or 18.7% of net revenues, for the three months ended September 30, 2002
from $1.5 million, or 9.8% of net revenues, for the three months ended September
30, 2001. Our net revenues derived from customers located in Europe as a
percentage of total net revenues increased due to a concentrated effort to
improve European sales through a new sales structure. Our net revenues derived
from customers located in other geographic areas increased slightly to $488,000,
or 3.8% of net revenues, for the three months ended September 30, 2002 from
$425,000, or 2.7% of net revenues, for the three months ended September 30,
2001.
Due to the significant economic slowdown in the technology industry, we
experience a significant slowdown in customer orders, as well as an increase in
the number of order cancellations. We experienced significant revenue declines
in the second, third and fourth quarters of fiscal 2002. The first quarter of
15
fiscal 2003 represents our first quarter of modest sequential revenue growth and
we expect flat to modest growth in the second quarter of fiscal 2003.
GROSS PROFIT
Gross profit represents net revenues less cost of revenues. Cost of
revenues consists primarily of the cost of raw material components, subcontract
labor assembly from outside manufacturers and associated overhead costs. 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 $416,000 for the three months
ended September 30, 2001. No royalties were paid for the three months ended
September 30, 2002 as a result of the new Gordian agreement. Additionally, cost
of revenues for the three months ended September 30, 2002 and 2001 consisted of
$1.0 million and $338,000 of non-cash amortization of purchased intangible
assets, respectively.
In May 2002, we signed a new agreement with Gordian to acquire a joint
interest in the intellectual property that is evident in 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 three years. Effective May 30,
2002, upon the signing of the 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
Gordian agreement, included in amortization of purchased intangible assets of
$1.0 million, totaled $640,000 for the three months ended September 30, 2002.
Gross profit decreased by $3.8 million, or 45.9%, to $4.5 million, or 35.4%
of net revenues, for the three months ended September 30, 2002 from $8.3
million, or 52.4% of net revenues, for the three months ended September 30,
2001. The decrease in gross profit in absolute dollars and as a percentage of
net revenues for the three months ended September 30, 2002 was mainly
attributable to an increase in our inventory reserve of $760,000, the increase
in non-cash amortization of purchased intangible assets charged to cost of
revenues of $690,000, volume-pricing agreements and competitive pricing
strategies. These increases were partially offset by a decrease in the amount of
Gordian royalties of $416,000.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expenses consist primarily of
personnel-related expenses including salaries and commissions, facility
expenses, information technology, trade show expenses, advertising, and
professional fees. Selling, general and administrative expenses increased
$294,000, or 3.9%, to $7.9 million, or 62.1% of net revenues, for the three
months ended September 30, 2002 from $7.6 million, or 47.9% of net revenues, for
the three months ended September 30, 2001. The increase in selling, general and
administrative expense in absolute dollars and as a percentage of net revenues
is primarily due to the increase in legal and other professional fees. We expect
selling, general and administrative expenses in absolute dollars and as a
percentage of net revenues will decrease in the foreseeable future as a result
of our restructuring plan.
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
$338,000, or 16.2%, to $2.4 million, or 19.2% of net revenues, for the three
months ended September 30, 2002 from $2.1 million, or 13.2% of net revenues, for
the three months ended September 30, 2001. This increase resulted primarily from
increased personnel-related costs due to the acquisition of Synergetic and
Premise and expenses related to new product development.
STOCK-BASED COMPENSATION
Stock-based compensation generally represents the amortization of deferred
compensation. We recorded no deferred compensation for the three months ended
September 30, 2002 and recorded deferred compensation forfeitures of $1.7
million for the three months ended September 30, 2002. Deferred compensation
represents the difference between the fair value of the underlying common stock
for accounting purposes and the exercise price of the stock options at the date
of grant. Deferred compensation is presented as a reduction of stockholders'
equity and is amortized ratably over the respective vesting periods of the
applicable options, which is generally four years. Included in cost of revenues
is stock-based compensation of $19,000 and $27,000 for the three months ended
September 30, 2002 and 2001, respectively. Stock-based compensation decreased
$727,000, or 62.0%, to $445,000, or 3.5% of net revenues, for the three months
ended September 30, 2002 from $1.2 million, or 7.4% of net revenues, for the
three months ended September 30, 2001. The decrease in stock-based compensation
for the three months ended September 30, 2002 is primarily attributable to the
restructuring plans whereby options for which deferred compensation has been
recorded are forfeited.
16
AMORTIZATION OF PURCHASED INTANGIBLE ASSETS
Purchased intangible assets primarily include existing technology and
customer agreements and are amortized on a straight-line basis over the
estimated useful lives of the respective assets, ranging from two to five years.
We obtained independent appraisals of the fair value of tangible and intangible
assets acquired in order to allocate the purchase price. We are in the process
of obtaining an independent appraisal of the fair value of the tangible and
intangible assets acquired related to the acquisition of Stallion in order to
allocate the purchase price in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 141, "Business Combinations" ("SFAS No. 141"). As a
result, the excess of the purchase price over the net assets acquired of
Stallion of approximately $3.1 million is included in goodwill and, accordingly,
not being amortized. The amortization of purchased intangible assets decreased
$58,000, or 20.3%, to $228,000, or 1.8% of net revenues, for the three months
ended September 30, 2002 from $286,000, or 1.8% of net revenues, for the three
months ended September 30, 2001. In addition, approximately $1.0 million and
$338,000 of amortization of purchased intangible assets has been classified as
cost of revenues for the three months ended September 30, 2002 and 2001,
respectively. The decrease in amortization of purchased intangible assets is due
to the impairment write-down of $4.4 million during the fourth quarter of fiscal
2002. At September 30, 2002 the unamortized balance of purchased intangible
assets that will be amortized to future operating expense was $13.4 million, of
which $3.7 million will be amortized in the remainder of fiscal 2003, $4.0
million in fiscal 2004, $3.1 million is fiscal 2005, $2.2 in fiscal 2006 and
$387,000 in fiscal 2007.
RESTRUCTURING CHARGES
On September 12, 2002, 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. This
restructuring plan includes a worldwide workforce reduction, consolidation of
excess facilities and other charges. As of September 30, 2002, we recorded
restructuring costs totaling $4.9 million or 38.9% of net revenues, which are
classified as operating expenses in the condensed consolidated statements of
operations.
Through September 30, 2002, the restructuring plan had resulted in the
reduction of approximately 50 regular employees worldwide. We recorded workforce
reduction charges of approximately $1.2 million related to severance and fringe
benefits for the terminated employees.
In connection with the restructuring plan, we recorded charges of
approximately $3.7 million through September 30, 2002 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.
INTEREST INCOME (EXPENSE), NET
Interest income (expense), net consists primarily of interest earned on
cash, cash equivalents and short-term investments. Interest income (expense),
net was $192,000 and $536,000 for the three months ended September 30, 2002 and
2001, respectively. The decrease is primarily due to lower average investment
balances and interest rates for the three months ended September 30, 2002
compared to September 30, 2001, as a result of the acquisitions of Synergetic,
Premise and Stallion, as well as our investment in Xanboo Inc. ("Xanboo").
Additionally, the decrease in the average investment balance is due to increased
legal and other professional fees resulting from our financial statement
restatements in fiscal 2002 and defense of our lawsuits.
OTHER INCOME (EXPENSE), NET
Other income (expense), net was $(90,000) and $(628,000) for the three
months ended September 30, 2002 and 2001, respectively. The decrease in other
expense is primarily attributable to the $500,000 revaluation in the carrying
amount of a strategic investment recorded for the three months ended September
30, 2001.
PROVISION FOR INCOME TAXES-EFFECTIVE TAX RATE
We utilize the liability method of accounting for income taxes as set forth
in SFAS No. 109, "Accounting for Income Taxes." Our effective tax rate was -1%
for the three months ended September 30, 2002, and 22% for the three months
ended September 30, 2001. The federal statutory rate was 34% for both periods.
Our effective tax rate associated with the income tax expense benefit for the
three months ended September 30, 2002, 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 three months ended September 30, 2001, was lower than the statutory rate
primarily due to foreign losses and amortization of stock-based compensation for
which no benefit was provided.
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IMPACT OF ADOPTION OF NEW ACCOUNTING STANDARDS
In June 2002, the FASB issued SFAS 146, Accounting for Costs Associated
with Exit or Disposal Activities ("SFAS No. 146"), which nullifies Emerging
Issues Task Force ("EITF") Issue No. 94-3, Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (including
Certain Costs Incurred in a Restructuring) ("EITF 94-3"). SFAS No. 146 requires
that a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred, whereas EITF 94-3 had recognized the
liability at the commitment date to an exit plan. We are required to adopt the
provisions of SFAS No. 146 effective for exit or disposal activities initiated
after December 31, 2002. We are currently evaluating the impact of adoption of
this statement.
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 $11.1 million at September 30, 2002.
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 $13.2 million at September 30, 2002. Long-term investments consist of
investment consists of an equity security of a privately held company, Xanboo,
and totaled $6.4 million at September 30, 2002.
Our operating activities used cash of $6.8 million for the three months
ended September 30, 2002. We incurred a net loss of $11.4 million, which
includes the following non-cash adjustments: depreciation of $616,000,
amortization of purchased intangible assets of $1.3 million, amortization of
stock-based compensation of $464,000, a restructuring charge of $4.5 million,
equity losses from unconsolidated businesses of $329,000 and a provision for
doubtful accounts of $231,000. The changes in our operating assets consist of a
decrease in accounts receivable of $623,000 and a decrease in prepaid expenses
and other assets of $1.5 million which was reduced by a decrease in due to
Gordian of $2.0 million, decrease in accrued Lightwave settlement of $2.0 and an
increase in inventory of $408,000. The decrease in due to Gordian is due to
payments in accordance with the agreement. The decrease in the accrued Lightwave
settlement is due to the settlement payment. The decrease in prepaid expenses
and other current assets is primarily due to the decrease in contract
manufacturer receivables and the completion of the Stallion acquisition. The
reduction in accounts receivable is primarily due to improved collections from
our distributors and European customers.
Our investing activities used cash of $8.6 million for the three months
ended September 30, 2002 compared with a $3.0 million use of cash for the three
months ended September 30, 2001. We used $2.1 million, net of cash acquired, to
acquire Stallion in August 2002. We used $9.3 million to purchase marketable
securities. We received $3.0 million in proceeds from the sales of marketable
securities. We also used $216,000 to purchase property and equipment.
Cash provided by financing activities was $9,000 for the three months ended
September 30, 2002. Cash provided by financing activities was $47.5 million for
the three months ended September 30, 2001, 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 is to be paid in January 2003. We are also required to pay a
quarterly unused line fee of 0.125% of the unused line of credit balance. The
line of credit contains customary affirmative and negative covenants. Effective
June 30, 2002, we amended the 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. To date, we have not borrowed
against this line of credit. We are not in compliance with the revised financial
covenants of the amended line of credit at September 30, 2002.
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The following table summarizes our contractual payment obligations and
commitments:
REMAINDER OF FISCAL FISCAL YEARS
-------------------------------------
2003 2004 2005 2006 2007 THEREAFTER TOTAL
------ ------ ------ ------ ----- ----------- -------
Operating leases $2,301 $2,994 $2,856 $1,741 $ 894 $ 1,994 $12,780
Other contractual obligations 108 62 11 1 - - 182
------ ------ ------ ------ ----- ----------- -------
Total $2,409 $3,056 $2,867 $1,742 $ 894 $ 1,994 $12,962
====== ====== ====== ====== ===== =========== =======
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 ("SEC") 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.
VARIATIONS IN QUARTERLY OPERATING RESULTS, DUE TO FACTORS INCLUDING CHANGES
IN DEMAND FOR OUR PRODUCTS AND CHANGES IN OUR MIX OF NET REVENUES, COULD CAUSE
OUR STOCK PRICE TO DECLINE.
Our quarterly net revenues, expenses and operating results have varied in
the past and might vary significantly from quarter to quarter in the future. We
therefore believe that quarter-to-quarter comparisons of our operating results
are not a good indication of our future performance, and you should not rely on
them to predict our future performance or the future performance of our stock
price. Our short-term expense levels are relatively fixed and are based on our
expectations of future net revenues. If we were to experience a reduction in net
revenues in a quarter, we would likely be unable to adjust our short-term
expenditures. If this were to occur, our operating results for that quarter
would be harmed. If our operating results in future quarters fall below the
expectations of market analysts and investors, the price of our common stock
would likely fall. Other factors that might cause our operating results to
fluctuate on a quarterly basis include:
- changes in the mix of net revenues attributable to higher-margin and
lower-margin products;
- customers' decisions to defer or accelerate orders;
- variations in the size or timing of orders for our products;
- short-term fluctuations in the cost or availability of our critical
components, such as flash memory;
- changes in demand for our products generally;
- loss or gain of significant customers;
- announcements or introductions of new products by our competitors;
- defects and other product quality problems; and
- changes in demand for devices that incorporate our connectivity
products.
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OUR COMMON STOCK MAY BE DELISTED, WHICH COULD SIGNIFICANTLY HARM OUR
BUSINESS
Our common stock is currently listed on The Nasdaq SmallCap Market under
the symbol "LTRX." We currently are not in compliance with the $1.00 minimum bid
price requirement for inclusion in The Nasdaq SmallCap Market, however, we have
until January 15, 2003, to regain compliance. At that time we may then be
eligible for an additional 180 calendar day grace period in which to regain
compliance with the $1.00 minimum bid price requirement. If our common stock was
delisted from The Nasdaq SmallCap Market, some or all of the following could be
reduced, harming our investors:
- the liquidity of our common stock;
- the market price of our common stock;
- the number of institutional investors that will consider investing in
our common stock;
- the number of investors in general that will consider investing in our
common stock;
- the number of market makers in our common stock;
- the availability of information concerning the trading prices and
volume of our common stock;
- the number of broker-dealers willing to execute trades in shares of
our common stock; and
- our ability to obtain financing for the continuation of our
operations.
IF OUR COMMON STOCK IS DELISTED, THE LIQUIDITY OF OUR STOCK WOULD BE
LIMITED
If our common stock were to be delisted from The Nasdaq SmallCap Market it
could become subject to the SEC "Penny Stock" rules. "Penny stocks" generally
are equity securities with a price of less than $5.00 per share that are not
registered on certain national securities exchanges or quoted on the Nasdaq
system. Broker-dealers dealing in our common stock would then be subject to the
disclosure rules for transactions involving penny stocks, which require the
broker-dealer to determine if purchasing our common stock is suitable for a
particular investor. The broker-dealer must also obtain the written consent of
purchasers to purchase our common stock. The broker-dealer must also disclose
the best bid and offer prices available for our stock and the price at which the
broker-dealer last purchased or sold our common stock. These additional burdens
imposed upon broker-dealers may discourage them from effecting transactions in
our common stock, which could make it difficult for investors to sell their
shares and, hence, limit the liquidity of our common stock.
WE ARE CURRENTLY ENGAGED IN MULTIPLE SECURITIES CLASS ACTION LAWSUITS, A
LAWSUIT BY THE FORMER OWNERS OF OUR USSC SUBSIDIARY AND A STATE DERIVATIVE SUIT,
ANY OF WHICH, IF IT RESULTS IN AN UNFAVORABLE RESOLUTION, COULD ADVERSELY AFFECT
OUR BUSINESS, RESULTS OF OPERATIONS OR FINANCIAL CONDITION.
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 we 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 stock as consideration in
acquisitions. The complaints have subsequently been consolidated into a single
action and the court has appointed a lead plaintiff. The Company is awaiting
the consolidated amended complaint, which is to be filed by the lead plaintiff.
We have not yet answered, discovery has not commenced, and no trial date has
been established.
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. The 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.
Discovery has not commenced and no trial date has been established.
On August 23, 2002, Donald and Diane Dunstan, the co-founders of USSC,
filed a complaint entitled Dunstan v. Lantronix, Inc., et al., in the Circuit
Court of the State of Oregon, County of Multnomah. The complaint alleges Oregon
state law claims for securities violations, fraud, and negligence. The complaint
seeks not less than $3.6 million in damages, interest, attorneys' fees, costs,
20
expenses, and an unspecified amount of punitive damages. Discovery has not
commenced and no trial date has been established. In addition, Donald Dunstan
has requested arbitration of certain contract claims including a claim of
entitlement to $9.8 million for lost earnout opportunities.
On October 17, 2002, Richard Goldstein and several other former shareholders of
Synergetic filed a complaint entitled Goldstein, et al v. Lantronix, Inc.,
Bernhard Bruscha, Frederick G. Thiel, Steven V. Cotton and Ernst & Young LLP in
the Superior Court of the State of California, County of Orange. The 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.
We have not yet answered the complaint.
All the above matters are in early stages and we cannot predict their outcomes
with certainty. The litigation process is inherently uncertain and we may not
prevail. Securities litigation can extend for protracted times, and involves
substantial legal fees. Moreover, litigation with the former stockholders of
companies we have acquired could significantly harm our business; in addition to
the monetary cost of defending or resolving such litigation, because this
litigation involves our former employees, the morale of our employees could be
harmed, resulting in lower productivity and increased attrition.
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.
On July 3, 2001, Digi International, Inc., filed a complaint alleging that
we directly and/or indirectly infringes upon Digi's U.S. Patent No. 6,047,319 by
making, using, selling and or offering for sale certain of our multiport device
servers, including the ETS line of products, when coupled with a software called
the comm port redirector software. Digi alleges that we have willfully and
intentionally infringed Digi's patent, and its complaint seeks injunctive relief
as well as unspecified damages, treble damages, attorney's fees, interest and
costs. Moreover, in conjunction with our acquisition of Stallion, we are party
to similar litigation in both the U.S. and Australia, in which Digi
International claims that Stallion's easyserverII and ePipe products when
coupled with software products called truport and extend, respectively, infringe
Digi's U.S. Patent No. 6,047,319. Digi filed suit in the U.S. District Court for
the District of Minnesota on November 21, 2000, and in the Supreme Court of
Queensland, Australia on August 10, 2001, claiming that the easy server II and
ePipe products when coupled with the truport and extend software, respectively,
infringe Digi's Australian Letters Patent No. 706,132.
On November 4, 2002, we entered into a settlement agreement with Digi, to
dismiss all of the above lawsuits. Lantronix and Digi also agreed to
cross-license the above patents. Neither party was required to provide
consideration for the settlement, other than the cross-license of its own
patent(s).
IF WE MAKE UNPROFITABLE ACQUISITIONS OR ARE UNABLE TO SUCCESSFULLY
INTEGRATE ANY FUTURE ACQUISITIONS, OUR BUSINESS COULD SUFFER.
We have in the past and intend to continue in the future to acquire
businesses, client lists, products or technologies that we believe complement or
expand our existing business. In 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 Systems,
Inc. ("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;
21
- 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, such as environmental and
tort liabilities, are difficult or impossible to quantify. If we do not receive
adequate indemnification for these liabilities our business may be harmed. In
addition, acquisitions are likely to result in a dilutive issuance of equity
securities. For example, we issued common stock and assumed options to acquire
our common stock in connection with our acquisitions of USSC, Lightwave,
Synergetic and Premise. We cannot assure you that any acquisitions or acquired
businesses, client lists, products or technologies associated therewith will
generate sufficient net revenues to offset the associated costs of the
acquisitions or will not result in other adverse effects. Moreover, from time to
time we may enter into negotiations for the acquisition of businesses, client
lists, products or technologies, but be unable or unwilling to consummate the
acquisition under consideration. This could cause significant diversion of
managerial attention and out of pocket expenses to us. We could also be exposed
to litigation as a result of an unconsummated acquisition, including claims that
we failed to negotiate in good faith, misappropriated confidential information
or other claims.
In addition, from time to time we intend to invest in businesses that we
believe present attractive investment opportunities, or provide other synergetic
benefits. In September and October 2001, we paid an aggregate of $3.0 million to
Xanboo for convertible promissory notes, which have converted, in accordance
with their terms, into Xanboo preferred stock. In addition, the Company
purchased an additional $4.0 million of preferred stock in Xanboo. As of
September 30, 2002, we hold a 15.8% ownership interest in Xanboo. This
investment is speculative in nature, and there is risk that we could lose part
or all of our investment.
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.
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. 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.
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 have not recorded deferred compensation during
the three months ended September 30, 2002. Additionally, we recorded deferred
compensation forfeitures of $1.7 million during the three months ended September
30, 2002. At September 30, 2002, a balance of $2.3 million remains and will be
amortized as follows: $972,000 in the remainder of fiscal 2003, $1.0 million in
fiscal 2004, $330,000 in fiscal 2005 and $17,000 in fiscal 2006.
The amount of stock-based compensation in future periods will increase if
we grant stock options where the exercise price is less than the quoted market
price of the underlying shares. The amount of stock-based compensation
amortization in future periods could decrease if options for which accrued, but
unvested deferred compensation has been recorded are forfeited.
WE PRIMARILY DEPEND ON THREE THIRD-PARTY MANUFACTURERS TO MANUFACTURE ALL
OF OUR PRODUCTS, WHICH REDUCES OUR CONTROL OVER THE MANUFACTURING PROCESS. IF
THESE MANUFACTURERS ARE UNABLE OR UNWILLING TO MANUFACTURE OUR PRODUCTS AT THE
QUALITY AND QUANTITY WE REQUEST, OUR BUSINESS COULD BE HARMED AND OUR STOCK
PRICE COULD DECLINE.
We primarily outsource all of our manufacturing to three third-party
manufacturers, APW, Inc., Irvine Electronics and Uniprecision. Our reliance on
these third-party manufacturers exposes us to a number of significant risks,
including:
22
- 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. We may also experience unforeseen problems as we attempt to
transition a significant portion of our manufacturing requirements to
Uniprecision. We do not have a significant operating history with this entity
and if this entity is unable to provide us with satisfactory service, or we are
unable to successfully complete the transition, our operations could be
interrupted. As 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. 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 by regional location.
These forecasts are used by our contract manufacturers to procure raw materials
and manufacture our finished goods. If we forecast demand too high, we may
invest too much cash in inventory and we may be forced to take a write-down of
our inventory balance, which would reduce our earnings. If our forecast is too
low for one or more products, we may be required to pay expedite charges which
would increase our cost of 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. WHILE AFFORDING
COST SAVINGS, OTHER RISKS COULD NEGATIVELY IMPACT US OR OFFSET THE ANTICIPATED
SAVINGS.
We have recently elected to use a contract manufacturer based in China,
which involves numerous risks, including:
- 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.
On September 12, 2002, we announced our intent to source our Lightwave
products from contract manufacturers, and close our operations in Milford,
Connecticut. If we are unsuccessful in making this transition, our supply of
these products and hence our revenues, could be reduced.
INABILITY OR DELAYS IN DELIVERIES FROM OUR COMPONENT SUPPLIERS COULD DAMAGE
OUR REPUTATION AND COULD CAUSE OUR NET REVENUES TO DECLINE AND HARM OUR RESULTS
OF OPERATIONS.
Our contract manufacturers and we are responsible for procuring raw
materials for our products. Our products incorporate components or technologies
that are only available from single or limited sources of supply. In particular,
some of our integrated circuits are available from a single source. From time to
time in the past, integrated circuits we use in our products have been phased
out of production. When this happens, we attempt to purchase sufficient
inventory to meet our needs until a substitute component can be incorporated
into our products. Nonetheless, we might be unable to purchase sufficient
components to meet our demands, or we might incorrectly forecast our demands,
and purchase too many or too few components. In addition, our products use
components that have in the past been subject to market shortages and
substantial price fluctuations. From time to time, we have been unable to meet
our orders because we were unable to purchase necessary components for our
products. We rely on a number of different component suppliers. Because we do
not have long-term supply arrangements with any vendor to obtain necessary
components or technology for our products, if we are unable to purchase
components from these suppliers, product shipments could be prevented or
delayed, which could result in a loss of sales. If we are unable to meet
existing orders or to enter into new orders because of a shortage in components,
we will likely lose net revenues and risk losing customers and harming our
reputation in the marketplace.
23
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 September 30, 2002, our
inventories were valued at $17.7 million and we had reserved $6.5 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.
OUR MANAGEMENT TEAM IS IN TRANSITION, WHICH COULD HARM OUR BUSINESS
Our management team is undergoing a significant transition. We have
recently replaced our Chairman of the Board, Chief Executive Officer and Chief
Financial Officer/Chief Operating Officer. Currently, Marc Nussbaum is serving
as our interim Chief Executive Officer, and James Kerrigan is serving as our
interim Chief Financial Officer. We will need to hire a permanent Chief
Executive Officer and Chief Financial Officer in the near future. Although the
Company might hire Mssrs. Nussbaum and Kerrigan to serve in permanent
capacities, it is also possible that new executives will be hired. The recent
management changes have been disruptive to our business and additional changes
would likely be disruptive as well. If we are unable to manage this process
effectively, our relationship with our employees, customers and vendors could be
significantly harmed.
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 Interim President and Chief Executive Officer, and
James Kerrigan, who serves as our Interim Chief Financial Officer. We have no
contract agreements with those executives who are serving on an interim basis.
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 VARs, system
integrators and OEMs. Although we intend to continue to use all of these sales
channels, we have begun to focus more heavily on selling our products to OEMs.
Selling products to OEMs involves unique risks, including the risk that OEMs
will develop internal expertise in network-enabling products or will otherwise
provide network functionality to their products without using our device server
technology. If this were to occur, our stock price could decline in value and
you could lose part or all of your investment.
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 result would be harmed, and
our stock price could decline.
IF OUR RESEARCH AND DEVELOPMENT EFFORTS ARE NOT SUCCESSFUL OUR REVENUES
COULD DECLINE AND BUSINESS COULD BE HARMED.
For the three months ended September 30, 2002, we incurred $2.4 million in
research and development expenses, which comprised 19.2% 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
24
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.
Our top five customers accounted for 32.75% of our net revenues for the
three months ended September 30, 2002. One customer accounted for approximately
10.5% and 12.6% of our net revenues for the three months ended September 30,
2002 and 2001, respectively. Accounts receivable attributable to this domestic
customer accounted for approximately 5.8% and 13.4% of total accounts receivable
at September 30, 2002 and June 30, 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. 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.
25
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 five 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 22.6% and 12.5% of net
revenues for the three months ended September 30, 2002 and 2001, respectively.
Net revenues from Europe represented 18.7% and 9.8% of our net revenues for the
three months ended September 30, 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;
26
- greater difficulty in staffing and managing foreign operations; and
- increased financial accounting and reporting burdens and complexities.
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.
TERRORIST ATTACKS OR THREATS OF ATTACKS, AND BUSINESS INTERRUPTION CAUSED
BY SUCH ATTACKS, NATURAL DISASTERS AND ELECTRICAL BLACKOUTS IN THE STATE OF
CALIFORNIA COULD ADVERSELY AFFECT OUR BUSINESS.
Interruptions in business, a decline in demand in our products, or a
general economic decline resulting from actual or threatened terrorist attacks
or military action could harm our business. Adverse effects could include, but
are not limited to, physical damage to our facilities, and disruptions caused by
trade restrictions imposed by the United States or foreign governments. In
addition, a general economic downturn in any of our target markets or general
disruption of the financial markets caused by such attacks could substantially
harm our business. Moreover, our operations are vulnerable to interruption by
fire, earthquake, power loss, telecommunications failure and other events beyond
our control. We do not have a detailed disaster recovery plan. Our facilities in
the State of California may be subject to electrical blackouts as a consequence
of a shortage of available electrical power. In the event these blackouts
continue or increase in severity, they could disrupt the operations of our
affected facilities.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES 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, cash equivalents and marketable securities and our credit facilities,
which is tied to market interest rates. As of September 30, 2002, we had cash
and cash equivalents of $11.1 million, which consisted of cash and short-term
investments with original maturities of ninety days or less, both domestically
and internationally. As of September 30, 2002 we had marketable securities of
$13.2 million 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 September 30, 2002, we have a net investment of $6.4 million 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
27
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 4. 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
Quarterly Report on Form 10-Q, 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 process improvements
that have been implemented, and will continue to be implemented after the
evaluation date. For example we have revised our process controls which will
facilitate timely Securities and Exchange Commission fillings and implemented
additional employee training.
28
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
INTELLECTUAL PROPERTY
On July 3, 2001, Digi International, Inc., filed a complaint alleging that
we directly and/or indirectly infringes upon Digi's U.S. Patent No. 6,047,319 by
making, using, selling and or offering for sale certain of our multiport device
servers, including the ETS line of products, when coupled with a software called
the comm port redirector software. Digi alleges that we have willfully and
intentionally infringed Digi's patent, and its complaint seeks injunctive relief
as well as unspecified damages, treble damages, attorney's fees, interest and
costs. Moreover, in conjunction with our acquisition of Stallion, we are party
to similar litigation in both the U.S. and Australia, in which Digi
International claims that Stallion's easyserverII and ePipe products when
coupled with software products called truport and extend, respectively, infringe
Digi's U.S. Patent No. 6,047,319. Digi filed suit in the U.S. District Court for
the District of Minnesota on November 21, 2000, and in the Supreme Court of
Queensland, Australia on August 10, 2001, claiming that the easy server II and
ePipe products when coupled with the truport and extend software, respectively,
infringe Digi's Australian Letters Patent No. 706,132.
On November 4, 2002, we entered into a settlement agreement with Digi, to
dismiss all of the above lawsuits. Lantronix and Digi also agreed to
cross-license the above patents. Neither party was required to provide
consideration for the settlement, other than the cross-license of its own
patent(s).
In addition, from time to time we could encounter other disputes over
rights and obligations concerning intellectual property. We cannot assume that
we will prevail in intellectual property disputes regarding infringement,
misappropriation or other disputes. Litigation in which we are accused of
infringement or misappropriation might cause a delay in the introduction of new
products, require us to develop non-infringing technology, require us to enter
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.
SEC INVESTIGATION
The SEC is conducting a formal investigation of the events leading up to
our restatement of our financial statements on June 25, 2002. From the inception
of the investigation, we have fully cooperated with the SEC.
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 we 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 stock as consideration in
acquisitions. The complaints have subsequently been consolidated into a single
action and the court has appointed a lead plaintiff. We are awaiting the
consolidated amended complaint, which is to be filed by the lead plaintiff. 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. The 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.
Discovery has not commenced and no trial date has been established.
29
SECURITIES CLAIMS AND EMPLOYMENT CLAIMS BROUGHT BY THE CO-FOUNDERS OF USSC
On August 23, 2002, Donald and Diane Dunstan, the co-founders of USSC,
filed a complaint entitled Dunstan v. Lantronix, Inc., et al., in the Circuit
Court of the State of Oregon, County of Multnomah. The complaint alleges Oregon
state law claims for securities violations, fraud, and negligence. The complaint
seeks not less than $3.6 million in damages, interest, attorneys' fees, costs,
expenses, and an unspecified amount of punitive damages. Discovery has not
commenced and no trial date has been established. In addition, Donald Dunstan
has requested arbitration of certain contract claims, including a claim of
entitlement to $9.8 million for lost earnout opportunities.
EMPLOYMENT SUIT BROUGHT BY FORMER CFO AND COO 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 the employment suit brought by Mr. Cotton 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. We have
requested a hearing be held on November 27, 2002.
SECURITIES CLAIMS BROUGHT BY FORMER SHAREHOLDERS OF SYNERGETIC
On October 17, 2002, Richard Goldstein and several other former shareholders of
Synergetic filed a complaint entitled Goldstein, et al v. Lantronix, Inc.,
Bernhard Bruscha, Frederick G. Thiel, Steven V. Cotton and Ernst & Young LLP in
the Superior Court of the State of California, County of Orange. The 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.
We have not yet answered the complaint.
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.
Although we believe that the claims or any litigation arising therefrom
will have no material impact on our business, all of the above matters are in
either the pleading stage or the discovery stage, and we cannot predict their
outcomes with certainty.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In August 2002, we completed the acquisition of Stallion Technologies, PTY,
LTD ("Stallion"), a provider of multiport and terminal server products. The
acquisition of Stallion complements our existing multiport and terminal server
product lines. In connection with the acquisition, we paid $1.2 million in cash
consideration 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 we are
unable to issue registered shares by the October 31, 2002 deadline. In addition,
we issued a two-year note in the principal amount of $867,000, and accruing
interest at a rate of 2.5% per annum. The note is convertible into our common
stock at any time, at the election of the holders at a $5.00 conversion price.
We 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. We were not
able to issue registered shares by the October 31, 2002 deadline accordingly;
the cash escrow amount of $867,000 was released on November 1, 2002.
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 is to be paid in January 2003. We are also required to pay a
quarterly unused line fee of 0.125% of the unused line of credit balance. The
line of credit contains customary affirmative and negative covenants. Effective
June 30, 2002, we amended the 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. To date, we have not borrowed
against this line of credit. We are not in compliance with the revised financial
covenants of the amended line of credit at September 30, 2002. Pursuant to our
line of credit, we are restricted from paying any dividends.
30
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On November 12, 2002, the Company held its annual meeting of security
holders. The Company submitted the following matters to a vote:
1. Reelection of Thomas W. Burton to the Company's Board of Directors, to serve
until the Company's 2005 Annual Meeting.
2. Ratification of the appointment of Ernst & Young, LLP, to serve as the
Company's independent auditor for the fiscal year ending June 30, 2003.
3. Authorizing the Board of Directors to approve a reverse stock split of the
Company's common stock at a ratio of 1:3.
All three matters were approved by the security holders.
ITEM 5. OTHER INFORMATION
In accord with Section 10A(i)(2) of the Securities Exchange Act of 1934, as
added by Section 202 of the Sarbanes-Oxley Act of 2002, the company is
responsible for listing the non-audit services approved in the three months
ended September 30, 2002, by the company's Audit Committee to be performed by
the company's external auditor. Non-audit services are defined in the law as
services other than those provided in connection with an audit or a review of
the financial statements of the company. The Audit Committee did not engage the
outside auditors in any non-audit related services in the three months ended
September 30, 2002.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------ -------------------------
99.1 Certification of CEO Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification of CFO Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
None.
31
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, as amended,
Lantronix has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Irvine, State of
California, on the 14th day of November, 2002.
LANTRONIX, INC.
By: /s/ James Kerrigan
------------------------------
JAMES KERRIGAN
INTERIM CHIEF FINANCIAL OFFICER
CERTIFICATIONS
I, Marc Nussbaum, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Lantronix, Inc.
(the "Company");
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the Company as of, and for, the periods presented in this
quarterly report;
4. The Company's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Company and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Company, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the Company's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Company's other certifying officers and I have disclosed, based on
our most recent evaluation, to the Company's auditors and the audit
committee of Company's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Company's ability to record,
process, summarize and report financial data and have identified for
the Company's auditors any material weaknesses in internal controls;
and
32
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company's internal
controls; and
6. The Company's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
November 14, 2002
/s/ Marc Nussbaum
- ---------------------------
Marc Nussbaum
Interim Chief Executive Officer
CERTIFICATIONS
I, James Kerrigan, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Lantronix, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the Company as of, and for, the periods presented in this
quarterly report;
4. The Company's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the Company and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the Company, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the Company's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Company's other certifying officers and I have disclosed, based on
our most recent evaluation, to the Company's auditors and the audit
committee of Company's board of directors (or persons performing the
equivalent function):
33
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Company's ability to record,
process, summarize and report financial data and have identified for
the Company's auditors any material weaknesses in internal controls;
and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company's internal
controls; and
6. The Company's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
November 14, 2002
/s/ James Kerrigan
- ---------------------
James Kerrigan
Interim Chief Financial Officer
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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
I, Marc Nussbaum, certify, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly
Report of Lantronix, Inc. on Form 10-Q for the fiscal quarter ended September
30, 2002, fully complies with the requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 and that information contained in such Quarterly
Report on Form 10-Q fairly presents in all material respects the financial
condition and results of operations of Lantronix, Inc.
By: /s/ Marc Nussbaum
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Name: Marc Nussbaum
Title: Interim Chief Executive Officer
I, James Kerrigan, certify, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly
Report of Lantronix, Inc. on Form 10-Q for the fiscal quarter ended September
30, 2002, fully complies with the requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 and that information contained in such Quarterly
Report on Form 10-Q fairly presents in all material respects the financial
condition and results of operations of Lantronix, Inc.
By: /s/ James Kerrigan
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Name: James Kerrigan
Title: Interim Chief Financial Officer
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