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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER 1-16027
LANTRONIX, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0362767
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
15353 BARRANCA PARKWAY, IRVINE, CALIFORNIA 92618
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(949) 453-3990
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
COMMON STOCK, $0.0001 PAR VALUE THE NASDAQ MARKET
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes [ ] No [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of the registrant's Common Stock held by
non-affiliates based upon the closing sales price of the Common Stock on
December 31, 2003, as reported by the Nasdaq National Market, was approximately
$31,192,000. Shares of Common Stock held by each current executive officer and
director and by each person who is known by the registrant to own 5% or more of
the outstanding Common Stock have been excluded from this computation in that
such persons may be deemed to be affiliates of the registrant. Share ownership
information of certain persons known by the registrant to own greater than 5% of
the outstanding common stock for purposes of the preceding calculation is based
solely on information on Schedule 13G filed with the Commission and is as of
December 31, 2003. This determination of affiliate status is not a conclusive
determination for other purposes.
As of August 31, 2004, there were 58,154,919 shares of the Registrant's common
stock outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the Lantronix, Inc. Annual
Meeting of Stockholders scheduled to be held on November 18, 2004 are
incorporated by reference into Part II and Part III of this Form 10-K.
Certain exhibits filed in connection with the Lantronix, Inc. Registration
Statement on Form S-1, originally filed May 19, 2000, and Registration Statement
on Form S-1, originally filed June 14, 2001, are incorporated by reference into
Part IV of this Form 10-K.
LANTRONIX, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED JUNE 30, 2004
TABLE OF CONTENTS
Page
----
PART I
ITEM 1. Business 4
ITEM 2. Properties 11
ITEM 3. Legal Proceedings 11
ITEM 4. Submission of Matters to a Vote of Security Holders 13
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters 14
ITEM 6. Selected Consolidated Financial Data 15
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 16
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk 37
ITEM 8. Financial Statements and Supplementary Data 37
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 37
ITEM 9A Controls and Procedures 37
PART III
ITEM 10. Directors and Executive Officers of the Registrant 39
ITEM 11. Executive Compensation 39
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 39
ITEM 13. Certain Relationships and Related Transactions 39
ITEM 14. Principal Accountant Fees and Services 39
PART IV
ITEM 15. Exhibits, Financial Statements, Schedules and Reports on Form 8-K 40
Officer Certifications II-4
2
FORWARD-LOOKING STATEMENTS
THIS DOCUMENT CONTAINS STATEMENTS THAT ARE NOT HISTORICAL FACTS BUT ARE
FORWARD-LOOKING STATEMENTS RELATING TO SUCH MATTERS AS ANTICIPATED FINANCIAL
PERFORMANCE, BUSINESS PROSPECTS, TECHNOLOGICAL DEVELOPMENTS, NEW PRODUCTS,
ENGINEERING AND DEVELOPMENT ACTIVITIES AND SIMILAR MATTERS. SUCH STATEMENTS ARE
GENERALLY IDENTIFIED BY THE USE OF FORWARD-LOOKING WORDS AND PHRASES, SUCH AS
"INTENDED," "EXPECTS," "ANTICIPATES" AND "IS (OR ARE) EXPECTED (OR
ANTICIPATED)." THESE FORWARD-LOOKING STATEMENTS INCLUDE BUT ARE NOT LIMITED TO
STATEMENTS CONCERNING INDUSTRY TRENDS, ANTICIPATED DEMAND FOR OUR PRODUCTS, THE
IMPACT OF PENDING LITIGATION, OUR STRATEGY, THE POSSIBILITY OF FUTURE
INVESTMENTS OR ACQUISITIONS, FUTURE CUSTOMER AND SALES DEVELOPMENTS,
MANUFACTURING FORECASTS, INCLUDING THE POTENTIAL BENEFITS OF OUR CONTRACT
MANUFACTURERS SOURCING AND SUPPLYING RAW MATERIALS, COMPONENTS AND INTEGRATED
CIRCUITS, THE POSSIBILITY OF AN EXPANDING ROLE FOR ORIGINAL EQUIPMENT
MANUFACTURERS IN OUR BUSINESS, THE FUTURE COST AND POTENTIAL BENEFITS OF OUR
RESEARCH AND DEVELOPMENT EFFORTS, AND LIQUIDITY AND CASH RESOURCES FORECASTS.
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE DISCUSSED IN SUCH
FORWARD-LOOKING STATEMENTS, AND OUR STOCKHOLDERS SHOULD CAREFULLY REVIEW THE
CAUTIONARY STATEMENTS SET FORTH IN THIS FORM 10-K, INCLUDING FACTORS THAT MAY
AFFECT FUTURE RESULTS. WE MAY FROM TIME TO TIME MAKE ADDITIONAL WRITTEN AND ORAL
FORWARD-LOOKING STATEMENTS, INCLUDING STATEMENTS CONTAINED IN OUR FILINGS WITH
THE SECURITIES AND EXCHANGE COMMISSION AND IN OUR REPORTS TO STOCKHOLDERS. WE DO
NOT UNDERTAKE TO UPDATE ANY FORWARD-LOOKING STATEMENTS THAT MAY BE MADE FROM
TIME TO TIME BY US OR ON OUR BEHALF.
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PART I
ITEM 1. BUSINESS
OVERVIEW
Lantronix, Inc. ("Lantronix" or "we" or "us") designs, develops and markets
devices and software solutions that make it possible to access, manage, control
and configure almost any electronic product over the Internet or other networks.
We are a leader in providing innovative networking solutions. We were initially
formed as "Lantronix," a California corporation, in June 1989. We reincorporated
as "Lantronix, Inc.," a Delaware corporation in May 2000.
We have a history of providing devices that enable information technology
("IT") equipment to network using standard protocols for connectivity, including
fiber optic, Ethernet and wireless. Our first device was a terminal server that
allowed "dumb" terminals to connect to a network. Building on the success of our
terminal servers, we introduced a complete line of print servers in 1991 that
enabled users to inexpensively share printers over a network. Over the years, we
have continually refined our core technology and have developed additional
innovative networking solutions that expand upon the business of providing our
customers network connectivity. With the expansion of networking and the
Internet, our technology focus is increasingly broader, so that our device
solutions provide a product manufacturer with the ability to network their
products within the industrial, service and consumer markets.
We provide three broad categories of products: "device networking solutions,"
that enable almost any electronic product to be connected to a network; "IT
management solutions," that enable multiple pieces of hardware, usually
IT-related network hardware such as servers, routers, switches, and similar
pieces of equipment to be managed over a network; and "non-core" products and
services that include visualization solutions, legacy print server's, software
revenues, and other miscellaneous products. The expansion of our business in the
future is directed at the first two of these categories, device networking and
IT management solutions.
Today, our solutions include fully integrated hardware and software
devices, as well as software tools, to develop related customer applications.
Because we deal with network connectivity, we provide hardware solutions to
extremely broad market segments, including industrial, medical, commercial,
financial, governmental, retail and building automation, and many more. Our
technology is used to provide networking capabilities to products such as
medical instruments, manufacturing equipment, bar code scanners, building HVAC
systems, elevators, process control equipment, vending machines, thermostats,
security cameras, temperature sensors, card readers, point of sale terminals,
time clocks, and virtually any product that has some form of standard data
control capability. Our current product offerings include a wide range of
hardware devices of varying size, packaging and, where appropriate, software
solutions that allow our customers to network-enable virtually any electronic
product.
We sell our devices through a global network of distributors, systems
integrators, value-added resellers (VARs), manufacturers' representatives and
original equipment manufacturers (OEMs). In addition, we sell directly to
selected accounts.
Our products are sold to distributors, OEMs, VARs, and systems integrators,
as well as directly to end-users. One customer, Ingram Micro Inc., accounted for
approximately 14%, 11% and 12% of our net revenues for the years ended June 30,
2004, 2003 and 2002, respectively. Another customer, Tech Data Corporation,
accounted for approximately 9%, 10% and 11% of our net revenues for the years
ended June 30, 2004, 2003 and 2002, respectively. Accounts receivable
attributable to these two domestic customers accounted for approximately 13% and
16% of total accounts receivable at June 30, 2004 and 2003, respectively.
Our common stock is currently traded on The Nasdaq SmallCap Market under
the symbol LTRX.
Our worldwide headquarters are located in Irvine, California and we have
offices in Milford, Connecticut and worldwide, including; Germany; France; Hong
Kong and Japan. We also have employees working from home offices in other areas
of the world including the United Kingdom and Netherlands. During the first
quarter of fiscal 2004, we closed our European administrative operations handled
by our Switzerland office. Since September 2003, European operations have been
managed from our Irvine, California facility.
We provide information regarding our company and our products on our
Internet web site, www.lantronix.com.
OUR STRATEGY
Our business strategy is based on our proven capability to develop fully
integrated networking solutions that increase the value of our customers'
products by making it easy to take advantage of features that can be made
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available when these products are network-enabled. This strategy is accomplished
by providing our customers with hardware and software that connects products and
systems to a network, and intelligently manages and controls them. Through our
15 years of networking expertise, knowledge of industry trends, and our
capability to develop solutions based on open industry standards, we have been
able to anticipate our customers' networking technology requirements and offer
solutions that enable them to achieve their connectivity objectives. By
providing a complete solution of hardware and integrated software, we have been
able to provide "turnkey" solutions, eliminating the need for our customers to
build expensive design and manufacturing expertise in-house. This results in
savings to the customer both in terms of financial investment and time.
Our fully integrated hardware, software, and application development tools
have enabled us to become a technology and industry leader. We focus on the
following key areas:
- - Device Networking Solutions - We offer an array of embedded and external
device networking solutions that enable integrators and manufacturers of
electronic and electro-mechanical products to add network connectivity,
manageability, and control to their products. Our customers' products
originate from a wide variety of applications, such as blood analyzers that
relay critical patient information directly to a hospital's information
system, to simple devices such as timeclocks or audio/visual equipment, to
improve how these products are managed and controlled.
- - IT Management Solutions - We offer off-the-shelf equipment that enables IT
professionals to remotely manage network infrastructure equipment and large
groups of servers. Our terminal and console management systems solutions
provide a comprehensive solution for the remote command and control of
today's network infrastructure.
- - Non-core Businesses - Over the years, we have innovated or acquired various
product lines that are no longer part of our primary, core markets
described above. In general, this category of business represents
decreasing markets and we minimize research and development in these
product lines. Included in this category are visualization solutions,
legacy print servers, software and other miscellaneous products.
Our strategy is to drive the product development and revenues of our core
areas, device networking solutions and IT management solutions.
PRODUCTS
DEVICE NETWORKING SOLUTIONS
We provide manufacturers, integrators, and users with complete device networking
solutions that include the technology required for products to be connected,
managed and controlled over networks using standard protocols for connectivity,
including fiber optic, Ethernet and wireless. As common, everyday products such
as lighting, security and audio/visual systems leverage the power of network
connectivity, manufacturers and users are realizing the benefits of networking.
Our device networking solutions dramatically shorten a manufacturer's
development time to implement network connectivity, provide competitive
advantages with new features, and greatly reduce engineering and marketing
risks. Our hardware solutions include embedded modules (completed boards or
intelligent connectors with electronic components and the necessary connectors
and software that is mounted within a customer's product), and external hardware
modules (with single, multi- or wireless ports), as well as the related
real-time operating system and application software that is required to make the
devices effective. We also offer application- and industry-specific solutions
such as industrial device servers.
Our device servers allow a wide range of equipment to be quickly
network-enabled without the need for intermediary gateways, workstations, or
PCs. This distributed computing approach significantly improves reliability and
up-time. Our device servers also eliminate the high cost of ownership associated
with networking, which frequently would otherwise require using PCs and
workstations to perform connectivity and remote management functions. Our device
servers contain high-performance processors capable of not only controlling the
attached device, but also of accumulating data and status. Such data can then be
formatted by the device server and presented to users via the built in web
server, SNMP, e-mail, etc. Device servers are easy to manage using any standard
Web browser, due to a built-in HTTP server.
In February 2003, we announced the release of our XPort device server,
which represents a significant improvement in technology, and a reduction in
physical size and price for this type of functionality. The thumb-sized XPort is
a self-contained network communications server and miniaturized web site
enclosed within a rugged RJ-45 connector package, which can be embedded in
virtually any electronic product. Products incorporating XPort have their own
address on the World Wide Web and can be accessed from any web browser,
including a wireless PC or Internet-enabled cell phone, from anywhere in the
world. The XPort can serve up Internet-standard web pages, initiate e-mails for
notifications or alerts, and run other applications as defined by the product
manufacturer. XPort eliminates the complexity for a product manufacturer to
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create network connectivity, because the XPort device includes a complete,
integrated solution with a 10/100 Base-T Ethernet connection, a reliable and
proven operating system, an embedded web server, flexible firmware, a full
TCP/IP protocol stack, and optional 256-bit standards-based (AES) encryption. We
believe the relatively low price of the XPort, as well as the speed and ease
with which a manufacturer can design the device into their products, will make a
customer's products more attractive, by providing network connectivity.
In March 2004, we introduced WiPort, a wireless (and wired) device server,
with substantially the same functionality as XPort, but with an 802.11 wireless
configuration, for embedded application to products and situations where a wired
Ethernet environment is not available or practical. In August 2004, we
introduced WiBox, an external wireless web server that is planned for transition
to volume production in the second and third quarters of fiscal 2005.
IT MANAGEMENT SOLUTIONS
Our IT management solutions provide IT professionals with the tools they
need to remotely manage computers and associated systems.
IT professionals use our multiport device solutions (including our terminal
and console servers) to monitor and run their systems to ensure the performance
and availability of critical business information systems, network
infrastructure, and telecommunications equipment. The equipment they manage
includes routers, switches, servers, phone switches and public branch exchanges
that are often located in remote or inaccessible locations.
Our console servers provide system administrators and network managers a
way to connect with their remote equipment through a universal interface called
a console port, helping them work more efficiently without having to leave their
desk or office. With remote access, system downtime, and its impact on business,
is minimized. Our console servers provide IT professionals with peace-of-mind
through extensive security features in some cases, and in some cases, provisions
for dial-in access via modem. These solutions are provided in various
configurations, and can manage up to 48 devices from one console server.
NON-CORE BUSINESSES: VISUALIZATION SOLUTIONS, PRINT SERVERS AND OTHER LEGACY
PRODUCTS
We offer visualization solutions that provide switching and optical
extension of high performance video, audio, keyboard and mouse over long
distances within a building or campus environment. Products include FiberLynx
video display extenders and keyboard, video, mouse ("KVM") switches, KVM
extension systems, and matrix hubs. These products provide a valuable solution
for extending and sharing audio, video, keyboard and mouse signals among many
users and over large distances without loss of resolution. KVM products enable a
single keyboard, monitor and mouse to be switched between multiple computers,
providing immediate access and control from a single location. The customers for
these devices are typically companies needing to isolate users from the core
computing center for security reasons, or have other needs requiring high speed
video sources to be shared among many users. Our visualization solutions can be
found in government agencies and at customers involved with large scale
simulation and display applications.
We began our business by providing external print servers that connect
various printers to a network for shared printing tasks. Over the years, we have
updated and continue to provide print servers that work with a myriad of
operating systems and network configurations. The requirement for external print
servers is decreasing, as manufacturers have incorporated the networking
hardware and software as part of many printers.
We acquired a line of low-cost products which we market under the
"Stallion" brand. Stallion products' range includes a variety of network servers
and a range of multiport serial I/O cards. Various other small categories of our
legacy business are included in this category, such as software revenues and
other product lines we have discontinued or that are being de-emphasized.
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The following are approximate revenues for these categories, the
definitions of which have been modified slightly as of June 30, 2004, and
previous years' data has been modified to conform to the new definitions:
NET REVENUES FOR THE YEARS ENDED JUNE 30,
-----------------------------------------
PRODUCT FAMILY PRIMARY PRODUCT FUNCTION 2004 2003 2002
- --------------------------- ---------------------------------------- ----- ----- -----
Device networking solutions Enable almost any electronic product to $ 27.5 $ 24.5 $ 28.7
become network enabled.
IT management solutions Allow the user to control equipment by way of $ 12.6 $ 13.1 $ 16.5
the Internet using a wide range of network
protocols. This category includes console
servers.
Non-core products Includes visualization solutions, legacy print $ 8.8 $ 11.8 $ 12.4
servers, software and other miscellaneous
products
Financial Accounting Standards Board ("FASB") Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information,"
establishes standards for disclosures about operating segments in annual
consolidated financial statements. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
We operate in one segment, networking and Internet connectivity.
CUSTOMERS
Distributors
Our principal customers are our distributors, who are the source of our
highest percentage of net revenues. Distributors resell our products to a wide
variety of customers including consumers, corporate customers, VARs, etc. We
sell to a group of ten major distributors, who operate, in some cases, from
multiple warehouses. Our major distributors in the U.S. include: Ingram Micro,
Tech Data, KMJ Communications and Arrow Electronics, Inc. In Europe, we
distribute directly from a public warehouse located in Belgium which serves, in
part, the following major distributors: transtec AG (a related party due to
common ownership by our largest shareholder), Sphinx Computer Vertriebs GmbH,
Powercorp PTY, LTD, Jade Communications, LTD, Astradis Elecktronik GmbH, and
Atlantik Systems GmbH.
OEM Manufacturers
We have established a broad range of OEM electro-mechanical manufacturing
customers in various industries such as industrial automation, medical,
security, building automation, consumer and audio/visual. Our OEM customers
typically lack the expertise or resources to develop hardware and software
required to introduce network solutions to their end-users in a timely manner.
To shorten the development cycle to add network connectivity to a product, OEMs
can use our external devices to network-enable their installed base of products,
while board-level embedded modules are typically used in new product designs.
Our capabilities and solutions enable OEMs to focus on their core competencies,
resulting in reduced research and development costs, fewer integration problems,
and faster time to market.
Our module products, including Xport, are particularly useful and adaptable
by OEM customers to enable network connectivity to a wide variety of
electro-mechanical products. In addition to the features it provides, the
advantage is low cost, and the fact that the device can be adapted for use in a
wide range of products without the necessity for lengthy engineering processes
by the OEM, or the time delays that activity might introduce.
End-User Businesses
We have established a broad range of end-user customers in various
businesses such as airports, retail, universities/education, manufacturing,
healthcare/hospitals and financial/banking. End-user businesses require
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solutions that are simple to install, setup, and operate, and can provide
immediate results. Generally, these customers have requirements to connect a
diverse range of products and equipment, without modifying existing software and
systems.
Our external device solutions enable end-users to quickly, securely and
easily connect their devices and equipment to networks, extending the life of
existing investments. In support of these customers, we provide a number of
programs including telephone-based sales and technical support as well as a wide
array of Internet-based resources. In many cases, the customer simply has to
call in to obtain assistance in identifying which networking device would be
most appropriate for its need. After buying the devices from us or one of our
distributors, a customer often only has to plug a cable from the device to be
managed to our external device, and then plug our device into their network.
SALES AND MARKETING
We maintain both an inside and a field sales force. We are also represented
by manufacturers' representatives, VARs and other resellers throughout the world
who call on engineering design and product management teams. We develop
marketing programs, products, tools and services specifically geared to meet the
needs of our targeted customers. Our sales and marketing force consisted of 82
employees as of June 30, 2004 and 83 employees as of June 30, 2003.
We believe that our multi-channel approach provides several advantages. We
can engage the customers and end-users through their channel of choice, making
our solution available from a variety of sources.
Our device networking solutions are principally sold to manufacturers by
our worldwide OEM sales force and through our group of manufacturers'
representatives. We have continued to expand our use of manufacturers'
representatives and other resellers, leveraging their established relationships
to bring our device networking solutions to a greater number of customers within
the OEM market.
We market and sell our IT management solutions and select external device
networking solutions through information technology resellers, industry-specific
system integrators, VARs and directly to end-user organizations. Resellers and
integrators will often obtain our products through distributors. These
distributors supply our products to a broad range of VARs, system integrators,
direct marketers, government resellers and e-commerce resellers. In turn, these
distributor customers market, sell, install, and in most cases, support our
solution to the end-users. We are continuing to expand our use of
cost-effective, indirect channels.
Net revenues generated from sales in the Americas, Europe and other
geographic areas including Asia and Japan for the year ended June 30, 2004 were
$33.8 million, $11.3 million and $3.8 million, respectively, compared to $37.4
million, $10.4 million and $1.6 million for the year ended June 30, 2003 and
$47.7 million, $8.2 million and $1.7 million for the year ended June 30, 2002,
respectively. Although the U.S. represents our largest geographic marketplace,
approximately 31%, 24% and 17% for the years ended June 30, 2004, 2003 and 2002,
respectively of our net sales came from sales to customers outside the U.S.
Gross margin on sales of our products in foreign countries, and sales of product
that include components obtained from foreign suppliers, can be adversely
affected by international trade regulations, including tariffs and antidumping
duties, and by fluctuations in foreign currency exchange rates. Information
concerning our sales by geographic region can be found in Note 15 to the Audited
Consolidated Financial Statements.
MANUFACTURING
Our manufacturing strategy is to produce reliable, high quality products at
competitive prices and to achieve on-time delivery to our customers. To achieve
this strategy, we generally contract with others for the manufacturing of our
products. This practice enables us to concentrate our resources on design,
engineering and marketing where we believe we have greater competitive
advantages.
We have agreements with multiple contract manufacturers. Our contract
manufacturers are located in and around Irvine, Sacramento and Lake Forest,
California; Dongguan, China; Tsao Tuen, Nan-to, Taiwan; and Penang, Malaysia.
Under these agreements, the manufacturers source and supply most raw materials,
components and integrated circuits in accordance with our pre-determined
specifications and forecasts, and perform final assembly, functional testing and
quality control. We believe that this arrangement decreases our working capital
requirements and provides better raw material and component pricing, enhancing
our gross and operating margins. Please see "Risk Factors" for a discussion of
the risks associated with contract manufacturing.
RESEARCH AND DEVELOPMENT
Our research and development efforts are focused on the development of
technology and products that will enhance our position in the markets we serve.
Products are developed in-house and through outside research and development
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resources. We employed 60 employees in our research and development organization
as of June 30, 2004, and 47 employees as of June 30, 2003. Our research and
development expenses were $7.8 million, $9.4 million and $8.7 million for the
years ended June 30, 2004, 2003 and 2002, respectively.
INDUSTRY PARTNERS
In keeping with our business strategy, we have engaged a portfolio of
partners, consortia, and standards committees in an effort to provide the most
complete networking solutions to our customers. We are an active member of
several leading professional and industry associations. Membership in these
associations provides us with a voice in the development of future standards
that are vital to our customers.
SOFTWARE DEVELOPER RELATIONS
Recruiting and informing third-party software developers is an integral
part of our ongoing strategy. We encourage, enable, and support programmers to
develop vertical applications using our hardware, firmware and software
products. With their help and investment in creating additional applications and
markets for our products, we secure a defensible market position and loyal
customers in the process.
COMPETITION
The markets in which we compete are dynamic and highly competitive. We
expect competition to intensify in the future. Our current and potential
competitors include the following:
- - companies with network-enabling technologies, such as Avocent, Echelon,
Moxa, Digi International, Cyclades, Quatech, Wind River, Rabbit, MRV
(formerly known as iTouch), Rose Electronics, Raritan, Equinox and Zilog;
- - companies with equipment for IT management solutions, such as Cyclades,
Moxa, Digi International, Sena, Logical Solutions, Cisco, MRV, DPAC
Technologies and Perle; and
- - companies with significant networking expertise and research and
development resources, including Cisco Systems, IBM and Lucent
Technologies.
The principal competitive factors that affect the market for our products
are:
- - product quality, technological innovation, compatibility with standards and
protocols, reliability, functionality, ease of use, and compatibility;
- - prices of the products; and
- - potential customers' awareness and perception of our products and of
network-enabling technologies.
Much of our technology can be reproduced by our competitors without
royalties or license fees and could compete with our offerings. In addition,
there is a risk that our customers or new entrants to the market could develop
and market their own solutions without paying a fee to us.
INTELLECTUAL PROPERTY RIGHTS
We have developed proprietary methodologies, tools, processes and software
in connection with delivering our services. We have not historically relied on
patents to protect our proprietary rights, although we have recently begun to
build a patent portfolio. We have historically relied on a combination of
copyright, trademark, trade secret laws, and contractual restrictions, such as
confidentiality agreements and licenses, to establish and protect our
proprietary rights.
Trade secret and copyright laws afford us only limited protection. We
cannot be certain that the steps we have taken in this regard will be adequate
to deter misappropriation of our proprietary information or that we will be able
to detect unauthorized use and take appropriate steps to enforce our
intellectual property rights. An adverse change in the laws protecting
intellectual property could harm our business. In addition, we believe that our
success will depend principally upon continuing innovation, technical expertise,
knowledge of networking, storage and applications, and to a lesser extent, on
our ability to protect our proprietary technology. Furthermore, there can be no
9
assurance that our current or future competitors will not develop technologies
that are substantially equivalent to ours.
LIMITATIONS ON OUR RIGHTS TO INTELLECTUAL PROPERTY
Gordian, Inc. ("Gordian") developed certain intellectual property used in
our micro serial server line of products. These products represented and
continue to represent a significant portion of our net revenues. Under the terms
of an agreement dated February 29, 1989, Gordian owned the rights to the
intellectual property developed under the agreement and required us to pay
royalties based upon gross margin of products sold under the agreement. For the
year ended June 30, 2002, we paid Gordian approximately $1.2 million for
royalties. No royalties were paid to Gordian for the years ended June 30, 2004
and 2003 as a result of a new Gordian agreement as described below. Our
agreement with Gordian was to terminate at the end of the sales life of the
products.
On May 30, 2002, we signed a new intellectual property agreement with
Gordian. The new agreement gives us joint ownership of the Gordian intellectual
property that is embodied in the products Gordian has designed for us since
1989. This new agreement provides that we will be able to use the intellectual
property to support, maintain and enhance our products. This new agreement
extinguishes our obligations to pay royalties for each unit of a
Gordian-designed product that we sell as of the effective date.
As part of the new agreement, we paid Gordian $6.0 million in three
installments. We paid $3.0 million concurrent with the signing of the new
agreement, $2.0 million on July 1, 2002, and we made the third and final payment
of $1.0 million on July 1, 2003. We also agreed to purchase $1.5 million of
engineering and support services from Gordian over the 18-month period that
ended November 2003. We are amortizing the intellectual property rights acquired
by this new agreement over the remaining life cycles of our products designed by
Gordian, or approximately three years. We recorded $1.8 million, $2.5 million
and $212,000 of amortization expense in cost of revenues for the years ended
June 30, 2004, 2003 and 2002, respectively.
UNITED STATES AND FOREIGN GOVERNMENT REGULATION
Many of our products and the industries in which they are used are subject
to federal, state or local regulation in the United States. In addition, our
products are exported worldwide. Therefore, we are subject to the regulation of
foreign governments. For example, wireless communication is highly regulated in
both the United States and elsewhere. Our products currently employ encryption
technology; the export of some encryption software is restricted. At this time
our activities comply with existing laws, but we cannot determine whether
future, more restrictive laws, if enacted, would adversely affect us.
Information regarding risks attendant to our foreign operations is set forth in
Part I, Item 7 under the heading "Risk Factors" of this Annual Report on Form
10-K.
EMPLOYEES
As of June 30, 2004, we had 198 full-time employees consisting of 60
employees in research and development, 82 in sales and marketing departments, 21
in operations departments, and 35 general and administrative employees. We have
not experienced any work stoppages and we believe that our relationship with our
employees is good. None of our employees are currently represented by a labor
union.
BACKLOG
Normally, we manufacture our products in advance of receiving firm product
orders from our customers based upon our forecasts of worldwide customer demand.
Most customer orders are placed on an as-needed basis and may be canceled or
rescheduled by the customer without significant penalty. Accordingly, backlog as
of any particular date is not necessarily indicative of our future sales.
Because most of our business is on an as-needed basis and varies slightly, only
because of short-term customer requests, we do not track backlog as a metric of
our operations. We have no customer orders extending more than several months
into the future.
AVAILABILITY OF THIS REPORT
Our annual report on Form 10-K, Quarterly Reports on Form 10-Q, Current
Reports on Form 8-K and amendments to reports filed or furnished pursuant to
Section 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are
available free of charge on our web site at www.lantronix.com shortly after we
-----------------
electronically file such material with the SEC. The public may read and copy any
materials we file with the SEC at the SEC's Public Reference Room at 450 Fifth
Street, NW, Washington, DC 20549. The public may obtain information on the
operation of the Public Reference Room by calling 1-800-SEC-0330. The SEC also
maintains a web site at www.sec.gov that contains reports, proxy, and
-----------
information statements, and other information regarding issues that file
electronically. We assume no obligation to update or revise forward looking
statement in this annual report, whether as a result of new information, future
events or otherwise, unless we are required to do so by law.
10
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table lists the names, ages and positions held by all our
executive officers as of August 31, 2004. There are no family relationships
between any director or executive officer and any other director or executive
officer of Lantronix. Executive officers serve at the discretion of the Board of
Directors.
NAME AGE POSITION
- ------------------------ --- --------
Marc Nussbaum 48 President and Chief Executive Officer
James Kerrigan 68 Chief Financial Officer
Katherine McDermott 44 Vice President of Finance and Secretary
MARC NUSSBAUM has served as our President and Chief Executive Officer since
May 2002 (on an Interim basis until February 2003). From April 2000 to March
2002, Mr. Nussbaum served as Senior Vice President and Chief Technical Officer
for MTI Technology Corporation, a developer of enterprise storage solutions.
From April 1981 to November 1998, Mr. Nussbaum served in various positions at
Western Digital Corporation, a manufacturer of PC components, communication
controllers, storage controllers and hard drives. Mr. Nussbaum lead business
development, strategic planning and product development activities, serving as
Western Digital's Senior Vice President, Chief Technical Officer from 1995 to
1998 and Vice President, Storage Technology and Product Development from 1988
through 1995. Mr. Nussbaum holds a BA degree in physics from the State
University of New York.
JAMES KERRIGAN has served as our Chief Financial Officer since May 2002 (on
an Interim basis until February 2003). From March 2000 to October 2000, he was
Chief Financial Officer of Motiva, a privately-owned company that developed,
marketed and sold collaboration software systems. From January 1998 to February
1999, he was Chief Financial Officer of Who?Vision Systems, Inc., an incubator
company that developed biometric fingerprint devices and software. From April
1995 to March 1997, Mr. Kerrigan was Chief Financial Officer of Artios, Inc., a
privately-owned company that designs, manufactures, and sells prototyping
hardware and software to the packaging industry. Previously, Mr. Kerrigan has
served as chief financial officer for other larger, public companies. He has a
BS degree in engineering and a MBA degree from Northwestern University.
KATHERINE MCDERMOTT has served as our Vice President of Finance since March
2001 and our Secretary since August 2004. Ms. McDermott joined Lantronix in
March 2000 as Corporate Controller. From 1988 through 1999, Ms. McDermott served
in a number of senior level finance positions with Bausch & Lomb, Inc., a global
health care company. Her most recent positions included Corporate Audit Manager,
Plant Controller, and Controller of a wholly owned subsidiary. From 1982 to
1988, Ms. McDermott held various financial positions at a division of General
Motors. Ms. McDermott holds a BBA degree in Business Administration from St.
Bonaventure University in New York, where she graduated cum laude. She also
earned a MBA degree, with a concentration in Finance and Economics, from the
Simon School of Business Administration at the University of Rochester.
ITEM 2. PROPERTIES
We lease a building in Irvine, California that comprises our corporate
headquarters and includes administration, sales, marketing, research and
development, warehouse and order fulfillment functions. We have smaller sales
offices in Milford, Connecticut; Germany; France; Hong Kong and Japan. The
foregoing leases comprise an aggregate of approximately 60,000 square feet of
which our Irvine facility represents the majority of our square footage. Our
Irvine facility has a lease term expiring in July 2005.
During the year ended June 30, 2004, we completed facility and
organizational restructuring activities that we began in fiscal 2003. In
September 2003, we ceased operational activities in Cham, Switzerland, the
headquarters of Lantronix International AG, which is our wholly owned
subsidiary; now, we support international sales and shipping from our Irvine,
California headquarters. In March 2004, we sold our Premise software unit and
closed our Redmond, Washington facility. We continue to make payments on our
lease obligations for facilities we no longer occupy including our facilities
located in Naperville, Illinois, Redmond Washington, Hillsboro, Oregon and Ames,
Iowa. The liability for these lease obligations are included in our
restructuring reserve at June 30, 2004.
ITEM 3. LEGAL PROCEEDINGS
Government Investigation
The SEC is conducting a formal investigation of the events leading up to
our restatement of our financial statements on June 25, 2002. The Department of
Justice is also conducting an investigation concerning events related to the
restatement.
11
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
directors and former officers alleging violations of the Securities Exchange Act
of 1934 and seeking unspecified damages. Subsequently, six similar actions were
filed in the same court. Each of the complaints purports to be a class action
lawsuit brought on behalf of persons who purchased or otherwise acquired our
common stock during the period of April 25, 2001 through May 30, 2002,
inclusive. The complaints allege that the defendants caused us to improperly
recognize revenue and make false and misleading statements about our business.
Plaintiffs further allege that the defendants materially overstated our reported
financial results, thereby inflating our stock price during our securities
offering in July 2001, as well as facilitating the use of our common stock as
consideration in acquisitions. The complaints have subsequently been
consolidated into a single action and the court has appointed a lead plaintiff.
The lead plaintiff filed a consolidated amended complaint on January 17, 2003.
The amended complaint now purports to be a class action brought on behalf of
persons who purchased or otherwise acquired our common stock during the period
of August 4, 2000 through May 30, 2002, inclusive. The amended complaint
continued to assert that we and the individual officer and director defendants
violated the 1934 Act, and also includes alleged claims that we and our officers
and directors violated the Securities Act of 1933 arising from our Initial
Public Offering in August 2000. We filed a motion to dismiss the additional
allegations on March 3, 2003. The Court granted the motion, with leave to amend,
on December 31, 2003. Plaintiffs filed their second amended complaint February
6, 2004, and we filed a motion to dismiss the additional allegations in the
second amended complaint on March 10, 2004. On August 19, 2004, the Court
granted in part and denied in part the motion to dismiss. On September 13, 2004,
plaintiffs filed their third amended complaint. We have not yet answered the
third amended complaint and discovery has not yet commenced.
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
directors and former officers. On January 7, 2003, the plaintiff filed an
amended complaint. The amended complaint alleges causes of action for breach of
fiduciary duty, abuse of control, gross mismanagement, unjust enrichment, and
improper insider stock sales. The complaint seeks unspecified damages against
the individual defendants on our behalf, equitable relief, and attorneys' fees.
We filed a demurrer/motion to dismiss the amended complaint on February 13,
2003. The basis of the demurrer is that the plaintiff does not have standing to
bring this lawsuit since plaintiff has never served a demand on our Board that
the Board take certain actions on our behalf. On April 17, 2003, the Court
overruled our demurrer. All defendants have answered the complaint and generally
denied the allegations. Discovery has commenced, but no trial date has been
established.
Employment Suit Brought by Former Chief Financial Officer and Chief Operating
Officer Steven Cotton
On September 6, 2002, Steven 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.
We filed a motion to dismiss on October 16, 2002, on the grounds that Mr.
Cotton's complaints are subject to the binding arbitration provisions in Mr.
Cotton's employment agreement. On January 13, 2003, the Court ruled that five of
the six counts in Mr. Cotton's complaint are subject to binding arbitration. The
court is staying the sixth count, for declaratory relief, until the underlying
facts are resolved in arbitration. No arbitration date has been set.
Securities Claims Brought by Former Shareholders of Synergetic Micro Systems,
Inc. ("Synergetic")
On October 17, 2002, Richard Goldstein and several other former
shareholders of Synergetic filed a complaint entitled Goldstein, et al v.
Lantronix, Inc., et al in the Superior Court of the State of California, County
of Orange, against us and certain of our former officers and directors.
Plaintiffs filed an amended complaint on January 7, 2003. The amended complaint
alleges fraud, negligent misrepresentation, breach of warranties and covenants,
breach of contract and negligence, all stemming from our acquisition of
Synergetic. The complaint seeks an unspecified amount of damages, interest,
attorneys' fees, costs, expenses, and an unspecified amount of punitive damages.
On May 5, 2003, we answered the complaint and generally denied the allegations
in the complaint. Discovery has commenced but no trial date has been
established.
12
Patent Infringement Litigation
On August 10, 2004, Digi International served a complaint on us alleging
that certain of our products infringe Digi's U.S. Patent No. 6,446,192. Digi
filed the complaint in the U.S. District Court in Minnesota. The complaint seeks
both monetary and non-monetary relief. We are still analyzing all of the
allegations of the complaint. On August 30, 2004, we served and filed an answer
and counterclaim seeking to invalidate U.S. Patent No. 6,446,192 for failure to
meet the applicable statutory requirements in Part II of Title 35 of the United
States Code including, without limitation, 35 U.S.C. Sec. 102, 103 and 112, as
conditions for patentability. The counterclaim seeks both monetary and
non-monetary relief.
We filed, on May 3, 2004, a complaint against Digi, alleging that certain
of Digi's products infringe on our U.S. Patent No. 6,571,305, in the U.S.
District Court for the Central District of California. The complaint seeks both
monetary and non-monetary relief from Digi's infringement. Digi has filed an
answer and counterclaim alleging invalidity of the patent. The Counterclaim
seeks both monetary and non-monetary relief.
Other
From time to time, we are subject to other legal proceedings and claims in
the ordinary course of business. We are currently not aware of any such legal
proceedings or claims that we believe will have, individually or in the
aggregate, a material adverse effect on our business, prospects, financial
position, operating results or cash flows.
The pending lawsuits involve complex questions of fact and law and likely will
continue to require the expenditure of significant funds and the diversion of
other resources to defend. Management is unable to determine the outcome of its
outstanding legal proceedings, claims and litigation involving us, our
subsidiaries, directors and former officers and cannot determine the extent to
which these results may have a material adverse effect on our business, results
of operations and financial condition taken as a whole. The results of
litigation are inherently uncertain, and adverse outcomes are possible. We are
unable to estimate the range of possible loss from outstanding litigation, and
no amounts have been provided for such matters in the consolidated financial
statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during the
fourth quarter of fiscal year ended June 30, 2004.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
Our common stock was traded on The Nasdaq National Market under the symbol
"LTRX" from our initial public offering on August 4, 2000 through October 22,
2002. On October 23, 2002 our listing was changed to The Nasdaq SmallCap Market.
The number of holders of record of our common stock as of August 31, 2004 was
approximately 97. The following table sets forth, for the period indicated, the
high and low per share closing prices for our common stock:
FISCAL YEAR 2003 HIGH LOW
- ------------------ ---- ---
First Quarter $1.03 $0.38
Second Quarter 0.92 0.36
Third Quarter 1.08 0.67
Fourth Quarter 0.91 0.49
FISCAL YEAR 2004 HIGH LOW
- ------------------ ---- ---
First Quarter $1.41 $0.78
Second Quarter 1.32 0.89
Third Quarter 1.86 1.06
Fourth Quarter 2.09 1.18
We believe that a number of factors, including but not limited to quarterly
fluctuations in results of operations, may cause the market price of our common
stock to fluctuate significantly. See "Management's Discussion and Analysis-Risk
Factors."
DIVIDEND POLICY
We have never declared or paid cash dividends on our common stock. We do
not anticipate paying any cash dividends on our common stock in the foreseeable
future, and we intend to retain any future earnings for use in the expansion of
our business and for general corporate purposes. Pursuant to a line of credit we
entered into in January 2002 and have amended on several occasions including
July 24, 2004, we are restricted from paying any dividends.
EQUITY COMPENSATION PLANS
The information required by this item regarding equity compensation plans
is incorporated by reference to the information set forth in Item 12 of this
Annual Report on Form 10-K. Item 12 of this Annual Report on Form 10-K
incorporates by reference the information contained in the sections captioned
"Election of Directors" and "Security Ownership of Certain Beneficial Owners and
Management" in Lantronix's definitive Proxy Statement for the Annual Meeting of
Stockholders to be held November 18, 2004 (the Proxy Statement), a copy of which
will be filed with the Securities and Exchange Commission before the meeting
date.
RECENT SALES OF UNREGISTERED SECURITIES
We have not issued unregistered securities since July 1, 2003. Also, we
have not repurchased any of our common stock during the fourth quarter of fiscal
2004.
14
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included below. In March 2004, we completed the sale of our Premise
business unit that was originally purchased in January 2002. Accordingly, the
information set forth in the table below reflects the Premise business unit as a
discontinued operation. The consolidated statements of operations data for the
years ended June 30, 2004, 2003 and 2002 and the balance sheet data as of June
30, 2004 and 2003, are derived from the audited consolidated financial
statements included elsewhere in this report. The consolidated statements of
operations data for the years ended June 30, 2001 and 2000, and the balance
sheet data as of June 30, 2002, 2001 and 2000, are derived from the audited
consolidated financial statements not included elsewhere in this report. The
historical results are not necessarily indicative of results to be expected for
future periods.
YEARS ENDED JUNE 30,
----------------------------------------------------
2004 2003 2002 2001 2000
--------- --------- --------- --------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Net revenues $ 48,885 $ 49,389 $ 57,591 $ 48,972 $44,975
Cost of revenues 25,026 36,264 40,281 24,530 21,526
--------- --------- --------- --------- --------
Gross profit 23,859 13,125 17,310 24,442 23,449
--------- --------- --------- --------- --------
Operating expenses:
Selling, general and administrative 23,293 28,660 40,538 23,998 16,744
Research and development 7,813 9,430 8,680 4,478 3,186
Stock-based compensation 347 1,453 2,863 3,019 1,093
Amortization of goodwill and purchased intangible assets 148 602 960 1,490 813
Impairment of goodwill and purchased intangible assets - 2,353 50,445 - -
Restructuring (recovery) charges (2,093) 5,600 3,473 - -
Litigation settlement costs - 1,533 1,912 - -
In-process research and development - - - 2,596 -
--------- --------- --------- --------- --------
Total operating expenses 29,508 49,631 108,871 35,581 21,826
--------- --------- --------- --------- --------
Income (loss) from operations (5,649) (36,506) (91,561) (11,139) 1,613
Minority interest - - - - (49)
Interest income (expense), net 50 248 1,548 2,182 187
Other income (expense), net (5,333) (926) (760) (167) (47)
--------- --------- --------- --------- --------
Income (loss) before income taxes and cumulative effect of
accounting changes (10,932) (37,184) (90,773) (9,124) 1,704
Provision (benefit) for income taxes (325) 250 (6,665) (1,876) 649
--------- --------- --------- --------- --------
Income (loss) from continuing operations before cumulative
effect of accounting changes (10,607) (37,434) (84,108) (7,248) 1,055
Loss from discontinued operations (5,047) (10,115) (3,444) - -
--------- --------- --------- --------- --------
Income (loss) before cumulative effect of accounting changes (15,654) (47,549) (87,552) (7,248) 1,055
Cumulative effect of accounting changes:
Change in revenue recognition policy, net of income tax
benefit of $176 - - - (597) -
Adoption of new accounting standard, SFAS No. 142 - - (5,905) - -
--------- --------- --------- --------- --------
Net income (loss) $(15,654) $(47,549) $(93,457) $ (7,845) $ 1,055
========= ========= ========= ========= ========
Basic income (loss) per share from continuing operations before
Cumulative effect of accounting changes $ (0.19) $ (0.69) $ (1.63) $ (0.19) $ 0.04
Loss from discontinued operations (0.09) (0.19) (0.07) - -
--------- --------- --------- --------- --------
Income (loss) before cumulative effect of accounting changes (0.28) (0.88) (1.70) (0.19) 0.04
Cumulative effect of accounting changes per share:
Change in revenue recognition policy, net of income tax
benefit of $176 - - - (0.02) -
Adoption of new accounting standard, SFAS No. 142 - - (0.12) - -
--------- --------- --------- --------- --------
Basic net income (loss) per share $ (0.28) $ (0.88) $ (1.82) $ (0.21) $ 0.04
========= ========= ========= ========= ========
Diluted income (loss) per share from continuing operations before
cumulative effect of accounting changes $ (0.19) $ (0.69) $ (1.63) $ (0.19) $ 0.03
Loss from discontinued operations (0.09) (0.19) (0.07) - -
--------- --------- --------- --------- --------
Income (loss) before cumulative effect of accounting changes (0.28) (0.88) (1.70) (0.19) 0.03
Cumulative effect of accounting changes per share:
Change in revenue recognition policy, net of income tax
benefit of $176 - - - (0.02) -
Adoption of new accounting standard, SFAS No. 142 - - (0.12) - -
--------- --------- --------- --------- --------
Diluted net income (loss) per share $ (0.28) $ (0.88) $ (1.82) $ (0.21) $ 0.03
========= ========= ========= ========= ========
Weighted average shares (basic) 56,862 54,329 51,403 36,946 29,274
========= ========= ========= ========= ========
Weighted average shares (diluted) 56,862 54,329 51,403 36,946 34,178
========= ========= ========= ========= ========
15
AS OF JUNE 30,
--------------
2004 2003 2002 2001 2000
---------- ---------- --------- -------- -------
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents $ 9,128 $ 7,328 $ 26,491 $ 15,367 $ 1,988
Marketable securities 3,050 6,750 6,963 1,973 -
Working capital 12,087 17,312 39,164 36,963 11,042
Goodwill, net 9,488 9,488 7,218 42,273 -
Purchased intangible assets, net 2,056 4,275 11,891 13,328 586
Total assets 37,250 54,947 103,812 116,861 20,210
Retained earnings (accumulated deficit) (156,078) (140,424) (92,875) 582 8,427
Total stockholders' equity 24,791 37,717 82,157 99,496 12,547
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with our consolidated
financial statements and related notes thereto included elsewhere in this
report. In addition to historical information, the discussion in this report
contains forward-looking statements that involve risks and uncertainties. Actual
results could differ materially from those anticipated by these forward-looking
statements due to factors including, but not limited to, those factors set forth
under "Risk Factors" and elsewhere in this report.
OVERVIEW
Lantronix designs, develops and markets products and software solutions
that make it possible to access, manage, control and configure almost any
electronic device over the Internet or other networks. We are a leader in
providing innovative networking solutions. We were initially formed as
"Lantronix," a California corporation, in June 1989. We reincorporated as
"Lantronix, Inc.," a Delaware corporation in May 2000.
Our products are sold to distributors, OEMs, VARs, and systems integrators,
as well as directly to end-users. One customer, Ingram Micro Inc., accounted for
approximately 14%, 11% and 12% of our net revenues for the years ended June 30,
2004, 2003 and 2002, respectively. Another customer, Tech Data Corporation,
accounted for approximately 9%, 10% and 11% of our net revenues for the years
ended June 30, 2004, 2003 and 2002, respectively. Accounts receivable
attributable to these two domestic customers accounted for approximately 13% and
16% of total accounts receivable at June 30, 2004 and 2003, respectively.
One international customer, transtec AG, which is a related party due to
common ownership by our largest stockholder and former Chairman of our Board of
Directors, Bernhard Bruscha, accounted for approximately 3%, 4% and 5% of our
net revenues for the years ended June 30, 2004, 2003 and 2002, respectively. We
also had an agreement with transtec AG for the provision of technical support
services at the rate of $7,500 per month which has now been terminated. Included
in selling, general and administrative expenses is $90,000 for the year ended
June 30, 2002 for these support services. No support services were incurred for
the years ended June 30, 2004 and 2003.
We have completed a number of acquisitions and investments the purpose of
which was to expand our product offerings, increase our technology base and
provide a foundation for future growth.
In October 2001, we completed the acquisition of Synergetic Micro Systems,
Inc. ("Synergetic"), a provider of high performance embedded network
communication solutions that complement our external device products. In
connection with the acquisition, we paid cash consideration of $2.7 million and
issued an aggregate of 2,234,715 shares of our common stock in exchange for all
outstanding shares of Synergetic common stock and reserved 615,705 additional
shares of common stock for issuance upon exercise of outstanding employee stock
options and other rights of Synergetic.
In January 2002, we completed the acquisition of Premise, a developer of
client-side software applications that complement our device networking products
by providing superior management and control capabilities for devices that have
been network and internet enabled. Prior to the acquisition, we held shares of
Premise representing 19.9% ownership and, in addition, held convertible
promissory notes of $1.2 million with interest accrued there-on at the rate of
9.0%. The convertible promissory notes were converted into equity securities of
Premise at the closing of the transaction. We issued an aggregate of 1,063,371
shares of our common stock in exchange for all remaining outstanding shares of
Premise common stock and reserved 875,000 additional shares of common stock for
issuance upon exercise of outstanding employee stock options and other rights of
Premise. In connection with the acquisition, we recorded a one-time charge for
purchased in-process research and development ("IPR&D") expenses of $1.0 million
in our fourth fiscal quarter ended June 30, 2002. In January 2003, we issued an
16
additional 1,063,372 shares of our common stock to the former shareholders of
Premise stock in exchange for a release of all claims relating to the
acquisition. We also accelerated the vesting of options held by certain former
Premise shareholders and released all shares that had been held in the
acquisition escrow. See "Discontinued Operations" section below.
In August 2002, we completed the acquisition of Stallion, a provider of
terminal servers and multiport products. In connection with the acquisition, we
paid $1.2 million in cash consideration, of which $200,000 was paid upon the
execution of the Letter of Intent dated May 9, 2002, and established a cash
escrow account in the amount of $867,000 at the acquisition date to be used in
lieu of our common stock, in the event that we were unable to issue registered
shares by October 31, 2002. In accordance with the terms of the agreement, we
were not able to issue registered shares by October 31, 2002; accordingly, the
cash escrow amount of $867,000 was released on November 1, 2002. In addition, we
issued two-year notes in the principal amount of $867,000 accruing interest at a
rate of 2.5% per annum. The notes were paid to the holders in August 2004.
In September and October 2001, we made a strategic investment in Xanboo, a
privately-held company that develops technology that allows users to control,
command and view their home or business remotely over the Internet. We paid an
aggregate of $3.0 million for convertible promissory notes, which converted in
January 2002, in accordance with their terms, into Xanboo preferred stock. In
addition, we purchased $4.0 million of Xanboo preferred stock in January 2002.
Our ownership interest in Xanboo was 14.9%, 15.3% and 15.8% at June 30, 2004,
2003 and 2002, respectively. Our investment in Xanboo is accounted for using the
equity method of accounting based on our ability through representation on
Xanboo's board of directors to exercise significant influence over its
operations. Our losses in Xanboo aggregating $413,000, $1.3 million and $526,000
for the years ended June 30, 2004, 2003 and 2002, respectively, have been
recognized as other expense in the accompanying consolidated statement of
operations. We periodically review our investments for which fair value is less
than cost to determine if the decline in value is other than temporary. If the
decline in value is judged to be other than temporary, the cost basis of the
security is written down to fair value. We generally believe an
other-than-temporary decline has occurred when the fair value of the investment
is below the carrying value for two consecutive quarters, absent evidence to the
contrary. On the basis of events occurring during the quarter ended June 30,
2004, we performed an analysis and recorded a charge in the amount of $5.0
million, representing a write-off of all remaining value of this non-marketable
equity security. This charge is included within the consolidated statements of
operations as other expense.
Discontinued operations
In August 2001, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS No. 144"). SFAS No. 144 supersedes FASB Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of;" however, it retains the fundamental provisions of that
statement related to the recognition and measurement of the impairment of
long-lived assets to be "held and used." SFAS No. 144 also supersedes the
accounting and reporting provisions of Accounting Principles Board ("APB")
Opinion No. 30, "Reporting the Results of Operation's - Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions", for the disposal of a segment of a business.
Under SFAS No. 144, a component of a business that is held for sale is reported
in discontinued operations if (i) the operations and cash flows will be, or have
been, eliminated from the ongoing operations of the company and, (ii) the
company will not have any significant continuing involvement in such operations.
In March 2004, we sold substantially all of the net assets of our Premise
business unit for $1.0 million. Additionally, we incurred $383,000 of disposal
costs.
Impairment of goodwill and purchased intangible assets related to
discontinued operations
During the second quarter of fiscal 2004, we identified indicators of an
other than temporary impairment as it related to our Premise acquisition of
goodwill and purchased intangible assets. We performed an assessment of the
value of our goodwill and purchased intangible assets in accordance with SFAS
No. 142, "Goodwill and Other Intangible Assets" and SFAS No. 144. We identified
certain conditions including continued losses and the inability to achieve
significant revenue from the existing home automation and media management
software markets as indicators of asset impairment. These conditions led to
operating results and forecasted future results that were substantially less
than had been anticipated. We revised our projections and determined that the
projected results utilizing a discounted cash flow valuation technique would not
fully support the carrying values of the goodwill and purchased intangible
assets associated with the Premise acquisition. Based on this assessment, we
recorded an impairment charge of $2.2 million during the second quarter of
fiscal 2004 to write-off the value of the Premise goodwill. Additionally, during
the second quarter of fiscal 2004, we recorded a $790,000 impairment charge of
the Premise purchased intangible assets of which $14,000 and $776,000 were
charged to operating expenses and cost of revenues, respectively. As a result of
the sale of the Premise business unit, the goodwill and purchased intangibles,
net of Premise at June 30, 2003 have been included as part of discontinued
operations.
17
During the third quarter of fiscal 2004, we sold the assets related to our
Premise business unit to an undisclosed buyer for $1.0 million cash. After
paying all related transaction fees, resolving our lease commitments, and paying
other restructuring costs related to the transaction, the transaction had a
then-favorable impact on our cash balance of approximately $250,000. For the
years ended June 30, 2004, 2003 and 2002, the impact of the Premise business
unit resulted in a $5.0 million, $10.1 million and $3.4 million loss,
respectively, recorded as discontinued operations in our consolidated statement
of operations.
The loss from discontinued operations for the year ended June 30, 2004 of
$5.0 million includes a negative gross profit of $822,000, primarily due to the
$776,000 purchased intangible asset impairment charge, $2.0 million of operating
expenses, $590,000 of restructuring charges, a $2.3 million impairment charge of
Premise goodwill charged to operating expenses, and a gain on the sale of
Premise of $592,000.
The loss from discontinued operations for the year ended June 30, 2003 of
$10.1 million includes a negative gross profit of $1.2 million primarily due to
the $846,000 purchased intangible asset impairment charge, $3.4 million of
operating expenses, $111,000 of restructuring charges, a $4.4 million impairment
charge of Premise goodwill, and a $1.1 million legal settlement with the former
shareholders of Premise.
The loss from discontinued operations for the year ended June 30, 2002 of
$3.4 million includes a negative gross profit of $174,000, $1.9 million of
operating expenses, $383,000 impairment charge of Premise purchased intangible
assets charged to operating expenses, and a $1.0 million IPR&D charge as a
result of the Premise acquisition.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires us to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of net revenues
and expenses during the reporting period. We regularly evaluate our estimates
and assumptions related to net revenues, allowances for doubtful accounts, sales
returns and allowances, inventory reserves, goodwill and purchased intangible
asset valuations, warranty reserves, restructuring costs, litigation and other
contingencies. We base our estimates and assumptions on historical experience
and on various other factors that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. To the extent there are material differences between our
estimates and the actual results, our future results of operations will be
affected.
We believe the following critical accounting policies require us to make
significant judgments and estimates in the preparation of our consolidated
financial statements:
Revenue Recognition
We do not recognize revenue until all of the following criteria are met:
persuasive evidence of an arrangement exists; delivery has occurred or services
have been rendered; our price to the buyer is fixed or determinable; and
collectibility is reasonably assured. Commencing July 1, 2000, we adopted a new
accounting policy for revenue recognition such that recognition of revenue and
related gross profit from sales to distributors are deferred until the
distributor resells the product. Net revenue from certain smaller distributors
for which point-of-sale information is not available, is recognized one month
after the shipment date. This estimate approximates the timing of the sale of
the product by the distributor to the end-user. 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 two year warranty. Although we engage
in extensive product quality programs and processes, our warranty obligation is
affected by product failure rates, use of materials or service delivery costs
that differ from our estimates. As a result, additional warranty reserves could
be required, which could reduce gross margins. Additionally, we sell extended
warranty services which extend the warranty period for an additional one to
three years. Warranty revenue is recognized evenly over the warranty service
period.
18
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. Our
allowance for doubtful accounts is based on our assessment of the collectibility
of specific customer accounts, the aging of accounts receivable, our history of
bad debts and the general condition of the industry. If a major customer's
credit worthiness deteriorates, or our customers' actual defaults exceed our
historical experience, our estimates could change and impact our reported
results. We also maintain a reserve for uncertainties relative to the collection
of officer notes receivable. Factors considered in determining the level of this
reserve include the value of the collateral securing the notes, our ability to
effectively enforce collection rights and the ability of the former officers to
honor their obligations.
Inventory Valuation
Our policy is to value inventories at the lower of cost or market on a
part-by-part basis. This policy requires us to make estimates regarding the
market value of our inventories, including an assessment of excess and obsolete
inventories. We determine excess and obsolete inventories based on an estimate
of the future sales demand for our products within a specified time horizon,
generally three to twelve months. The estimates we use for demand are also used
for near-term capacity planning and inventory purchasing and are consistent with
our revenue forecasts. In addition, specific reserves are recorded to cover
risks in the area of end of life products, inventory located at our contract
manufacturers, deferred inventory in our sales channel and warranty replacement
stock.
If our sales forecast is less than the inventory we have on hand at the end
of an accounting period, we may be required to take excess and obsolete
inventory charges which will decrease gross margin and net operating results for
that period.
Valuation of Deferred Income Taxes
We have recorded a valuation allowance to reduce our net deferred tax
assets to zero, primarily due to our inability to estimate future taxable
income. We consider estimated future taxable income and ongoing prudent and
feasible tax planning strategies in assessing the need for a valuation
allowance. If we determine that it is more likely than not that we will realize
a deferred tax asset, which currently has a valuation allowance, we would be
required to reverse the valuation allowance which would be reflected as an
income tax benefit at that time.
Goodwill and Purchased Intangible Assets
The purchase method of accounting for acquisitions requires extensive use
of accounting estimates and judgments to allocate the purchase price to the fair
value of the net tangible and intangible assets acquired, including IPR&D.
Goodwill and intangible assets deemed to have indefinite lives are no longer
amortized but are subject to annual impairment tests. The amounts and useful
lives assigned to intangible assets impact future amortization and the amount
assigned to IPR&D is expensed immediately. If the assumptions and estimates used
to allocate the purchase price are not correct, purchase price adjustments or
future asset impairment charges could be required.
Impairment of Long-Lived Assets
We evaluate long-lived assets used in operations when indicators of
impairment, such as reductions in demand or significant economic slowdowns, are
present. Reviews are performed to determine whether the carrying values of
assets are impaired based on a 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
the event they are lower, additional impairment charges or shortened useful
lives of certain long-lived assets could be required.
Strategic Investments
We have made strategic investments in privately held companies for the
promotion of business and strategic investments. Strategic investments with less
than a 20% voting interest are generally carried at cost. We will use the equity
method to account for strategic investments in which we have a voting interest
of 20% to 50% or in which we otherwise have the ability to exercise significant
influence. Under the equity method, the investment is originally recorded at
cost and adjusted to recognize our share of net earnings or losses of the
investee, limited to the extent of our investment in the investee. From time to
time we are required to estimate the amount of our losses of the investee. Our
estimates are based on historical experience. The value of non-publicly traded
securities is difficult to determine. We periodically review these investments
for other-than-temporary declines in fair value based on the specific
identification method and write down investments to their fair value when an
19
other-than-temporary decline has occurred. We generally believe an
other-than-temporary decline has occurred when the fair value of the investment
is below the carrying value for two consecutive quarters, absent evidence to the
contrary. Fair values for investments in privately held companies are estimated
based upon the values of recent rounds of financing. Although we believe our
estimates reasonably reflect the fair value of the non-publicly traded
securities held by us, had there been an active market for the equity
securities, the carrying values might have been materially different than the
amounts reported. Future adverse changes in market conditions or poor operating
results of companies in which we have such investments could result in losses or
an inability to recover the carrying value of the investments that may not be
reflected in an investment's current carrying value and which could require a
future impairment charge. During the fourth quarter of 2004, we wrote-off $5.0
million representing the remaining balance of our investment in Xanboo.
Subsequent to the write-off of Xanboo, there are no other strategic investments
as of June 30, 2004.
Restructuring Charge
Over the last several quarters we have undertaken, and we may continue to
undertake, significant restructuring initiatives, which have required us to
develop formalized plans for exiting certain business activities. We have had to
record estimated expenses for lease cancellations, contract termination
expenses, long-term asset write-downs, severance and outplacement costs and
other restructuring costs. Given the significance of, and the timing of the
execution of such activities, this process is complex and involves periodic
reassessments of estimates made at the time the original decisions were made.
Through December 31, 2002, the accounting rules for restructuring costs and
asset impairments required us to record provisions and charges when we had a
formal and committed plan. Beginning January 1, 2003, the accounting rules now
require us to record any future provisions and changes at fair value in the
period in which they are incurred. In calculating the cost to dispose of our
excess facilities, we had to estimate our future space requirements and the
timing of exiting excess facilities and then estimate for each location the
future lease and operating costs to be paid until the lease is terminated and
the amount, if any, of sublease income. This required us to estimate the timing
and costs of each lease to be terminated, including the amount of operating
costs and the rate at which we might be able to sublease the site. To form our
estimates for these costs, we performed an assessment of the affected facilities
and considered the current market conditions for each site. Our assumptions on
future space requirements, the operating costs until termination or the
offsetting sublease revenues may turn out to be incorrect, and our actual costs
may be materially different from our estimates, which could result in the need
to record additional costs or to reverse previously recorded liabilities. Our
policies require us to periodically evaluate the adequacy of the remaining
liabilities under our restructuring initiatives. As management continues to
evaluate the business, there may be additional charges for new restructuring
activities as well as changes in estimates to amounts previously recorded.
Settlement Costs
From time to time, we are involved in legal actions arising in the ordinary
course of business. We cannot assure you that these actions or other third party
assertions against us will be resolved without costly litigation, in a manner
that is not adverse to our financial position, results of operations or cash
flows. As facts concerning contingencies become known, we reassess our position
and make appropriate adjustments to the financial statements. There are many
uncertainties associated with any litigation. If our initial assessments
regarding the merits of a claim prove to be wrong, our results of operations and
financial condition could be materially and adversely affected. In addition, if
further information becomes available that causes us to determine a loss in any
of our pending litigation, is probable and we can reasonably estimate a range of
loss associated with such litigation, then we would record at least the minimum
estimated liability. However, the actual liability in any such litigation may be
materially different from our estimates, which could result in the need to
record additional costs. We record our legal expenses as incurred; reimbursement
of legal expenses from insurance or other sources are recorded upon receipt.
Recent Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51," ("FIN 46"). FIN 46
requires certain variable interest entities ("VIE") to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective for all new VIEs created or acquired after January 31, 2003. For VIEs
created or acquired prior to February 1, 2003, the provisions of FIN 46 must be
applied for the first interim or annual period ending March 15, 2004. We
reviewed our investments and other arrangements and determined that none of our
investee companies are VIE's.
In May 2003, the FASB issued SFAS No. 150, "Accounting For Certain
Financial Instruments with Characteristics of Both Liabilities and Equity"
("SFAS No. 150") which establishes standards for how an issuer of financial
instruments classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability (or an
asset in some circumstances) if, at inception, the monetary value of the
obligation is based solely or predominantly on a fixed monetary amount known at
inception, variations in something other than the fair value of the issuer's
equity shares or variations inversely related to changes in the fair value of
the issuer's equity shares. SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
20
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 did not have a material impact on our financial
position, results of operations or cash flows.
Cumulative effect of an accounting change
Under the transitional provisions of SFAS No. 142, effective as of July 1,
2002, we completed our initial assessment and concluded that goodwill arising
from the acquisition of United States Software Corporation ("USSC"), having a
carrying amount of approximately $5.9 million as of July 1, 2001, may be
impaired. We engaged an independent valuation company to perform a review of the
value of our goodwill related to USSC. Based on the independent valuation, which
utilized a discounted cash flow valuation technique, we recorded a $5.9 million
charge for the impairment of our USSC goodwill. This amount is reflected as the
cumulative effect of adopting the new accounting standard effective July 1,
2001.
The following discussion of results of operations includes discussion of
continuing operations only. Certain amounts in the 2003 and 2002 consolidated
financial statements have been reclassified to conform with current year
presentation.
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
of net revenues represented by each item in our consolidated statements of
operations:
YEAR ENDED JUNE 30,
----------------------
2004 2003 2002
------- ------- --------
Net revenues 100.0% 100.0% 100.0%
Cost of revenues 51.2 73.4 69.9
------- ------- --------
Gross profit 48.8 26.6 30.1
------- ------- --------
Operating expenses:
Selling, general and administrative 47.6 58.0 70.4
Research and development 16.0 19.1 15.1
Stock-based compensation 0.7 2.9 5.0
Amortization of purchased intangible assets 0.3 1.2 1.7
Impairment of goodwill and purchased intangible assets - 4.8 87.6
Restructuring (recovery) charges (4.3) 11.3 6.0
Litigation settlement costs - 3.1 3.3
------- ------- --------
Total operating expenses 60.4 100.5 189.0
------- ------- --------
Loss from operations (11.6) (73.9) (159.0)
Interest income (expense), net 0.1 0.5 2.7
Other income (expense), net (10.9) (1.9) (1.3)
------- ------- --------
Loss before income taxes and cumulative effect of an accounting change (22.4) (75.3) (157.6)
Provision (benefit) for income taxes (0.7) 0.5 (11.6)
------- ------- --------
Loss from continuing operations before cumulative effect of an accounting change (21.7) (75.8) (146.0)
Loss from discontinued operations (10.3) (20.5) (6.0)
------- ------- --------
Loss before cumulative effect of an accounting change (32.0) (96.3) (152.0)
Cumulative effect of adoption of new accounting standard, SFAS No. 142 - - (10.33)
------- ------- --------
Net loss (32.0)% (96.3)% (162.3)%
======= ======= ========
COMPARISON OF THE YEARS ENDED JUNE 30, 2004 AND 2003
Net Revenues by Product Category
YEAR ENDED
JUNE 30,
-------------------------------------------------------------
% OF NET % OF NET $ %
PRODUCT CATEGORIES 2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
- ------------------ ------- --------- ------- --------- ---------- ---------
Device networking $27,481 56.2% $24,523 49.6% $ 2,958 12.1%
IT management 12,555 25.7% 13,034 26.4% (479) (3.7)%
Non-core 8,849 18.1% 11,832 24.0% (2,983) (25.2)%
------- --------- ------- --------- ---------- ---------
TOTAL $48,885 100.0% $49,389 100.0% $ (504) (1.0)%
======= ========= ======= ========= ========== =========
The overall decrease in net revenues was primarily attributable to a
decrease in net revenues of our non-core and IT management product lines offset
by an increase in our device networking product line. Our increase in device
networking products included increases from our newly introduced XPort product.
The decrease in our IT management product line is primarily due to delays in
21
introducing certain new products. During the fourth quarter of fiscal 2004, we
introduced a new line of console servers and we have substantially increased our
marketing and sales efforts in our IT management solutions product family. The
decrease in our non-core product line was primarily attributable to a decrease
in our legacy print server, industrial controller board and Stallion product
lines. We are no longer investing in the development of these product lines and
expect net revenues related to these product lines to continue to decline in the
future as we focus our investment on device networking and IT management
products.
Net Revenues by Region
YEAR ENDED
JUNE 30,
-------------------------------------------------------------
% OF NET % OF NET $ %
GEOGRAPHIC REGION 2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
- ----------------- --------- --------- ----- -------- --------- ---------
Americas $ 33,847 69.3% $37,391 75.7% $(3,544) (9.5)%
Europe 11,252 23.0% 10,366 21.0% 886 8.5 %
Other 3,786 7.7% 1,632 3.3% 2,154 132.0 %
--------- --------- ------- ------- -------- -------
TOTAL $ 48,885 100.0% $49,389 100.0% $ (504) (1.0)%
========= ========= ======= ======= ======== =======
The overall decrease in net revenues is primarily due to a decrease in the
Americas region. The decrease in net revenues in the Americas region is
primarily attributable to our exit of the industrial controller board product
line, which was sold entirely in the Americas as well as our decrease in the IT
management product family net revenues. The increase in Europe is primarily due
to the addition of new customers including three new distributors and several
channel customers. The increase in other is primarily due to the signing of
several new customers and our increased sales efforts in the Asia Pacific
region.
Gross Profit
YEAR ENDED
JUNE 30,
--------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
------- --------- ------- --------- --------- ---------
Gross profit $23,859 48.8% $13,125 26.6% $ 10,734 8.5 %
======= ========= ======= ========= ========= =========
Gross profit represents net revenues less cost of revenues. Cost of
revenues consists primarily of the cost of raw material components, subcontract
labor assembly from outside manufacturers, amortization of purchased intangible
assets, impairment of purchased intangible assets, establishing or relieving
inventory reserves for excess and obsolete products or raw materials, overhead
and warranty costs. Cost of revenues for the years ended June 30, 2004 and 2003
included $2.1 million and $3.6 million of amortization of purchased intangible
assets, respectively. Cost of revenues for the year ended June 30, 2003 includes
a $3.1 million impairment charge of purchased intangible assets, in accordance
with SFAS No. 144. No impairment charge was recorded for the year ended June 30,
2004. At June 30, 2004, the unamortized balance of purchased intangible assets
that will be amortized to future cost of revenues was $2.0 million, of which
$1.4 million will be amortized in fiscal 2005 and $557,000 in fiscal 2006.
In May 2002, we signed a new agreement with Gordian to acquire a joint
interest in the intellectual property that is evident in our products designed
by Gordian and to extinguish our obligation to pay royalties on future sales of
our products. We paid $6.0 million for this intellectual property and are
amortizing this asset to cost of revenues over the remaining life of our
products designed by Gordian, or approximately 3 years. Effective May 30, 2002,
upon the signing of the new agreement, royalty expenses have been replaced by an
amortization of the prepaid royalties and entitlement to the intellectual
property that was part of the agreement. Amortization expense related to the new
Gordian agreement, included in amortization of purchased intangible assets of
$2.1 million, totaled $1.8 million for the year ended June 30, 2004.
Amortization expense related to the new Gordian agreement, included in
amortization of purchased intangible assets of $3.6 million totaled $2.5 million
for the year ended June 30, 2003. The increase in gross profit is primarily
attributable to a lower inventory reserve provision in fiscal 2004 compared to
fiscal 2003, an overall reduction in payroll and payroll related costs due to
the closing of our Milford, Connecticut facility in February 2003, an increase
in our capitalized inventory overhead and a decrease in the amortization of
purchased intangible assets due to the impairment write-down of $3.1 million
during the fourth quarter of fiscal 2003. These decreases were offset by an
increase in our warranty expense.
22
Selling, General and Administrative
YEAR ENDED
JUNE 30,
--------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
------- --------- ------- --------- ---------- ---------
Selling, general and administrative $23,293 47.6% $28,660 58.0% $ (5,367) (18.7)%
======= ========= ======= ========= ========== =========
Selling, general and administrative expenses consist primarily of
personnel-related expenses including salaries and commissions, facility
expenses, information technology, trade show expenses, advertising, insurance
proceeds, and professional legal and accounting fees. Selling, general and
administrative expense decreased primarily due to reductions in headcount and
facility costs as a result of our fiscal 2003 restructurings, decrease in legal
and other professional fees, improvement in our accounts receivable resulting in
a reduction of our allowance for doubtful accounts, offset by an increase in our
directors and officers liability insurance. The legal fees primarily relate to
our defense of the shareholders and various other lawsuits and the SEC
investigation. Legal fees incurred in defense of the shareholder suits are
reimbursable to the extent provided in our directors and officers liability
insurance policies, and subject to the coverage limitations and exclusions
contained in such policies. For the years ended June 30, 2004 and 2003, we have
been reimbursed $3.0 million and $1.4 million of these expenses. Management
expects to receive additional reimbursements from insurance sources for legal
fees in fiscal 2005.
Research and Development
YEAR ENDED
JUNE 30,
--------------------------------------------------------------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
--------- --------- ------ --------- ---------- ---------
Research and development $ 7,813 16.0% $9,430 19.1% $ (1,617) (17.1)%
========= ========= ====== ========= ========== =========
Research and development expenses consist primarily of personnel-related
costs of employees, as well as expenditures to third-party vendors for research
and development activities. Research and development expenses decreased
primarily due to our fiscal 2003 restructurings which resulted in the
consolidation of our research and development activities primarily to our
Irvine, California facility.
Stock-based compensation
YEAR ENDED
JUNE 30,
----------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
----- --------- ------ --------- ---------- ---------
Stock-based compensation $ 347 0.7% $1,453 2.9% $ (1,106) (76.1)%
===== ========= ====== ========= ========== =========
Stock-based compensation expense generally represents the amortization of
deferred compensation. We recorded no deferred compensation for the year ended
June 30, 2004 and recorded a reduction to deferred compensation as a result of
employee stock option forfeitures in the amount of $197,000. Deferred
compensation represents the difference between the fair value of the underlying
common stock for accounting purposes and the exercise price of the stock options
at the date of grant as well as the fair market value of the vested portion of
non-employee stock options utilizing the Black-Scholes option pricing model.
Deferred compensation also includes the value of employee stock options assumed
in connection with our acquisitions calculated in accordance with current
accounting guidelines. Deferred compensation is presented as a reduction of
stockholders' equity and is amortized ratably over the respective vesting
periods of the applicable options, which is generally four years.
Included in cost of revenues is stock-based compensation of $48,000 and
$89,000 for the years ended June 30, 2004 and 2003, respectively. Stock-based
compensation decreased primarily due to the restructuring plan whereby options
for which deferred compensation has been recorded were forfeited by terminated
employees. Additionally, the decrease is due to the acceleration of
approximately $239,000 of stock-based compensation in January 2003 as a result
of our completion of a stock option exchange program whereby employees holding
options to purchase our common stock were given the opportunity to cancel
certain of their existing options in exchange for the opportunity to receive new
options. At June 30, 2004, a balance of $103,000 remains and will be amortized
as follows: $86,000 in fiscal 2005 and $17,000 in fiscal 2006.
23
Amortization of purchased intangible assets
YEARS ENDED
JUNE 30,
-----------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
----- --------- ----- --------- ---------- ---------
Amortization of purchased intangible assets $ 148 0.3% $ 602 1.2% $ (454) (75.4)%
===== ========= ===== ========= ========== =========
Purchased intangible assets primarily include existing technology, patents
and non-compete agreements and are amortized on a straight-line basis over the
estimated useful lives of the respective assets, ranging from one to five years.
We obtained independent appraisals of the fair value of tangible and intangible
assets acquired in order to allocate the purchase price. In addition,
approximately $2.1 million and $3.6 million of amortization of purchased
intangible assets have been classified as cost of revenues for the years ended
June 30, 2004 and 2003, respectively. During the fourth fiscal quarter of 2004,
we completed our annual impairment assessment and determined that no impairment
was indicated as the estimated fair values exceeded their respective carrying
values. The overall decrease is primarily due to the impairment charge of $2.4
million recorded during the year ended June 30, 2003. At June 30, 2004, the
unamortized balance of purchased intangible assets that will be amortized to
future operating expense was $67,000 which will be amortized in fiscal 2005.
Impairment of goodwill and purchased intangible assets
During the fourth quarter of fiscal 2003, we performed an assessment of the
value of our purchased intangible assets in accordance with SFAS No. 144. As a
result of industry conditions, continued lower market valuations and reduced
estimates in information technology capital equipment spending in the future and
other factors impacting expected future cash flows, we determined that there
were indicators of impairment to the carrying value of our purchased intangible
assets recorded as part of our acquisitions. We engaged an independent valuation
company to perform a review of the value of our purchased intangible assets. In
accordance with SFAS No. 144, we utilized a cash flow estimation approach,
comparing the discounted expected future cash flows to the carrying value of the
subject assets. Based on the independent valuations, during the fourth quarter
of fiscal 2003 we recorded a $5.4 million impairment charge of which $2.4
million and $3.1 million were charged to operating expenses and cost of
revenues, respectively.
Restructuring (recovery) charges
On September 12, 2002 and again on March 14, 2003, we announced a
restructuring plan to prioritize our initiatives around the growth areas of our
business, focus on profit contribution, reduce expenses and improve operating
efficiency. These restructuring plans included a worldwide workforce reduction,
consolidation of excess facilities and other charges. We recorded restructuring
costs totaling $5.6 million which were classified as operating expenses in the
consolidated statements of operations for the year ended June 30, 2003. The
restructuring plans resulted in the reduction of approximately 58 regular
employees worldwide. We recorded workforce reduction charges of approximately
$1.2 million related to severance and fringe benefits for the terminated
employees. We recorded charges of approximately $4.4 million related to
consolidation of excess facilities, relating primarily to lease terminations,
non-cancelable lease costs, write-off of leasehold improvements and termination
of a contractual obligation.
During the year ended June 30, 2004, approximately $2.1 million of
restructuring charges were recovered related to a favorable settlement of a
contractual obligation, consolidation of excess facilities and workforce
reductions which were previously accrued for in fiscal 2003. The remaining
restructuring reserve is related to facility closures in Naperville, Illinois;
Hillsboro, Oregon; Redmond, Washington and Ames, Iowa. Payments under the lease
obligations will end in fiscal 2007.
Litigation settlement costs
On August 23, 2002, a complaint entitled Dunstan v. Lantronix, Inc., et
al., was filed in the Circuit Court of the State of Oregon, County of Multnomah,
against us and certain of our current and former officers and directors by the
co-founders of USSC. The parties participated in mediation on June 30, 2003, and
subsequently reached an agreement to settle the dispute. The agreement called
for us to release to the plaintiffs approximately $400,000 in cash and 49,038
shares of our common stock that had been held in an escrow since December 2000
as part of the acquisition of USSC. The agreement also called for us to issue to
the plaintiffs additional shares of our common stock worth approximately $1.5
million, which was recorded in our results of operations as litigation
settlement costs for the year ended June 30, 2003. Accordingly, 1,726,703 shares
24
were issued following a fairness determination by the state court in Oregon. In
exchange, the plaintiffs released all claims against all defendants. No
litigation settlement costs related to this matter were incurred during the year
ended June 30, 2004.
Interest Income (Expense), Net
YEAR ENDED
JUNE 30,
----------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
----- --------- ----- --------- ---------- ---------
Interest income (expense), net $ 50 0.1% $ 248 0.5% $ (198) (79.8)%
===== ========= ===== ========= ========== =========
Interest income (expense), net consists primarily of interest earned on
cash, cash equivalents and marketable securities. The decrease is primarily due
to lower average investment balances and interest rates. Additionally, the
decrease in the average investment balance is due to increased legal and other
professional fees, settlement of litigation and contractual obligations, cash
portions of settlements with prior owners of some of the businesses we have
acquired, the settlement of the Milford lease obligation included in our
restructuring charge, the purchase of a joint interest in intellectual property
from Gordian, our acquisition of Stallion and to fund current operations.
Other Income (Expense), Net
YEAR ENDED
JUNE 30,
----------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
-------- --------- ------ --------- --------- ---------
Other income (expense), net $(5,333) (10.9)% $(926) (1.9)% $ 4,407 475.9%
======== ========= ====== ========= ========= =========
The increase in other expense is due to our decision to write-off our
investment in Xanboo. We periodically review our investments for which fair
value is less than cost to determine if the decline in value is other than
temporary. If the decline in value is judged to be other than temporary, the
cost basis of the security is written down to fair value. We generally believe
an other-than-temporary decline has occurred when the fair value of the
investment is below the carrying value for two consecutive quarters, absent
evidence to the contrary. On the basis of events occurring during the quarter
ended June 30, 2004, we performed an analysis and recorded a charge in the
amount of $5.0 million, representing a write-off of all remaining value of this
non-marketable equity security. This charge is included within the consolidated
statements of operations as other expense.
Provision (Benefit) for Income Taxes
We utilize the liability method of accounting for income taxes as set forth
in FASB Statement No. 109, "Accounting for Income Taxes." Our effective tax rate
was 3% for the year ended June 30, 2004, and 0% for the year ended June 30,
2003. The federal statutory rate was 34% for both periods. Our effective tax
rate associated with the income tax expense for the year ended June 30, 2004,
was lower than the federal statutory rate primarily due to the increase in
valuation allowance. Our effective tax rate associated with the income tax
benefit for the year ended June 30, 2003, was lower than the federal statutory
rate primarily due to the increase in valuation allowance and amortization of
stock-based compensation for which no benefit was provided. In 2003, the
Internal Revenue Service ("IRS") completed its audit of our federal income tax
returns for the fiscal years ended June 30, 1999, 2000 and 2001. As a result, we
were required to pay approximately $776,000 in tax and interest to the IRS and
the California Franchise Tax Board. We accrued $1.3 million for this liability
in prior fiscal periods. Based on the final resolution of their examination and
related state impact of the IRS examination, we recorded a reduction in our tax
contingency reserve of approximately $500,000. We have paid $662,000 of this
liability through June 30, 2004 and $114,000 was paid during the quarter ended
September 30, 2004.
COMPARISON OF THE YEARS ENDED JUNE 30, 2003 AND 2002
Net Revenues
NET REVENUES BY PRODUCT CATEGORY
YEAR ENDED
JUNE 30,
----------
% OF NET % OF NET $ %
PRODUCT CATEGORIES 2003 REVENUE 2002 REVENUE VARIANCE VARIANCE
- ------------------ ------- --------- -------- --------- ---------- ---------
Device networking $24,523 49.6% $ 28,607 49.8% $ (4,084) (14.3)%
==========
IT management 13,034 26.4% 16,528 28.7% (3,494) (21.1)%
Non-core 11,832 24.0% 12,456 21.5% (624) (5.0)%
------- --------- -------- --------- ---------- ---------
TOTAL $49,389 100.0% $ 57,591 100.0% $ (8,202) (14.3)%
======= ========= ======== ========= ========== =========
25
The overall decrease in net revenues by product is primarily attributable
to logistical issues surrounding the restructuring of our Milford, Connecticut
operations, whereby we began to outsource our manufacturing to three contract
manufacturers, our discontinuance of certain product offerings as well as the
overall decrease in industry technology spending year to year.
NET REVENUES BY REGION
YEAR ENDED
JUNE 30,
----------
% OF NET % OF NET $ %
GEOGRAPHIC REGION 2003 REVENUE 2002 REVENUE VARIANCE VARIANCE
- ----------------- ------- --------- ------- --------- ---------- ---------
Americas $37,391 75.7% $47,691 82.8% $ (10,300) (21.6)%
Europe 10,366 21.0% 8,249 14.3% 2,117 25.7%
Other 1,632 3.3% 1,651 2.9% (19) (1.2)%
------- --------- ------- --------- ---------- ---------
TOTAL $49,389 100.0% $57,591 100.0% $ (8,202) (14.2)%
======= ========= ======= ========= ========== =========
Our net revenues derived from customers located in the Americas decreased
primarily due to logistical issues surrounding the restructuring of our Milford,
Connecticut operations, whereby we began to outsource our manufacturing to three
contract manufacturers, our discontinuance of certain product offerings as well
as the overall decrease in industry technology spending year to year. The
increase in the Europe region was primarily due to a concentrated effort to
improve sales through a stronger sales structure.
Gross Profit
YEAR ENDED
JUNE 30,
----------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
------- --------- ------- --------- ---------- ---------
Gross profit $13,125 26.6% $17,310 30.1% $ (4,185) (24.2)%
======= ========= ======= ========= ========== =========
Gross profit represents net revenues less cost of revenues. Cost of
revenues consists primarily of the cost of raw material components, subcontract
labor assembly from outside manufacturers, amortization of purchased intangible
assets, establishing inventory reserves for excess and obsolete products or raw
materials and overhead costs. As part of an agreement with Gordian, an outside
research and development firm, a royalty charge was included in cost of revenues
and was calculated based on the related products sold. Gordian royalties were
$1.2 million for the year ended June 30, 2002. No royalties were paid for the
year ended June 30, 2003 as a result of a new Gordian agreement as described
below. Cost of revenues for the years ended June 30, 2003 and 2002 consisted of
$3.6 million and $2.2 million of amortization of purchased intangible assets,
respectively. Cost of revenues for the years ended June 30, 2003 and 2002 also
includes a $3.1 million and $6.4 million impairment charge of purchased
intangible assets, respectively, in accordance with SFAS No. 144.
In May 2002, we signed a new agreement with Gordian to acquire a joint
interest in the intellectual property that is evident in our products designed
by Gordian and to extinguish our obligation to pay royalties on future sales of
our products. We paid $6.0 million for this intellectual property and are
amortizing this asset to cost of revenues over the remaining life of our
products designed by Gordian, or approximately 3 years. Effective May 30, 2002,
upon the signing of the new agreement, royalty expenses have been replaced by an
amortization of the prepaid royalties and entitlement to the intellectual
property that was part of the agreement. Amortization expense related to the new
Gordian agreement, included in amortization of purchased intangible assets of
$3.6 million, totaled $2.5 million for the year ended June 30, 2003.
Amortization expense related to the new Gordian agreement, included in
amortization of purchased intangible assets of $2.2 million, totaled $212,000
for the year ended June 30, 2002.
The overall decrease in gross profit is primarily attributable to a
decrease in net revenues, an increase in the amortization of purchased
intangible assets relating to technology acquired in our acquisitions, an
increase in production expenses related to the closing of our Milford,
Connecticut facility and an increase in our reserves for excess and obsolete
inventory and warranty.
26
Selling, General and Administrative
YEAR ENDED
JUNE 30,
----------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
------- --------- ------- --------- ---------- ---------
Selling, general and administrative $28,660 58.0% $40,538 70.4% $ (11,878) (29.3)%
======= ========= ======= ========= ========== =========
Selling, general and administrative expenses consist primarily of
personnel-related expenses including salaries and commissions, facilities
expenses, information technology, trade show expenses, advertising, and
professional legal and accounting fees. Selling, general and administrative
expense decreased primarily due to reductions in headcount and facility costs as
a result of our restructurings in the second quarter of fiscal 2002 and the
first and third quarters of fiscal 2003, as well as a favorable settlement of a
contractual service obligation and a reduction in our allowance for doubtful
accounts. These decreases are partially offset by increases in legal and other
professional fees. The legal fees primarily relate to our defense of the
shareholder lawsuits, government investigations, and the defense of the
intellectual property lawsuit, which was settled during the second quarter of
fiscal 2003. Legal fees incurred in defense of the shareholder suits are
reimbursable to the extent provided in our directors and officers liability
insurance policies, and subject to the coverage limitations and exclusions
contained in such policies. For the year ended June 30, 2003, we have been
reimbursed $1.4 million of these expenses. There were no reimbursements for the
year ended June 30, 2002.
Research and Development
YEAR ENDED
JUNE 30,
----------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
------ --------- ------ --------- --------- ---------
Research and development $9,430 19.1% $8,680 15.1% $ 750 8.6%
====== ========= ====== ========= ========= =========
Research and development expenses consist primarily of
personnel-related costs of employees, as well as expenditures to third-party
vendors for research and development activities. Research and development
expenses increased primarily due to increased personnel-related costs including
the acquisitions of Synergetic and Stallion and third-party expenses related to
new product development.
Stock-based compensation
YEAR ENDED
JUNE 30,
----------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
------ --------- ------ --------- ---------- ---------
Stock-based compensation $1,453 2.9% $2,863 5.0% $ (1,410) (49.2)%
====== ========= ====== ========= ========== =========
Stock-based compensation expense generally represents the amortization of
deferred compensation. We recorded approximately $73,000 of deferred
compensation for the year ended June 30, 2003. Additionally, we recorded
deferred compensation forfeitures of $2.6 million for the year ended June 30,
2003. Deferred compensation represents the difference between the fair value of
the underlying common stock for accounting purposes and the exercise price of
the stock options at the date of grant as well as the fair market value of the
vested portion of non-employee stock options utilizing the Black-Scholes option
pricing model. Deferred compensation also includes the value of employee stock
options assumed in connection with our acquisitions calculated in accordance
with current accounting guidelines. Deferred compensation is presented as a
reduction of stockholders' equity and is amortized ratably over the respective
vesting periods of the applicable options, which is generally four years.
Included in cost of revenues is stock-based compensation of $89,000 and
$117,000 for the years ended June 30, 2003 and 2002, respectively. The decrease
in stock-based compensation for the year ended June 30, 2003 is primarily
attributable to the restructuring plan whereby options for which deferred
compensation has been recorded are forfeited for terminated employees.
27
Amortization of purchased intangible assets
YEARS ENDED
JUNE 30,
----------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
----- --------- ----- --------- ---------- ---------
Amortization of purchased intangible assets $ 602 1.2% $ 960 1.7% $ (358) (37.3)%
===== ========= ===== ========= ========== =========
Purchased intangible assets primarily include existing technology,
customer agreements, patents and trademarks and are amortized on a straight-line
basis over the estimated useful lives of the respective assets, ranging from one
to five years. We obtained independent appraisals of the fair value of tangible
and intangible assets acquired in order to allocate the purchase price. The
increase in amortization of purchased intangible assets included in cost of
revenues is primarily due to the amortization of the intellectual property
agreement with Gordian signed in May 2002, and existing technology recorded as
part of the Stallion acquisition in August 2002, offset by the impairment
write-down of $6.4 million during the fourth quarter of fiscal 2002 as well as
the $3.1 million impairment during the fourth quarter of fiscal 2003. The
decrease in amortization of purchased intangible assets is primarily due to the
impairment write-down of $4.0 million during the fourth quarter of fiscal 2002
as well as the $2.4 million impairment write-down during the fourth quarter of
fiscal 2003.
Impairment of goodwill and purchased intangible assets
We performed the first of the required annual impairment tests of goodwill
under the guidelines of SFAS No. 142 effective as of June 1, 2002. As a result
of industry conditions, lower market valuations and reduced estimates of
information technology capital equipment spending in the future, we determined
that there were indicators of impairment to the carrying value of goodwill
related to the acquisitions of Lightwave and Synergetic which had carrying
values of $39.7 million and $13.9 million, respectively, as of June 30, 2002.
During the fourth quarter of fiscal 2002, we engaged an independent valuation
company to perform a review of the value of our goodwill and based on the
independent valuation we recorded a $46.4 million impairment charge of our
goodwill.
Additionally, during the fourth quarter of fiscal 2002, we performed a
review of the value of our purchased intangible assets in accordance with SFAS
No. 144. As a result of industry conditions, lower market valuations and reduced
estimates of information technology capital equipment spending in the future, we
determined that there were indicators of impairment to the carrying value of our
purchased intangible assets related to our acquisitions. During the fourth
quarter of fiscal 2002, we engaged an independent valuation company to perform a
review of the value of our purchased intangible assets and based on the
independent valuation we recorded a $9.8 million impairment charge of which $4.0
million and $5.8 million were charged to operating expenses and cost of
revenues, respectively. Additionally, we recorded an impairment charge of
$665,000 to cost of revenues related to intellectual property not associated
with an acquisition.
During the fourth quarter of fiscal 2003, we performed an assessment of the
value of our purchased intangible assets in accordance with SFAS No. 144. As a
result of industry conditions, continued lower market valuations and reduced
estimates in information technology capital equipment spending in the future and
other factors impacting expected future cash flows, we determined that there
were indicators of impairment to the carrying value of our purchased intangible
assets recorded as part of our acquisitions. We engaged an independent valuation
company to perform a review of the value of our purchased intangible assets. In
accordance with SFAS No. 144, we utilized a cash flow estimation approach,
comparing the discounted expected future cash flows to the carrying value of the
subject assets. Based on the independent valuations, during the fourth quarter
of fiscal 2003 we recorded a $5.4 million impairment charge of which $2.3
million and $3.1 million were charged to operating expenses and cost of
revenues, respectively.
Restructuring charges
On September 12, 2002 and March 14, 2003, we announced restructuring plans
to prioritize our initiatives around the growth areas of our business, focus on
profit contribution, reduce expenses, and improve operating efficiency. These
restructuring plans included a worldwide workforce reduction, consolidation of
excess facilities and other charges. We recorded restructuring costs totaling
$5.6 million, which were classified as operating expenses in the consolidated
statement of operations for the year ended June 30, 2003. These restructuring
plans resulted in the reduction of approximately 58 regular employees worldwide.
We recorded workforce reduction charges of approximately $1.2 million related to
severance and fringe benefits for the terminated employees. We recorded charges
of approximately $4.4 million related to 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.
28
On February 6, 2002, we announced a restructuring plan to prioritize our
initiatives around the growth area of our business, focus on profit
contribution, reduce expenses, and improve operating efficiency. This
restructuring plan included a worldwide workforce reduction, consolidation of
excess facilities and other charges. As of June 30, 2002, we recorded
restructuring costs totaling $3.5 million. Through June 30, 2003, the February
2002 restructuring plan has resulted in the reduction of approximately 50
regular employees worldwide and we incurred actual workforce reduction charges
of approximately $1.9 million related to severance and fringe benefits. Included
in the workforce reduction charge was a non-cash stock-based compensation charge
in the amount of $595,000 associated with the modification of stock options that
were outstanding at the termination date. Property, equipment and other assets
that were disposed of or removed from operations resulted in a charge of $1.6
million and consisted primarily of computer software and related equipment,
production, engineering and office equipment, and furniture and fixtures.
Litigation settlement costs
On August 23, 2002, a complaint entitled Dunstan v. Lantronix, Inc., et
al., was filed in the Circuit Court of the State of Oregon, County of Multnomah,
against us and certain of our current and former officers and directors by the
co-founders of USSC. The parties participated in mediation on June 30, 2003, and
subsequently reached an agreement to settle the dispute. The agreement called
for us to release to the plaintiffs approximately $400,000 in cash and 49,038
shares of our common stock that had been held in an escrow since December 2000
as part of the acquisition of USSC. The agreement also called for us to issue to
the plaintiffs additional shares of our common stock worth approximately $1.5
million, which was recorded in our results of operations as litigation
settlement costs for the year ended June 30, 2003. Accordingly, 1,726,703 shares
were issued following a fairness determination by the state court in Oregon. In
exchange, the plaintiffs released all claims against all defendants.
We received an informal notice from several holders of our unregistered
shares of common stock that were issued in connection with the acquisition of
Lightwave. The shares were issued to the holders in a private transaction not
registered under the Securities Act of 1933, and therefore could not be sold by
the stockholders without a valid registration statement. The stockholders
alleged that we failed to honor their rights to have the shares registered and
that they were therefore precluded from selling the shares. Effective July 26,
2002, we settled with the stockholders of Lightwave in the amount of $2.0
million in exchange for 240,000 shares of our common stock held in escrow and
208,335 additional shares issued to the former owners of Lightwave on the
acquisition date. This settlement resulted in a net charge to our results of
operations of approximately $1.9 million for the year ended June 30, 2002 and
has been recognized as litigation settlement costs.
Interest Income (Expense), Net
YEAR ENDED
JUNE 30,
----------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
----- --------- ------ --------- ---------- ---------
Interest income (expense), net $ 248 0.5% $1,548 2.7% $ (1,300) (84.0)%
===== ========= ====== ========= ========== =========
Interest income (expense), net consists primarily of interest earned on
cash, cash equivalents and marketable securities. The decrease is primarily due
to lower average investment balances and interest rates. Additionally, the
decrease in the average investment balance is due to increased expenditures for
legal and other professional fees resulting from our financial statement
restatements in fiscal 2002 and defense of our lawsuits. Also, the decrease is
due to the settlement of the Milford lease obligation included in our
restructuring charge, the purchase of a joint interest in intellectual property
from Gordian, our acquisition of Stallion and to fund current operations.
Other Income (Expense), Net
YEAR ENDED
JUNE 30,
----------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
------ --------- ------ --------- ---------- ---------
Other income (expense), net $(926) (1.9)% $(760) (1.3)% $ (166) (21.8)%
====== ========= ====== ========= ========== =========
The increase for the year ended June 30, 2003 is primarily attributable to
our share of the losses from our investment in Xanboo.
29
Provision (Benefit) for Income Taxes
We utilize the liability method of accounting for income taxes as set
forth in FASB Statement No. 109, "Accounting for Income Taxes." Our effective
tax rate was 0% for the year ended June 30, 2003, and 7% for the year ended June
30, 2002. The federal statutory rate was 34% for both periods. Our effective tax
rate associated with the income tax expense for the year ended June 30, 2003,
was lower than the federal statutory rate primarily due to the increase in
valuation allowance, as well as the amortization of stock-based compensation for
which no current year tax benefit was provided. Our effective tax rate
associated with the income tax benefit for the year ended June 30, 2002, was
lower than the federal statutory rate primarily due to foreign losses and
amortization of stock-based compensation for which no benefit was provided.
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 $9.1 million at June 30, 2004. 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 $3.1 million
at June 30, 2004.
Our operating activities used cash of $2.9 million for the year ended June 30,
2004. We incurred a net loss of $15.7 million of which $10.6 million is from
continuing operations and $5.1 million is from discontinued operations, which
includes the following adjustments: depreciation of $1.7 million, amortization
of purchased intangible assets of $2.2 million, amortization of stock-based
compensation of $395,000, equity losses from unconsolidated businesses of
$413,000, revaluation of a strategic investment of $5.0 million, offset by a
recovery in the restructuring reserve of $1.6 million and a deferred tax
liability of $600,000. The revaluation of a strategic investment is due to the
write-off of our remaining investment in Xanboo due to an other-than temporary
impairment. The restructuring reserve recovery is primarily due to the favorable
settlement of a contractual obligation. The changes in our operating assets
consist of a decrease in accounts receivable of $708,000, decrease in contract
manufacturer receivable of $745,000, decrease in prepaid expenses and other
current assets of $1.1 million, decrease in net assets of discontinued
operations of $3.4 million, increase in warranty reserve of $577,000, increase
in other current liabilities of $732,000, which was reduced by a decrease in
accounts payable of $725,000, decrease in our liability to Gordian of $1.0
million and a decrease in restructuring reserve of $932,000. The reduction in
accounts receivable is primarily due to improved collections from our
distributors and European customers. The decrease in contract manufacturer
receivables is due to improved collections. The decrease in our prepaid and
other current assets is primarily due to the Gordian payment whereby we
maintained a time deposit for $1.0 million as well as the maturity of additional
time deposits totaling $682,000. Net assets of discontinued operations are due
to the sale of the Premise business unit in March 2004. The increase in the
warranty reserve is primarily due to the increase in historical actual warranty
costs. The increase in other current liabilities is primarily due to an increase
in accrued payroll and an increase in general liabilities such as audit fees,
legal fees and inventory purchases. The decrease in accounts payable is due to
the timing of payments to our suppliers. The decrease in the balance due to
Gordian is due to payments in accordance with the agreement. The decrease in the
restructuring reserve is due to payments on lease obligations and workforce
reductions. Our operating activities used cash of $17.6 million for the year
ended June 30, 2003.
Cash provided by investing activities was $3.5 million for the year ended
June 30, 2004 compared with a $2.1 million usage of cash for the year ended June
30, 2003. We received $4.3 million in proceeds from the sales of marketable
securities. We used $552,000 to purchase marketable securities. We also used
$248,000 to purchase property and equipment.
Cash provided by financing activities was $1.2 million for the year ended
June 30, 2004 primarily related to the purchases by the employee stock purchase
plan and $500,000 in borrowings under our line of credit. Cash provided by
financing activities was $345,000 for the year ended June 30, 2003.
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 which was reduced to $62,500 and was
paid. We were also required to pay a quarterly unused line fee of .125% of the
unused line of credit balance. Since establishing the line of credit, we have
twice reduced the amount of the line, modified customary financial covenants and
adjusted the interest rate to be charged on borrowings to the prime rate plus
..50% and eliminated the LIBOR option. Effective July 25, 2003, we further
modified this line of credit, reducing the revolving line to $5.0 million and
adjusting the customary affirmative and negative covenants. We are also required
to maintain certain financial ratios as defined in the agreement. The agreement
has an annual revolving maturity date that renews on the effective date. The
agreement was renewed on July 24, 2004 with an amendment to a financial ratio.
We are required to pay a $12,500 facility fee for the renewal. Our borrowing
base at June 30, 2004, was $3.2 million. In March 2004, we borrowed $500,000
against this line of credit. Additionally, we have used letters of credit
available under our line of credit totaling approximately $1.0 million in place
of cash to fund deposits on leases, tax account deposits and security deposits.
As a result, our available line of credit at June 30, 2004 was $1.6 million. We
are currently in compliance with the revised financial covenants of the July 24,
2004 amended line of credit. Pursuant to the line of credit, we are restricted
from paying any dividends.
The following table summarizes our contractual payment obligations and
commitments:
Fiscal Years
---------------------
2005 2006 2007 TOTAL
------ ------ ----- ------
Convertible note payable $ 867 $ - $ - $ 867
Bank line of credit 500 - - 500
Operating leases 1,562 437 162 2,161
------ ------ ----- ------
Total $2,929 $ 437 $ 162 $3,528
====== ====== ===== ======
30
In March 2004, we completed the sale of substantially all of the net assets
of the Premise business unit with a net book value of approximately $25,000 for
$1.0 million. Additionally, we incurred $383,000 of disposal costs.
At June 30, 2004, we had purchase obligations which consists of our
finished goods purchases from our contract manufacturers and raw materials from
our suppliers in the amount of approximately $5.5 million.
Additionally, in the first fiscal quarter of 2005, our convertible note
will become due. If the notes are not converted to our common stock we will be
required to pay up to $867,000. On August 22, 2004, the notes were not converted
into our common stock and were paid.
Net cash requirements in the first fiscal quarter of 2005 may represent an
increase from the average net cash usage of the previous quarters. During the
first quarter of fiscal 2005, we expect to use approximately $2.2 to $2.8
million in cash. This increase is primarily the result of payment of our
convertible note as discussed above. Additionally, we expect to incur higher
expenses for this quarter in marketing, sales and research and development that
are related to our product launches, as well as the tax payment also discussed
above. We expect to return to a more normal range of cash usage of approximately
$1.0 million in the second quarter of fiscal 2005.
At June 30, 2004, approximately $2.9 million of our net tangible assets
(primarily cash held in foreign bank accounts) were located outside the United
States. Such assets are unrestricted with regard to foreign liquidity needs,
however, our ability to utilize such assets to satisfy liquidity needs outside
of such foreign locations are subject to approval by the foreign location board
of directors. 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 on-going government
investigations 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:
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- - changes in the mix of net revenues attributable to higher-margin and
lower-margin products;
- - customers' decisions to defer or accelerate orders;
- - variations in the size or timing of orders for our products;
- - short-term fluctuations in the cost or availability of our critical
components;
- - changes in demand for our products;
- - loss or gain of significant customers;
- - announcements or introductions of new products by our competitors;
- - defects and other product quality problems; and
- - changes in demand for devices that incorporate our products.
WE ARE CURRENTLY ENGAGED IN MULTIPLE SECURITIES CLASS ACTION LAWSUITS, A
STATE DERIVATIVE SUIT, A LAWSUIT BY OUR FORMER CFO AND COO STEVEN V. COTTON, A
LAWSUIT BY FORMER SHAREHOLDERS OF OUR SYNERGETIC SUBSIDIARY, AND PATENT
INFRINGEMENT LITIGATION ANY OF WHICH, IF IT RESULTS IN AN UNFAVORABLE
RESOLUTION, COULD ADVERSELY AFFECT OUR BUSINESS, RESULTS OF OPERATIONS OR
FINANCIAL CONDITION.
From time to time, we are subject to other legal proceedings and claims in
the ordinary course of business.
We are currently involved in significant litigation, including multiple
security class action lawsuits, a state derivative lawsuit, litigation with a
former executive officer and patent infringement litigation. The pending
lawsuits involve complex questions of fact and law and likely will continue to
require the expenditure of significant funds and the diversion of other
resources to defend. We do not know what the outcome of outstanding legal
proceedings will be and cannot determine the extent to which these resolutions
might have a material adverse effect on our business, results of operations and
financial condition taken as a whole. The results of litigation are inherently
uncertain, and adverse outcomes are possible. For a more detailed description of
pending litigation, see Part 3, Item 1 on page 13.
WE MIGHT BECOME INVOLVED IN LITIGATION OVER PROPRIETARY RIGHTS, WHICH COULD
BE COSTLY AND TIME CONSUMING.
Substantial litigation regarding intellectual property rights exists in our
industry. There is a risk that third-parties, including current and potential
competitors, current developers of our intellectual property, our manufacturing
partners, or parties with which we have contemplated a business combination will
claim that our products, or our customers' products, infringe on their
intellectual property rights or that we have misappropriated their intellectual
property. In addition, software, business processes and other property rights in
our industry might be increasingly subject to third-party infringement claims as
the number of competitors grows and the functionality of products in different
industry segments overlaps. Other parties might currently have, or might
eventually be issued, patents that infringe on the proprietary rights we use.
Any of these third parties might make a claim of infringement against us. For
example, Digi International, ("Digi") has just filed a lawsuit alleging that we
infringe their '192 patent. We have filed suit alleging that Digi infringes our
'305 patent. Please refer to Part I, Item 3 on page 13 for more information.
From time to time in the future we could encounter other disputes over
rights and obligations concerning intellectual property. We cannot assume that
we will prevail in intellectual property disputes regarding infringement,
misappropriation or other disputes. Litigation in which we are accused of
infringement or misappropriation might cause a delay in the introduction of new
products, require us to develop non-infringing technology, require us to enter
into royalty or license agreements, which might not be available on acceptable
terms, or at all, or require us to pay substantial damages, including treble
damages if we are held to have willfully infringed. In addition, we have
obligations to indemnify certain of our customers under some circumstances for
infringement of third-party intellectual property rights. If any claims from
third-parties were to require us to indemnify customers under our agreements,
the costs could be substantial, and our business could be harmed. If a
successful claim of infringement were made against us and we could not develop
non-infringing technology or license the infringed or similar technology on a
timely and cost-effective basis, our business could be significantly harmed.
WE HAVE ELECTED TO USE A CONTRACT MANUFACTURER IN CHINA, WHICH INVOLVES
SIGNIFICANT RISKS.
One of our contract manufacturers is based in China. There are significant
risks of doing business in China, 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.
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- - 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 was 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.
INABILITY, DELAYS IN DELIVERIES OR QUALITY PROBLEMS FROM OUR COMPONENT
SUPPLIERS COULD DAMAGE OUR REPUTATION AND COULD CAUSE OUR NET REVENUES TO
DECLINE AND HARM OUR RESULTS OF OPERATIONS.
Our contract manufacturers and we are responsible for procuring raw
materials for our products. Our products incorporate components or technologies
that are only available from single or limited sources of supply. In particular,
some of our integrated circuits are available from a single source. From time to
time in the past, integrated circuits we use in our products have been phased
out of production. When this happens, we attempt to purchase sufficient
inventory to meet our needs until a substitute component can be incorporated
into our products. Nonetheless, we might be unable to purchase sufficient
components to meet our demands, or we might incorrectly forecast our demands,
and purchase too many or too few components. In addition, our products use
components that have in the past been subject to market shortages and
substantial price fluctuations. From time to time, we have been unable to meet
our orders because we were unable to purchase necessary components for our
products. We rely on a number of different component suppliers. Because we do
not have long-term supply arrangements with any vendor to obtain necessary
components or technology for our products, if we are unable to purchase
components from these suppliers, product shipments could be prevented or
delayed, which could result in a loss of sales. If we are unable to meet
existing orders or to enter into new orders because of a shortage in components,
we will likely lose net revenues and risk losing customers and harming our
reputation in the marketplace.
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.
IF OUR RESEARCH AND DEVELOPMENT EFFORTS ARE NOT SUCCESSFUL, OUR NET
REVENUES COULD DECLINE AND OUR BUSINESS COULD BE HARMED.
For the year ended June 30, 2004, we incurred $7.8 million in research and
development expenses, which comprised 16.0% of our net revenues. If we are
unable to develop new products as a result of this effort, or if the products we
develop are not successful, our business could be harmed. Even if we do develop
new products that are accepted by our target markets, we do not know whether the
net revenue from these products will be sufficient to justify our investment in
research and development.
IF A MAJOR CUSTOMER CANCELS, REDUCES, OR DELAYS PURCHASES, OUR NET REVENUES
MIGHT DECLINE AND OUR BUSINESS COULD BE ADVERSELY AFFECTED.
Our top five customers accounted for 38% of our net revenues for the year
ended June 30, 2004. One customer, Ingram Micro, Inc., accounted for
approximately 14%, 11% and 12% of our net revenues for the years ended June 30,
2004, 2003 and 2002, respectively. Another customer, Tech Data, accounted for
approximately 9%, 10% and 11% of our net revenues for the years ended June 30,
2004, 2003 and 2002, respectively. Accounts receivable attributable to these two
domestic customers accounted for approximately 13% and 16% of total accounts
receivable at June 30, 2004 and 2003, respectively. The number and timing of
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sales to our distributors have been difficult for us to predict. While our
distributors are customers in the sense they buy our products, they are also
part of our product distribution system. To some extent, the business lost for
some reason to a distributor would likely be replaced by sales to other
customer/distributors in a reasonable period, rather than a total loss of that
business such as from a customer who used our products in their business.
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 networking solutions 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.
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. 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. We also may not be
able to increase the price of our products in the event that the prices of
components or our overhead costs increase. Changes in exchange rates between
currencies might change in such a way or over a period such that we cannot
adjust prices to maintain gross margins. If these 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.
UNDETECTED PRODUCT ERRORS OR DEFECTS COULD RESULT IN LOSS OF NET REVENUES,
DELAYED MARKET ACCEPTANCE AND CLAIMS AGAINST US.
We currently offer warranties ranging from ninety days to two years on each
of our products. Our products could contain undetected errors or defects. If
there is a product failure, we might have to replace all affected products
without being able to book revenue for replacement units, or we may have to
refund the purchase price for the units. Because of our recent introduction of
our line of device servers, we do not have a long history with which to assess
the risks of unexpected product failures or defects for this product line.
Regardless of the amount of testing we undertake, some errors might be
discovered only after a product has been installed and used by customers. Any
errors discovered after commercial release could result in loss of net revenues
and claims against us. Significant product warranty claims against us could harm
our business, reputation and financial results and cause the price of our stock
to decline.
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 the restatement of our
financial statements filed on June 25, 2002 for the year ended June 30, 2001 and
for the six months ended December 31, 2002. The SEC could conclude that we
violated the rules of the Securities Act of 1933 or the Securities and Exchange
Act of 1934. In either event, the SEC might levy civil fines against us, or
might conclude that we lack sufficient internal controls to warrant our being
allowed to continue offering our shares to the public. This investigation
involves substantial cost and could significantly divert the attention of
management. These costs, and the cost of any fines imposed by the SEC, are not
covered by insurance. In addition to sanctions imposed by the SEC, an adverse
determination could significantly damage our reputation with customers and
vendors, and harm our employees' morale.
34
WE INCORPORATE SOFTWARE LICENSED FROM THIRD PARTIES INTO SOME OF OUR
PRODUCTS AND ANY SIGNIFICANT INTERRUPTION IN THE AVAILABILITY OF THESE
THIRD-PARTY SOFTWARE PRODUCTS OR DEFECTS IN THESE PRODUCTS COULD REDUCE THE
DEMAND FOR, OR PREVENT THE SALE OR USE OF, OUR PRODUCTS.
Certain of our products contain components developed and maintained by
third-party software vendors or available through the "open source" software
community. We also expect that we may incorporate software from third-party
vendors and open source software in our future products. Our business would be
disrupted if this software, or functional equivalents of this software, were
either no longer available to us or no longer offered to us on commercially
reasonable terms. In either case, we would be required to either redesign our
products to function with alternate third-party software or open source
software, or develop these components ourselves, which would result in increased
costs and could result in delays in our product shipments. Furthermore, we might
be forced to limit the features available in our current or future product
offerings. We presently are developing products for use on the Linux platform.
The SCO Group (SCO) has filed and threatened to file lawsuits against companies
that operate Linux for commercial purposes, alleging that such use of Linux
infringes SCOs rights. These allegations may adversely affect the demand for the
Linux platform and, consequently, the sales of our Linux-based products.
WE PRIMARILY DEPEND ON FIVE THIRD-PARTY MANUFACTURERS TO MANUFACTURE
SUBSTANTIALLY ALL OF OUR PRODUCTS, WHICH REDUCES OUR CONTROL OVER THE
MANUFACTURING PROCESS. IF THESE MANUFACTURERS ARE UNABLE OR UNWILLING TO
MANUFACTURE OUR PRODUCTS AT THE QUALITY AND QUANTITY WE REQUEST, OUR BUSINESS
COULD BE HARMED AND OUR STOCK PRICE COULD DECLINE.
We outsource substantially all of our manufacturing to five third-party
manufacturers, Venture Electronics Services, Varian, Inc., Irvine Electronics,
Inc., Uni Precision Industrial Ltd, and Universal Scientific Industrial Company,
LTD. Our reliance on these third-party manufacturers exposes us to a number of
significant risks, including:
- - reduced control over delivery schedules, quality assurance, manufacturing
yields and production costs;
- - lack of guaranteed production capacity or product supply; and
- - reliance on third-party manufacturers to maintain competitive manufacturing
technologies.
Our agreements with these manufacturers provide for services on a purchase
order basis. If our manufacturers were to become unable or unwilling to continue
to manufacture our products in required volumes, at acceptable quality,
quantity, yields and costs, or in a timely manner, our business would be
seriously harmed. As a result, we would have to attempt to identify and qualify
substitute manufacturers, which could be time consuming and difficult, and might
result in unforeseen manufacturing and operations problems. Moreover, if we
shift products among third-party manufacturers, we may incur substantial
expenses, risk material delays, or encounter other unexpected issues. For
example, in the third quarter of fiscal 2003 we encountered product shortages
related to the transition to a third-party manufacturer. This product shortage
contributed to our net revenues falling below our publicly announced estimates.
In addition, a natural disaster could disrupt our manufacturers' facilities
and could inhibit our manufacturers' ability to provide us with manufacturing
capacity on a timely basis, or at all. If this were to occur, we likely would be
unable to fill customers' existing orders or accept new orders for our products.
The resulting decline in net revenues would harm our business. We also are
responsible for forecasting the demand for our individual products. These
forecasts are used by our contract manufacturers to procure raw materials and
manufacture our finished goods. If we forecast demand too high, we may invest
too much cash in inventory and we may be forced to take a write-down of our
inventory balance, which would reduce our earnings. If our forecast is too low
for one or more products, we may be required to pay expedite charges which would
increase our cost of revenues or we may be unable to fulfill customer orders,
thus reducing net revenues and therefore earnings.
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 31%, 24% and 17% of net
revenues for the years ended June 30, 2004, 2003 and 2002, respectively. Net
revenues from Europe represented 23%, 21% and 14% of our net revenues for the
years ended June 30, 2004, 2003 and 2002, respectively. Our revenues in Japan
and the People's Republic of China are increasing, as well.
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:
35
- - unexpected changes in regulatory requirements, taxes, trade laws and
tariffs;
- - reduced protection for intellectual property rights in some countries;
- - differing labor regulations;
- - compliance with a wide variety of complex regulatory requirements;
- - changes in a country's or region's political or economic conditions;
- - greater difficulty in staffing and managing foreign operations; and
- - increased financial accounting and reporting burdens and complexities.
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.
OUR EXECUTIVE OFFICERS AND TECHNICAL PERSONNEL ARE CRITICAL TO OUR
BUSINESS, AND WITHOUT THEM WE MIGHT NOT BE ABLE TO EXECUTE OUR BUSINESS
STRATEGY.
Our financial performance depends substantially on the performance of our
executive officers and key employees. We are dependent in particular on Marc
Nussbaum, who serves as our President and Chief Executive Officer, and James
Kerrigan, who serves as our Chief Financial Officer. We have no employment
contracts with those executives who are at-will employees. We are also dependent
upon our technical personnel, due to the specialized technical nature of our
business. If we lose the services of Mr. Nussbaum, Mr. Kerrigan or any of our
key personnel and are not able to find replacements in a timely manner, our
business could be disrupted, other key personnel might decide to leave, and we
might incur increased operating expenses associated with finding and
compensating replacements.
THERE IS A RISK THAT OUR OEM CUSTOMERS WILL DEVELOP THEIR OWN INTERNAL
EXPERTISE IN NETWORK-ENABLING PRODUCTS, WHICH COULD RESULT IN REDUCED SALES OF
OUR PRODUCTS.
For most of our existence, we primarily sold our products to distributors,
VARs and system integrators. Although we intend to continue to use all of these
sales channels, we have begun to focus more heavily on selling our products to
OEMs. Selling products to OEMs involves unique risks, including the risk that
OEMs will develop internal expertise in network-enabling products or will
otherwise provide network functionality to their products without using our
device networking solutions. If this were to occur, our stock price could
decline in value and you could lose part or all of your investment.
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, semiconductor companies, 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.
WE CARRY INVENTORY AND THERE IS A RISK WE MAY BE UNABLE TO DISPOSE OF THEM.
Our products and therefore our inventories are subject to technological
risk. At any time either new products may enter the market or prices of
competitive products may be introduced with more attractive features or at lower
prices than ours. There is a risk that we may be unable to sell our inventory in
a timely manner to avoid their becoming obsolete. As of June 30, 2004, our
inventories including raw materials, finished goods and inventory at
distributors, were valued at $12.7 million and we had excess and obsolete
inventory reserves of $6.0 million against these inventories. As of June 30,
2003, our inventories, including raw materials, finished goods and inventory at
distributors were valued at $14.0 million and we had reserved $8.0 million
against these inventories. In the event we are required to substantially
discount our inventory or are unable to sell our inventory in a timely manner,
we would be required to increase our reserves and our operating results could be
substantially harmed.
OUR INTELLECTUAL PROPERTY PROTECTION MIGHT BE LIMITED.
We have not historically relied on patents to protect our proprietary
rights, although we are now building 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:
36
- - 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;
- - other companies might assert other rights to market products using our
trademarks;
- - 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;
- - courts may determine that our software programs use open source software in
such a way that deprives the entire programs of intellectual property
protection; and
- - current federal laws that prohibit software copying provide only limited
protection from software pirates.
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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates primarily
to our investment portfolio. We do not use derivative financial instruments for
speculative or trading purposes. We place our investments in instruments that
meet high credit quality standards, as specified in our investment policy.
Information relating to quantitative and qualitative disclosure about market
risk is set forth below and in "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital Resources."
INTEREST RATE RISK
Our exposure to interest rate risk is limited to the exposure related to
our cash, cash equivalents, marketable securities and our credit facilities,
which is tied to market interest rates. As of June 30, 2004 and 2003, we had
cash and cash equivalents of $9.1 million and $7.3 million, respectively, which
consisted of cash and short-term investments with original maturities of ninety
days or less, both domestically and internationally. As of June 30, 2004 and
2003, we had marketable securities of $3.1 million and $7.0 million,
respectively, consisting of obligations of U.S. Government agencies, state,
municipal and county government notes and bonds. We believe our marketable
securities will decline in value by an insignificant amount if interest rates
increase, and therefore would not have a material effect on our financial
condition or results of operations.
FOREIGN CURRENCY RISK
We sell products internationally. As a result, our financial results could
be harmed by factors such as changes in foreign currency exchange rates or weak
economic conditions in foreign markets.
INVESTMENT RISK
As of June 30, 2003, we had a net investment of $5.4 million, in Xanboo, a
privately held company which can still be considered in the start-up or
development stage. We performed an analysis and recorded a charge in the amount
of $5.0 million, representing a write-off of all remaining value of this
non-marketable equity security. This charge was included within the consolidated
statements of operations as other expense.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by this item are
incorporated by reference from Part IV, Item 15 of this Form 10-K and are
presented beginning on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
37
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
We carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and our
Chief Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934 (the "Exchange Act")) as of the end of
our fiscal year. Based upon that evaluation, our Chief Executive Officer and our
Chief Financial Officer concluded that our disclosure controls and procedures
are sufficiently effective in ensuring that information required to be disclosed
by us in reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission's rules and instructions for Form 10-K.
(b) Changes in internal controls.
There have been no changes in our internal control over financial
reporting identified in connection with our evaluation as of the end of our
fiscal year that occurred during such quarter that have materially affected, or
are reasonably likely to materially affect, our internal control over financial
reporting. We are aware that any system of controls, however well designed and
operated, can only provide reasonable, and not absolute, assurance that the
objectives of the system are met, and that maintenance of disclosure controls
and procedures is an ongoing process that may change over time.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) The information required by Item 10 of this Annual Report on Form 10-K with
respect to identification of directors is incorporated by reference from
the information contained in the section captioned "Election of Directors"
in Lantronix's definitive Proxy Statement for the Annual Meeting of
Stockholders to be held November 18, 2004 (the Proxy Statement), a copy of
which will be filed with the Securities and Exchange Commission before the
meeting date. For information with respect to the executive officers of
Lantronix, see "Executive Officers of the Registrant" included in Part I,
Item 4 of this report.
(b) For information regarding our Directors Code of Ethics and compliance with
Section 16(a) of the Securities Exchange Act of 1934, we direct you to the
sections entitled Proposal I - Election of Directors, Audit Committee, Code
of Ethics and Complaint Procedures and Section 16(a) Beneficial Ownership
Reporting Compliance, respectively, in the Proxy Statement we will deliver
to our stockholders in connection with our Annual Meeting of Stockholders
to be held on November 18, 2004. We are incorporating the information
contained in those sections of our Proxy Statement, herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 of this Annual Report on Form 10-K is
incorporated by reference from the information contained in the section
captioned "Executive Compensation and Related Information" in the Proxy
Statement, which we will deliver to our stockholders in connection with our
Annual Meeting of Stockholders to be held on November 18, 2004.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 of this Annual Report on Form 10-K is
incorporated by reference from the information contained in the sections
captioned "Election of Directors" and "Security Ownership of Certain Beneficial
Owners and Management" in the Proxy Statement which we will deliver to our
stockholders in connection with our Annual Meeting of Stockholders to be held on
November 18, 2004.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Except as set forth below, the information required by Item 13 of this
Annual Report on Form 10-K is incorporated by reference from the information
contained in the sections captioned "Election of Directors" and "Security
Ownership of Certain Beneficial Owners and Management" in the Proxy Statement
which we will deliver to our stockholders in connection with our Annual Meeting
of Stockholders to be held on November 18, 2004.
Howard Slayen, a member of our Board of Directors also serves as our
nominee to the Xanboo Board of Directors. Marc Nussbaum our Chief Executive
Officer also served as a nominee to the Xanboo Board of Directors prior to his
resignation from the Xanboo board in August 2003.
One international customer, transtec AG, which is a related party due to
common ownership by our largest stockholder and former Chairman of our Board of
Directors, Bernhard Bruscha, accounted for approximately 3%, 4% and 5% of our
net revenues for the years ended June 30, 2004, 2003 and 2002, respectively. We
also had an agreement with transtec AG for the provision of technical support
services at the rate of $7,500 per month, which has now been terminated.
Included in selling, general and administrative expenses are $90,000 for the
year ended June 30, 2002. No similar expenses were recorded for the years ended
June 30, 2004 and 2003.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The information under the caption "Fees Paid to Independent Auditors,"
appearing in the Proxy Statement which we will deliver to our stockholders in
connection with our Annual Meeting of Stockholders to be held on November 18,
2004, is incorporated herein by reference.
39
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULE AND REPORTS ON 8-K.
(a) 1. Consolidated Financial Statement
The following financial statement schedule of the Company and related
Report of Independent Registered Public Accounting Firm is filed as part of this
Form 10-K.
PAGE
----------
Report of Independent Registered Public Accounting Firm. . . . . . . . . . . . . . . . . . . F-1
Consolidated Balance Sheets as of June 30, 2004 and 2003 . . . . . . . . . . . . . . . . . . . . F-2
Consolidated Statements of Operations for the years ended June 30, 2004, 2003 and 2002 . . . . . F-3
Consolidated Statements of Stockholders' Equity for the years ended June 30, 2004, 2003 and 2002 F-4
Consolidated Statements of Cash Flows for the years ended June 30, 2004, 2003 and 2002 . . . . . F-5
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . F-6 - F-29
2. Financial Statement Schedule
The following financial statement schedule of the Company and related
Report of Independent Registered Public Accounting Firm is filed as part of this
Form 10-K.
PAGE
-----
(1) Report of Independent Registered Public Accounting Firm on
Financial Statement Schedule. . . . . . . . . . . . . . . . . . . . . . S-1
(2) Schedule II-Consolidated Valuation and Qualifying Accounts. . . . . . . S-2
All other financial statement schedules have been omitted because they are
not applicable, not required, or the information is included in the consolidated
financial statements or notes thereto.
3. Exhibits
The exhibits listed on the accompanying index to exhibits immediately
follow the financial statements are filed as part of, or hereby incorporated by
reference into, this Form 10-K.
(b) Reports on Form 8-K.
We filed the following current reports on Form 8-K during the quarter ended
June 30, 2004:
Form 8-K filed on April 2, 2004, Lantronix, reporting the Company's sale of
its Premise software unit assets to an undisclosed buyer for $1.0 million in
cash.
Form 8-K filed on May 7, 2004 reporting the results of the Company's third
fiscal quarter ended March 31, 2004, with selected consolidated balance sheet
data and selected unaudited consolidated statement of operations data.
40
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders Lantronix, Inc.
We have audited the accompanying consolidated balance sheets of Lantronix,
Inc. as of June 30, 2004 and 2003, and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended June 30, 2004. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Lantronix, Inc.
at June 30, 2004 and 2003, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended June 30, 2004, in
conformity with U.S. generally accepted accounting principles.
As discussed in Note 5, effective July 1, 2001, the Company adopted the
provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets."
/s/ ERNST & YOUNG LLP
Orange County, California
September 10, 2004
F-1
LANTRONIX, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30,
--------
2004 2003
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 9,128 $ 7,328
Marketable securities 3,050 6,750
Accounts receivable (net of allowance for doubtful accounts
of $177 and $572 at June 30, 2004 and 2003, respectively) 3,242 3,818
Inventories 6,677 6,011
Contract manufacturers receivable (net of allowance of $38
and $62 at June 30, 2004 and 2003, respectively) 999 1,744
Prepaid expenses and other current assets 1,450 3,834
Assets of discontinued operations - 3,590
---------- ----------
Total current assets 24,546 33,075
Property and equipment, net 865 2,384
Goodwill 9,488 9,488
Purchased intangible assets, net 2,056 4,275
Long-term investments - 5,458
Officer loans (net of allowance of $4,470 at June 30, 2004
and 2003, respectively) 110 104
Other assets 185 163
---------- ----------
Total assets $ 37,250 $ 54,947
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,049 $ 4,774
Accrued payroll and related expenses 1,599 1,185
Due to Gordian - 1,000
Accrued litigation settlement - 1,533
Warranty reserve 1,770 1,193
Restructuring reserve 752 3,235
Other current liabilities 2,922 2,604
Liabilities of discontinued operations - 239
Convertible note payable 867 -
Bank line of credit 500 -
---------- ----------
Total current liabilities 12,459 15,763
Deferred income taxes - 600
Convertible note payable - 867
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.0001 par value; 5,000,000 shares authorized;
none issued and outstanding - -
Common stock, $0.0001 par value; 200,000,000 shares authorized;
58,154,747 and 55,425,774 shares issued and outstanding at
June 30, 2004 and 2003, respectively 6 6
Additional paid-in capital 180,712 178,628
Deferred compensation (103) (695)
Accumulated deficit (156,078) (140,424)
Accumulated other comprehensive gain 254 202
---------- ----------
Total stockholders' equity 24,791 37,717
---------- ----------
Total liabilities and stockholders' equity $ 37,250 $ 54,947
========== ==========
See accompanying notes.
F-2
LANTRONIX, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED JUNE 30,
--------------------
2004 2003 2002
--------- --------- ---------
Net revenues (A) $ 48,885 $ 49,389 $ 57,591
Cost of revenues (B) 25,026 36,264 40,281
--------- --------- ---------
Gross profit 23,859 13,125 17,310
--------- --------- ---------
Operating expenses:
Selling, general and administrative (C) 23,293 28,660 40,538
Research and development (C) 7,813 9,430 8,680
Stock-based compensation (B) (C) 347 1,453 2,863
Amortization of purchased intangible assets 148 602 960
Impairment of goodwill and purchased intangible assets - 2,353 50,445
Restructuring (recovery) charges (2,093) 5,600 3,473
Litigation settlement costs - 1,533 1,912
--------- --------- ---------
Total operating expenses 29,508 49,631 108,871
--------- --------- ---------
Loss from operations (5,649) (36,506) (91,561)
Interest income (expense), net 50 248 1,548
Other income (expense), net (5,333) (926) (760)
--------- --------- ---------
Loss before income taxes and cumulative effect of an
accounting change (10,932) (37,184) (90,773)
Provision (benefit) for income taxes (325) 250 (6,665)
--------- --------- ---------
Loss from continuing operations before cumulative effect of an
accounting change (10,607) (37,434) (84,108)
Loss from discontinued operations (5,047) (10,115) (3,444)
--------- --------- ---------
Loss before cumulative effect of an accounting change (15,654) (47,549) (87,552)
Cumulative effect of adoption of new accounting standard,
SFAS No. 142 - - (5,905)
--------- --------- ---------
Net loss $(15,654) $(47,549) $(93,457)
========= ========= =========
Basic and diluted loss per share from continuing operations before
cumulative effect of an accounting change $ (0.19) $ (0.69) $ (1.63)
Loss from discontinued operations (0.09) (0.19) (0.07)
--------- --------- ---------
Loss before cumulative effect of an accounting change (0.28) (0.88) (1.70)
Cumulative effect of adoption of new accounting standard,
SFAS No. 142 - - (0.12)
--------- --------- ---------
Basic and diluted net loss per share $ (0.28) $ (0.88) $ (1.82)
========= ========= =========
Weighted average shares (basic and diluted) 56,862 54,329 51,403
========= ========= =========
(A) Includes revenues from related parties $ 1,416 $ 1,845 $ 2,644
========= ========= =========
(B) Cost of revenues includes the following:
Amortization of purchased intangible assets $ 2,071 $ 3,619 $ 2,223
Impairment of purchased intangible assets - 3,082 6,448
Stock-based compensation 48 89 117
--------- --------- ---------
$ 2,119 $ 6,790 $ 8,788
========= ========= =========
(C) Stock-based compensation is excluded from the following:
Selling, general and administrative expenses $ 306 $ 1,074 $ 2,086
Research and development expenses 41 379 777
--------- --------- ---------
$ 347 $ 1,453 $ 2,863
========= ========= =========
See accompanying notes.
F-3
LANTRONIX, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
ACCUM-
NOTES RETAINED ULATED
ADDI- RECEI- EARNINGS OTHER TOTAL
COMMON STOCK TIONAL VABLE DEFERRED (ACCUM- COMPRE- STOCK
-------------------- PAID-IN FROM COMPEN- ULATED HENSIVE HOLDERS'
SHARES AMOUNT CAPITAL OFFICERS SATION DEFICIT) GAIN (LOSS) EQUITY
----------- ------- --------- ---------- ---------- ---------- ------------ ----------
Balance at June 30, 2001 43,301,803 $ 4 $109,871 $ (790) $ (10,020) $ 582 $ (151) $ 99,496
Issuance of common stock in
secondary public offering 6,400,500 1 47,085 - - - - 47,086
Stock options exercised 1,073,452 - 1,619 - - - - 1,619
Employee stock purchase plan 178,687 - 437 - - - - 437
Deferred compensation, net - - (1,899) - 1,899 - - -
Stock-based compensation - - - - 3,575 - - 3,575
Repayment of notes receivable - - - 513 - - - 513
Provision for notes receivable
from officers - - - 249 - - - 249
Purchase transactions 3,298,086 - 22,941 - - - - 22,941
Repurchase of common stock - - (507) - - - - (507)
Components of comprehensive
loss:
Translation adjustment - - - - - - 73 73
Change in net unrealized
loss on investment - - - - - - 132 132
Net loss - - - - - (93,457) - (93,457)
----------
Comprehensive loss (93,252)
----------- ------- --------- ---------- ---------- ---------- ------------ ----------
Balance at June 30, 2002 54,252,528 5 179,547 (28) (4,546) (92,875) 54 82,157
Stock options exercised 152,004 - 37 - - - - 37
Repurchase of common stock (448,335) - - - - - - -
Employee stock purchase plan 406,205 - 280 - - - - 280
Deferred compensation, net - - (2,310) - 2,548 - - 238
Stock-based compensation - - - - 1,303 - - 1,303
Repayment of notes receivable - - - 28 - - - 28
Premise settlement 1,063,372 1 1,074 - - - - 1,075
Components of comprehensive
loss:
Translation adjustment - - - - - - 148 148
Net loss - - - - - (47,549) - (47,549)
----------
Comprehensive loss (47,401)
----------- ------- --------- ---------- ---------- ---------- ------------ ----------
Balance at June 30, 2003 55,425,774 6 $178,628 (-) (695) (140,424) 202 37,717
Stock options exercised 496,335 - 359 - - - - 359
Employee stock purchase plan 505,935 - 369 - - - - 369
Deferred compensation, net - - (197) - 197 - - -
Stock-based compensation - - - - 395 - - 395
Dunstan settlement 1,726,703 - 1,553 - - - - 1,553
Components of comprehensive
loss:
Translation adjustment - - - - - - 52 52
Net loss - - - - - (15,654) - (15,654)
----------
Comprehensive loss (15,602)
----------
Balance at June 30, 2004 58,154,747 $ 6 $180,712 $ (-) $ (103) $(156,078) $ 254 $ 24,791
=========== ======= ========= ========== ========== ========== ============ ==========
See accompanying notes.
F-4
LANTRONIX, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED JUNE 30,
--------------------
2004 2003 2002
--------- --------- ---------
Cash flows from operating activities:
Net loss from continuing operations $(10,607) $(37,434) $(90,013)
Net loss from discontinued operations (5,047) (10,115) (3,444)
Adjustments to reconcile net loss to net cash used in operating activities:
Cumulative effect of adoption of new accounting standard, SFAS No. 142 - - 5,905
Depreciation 1,742 2,361 2,465
Amortization of purchased intangible assets 2,219 4,221 3,709
Impairment of goodwill and purchased intangible assets - 5,435 57,276
Stock-based compensation 395 1,542 2,980
Deferred income taxes (600) - (5,594)
Provision for officer loans - - 4,403
Loss on sale of long-term investment 31 - -
Restructuring (recovery) charges (1,551) 5,600 3,473
Litigation settlement costs - 1,533 1,912
Equity losses from unconsolidated businesses 413 1,303 1,002
Provision for doubtful accounts (164) (473) 1,680
Provision for inventory reserves 368 4,189 3,443
Revaluation of strategic investment 5,007 - 500
Loss on disposal of assets 25 - -
Changes in operating assets and liabilities, net of effect from acquisitions:
Accounts receivable 708 2,875 2,557
Inventories 199 581 (456)
Contract manufacturers receivable 777 (154) -
Prepaid expenses and other current assets 1,173 1,729 (1,034)
Other assets (28) 148 (2,404)
Accounts payable (725) 195 (3,857)
Due to related party - (246) (541)
Due to Gordian (1,000) (2,000) 3,000
Accrued Lightwave settlement - (2,004) -
Warranty reserve 577 714 (83)
Restructuring reserve (932) (2,772)
Net assets of discontinued operations 3,351 7,108 1,790
Other current liabilities 732 (1,906) (590)
--------- --------- ---------
Net cash used in operating activities (2,937) (17,570) (12,830)
--------- --------- ---------
Cash flows from investing activities:
Purchases of property and equipment, net (248) (222) (2,750)
Purchases of marketable securities (552) (11,000) (9,490)
Purchase of intellectual property - - (6,000)
Purchases of minority investments - - (7,288)
Proceeds from sale of long-term investment 7
Proceeds from sale of marketable securities 4,252 11,250 4,500
Acquisition of businesses, net of cash acquired - (2,114) (4,746)
--------- --------- ---------
Net cash used in investing activities 3,459 (2,086) (25,774)
--------- --------- ---------
Cash flows from financing activities:
Net proceeds from underwritten offerings of common stock - - 47,085
Net proceeds from other issuances of common stock 726 317 2,057
Proceeds from repayment of notes receivable from officers - 28 513
Borrowings on revolving line of credit 500 - -
--------- --------- ---------
Net cash provided by financing activities 1,226 345 49,655
Effect of exchange rates on cash 52 148 73
--------- --------- ---------
Net increase (decrease) in cash 1,800 (19,163) 11,124
Cash and cash equivalents at beginning of year 7,328 26,491 15,367
--------- --------- ---------
Cash and cash equivalents at end of year $ 9,128 $ 7,328 $ 26,491
========= ========= =========
Supplemental disclosure of cash flow information:
Interest paid $ 43 $ 13 $ 49
Income taxes paid $ 485 $ 49 $ 210
See accompanying notes.
F-5
LANTRONIX, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company
Lantronix, Inc. (the "Company"), incorporated in California in June 1989
and re-incorporated in the State of Delaware in May 2000, is engaged primarily
in the design and distribution of networking and Internet connectivity products
on a worldwide basis. The actual assembly and a portion of the engineering of
the Company's products are outsourced to third parties.
The Company has incurred losses from operations and has reported negative
operating cash flows. As of June 30, 2004, the Company had an accumulated
deficit of $156.1 million and cash, cash equivalents and marketable securities
of $12.2 million. The Company has no material financial commitments other than
$500,000 in borrowings under a line of credit, $867,000 convertible note payable
which was paid in August 2004, operating lease agreements and inventory purchase
orders. The Company believes that its existing cash, cash equivalents and
marketable securities, and any cash generated from operations will be sufficient
to fund its working capital requirements, capital expenditures and other
obligations through the next 12 months. Long term the Company may face
significant risks associated with the successful execution of its business
strategy and may need to raise additional capital in order to fund more rapid
expansion, to expand its marketing activities, to develop new or enhance
existing services or products, and to respond to competitive pressures or to
acquire complementary services, businesses, or technologies. If the Company is
not successful in generating sufficient cash flow from operations, it may need
to raise additional capital through public or private financing, strategic
relationships, or other arrangements.
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany transactions and
balances have been eliminated in consolidation. At June 30, 2004, approximately
$2.9 million of the Company's net tangible assets (primarily cash held in
foreign bank accounts) were located outside the United States. Such assets are
unrestricted with regard to foreign liquidity needs, however, the ability of the
Company to utilize such assets to satisfy liquidity needs outside of such
foreign locations are subject to approval by the foreign location board of
directors.
In March 2004, the Company completed the sale of substantially all of the
net assets of Premise Systems, Inc. ("Premise") (Note 7). The Company's
consolidated financial statements have been presented to reflect Premise as a
discontinued operation for all periods.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. The industry in which the Company operates is
characterized by rapid technological change and short product life cycles. As a
result, estimates made in preparing the financial statements include the
allowance for doubtful accounts, sales returns and allowances, inventory
reserves, allowance for officer loans, strategic investments, goodwill and
purchased intangible asset valuations, deferred income tax asset valuation
allowances, warranty reserves, restructuring costs, litigation and other
contingencies. To the extent there are material differences between estimates
and the actual results, future results of operations will be affected.
Revenue Recognition
The Company does not recognize revenue until all of the following criteria
are met: persuasive evidence of an arrangement exists; delivery has occurred or
services have been rendered; the Company's price to the buyer is fixed or
determinable; and collectibility is reasonably assured. Commencing July 1, 2000,
the Company adopted a new accounting policy for revenue recognition such that
recognition of revenue and related gross profit from sales to distributors are
deferred until the distributor resells the product. Net revenue from certain
smaller distributors, for which point-of-sale information is not available, is
recognized one month after the shipment date. This estimate approximates the
timing of the sale of the product by the distributor to the end user. When
product sales revenue is recognized, the Company establishes an estimated
allowance for future product returns based on historical returns experience;
when price reductions are approved, it establishes an estimated liability for
price protection payable on inventories owned by product resellers. Should
actual product returns or pricing adjustments exceed the Company's estimates,
F-6
additional reductions to revenues would result. Revenue from the licensing of
software is recognized at the time of shipment (or at the time of resale in the
case of software products sold through distributors), provided the Company has
vendor-specific objective evidence of the fair value of each element of the
software offering and collectibility is probable. Revenue from post contract
customer support and any other future deliverables is deferred and recognized
over the support period or as contract elements are delivered. The Company's
products typically carry a ninety day to two year warranty. Although the Company
engages in extensive product quality programs and processes, its 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. Additionally, the
Company sells extended warranty services which extend the warranty period for an
additional one to three years. Warranty revenue is recognized evenly over the
warranty service period.
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts for estimated
losses resulting from the inability of its customers to make required payments.
The Company's allowance for doubtful accounts is based on its assessment of the
collectibility of specific customer accounts, the aging of accounts receivable,
the Company's history of bad debts and the general condition of the industry. If
a major customer's credit worthiness deteriorates, or the Company's customers'
actual defaults exceed its historical experience, its estimates could change and
impact its reported results. The Company also maintains a reserve for
uncertainties relative to the collection of officer notes receivable. Factors
considered in determining the level of this reserve include the value of the
collateral securing the notes, our ability to effectively enforce collection
rights and the ability of the former officers to honor their obligations.
F-7
Concentration of Credit Risk
The Company's accounts receivable are derived from revenues earned from
customers located throughout North America, Europe and Asia. The Company
performs ongoing credit evaluations of its customers' financial condition and
maintains allowances for potential credit losses. Credit losses have
historically been within management's expectations. The Company generally does
not require collateral or other security from its customers. The Company invests
its excess cash in deposits with major banks, in U.S. Government agencies,
state, municipal and county governments notes and bonds.
Fair Value of Financial Instruments
The Company's financial instruments consist principally of cash, cash
equivalents, marketable securities, accounts receivable, notes receivable,
contract manufacturer receivable, accounts payable, convertible debt, bank line
of credit and accrued liabilities. The Company believes all of the financial
instruments' recorded values approximate current values because of the short
maturities of these investments.
Marketable Securities
The Company classifies its marketable securities as available for sale.
Marketable securities consist of obligations of U.S. Government agencies, state,
municipal and county governments notes and bonds which can be readily converted
to cash.
Foreign Currency Translation
The financial statements of foreign subsidiaries whose functional currency
is not the U.S. dollar have been translated to U.S. dollars in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 52, "Foreign Currency
Translation." Foreign currency assets and liabilities are remeasured into U.S.
dollars at the end-of-period exchange rates. Revenues and expenses are
translated at average exchange rates in effect during each period, except for
those expenses related to balance sheet amounts, which are translated at
historical exchange rates. Exchange gains and losses from foreign currency
translations are reported as a component of accumulated other comprehensive gain
(loss) within stockholders' equity. Exchange gains and losses from foreign
currency transactions are recognized in the consolidated statement of operations
and historically have not been material.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and short-term investments with
original maturities of ninety days or less.
Investments
The Company accounts for its investments in debt and equity securities with
readily determinable fair values that are not accounted for under the equity
method of accounting under SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." Management determines the appropriate
classification of such securities at the time of purchase and reevaluates such
classification as of each balance sheet date. The investments are adjusted for
amortization of premiums and discounts to maturity and such amortization is
included in interest income.
In September and October 2001, the Company paid an aggregate of $3.0
million to Xanboo Inc. ("Xanboo") for convertible promissory notes, which
converted in January 2002, in accordance with their terms, into Xanboo preferred
stock. In addition, the Company purchased $4.0 million of Xanboo preferred stock
in January 2002. The Company's ownership interest in Xanboo was 14.9% and 15.3%
at June 30, 2004 and 2003, respectively. The Company is accounting for this
long-term investment under the equity method based upon the Company's ability,
through representation on Xanboo's board of directors, to exercise significant
influence over its operations. The Company's interest in the losses of Xanboo
aggregating $413,000, $1.3 million and $526,000 during the years ended June 30,
2004, 2003 and 2002, respectively, have been recognized as other expense in the
accompanying consolidated statement of operations.
F-8
The Company periodically reviews its investments for which fair value is
less than cost to determine if the decline in value is other than temporary. If
the decline in value is judged to be other than temporary, the cost basis of the
security is written down to fair value. The Company generally believes an
other-than-temporary decline has occurred when the fair value of the investment
is below the carrying value for two consecutive quarters, absent evidence to the
contrary. On the basis of events occurring during the quarter ended June 30,
2004, the Company performed an analysis and recorded a charge in the amount of
$5.0 million, representing a write-off of all remaining value of this
non-marketable equity security. This charge was included within the consolidated
statements of operations as other expense. During the year ended June 30, 2002,
the Company recorded a $500,000 impairment charge related to another
non-marketable equity investment resulting from an other-than-temporary decline
in its value. This amount was included within the consolidated statements of
operations as other expense.
Inventories
Inventories are stated at the lower of cost (on a first-in, first-out
basis) or market. The Company provides reserves for excess and obsolete
inventories determined primarily based upon estimates of future demand for the
Company's products. Shipping and handling costs are classified as a component of
cost of revenues in the consolidated statements of operations.
Property and Equipment
Property and equipment are carried at cost. Depreciation is provided using
the straight-line method over the assets' estimated useful lives ranging from
three to five years. Depreciation and amortization of leasehold improvements are
computed using the shorter of the remaining lease term or five years. Major
renewals and betterments are capitalized, while replacements, maintenance and
repairs which do not improve or extend the lives of the respective assets are
expensed as incurred.
Long-Lived Assets
Long-lived assets and certain identifiable intangible assets to be held and
used are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of such assets may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the
carrying amount of an asset to future net cash flows expected to be generated by
the asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets.
Capitalized Internal Use Software Costs
The Company capitalizes the costs of computer software developed or
obtained for internal use in accordance with AICPA Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use." Capitalized computer software costs consist of purchased software
licenses and implementation costs. At June 30, 2004 and 2003, $75,000 and
$734,000, respectively, are included in computer and office equipment in the
accompanying consolidated balance sheet. The capitalized software costs are
being amortized on a straight-line basis over a period of three years.
Amortization for the years ended June 30, 2004, 2003 and 2002 totaled $659,000,
$776,000 and $999,000, respectively. Capitalized internal use software with a
net carrying amount of approximately $107,000 and $898,000 were written off for
the years ended June 30, 2003 and 2002, respectively, as a result of the
Company's fiscal 2003 and 2002 restructuring plans (Note 6). No similar
write-offs were recorded for the year ended June 30, 2004.
Income Taxes
Income taxes are computed under the liability method. This method requires
the recognition of deferred tax assets and liabilities for temporary differences
between the financial reporting basis and the tax basis of the Company's assets
and liabilities. The impact on deferred taxes of changes in tax rates and laws,
if any, are applied to the years during which temporary differences are expected
to be settled and are reflected in the consolidated financial statements in the
period of enactment. A valuation allowance is recorded when it is more likely
than not that some of the deferred tax assets will not be realized.
Stock-Based Compensation
The Company accounts for stock-based awards to employees in accordance with
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees" ("APB 25"), and related interpretations, and has adopted the
disclosure-only alternative of SFAS No. 123, "Accounting for Stock-Based
Compensation ("SFAS No. 123"), and SFAS No. 148, "Accounting for Stock-Based
F-9
Compensation Transition and Disclosure ("SFAS No. 148"). Options granted to
non-employees, as defined, have been accounted for at fair market value in
accordance with SFAS No. 123.
The Company also complies with Financial Accounting Standards Board
("FASB") Interpretation No. 44, "Accounting for Certain Transactions Involving
Stock Compensation - An Interpretation of APB Opinion No. 25", ("FIN 44"). FIN
44 clarifies the definition of an employee for purposes of applying APB 25, the
criteria for determining whether a plan qualifies as a noncompensatory plan, the
accounting consequence of various modifications to the terms of a previously
fixed stock option or award, and the accounting for an exchange of stock
compensation awards in a business combination.
For stock option grants to non-employees who are consultants to the
Company, the Company complies with the provisions of Emerging Issues Task Force
("EITF") Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to
Other Than Employees for Acquiring, or in Conjunction with, Selling Goods or
Services" ("EITF 96-18"). EITF 96-18 requires variable plan accounting with
respect to such non-employee stock options, whereby compensation associated with
such options is measured on the date such options vest, and incorporates the
then-current fair market value of the Company's common stock into the option
valuation model.
Pro forma information regarding net income loss per share is required by
SFAS No. 123 and has been determined as if the Company had accounted for its
employee stock options under the fair value method of SFAS No. 123.
The value of the Company's stock-based awards granted to employees prior to
the Company's initial public offering in August 2000 was estimated using the
minimum value method, which does not consider stock price volatility.
Stock-based awards granted subsequent to the initial public offering have been
valued using the Black-Scholes option pricing model. Among other things, the
Black-Scholes model considers the expected volatility of the Company's stock
price, determined in accordance with SFAS No. 123, in arriving at an option
valuation. Estimates and other assumptions necessary to apply the Black-Scholes
model may differ significantly from assumptions used in calculating the value of
options granted prior to the initial public offering under the minimum value
method.
The fair value of options granted to employees after the initial public offering
have been estimated with the following weighted average assumptions:
YEARS ENDED JUNE 30,
--------------------
2004 2003 2002
------ ------ ------
Expected life (in years) . . 4.00 4.00 4.00
Volatility . . . . . . . . . 1.24 1.28 1.31
Risk-free interest rate. . . 3.60% 1.90% 4.10%
Dividend yield . . . . . . . 0.00% 0.00% 0.00%
Weighted average fair value. $1.09 $0.68 $3.81
For pro forma purposes, the estimated value of the Company's stock-based
awards to employees is amortized over the vesting period of the underlying
instruments. The results of applying SFAS No. 123 to the Company's stock-based
awards to employees would approximate the following:
YEARS ENDED JUNE 30,
-------------------------
2004 2003 2002
----- ----- -----
(in thousands, except per share data)
Net loss:
As reported $(15,654) $(47,549) $(93,457)
Pro forma (18,351) (52,311) (97,708)
Basic and diluted net loss per share:
As reported $ (0.28) $ (0.88) $ (1.82)
Pro forma (0.32) (0.96) (1.90)
F-10
Loss Per Share
Basic and diluted loss per share is calculated by dividing net loss by the
weighted average number of common shares outstanding during the year.
YEARS ENDED JUNE 30,
-------------------------------
2004 2003 2002
--------- --------- ---------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
Numerator:
Loss from continuing operations before cumulative
effect of an accounting change $(10,607) $(37,434) $(84,108)
Loss from discontinued operations (5,047) (10,115) (3,444)
--------- --------- ---------
Loss before cumulative effect of an accounting change (15,654) (47,549) (87,552)
Cumulative effect of adoption of new accounting standard,
SFAS No. 142 - - (5,905)
--------- --------- ---------
Net loss $(15,654) $(47,549) $(93,457)
========= ========= =========
Denominator:
Weighted-average shares outstanding 57,194 54,661 51,909
Less: Non-vested common shares outstanding (332) (332) (506)
--------- --------- ---------
Denominator for basic and diluted loss per share 56,862 54,329 51,403
========= ========= =========
Basic and diluted loss per share from continuing operations
before cumulative effect of an accounting change $ (0.19) $ (0.69) $ (1.63)
Loss from discontinued operations (0.09) (0.19) (0.07)
--------- --------- ---------
Loss before cumulative effect of an accounting change (0.28) (0.88) (1.70)
Cumulative effect of adoption of new accounting standard,
SFAS No. 142 - - (0.12)
--------- --------- ---------
Basic and diluted net loss per share $ (0.28) $ (0.88) $ (1.82)
========= ========= =========
Common share equivalents of 1,126,503, 453,053 and 359,222 have been
excluded from the diluted net loss per share calculation for the years ended
June 30, 2004, 2003 and 2002, respectively, because they were antidilutive as of
such dates. These excluded common stock equivalents could be dilutive in the
future.
Research and Development Costs
Costs incurred in the research and development of new products and
enhancements to existing products are expensed as incurred. The Company believes
its current process for developing products is essentially completed
concurrently with the establishment of technological feasibility. Software
development costs incurred after the establishment of technological feasibility
have not been material and, therefore, have been expensed as incurred.
Warranty
Upon shipment to its customers, the Company provides for the estimated cost
to repair or replace products to be returned under warranty. The Company's
current warranty periods generally range from ninety days to two years from the
date of shipment. In addition, the Company also sells extended warranty services
which extend the warranty period for an additional one to three years.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense was
approximately $392,000, $336,000, and $703,000 for the years ended June 30,
2004, 2003 and 2002, respectively.
Comprehensive Income
SFAS No. 130, "Reporting Comprehensive Income" establishes standards for
reporting and displaying comprehensive income (loss), and its components in the
consolidated financial statements. Other accumulated comprehensive loss includes
foreign currency translation adjustments and unrealized losses on investments.
F-11
Segment Information
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" establishes standards for the way companies report information
about operating segments in annual financial statements. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. The Company has only one reportable segment, networking and
internet connectivity.
Reclassifications
Certain amounts in the 2003 and 2002 consolidated financial statements have
been reclassified to conform with current year presentation.
Recent Accounting Pronouncements
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51," ("FIN 46"). FIN 46
requires certain variable interest entities ("VIE") to be consolidated by the
primary beneficiary of the entity if the equity investors in the entity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective for all new VIEs created or acquired after January 31, 2003. For VIEs
created or acquired prior to February 1, 2003, the provisions of FIN 46 must be
applied for the first interim or annual period ending March 15, 2004. The
Company reviewed its investments and other arrangements and determined that none
of its investee companies are VIE's.
In May 2003, the FASB issued SFAS No. 150, "Accounting For Certain
Financial Instruments with Characteristics of Both Liabilities and Equity"
("SFAS No. 150") which establishes standards for how an issuer of financial
instruments classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability (or an
asset in some circumstances) if, at inception, the monetary value of the
obligation is based solely or predominantly on a fixed monetary amount known at
inception, variations in something other than the fair value of the issuer's
equity shares or variations inversely related to changes in the fair value of
the issuer's equity shares. SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 did not have a material impact on the Company's
financial position, results of operations or cash flows.
2. BUSINESS COMBINATIONS
During fiscal year 2002, the Company completed the acquisitions of
Synergetic Micro Systems, Inc. ("Synergetic") and Premise Systems, Inc.
("Premise"). During fiscal year 2003, the Company completed the acquisition of
Stallion Technologies PTY, LTD ("Stallion"). These acquisitions have been
accounted for under the purchase method of accounting. The consolidated
financial statements include the results of operations of these acquisitions
after their dates of acquisition. The acquisition of Synergetic provides the
Company with high-performance embedded chips to complement its device networking
products. The acquisition of Stallion complements the Company's existing
multiport and terminal server product lines.
F-12
A summary of transactions accounted for using the purchase method of
accounting is outlined below:
SHARES TOTAL
RESERVED SHARES
DATE SHARES FOR OPTIONS ISSUED OR CASH
COMPANY ACQUIRED ACQUIRED BUSINESS ISSUED ASSUMED RESERVED CONSIDERATION
- ---------------- --------- --------------------- --------- ----------- --------- -------------
Embedded network
Communications
Synergetic Oct. 2001 solutions provider 2,234,715 615,705 2,850,420 $2.7 million
Developer of client
side software
Premise Jan. 2002 applications 1,063,371 875,000 1,938,371 -
Provider of terminal
servers and multiport
Stallion Aug. 2002 products - - - 2.1 million
The share issuances were exempt from registration pursuant to section 4(2)
of the Securities Act of 1933, as amended. Portions of the cash consideration
and shares issued were held in escrow pursuant to the terms of the acquisition
agreements.
The Premise agreement required the Company to issue 1,150,000 shares of
common stock in exchange for all remaining shares of Premise. Prior to the
acquisition, the Company held shares of Premise representing 19.9% ownership
and, in addition, held convertible promissory notes of $1.2 million with
interest accrued thereon at the rate of 9.0%. The convertible promissory notes
were converted into equity securities of Premise at the closing of the
transaction. The Company issued an aggregate of 1,063,371 shares of its common
stock in exchange for all remaining outstanding shares of Premise common stock
and reserved 875,000 additional shares of common stock for issuance upon
exercise of outstanding employee stock options and other rights of Premise.
Refer to Note 7 for the discontinued operations of Premise.
The Stallion agreement required the Company to pay $1.2 million in cash
consideration and establish a cash escrow account in the amount of $867,000 at
the acquisition date to be used in lieu of the Company's common stock in the
event that the Company was unable to issue registered shares by October 31,
2002. In accordance with the terms of the acquisition agreement, the Company was
not able to issue registered shares by October 31, 2002; accordingly, the cash
escrow amount of $867,000 was released on November 1, 2002. In addition, the
Company issued a two-year note in the principal amount of $867,000, which is due
in August 2004 (Note 8). The Company relied on the exemption in Section 4 (2) of
the Securities Act of 1933 in that the offering of the convertible note was not
a public offering.
Allocation of Purchase Consideration
For each of the three purchase transactions, the Company obtained
independent appraisals of the fair value of the tangible and intangible assets
acquired in order to allocate the purchase price. Based upon those appraisals,
the purchase price was allocated as follows (in thousands):
NET TANGIBLE
-------------
ASSETS
(LIABILITIES) PURCHASED DEFERRED DEFERRED TAX TOTAL
----------- -------------
COMPANY ACQUIRED ACQUIRED GOODWILL INTANGIBLES COMPENSATION LIABILITIES IPR&D CONSIDERATION
- ---------------- ------------- -------- ----------- ------------ ------------- ----- -------------
Synergetic $ (233) $ 13,952 $ 11,100 $ 203 $ (5,213) $ - $ 19,809
Premise (79) 6,593 3,700 - (1,480) 1,000 9,734
Stallion (93) 2,270 1,500 - (600) - 3,077
The consideration for the purchase transactions was calculated as follows:
a) common shares issued were valued based upon the Company's stock price for a
short period just before and after the companies reached agreement and the
proposed transactions were announced and b) employee stock options were valued
in accordance with FIN 44. Net tangible assets acquired in connection with the
purchase transactions include the acquisition costs incurred by the Company.
Additionally, the net tangible assets of Synergetic reflect an outstanding
credit facility aggregating $626,000, which was paid in full by the Company in
connection with the terms of the merger agreements.
F-13
Unaudited 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 2003 and excludes the discontinued operations of Premise
which was acquired in January 2002. The results for the year ended June 30, 2004
includes a full year of operations from the acquisition of Stallion. The
following unaudited pro forma statement of operations data includes the
amortization of purchased intangible assets and stock-based compensation. This
pro forma data is presented for informational purposes only and does not purport
to be indicative of the results of future operations of the Company or the
results that would have actually occurred had the acquisitions taken place at
the beginning of fiscal 2003:
YEAR ENDED
JUNE 30, 2003
(IN THOUSANDS,
EXCEPT PER SHARE
DATA)
Net revenues $49,712
==================
Net loss $(47,543)
==================
Basic and diluted net loss per share $ (0.88)
==================
3. COMPONENTS OF BALANCE SHEET
Inventories
JUNE 30,
------------------
2004 2003
-------- --------
(IN THOUSANDS)
Raw materials $ 4,047 $ 5,109
Finished goods 7,368 7,940
Inventory at distributors 1,291 959
-------- --------
12,706 14,008
Reserve for excess and obsolete inventory (6,029) (7,997)
-------- --------
$ 6,677 $ 6,011
======== ========
Property and Equipment
JUNE 30,
------------------
2004 2003
-------- --------
(IN THOUSANDS)
Computer and office equipment $ 5,873 $ 6,057
Furniture and fixtures 978 964
Production and warehouse equipment 599 469
Transportation equipment 27 33
-------- --------
7,477 7,523
Accumulated depreciation (6,612) (5,139)
-------- --------
$ 865 $ 2,384
======== ========
F-14
Warranty Reserve
JUNE 30,
---------------
2004 2003
------ -------
(IN THOUSANDS)
Beginning balance $1,193 $ 479
Charged to costs and expenses 1,168 878
Charged to other expenses - (153)
Deductions (591) (11)
------ -------
Ending balance $1,770 $1,193
====== =======
4. OFFICER LOANS
The Company had net outstanding notes receivable from officers of $110,000
(net of allowance of $4.5 million) at June 30, 2004 and 2003 primarily related
to taxes on exercised stock options. These notes are non-recourse, are secured
by 2,573,394 shares of common stock, and are interest bearing at rates ranging
from 5.19% to 7.50% per annum. Principal and any unpaid interest are due upon
any transfer or disposition of the common stock. One of the note holders is the
former Chief Executive Officer who assumed the role of Chief Technology and
Strategy Officer of the Company effective May 30, 2002 and resigned from the
Company effective September 1, 2002. One of the note holders is one of the
Company's outside directors and one of the note holders is the former Chief
Operating/Chief Financial Officer who was terminated by the Company on May 3,
2002. The Company reduced the carrying amount of the officer loans by $4.5
million by establishing a reserve for uncertainties relative to collection of
the related receivables. Factors considered in determining the level of this
reserve include the value of the collateral securing the notes, the ability of
the Company to effectively enforce its collection rights and the ability of the
former officers to honor their obligations to the Company. As of June 30, 2004,
no impairment has been recorded as it relates to the note receivable from the
outside director.
5. GOODWILL AND PURCHASED INTANGIBLE ASSETS
Goodwill
The change in the carrying amount of goodwill is as follows (in thousands):
YEARS ENDED
JUNE 30,
--------------
2004 2003
------ ------
Balance as of July 1 $9,488 $7,218
Goodwill acquired during the period - 2,270
------ ------
Balance as of June 30 $9,488 $9,488
====== ======
F-15
Purchased Intangible Assets
The composition of purchased intangible assets is as follows (in
thousands):
JUNE 30, 2004 JUNE 30, 2003
------------------------------ ------------------------------
USEFUL ACCUMULATED ACCUMULATED
LIVES GROSS AMORTIZATION NET GROSS AMORTIZATION NET
--------- ------ -------------- ------ ------ -------------- ------
Existing technology 1-5 years $7,090 $ (5,101 ) $1,989 $7,090 $ (3,029) $4,061
Patent/core technology 5 405 (365) 40 405 (283) 122
Tradename/trademark 5 32 (24) 8 32 (18) 14
Non-compete agreements 2-3 140 (121) 19 140 (62) 78
------ -------------- ------ ------ -------------- ------
Total $7,667 $ (5,611) $2,056 $7,667 $ (3,392) $4,275
====== ============== ====== ====== ============== ======
The amortization expense for purchased intangible assets for the year
ended June 30, 2004 was $2.2 million, of which $2.1 million was amortized to
cost of revenues and $148,000 was amortized to operating expenses. The estimated
amortization expenses for the next two years are as follows:
COST OF OPERATING
REVENUES EXPENSES TOTAL
--------- --------- ------
Fiscal year ending June 30:
2005 $ 1,432 $ 67 $1,499
2006 557 - 557
--------- --------- ------
Total $ 1,989 $ 67 $2,056
========= ========= ======
In acquisitions accounted for using the purchase method, goodwill is recorded as
the difference, if any, between the aggregate consideration paid for an
acquisition and the fair value of the net tangible and intangible assets
acquired. Prior to the adoption of SFAS No. 142 "Goodwill and Other Intangible
Assets" ("SFAS No. 142"), effective July 1, 2002, goodwill was amortized on a
straight-line basis over a seven-year period. Purchased intangible assets are
amortized on a straight-line basis over periods ranging from one to five years.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations,"
effective for acquisitions consummated after June 30, 2001, and SFAS No. 142,
effective for fiscal years beginning after December 15, 2001. Under the new
rules, goodwill and certain intangible assets deemed to have indefinite lives
are no longer amortized but are subject to annual impairment tests. Other
intangible assets will continue to be amortized over their useful lives.
In connection with the adoption of SFAS No. 142, the Company completed its
initial assessment and concluded that goodwill arising from the acquisition of
United States Software Corporation ("USSC"), having a carrying value of
approximately $5.9 million as of July 1, 2001, may be impaired. The Company
engaged an independent valuation company to perform a review of the value of
goodwill related to USSC. Based on the independent valuation, which utilized a
discounted cash flow valuation technique, the Company recorded a $5.9 million
charge for the impairment of the USSC goodwill. This amount is reflected as the
cumulative effect of adopting the new accounting standard effective July 1,
2001.
The Company performed the first of the required annual impairment tests of
goodwill under the guidelines of SFAS No. 142 effective as of June 1, 2002. As a
result of industry conditions, lower market valuations and reduced estimates of
information technology capital equipment spending in the future, the Company
determined that there were indicators of impairment to the carrying value of
goodwill related to the acquisitions of Lightwave and Synergetic which had
carrying values of $39.7 million and $13.9 million, respectively, as of June 30,
2002. During the fourth quarter of fiscal 2002, the Company engaged an
independent valuation company to perform a review of the value of goodwill and
based on the independent valuation the Company recorded a $46.4 million
impairment charge on its goodwill.
Additionally, during the fourth quarter of 2002, the Company performed a
review of the value of its purchased intangible assets in accordance with SFAS
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets,"
("SFAS No. 144"). As a result of industry conditions, lower market valuations
and reduced estimates of information technology capital equipment spending in
the future, the Company determined that there were indicators of impairment to
the carrying value of its purchased intangible assets related to its
F-16
acquisitions. During the fourth quarter of fiscal 2002, the Company engaged an
independent valuation company to perform a review of the value of its purchased
intangible assets and based on the independent valuation the Company recorded a
$9.8 million impairment charge of which $4.0 million and $5.8 million was
charged to operating expenses and cost of revenues, respectively. Additionally,
the Company recorded an impairment charge of $665,000 related to intellectual
property not associated with an acquisition.
During the fourth quarter of fiscal 2003, the Company performed an
assessment of the value of its purchased intangible assets in accordance with
SFAS No. 144. As a result of industry conditions, continued lower market
valuations, reduced estimates in information technology capital equipment
spending in the future and other factors impacting expected future cash flows,
the Company determined that there were indicators of impairment to the carrying
value of its purchased intangible assets recorded as part of its acquisitions.
The Company engaged an independent valuation company to perform a review of the
value of its purchased intangible assets. Based on the independent valuations
during the fourth quarter of fiscal 2003, the Company recorded a $5.4 million
impairment charge of which $2.3 million and $3.1 million were charged to
operating expenses and cost of revenues, respectively.
During the fourth quarter of fiscal 2004, the Company completed its annual
impairment assessment and determined that no impairment was indicated as the
estimated fair values exceeded their respective carrying values.
The Company announced on May 30, 2002 that it had signed a new intellectual
property agreement with Gordian, Inc., the Company's provider of product designs
and engineering services. The agreement gives the Company joint ownership of the
Gordian intellectual property that is embodied in the products Gordian has
designed for the Company since 1989. The agreement provides that the Company
will be able to use the intellectual property to support, maintain and enhance
its products. The agreement extinguishes the Company's obligations to pay
royalties for each unit of a Gordian-designed product that it sells (Note 13).
The intellectual property agreement required the Company to pay Gordian
$6.0 million in order to acquire an interest in the Gordian intellectual
property, which was paid in three installments. The Company paid $3.0 million
concurrent with the signing of the agreement, $2.0 million on July 1, 2002 and
the remaining $1.0 million on July 1, 2003. The Company agreed to purchase $1.5
million of engineering and support services from Gordian over the next 18
months. The Company is amortizing the intellectual property rights over the
remaining life cycles of the products designed by Gordian, or approximately
three years. The Company recorded $1.8 million, $2.5 million and $212,000 of
amortization expense included in cost of revenues for the years ended June 30,
2004, 2003 and 2002.
6. RESTRUCTURING CHARGES
On February 6, 2002, the Company announced a restructuring plan to
prioritize its initiatives around the growth area of its business, focus on
profit contribution, reduce expenses, and improve operating efficiency. This
restructuring plan included a worldwide workforce reduction, consolidation of
excess facilities and other charges. As of June 30, 2002, the Company recorded
restructuring costs totaling $3.5 million. Through June 30, 2003, the February
2002 restructuring plan had resulted in the reduction of approximately 50
regular employees worldwide and the Company incurred actual workforce reduction
charges of approximately $1.9 million related to severance and fringe benefits.
Included in the workforce reduction charge was a non-cash stock-based
compensation charge in the amount of $595,000 associated with the modification
of stock options that were outstanding at the termination date. Property,
equipment and other assets that were disposed of or removed from operations
resulted in a charge of $1.6 million and consisted primarily of computer
software and related equipment, production, engineering and office equipment,
and furniture and fixtures.
On September 12, 2002 and March 14, 2003, 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. These restructuring plans included a worldwide workforce reduction,
consolidation of excess facilities and other charges. The Company recorded
restructuring costs totaling $5.6 million, which were classified as operating
expenses in the Company's consolidated statement of operations for the year
ended June 30, 2003. These restructuring plans resulted in the reduction of
approximately 58 regular employees worldwide. The Company recorded workforce
reduction charges of approximately $1.2 million related to severance and fringe
benefits for the terminated employees. The Company recorded charges of
approximately $4.4 million related to consolidation of excess facilities,
relating primarily to lease terminations, non-cancelable lease costs, write-off
of leasehold improvements and terminations of a contractual obligation.
During the year ended June 30, 2004, the Company completed the sale of its
Premise business unit as more fully disclosed in Note 7. As a result, the
Company recorded approximately $670,000 of restructuring charges which are
included in discontinued operations of which $633,000 related to certain future
lease obligations and $37,000 related to workforce reductions of three Premise
employees that were not transferred to the buyer.
F-17
During the year ended June 30, 2004, approximately $2.1 million of
restructuring charges were recovered related to a favorable settlement of a
contractual obligation, consolidation of excess facilities and workforce
reductions which were previously accrued for in fiscal year 2003. The remaining
restructuring reserve is related to facility closures in Naperville, Illinois,
Hillsboro, Oregon, Redmond, Washington and Ames, Iowa. Payments under the lease
obligations will end in fiscal 2007.
A summary of the activity in the restructuring liability account is as
follows (in thousands):
RESTRUCTURING
RESTRUCTURING COSTS CASH
RESERVE AT INCLUDED IN CHARGES RESTRUCTURING
JUNE 30, DISCONTINUED AGAINST RESTRUCTURING RESERVE AT
2003 OPERATIONS RESERVE RECOVERY JUNE 30, 2004
------------- ------------- ------- ------------- -------------
Workforce reductions . . . . . . . $ 260 $ 21 $ (98) $ (183) $ -
Contractual obligations. . . . . . 2,000 - (450) (1,550) -
Consolidation of excess facilities 975 521 (384) (360) 752
------------- ------------- ------- ---------- -------------
Total. . . . . . . . . . . . . . . $3,235 $ 542 $ (932) $ (2,093) $ 752
============= ============= ======= ============= =============
7. DISCONTINUED OPERATIONS
In August 2001, the FASB issued SFAS No. 144. SFAS No. 144 supersedes FASB
Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of;" however, it retains the fundamental
provisions of that statement related to the recognition and measurement of the
impairment of long-lived assets to be "held and used." SFAS No. 144 also
supersedes the accounting and reporting provisions of APB Opinion No. 30,
"Reporting the Results of Operation's - Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" ("APB 30"), for the disposal of a segment of a
business. Under SFAS No. 144, a component of a business that is held for sale is
reported in discontinued operations if (i) the operations and cash flows will
be, or have been, eliminated from the ongoing operations of the company and,
(ii) the company will not have any significant continuing involvement in such
operations.
In March 2004, the Company completed the sale of substantially all of the net
assets of its Premise business unit for $1.0 million. Additionally, the Company
incurred $383,000 of disposal costs.
The net revenues and loss from discontinued operations are as follows (in
thousands):
YEAR ENDED
JUNE 30,
----------
2004 2003 2002
------------ --------- --------
Net revenues $ 86 $ 120 $ 55
============ ========= ========
Loss from discontinued operations $ (5,639) $(10,115) $(3,444)
Gain on sale of assets of discontinued operations 592 - -
------------ --------- --------
Loss from discontinued operations, net of income taxes of $0 $ (5,047) $(10,115) $(3,444)
============ ========= ========
F-18
The assets and liabilities of the discontinued operations consisted of the
following (in thousands):
JUNE 30, 2003
--------------
Accounts receivable, net . . . . . . . . . . $ 40
Prepaid expenses and other current assets. . 27
Property and equipment, net. . . . . . . . . 157
Goodwill . . . . . . . . . . . . . . . . . . 2,238
Purchased intangible assets, net . . . . . . 1,119
Other assets . . . . . . . . . . . . . . . . 9
--------------
Total assets of discontinued operations. . . $ 3,590
==============
Accounts payable . . . . . . . . . . . . . . $ 27
Accrued payroll and related expenses . . . . 182
Other current liabilities. . . . . . . . . . 30
--------------
Total liabilities of discontinued operations $ 239
==============
The Company performed its annual impairment tests under the guidelines of
SFAS No. 142 as of April 1, 2003. The Company compared the carrying value of
each reporting unit to its estimated fair value calculated with the assistance
of an independent valuation company. An impairment loss was recognized for
reporting units where the carrying value of their goodwill exceeded the implied
fair value of goodwill. Based on this assessment, the Company recorded a charge
of $4.4 million during the fourth quarter of fiscal 2003 to write down the value
of goodwill. This amount is included as part of discontinued operations for the
year ended June 30, 2004.
During the quarter ended December 31, 2003, the Company identified
indicators of an other than temporary impairment as it related to its Premise
acquisition of goodwill and purchased intangible assets. The Company performed
an assessment of the value of its goodwill and purchased intangible assets
related to the Premise acquisition in accordance with SFAS No. 142, and SFAS No.
144. The Company identified certain conditions including continued losses and
the inability to achieve significant revenues from the existing home automation
and media management software markets as indicators of asset impairment. These
conditions led to operating results and forecasted future results that were
substantially less than had been anticipated. The Company revised its
projections and determined that the projected results utilizing a discounted
cash flow valuation technique would not fully support the carrying values of the
goodwill and purchased intangible assets associated with the Premise
acquisition. Based on this assessment, the Company recorded an impairment charge
of $2.2 million during the second quarter of fiscal 2004 to write-off the value
of the Premise goodwill. Additionally during the quarter ended December 31,
2003, the Company recorded a $790,000 impairment charge of the Premise purchased
intangible assets of which $14,000 and $776,000 were charged to operating
expenses and cost of revenues, respectively. As a result of the sale of the
Premise business unit, the goodwill and purchased intangibles, net of Premise at
June 30, 2003, have been included as part of discontinued operations.
8. BANK LINE OF CREDIT AND DEBT
In January 2002, the Company entered into a two-year line of credit with a
bank in an amount not to exceed $20.0 million. Borrowings under the line of
credit bear interest at either (i) the prime rate or (ii) the LIBOR rate plus
2.0%. The Company was required to pay a $100,000 facility fee which was reduced
to $62,500 and was paid. The Company was also required to pay a quarterly unused
line fee of .125% of the unused line of credit balance. Since establishing the
line of credit, the Company has twice reduced the amount of the line, modified
customary financial covenants and adjusted the interest rate to be charged on
borrowings to the prime rate plus .50% and eliminated the LIBOR option.
Effective July 25, 2003, the Company further modified this line of credit,
reducing the revolving line to $5.0 million and adjusting the customary
affirmative and negative covenants. The Company is also required to maintain
certain financial ratios as defined in the agreement. The agreement has an
annual revolving maturity date that renews on the effective date. The agreement
was renewed on July 24, 2004 with an amendment to a financial ratio. The Company
is required to pay a $12,500 facility fee for the renewal. The Company's
borrowing base at June 30, 2004 was $3.2 million. In March 2004, the Company
borrowed $500,000 against this line of credit. Additionally, the Company has
F-19
used letters of credit available under its line of credit totaling approximately
$1.0 million in place of cash to fund deposits on leases, tax account deposits
and security deposits. As a result, the Company's available line of credit at
June 30, 2004 was $1.6 million. The Company is currently in compliance with the
revised financial covenants of the July 24, 2004 amended line of credit.
Pursuant to the line of credit, the Company is restricted from paying any
dividends.
The Company issued a two-year note in the principal amount of $867,000 as a
result of its acquisition of Stallion (note 2) accruing interest at a rate of
2.5% per annum. Interest expense related to the note totaled approximately
$22,000 and $19,000 at June 30, 2004 and 2003, respectively. No similar interest
expense was recorded for the year ended June 30, 2002. The notes are convertible
into the Company's common stock at any time, at the election of the holders, at
a $5.00 conversion price. The notes were due and paid in August 2004 as the
holders elected not to convert the notes into the Company's common stock.
9. STOCKHOLDERS' EQUITY
Secondary Public Offering
In July 2001, the Company completed a public offering of 8,534,000 shares
of its common stock, including an underwriter's over-allotment option to
purchase an additional 534,000 shares, at an offering price of $8.00 per share.
The Company sold 6,000,000 shares and selling stockholders sold 2,000,000 shares
of the primary offering. Additionally, the Company sold 400,500 shares and
selling stockholders sold 133,500 shares of the over-allotment option. The
Company received net proceeds of approximately $47.1 million in connection with
this offering.
Employee Stock Purchase Plan
In May 2000, the Board of Directors approved the 2000 Employee Stock
Purchase Plan (the "Purchase Plan") effective upon the completion of the initial
public offering. A total of 1,050,000 shares of common stock have been reserved
for issuance under the Purchase Plan. The number of shares available for
issuance pursuant to the Purchase Plan increases annually commencing in fiscal
year 2001. The Purchase Plan permits participants to purchase common stock at
six-month intervals through payroll deductions of up to 15% of the participant's
compensation, as defined. Amounts deducted and accumulated by the participants
are to be used to purchase shares of common stock at the end of each offering
period, as defined, at 85% of the lower of the fair market value of the common
stock at the beginning or end of the offering period. For the years ended June
30, 2004, 2003 and 2002, 505,935, 406,205 and 178,687 shares were issued under
the plan at an average per share price of $0.73, $0.69 and $2.45, respectively.
At June 30, 2004, 107,942 shares were available for future issuances under this
plan.
Reverse Stock Split
On November 12, 2002, the Company's shareholders approved a proposal to
effect a 3:1 reverse stock split of the Company's outstanding common stock (a
"Reverse Stock Split") and authorized the Board of Directors to determine if and
when to effectuate a Reverse Stock Split. This authorization expired in November
2003 without being exercised.
Stock Option Plans
The Company has in effect several stock-based plans under which
non-qualified and incentive stock options have been granted to employees,
non-employees and board members.
The Board of Directors determines eligibility, vesting schedules and
exercise prices for options granted under the plans. Options generally have a
term of 10 years and vest and become exercisable, generally over a four-year
period.
Under the Company's 1993 Incentive Stock Option Plan (the "1993 Plan"), the
Company has reserved 4,000,000 shares of common stock for the granting of
options. Such options are to be granted at or above the fair market value of the
Company's common stock on the date of grant. All stock options are to vest over
a period determined by the Board of Directors (generally four years) and expire
not more than ten years from the date of grant. As of June 30, 2004, 1,412,090
options were available for grant under the 1993 Plan.
F-20
Under the Company's 1994 Nonstatutory Stock Option Plan (the "1994 Plan"),
the Company has reserved 10,000,000 shares of common stock for grant at prices
and vesting periods to be determined by the Company's Board of Directors. In
certain cases, the Company has granted options, which became fully vested on the
date granted. As of June 30, 2004, 7,142,268 options were available for grant
under the 1994 Plan.
Under the Company's 2000 Stock Plan (the "2000 Plan"), the Company has
reserved 6,000,000 shares of common stock for issuance pursuant to option
grants. The number of shares available for issuance increases by 2,000,000
shares annually commencing in calendar year 2002. Each outside director is
automatically granted an option to purchase 25,000 shares of common stock
annually, subject to certain eligibility requirements. As of June 30, 2004,
440,633 options were available for grant under the 2000 Plan.
As a result of the Company's acquisitions, the Company assumed stock
options granted under stock option plans established by each acquired company;
no additional options will be granted under those plans. As of June 30, 2004,
167,989 shares of common stock were reserved for issuance upon exercise of
outstanding options assumed under these stock option plans.
A summary of all stock option activity under the plans is as follows:
NUMBER OF WEIGHTED AVERAGE
OPTIONS EXERCISE PRICE
----------- ----------------
Outstanding at June 30, 2001 4,150,263 $ 4.17
Granted 4,179,668 5.12
Canceled (1,278,113) 5.49
Exercised (1,073,452) 1.51
-----------
Outstanding at June 30, 2002 5,978,366 5.14
Granted 1,985,361 0.67
Canceled (3,613,674) 6.42
Exercised (152,004) 0.24
-----------
Outstanding at June 30, 2003 4,198,049 2.10
Granted 2,814,899 1.09
Canceled (942,627) 1.52
Exercised (496,335) 0.72
-----------
Outstanding at June 30, 2004 5,573,986 1.81
===========
Exercisable at June 30, 2002 1,823,365
===========
Exercisable at June 30, 2003 2,338,610
===========
Exercisable at June 30, 2004 2,669,069
===========
The weighted average exercise price of options outstanding and of options
exercisable as of June 30, 2004 were as follows:
OUTSTANDING EXERCISABLE
---------------------- ---------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
NUMBER OF REMAINING AVERAGE AVERAGE
OPTIONS CONTRACTUAL EXERCISE OPTIONS EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
- ------------------------- ----------- ------------ -------- ----------- --------
0 to $0.29 52,729 3.21 $ 0.13 51,843 $ 0.13
0.55 to $1.00 2,244,728 9.58 0.67 1,168,231 0.65
1.01 to $2.59 2,426,003 8.76 1.57 660,060 2.21
4.00 to $5.89 469,884 3.61 5.06 458,216 5.07
6.00 to $14.00 380,642 4.94 6.29 330,719 6.27
At June 30, 2004, 14,844,908 shares of the Company's common stock are
reserved for issuance pursuant to the employee stock purchase and stock option
plans. Certain of the Company's employees hold options that were assumed by the
Company in connection with its acquisitions of the businesses that previously
employed those individuals; in the business combinations that have been
F-21
accounted for as purchases, the Company has recorded deferred compensation with
respect to those options. Additionally, the Company granted stock options to
employees where the option exercise price is less that the estimated fair value
of the underlying shares of common stock as determined for financial reporting
purposes, as well as the fair market value of the vested portion of non-employee
stock options utilizing the Black-Scholes option pricing model. The Company has
recorded net deferred compensation forfeitures of $197,000 and $2.5 million, for
the years ended June 30, 2004 and 2003, respectively.
The Company is amortizing the deferred compensation over the shorter of the
period in which the employee provides services or the applicable vesting period,
which is generally four years. For the years ended June 30, 2004, 2003 and 2002,
stock-based compensation was approximately $395,000, $1.3 million and $3.6
million, respectively. The amount of stock-based compensation in future periods
will increase if we grant stock options where the exercise price is less than
the quoted market price of the underlying shares or if we assume employee stock
options in connection with additional acquisitions of businesses. Deferred
compensation is decreased in the period of forfeiture arising from the early
termination of an option holder's services. No compensation expense related to
stock options that existed for any other period has been recorded. The weighted
average grant date fair value of options granted during the years ended June 30,
2004, 2003 and 2002 was $1.09, $0.67 and $5.12, respectively. The weighted
average grant date fair value of in the money options granted during the years
ended June 30, 2003 and 2002 was $0.65 and $6.77, respectively. The weighted
average exercise price of in the money options granted during the years ended
June 30, 2003 and 2002 was, $0.50 and $3.26, respectively. The Company did not
grant any in the money options during the year ended June 30, 2004.
Stock Option Exchange Offer
On January 24, 2003, the Company completed an offering to employees whereby
employees holding options to purchase the Company's common stock with exercise
prices at or above $3.01 per share were given the opportunity to cancel certain
of their existing options in exchange for the opportunity to receive new options
to purchase the Company's common stock. Each new option shall represent 0.75 of
the underlying shares of the options cancelled. Approximately 1,378,124 options
with a weighted average exercise price of $9.01 were tendered. On January 27,
2003, those options were cancelled by the Company. The new options were not
granted until at least six months and one day after acceptance of the old
options for exchange and cancellation and were only granted to those exchange
participants who remained as employees at the time of the new grant. The
exercise price of the new options was determined based upon the last reported
trading price of the Company's common stock on the grant date. On July 28, 2003,
the Company granted replacement options to purchase 1,033,593 shares of its
common stock to employees who tendered options under the stock option exchange
offer, at an exercise price of $0.81 per share.
10. 401(K) PLAN
The Company has a savings plan (the "Plan") which is qualified under
Section 401(k) of the Internal Revenue Code. Eligible employees may elect to
make contributions to the Plan through salary deferrals up to 15% of their base
pay, subject to limitations. The Company's contributions are discretionary and
are subject to limitations. For the years ended June 30, 2004, 2003 and 2002,
the Company contributed $0.50 for each $1.00 of employee salary deferral
contributions up to a maximum of 6% of the employee's annual gross wages,
subject to limitations. Selling, general and administrative expenses include
contributions of approximately $166,000, $192,000 and $202,000 for the years
ended June 30, 2004, 2003 and 2002, respectively.
11. LITIGATION SETTLEMENTS
Lightwave Settlement
The Company received an informal notice from several holders of the
Company's unregistered shares of common stock that were issued in connection
with the acquisition of Lightwave. The shares were issued to the holders in a
private transaction not registered under the Securities Act of 1933, and
therefore could not be sold by the stockholders without a valid registration
statement. The stockholders alleged that the Company failed to honor their
rights to have the shares registered and that they were therefore precluded from
selling the shares. Effective July 26, 2002, the Company settled with the
stockholders of Lightwave in the amount of $2.0 million in exchange for 240,000
shares of the Company's common stock held in escrow and 208,335 additional
shares issued to the former owners of Lightwave on the acquisition date. This
settlement resulted in a net charge to the Company's results of operations of
approximately $1.9 million for the year ended June 30, 2002 and has been
recognized as litigation settlement costs.
F-22
Securities Claims and Employment Claims Brought by the Co-Founders of United
States Software Corporation
On August 23, 2002, a complaint entitled Dunstan v. Lantronix, Inc., et
al., was filed in the Circuit Court of the State of Oregon, County of Multnomah,
against the Company and certain of its current and former officers and directors
by the co-founders of USSC. The complaint alleged Oregon state law claims for
securities violations, fraud, and negligence. The original complaint sought not
less than $3.6 million in damages, interest, attorneys' fees, costs, expenses,
and an unspecified amount of punitive damages. The Company moved to compel
arbitration in November 2002, and in a ruling dated February 9, 2003, the court
ordered the matter stayed pending arbitration of all claims. The Company filed
an arbitration demand on or about February 21, 2003 which included additional
claims related to the Company's acquisition of USSC. The arbitration demand
sought more than $14.0 million in damages and an unspecified amount in
attorneys' fees, costs, expenses, and punitive damages. The parties participated
in a mediation on June 30, 2003, and subsequently reached an agreement to settle
the dispute. The agreement called for the Company to release to the plaintiffs
approximately $400,000 in cash and 49,038 shares of the Company's common stock
that had been held in an escrow since December 2000 as part of the acquisition
of USSC. The agreement also called for the Company to issue to the plaintiffs
additional shares of its common stock worth approximately $1.5 million, which
was recorded in the Company's results of operations as litigation settlement
costs for the year ended June 30, 2003. Accordingly, 1,726,703 shares were
issued following a fairness determination by the state court in Oregon. In
exchange, the plaintiffs released all claims against all defendants.
12. INCOME TAXES
The income tax provision (benefit) is comprised of the following:
YEARS ENDED JUNE 30,
-----------------------
2004 2003 2002
------ ----- --------
(IN THOUSANDS)
Current:
Federal $ 91 $ 18 $(1,423)
State 7 100 -
Foreign 177 132 352
------ ----- --------
Total current 275 250 (1,071)
Deferred:
Federal (476) - (4,127)
State (124) - (1,467)
Foreign - - -
------ ----- --------
Total deferred (600) - (5,594)
Total income tax provision (benefit) $(325) $ 250 $(6,665)
====== ===== ========
United States and foreign income (loss) from continuing operations before
taxes are as follows:
YEARS ENDED JUNE 30,
--------------------
2004 2003 2002
--------- --------- ---------
(IN THOUSANDS)
United States $(11,716) $(40,404) $(87,199)
Foreign 784 3,220 (3,574)
--------- --------- ---------
$(10,932) $(37,184) $(90,773)
========= ========= =========
F-23
The tax effects of temporary differences that give rise to deferred tax
assets and liabilities are as follows:
JUNE 30,
--------
2004 2003
--------- ---------
(IN THOUSANDS)
Deferred tax assets:
Reserves not currently deductible $ 4,620 $ 4,790
Inventory capitalization 2,749 3,680
Marketing rights 1,360 -
Tax losses and credits 32,446 27,460
--------- ---------
41,175 35,930
Valuation allowance (38,946) (33,075)
--------- ---------
Total deferred tax assets 2,229 2,855
--------- ---------
Deferred tax liabilities:
State taxes - (467)
Identified intangibles (310) (644)
Depreciation (255) (671)
Deferred compensation (1,664) (1,673)
--------- ---------
Total deferred tax liabilities (2,229) (3,455)
--------- ---------
Net deferred tax assets (liabilities) $ - $ (600)
========= =========
A reconciliation of the income tax provision (benefit) for loss from
continuing operations before discontinued operations and cumulative effect of
accounting changes to taxes computed at the U.S. federal statutory rate is as
follows:
YEARS ENDED JUNE 30,
------------------------------
2004 2003 2002
-------- --------- ---------
(IN THOUSANDS)
Federal income tax (benefit) at statutory rate $(3,717) $(12,642) $(30,863)
State taxes (net of federal tax benefit) (77) 66 (968)
Non deductible goodwill - 1,481 16,176
Change in valuation allowance 4,338 12,646 7,865
Permanent differences 193 10 403
Research and development credit (570) (596) (399)
Foreign tax rate variances (90) 411 248
Deferred compensation 84 337 250
In process technology - - 340
Reduction in tax contingency reserve based
on IRS exam and other (486) 18 623
-------- --------- ---------
$ (325) $ 250 $ (6,665)
======== ========= =========
As of June 30, 2004, the Company has net operating loss carryovers of $69.7
million and $39.0 million for federal and California income tax purposes,
respectively. The federal and California net operating loss carryovers begin to
expire in years 2021 and 2013, respectively.
Approximately $2.3 million of the net operating loss carryforwards resulted
from the Company's acquisition of Synergetic (Note 2). For financial reporting
purposes, a valuation allowance of approximately $773,000 has been recognized to
offset the deferred tax asset related to those carryforwards. If or when
realized, a portion of the tax benefit for those items will be applied to reduce
goodwill and acquired intangibles related to the acquisition of Synergetic.
F-24
The Company has recorded a valuation allowance against its net deferred tax
assets of $39.0 million. If or when realized, the tax benefits relating to, and
the reversal of, approximately $3.1 million of the valuation allowance will be
accounted for as an increase in additional paid-in capital. The valuation
allowance was established due to uncertainties surrounding the realization of
the deferred tax assets.
Due to the "change of ownership" provision of the Tax Reform Act of 1986,
utilization of the Company's net operating loss carryforwards and tax credit
carryforwards may be subject to an annual limitation against taxable income in
future periods. As a result of the annual limitation, a portion of these
carryforwards may expire before ultimately becoming available to reduce future
income tax liabilities.
In 2003, the Internal Revenue Service completed its audit of the Company's
federal income tax returns for the years ended June 30, 1999, 2000 and 2001. The
Company had accrued for this liability in prior fiscal periods. Based on the
final resolution and related state impact of the IRS examination, the Company
recorded a reduction in its tax contingency reserve of approximately $500,000.
The Company is under current discussions with the Swiss Federal Tax
Authorities ("SFTA") regarding the inability of the Company's Swiss subsidiary,
Lantronix International AG, to meet certain guidelines as set within a tax
ruling that was obtained in May 2001. The ruling provided for reduced Swiss tax
rates. The subsidiary was unable to meet the guidelines set forth in the ruling
due to slower than planned growth in this subsidiary, consistent with the
overall Company, and has since converted the subsidiary to a holding company. At
this time, neither the Company nor the SFTA have taken a definitive position
regarding resolution of open tax matters. Based on a variety of assumptions and
positions possible, the potential future tax exposure in this matter is
estimated at $0 to $700,000. The Company has not provided any amounts for this
matter in the consolidated financial statements.
13. COMMITMENTS AND CONTINGENCIES
Leases
The Company leases office equipment and its office and warehouse facilities
under noncancelable operating leases. In July 2000, the Company renewed its
office and warehouse facility lease in Irvine, California commencing in August
2000 and expiring in July 2005.
The following schedule represents minimum lease payments for all
noncancelable-operating leases as of June 30, 2004.
Fiscal year ending June 30 (in thousands):
2005 $1,562
2006 437
2007 162
------
Total minimum lease payments $2,161
======
Facilities rent expense for the years ended June 30, 2004, 2003 and 2002
were $1.3 million, $1.7 million and $1.9 million, respectively.
Royalties
The Company has historically outsourced a substantial portion of its
engineering and production development activities under contract. Certain
development contracts contain royalty provisions based upon sales and/or margin
activity of the underlying products. Approximately $1.2 million is included in
cost of sales in the accompanying consolidated statements of operations for the
year ended June 30, 2002, relating to royalties paid on applicable product
sales. During the years ended June 30, 2004 and 2003 no accrued royalties or
royalty expense was recorded.
F-25
The Company announced on May 30, 2002, that it had signed a new
intellectual property agreement with Gordian. The agreement extinguishes the
Company's obligation to pay royalties for each unit of a Gordian designed
product that it sells (Note 5).
14. LITIGATION
Government Investigation
The Securities and Exchange Commission ("SEC") is conducting a formal
investigation of the events leading up to the Company's restatement of its
financial statements on June 25, 2002. The Department of Justice is also
conducting an investigation concerning events related to the restatement.
Class Action Lawsuits
On May 15, 2002, Stephen Bachman filed a class action complaint entitled
Bachman v. Lantronix, Inc., et al., No. 02-3899, in the U.S. District Court for
the Central District of California against the Company and certain of its
current and former officers and directors alleging violations of the Securities
Exchange Act of 1934 and seeking unspecified damages. Subsequently, six similar
actions were filed in the same court. Each of the complaints purports to be a
class action lawsuit brought on behalf of persons who purchased or otherwise
acquired the Company's common stock during the period of April 25, 2001 through
May 30, 2002, inclusive. The complaints allege that the defendants caused the
Company to improperly recognize revenue and make false and misleading statements
about its business. Plaintiffs further allege that the defendants materially
overstated the Company's reported financial results, thereby inflating its stock
price during its securities offering in July 2001, as well as facilitating the
use of its common stock as consideration in acquisitions. The complaints have
subsequently been consolidated into a single action and the court has appointed
a lead plaintiff. The lead plaintiff filed a consolidated amended complaint on
January 17, 2003. The amended complaint now purports to be a class action
brought on behalf of persons who purchased or otherwise acquired the Company's
common stock during the period of August 4, 2000 through May 30, 2002,
inclusive. The amended complaint continued to assert that the Company and the
individual officer and director defendants violated the 1934 Act, and also
includes alleged claims that the Company and its officers and directors violated
the Securities Act of 1933 arising from the Company's Initial Public Offering in
August 2000. The Company has filed a motion to dismiss the additional
allegations on March 3, 2003. Plaintiffs filed their second amended complaint
February 6, 2004, and the Company filed a motion to dismiss the additional
allegations in the second amended complaint on March 10, 2004. On August 19,
2004, the Court granted in part and denied in part the motion to dismiss. On
September 13, 2004, Plaintiff's filed their third amended complaint. We have not
yet answered the third amended complaint, and discovery has not yet commenced.
Derivative Lawsuit
On July 26, 2002, Samuel Ivy filed a shareholder derivative complaint
entitled Ivy v. Bernhard Bruscha, et al., No. 02CC00209, in the Superior Court
of the State of California, County of Orange, against certain of the Company's
current and former officers and directors. On January 7, 2003, the plaintiff
filed an amended complaint. The amended complaint alleges causes of action for
breach of fiduciary duty, abuse of control, gross mismanagement, unjust
enrichment, and improper insider stock sales. The complaint seeks unspecified
damages against the individual defendants on the Company's behalf, equitable
relief, and attorneys' fees.
The Company filed a demurrer/motion to dismiss the amended complaint on
February 13, 2003. The basis of the demurrer is that the plaintiff does not have
standing to bring this lawsuit since plaintiff has never served a demand on the
Company's Board that the Board take certain actions on behalf of the Company. On
April 17, 2003, the Court overruled the Company's demurrer. All defendants have
answered the complaint and generally denied the allegations. Discovery has
commenced, but no trial date has been established.
Employment Suit Brought by Former Chief Financial Officer and Chief Operating
Officer Steve Cotton
On September 6, 2002, Steve Cotton, 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.
F-26
The Company filed a motion to dismiss on October 16, 2002, on the grounds
that Mr. Cotton's complaints are subject to the binding arbitration provisions
in Mr. Cotton's employment agreement. On January 13, 2003, the Court ruled that
five of the six counts in Mr. Cotton's complaint are subject to binding
arbitration. The court is staying the sixth count, for declaratory relief, until
the underlying facts are resolved in arbitration. No arbitration date has been
set.
Securities Claims Brought by Former Shareholders of Synergetic Micro Systems,
Inc.
On October 17, 2002, Richard Goldstein and several other former
shareholders of Synergetic filed a complaint entitled Goldstein, et al v.
Lantronix, Inc., et al in the Superior Court of the State of California, County
of Orange, against the Company and certain of its former officers and directors.
Plaintiffs filed an amended complaint on January 7, 2003. The amended complaint
alleges fraud, negligent misrepresentation, breach of warranties and covenants,
breach of contract and negligence, all stemming from its acquisition of
Synergetic. The complaint seeks an unspecified amount of damages, interest,
attorneys' fees, costs, expenses, and an unspecified amount of punitive damages.
On May 5, 2003, the Company answered the complaint and generally denied the
allegations in the complaint. Discovery has commenced but no trial date has been
established.
Patent Infringement Litigation
On August 10, 2004, Digi International served a complaint on the Company
alleging that certain of the Company's products infringe Digi's U.S. Patent No.
6,446,192. Digi filed the complaint in the U.S. District Court in Minnesota. The
complaint seeks both monetary and non-monetary relief. The Company is still
analyzing all of the allegations of the complaint. On August 30, 2004, the
Company served and filed an answer and counterclaim seeking to invalidate U.S.
Patent No. 6,446,192 for failure to meet the applicable statutory requirements
in Part II of Title 35 of the United States Code including, without limitation,
35 U.S.C. Sec. 102, 103 and 112, as conditions for patentability. The
counterclaim seeks both monetary and non-monetary relief.
The Company filed, on May 3, 2004, a complaint against Digi, alleging that
certain of Digi's products infringe the Company's U.S. Patent No. 6,571,305, in
the U.S. District Court for the Central District of California. The Complaint
seeks both monetary and non-monetary relief from Digi's alleged infringement.
Digi has filed an answer and counterclaim alleging invalidity of the patent. The
counterclaim seeks both monetary and non-monetary relief.
Other
From time to time, the Company is subject to other legal proceedings and
claims in the ordinary course of business. The Company is currently not aware of
any such legal proceedings or claims that it believes will have, individually or
in the aggregate, a material adverse effect on its business, prospects,
financial position, operating results or cash flows.
The pending lawsuits involve complex questions of fact and law and likely
will continue to require the expenditure of significant funds and the diversion
of other resources to defend. Management is unable to determine the outcome of
its outstanding legal proceedings, claims and litigation involving the Company,
its subsidiaries, directors and officers and cannot determine the extent to
which these results may have a material adverse effect on the Company's
business, results of operations and financial condition taken as a whole. The
results of litigation are inherently uncertain, and adverse outcomes are
possible. The Company is unable to estimate the range of possible loss from
outstanding litigation, and no amounts have been provided for such matters in
the consolidated financial statements.
15. GEOGRAPHIC AND SIGNIFICANT CUSTOMER INFORMATION
Revenue by Geographic Area
Net revenue by geographic area is provided below:
YEAR ENDED JUNE 30,
-------------------
2004 2003 2002
-------------- -------------- --------------
(AMOUNTS IN THOUSANDS)
America $33,847 69% $37,391 76% $47,691 83%
Europe 11,252 23% 10,366 21% 8,249 14%
Other 3,786 8% 1,632 3% 1,651 3%
------- ----- ------- ----- ------- -----
Total net revenues $48,885 100% $49,389 100% $57,591 100%
======= ===== ======= ===== ======= =====
F-27
Significant Customer Information
One customer, Ingram Micro, Inc., accounted for approximately 14%, 11% and
12% of the Company's net revenues for the years ended June 30, 2004, 2003 and
2002, respectively. Another customer, Tech Data Corporation, accounted for
approximately 9%, 10% and 11% of the Company's net revenues for the years ended
June 30, 2004, 2003 and 2002, respectively. Accounts receivable attributable to
these two domestic customers accounted for approximately 13% and 16% of total
accounts receivable at June 30, 2004 and 2003, respectively.
One international customer, a related party due to common ownership by the
Company's major stockholder, accounted for approximately 3%, 4% and 5% of the
Company's net revenues for the years ended June 30, 2004, 2003 and 2002,
respectively. The Company also had an agreement with the same related
international customer for the provision of technical support services to the
Company at the rate of $7,500 per month, which has now been terminated. Included
in selling, general and administrative expenses is $90,000 for the year ended
June 30, 2002, for these support services. No support services were incurred for
the years ended June 30, 2004 and 2003.
16. QUARTERLY FINANCIAL DATA (UNAUDITED)
Set forth below is summarized unaudited quarterly data:
INCOME (LOSS) FROM
CONTINUING OPERATIONS Net loss
---------
GROSS DILUTED DILUTED
Net revenues PROFIT (LOSS) Amount PER SHARE Amount PER SHARE
------------- -------------- --------- ----------- --------- -----------
Fiscal 2004
First quarter $ 12,201 $ 6,156 $ (2,272) $ (0.04) $ 3,049) $ (0.05)
Second quarter 12,498 5,644 (1,516) (0.03) (5,255) (4) (0.09)
Third quarter 12,310 6,917 116 (0.00) (553) (5) (0.01)
Fourth quarter 11,876 5,142 (6,935) (0.12) (6,797) (6) (0.12)
------------- -------------- --------- ----------- --------- -----------
Total $ 48,885 $ 23,859 $(10,607) $ (0.19) $(15,654) $ (0.28)*
============= ============== ========= =========== ========= ===========
Fiscal 2003
First quarter $ 12,681 $ 4,605 $(10,358) $ (0.19) $(11,402) (1) $ (0.21)
Second quarter 12,603 5,071 (6,250) (0.12) (7,122) (0.13)
Third quarter 12,340 3,114 (7,803) (0.14) (9,921) (2) (0.18)
Fourth quarter 11,765 335 (13,023) (0.24) (19,104) (3) (0.35)
------------- -------------- --------- ----------- --------- -----------
Totals $ 49,389 $ 13,125 $(37,434) $ (0.69)* $(47,549) $ (0.88)*
============= ============== ========= =========== ========= ===========
* Annual per share amounts may not agree to the sum of the quarterly per share amounts
due to differences between average shares outstanding during the periods.
(1) Includes restructuring charges of $4,929.
(2) Includes litigation settlement costs of $1,075 and restructuring charges of $120.
(3) Includes impairment of goodwill and purchased intangible assets of $10,637, litigation
settlement costs of $1,532 and restructuring charges of $662.
(4) Includes impairment of goodwill and purchased intangible assets of $3.0
million.
(5) Includes a $2.1 million recovery from previously recorded restructuring
reserves.
(6) Includes $5.0 million write-off of the Company's investment in Xanboo.
F-28
INDEX TO EXHIBITS
INCORPORATED BY REFERENCE
--------------------------------
EXHIBIT FILED
NUMBER EXHIBIT DESCRIPTION FORM FILE NO. EXHIBIT FILING DATE HEREWITH
--------- -------- ----------- --------
3.1 Certificate of Incorporation of Registrant . . S - 1 333-37508 3.2 05/19/2000
Bylaws of the registrant as amended
3.4 on October 1, 2002 . . . . . . . . . . . . . . 10-K 001-16027 3.4 10/08/2002
Form of Registrant's common stock. . . . . . . S - 1, 06/13/2000
4.1 certificate. . . . . . . . . . . . . . . . . . Amend. No. 1 333-37508 4.1
Form of Indemnification Agreement
entered into by registrant with each of its. . S - 1, 06/13/2000
10.1 directors and executive officers . . . . . . . Amend. No. 1 333-37508 10.1
1993 Stock Option Plan and forms of. . . . . . S - 1,
10.2 agreements thereunder. . . . . . . . . . . . . Amend. No. 1 333-37508 10.2 06/13/2000
1994 Nonstatutory Stock Option Plan. . . . . . S - 1,
10.3 and forms of agreements thereunder . . . . . . Amend. No. 1 333-37508 10.3 06/13/2000
2000 Stock Plan and forms of agreements. . . . S - 1,
10.4 thereunder . . . . . . . . . . . . . . . . . . Amend. No. 1 333-63030 10.4 06/13/2000
S - 1,
10.5 2000 Employee Stock Purchase Plan. . . . . . . Amend. No. 1 333-37508 10.5 06/13/2000
S - 1,
10.6 Form of Warranty . . . . . . . . . . . . . . . Amend. No. 1 333-37508 10.6 06/13/2000
Employment Agreement between registrant
10.7 and Fred Thiel . . . . . . . . . . . . . . . . S - 1 333-37508 10.7 05/19/2000
Employment Agreement between registrant
10.8 and Steve Cotton . . . . . . . . . . . . . . . S - 1 333-37508 10.8 05/19/2000
Employment Agreement between registrant
10.9 and Johannes Rietschel . . . . . . . . . . . . S - 1 333-37508 10.9 05/19/2000
Lease Agreement between registrant and . . . . S - 1,
10.10 The Irvine Company . . . . . . . . . . . . . . Amend. No. 1 333-37508 10.10 06/13/2000
Loan and Security Agreement between. . . . . . S - 1,
10.11 registrant and Silicon Valley Bank . . . . . . Amend. No. 1 333-37508 10.11 06/13/2000
Research and Development Agreement
between registrant and Gordian . . . . . . . . S - 1,
10.12 * Confidential treatment pursuant to Rule 406. Amend. No. 1 333-37508 10.12 06/13/2000
Distributor Contract between registrant and
Tech Data Corporation. . . . . . . . . . . . . S - 1,
10.13 * Confidential treatment pursuant to Rule 406. Amend. No. 1 333-37508 10.13 06/13/2000
Distributor Contract between registrant and
Ingram Micro Inc.. . . . . . . . . . . . . . . S - 1,
10.14 * Confidential treatment pursuant to Rule 406. Amend. No. 1 333-37508 10.14 06/13/2000
Offer to Exchange Outstanding Options,
10.15 dated December 19, 2002. . . . . . . . . . . . Schedule TO 005-60979 99(a)(1) 12/19/2002
21.1 Subsidiaries of registrant . . . . . . . . . . 10 - K 001-16027 21.1 09/28/2001
Consent of Independent Registered Public
23.1 Accounting Firm X
24.1 Power of Attorney (see page II-2) X
31.1 Certificate of Principal Executive Officer X
31.2 Certificate of Principal Financial Officer X
Certification of Chief Executive Officer and
Chief Financial Officer pursuant to 18 U.S.C.
1350, as adopted pursuant to 906 of
32.1 Sarbanes Oxley Act of 2002 X
II-1
SIGNATURES
Pursuant to the requirements of Section 13 and 15(d) of the Securities
Exchange Act of 1934 Lantronix has duly caused this Registration Statement on
Form 10-K to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Irvine, State of California, on the 27th day of
September, 2004.
LANTRONIX, INC.
By: /s/ JAMES W. KERRIGAN
------------------------
JAMES W. KERRIGAN
CHIEF FINANCIAL OFFICER
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints James Kerrigan, his attorney-in-fact,
with the power of substitution, for him and in his name, place and stead, in any
and all capacities, to sign any and all amendments to this Form 10-K and to file
the same, with all exhibits thereto in all documents in connection therewith,
with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that such
attorneys-in-fact and agents or any of them, or his or their substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report on Form 10-K has been signed by the following persons in
the capacities and on the dates indicated.
Signature Title Date
- ----------------------- -------------------------------------------- -------
/s/ H. K. DESAI Chairman of the Board 9/27/04
- ------------------
H. K. DESAI
/s/ MARC H. NUSSBAUM Chief Executive Officer, 9/27/04
- ------------------- President (Principal Executive Officer)
MARC H. NUSSBAUM
/s/ JAMES W. KERRIGAN Chief Financial Officer 9/27/04
- -------------------- (Principal Financial and Accounting Officer)
JAMES W. KERRIGAN
/s/ THOMAS W. BURTON Director 9/27/04
- -----------------------
THOMAS W. BURTON
/s/ HOWARD T. SLAYEN Director 9/27/04
- -----------------------
HOWARD T. SLAYEN
/s/ KATHRYN B. LEWIS Director 9/27/04
- -----------------------
KATHRYN B. LEWIS
II-2