Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark one)
[X] Quarterly report pursuant to section 13 or 15(d)
of the Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED APRIL 30, 2005
[ ] Transition report pursuant to section 13 or 15(d) of the
Securities and Exchange Act of 1934
For the transition period from _______ to ________
Commission file number 0-8419
SBE, INC.
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 94-1517641
------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2305 Camino Ramon, Suite 200, San Ramon, California 94583
---------------------------------------------------------
(Address of principal executive offices and zip code)
(925) 355-2000
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that 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 in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The number of shares of Registrant's Common Stock outstanding as of April 30,
2005 was 5,243,033.
SBE, INC.
INDEX TO APRIL 30, 2005 FORM 10-Q
PART I FINANCIAL INFORMATION
ITEM 1 Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of
April 30, 2005 and October 31, 2004....................................3
Condensed Consolidated Statements of Operations for the
three and six months ended April 30, 2005 and 2004.....................4
Condensed Consolidated Statements of Cash Flows for the
six months ended April 30, 2005 and 2004...............................5
Notes to Condensed Consolidated Financial Statements......................6
ITEM 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations.........................12
ITEM 3 Quantitative and Qualitative Disclosures about
Market Risk.................................................27
ITEM 4 Controls and Procedures.....................................27
PART II OTHER INFORMATION
ITEM 4 Submission of Matters to a Vote of Security Holders.........28
ITEM 6 Exhibits and Reports on Form 8-K............................29
SIGNATURES....................................................................31
EXHIBITS......................................................................32
-2-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SBE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
April 30, October 31,
ASSETS 2005 2004
-------- --------
(Unaudited)
Current assets:
Cash and cash equivalents $ 1,221 $ 1,849
Trade accounts receivable, net 1,599 1,668
Inventories 1,474 1,926
Other 262 227
-------- --------
Total current assets 4,556 5,670
Property, plant and equipment, net 392 427
Capitalized software costs, net 149 48
Other 288 28
-------- --------
Total assets $ 5,385 $ 6,173
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 854 $ 856
Accrued payroll and employee benefits 329 391
Capital lease obligations - current portion 27 25
Other accrued liabilities 164 459
-------- --------
Total current liabilities 1,374 1,731
Capital lease obligations and long term liabilities
net of current portion 135 139
-------- --------
Total liabilities 1,509 1,870
-------- --------
Commitments
Stockholders' equity:
Common stock 16,175 15,755
Deferred compensation (88) --
Accumulated deficit (12,211) (11,452)
-------- --------
Total stockholders' equity 3,876 4,303
-------- --------
Total liabilities and stockholders' equity $ 5,385 $ 6,173
======== ========
See notes to condensed consolidated financial statements.
-3-
SBE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
Three months ended Six months ended
April 30, April 30,
2005 2004 2005 2004
------- ------- ------- -------
Net sales $ 1,706 $ 2,977 $ 4,520 $ 5,947
Cost of sales 1,076 1,417 2,305 2,742
------- ------- ------- -------
Gross profit 630 1,560 2,215 3,205
Product research and development 573 543 1,046 1,048
Sales and marketing 567 564 1,126 1,053
General and administrative 426 400 795 764
Loan loss recovery -- -- -- (239)
------- ------- ------- -------
Total operating expenses 1,566 1,507 2,967 2,626
------- ------- ------- -------
Operating income (loss) (936) 53 (752) 579
Interest income (expense) -- 1 (3) 2
------- ------- ------- -------
Income (loss) before income taxes (936) 54 (755) 581
Income tax provision -- -- 5 --
------- ------- ------- -------
Net income (loss) $ (936) $ 54 $ (760) $ 581
======= ======= ======= =======
Basic income (loss) per share $ (0.18) $ 0.01 $ (0.15) $ 0.12
======= ======= ======= =======
Diluted income (loss) per share $ (0.18) $ 0.01 $ (0.15) $ 0.09
======= ======= ======= =======
Basic - weighted average shares
used in per share computations 5,207 5,003 5,175 4,961
======= ======= ======= =======
Diluted - weighted average shares
used in per share computations 5,207 6,030 5,175 6,134
======= ======= ======= =======
See notes to condensed consolidated financial statements.
-4-
SBE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Six months ended
April 30,
------------------
2005 2004
------- -------
Cash flows from operating activities:
Net income (loss) $ (760) $ 581
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Depreciation and amortization:
Property and equipment 105 106
Software 20 22
Deferred compensation 32 --
Amortization of intellectual property -- 204
Changes in operating assets and liabilities:
Accounts receivable 69 185
Inventories 451 129
Other assets (294) (173)
Trade accounts payable (2) (119)
Other accrued liabilities (163) (276)
------- -------
Net cash provided (used) by operating activities (542) 659
------- -------
Cash flows from investing activities:
Purchases of property, plant and equipment (70) (55)
Capitalized software costs (120) (78)
------- -------
Net cash used in investing activities (190) (133)
------- -------
Cash flows from financing activities:
Proceeds from exercise of warrants -- 116
Proceeds from repayment of stockholder note -- 142
Proceeds from exercise of stock options 104 227
------- -------
Net cash provided by financing activities 104 485
------- -------
Net increase (decrease) in cash and cash equivalents (628) 1,011
Cash and cash equivalents at beginning of period 1,849 1,378
------- -------
Cash and cash equivalents at end of period $ 1,221 $ 2,389
======= =======
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES:
Non-cash stock portion of Antares purchase price $ 196 $ --
======= =======
See notes to condensed consolidated financial statements.
-5-
SBE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. INTERIM PERIOD REPORTING:
These condensed consolidated financial statements of SBE, Inc. are unaudited and
include all adjustments, consisting of normal recurring adjustments, that are,
in the opinion of management, necessary for a fair presentation of the financial
position and results of operations and cash flows for the interim periods. The
results of operations for the three and six and months ended April 30, 2005 are
not necessarily indicative of expected results for the full 2005 fiscal year.
Certain information and footnote disclosures normally contained in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These condensed consolidated financial
statements should be read in conjunction with the financial statements and notes
contained in our Annual Report on Form 10-K for the year ended October 31, 2004.
MANAGEMENT ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles in the U.S. requires us to make estimates and assumptions
that affect the reported amounts of assets and liabilities, as well as certain
disclosure of contingent assets and liabilities as of the date of the financial
statements and the reported amounts of net sales and expenses during the
reporting period. Actual results could differ from these estimates. Significant
estimates and judgments made by us relate to matters such as potential liability
for sales allowances, warranty and indemnification obligations, collectibility
of accounts receivable, realizability of inventories and recoverability of
capitalized software and deferred tax assets.
2. INVENTORIES:
Inventories were comprised of the following (in thousands):
April 30, October 31,
2005 2004
--------- -----------
Finished goods$ 257 $1,343
Parts and materials 1,217 583
------ ------
$1,474 $1,926
====== ======
3. NET INCOME (LOSS) PER SHARE:
Basic income (loss) per common share for the three and six months ended April
30, 2005 and 2004 was computed by dividing the net income for such period by the
weighted average number of shares of common stock outstanding for such period. .
-6-
Common stock equivalents for the three months and six months ended April 30,
2005 were 510,547 and 583,747, respectively and were anti-dilutive and as such
are not included in the calculation of diluted net income per share. Common
stock equivalents for the three months and six months ended April 30, 2004 were
1,026,890 and 1,173,517, respectively, and have been included in the calculation
of diluted net income per share. The common stock equivalents for the three and
six months ended April 30, 2004 include the following items: 1) 867,238 and
1,006,914 vested employee stock options, respectively; 2) 90,707 and 97,658
common stock equivalents subject to warrants, respectively 3) 68,945 shares of
common stock to be issued in connection with the purchase of Antares.
Three months ended Six months ended
($000 omitted) April 30, April 30,
- -------------- ------------------ ------------------
2005 2004 2005 2004
------- ------- ------- -------
BASIC
Weighted average number of
common shares outstanding 5,207 5,003 5,175 4,961
------- ------- ------- -------
Number of shares for computation of
net income (loss) per share 5,207 5,003 5,175 4,961
======= ======= ======= =======
Net income (loss) $ (936) $ 54 $ (760) $ 581
======= ======= ======= =======
Net income (loss) per share $ (0.18) $ 0.01 $ (0.15) $ 0.12
======= ======= ======= =======
DILUTED
Weighted average number of
common shares outstanding 5,207 5,003 5,175 4,961
Shares issuable pursuant to options granted
under stock option plans and warrants granted,
less assumed repurchase at the average fair
market value for the period -- 1,027 -- 1,173
------- ------- ------- -------
Number of shares for computation of
net income (loss) per share 5,207 6,030 5,175 6,134
======= ======= ======= =======
Net income (loss) $ (936) $ 54 $ (760) $ 581
======= ======= ======= =======
Net income (loss) per share $ (0.18) $ 0.01 $ (0.15) $ 0.09
======= ======= ======= =======
-7-
4. STOCK BASED COMPENSATION:
At April 30, 2005, we had two stock-based employee compensation plans and one
stock-based director compensation plan. We account for these plans under the
recognition and measurement principles of Accounting Principle Board Opinion No.
25, "Accounting for Stock Issued to Employees," ("APB 25") and related
interpretations. Accordingly, no stock-based employee compensation cost has been
recognized in net income for the stock option plans. Had compensation cost for
our stock option plans been determined based on the fair value recognition
provisions of Statement of Financial Accounting Standard No. 123, "Accounting
for Stock-Based Compensation," ("SFAS 123") our net income (loss) and income
(loss) per share would have been as follows (in thousands):
Three Months Six Months
Ended April 30, Ended April 30,
2005 2004 2005 2004
------- ------- ------- -------
Net income (loss), as reported $ (936) $ 54 $ (760) $ 581
Add: Total stock-based compensation
expense (benefit) included in the net
loss determined under the recognition
and measurement principles of APB 25 -- -- -- --
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects 388 96 1,139 166
------- ------- ------- -------
Pro forma net income (loss) $(1,324) $ (42) $(1,894) $ 415
======= ======= ======= =======
Income (loss) per share:
Basic - as reported $ (0.18) $ 0.01 $ (0.15) $ 0.12
======= ======= ======= =======
Basic - pro forma $ (0.25) $ (0.01) $ (0.37) $ 0.08
======= ======= ======= =======
Diluted - as reported $ (0.18) $ 0.01 $ (0.15) $ 0.09
======= ======= ======= =======
Diluted - pro forma $ (0.25) $ (0.01) $ (0.37) $ 0.07
======= ======= ======= =======
There were 280,000 stock options granted in the quarter ended April 30, 2005.
The assumptions regarding the annual vesting of stock options were 25% per year
for options granted in 2005. The fair value of each option grant is estimated on
the date of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions used for grants in 2005: Dividend yield
of 0%; expected volatility of 121.5%, risk-free interest rate of 3.1%, and
expected life of four years.
-8-
5. CONCENTRATION OF RISK:
In the three and six months ended April 30, 2005 and 2004, most of our sales
were attributable to sales of communications products and were derived from a
limited number of original equipment manufacturer ("OEM") customers. In our
second quarter of fiscal 2005, we had sales to two customers that were each
greater than 10% of our net sales for the quarter and collectively accounted for
54% of net sales during the second quarter of fiscal 2005. In our second quarter
of fiscal 2004, we had sales to two customers that individually accounted for
greater than 10% of our net sales for the quarter and collectively accounted for
50% of our net sales for that quarter. In the first six months of fiscal 2005,
we had sales to three customers that were each greater than 10% of our sales for
that period and collectively accounted for 61% of net sales during the first two
quarters of fiscal 2005. In the first six months of fiscal 2004, we had sales to
two customers that individually accounted for greater than 10% of our net sales
for that period and collectively accounted for 56% of our net sales for the
first two quarters of fiscal 2004.
As of April 30, 2005, we had two customers that each accounted for more than 10%
of our accounts receivable compared to three customers as of April 30, 2004.
6. WARRANTY OBLIGATIONS AND OTHER GUARANTEES:
Warranty Reserve:
Our products are sold with warranty provisions that require us to remedy
deficiencies in quality or performance of our products over a specified period
of time, generally 12 months, at no cost to our customers. We accrue the
estimated costs to be incurred in performing warranty services at the time of
revenue recognition and shipment of our products to our customers. Our estimate
of costs to service our warranty obligations is based on historical experience
and expectation of future conditions. To the extent we experience increased
warranty claim activity or increased costs associated with servicing those
claims, the warranty accrual may increase, resulting in decreased gross margin.
The following table sets forth an analysis of our warranty reserve at (in
thousands):
April 30,
2005 2004
---- ----
Warranty reserve at beginning of period $ 20 $ 53
Less: Cost to service warranty obligations (4) (33)
Plus: Increases to reserves 4 33
---- ----
Total warranty reserve included in other accrued expenses $ 20 $ 20
==== ====
The following is a summary of our agreements that we have determined are within
the scope of the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 45 "Guarantor's Accounting and Disclosure Requirements for
Guarantees" ("FIN 45").
-9-
Indemnification Agreements:
We have agreed to indemnify each of our executive officers and directors for
certain events or occurrences arising as a result of the officer or director
serving in such capacity. The term of the indemnification period is for the
officer's or director's lifetime. The maximum potential amount of future
payments we could be required to make under these indemnification agreements is
unlimited. However, we have a directors' and officers' liability insurance
policy that should enable us to recover a portion of any future amount paid. As
a result of our insurance policy coverage, we believe the estimated fair value
of these indemnification agreements is minimal and have no liabilities recorded
for these agreements as of April 30, 2005 and October 31, 2004.
We enter into agreements with other companies containing indemnification
provisions in the ordinary course of business, typically with business partners,
contractors, customers and landlords. Under these provisions, we generally agree
to indemnify and hold harmless the indemnified party for losses suffered or
incurred by the indemnified party as a result of our activities or, in some
cases, as a result of the indemnified party's activities under the agreement.
These indemnification provisions often relate to representations made by us with
regard to our intellectual property rights. These indemnification provisions
generally survive termination of the underlying agreement. The maximum potential
amount of future payments we could be required to make under these
indemnification provisions is unlimited. To date, we have not incurred material
costs to defend lawsuits or settle claims related to these indemnification
provisions. As a result, we believe the estimated fair value of these agreements
is minimal. Accordingly, we have no liabilities recorded for these agreements as
of April 30, 2005 and October 31, 2004.
Other:
We are the secondary guarantor on the lease assignment of our previous
headquarters that expires in 2006. We believe we will not have to make any
payments as a result of this guarantee and thus have not recorded a liability at
April 30, 2005.
7. LOAN TO OFFICER
On November 6, 1998, we made a loan to one of our officers and stockholders,
which was used by the officer/stockholder to exercise an option to purchase
139,400 shares of our common stock and related taxes. The loan, as amended, was
collateralized by shares of our common stock, bore interest at a rate of 2.48%
per annum, with interest due annually and the entire amount of the principal was
due on December 14, 2003.
On October 31, 2002, we determined that it was probable that we would be unable
to fully recover the balance of the loan on its due date of December 14, 2003.
Accordingly, a valuation allowance of $474,000 was recorded based on the fair
value of the common stock collateralizing the note at October 31, 2002 and the
amount of the officer's personal assets considered likely to be available to
settle the note in December 2003.
During the fourth quarter of fiscal 2003, the officer sold 139,400 shares of our
common stock and used the proceeds from the stock sale to repay $362,800 of the
loan from us. As a result of the fiscal 2003 loan payment, we recognized a
benefit in the fourth quarter of 2003 of $235,000 related to the reversal of the
loan impairment charge taken by us in fiscal 2002. In November 2003, the officer
-10-
sold additional shares of our common stock and used the proceeds to repay the
remaining loan balance in full. As a result, in our first quarter of fiscal 2004
we recorded a benefit of $239,000 resulting from the reversal of the remaining
loan impairment charge.
8. DEFERRED COMPENSATION
On January 1, 2005, the Company's retiring President and Chief Executive Officer
was awarded options to purchase 75,000 shares of the Company's stock at a price
of $4.00 per share (closing price on December 31, 2004). The fair value of this
option grant is estimated on the date of grant using the Black-Scholes
option-pricing model and is included as deferred compensation on the balance
sheet. The $120,000 deferred compensation is amortized to general and
administrative expense at the rate of $8,000 per month over the 15 month vesting
period ending March 2006 based on his continued service as a director of the
Company. As of April 30, 2005, $32,000 of the deferred compensation has been
amortized to expense and is included in General and Administrative expense.
9. PENDING ACQUISITION AND PRIVATE PLACEMENT FINANCING
On March 28, 2005, the Company entered into an Agreement and Plan of Merger and
Reorganization (the "Merger Agreement") with PyX Technologies, Inc., a
California corporation ("PyX"). The Merger Agreement provides for PyX to merge
with and into a wholly-owned subsidiary of the Company. At the effective time of
the merger, each share of issued and outstanding PyX Common Stock will be
converted into the right to receive 0.46 shares of the Company's Common Stock,
and all outstanding options to acquire PyX Common Stock will be assumed. A total
of 2,561,050 shares of the Company's Common Stock will be issued in respect of
outstanding PyX Common Stock. An additional 2,038,950 shares of the Company's
Common Stock will be issuable upon exercise of assumed stock options for
services of selling shareholders who will become employees of the Company. A
total of 95% of the Company's shares issued in connection with the merger will
be subject to a one-year market standoff, such that only 128,053 of such shares
will be freely tradable prior to the first anniversary of the closing date. The
Company has also agreed to register the option shares on a Form S-8 shortly
following the closing. The option shares are issuable upon exercise of options,
subject to vesting restrictions that do not begin to lapse until February 2006,
except that if an optionee's employment is terminated without cause or the
optionee resigns for certain specified reasons, the vesting will accelerate and
the options will become fully vested. The Board of Directors of each of the
Company and PyX have approved the Merger Agreement. The transactions
contemplated by the Merger Agreement are subject to the approval of the
Company's stockholders, the Company obtaining at least $5.0 million in gross
proceeds from a financing to close in connection with the Merger, the receipt by
the Company of audited financial statements of PyX and other customary closing
conditions.
On May 4, 2005, the Company entered into a unit subscription agreement with AIGH
Investment Partners, LLC and other accredited investors providing for the
private placement of shares of the Company's common stock and warrants to
purchase shares of the Company's common stock, with gross proceeds to the
Company of $5,150,000. The unit subscription agreement provides that the
investors will invest $5,150,000 for units consisting of one share of the
-11-
Company's common stock and a warrant to purchase 0.5 of a share of the Company's
common stock concurrent with the close of the above merger agreement. The price
per unit is to be the lowest of:
o $2.50;
o 92% of the average closing sale price per share of the Company's
common stock as quoted on the Nasdaq SmallCap Market for the five
preceding consecutive trading days on which the Company's common
stock trades ending on the date immediately before the closing date
of the private placement; and
o 95% of the closing sale price per share of the Company's common
stock as quoted on The Nasdaq SmallCap Market on the trading day on
which the Company's common stock trades immediately preceding the
closing date of the private placement.
The Company has the right to terminate the unit subscription agreement and not
close the transaction if the price per unit is less than $2.00.
The warrants issued in connection with the private placement will have a term of
five years and will be exercisable at a per share price equal to 133% of the
unit price, subject to proportional adjustments for stock splits, stock
dividends, recapitalizations and the like. The warrants will also contain a
cashless exercise feature.
The Company has agreed to file a registration statement within 60 days after
completion of the private placement registering for resale the shares of our
common stock, including shares issuable upon exercise of the warrants, issued to
the purchasers in the private placement.
The Company has capitalized in other assets approximately $254,000 in prepaid
costs related to this transaction.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements that involve risks and
uncertainties. Words such as "believes," "anticipates," "expects," "intends" and
similar expressions are intended to identify forward-looking statements, but are
not the exclusive means of identifying such statements. Readers are cautioned
that the forward-looking statements reflect our analysis only as of the date
hereof, and we assume no obligation to update these statements. Actual events or
results may differ materially from the results discussed in or implied by the
forward-looking statements. Factors that might cause such a difference include,
but are not limited to, those risks and uncertainties set forth under the
caption "Risk Factors" below.
-12-
The following discussion should be read in conjunction with the condensed
consolidated financial statements and the notes thereto included in Item 1 of
this Quarterly Report on Form 10-Q and in our Form 10-K for the fiscal year
ended October 31, 2004.
RISK FACTORS
In addition to the other information in this Quarterly Report on Form 10-Q,
stockholders or prospective investors should carefully consider the following
risk factors:
RISKS RELATED TO OUR BUSINESS
IF WE ARE UNABLE TO COMPLETE THE PYX MERGER AND THE PROPOSED PRIVATE PLACEMENT,
OUR BUSINESS WILL BE ADVERSELY AFFECTED.
If the merger with PyX and the private placement are not completed, our business
and the market price of our stock price may be adversely affected. We currently
anticipate that our available cash balances, available borrowings and cash
generated from operations will be sufficient to fund our operations only through
July 2005. If we are unable to complete the transactions, we may be unable to
find another way to grow our business. Costs related to the transactions, such
as legal, accounting and financial advisor fees, must be paid even if the
transactions are not completed. In addition, even if we have sufficient funds to
continue to operate our business but the transactions are not completed, the
current market price of our common stock may decline.
WE DEPEND UPON A SMALL NUMBER OF ORIGINAL EQUIPMENT MANUFACTURERS ("OEM")
CUSTOMERS. THE LOSS OF ANY OF THESE CUSTOMERS, OR THEIR FAILURE TO SELL THEIR
PRODUCTS, COULD LIMIT OUR ABILITY TO GENERATE REVENUES. IN PARTICULAR, WE EXPECT
HP WILL CEASE TO BE A SIGNIFICANT CUSTOMER OF OURS IN FISCAL 2005, AND OUR
SUCCESS DEPENDS ON BEING ABLE TO REPLACE NET SALES PREVIOUSLY ATTRIBUTABLE TO HP
WITH SALES TO OTHER CUSTOMERS.
In the first two quarters of fiscal 2005 and 2004, sales of Versa Module Europa
("VME") products to The Hewlett-Packard Company ("HP") accounted for 23% and
42%, respectively, of our net sales. We made our final shipment for $1.0 million
of our VME products to HP in the first fiscal quarter of fiscal 2005. Our future
success depends on being able to replace net sales previously attributable to HP
with sales to other customers. We can provide no assurance that we will succeed
in obtaining new orders from existing or new customers sufficient to replace or
exceed the net sales previously attributable to HP.
Even after HP ceases to be a customer, we expect to continue to depend on sales
to a small number of OEM customers, including Data Connection Limited and Nortel
Networks. Sales to Data Connection Limited and Nortel Networks accounted for 34%
and 20% of our net sales for the quarter ended April 30, 2005, respectively.
There can be no assurance that we will become a qualified supplier with new OEM
customers or that we will remain a qualified supplier with existing OEM
customers.
-13-
Orders by our OEM customers are affected by factors such as new product
introductions, product life cycles, inventory levels, manufacturing strategies,
contract awards, competitive conditions and general economic conditions. Our
sales to any single OEM customer are also subject to significant variability
from quarter to quarter. Such fluctuations may have a material adverse effect on
our operating results. A significant reduction in orders from any of our OEM
customers, could have a material adverse effect on our operating results,
financial condition and cash flows.
As of April 30, 2005, Data Connection Limited and Nortel Networks individually
accounted for 43% and 23% of our accounts receivable, respectively, and
collectively accounted for 66% of our accounts receivable. A failure to collect
outstanding accounts receivable from any of our OEM customers could have a
material adverse effect on our business, operating results, financial condition
and cash flows.
OUR FUTURE CAPITAL NEEDS MAY EXCEED OUR ABILITY TO RAISE CAPITAL OR USE OUR
EXISTING CREDIT LINE WITH A BANK.
The development and marketing of our products is capital-intensive. We believe
that our existing cash balances and our anticipated cash flow from operations
and financing alternatives will satisfy our working capital needs only through
July 2005. [Declines in our sales or a failure to keep expenses in line with
revenues could require us to seek additional financing or force us to draw down
on our existing line of credit with a bank in fiscal 2005. In addition, should
we experience a significant growth in customer orders or wish to make strategic
acquisitions of business or assets, we may be required to seek additional
capital to meet our working capital needs. There can be no assurance that
additional financing, if required, will be available on reasonable terms or at
all. To the extent that additional capital is raised through the sale of
additional equity or convertible debt securities, the issuance of such
securities could result in additional dilution to our stockholders.] Update for
current cash situation
BECAUSE OF OUR DEPENDENCE ON SINGLE SUPPLIERS FOR SOME COMPONENTS, WE MAY BE
UNABLE TO OBTAIN AN ADEQUATE SUPPLY OF SUCH COMPONENTS, OR WE MAY BE REQUIRED TO
PAY HIGHER PRICES OR TO PURCHASE COMPONENTS OF LESSER QUALITY.
The chip sets used in most of our products are currently available only from
Motorola. In addition, certain other components are currently available only
from other single suppliers. If these suppliers discontinue or upgrade some of
the components used in our products, we could be required to redesign a product
to incorporate newer or alternative technology. The inability to obtain
sufficient key components as required, or to develop alternative sources if and
as required in the future, could result in delays or reductions in product
shipments or margins that, in turn, would have a material adverse effect on our
business, operating results, financial condition and cash flows. If enough
components are unavailable, we may have to pay a premium in order to meet
customer demand. Paying premiums for parts, building inventories of scarce parts
and obsolesce of existing inventories could lower or eliminate our profit
margin, reduce our cash flow and otherwise harm our business. To offset
potential component shortages, we have in the past, and may in the future, carry
an inventory of these components. As a result, our inventory of components parts
may become obsolete and may result in write-downs.
-14-
IF WE FAIL TO DEVELOP AND PRODUCE NEW HIGHWIRE, WAN AND LAN ADAPTERS, TOE AND
STORAGE PRODUCTS, WE MAY LOSE SALES AND OUR REPUTATION MAY BE HARMED.
The markets for our products are characterized by rapidly changing technologies,
evolving industry standards and frequent new product introductions. Our future
success will depend on our ability to enhance our existing products and to
introduce new products and features to meet and adapt to changing customer
requirements and emerging technologies such as voice over IP ("VoIP"), third
generation wireless services ("3G Wireless "), Serial ATA ("SATA "), , Internet
Small Computer System Interface ("iSCSI")Serial Attached SCSI ("SAS "), Gigabit
Ethernet, 10 Gigabit Ethernet and TCP/IP Offload Engine ("TOE"). There can be no
assurance that we will be successful in identifying, developing, manufacturing
and marketing new products or enhancing our existing products. In addition,
there can be no assurance that services, products or technologies developed by
others will not render our products noncompetitive or obsolete.
We have focused a significant portion of our research and development, marketing
and sales efforts on HighWire, wide area network ("WAN") and local area network
("LAN") adapters, encryption, iSCSI and TOE products. The success of these
products is dependent on several factors, including timely completion of new
product designs, achievement of acceptable manufacturing quality and yields,
introduction of competitive products by other companies, market acceptance of
our products and our ability to sell our products. If the TOE, iSCSI, HighWire,
encryption and adapter products or other new products developed by us do not
gain market acceptance, our business, operating results, financial condition and
cash flows would be materially adversely affected.
THE COMMUNICATIONS AND STORAGE PRODUCTS MARKET IS INTENSELY COMPETITIVE, AND OUR
FAILURE TO COMPETE EFFECTIVELY COULD REDUCE OUR REVENUES AND MARGINS.
We compete directly with traditional vendors of terminal servers, modems, remote
control software, terminal emulation software and application-specific
communications and storage solutions. We also compete with suppliers of routers,
hubs, network interface cards and other data communications and storage
products. In the future, we expect competition from companies offering
client/server access solutions based on emerging technologies such as switched
digital telephone services, iSCSI, SAS, TOE, VoIP and other technologies. In
addition, we may encounter increased competition from operating system and
network operating system vendors to the extent that such vendors include full
communications and storage capabilities in their products. We may also encounter
future competition from telephony service providers (such as AT&T or the
regional Bell operating companies) that may offer communications services
through their telephone networks.
Increased competition with respect to any of our products could result in price
reductions and loss of market share, which would adversely affect our business,
operating results, financial condition and cash flows. Many of our current and
potential competitors have greater financial, marketing, technical and other
resources than we do. There can be no assurance that we will be able to compete
successfully with our existing competitors or will be able to compete
successfully with new competitors.
-15-
WE DEPEND ON OUR KEY PERSONNEL. IF WE ARE UNABLE TO RETAIN OUR CURRENT PERSONNEL
AND HIRE ADDITIONAL QUALIFIED PERSONNEL AS NEEDED, OUR BUSINESS WOULD BE HARMED.
We are highly dependent on the technical, management, marketing and sales skills
of a limited number of key employees. We do not have employment agreements with,
or life insurance on the lives of, any of our key employees. The loss of the
services of any key employees could adversely affect our business and operating
results. Our future success will depend on our ability to continue to attract
and retain highly talented personnel to the extent our business grows.
Competition for qualified personnel in the networking industry, and in the San
Francisco Bay Area, is intense. There can be no assurance that we will be
successful in retaining our key employees or that we can attract or retain
additional skilled personnel as required.
WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WHICH COULD REDUCE ANY
COMPETITIVE ADVANTAGE WE HAVE.
Although we believe that our future success will depend primarily on continuing
innovation, sales, marketing and technical expertise, the quality of product
support and customer relations, we must also protect the proprietary technology
contained in our products. We do not currently hold any patents and rely on a
combination of copyright, trademark, trade secret laws and contractual
provisions to establish and protect proprietary rights in our products. There
can be no assurance that steps taken by us in this regard will be adequate to
deter misappropriation or independent third-party development of our technology.
Although we believe that our products and technology do not infringe on the
proprietary rights of others, there can be no assurance that third parties will
not assert infringement claims against us.
RISKS ASSOCIATED WITH OWNERSHIP OF OUR COMMON STOCK
THE MARKET PRICE OF OUR COMMON STOCK IS LIKELY TO CONTINUE TO BE VOLATILE. YOU
MAY NOT BE ABLE TO RESELL YOUR SHARES AT OR ABOVE THE PRICE AT WHICH YOU
PURCHASED SUCH SHARES.
The trading price of our common stock is subject to wide fluctuations in
response to quarter-to-quarter fluctuations in operating results, the failure to
meet analyst estimates, announcements of technological innovations or new
products by us or our competitors, general conditions in the computer and
communications industries and other events or factors. In addition, stock
markets have experienced extreme price and trading volume volatility in recent
years. This volatility has had a substantial effect on the market price of the
securities of many high technology companies for reasons frequently unrelated to
the operating performance of the specific companies. These broad market
fluctuations may adversely affect the market price of our common stock.
OUR CERTIFICATE OF INCORPORATION AND BYLAWS, AND THE DELAWARE GENERAL
CORPORATION LAW, CONTAIN PROVISIONS THAT COULD DELAY OR PREVENT A CHANGE IN
CONTROL.
Our board of directors has the authority to issue up to 2,000,000 shares of
preferred stock and to determine the price, rights, preferences and privileges
of those shares without any further vote or action by our stockholders. The
-16-
rights of the holders of our common stock will be subject to, and may be
materially adversely affected by, the rights of the holders of any preferred
stock that may be issued in the future. The issuance of preferred stock could
have the effect of making it more difficult for a third party to acquire a
majority of our outstanding voting stock. Furthermore, certain other provisions
of our certificate of incorporation and bylaws may have the effect of delaying
or preventing changes in control or management, which could adversely affect the
market price of our common stock. In addition, we are subject to the provisions
of Section 203 of the Delaware General Corporation Law, an anti-takeover law.
OUR SALES AND OPERATING RESULTS HAVE FLUCTUATED, AND ARE LIKELY TO CONTINUE TO
FLUCTUATE SIGNIFICANTLY IN FUTURE PERIODS, WHICH MAY CAUSE OUR STOCK PRICE TO
FALL AS A RESULT OF FAILURE TO MEET THE EXPECTATIONS OF SECURITIES ANALYSTS OR
INVESTORS.
Our quarterly operating results have fluctuated significantly in the past and
are likely to fluctuate significantly in the future due to several factors, some
of which are outside our control and which we may not be able to predict,
including the existence or absence of significant orders from OEM customers,
fluctuating market demand for, and declines in the average selling prices of,
our products, success in achieving design wins, delays in the introduction of
our new products, competitive product introductions, the mix of products sold,
changes in our distribution network, the failure to anticipate changing customer
product requirements, the cost and availability of components and general
economic conditions. We generally do not operate with a significant order
backlog, and a substantial portion of our net sales in any quarter is derived
from orders booked in that quarter. Accordingly, our sales expectations are
based almost entirely on our internal estimates of future demand and not on firm
customer orders.
Due to the adverse economic conditions in the telecommunications industry, many
of our customers may hold excess inventory of our products. A result of the
economic downturn is that certain of our customers have cancelled or delayed
many of their new design projects and new product rollouts that included our
products. Due to the current economic uncertainty, our customers now typically
require a "just-in-time" ordering and delivery cycle where they will place a
purchase order with us after they receive an order from their customer. This
"just-in-time" inventory purchase cycle by our customers has made forecasting of
our future sales volumes very difficult.
Based on the foregoing, we believe that quarterly operating results are likely
to vary significantly in the future and that period-to-period comparisons of our
results of operations are not necessarily meaningful and should not be relied
upon as indications of future performance. Further, it is likely that in some
future quarter our net sales or operating results will be below the expectations
of public market analysts and investors. In such event, the price of our common
stock is likely to fall.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OVERVIEW
SBE, Inc. designs, develops and sells network communications and storage
solutions to original equipment manufacturers ("OEM") in the embedded computing
and storage markets. Our solutions enable data communications,
-17-
telecommunications and storage solution companies, in addition to enterprise
class high-end server customers, to rapidly deliver advanced networking and
storage products and services. Our products include wide area network ("WAN"),
local area network ("LAN"), Internet Small Computer System Interface ("iSCSI")
software, SCSI, Fibre Channel, intelligent carrier cards, Encryption and TCP/IP
Offload Engine ("TOE") cards. These products perform critical computing,
processing offload, Input/Output ("I/O") and storage tasks across both the
enterprise server and embedded markets such as high-end enterprise level
servers, Linux super computing clusters, workstations, media gateways, routers,
internet access devices, home location registers, data messaging applications,
network attached storage ("NAS") and remote storage devices and networks.
In January 2004, we partnered with NCOMM, a New Hampshire company, to provide
Call Control Trunk Management Software for our WAN wireline products. NCOMM
delivers the underpinning drop-in software technology necessary to build
interoperable, standards-compliant WAN access devices: framer configuration,
alarming & fault management, PerfMon, line testing, signaling and Automatic
Protection Switching. The combination of our WAN products and the NCOMM software
reduces our telecommunications customers product time-to-market through turnkey
T1/E1/T3/E3 telecommunications source code.
In April 2005, we contracted with SignaLogic, a Texas company, to develop a
family of VoIP Digital Signal Protocol ("DSP") products that will interoperate
with our HighWire and WAN products to provide a high-density cost efficient VoIP
gateway with full media gateway functionality. The VoIP gateway is targeted at
telecommunications, cable and Internet Service Providers (`ISP") companies that
provide VoIP services. The first product will be completed in our third quarter.
We are currently developing an IP Post Branch Exchange ("PBX") software stack.
The software stack will convert analog-based telecommunications signals into
packet based signals to enable VoIP services using our WAN products.
In May 2004, we partnered with PyX Technologies, a California company, to
provide iSCSI software products that strategically support our TOE development
plans. Thishigh-value iSCSI storage software stack utilizes our TOE hardware to
facilitate Internet based storage solutions to large, small and medium sized
businesses. iSCSI is an end-to-end protocol for transporting storage I/O block
data over an Internet Protocol ("IP") network. The protocol is used on servers
(initiators), storage devices (targets), and protocol transfer gateway devices.
iSCSI uses standard Ethernet switches and routers to move the data from the
server to storage. The initiator is typically a host (either a PC, server or
laptop) that is running an iSCSI initiator driver (such as the PyX or Microsoft
iSCSI initiator) that will be accessing storage on the IP Storage Area Network
("SAN"). The target is any storage device, such as disk drives, raid systems,
CDROM's, DVD's, or tapes. On March 28, 2005, we entered into a definitive merger
agreement with PyX pursuant to which PyX will merge with and into a wholly-owned
subsidiary of ours. This merger will allow us to own the intellectual property
imbedded in the PyX iSCSI software product. The merger is subject to the
approval of our stockholders.
Managing storage is universally regarded as one of the most burdensome of IT
responsibilities. In the direct-attached storage environments that most small to
-18-
mid-sized companies deploy, the process of managing storage is multiplied by the
number of physical connection points and the number of storage systems in an
organization. Imagine an environment with ten computers, each with its own
storage system. Not only does that create ten point-for-management for the
storage systems themselves, it also requires ten times the effort normally
required in order to handle storage expansion, reallocation and repairs. With
SANs, storage management is consolidated into a single point from which an IT
manager can partition, allocate, expand, reassign, backup and repair storage. By
moving to a SAN, small to mid-sized organizations can scale their storage
infrastructure much more easily than with a direct attached storage system. When
additional capacity is needed, IT managers can simply add additional storage to
the SAN. IP SANs, such as iSCSI, provide higher-speed storage access than
internal disks while also enabling load balancing across multiple connections.
Remote storage powered by iSCSI also enables on-line data back up, disaster
recover and high-speed access to data by remote users.
The PyX iSCSI software uses the port aggregation and port failover features of
our TOE dual port Gigabit Ethernet card to recover from transmission failures.
In addition, the PyX iSCSI software uses our TOE acceleration feature to obtain
wire transmission speeds of up to two Gigabits per second. The SBE/PyX TOE/iSCSI
product has Error Recovery Level 0 ("ERL0") through Error Recovery Level 2
("ERL2") failure recovery functionality. ERL2 functionality is reached when a
TCP/IP and iSCSI transmission can recover from a breakdown in the initiator, the
target or the transport medium. When using the PyX ERL2 iSCSI software and our
TOE hardware, the transmission is re-sent from the point of failure and not from
the beginning of the transmission, as is the case with other ERL0 iSCSI
products, enabling the user to ensure that all data has been transmitted
successfully.
Our business is characterized by a concentration of sales to a small number of
OEMs and distributors, consequently, the timing of significant orders from major
customers and their product cycles causes fluctuations in our operating results.
HP has been the largest of our customers. Sales to HP accounted for 0% and 23%
of our net sales in the three and six months ended April 30, 2005, respectively,
and 36% and 42% for the same periods in fiscal 2004, respectively. We made our
final shipment to HP in the first fiscal quarter of fiscal 2005. In the second
quarter of fiscal 2005 sales to Nortel Networks and Data Connections Limited
accounted for greater than 10% of net sales for the quarter. Nortel was the only
customer other than HP that accounted for greater than 10% of our net sales in
the three or six months ended April 30, 2004. As of April 30, 2005, Data
Connection Limited and Nortel Networks individually accounted for 43% and 18% of
our accounts receivable, respectively, and collectively accounted for 61% of our
accounts receivable. HP accounted for 17% of our accounts receivable as of April
30, 2004 and two other customers each accounted for greater that 10% of our
accounts receivable. No other customer individually accounted for more than 10%
of our accounts receivable as of April 30, 2005 or 2004, respectively. Orders by
our OEM customers are affected by factors such as new product introductions,
product life cycles, inventory levels, manufacturing strategy, contract awards,
competitive conditions and general economic conditions. A significant reduction
in orders from any of our OEM customers, or a failure to collect outstanding
accounts receivable from any of our OEM customers, could have a material adverse
effect on our business, operating results, financial condition and cash flows.
-19-
Our products are distributed worldwide through a direct sales force,
distributors, independent manufacturers' representatives and value-added
resellers. Our business falls primarily within one industry segment.
BACKLOG
On April 30, 2005, we had a sales backlog of product orders of approximately
$1.2 million compared to a sales backlog of product orders of approximately $4.8
million one year ago. None of the April 30, 2005 backlog is related to sales of
VME products to HP, as compared to $2.8 million as of April 30, 2004.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles in the U.S. requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Significant estimates and judgments made by us
include matters such as indemnifications obligations, accounts receivable,
realizability of inventories and recoverability of capitalized software and
deferred tax assets. Actual results could differ from those estimates.
Our critical accounting policies and estimates include the following:
Revenue Recognition:
Our policy is to recognize revenues for product sales upon shipment of our
products to our customers, provided that no significant obligation on our part
remains outstanding and collection of the receivable is considered probable.
Shipping terms are generally FOB shipping point. We defer and recognize service
revenues over the contractual period or as services are rendered. We estimate
expected sales returns and record the amount as a reduction of revenue and cost
of goods ("COGS") at the time of shipment. Our policy complies with the guidance
provided by Staff Accounting Bulletin No. 104, Revenue Recognition in Financial
Statements, issued by the Securities and Exchange Commission. Judgments are
required in evaluating the credit worthiness of our customers. Credit is not
extended to customers and revenue is not recognized until we have determined
that collectibility is reasonably assured. Our sales transactions are
denominated in U.S. dollars. The software component of our hardware products is
considered incidental to our products. We therefore do not recognize software
revenues separately from the product sale.
Our agreements with OEMs, such as HP and Nortel Networks, typically incorporate
clauses reflecting the following understandings:
- all prices are fixed and determinable at the time of sale;
- title and risk of loss pass at the time of shipment (FOB shipping
point);
- collectibility of the sales price is probable (the OEM is obligated
to pay and such obligation is not contingent on the ultimate sale of
the OEM's integrated solution);
-20-
- the OEM's obligation to us will not be changed in the event of theft
or physical destruction or damage of the product;
- we do not have significant obligations for future performance to
directly assist in the resale of the product by the OEMs; and
- there is no contractual right of return other than for defective
products.
Our agreements with our distributors include certain product rotation and price
protection rights. All distributors have the right to rotate slow moving
products once each fiscal quarter. The maximum dollar value of inventory
eligible for rotation is equal to 25% of our products purchased by the
distributor during the previous quarter. In order to take advantage of their
product rotation rights, the distributors must order and take delivery of
additional SBE products equal to at least the dollar value of the products that
they want to rotate.
Each distributor is also allowed certain price protection rights. If, and when,
we reduce or plan to reduce the price of any of our products, and the
distributor is holding any of the affected products in inventory, we will credit
the distributor the difference in price when it places its next order with us.
We record an allowance for price protection thereby reducing our net sales and
accounts receivable. The allowance is based on the price difference of the
inventory held by our stocking distributors at the time we expect to reduce
selling prices. Reserves for the right of return and restocking are established
based on the requirements of Statement of Financial Accounting Standards 48,
"Revenue Recognition when Right of Return Exists," because we have visibility
into our distributor's inventory and have sufficient history to estimate
returns.
During the quarter ended April 30, 2005, $79,000, or 5%, of our sales were sold
to distributors as compared to $361,000, or 12%, of our sales in the same
quarter of fiscal 2004. During the six months ended April 30, 2005, $253,000, or
6%, of our sales were sold to distributors as compared to $590,000, or 10%, of
our sales in the same period of fiscal 2004.
Allowance for Doubtful Accounts:
Our policy is to maintain allowances for estimated losses resulting from the
inability of our customers to make required payments. Credit limits are
established through a process of reviewing the financial history and stability
of each customer. Where appropriate, we obtain credit rating reports and
financial statements of the customer when determining or modifying their credit
limits. We regularly evaluate the collectibility of our trade receivable
balances based on a combination of factors. When a customer's account balance
becomes past due, we initiate dialogue with the customer to determine the cause.
If it is determined that the customer will be unable to meet its financial
obligation to us, such as in the case of a bankruptcy filing, deterioration in
the customer's operating results or financial position or other material events
impacting its business, we record a specific allowance to reduce the related
receivable to the amount we expect to recover.
We also record an allowance for all customers based on certain other factors,
including the length of time the receivables are past due and historical
collection experience with customers. We believe our reported allowances are
adequate. If the financial conditions of those customers were to deteriorate,
however, resulting in their inability to make payments, we may need to record
-21-
additional allowances which would result in additional general and
administrative expenses being recorded for the period in which such
determination was made.
Warranty Reserves:
We accrue the estimated costs to be incurred in performing warranty services at
the time of revenue recognition and shipment of the products to OEMs. Because
there is no contractual right of return other than for defective products or
stock rotation rights by certain distributors, we can reasonably estimate such
returns and record a warranty reserve at the point of shipment. Our estimate of
costs to service our warranty obligations is based on historical experience and
expectation of future conditions. To the extent that we experience increased
warranty claim activity or increased costs associated with servicing those
claims, the warranty accrual will increase, resulting in increased COGS and
decreased gross profit margin.
Inventories:
We are exposed to a number of economic and industry factors that could result in
portions of our inventory becoming either obsolete or in excess of anticipated
usage. These factors include, but are not limited to, technological changes in
our markets, our ability to meet changing customer requirements, competitive
pressures in products and prices and the availability of key components from our
suppliers. Our policy is to establish inventory reserves when conditions exist
that suggest that our inventory may be in excess of anticipated demand or is
obsolete based upon our assumptions about future demand for our products and
market conditions. We regularly evaluate our ability to realize the value of our
inventory based on a combination of factors including the following: historical
usage rates, forecasted sales or usage, product end-of-life dates, estimated
current and future market values and new product introductions. Purchasing
practices and alternative usage avenues are explored within these processes to
mitigate inventory exposure. When recorded, our reserves are intended to reduce
the carrying value of our inventory to its net realizable value. If actual
demand for our products deteriorates, or market conditions are less favorable
than those that we project, additional inventory reserves may be required.
Inventories are stated at the lower of cost, using the first-in, first-out
method, or market value.
Deferred Taxes
We record a valuation allowance to reduce our deferred taxes to the amount that
is more likely than not to be realized. Based on the uncertainty of future
pre-tax income, we have fully reserved our deferred tax assets as of each of
April 30, 2005 and October 31, 2004. In the event that we were to determine that
we would be able to realize our deferred tax assets in the future, an adjustment
to the deferred tax asset would increase income in the period such determination
was made.
-22-
New Accounting Pronouncements
In December 2004, the FASB issued Statement of Financial Accounting S No. 123R,
"Share Based Payments" ("SFAS 123R"), which amends Statement of Financial
Accounting Standard No. 123, "Accounting for Stock-Based Compensation," and
requires public entities (other than those filing as small business issuers) to
report stock-based employee compensation in their financial statements. As
modified in April 2004, we will be required to comply with the provisions of
SFAS 123R as of the first interim period for the fiscal year beginning on or
after June 15, 2005. Thus, we will be required to comply with SFAS 123R
beginning with our quarter ending January 31, 2006. We currently do not record
compensation expense related to our stock-based employee compensation plans in
our financial statements.
RESULTS OF OPERATIONS
The following table sets forth, as a percentage of net sales, our consolidated
statements of operations data for the three and six months ended April 30, 2005
and 2004. These operating results are not necessarily indicative of our
operating results for any future period.
THREE MONTHS ENDED SIX MONTHS ENDED
APRIL 30, APRIL 30,
-------------------- --------------------
2005 2004 2005 2004
-------- -------- -------- --------
Net sales 100% 100% 100% 100%
Cost of sales 63 48 51 46
-------- -------- -------- --------
Gross profit 37 52 49 54
-------- -------- -------- --------
Product research and development 34 18 23 18
Sales and marketing 33 19 25 18
General and administrative 25 13 18 12
Loan benefit -- -- -- (4)
-------- -------- -------- ---------
Total operating expenses 92 50 66 44
-------- -------- -------- --------
Operating income (loss) (55) 2 (17) 10
Interest income -- -- -- --
Income tax benefit -- -- -- --
-------- -------- -------- --------
Net income (loss) (55)% 2% (17)% 10%
========= ======== ========= ========
NET SALES
Net sales for the second quarter of fiscal 2005 were $1.7 million, a 43%
decrease from $3.0 million in the second quarter of fiscal 2004. For the first
six months of fiscal 2005, net sales were $4.5 million, which represented a 24%
decrease over net sales of $5.9 million for the same period in fiscal 2004. This
decrease was primarily attributable to a decline in shipments to HP combined
with a decrease in shipments in our adapter products. This decrease in shipments
was partially offset by an increase in our HighWire business. Sales to HP were
$0 and $1.0 million in the three and six months ended April 30, 2005,
respectively, compared to $1.1 million and $2.5 million for the same periods of
fiscal 2004, respectively. Sales to HP, primarily of VME products, represented
-23-
0% and 23% of total sales for the three and six months ended April 30, 2005 as
compared to 36% and 42% of total sales during the comparable periods in fiscal
2004. We shipped our final order of VME products to HP in the first fiscal
quarter of 2005 and do not expect sales of VME products to HP to be a
substantial portion of our net sales in the future. We may not succeed in
obtaining new orders from existing or new customers sufficient to replace or
exceed the net sales attributable to HP. Data Connection Limited represented 34%
and 22% and Nortel Networks represented 20% and 16% of our net sales for the
three months and six months ended April 30, 2005, respectively. Nortel Networks
was our only customer other than HP that individually accounted for over 10% of
our sales in the three-month period ended April 30, 2004.
Sales of our adapter products were $812,000 and $1.7 million for the three and
six months ended April 30, 2005, respectively, as compared to $1.5 million and
$2.8 million for the same periods in fiscal 2004, respectively. Sales of our
HighWire products were $707,000 and $1.3 million for the three and six months
ended April 30, 2005, respectively, as compared to $323,000 and $476,000 for the
same periods in fiscal 2004, respectively. Our adapter products are used
primarily in edge-of-the-network applications such as Virtual Private Network
("VPN") and other routers, VoIP gateways and security devices. Our HighWire
products are primarily targeted at core-of-the-network applications used
primarily by telecommunications central offices and VoIP providers. The Gigabit
Ethernet and other adapter products we acquired in the Antares acquisition are
used primarily in enterprise applications such as high-end servers and storage
arrays using both Solaris and Linux software. In the next few years, if the
acquisition of PyX is finalized, we expect our net sales will be generated
primarily by sales of our iSCSI storage software products, followed by sales of
our VoIP/HighWire products and our adapter products with Linux software.
Although we expect to see sales growth in our iSCSI products as these products
gain market acceptance, there can be no assurance that such an increase or
adoption will occur. We expect to see continued slowness in the sale of our
adapter products, but are encouraged by the acceptance of our HighWire products
and expect to see continued grow in these high margin products. In addition, we
will continue to sell and support our older VME products, but expect them to
decline significantly as the OEM products in which they are embedded are phased
out.
The communications market continues to be slow in recovering economically and,
due to the continuing economic uncertainty, our customers typically require a
"just-in-time" ordering and delivery cycle where they will place a purchase
order with us after they receive an order from their customer. This
"just-in-time" inventory purchase cycle by our customers has made forecasting of
our future sales volumes very difficult. Because our sales are generally
concentrated among a small group of OEM customers, we could experience
significant fluctuations in our quarterly sales volumes due to fluctuating
demand from any major customer or delay in the rollout of any significant new
product by a major customer.
GROSS MARGIN
Gross margin as a percentage of sales in the second quarter of fiscal 2005 was
37% as compared to 52% for the second quarter of fiscal 2004. For the first six
-24-
months of fiscal 2005, our gross margin was 49% as compared to 54% for the same
period in fiscal 2004. The decrease in the gross margin is due primarily to the
product mix of our sales. In the quarter ended April 30, 2005, we had no sales
to HP as compared to net sales of $1.1 million in the same quarter of fiscal
2004 and in the six months ended April 30, 2005, we had net sales of $1.0
million to HP as compared to $2.5 million in the same period last year. The
gross margin on the HP sales was approximately 70% as compared to the average
gross margin on HighWire and adapter products of mid-50%. We expect our gross
margin to range between 47% and 49% for fiscal 2005. However, if market and
economic conditions, particularly in the telecommunications sector, continue to
deteriorate or fail to recover, our gross margin may be lower than expected.
PRODUCT RESEARCH AND DEVELOPMENT
Product research and development expenses for the three and six month periods
ended April 30, 2005 were $573,000 and $1.1 million, respectively, a slight
increase from $543,000 for each of the comparable three month period in fiscal
2004 and no change from the comparable six month period. The increase resulted
primarily from engineering staffing increases to work on PyX software products.
We remain committed to the development and enhancement of new and existing
products and anticipate increasing our spending over the course of fiscal 2005
to capitalize on new products. We did not capitalize any internal software
development costs in the six month period ended April 30, 2005.
SALES AND MARKETING
Sales and marketing expenses for the three and six month periods ended April 30,
2005 were $567,000 and $1.1 million, respectively, virtually unchanged from
$564,000 and $1.1 million for the same periods in fiscal 2004. We expect our
sales and marketing expenses to increase over the remainder of fiscal 2005 as we
continue to accelerate our product marketing efforts and attend an increasing
number of industry-specific trade shows, especially for the iSCSI and VoIP
products.
GENERAL AND ADMINISTRATIVE
General and administrative expenses for the three and six months periods ended
April 30, 2005 were $426,000 and $795,000, respectively, an increase from
$400,000 and $764,000 for the same periods in fiscal 2004. The increase in our
general and administrative expense was primarily due to our compliance efforts
related to Section 404 of the Sarbanes-Oxley Act of 2002. General and
administrative expenses are expected to remain flat for the remainder of fiscal
2005.
LOAN RESERVE BENEFIT
On November 6, 1998, we made a loan to our former president and chief executive
offer, who retired as of December 31, 2004, which was used by him to exercise an
option to purchase 139,400 shares of our common stock and pay related taxes. The
loan, as amended, was collateralized by shares of our common stock, bore
interest at a rate of 2.48% per annum and was due on December 14, 2003.
-25-
On October 31, 2002, we determined that it was probable that we would be unable
to fully recover the balance of the loan on its due date of December 14, 2003.
Accordingly, a valuation allowance of $474,000 was recorded against the loan at
October 31, 2002.
During the fourth quarter of fiscal 2003, the officer repaid $362,800 of the
loan and, as a result, we recognized a benefit of $235,000 related to the
reversal of the loan impairment charge taken by us in fiscal 2002. During the
first quarter of fiscal 2004, the officer repaid the remaining loan balance in
full and, as a result, we recorded a benefit of $239,000 relating to the
reversal of the remaining loan impairment charge.
NET INCOME (LOSS)
As a result of the factors discussed above, we recorded net losses of $936,000
and $760,000 in the three and six month periods ended April 30, 2005, as
compared to net income of $54,000 and $581,000 for the same periods in fiscal
2004.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any transactions, arrangements, or other relationships with
unconsolidated entities that are reasonably likely to affect our liquidity or
capital resources. We have no special purpose or limited purpose entities that
provide off-balance sheet financing, liquidity, or market or credit risk
support. We also do not engage in leasing, hedging, research and development
services, or other relationships that could expose us to liability that is not
reflected on the face of the financial statements.
LIQUIDITY AND CAPITAL RESOURCES
Our liquidity is dependent on many factors, including sales volume, operating
profit and the efficiency of asset use and turnover. Our future liquidity will
be affected by, among other things:
- actual versus anticipated increase in sales of our products;
- ongoing cost control actions and expenses, including, for example,
research and development and capital expenditures;
- timing of product shipments, which occur primarily during the last
month of the quarter;
- our gross profit margin;
- our ability to raise additional capital, if necessary; and
- our ability to secure credit facilities, if necessary.
At April 30, 2005, we had cash and cash equivalents of $1.2 million, as compared
to $1.8 million at October 31, 2004. In the first six months of fiscal 2005,
$542,000 of cash was used in operating activities, primarily as a result of our
net loss and an increase in our other assets and a decrease in our accrued
liabilities, partially offset by a decrease in inventory and accounts
receivable. The decrease in accounts payable is related to payments to our
contract manufacturers for finished goods inventory received at the end of
October 2004. The decrease in inventory is due to the shipment of VME products
to HP in January 2005 with an inventory cost of approximately $300,000 that was
held as inventory at October 31, 2004. Working capital, comprised of our current
-26-
assets less our current liabilities, at April 30, 2005 was $3.2 million, as
compared to $3.9 million at October 31, 2004.
In the first six months of fiscal 2005, we purchased $70,000 of fixed assets,
consisting primarily of computer and engineering equipment, and $120,000 in
software, primarily for engineering and product design activities and payments
related to the contract to design our VoIP products. Capital expenditures for
each of the remaining quarters of fiscal 2005 are expected to range from $25,000
to $100,000 per quarter.
We received $104,000 in the first six months of fiscal 2005 from payments
related to common stock purchases made by employees pursuant to our employee
stock purchase plan and the exercise of employee stock options.
We have a working capital line of credit with a Bank that has an annual renewal
date of May 14. The credit line is secured by a first lien on all our assets and
carries a floating annual interest rate equal to the bank's prime rate, plus
1.50%. Draw-downs on the credit line are based on a formula equal to 80% of our
domestic accounts receivable. We have not drawn down on this line of credit and
have no amounts payable at April 30, 2005.
Our projected quarterly cash flow break-even point is approximately $3.0 million
to $3.1 million in net sales if gross margin is 47% to 49%. Our projected sales
are to a limited number of new and existing OEM customers and are based on
internal and customer-provided estimates of future demand, not firm customer
orders. If our projected sales do not materialize, we may need to reduce
expenses and raise additional capital through customer prepayments or the
issuance of debt or equity securities. If additional funds are raised through
the issuance of preferred stock or debt, these securities could have rights,
privileges or preferences senior to those of common stock, and debt covenants
could impose restrictions on our operations. The sale of equity or debt could
result in additional dilution to current stockholders, and such financing may
not be available to us on acceptable terms, if at all.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our cash and cash equivalents are subject to interest rate risk. We invest
primarily on a short-term basis, maturity of less than three months. Our
financial instrument holdings at April 30, 2005 were analyzed to determine their
sensitivity to interest rate changes. The fair values of these instruments were
determined by net present values. In our sensitivity analysis, the same change
in interest rate was used for all maturities and all other factors were held
constant. If interest rates increased by 10%, the expected effect on net income
related to our financial instruments would be immaterial. We hold no assets or
liabilities denominated in a foreign currency. Since October 31, 2004, there has
been no change in our exposure to market risk.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
-27-
An evaluation as of April 30, 2005 was carried out under the
supervision of and with the participation of the Company's management, including
the Company's Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of the Company's "disclosure controls
and procedures," which are defined under Securities and Exchange Commission
rules as controls and other procedures of a company that are designed to ensure
that information required to be disclosed by a company in the reports that it
files under the Securities Exchange Act of 1934 (the "Exchange Act") is
recorded, processed, summarized and reported within required time periods. Based
upon that evaluation, the Company's Chief Executive Officer and Chief Financial
Officer concluded that the Company's disclosure controls and procedures were
effective.
(b) Changes in Internal Controls over Financial Reporting
The Company's management, including the Company's Chief Executive
Officer and Chief Financial Officer, has evaluated any changes in the company's
internal control over financial reporting that occurred during the quarter ended
April 30, 2005, and has concluded that there was no change during such quarter
that has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The annual meeting of stockholders was held on Tuesday, March 22, 2005, at
our corporate offices located at 2305 Camino Ramon, Suite 200, San Ramon,
California.
The stockholders approved the following two items:
(i) The election of two directors to hold office until the 2008 Annual
Meeting of Stockholders:
For Withhold
--------- --------
Ronald Ritchie 4,995,934 4,843
Daniel Grey 4,995,405 5,372
(ii) The ratification of the selection of BDO Seidman LLP as our
independent auditors for the fiscal year ending October 31, 2005.
For Against Abstain
--------- ------- -------
4,996,990 1,767 2,020
-28-
ITEM 6. EXHIBITS
Exhibit
Number Description
- ------- -----------
2.1(1) Asset Purchase Agreement dated August 8, 2003, by and between D.R.
Barthol & Company and SBE, Inc.
3.1(2) Certificate of Incorporation, as amended through December 15, 1997.
3.2(3) Bylaws, as amended through December 8, 1998.
10.1(4)* 1996 Stock Option Plan, as amended.
10.2(4)* 1991 Non-Employee Directors' Stock Option Plan, as amended.
10.3(4) 1992 Employee Stock Purchase Plan, as amended.
10.4(4) 1998 Non-Officer Stock Option Plan as amended.
10.5(5) Lease for 4550 Norris Canyon Road, San Ramon, California dated
November 2, 1992 between the Company and PacTel Properties.
10.6(6) Amendment dated June 6, 1995 to lease for 4550 Norris Canyon Road,
San Ramon, California, between the Company and CalProp L.P.
(assignee of PacTel Properties).
10.7(4)* Full Recourse Promissory Note executed by William B. Heye, Jr. in
favor of the Company dated November 6, 1998, as amended and restated
on December 14, 2001.
10.8(4)+ Letter Agreement, dated October 30, 2001, amending (i) Amendment No.
S/M 018-4 dated April 3, 2001, and (ii) Purchase Agreement dated May
6, 1991, each between SBE, Inc. and Compaq Computer Corporation
10.9(7) Stock subscription agreement and warrant to purchase111,111 of SBE,
Inc. Common Stock dated April 30, 2002 between SBE, Inc. and
Stonestreet Limited Partnership.
10.10(8) Amendment dated August 22, 2002 to stock subscription agreement
dated April 20, 2002 between SBE, Inc. and Stonestreet LP.
10.11(9) Securities Purchase Agreement, dated July 27, 2003, between SBE,
Inc. and purchasers of SBE's common stock thereunder, including form
of warrant issued thereunder
10.12(9) Form of warrant issued to associates of Puglisi & Co. ($1.50
exercise price)
10.13(9) Form of warrant issued to associates of Puglisi & Co. ($1.75 and
$2.00 exercise price)
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
-29-
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
* Indicates management contract or compensation plans or arrangements
filed pursuant to Item 601(b)(10) of Regulation SK.
+ Certain confidential information has been deleted from this exhibit
pursuant to a confidential treatment order that has been granted.
(1) Filed as an exhibit to Current Report on Form 8-K, dated April 30,
2002 and incorporated herein by reference.
(2) Filed as an exhibit to Annual Report on Form 10-K for the year ended
October 31, 1997 and incorporated herein by reference.
(3) Filed as an exhibit to Annual Report on Form 10-K for the year ended
October 31, 1998 and incorporated herein by reference.
(4) Filed as an exhibit to Annual Report on Form 10-K for the year ended
October 31, 2002 and incorporated herein by reference.
(5) Filed as an exhibit to Annual Report on Form 10-K for the year ended
October 31, 1993 and incorporated herein by reference.
(6) Filed as an exhibit to Annual Report on Form 10-K for the year ended
October 31, 1995 and incorporated herein by reference.
(7) Filed as an exhibit to Registration Statement on Form S-3 dated May
23, 2002 and incorporated herein by reference.
(8) Filed as an exhibit to Quarterly Report on Form 10-Q for the quarter
ended July 31, 2002 and incorporated herein by reference.
(9) Filed as an exhibit to Registration Statement on Form S-3 dated July
11, 2003 and incorporated herein by reference.
-30-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized, on June 2, 2005.
SBE, INC.
Registrant
Date: June 2, 2005 By: /s/ Daniel Grey
------------------
Daniel Grey
Chief Executive Officer and
President
(Principal Executive Officer)
Date: June 2, 2005 By: /s/ David W. Brunton
-----------------------------------
David W. Brunton
Chief Financial Officer,
Vice President, Finance
and Secretary
(Principal Financial and
Accounting Officer)
-31-