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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to ___________.
Commission file 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
(Address of principal executive offices)
92618
(Zip Code)
__________
(949) 453-3990
(Registrant's Telephone Number, Including Area Code)
Former name, former address and former fiscal year, if changed since last
report: N/A
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 whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act). Yes [ ] No [X].
As of October 31, 2004, 58,447,146 shares of the Registrant's common stock
were outstanding.
===============================================================================
LANTRONIX, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2004
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION 3
Item 1. Financial Statements 3
Unaudited Condensed Consolidated Balance Sheets at September 30, 2004 and June 30, 2004 3
Unaudited Condensed Consolidated Statements of Operations for the Three Months Ended
September 30, 2004 and 2003 4
Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended
September 30, 2004 and 2003 5
Notes to Unaudited Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 29
Item 4. Controls and Procedures 29
PART II. OTHER INFORMATION 30
Item 1. Legal Proceedings 30
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 30
Item 3. Defaults Upon Senior Securities 30
Item 4. Submission of Matters to a Vote of Security Holders 30
Item 5. Other Information 30
Item 6. Exhibits 30
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30, JUNE 30,
2004 2004
---------- ----------
ASSETS
- ------------------------------------------
Current assets:
Cash and cash equivalents $ 8,188 $ 9,128
Marketable securities 1,000 3,050
Accounts receivable, net 3,947 3,242
Inventories 6,506 6,677
Contract manufacturers receivable, net 531 999
Prepaid expenses and other current assets 1,304 1,450
---------- ----------
Total current assets 21,476 24,546
Property and equipment, net 670 865
Goodwill 9,488 9,488
Purchased intangible assets, net 1,662 2,056
Officer loans 112 110
Other assets 189 185
---------- ----------
Total assets $ 33,597 $ 37,250
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------------
Current liabilities:
Accounts payable $ 4,844 $ 4,049
Accrued payroll and related expenses 1,419 1,599
Warranty reserve 1,810 1,770
Restructuring reserve 461 752
Other current liabilities 3,136 2,922
Convertible note payable - 867
Bank line of credit 500 500
---------- ----------
Total current liabilities 12,170 12,459
Stockholders' equity:
Common stock 6 6
Additional paid-in capital 181,045 180,712
Deferred compensation (41) (103)
Accumulated deficit (159,857) (156,078)
Accumulated other comprehensive income 274 254
---------- ----------
Total stockholders' equity 21,427 24,791
---------- ----------
Total liabilities and stockholders' equity $ 33,597 $ 37,250
========== ==========
See accompanying notes.
3
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED
SEPTEMBER 30,
-------------
2004 2003
-------- --------
Net revenues (A) $11,045 $12,201
Cost of revenues (B) 5,488 6,045
-------- --------
Gross profit 5,557 6,156
-------- --------
Operating expenses:
Selling, general and administrative (C) 6,904 6,263
Research and development (C) 2,297 1,787
Stock-based compensation (B) (C) 180 155
Amortization of purchased intangible assets 29 44
-------- --------
Total operating expenses 9,410 8,249
-------- --------
Loss from operations (3,853) (2,093)
Interest income (expense), net 9 24
Other income (expense), net 70 (170)
-------- --------
Loss before income taxes (3,774) (2,239)
Provision for income taxes 61 33
-------- --------
Loss from continuing operations (3,835) (2,272)
Income (loss) from discontinued operations 56 (777)
-------- --------
Net loss $(3,779) $(3,049)
======== ========
Basic and diluted income (loss) per share:
Loss from continuing operations $ (0.07) $ (0.04)
Income (loss) from discontinued operations - (0.01)
-------- --------
Basic and diluted net loss per share $ (0.07) $ (0.05)
======== ========
Weighted average shares (basic and diluted) 57,922 55,484
======== ========
(A) Includes net revenues from related parties $ 318 $ 311
======== ========
(B) Cost of revenues includes the following:
Amortization of purchased intangible assets $ 365 $ 532
Stock-based compensation - 16
-------- --------
$ 365 $ 548
======== ========
(C) Stock-based compensation is excluded from the following:
Selling, general and administrative expenses $ 57 $ 113
Research and development expenses 123 42
-------- --------
$ 180 $ 155
======== ========
See accompanying notes.
4
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
THREE MONTHS ENDED
SEPTEMBER 30,
------------
2004 2003
-------- --------
Cash flows from operating activities:
Net loss from continuing operations $(3,835) $(2,272)
Net income (loss) from discontinued operations 56 (777)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 225 479
Amortization of purchased intangible assets 394 576
Stock-based compensation 180 171
Provision for inventory reserves (179) (914)
Provision for doubtful accounts 191 142
Loss on sale of fixed assets - 31
Equity losses from unconsolidated businesses - 209
Restructuring recovery (56) -
Changes in operating assets and liabilities, net of effect from acquisition:
Accounts receivable (896) (24)
Inventories 350 813
Contract manufacturers receivable 468 679
Prepaid expenses and other current assets 146 1,359
Other assets (6) (7)
Accounts payable 795 (1,051)
Due to Gordian - (1,000)
Warranty reserve 40 108
Restructuring reserve (235) (67)
Other current liabilities 34 725
Net assets of discontinued operations - 119
-------- --------
Net cash used in operating activities (2,328) (701)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment, net (30) (84)
Payment of convertible note (867) -
Purchases of marketable securities (1,000) -
Proceeds from sale of marketable securities 3,050 2,150
-------- --------
Net cash provided by investing activities 1,153 2,066
-------- --------
Cash flows from financing activities:
Net proceeds from issuances of common stock 215 163
-------- --------
Net cash provided by financing activities 215 163
-------- --------
Effect of foreign exchange rates on cash 20 11
-------- --------
Increase (decrease) in cash and cash equivalents (940) 1,539
Cash and cash equivalents at beginning of period 9,128 7,328
-------- --------
Cash and cash equivalents at end of period $ 8,188 $ 8,867
======== ========
See accompanying notes.
5
LANTRONIX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2004
1. BASIS OF PRESENTATION
The condensed consolidated financial statements included herein are
unaudited. They contain all normal recurring accruals and adjustments which, in
the opinion of management, are necessary to present fairly the consolidated
financial position of Lantronix, Inc. and its subsidiaries (collectively, the
"Company") at September 30, 2004, and the consolidated results of its operations
and its cash flows for the three months ended September 30, 2004 and 2003. All
intercompany accounts and transactions have been eliminated. It should be
understood that accounting measurements at interim dates inherently involve
greater reliance on estimates than at year-end. The results of operations for
the three months ended September 30, 2004 are not necessarily indicative of the
results to be expected for the full year or any future interim periods.
These financial statements do not include certain footnotes and financial
presentations normally required under generally accepted accounting principles.
Therefore, they should be read in conjunction with the audited consolidated
financial statements and notes thereto for the year ended June 30, 2004,
included in the Company's Annual Report on Form 10-K/A filed with the Securities
and Exchange Commission ("SEC") on October 12, 2004.
In March 2004, the Company completed the sale of substantially all of the
net assets of Premise Systems, Inc. ("Premise") (Note 8). The Company's
condensed consolidated financial statements have been presented to reflect
Premise as a discontinued operation for all periods.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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.
3. NET LOSS PER SHARE
Basic net loss per share is calculated by dividing net loss by the weighted
average number of common shares outstanding during the period. Diluted net loss
per share is calculated by adjusting outstanding shares assuming any dilutive
effects of options. However, for periods in which the Company incurred a net
loss, these shares are excluded because their effect would be to reduce recorded
net loss per share.
6
The following table sets forth the computation of net loss per share (in
thousands, except per share amounts):
THREE MONTHS ENDED
SEPTEMBER 30,
------------------
2004 2003
-------- --------
Numerator:
Loss from continuing operations $(3,835) $(2,272)
Income (loss) from discontinued operations 56 (777)
-------- --------
Net loss $(3,779) $(3,049)
======== ========
Denominator:
Weighted-average shares outstanding 58,254 55,816
Less: non-vested common shares outstanding (332) (332)
-------- --------
Denominator for basic and diluted income (loss) per share 57,922 55,484
======== ========
Basic and diluted income (loss) per share:
Loss from continuing operations $ (0.07) $ (0.04)
Income (loss) from discontinued operations - (0.01)
-------- --------
Basic and diluted net loss per share $ (0.07) $ (0.05)
======== ========
4. MARKETABLE SECURITIES
The Company classifies its marketable securities as available for sale.
Marketable securities consist of obligations of municipal bonds which can
readily be converted to cash.
5. INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out) or market
and consist of the following (in thousands):
SEPTEMBER 30, JUNE 30,
2004 2004
--------------- ----------
Raw materials . . . . . . . . . . . . . . $ 4,432 $ 4,047
Finished goods. . . . . . . . . . . . . . 6,673 7,368
Inventory at distributors . . . . . . . . 1,140 1,291
--------------- ----------
12,245 12,706
Reserve for excess and obsolete inventory (5,739) (6,029)
--------------- ----------
$ 6,506 $ 6,677
=============== ==========
6. PURCHASED INTANGIBLE ASSETS
The composition of purchased intangible assets is as follows (in
thousands):
SEPTEMBER 30, 2004 JUNE 30, 2004
------------------------------ ------------------------------
USEFUL ACCUMULATED ACCUMULATED
LIVES GROSS AMORTIZATION NET GROSS AMORTIZATION NET
--------- ------ -------------- ------ ------ -------------- ------
Existing technology 1-5 years $7,090 $ (5,466) $1,624 $7,090 $ (5,101) $1,989
Patent/core technology 5 405 (378) 27 405 (365) 40
Tradename/trademark 5 32 (26) 6 32 (24) 8
Non-compete agreements 2-3 140 (135) 5 140 (121) 19
------ -------------- ------ ------ -------------- ------
Total $7,667 $ (6,005) $1,662 $7,667 $ (5,611) $2,056
====== ============== ====== ====== ============== ======
The amortization expense for purchased intangible assets for the three
months ended September 30, 2004 was $394,000, of which $365,000 was amortized to
cost of revenues and $29,000 was amortized to operating expenses. The
amortization expense for purchased intangible assets for the three months ended
September 30, 2003 was $576,000, of which $532,000 was amortized to cost of
revenues and $44,000 was amortized to operating expenses. The estimated
amortization expense for the remainder of fiscal 2005 and the next year are as
follows:
7
COST OF OPERATING
Fiscal year ending June 30: REVENUES EXPENSES TOTAL
--------- --------- ------
2005 (Remainder of fiscal year) $ 1,067 $ 38 $1,105
2006 557 - 557
--------- --------- ------
Total $ 1,624 $ 38 $1,662
========= ========= ======
7. RESTRUCTURING RESERVE
A summary of the activity in the restructuring reserve account is as
follows (in thousands):
CASH RESTRUCTURING
RESTRUCTURING CHARGES RESERVE AT
RESERVE AT AGAINST RESTRUCTURING SEPTEMBER 30,
JUNE 30, 2004 RESERVE RECOVERY 2004
-------------- --------- --------------- --------------
Consolidation of excess facilities $ 752 $ (235) $ (56) $ 461
============== ========= =============== ==============
The remaining restructuring reserve is related to facility closures in
Naperville, Illinois; Hillsboro, Oregon and Ames, Iowa. Payments under the lease
obligations will end in fiscal 2007.
8. 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
and 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):
THREE MONTHS ENDED
SEPTEMBER 30,
----------------
2004 2003
-------- ------
Net revenues $ - $ 29
======== ======
Income (loss) from discontinued operations, net of income taxes of $0 $ 56 $(777)
======== ======
9. 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. The
following table is a reconciliation of the changes to the product warranty
liability for the periods presented:
8
THREE MONTHS
ENDED YEAR ENDED
SEPTEMBER 30, JUNE 30,
2004 2004
--------------- ------------
Balance beginning of period $ 1,770 $ 1,193
Charged to cost of revenues 165 1,168
Deductions (125) (591)
--------------- ------------
Balance end of period $ 1,810 $ 1,770
=============== ============
10. PROVISION FOR INCOME TAXES AND EFFECTIVE TAX RATE
The Company utilizes the liability method of accounting for income taxes as
set forth in SFAS No. 109, "Accounting for Income Taxes." The Company's
effective tax rate was (2)% and (1)% for the three month periods ended September
30, 2004 and September 30, 2003, respectively. The federal statutory rate was
34% for both periods. The effective tax rate associated with the income tax
expense for both the three month periods ended September 30, 2004 and 2003, was
lower than the federal statutory rate primarily due to the increase in the
valuation allowance.
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 expected
at $0 to $700,000. The Company has not provided any amounts for this matter in
the consolidated financial statements.
11. 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 September 30, 2004 was $3.4 million. In March 2004, the
Company borrowed $500,000 against this line of credit. Additionally, the Company
has used letters of credit available under its line of credit totaling
approximately $428,000 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 September 30, 2004 was $2.5 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, accruing interest at a rate of 2.5% per
annum. Interest expense related to the note totaled approximately $5,000 and
$3,000 for the three months ended September 30, 2004 and 2003, respectively. The
notes were 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.
12. COMPREHENSIVE LOSS
SFAS No. 130, "Reporting Comprehensive Income (Loss)," establishes
standards for reporting and displaying comprehensive income (loss) and its
components in the condensed consolidated financial statements.
9
The components of comprehensive loss are as follows (in thousands):
THREE MONTHS ENDED
SEPTEMBER 30,
-------------
2004 2003
-------- --------
Net loss $(3,779) $(3,049)
Other comprehensive loss:
Change in accumulated translation adjustments 20 11
-------- --------
Total comprehensive loss $(3,759) $(3,038)
======== ========
13. STOCK-BASED COMPENSATION
The Company has in effect several stock-based plans under which
non-qualified and incentive stock options have been granted to employees,
non-employee board members and other non-employees. The Company also has an
employee stock purchase plan for all eligible employees. The Company accounts
for stock-based awards to employees in accordance with Accounting Principles
Board ("APB") Opinion No. 25, "Accounting for Stock Issues to Employees" ("APB
25"), and related interpretations, and has adopted the disclosure-only
alternative of SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS
No. 123") and SFAS No. 148, "Accounting for Stock-Based Compensation Transition
and Disclosure." Options granted to non-employees, as defined, have been
accounted for at fair market value in accordance with SFAS No. 123.
In accordance with the disclosure requirements of SFAS No. 123, set forth
below are the assumptions used and pro forma statement of operations data of the
Company giving effect to valuing stock-based awards to employees using the
Black-Scholes option pricing model instead of the guidelines provided by APB No.
25. Among other factors, the Black-Scholes model considers the expected life of
the option and the expected volatility of the Company's stock price in arriving
at an option valuation.
The results of applying the requirements of the disclosure-only alternative
of SFAS No. 123 to the Company's stock-based awards to employees would
approximate the following (in thousands, except per share data):
THREE MONTHS ENDED
SEPTEMBER 30,
--------------------
2004 2003
-------- --------
Net loss - as reported $(3,779) $(3,049)
Add: Stock-based compensation expense included in net loss - as
reported 180 171
Deduct: Stock-based compensation expense determined under fair value
method (447) (953)
-------- --------
Net loss - pro forma $(4,046) $(3,831)
======== ========
Net loss per share (basic and diluted) - as reported $ (0.07) $ (0.05)
======== ========
Net loss per share (basic and diluted) - pro forma $ (0.07) $ (0.07)
======== ========
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
10
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, Plaintiffs filed their third amended complaint, and on
October 18, 2004, the Company answered that complaint. Discovery has commenced,
but no trial date has been established.
Derivative Lawsuit
On July 26, 2002, Samuel Ivy filed a shareholder derivative complaint
entitled Ivy v. Bernhard Bruscha, et al., No. 02CC00209, in the Superior Court
of the State of California, County of Orange, against certain of the Company's
current and former officers and directors. 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.
The Company filed a motion to dismiss on October 16, 2002, on the grounds
that Mr. Cotton's complaints are subject to the binding arbitration provisions
in Mr. Cotton's employment agreement. On January 13, 2003, the Court ruled that
five of the six counts in Mr. Cotton's complaint are subject to binding
arbitration. The court is staying the sixth count, for declaratory relief, until
the underlying facts are resolved in arbitration. No arbitration date has been
set.
Securities Claims Brought by Former Shareholders of Synergetic Micro Systems,
Inc. ("Synergetic")
On October 17, 2002, Richard Goldstein and several other former
shareholders of Synergetic filed a complaint entitled Goldstein, et al. v.
Lantronix, Inc., et al. in the Superior Court of the State of California, County
of Orange, against the Company and certain of its former officers and directors.
Plaintiffs filed an amended complaint on January 7, 2003. The amended complaint
alleges fraud, negligent misrepresentation, breach of warranties and covenants,
breach of contract and negligence, all stemming from its acquisition of
Synergetic. The complaint seeks an unspecified amount of damages, interest,
attorneys' fees, costs, expenses, and an unspecified amount of punitive damages.
On May 5, 2003, the Company answered the complaint and generally denied the
allegations in the complaint. Discovery has commenced but no trial date has been
established.
Patent Infringement Litigation
On August 10, 2004, Digi International Inc. ("Digi") 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
11
including, without limitation, 35 U.S.C. 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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with
the Unaudited Condensed Consolidated Financial Statements and related Notes
thereto contained elsewhere in this Report. The information in this Quarterly
Report on Form 10-Q is not a complete description of our business or the risks
associated with an investment in our common stock. We urge you to carefully
review and consider the various disclosures made by us in this Report and in
other reports filed with the Securities and Exchange Commission ("SEC"),
including our Annual Report on Form 10-K/A for the fiscal year ended June 30,
2004 and our subsequent reports on Form 8-K that discuss our business in greater
detail.
The section entitled "Risk Factors" set forth below, and similar
discussions in our other SEC filings, discuss some of the important factors that
may affect our business, results of operations and financial condition. You
should carefully consider those factors, in addition to the other information in
this Report and in our other filings with the SEC, before deciding to invest in
our company or to maintain or increase your investment.
This report contains forward-looking statements which include, but are not
limited to, statements concerning projected net revenues, expenses, gross profit
and income (loss), the need for additional capital, market acceptance of our
products, our ability to consummate acquisitions and integrate their operations
successfully, our ability to achieve further product integration, the status of
evolving technologies and their growth potential and our production capacity.
These forward-looking statements are based on our current expectations,
estimates and projections about our industry, our beliefs and certain
assumptions made by us. Words such as "anticipates," "expects," "intends,"
"plans," "believes," "seeks," "estimates," "may," "will" and variations of these
words or similar expressions are intended to identify forward-looking
statements. In addition, any statements that refer to expectations, projections
or other characterizations of future events or circumstances, including any
underlying assumptions, are forward-looking statements. These statements are not
guarantees of future performance and are subject to certain risks, uncertainties
and assumptions that are difficult to predict. Therefore, our actual results
could differ materially and adversely from those expressed in any
forward-looking statements as a result of various factors. We undertake no
obligation to revise or update publicly any forward-looking statements for any
reason.
OVERVIEW
Lantronix designs, develops and markets products and software solutions
that make it possible to access, manage, control and configure almost any
electronic device over the Internet or other networks. We are a leader in
providing innovative networking solutions. We were initially formed as
"Lantronix," a California corporation, in June 1989. We reincorporated as
"Lantronix, Inc.," a Delaware corporation in May 2000.
We have a history of providing devices that enable information technology
("IT") equipment to network using standard protocols for connectivity, including
fiber optic, Ethernet and wireless. Our first device was a terminal server that
12
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: (i) "device networking
solutions" that enable almost any electronic product to be connected to a
network; (ii) "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 (iii) "non-core"
products and services that include visualization solutions, legacy print
servers, 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, 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, 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.
THE NATURE OF OUR BUSINESS
Currently, we develop our products through engineering and product
development activities of our research and development organization. In prior
years, most engineering and product development was outsourced with independent
contractors. This practice has been discontinued; however, some portions of our
engineering are subcontracted as needed. We use outside contract manufacturers
to make our products, which are then taken to market by our marketing and sales
organizations.
We sell our devices through distribution partners to a global network of
distributors, system integrators, value added resellers ("VARs"), manufacturers'
representatives and original equipment manufacturers ("OEMs"). In addition, we
sell directly to selected accounts. One distribution customer, Ingram Micro,
accounted for approximately 19.8% and 13.4% of our net revenues for the three
months ended September 30, 2004 and 2003, respectively. Another distribution
customer, Tech Data, accounted for approximately 10.5% and 10.4% of our net
revenues for the three months ended September 30, 2004 and 2003, respectively.
Accounts receivable attributable to these domestic customers accounted for
approximately 33.5% and 12.9% of total accounts receivable at September 30, 2004
and June 30, 2004, 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 2.9% and 2.5% of our
net revenues for the three months ended September 30, 2004 and 2003,
respectively.
DISCONTINUED OPERATIONS
In August 2001, the FASB issued 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" ("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, we completed the sale of substantially all of the net assets
of our Premise business unit for $1.0 million. Additionally, we incurred
$383,000 of disposal costs.
13
SUMMARY OVERVIEW OF THE FIRST FISCAL QUARTER ENDED SEPTEMBER 30, 2004
The following discussion of results of operations includes discussion of
continuing operations only.
SUMMARY OVERVIEW OF THE FIRST FISCAL QUARTER ENDED SEPTEMBER 30, 2004
As described in more detail elsewhere in this document, our business
operated in a manner consistent with the fiscal year ended June 30, 2004. Net
revenues decreased from the prior quarter from $11.9 million for the quarter
ended June 30, 2004 , to $11.0 million this quarter. We had expected a
relatively flat revenue quarter from the prior quarter. Revenues of $11.0
million for the quarter ended September 30, 2004 compared to revenues of $12.2
for the same quarter a year earlier. The decrease of $1.2 million in revenue
compared to the same period last year is primarily due to a decline in sales of
non-core products of $900,000.
The decrease in revenues from the prior quarter is due to three primary
factors as follows:
First, we continued to experience the effects of several large customers
transitioning from higher priced networking products to our newer lower priced
solutions. Typically, customers build a safety stock of inventory prior to
beginning production using the newer product. This causes erratic purchasing
patterns and delays in placing orders for the new products for the first few
quarters as production is ramped up. In addition, the new technology purchased
from Lantronix is often at a lower average selling price, resulting in a
temporary decline in revenue sold to that customer. We believe that over time,
the expansion of demand for connected products will grow, partially or fully
offsetting this decline.
During the quarter, we also experienced lower order rates from several OEM
device customers, compared to their original forecasts or past order rates for
the period.
Finally, we experienced a delay in availability of a small portion of our
planned XPort shipments during the quarter that was associated with our
transition to a new core processor chip. During the transition, we were able to
keep our customers' lines up and running, but were unable to fulfill all of the
orders required to replenish inventory levels at all of our accounts.
Our cash, cash equivalents and marketable securities balances decreased by
$3.0 million, from $12.2 million at June 30, 2004 to $9.2 million at September
30, 2004. We averaged less than $0.5 million of cash usage per quarter during
the fiscal year ended June 30, 2004. The forecast increase for the first fiscal
quarter was attributed to a note repayment of $867,000 related to the Stallion
acquisition two years ago, expanded SG&A expenses for the first fiscal quarter
of approximately $0.6 million to kick-off marketing programs related to new
products, tax payments made related to an IRS audit, audit payments, and other
costs. Cash usage was higher than previous guidance of $2.2-$2.8 million because
of the lower revenues and, therefore, lower collections during the quarter.
Our gross margin was 50.3% for the quarter ended September 30, 2004,
compared to a gross margin of 50.5% for the same quarter a year earlier and an
improvement over gross margin of 43.3% for the quarter ended June 30, 2004. The
improvement is primarily due to lower inventory reserves, physical inventory
adjustments and lower costs related to amortization of intangible assets that
are recorded in cost of revenues. These lower amortization costs will continue
in future quarters.
For the quarter ended September 30, 2004, we had a loss from continuing
operations of $3.8 million, compared to a loss of $2.3 million for the same
quarter a year earlier, primarily related to lower revenues and higher expenses
in SG&A and R&D. Operating expenses related to continuing operations increased
to $9.4 million for the quarter ended September 30, 2004 from $8.2 million for
the same quarter a year earlier. This increase is attributable to the increased
marketing and sales programs of $600,000 in the most recent period described
above, and increases of approximately $500,000 in R&D expenses. We made a
decision to reinvest the savings realized as a result of discontinuing our
Premise business in March 2004 into marketing and R&D activities related to
ongoing operations.
OUTLOOK
While revenues were lower than anticipated in the quarter ended September
30, 2004, we have reviewed our plans and activities going forward and continue
to drive to achieve revenue growth. We have programs in effect that we believe
will increase revenues in the second fiscal quarter ending December 31, 2004. We
are driving our business to become cash positive and increase our cash, cash
equivalents and marketable securities balances, and thereafter reach
profitability. We continue to evaluate opportunities to reduce our expenses and
lower our cash breakeven point.
14
Our device networking business is fundamentally directed to the market of
products that could be networked together and/or connected to the Internet. We
see as inevitable, a world where myriads of devices are interconnected to
enhance their operation, maintenance, or to provide new functionality.
Independent researchers have made varying estimates as to the size and rate of
this expansion. However, networking growth as evidenced by our net revenue
growth or that of our peers is still in the early adoption phase. We believe in
the next several years, the market adoption of our networking solution devices
will be strongest in the commercial and industrial markets such as security,
medical, factory automation and similar devices, rather than in consumer
electronics devices. In the short run, particularly from quarter to quarter,
revenues can vary. However, our operations are fundamentally organized to
achieve continuing revenue improvement as our products are accepted and ordered
by an expanding customer base.
Our IT management business provides remote management solutions to our
customers' IT infrastructure of servers, routers, switches, power supplies, and
other devices that comprise their networks. This business was severely impacted
by the recession of the past several years, and we are just beginning to emerge
from that recession. While we have not yet achieved a high rate of net revenue
growth, we have confidence in our position in this market, and we have recently
introduced new products that are achieving recognition in the marketplace.
With the exception of the higher planned and actual expenditures for the
quarter ended September 30, 2004, our cash usage performance over the previous
four quarters has resulted in lower cash usage than this financial model
described above might indicate. We incur legal expenses that increase and
decrease with activity each quarter, receive varying levels of reimbursement for
some of these legal expenses from our insurance carriers, and we have occasional
annual expenses we have to pay. On the other hand, we have benefited from other
cash management activities to improve cash flow by improving balance sheet
accounts. We have previously indicated guidance that we are managing our
business such that we have a target cash usage in the range of $1.0 million per
quarter; as noted, we have been doing somewhat better than this guidance
throughout all of FY04. Over the prior four quarters, we have had a series of
events which have, from time to time, provided cash because of specific
transactions such as our sale of Premise and our recovery of legal expenses
through insurance reimbursements, and we have exchanged deposits in the form of
cash with letters of credit. Alternatively, we have had exceptional events that
used cash from time to time. Notwithstanding the usage of $3.0 million in the
first fiscal quarter ended September 30, 2004, our operating objectives are to
reduce operating expense levels to return to the previous fiscal year model of
cash usage in the range of $1.0 million or less for the second fiscal quarter.
As of the end of September 2004, the Company had a balance of cash, cash
equivalents and marketable securities of $9.2 million.
We are driving revenues in fiscal 2005 with programs that include new
products recently introduced, increased distribution through an expanded sales
network and a commitment to new and expanded marketing and advertising programs.
During the past several quarters, we introduced several new products we believe
will contribute to growth in revenues. These products include WiPort, a wireless
version of our XPort device server; WiBox, a wireless external device networking
solution; Secure Box, AES-encryption device networking products; a
NEBS-compliant secure console server for telecommunications applications; and
the SecureLinx Remote KVM product line designed to remotely connect IT
administrators to their Windows-based equipment, and an SLC line of console
servers.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires us to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of net revenues
and expenses during the reporting period. We regularly evaluate our estimates
and assumptions related to net revenues, allowances for doubtful accounts, sales
returns and allowances, inventory reserves, goodwill and purchased intangible
asset valuations, warranty reserves, restructuring costs, litigation and other
contingencies. We base our estimates and assumptions on historical experience
and on various other factors that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. To the extent there are material differences between our
estimates and the actual results, our future results of operations will be
affected.
We believe the following critical accounting policies require us to make
significant judgments and estimates in the preparation of our condensed
consolidated financial statements:
Revenue Recognition
We do not recognize revenue until all of the following criteria are met:
persuasive evidence of an arrangement exists; delivery has occurred or services
have been rendered; our price to the buyer is fixed or determinable; and
collectibility is reasonably assured. Commencing July 1, 2001, we adopted a new
accounting policy for revenue recognition such that recognition of revenue and
15
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.
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
16
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.
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 terminations,
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 charges 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 May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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 our financial
position, results of operations or cash flows.
17
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
of net revenues represented by each item in our condensed consolidated statement
of operations:
THREE MONTHS
ENDED
SEPTEMBER 30,
----------------
2004 2003
------- -------
Net revenues 100.0% 100.0%
Cost of revenues 49.7 49.5
------- -------
Gross profit 50.3 50.5
------- -------
Operating expenses:
Selling, general and administrative 62.5 51.3
Research and development 20.8 14.6
Stock-based compensation 1.6 1.3
Amortization of purchased intangible assets 0.3 0.4
------- -------
Total operating expenses 85.2 67.6
------- -------
Loss from operations (34.9) (17.1)
Interest income (expense), net 0.1 0.2
Other income (expense), net 0.6 (1.4)
------- -------
Loss before income taxes (34.2) (18.3)
Provision for income taxes 0.5 0.3
------- -------
Loss from continuing operations (34.7) (18.6)
Income (loss) from discontinued operations 0.5 (6.4)
------- -------
Net loss (34.2)% (25.0)%
======= =======
COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
The following discussion of results of operations includes discussion of
continuing operations only.
NET REVENUES BY PRODUCT CATEGORY
THREE MONTHS ENDED
SEPTEMBER 30,
-------------
% OF NET % OF NET $ %
PRODUCT CATEGORIES 2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
- ------------------ ------- --------- ------- --------- ---------- ---------
Device networking $ 6,226 56.3% $ 6,519 53.4% $ (293) (4.5)%
IT management 3,122 28.3% 3,058 25.1% 64 2.1%
Non-core 1,697 15.4% 2,624 21.5% (927) (35.3)%
------- --------- ------- --------- ---------- ---------
TOTAL $11,045 100.0% $12,201 100.0% $ (1,156) (9.5)%
======= ========= ======= ========= ========== =========
The decrease for the three months ended September 30, 2004 was primarily
attributable to a decrease in net revenues of our non-core products and to a
lesser extent a decrease in our device networking products. The decrease in our
non-core product net revenues is primarily due to a decrease in our
visualization, print server and Stallion products. We are no longer investing in
the development of these product lines and expect net revenues related to these
products to continue to decline in the future as we focus our investment in
device networking and IT management products. The decrease in device networking
net revenue is primarily due to the timing of purchases by our larger OEM
customers, weaker demand for our customers' products in certain verticals and a
general shift from higher priced external products to lower priced embedded
products.
18
NET REVENUES BY REGION
THREE MONTHS ENDED
SEPTEMBER 30,
-------------
% OF NET % OF NET $ %
GEOGRAPHIC REGION 2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
- ----------------- ------- --------- ------- --------- ---------- ---------
Americas $ 7,531 68.2% $ 9,480 77.7% $ (1,949) (20.6)%
Europe 2,793 25.3% 2,172 17.8% 621 28.6 %
Other 721 6.5% 549 4.5% 172 31.3 %
------- --------- ------- --------- ---------- ---------
TOTAL $11,045 100.0% $12,201 100.0% $ (1,156) (9.5)%
======= ========= ======= ========= ========== =========
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 lower sales of non-core products and, to a lesser
extent, a decrease in sales of external device servers. The decrease in non-core
products is due to a decrease in sales of our visualization and print server
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. The increase in the European region 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 addition of new
customers and our increased sales effort in the Asia Pacific region.
GROSS PROFIT
THREE MONTHS ENDED
SEPTEMBER 30,
-------------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
------ --------- ------ --------- ---------- ---------
Gross profit $5,557 50.3% $6,156 50.5% $ (599) (9.7)%
====== ========= ====== ========= ========== =========
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 or relieving inventory reserves for excess and obsolete
products or raw materials, overhead and warranty costs. Cost of revenues for the
three months ended September 30, 2004 and 2003 included $365,000 and $532,000 of
amortization of purchased intangible assets, respectively. At September 30, 2004
the unamortized balance of purchased intangible assets that will be amortized to
future cost of revenues was $1.6 million, of which $1.1 million will be
amortized in the remainder of fiscal 2005 and $557,000 in fiscal 2006.
The decrease in gross profit in absolute dollars and as a percentage of net
revenues for the three months ended September 30, 2004 was primarily
attributable to a decrease in net revenues and a $735,000 lower benefit from an
inventory reserve adjustment in the current quarter compared to prior year,
partially offset by an overall reduction in payroll and payroll related costs,
warranty expense and the amortization of purchased intangible assets recorded
during the three months ended September 30, 2004. Adjustments to our inventory
reserve occur primarily due to the sale of products during a period for which
reserves had been previously recorded. The decrease in the amortization of
purchased intangible assets is primarily due to a decrease in the amortization
of the Gordian asset which is being amortized over the remaining life of our
products designed by Gordian, as well as an impairment of our Premise intangible
assets during the quarter ended December 31, 2003.
SELLING, GENERAL AND ADMINISTRATIVE
THREE MONTHS ENDED
SEPTEMBER 30,
-------------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
------ --------- ------ --------- --------- ---------
Selling, general and administrative $6,904 62.5% $6,263 51.3% $ 641 10.2%
====== ========= ====== ========= ========= =========
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 increased primarily due to increased marketing expenses
for new product introductions, increased marketing for existing products, legal
and other expenses. These increases were partially offset by decreases in
professional fees as well as depreciation expense. The legal fees increased due
to the timing of reimbursements from the insurance company. 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 three
19
months ended September 30, 2004 and 2003, we have been reimbursed $109,000 and
$325,000 of these expenses, respectively. Management expects to receive
additional reimbursements from insurance sources for legal fees in the future.
RESEARCH AND DEVELOPMENT
THREE MONTHS ENDED
SEPTEMBER 30,
-------------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
------ --------- ------ --------- --------- ---------
Research and development $2,297 20.8% $1,787 14.6% $ 510 28.5%
====== ========= ====== ========= ========= =========
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. The increase in research and development expenses is
primarily due to a reallocation of the savings realized from our discontinued
Premise business to our core IT Management and Device Networking business. We
also increased headcount to improve our product introduction and quality
infrastructure.
STOCK-BASED COMPENSATION
THREE MONTHS ENDED
SEPTEMBER 30,
-------------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
----- --------- ----- --------- --------- ---------
Stock-based compensation $ 180 1.6% $ 155 1.3% $ 25 16.1%
===== ========= ===== ========= ========= =========
Stock-based compensation generally represents the amortization of deferred
compensation. We recorded no deferred compensation or deferred compensation
forfeitures for the three months ended September 30, 2004. 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 $0 and $16,000
for the three months ended September 30, 2004 and 2003, respectively. The
increase in stock-based compensation for the three months ended September 30,
2004 is primarily attributable to a charge for the valuation of vested options
for a terminated executive. At September 30, 2004, a balance of $41,000 remains
and will be amortized as follows: $24,000 for the remainder of fiscal 2005 and
$17,000 in fiscal 2006.
AMORTIZATION OF PURCHASED INTANGIBLE ASSETS
THREE MONTHS ENDED
SEPTEMBER 30,
-------------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
----- --------- ----- --------- ---------- ---------
Amortization of purchased intangible assets $ 29 0.3% $ 44 0.4% $ (15) (34.1)%
===== ========= ===== ========= ========== =========
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 assist us in allocating the purchase price. In
addition, approximately $365,000 and $532,000 of amortization of purchased
intangible assets has been classified as cost of revenues for the three months
ended September 30, 2004 and 2003, respectively. The decrease in amortization of
purchased intangible assets is primarily due to the impairment write-down of
Premise intangible assets during the quarter ended December 31, 2003. At
September 30, 2004, the unamortized balance of purchased intangible assets that
will be amortized to future operating expense was $38,000, which will be
amortized in the remainder of fiscal 2005.
RESTRUCTURING CHARGES
During the three months ended September 30, 2004, approximately $56,000 of
restructuring charges were recovered for a facility lease settlement related to
20
a discontinued operation.
INTEREST INCOME (EXPENSE), NET
THREE MONTHS ENDED
SEPTEMBER 30,
-------------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
----- --------- ----- --------- ---------- ---------
Interest income (expense), net $ 9 0.1% $ 24 0.2% $ (15) (62.5)%
===== ========= ===== ========= ========== =========
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.
OTHER INCOME (EXPENSE), NET
THREE MONTHS ENDED
MARCH 31,
---------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
----- --------- ------ --------- --------- ---------
Other income (expense), net $ 70 0.6% $(170) (1.4)% $ 240 141.2%
===== ========= ====== ========= ========= =========
Other income (expense), net improved over prior year, primarily due to the
write-off of our Xanboo investment in June 2004, thereby eliminating our equity
share of losses in this investment.
PROVISION FOR INCOME TAXES - EFFECTIVE TAX RATE
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 (2)% and (1)% for the three month periods ended September 30, 2004 and 2003,
respectively. The federal statutory rate was 34% for both periods. Our effective
tax rate associated with the income tax expense for both the three month periods
ended September 30, 2004 and 2003, was lower than the federal statutory rate
primarily due to the increase in valuation allowance. In 2003, the Internal
Revenue Service completed its audit of our federal income tax returns for the
years ended June 30, 1999, 2000 and 2001. As a result, we paid tax and interest
to the IRS and the California Franchise Tax Board of approximately $222,000,
$441,000 and $113,000 in quarters ending March 31, 2004, June 30, 2004 and
September 30, 2004, respectively.
The Company is under 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 expected
at $0 to $700,000. The Company has not provided any amounts for this matter in
the consolidated financial statements.
IMPACT OF ADOPTION OF NEW ACCOUNTING STANDARDS
In May 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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.
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
21
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 $8.2 million at September 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 $1.0 million at September 30, 2004.
Our operating activities used cash of $2.3 million for the three months
ended September 30, 2004. We incurred a net loss of $3.8 million, of which $3.8
million is a loss from continuing operations and $56,000 is net income from
discontinued operations, which includes the following adjustments: depreciation
of $225,000, amortization of purchased intangible assets of $394,000,
amortization of stock-based compensation of $180,000, provision for doubtful
accounts of $191,000 offset by a recovery in the restructuring reserve of
$56,000 and a benefit from the inventory reserve of $179,000. The changes in our
operating assets consist of a decrease in inventory of $350,000, decrease in
contract manufacturer receivable of $468,000, decrease in prepaid expenses and
other assets of $146,000 and an increase in accounts payable of $795,000, offset
by an increase in accounts receivable of $896,000 and a decrease in
restructuring reserve of $235,000. The decrease in inventory is primarily
attributable to a reduction in slower moving products due to marketing programs,
partially offset by an increase in new product inventory. The decrease in
contract manufacturer receivables is due to improved collections. The decrease
in prepaid expenses and other current assets is primarily due to the
amortization of prepaid expense during the period. The decrease in the
restructuring reserve is due to payments on lease obligations. The increase in
accounts receivable is due to slower collections from our large distributor
customers. The increase in accounts payable is due to the timing of payments to
our suppliers.
Cash provided by investing activities was $1.2 million for the three months
ended September 30, 2004. We received $3.1 million in proceeds from the sales of
marketable securities. We used $1.0 million to purchase marketable securities.
We also used $30,000 to purchase property and equipment and $867,000 to pay the
convertible note from the Stallion acquisition. Cash provided by investing
activities was $2.1 million for the three months ended September 30, 2003.
Cash provided by financing activities was $215,000 for the three months
ended September 30, 2004 primarily related to the purchase of common shares by
the employee stock purchase plan. Cash provided by financing activities was
$163,000 for the three months ended September 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 are 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 September 30, 2004, was $3.4 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 $428,000 in
place of cash to fund deposits on leases, tax account deposits and security
deposits. As a result, our available line of credit at September 30, 2004 was
$2.5 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:
Remainder of fiscal year Fiscal Years
------------------------ ------------
2005 2006 2007 Total
------ ----- ----- ------
Bank line of credit $ 500 $ - $ - $ 500
Operating leases 947 480 169 1,596
------ ----- ----- ------
Total $1,447 $ 480 $ 169 $2,096
====== ===== ===== ======
At September 30, 2004, approximately $2.8 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 ongoing
22
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.
In October 2004, we paid $125,000 towards our bank line of credit. We
expect to make similar quarterly payments throughout fiscal year 2005.
RISK FACTORS
You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only ones facing our company. Our business operations may be impaired by
additional risks and uncertainties of which we are unaware or that we currently
consider immaterial.
Our business, results of operations or cash flows may be adversely affected
if any of the following risks actually occur. In such case, the trading price of
our common stock could decline, and you may lose all or part of your investment.
VARIATIONS IN QUARTERLY OPERATING RESULTS, DUE TO FACTORS INCLUDING CHANGES
IN DEMAND FOR OUR PRODUCTS AND CHANGES IN OUR MIX OF NET REVENUES, COULD CAUSE
OUR STOCK PRICE TO DECLINE.
Our quarterly net revenues, expenses and operating results have varied in
the past and might vary significantly from quarter to quarter in the future. We,
therefore, believe that quarter-to-quarter comparisons of our operating results
are not a good indication of our future performance, and you should not rely on
them to predict our future performance or the future performance of our stock
price. Our short-term expense levels are relatively fixed and are based on our
expectations of future net revenues. If we were to experience a reduction in net
revenues in a quarter, we would likely be unable to adjust our short-term
expenditures. If this were to occur, our operating results for that quarter
would be harmed. If our operating results in future quarters fall below the
expectations of market analysts and investors, the price of our common stock
would likely fall. Other factors that might cause our operating results to
fluctuate on a quarterly basis include:
- - changes in the mix of net revenues attributable to higher-margin and
lower-margin products;
- - customers' decisions to defer or accelerate orders;
- - variations in the size or timing of orders for our products;
- - changes in demand for our products;
- - loss or gain of significant customers;
- - short-term fluctuations in the cost or availability of our critical
components;
- - 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
23
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 Note 14 of Part I of this Form 10-Q.
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 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 Note 14 of Part I of this Form 10-Q 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 was 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.
- - 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
24
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.
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 46.8% of our net revenues for the
three months ended September 30, 2004. One customer, Ingram Micro, Inc.,
accounted for approximately 19.8% and 13.4% of our net revenues for the three
months ended September 30, 2004 and 2003, respectively. Another customer, Tech
Data, accounted for approximately 10.5% and 10.4% of our net revenues for the
three months ended September 30, 2004 and 2003, respectively. Accounts
receivable attributable to these two domestic customers accounted for
approximately 33.5% and 12.9% of total accounts receivable at September 30, 2004
and June 30, 2004, respectively. The number and timing of 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, 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 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 three months ended September 30, 2004, we incurred $2.3 million in
research and development expenses, which comprised 20.8% 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.
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
25
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.
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.
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 are 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 SCO's rights. These allegations may adversely affect the demand for
the Linux platform and, consequently, the sales of our Linux-based products.
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.
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.
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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 31.8% and 22.3% of net
revenues for the three months ended September 30, 2004 and 2003, respectively.
Net revenues from Europe represented 25.3% and 17.8% of our net revenues for the
three months ended September 30, 2004 and 2003, 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:
- - 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.
WE CARRY INVENTORY AND THERE IS A RISK WE MAY BE UNABLE TO DISPOSE OF IT.
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 it becoming obsolete. As of September 30, 2004, our
inventories, including raw materials, finished goods and inventory at
distributors, were valued at $12.2 million and we had excess and obsolete
inventory reserves of $5.7 million against these inventories. 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. In the event we
are required to substantially discount our inventory or are unable to sell our
27
inventory in a timely manner, we would be required to increase our reserves and
our operating results could be substantially harmed.
OUR EXECUTIVE OFFICERS AND TECHNICAL PERSONNEL ARE CRITICAL TO OUR
BUSINESS, AND WITHOUT THEM WE MIGHT NOT BE ABLE TO EXECUTE OUR BUSINESS
STRATEGY.
Our financial performance depends substantially on the performance of our
executive officers and key employees. We are dependent in particular on Marc
Nussbaum, who serves as our 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.
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:
- - 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.
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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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates primarily
to our investment portfolio. We do not use derivative financial instruments for
speculative or trading purposes. We place our investments in instruments that
meet high credit quality standards, as specified in our investment policy.
Information relating to quantitative and qualitative disclosure about market
risk is set forth below and in "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital Resources."
INTEREST RATE RISK
Our exposure to interest rate risk is limited to the exposure related to
our cash, cash equivalents, marketable securities and our credit facilities,
which is tied to market interest rates. As of September 30, 2004 and June 30,
2004, we had cash and cash equivalents of $8.2 million and $9.1 million,
respectively, which consisted of cash and short-term investments with original
maturities of ninety days or less, both domestically and internationally. As of
September 30, 2004 and June 30, 2004, we had marketable securities of $1.0
million and $3.1 million, respectively, consisting of obligations of municipal
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.
ITEM 4. 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 first fiscal quarter. 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 forms.
(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 first fiscal
quarter 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.
29
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information set forth in Note 14 of Part I, Item 1 of this Form 10-Q is
hereby incorporated by reference.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
- ------- ------------------------------------------------------------------------------------------------
10.1 Silicon Valley Bank Amendment to Loan Documents
Certification of Principal Executive Officer pursuant to Securities Exchange Act Rules
31.1 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Certification of Principal Financial Officer pursuant to Securities Exchange Act Rules 13a-15(e)
31.2 and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to
32.1 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
* Furnished, not filed.
30
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the Registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
Date: November 9, 2004 LANTRONIX, INC.
(Registrant)
By: /s/ Marc H. Nussbaum
MARC H. NUSSBAUM
----------------
CHIEF EXECUTIVE OFFICER
(PRINCIPAL EXECUTIVE OFFICER)
By: /s/ James W. Kerrigan
JAMES W. KERRIGAN
-----------------
CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL OFFICER)
31