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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER 1-16027
LANTRONIX, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0362767
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
15353 BARRANCA PARKWAY, IRVINE, CALIFORNIA 92618
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(949) 453-3990
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
COMMON STOCK, $0.0001 PAR VALUE THE NASDAQ SMALLCAP MARKET
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes [ ] No [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
last sold, or the average bid and asked price of such common equity, as of the
last business day of the registrant's most recently completed fiscal year (June
30, 2003), was $18,260,000. Shares of common stock held by each executive
officer, director and each person who beneficially owns 5% or more of the
outstanding common stock have been excluded because such persons may, under
certain circumstances, be deemed to be affiliates. The determination of
affiliate or executive officer status is not necessarily conclusive for other
purposes.
As of August 31, 2003, there were 55,657,903 shares of the Registrant's common
stock outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the Lantronix, Inc. Annual
Meeting of Stockholders scheduled to be held on November 20, 2003 are
incorporated by reference into Part II and Part III of this Form 10-K.
Certain exhibits filed in connection with the Lantronix, Inc. Registration
Statement on Form S-1, originally filed May 19, 2000, and Registration Statement
on Form S-1, originally filed June 13, 2001, are incorporated by reference into
Part IV of this Form 10-K.
LANTRONIX, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED JUNE 30, 2003
TABLE OF CONTENTS
PAGE
----
PART I
ITEM 1. Business 4
ITEM 2. Properties 11
ITEM 3. Legal Proceedings 11
ITEM 4. Submission of Matters to a Vote of Security Holders 13
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters 14
ITEM 6. Selected Consolidated Financial Data 15
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 16
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk 40
ITEM 8. Financial Statements and Supplementary Data 40
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 40
ITEM 9A Controls and Procedures
PART III
ITEM 10. Directors and Executive Officers of the Registrant 41
ITEM 11. Executive Compensation 41
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 41
ITEM 13. Certain Relationships and Related Transactions 41
ITEM 15. Principal Accountant Fees and Services 41
PART IV
ITEM 16. Exhibits, Financial Statements, Schedules and Reports on Form 8-K 42
Officer Certifications II-3
2
FORWARD-LOOKING STATEMENTS
THIS DOCUMENT CONTAINS STATEMENTS THAT ARE NOT HISTORICAL FACTS BUT ARE
FORWARD-LOOKING STATEMENTS RELATING TO SUCH MATTERS AS ANTICIPATED FINANCIAL
PERFORMANCE, BUSINESS PROSPECTS, TECHNOLOGICAL DEVELOPMENTS, NEW PRODUCTS,
ENGINEERING AND DEVELOPMENT ACTIVITIES AND SIMILAR MATTERS. SUCH STATEMENTS ARE
GENERALLY IDENTIFIED BY THE USE OF FORWARD-LOOKING WORDS AND PHRASES, SUCH AS
"INTENDED," "EXPECTS," "ANTICIPATES" AND "IS (OR ARE) EXPECTED (OR
ANTICIPATED)." THESE FORWARD-LOOKING STATEMENTS INCLUDE BUT ARE NOT LIMITED TO
STATEMENTS CONCERNING INDUSTRY TRENDS, ANTICIPATED DEMAND FOR OUR PRODUCTS, THE
IMPACT OF PENDING LITIGATION, OUR STRATEGY, THE FUTURE BENEFITS OF OUR
ACQUISITIONS, INCLUDING THE BENEFITS OF USING THE TECHNOLOGY DEVELOPED BY THE
COMPANIES WE ACQUIRE IN OUR EXISTING PRODUCT LINE AND THE POSSIBLE SALES OF OUR
PRODUCTS TO THE ACQUIRED COMPANIES' EXISTING CUSTOMERS, THE POSSIBILITY OF
FUTURE INVESTMENTS OR ACQUISITIONS, FUTURE CUSTOMER AND SALES DEVELOPMENTS,
MANUFACTURING FORECASTS, INCLUDING THE POTENTIAL BENEFITS OF OUR CONTRACT
MANUFACTURERS SOURCING AND SUPPLYING RAW MATERIALS, COMPONENTS AND INTEGRATED
CIRCUITS, THE POSSIBILITY OF AN EXPANDING ROLE FOR ORIGINAL EQUIPMENT
MANUFACTURERS IN OUR BUSINESS, THE FUTURE COST AND POTENTIAL BENEFITS OF OUR
RESEARCH AND DEVELOPMENT EFFORTS, AND LIQUIDITY AND CASH RESOURCES FORECASTS.
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE DISCUSSED IN SUCH
FORWARD-LOOKING STATEMENTS, AND OUR STOCKHOLDERS SHOULD CAREFULLY REVIEW THE
CAUTIONARY STATEMENTS SET FORTH IN THIS FORM 10-K, INCLUDING FACTORS THAT MAY
AFFECT FUTURE RESULTS. WE MAY FROM TIME TO TIME MAKE ADDITIONAL WRITTEN AND ORAL
FORWARD-LOOKING STATEMENTS, INCLUDING STATEMENTS CONTAINED IN OUR FILINGS WITH
THE SECURITIES AND EXCHANGE COMMISSION AND IN OUR REPORTS TO STOCKHOLDERS. WE DO
NOT UNDERTAKE TO UPDATE ANY FORWARD-LOOKING STATEMENTS THAT MAY BE MADE FROM
TIME TO TIME BY US OR ON OUR BEHALF.
3
PART I
ITEM 1. BUSINESS
OVERVIEW
Lantronix, Inc. ("Lantronix" or "we" or "us") designs, develops and markets
devices and software solutions that make it possible to access, manage, control
and configure almost any electronic product over the Internet or other networks.
We are a leader in providing innovative networking solutions. We were initially
formed as "Lantronix," a California corporation, in June 1989. We reincorporated
as "Lantronix, Inc.," a Delaware corporation in May 2000.
We have a history of providing devices that enable information technology
("IT") equipment to network using standard protocols for connectivity, including
fiber optic, Ethernet and wireless. Our first device was a terminal server that
allowed "dumb" terminals to connect to a network. Building on the success of our
terminal servers, we introduced a complete line of print servers in 1991 that
enabled users to inexpensively share printers over a network. Over the years, we
have continually refined our core technology and have developed additional
innovative networking solutions that expand upon the business of providing our
customers network connectivity. With the expansion of networking and the
Internet, our technology focus is increasingly broader, so that our device
solutions provide a product manufacturer with the ability to network their
products within the industrial, service and consumer markets.
We provide three broad categories of products: "device networking
solutions," that enable almost any electronic product to be connected to a
network; IT management solutions," that enable multiple pieces of hardware,
usually IT-related network hardware such as servers, routers, switches, and
similar pieces of equipment to be managed over a network; and software that is
either embedded in the hardware devices that are mentioned above, or stand-alone
application software.
Today, our solutions include fully integrated hardware and software
devices, as well as software tools to develop related customer applications.
Because we deal with network connectivity, we provide hardware solutions to
extremely broad market segments, including industrial, medical, commercial,
financial, governmental, retail, building and home automation, and many more.
Our technology is used with products such as networking routers, medical
instruments, manufacturing equipment, bar code scanners, building HVAC systems,
elevators, process control equipment, vending machines, thermostats, security
cameras, temperature sensors, card readers, point of sale terminals, time
clocks, and virtually any product that has some form of standard data control
capability. Our current offerings include a wide range of hardware devices of
varying size, packaging and, where appropriate, software solutions that allow
our customers to network-enable virtually any electronic product.
We sell our devices through a global network of distributors, systems
integrators, value-added resellers (VARs), manufacturers' representatives and
original equipment manufacturers (OEMs). In addition, we sell directly to
selected accounts.
Our common stock is currently traded on The Nasdaq SmallCap Market under
the symbol LTRX.
Our worldwide headquarters are located in Irvine, California and we have
offices throughout the U.S. and worldwide, including Redmond, Washington;
Milford, Connecticut; Switzerland; Germany; France; Hong Kong and Japan. We also
have employees working from home offices in other areas of the world including
the UK and Netherlands. During fiscal 2003, we closed or administratively
dissolved the following subsidiaries, integrating their operations into our
operations: Premise Systems, Inc., ("Premise"), Synergetic Micro systems, Inc.,
("Synergetic") and United States Software Corporation ("USSC"). Operations from
our Switzerland facility will cease in October 2003, and thereafter, operations
will be managed from our Irvine, California facility.
OUR STRATEGY
Our business strategy is based on our proven capability to develop fully
integrated networking solutions that increase the value of our customers'
products by making it easy to take advantage of features that can be made
available when these products are network-enabled. This strategy is accomplished
by providing our customers with hardware and software that connects products and
systems to a network, and intelligently manages and controls them. Through our
14 years of networking expertise, knowledge of industry trends, and our
capability to develop solutions based on open industry standards, we have been
able to anticipate our customers' networking technology requirements and offer
solutions that enable them to achieve their connectivity objectives. By
providing a complete solution of hardware and integrated software, we have been
able to provide "turnkey" solutions, eliminating the need for our customers to
build expensive design and manufacturing expertise in-house. This results in
savings to the customer both in terms of financial investment, and in time.
Our fully integrated hardware, software, and application development tools
have enabled us to become a technology and industry leader. While our solutions
could address practically any application, we have focused on the following key
areas:
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- - Device Networking Solutions - We offer an array of embedded and external
device networking solutions that enable manufacturers of electronic and
electro-mechanical products to add network connectivity, manageability, and
control to their products. Our customers' products originate from a wide
variety of applications, such as blood analyzers that relay critical
patient information directly to a hospital's information system, to simple
devices such as timeclocks or audio/visual equipment, to improve how these
products are managed and controlled.
- - IT Management Solutions - We offer off-the-shelf equipment that enables IT
professionals to remotely manage network infrastructure equipment and large
groups of servers. Our terminal and console management systems solutions
provide a comprehensive solution for the command and control of today's
network infrastructure.
- - Residential/Building Automation - Our home and building management
solutions link security, lighting, air conditioning and other systems
together by providing the necessary tools to more efficiently manage an
entire home or building. Our solutions include an entire software platform
that is the basis for much more extensive command and control systems. This
software is currently being adapted specifically to the PC market, to
provide management of music and other media within the home environment.
- - Visualization Solutions - We offer solutions that provide switching and
extension of high performance video, audio, keyboard and mouse over long
distances within a building or campus environment. The customers for these
devices are typically companies needing to isolate users from the core
computing center for security reasons, or have other needs requiring high
speed video sources to be shared among many users. Our visualization
solutions can be found in government agencies and at customers involved
with large scale simulation and display applications.
RECENT ACQUISITIONS AND INVESTMENTS
We have completed a number of acquisitions and investments since our
initial public offering in August 2000, the purpose of which is to expand our
product offerings, increase our technology base and provide a foundation for
future growth. In December 2000, we completed the acquisition of USSC, a
developer of software operating systems, protocol stacks and an application
development environment for embedded technology.
In June 2001, we completed the acquisition of Lightwave Communications,
Inc., ("Lightwave"), a developer of console management products, visualization
(video extension and matrix switches), and keyboard, video and mouse ("KVM")
switches.
In October 2001, we completed the acquisition of Synergetic, a provider of
embedded network communication solutions that complement our device server
products.
In January 2002, we completed the acquisition of Premise, a developer of
client-side software applications that complement our device networking products
by providing management and control capabilities for devices that have been
network and Internet enabled.
In January 2002, we acquired a minority interest in Xanboo Inc. ("Xanboo")
through a cash investment. Xanboo, a privately-held company, develops technology
that allows users to control, command and view their home or business remotely
over the Internet.
In August 2002, we completed the acquisition of Stallion Technologies PTY,
LTD ("Stallion"), an Australian company that provides terminal servers and
multiport board-level products. Stallion products are complementary to our
existing product line.
With the exception of Xanboo, which is a minority investment, these
acquisitions have been integrated into our general product offerings and
operations.
PRODUCTS
DEVICE NETWORKING SOLUTIONS
We provide manufacturers, integrators, and users with complete device
networking solutions that include the technology required for products to be
connected, managed and controlled over networks using standard protocols for
connectivity, including fiber optic, Ethernet and wireless. As common, everyday
products such as lighting, security and audio/visual systems leverage the power
of network connectivity, manufacturers and users are realizing the benefits of
networking. Our device networking solutions dramatically shorten a
manufacturer's development time to implement network connectivity, significantly
5
speed time-to-market with competitive advantages of new features, and greatly
reduce engineering and marketing risks. Our hardware solutions include
integrated circuits (ICs), embedded modules (completed boards or intelligent
connectors with electronic components and the necessary connectors and software
that is mounted within a customer's product), and external hardware modules
(with single, multi- or wireless ports), as well as the related real-time
operating system and application software that is required to make the devices
effective. We also offer application- and industry-specific solutions such as
industrial device servers, network time servers and print servers.
Our device servers allow a wide range of equipment to be quickly
network-enabled without the need for intermediary gateways, workstations, or
PCs. This distributed computing approach significantly improves the reliability
and up-time of the network. Our device servers also eliminate the high cost of
ownership associated with PCs and workstations needed when device server
technology is not used. Our device servers contain high-performance processors
capable of not only controlling the attached device, but are also capable of
accumulating data and status. Such data can then be formatted by the device
server and presented to users via the built in web server, SNMP, e-mail, etc.
Device servers are easy to manage using any standard Web browser, due to a
built-in HTTP server and powerful Java technology.
In February 2003, we announced the release of our XPort device server,
which represents a significant improvement in technology, and a reduction in
physical size and price for this type of functionality. The thumb-sized XPort is
a self-contained network communications server and miniaturized web site
enclosed within a rugged RJ-45 connector package, which can be embedded in
virtually any electronic product. Products incorporating XPort have their own
address on the World Wide Web and can be accessed from any web browser,
including a wireless PC or Internet-enabled cell phone, from anywhere in the
world. The XPort can serve up Internet-standard web pages, initiate e-mails for
notifications or alerts, and run other applications as defined by the product
manufacturer. XPort eliminates the complexity for a product manufacturer to
create network connectivity, because the XPort device includes a complete,
integrated solution with a 10Base-T / 100Base-TX Ethernet connection, a reliable
and proven operating system, an embedded web server, flexible firmware, a full
TCP/IP protocol stack, and optional 256-bit standards-based (AES) encryption. We
believe the relatively low price of the XPort, as well as the speed and ease
with which a manufacturer can design the device into their products, will make a
customer's products more attractive, by providing network connectivity.
IT MANAGEMENT SOLUTIONS
Our IT management solutions provide IT professionals with the tools they
need to remotely manage computer network hardware and software systems. Our
terminal servers provide simple and cost-effective network connectivity.
IT professionals use our multiport device solutions (including our terminal
and console servers) to monitor and run their systems to assure the performance
and availability of critical business information systems, network
infrastructure, and telecommunications equipment. The equipment they manage
includes routers, switches, servers, phone switches and public branch exchanges
(PBXs) that are often located in remote or inaccessible locations.
Our console servers provide system administrators and network managers a
way to connect with their remote equipment through a universal interface called
a console port, helping them work more efficiently without having to leave their
desk or office. With remote access, system downtime, and its impact on business,
is minimized. Our console servers provide IT professionals with peace-of-mind
through extensive security features and provisions for dial-in access via modem
("out of band" connectivity) in case the network is not available. These
solutions are provided in various configurations, and can manage up to 48
devices from one console server.
PRINT SERVERS AND OTHER LEGACY PRODUCTS
We began our business by providing external print servers that connect
various printers to a network for shared printing tasks. Over the years, we have
updated and continue to provide print servers that work with a myriad of
operating systems and network configurations. The requirement for external print
servers is decreasing, as manufacturers have incorporated the networking
hardware and software as part of many printers.
We also design and manufacture visualization products including video
display extenders ("VDE") and FiberLynx (video display extenders), KVM switches,
KVM extension systems and matrix hubs. These products provide a valuable
solution for extending and sharing audio, video, keyboard and mouse signals
among many users and over large distances without loss of resolution. KVM
products enable a single keyboard, monitor and mouse to be switched between
multiple computers, providing immediate access and control from a single
location.
6
SOFTWARE APPLICATION SOLUTIONS
We produce software application solutions targeted at the residential and
building automation markets. These markets are emerging and fragmented, with
numerous providers and a wide range of products and services. Our current
product offering, Premise SYS software, is a PC-based system that controls items
such as audio, video, home theater systems, lighting, motorized drapes, heating
and air conditioning units, closed circuit cameras, security systems, and other
home electronic equipment. Premise SYS can be used to manage and play digital
media. Although this is an emerging market and we have not realized significant
revenues for this software through June 30, 2003, our solution has received
significant recognition in its marketplace. Currently, our software is being
adapted for use in PCs being offered by various manufacturers.
The following are approximate revenues for these categories, the
definitions of which have been modified slightly as of June 30, 2003, and
previous years' data has been modified to conform to the new definitions:
NET REVENUES FOR THE YEARS ENDED JUNE 30,
--------------------------------
PRODUCT FAMILY PRIMARY PRODUCT FUNCTION 2003 2002 2001
- ---------------------------------------- ---------------------------------- ----- ------ -----
Enable almost any electronic
Device networking solutions. . . . . . . product to become network
(including software) . . . . . . . . . . enabled. $26.8 $30.0 $34.3
Allow the user to control equipment
by way of the Internet using a wide
IT management solutions. . . . . . . . . range of network protocols. This
(including software) . . . . . . . . . . category includes console servers. $13.2 $16.5 $14.0
Allow the user to share network
printers. This category also includes
visualization and KVM products, as
well as software and Miscellaneous
Print server and others . . . . . . . older products. $ 9.5 $11.1 $ 4.7
Financial Accounting Standards Board ("FASB") Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information,"
establishes standards for disclosures about operating segments in annual
consolidated financial statements. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
We operate in one segment, networking and Internet connectivity.
CUSTOMERS
Distributors
Our principal customers are our distributors, who are the source of our
highest percentage of net revenues. Distributors resell our products to a wide
variety of customers including consumers, corporate customers, VARs, etc. We
sell to a group of eight major distributors, who operate, in some cases, from
multiple warehouses. Our major distributors in the U.S. include: Ingram Micro,
Tech Data, KMJ Communications and Arrow Electronics, Inc. In Europe, we
distribute directly from a public warehouse located in Belgium which services,
in part, the following major distributors: transtec AG (a related party due to
common ownership by our largest shareholder), Atlantik Systems GmbH, Astradis
Elecktronik GmbH and Lightwave Communications GmbH (not affiliated with
Lantronix).
OEM Manufacturers
We have established a broad range of OEM electro-mechanical manufacturing
customers in various industries such as industrial automation, medical,
security, building automation, consumer and audio/visual. Our OEM customers
typically lack the expertise or resources to develop hardware and software
required to introduce network solutions to their end users in a timely manner.
To shorten the development cycle to add network connectivity to a product, OEMs
can use our external devices to network-enable their installed base of products,
while board-level solutions, chips and embedded software are typically used in
new product designs. Our capabilities and hardware and software solutions enable
OEMs to focus on their core competencies, resulting in reduced research and
development costs, fewer integration problems, and faster time to market.
Our new product Xport, is particularly useful and adaptable by OEM
customers to enable network connectivity to a wide variety of electro-mechanical
products. In addition to the features it provides, the advantage is low cost,
and the fact that the device can be adapted for use in a wide range of products
without the necessity for lengthy engineering processes by the OEM, or the time
delays that activity might introduce.
7
End User Businesses
We have established a broad range of end user customers in various
businesses such as airports, retail, universities/education, manufacturing,
healthcare/hospitals and financial/banking. End user businesses require
solutions that are simple to install, setup, and operate, and can provide
immediate results. Generally, these customers have requirements to connect a
diverse range of products and equipment, without modifying existing software and
systems.
Our external device solutions enable end users to quickly, securely and
easily connect their devices and equipment to networks, extending the life of
existing investments. In support of these customers, we provide a number of
programs including telephone-based sales and technical support as well as a wide
array of Internet-based resources. We maintain a field sales force and network
of VARs and system integrators throughout the world to call on IT departments
and decision-makers within the end user accounts. In many cases, the customer
simply has to call in to obtain assistance in identifying which networking
device would be most appropriate for its need. After buying the devices from us
or one of our distributors, a customer often only has to plug a cable from the
device to be managed to our external device, and then plug our device into their
network.
Consumer Market
We have made a preliminary entry into the consumer networking market. The
networking of consumer products and services will impact the value of broadband
and entertainment services delivered to the home, as well as create demand for
newly emerging classes of computer, networking, and consumer electronics
products.
We believe the consumer networking market will develop very differently
from the enterprise local area network market. We believe the home network will
evolve steadily to encompass entertainment, communications, security,
convenience and control applications. We expect the key applications driving
consumer networking adoption will include PCs, integrated controllers, gateways,
distribution of digital music and video, IP-based telephony, security and the
automation of home appliances. In support of these customer and home integrator
needs, we offer embedded devices and our Premise SYS software.
SALES AND MARKETING
We maintain both an inside and a field sales force. We are also represented
by manufacturers' representatives and VARs throughout the world who call on
engineering design and product management teams. We develop marketing programs,
products, tools and services specifically geared to meet the needs of our
targeted customers. Our sales and marketing force consisted of 83 employees as
of June 30, 2003 and 89 employees as of June 30, 2002.
We believe that our direct distribution and multi-channel approach provides
several advantages. We can engage the customers and end users through their
channel of choice, making our solution available from a variety of sources.
Our device networking solutions are principally sold direct to
manufacturers by our worldwide OEM sales force and through our group of
manufacturers' representatives. We have expanded our use of manufacturers'
representatives and VARs in the past year, leveraging their established
relationships to bring our device networking solutions to a greater number of
customers within the OEM market.
We market and sell our IT management solutions, application software and
select external device networking solutions through information technology
resellers, industry-specific system integrators, VARs and directly to end user
organizations. Resellers and integrators will often obtain our products through
distributors such as Ingram Micro, Tech Data and Atlantik Systems GmbH. These
distributors supply our products to a broad range of VARs, system integrators,
direct marketers, government resellers and e-commerce resellers. In turn, these
distributor customers market, sell, install, and in most cases, support our
solution to the end users. We are continuing to expand our use of
cost-effective, indirect channels for basic offerings and will focus our direct
end user sales force for our more advanced technologies and solution selling.
Net revenues generated from sales in the Americas, Europe and other
geographic areas including Asia and Japan for the year ended June 30, 2003 were
$37.5 million, $10.4 million and $1.6 million, respectively, compared to $47.7
million, $8.2 million and $1.7 million for year ended June 30, 2002,
respectively.
8
MANUFACTURING
Our manufacturing strategy is to produce reliable, high quality products at
competitive prices and to achieve on-time delivery to our customers. To achieve
this strategy, we generally contract with others for the manufacturing of our
products. This practice enables us to concentrate our resources on design,
engineering and marketing where we believe we have greater competitive
advantages.
We have agreements with multiple contract manufacturers. Our contract
manufacturers are located in and around Irvine, California; Sacramento,
California; Durham, Connecticut; and Dongguan, China. Under these agreements,
the manufacturers source and supply most raw materials, components and
integrated circuits in accordance with our pre-determined specifications and
forecasts, and perform final assembly, functional testing and quality control.
We believe that this arrangement decreases our working capital requirements and
provides better raw material and component pricing, enhancing our gross and
operating margins. Please see "Risk Factors" for a discussion of the risks
associated with contract manufacturing.
RESEARCH AND DEVELOPMENT
Our research and development efforts are focused on the development of
technology and products that will enhance our position in our markets. Products
are developed in-house and through outside research and development resources.
We employed 47 employees in our research and development organization as of June
30, 2003, and 67 employees as of June 30, 2002. Our research and development
expenses were $10.4 million, $9.2 million (excluding $1.0 million of acquired
in-process research and development) and $4.5 million (excluding $2.6 million of
acquired in-process research and development) for the years ended June 30, 2003,
2002 and 2001, respectively.
INDUSTRY PARTNERS
In keeping with our business strategy, we have engaged a portfolio of
partners, consortia, and standards committees in an effort to provide the most
complete networking solutions to our customers. We are an active member of many
leading professional and industry associations. Membership in these associations
provides us with a voice in the development of future standards that are vital
to our customers. Industry associations also provide much needed standardization
in specific technology areas and ensure that customers benefit from
interoperable products regardless of vendor. To enhance our software products,
for example, we embrace open standards-based systems, and participate in the
development of these standards.
SOFTWARE DEVELOPER RELATIONS
Recruiting and informing third-party software developers is an integral
part of our ongoing strategy. We encourage, enable, and support programmers to
develop vertical applications using our hardware, firmware and software
products. With their help and investment in creating additional applications and
markets for our products, we secure a defensible market position and loyal
customers in the process.
COMPETITION
The markets in which we compete are dynamic and highly competitive. We
expect competition to intensify in the future. Our current and potential
competitors include the following:
- - companies with network-enabling technologies, such as Avocent, Echelon,
Moxa, Digi International, Cyclades, Quatech, Wind River, Rabbit and Zilog;
- - companies with equipment for IT management solutions, such as Cyclades,
Moxa, Digi International, Sena, Logical Solutions, Cisco and Perle;
- - companies with significant networking expertise and research and
development resources, including Cisco Systems, IBM and Lucent
Technologies.
The principal competitive factors that affect the market for our products
are:
- - product quality, technological innovation, compatibility with standards and
protocols, reliability, functionality, ease of use, and compatibility;
- - prices of the products; and
- - potential customers' awareness and perception of our products and of
network-enabling technologies.
9
Much of our technology can be reproduced by our competitors without
royalties or license fees and could compete with our offerings. In addition,
there is a risk that our customers or new entrants to the market could develop
and market their own solutions without paying a fee to us.
INTELLECTUAL PROPERTY RIGHTS
We have developed proprietary methodologies, tools, processes and software
in connection with delivering our services. We have not historically relied on
patents to protect our proprietary rights, although we have recently begun to
build a patent portfolio. We have historically relied on a combination of
copyright, trademark, trade secret laws, and contractual restrictions, such as
confidentiality agreements and licenses to establish and protect our proprietary
rights. As of June 30, 2003, we owned four United States patents and one patent
issued in Germany.
Trade secret and copyright laws afford us only limited protection. We
cannot be certain that the steps we have taken in this regard will be adequate
to deter misappropriation of our proprietary information or that we will be able
to detect unauthorized use and take appropriate steps to enforce our
intellectual property rights. An adverse change in the laws protecting
intellectual property could harm our business. In addition, we believe that our
success will depend principally upon continuing innovation, technical expertise,
knowledge of networking, storage and applications, and to a lesser extent, on
our ability to protect our proprietary technology. Furthermore, there can be no
assurance that our current or future competitors will not develop technologies
that are substantially equivalent to ours.
In July 2001, Digi International, Inc. ("Digi") filed a lawsuit against us
alleging that our multiport device servers, specifically our ETS line of
products, when coupled with our Comm Port Redirector software, infringe a patent
held by Digi. In November 2002, this and related lawsuits were settled.
In March 2003, we filed a lawsuit against Logical Solutions, Inc.
("Logical"). This company was founded principally by former owners of Lightwave
Communications, Inc., a company we purchased in June 2001. In this lawsuit, we
allege that Logical has failed to honor covenants not to compete that had been
signed by its principals, and Logical has illegally used intellectual property,
trade secrets, and proprietary information to further its business. The
litigation seeks a permanent injunction and damages. Please see "ITEM 3. Legal
Proceedings," for a discussion of this litigation.
LIMITATIONS ON OUR RIGHTS TO INTELLECTUAL PROPERTY
Gordian, Inc. ("Gordian") has developed certain intellectual property used
in our micro serial server line of products. These products represented and
continue to represent a significant portion of our net revenues. Under the terms
of an agreement dated February 29, 1989, Gordian owned the rights to the
intellectual property developed under the agreement and required us to pay
royalties based upon gross margin of products sold under the agreement. For the
years ended June 30, 2002 and 2001, we paid Gordian approximately $1.2 million
and $2.2 million for royalties, respectively. No royalties were paid to Gordian
for the year ended June 30, 2003 as a result of a new Gordian agreement as
described below. Our agreement with Gordian was to terminate at the end of the
sales life of the products.
On May 30, 2002, we signed a new intellectual property agreement with
Gordian. The new agreement gives us joint ownership of the Gordian intellectual
property that is embodied in the products Gordian has designed for us since
1989. This new agreement provides that we will be able to use the intellectual
property to support, maintain and enhance our products. This new agreement
extinguishes our obligations to pay royalties for each unit of a
Gordian-designed product that we sell as of the effective date.
As part of the new agreement, we paid Gordian $6.0 million in three
installments. We paid $3.0 million concurrent with the signing of the new
agreement, $2.0 million on July 1, 2002, and we made the third and final payment
of $1.0 million on July 1, 2003. We also agreed to purchase $1.5 million of
engineering and support services from Gordian over the 18-month period ending
November 2003. We are amortizing the intellectual property rights acquired by
this new agreement over the remaining life cycles of our products designed by
Gordian, or approximately three years. We recorded $2.5 million and $212,000 of
amortization expense in cost of revenues for the years ended June 30, 2003 and
2002, respectively.
UNITED STATES AND FOREIGN GOVERNMENT REGULATION
Many of our products and the industries in which they are used are subject
to federal, state or local regulation in the United States. In addition, our
products are exported worldwide. Therefore, we are subject to the regulation of
foreign governments. For example, wireless communication is highly regulated in
both the United States and elsewhere. Our products currently employ encryption
technology; the export of some encryption software is restricted. We do not know
whether these or other existing or future laws or regulations will adversely
affect us.
10
EMPLOYEES
As of June 30, 2003, we had 181 full-time employees consisting of 47
employees in research and development, 83 in sales and marketing departments, 17
in operations departments, and 34 general and administrative employees. We have
not experienced any work stoppages and we believe that our relationship with our
employees is good. None of our employees are currently represented by a labor
union.
BACKLOG
In many cases, we manufacture our products in advance of receiving firm
product orders from our customers based upon our forecasts of worldwide customer
demand. Generally, orders are placed by the customer on an as-needed basis and
may be canceled or rescheduled by the customer without significant penalty.
Accordingly, backlog as of any particular date is not necessarily indicative of
our future sales. As of June 30, 2003 and June 30, 2002, we had backlog of
approximately $2.3 million and $1.3 million, respectively. We do not have
backlog orders that cannot be filled within the next fiscal year.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table lists the names, ages and positions held by all our
executive officers as of September 29, 2003. There are no family relationships
between any director or executive officer and any other director or executive
officer of Lantronix. Executive officers serve at the discretion of the Board of
Directors.
NAME AGE POSITION
- --------------------- --- ---------------------------------------
Marc H. Nussbaum 47 President and Chief Executive Officer
James W. Kerrigan 67 Chief Financial Officer
Michael Oswald 48 General Counsel and Secretary
MARC H. NUSSBAUM has served as our President and Chief Executive Officer
since May 2002 (on an Interim basis until February 2003). From April 2000 to
March 2002, Mr. Nussbaum served as Senior Vice President and Chief Technical
Officer for MTI Technology Corporation, a developer of enterprise storage
solutions. From April 1981 to November 1998, Mr. Nussbaum served in various
positions at Western Digital Corporation, a manufacturer of PC components,
communication controllers, storage controllers and hard drives. Mr. Nussbaum
lead business development, strategic planning and product development
activities, serving as Western Digital's Senior Vice President, Chief Technical
Officer from 1995 to 1998 and Vice President, Storage Technology and Product
Development from 1988 through 1995. Mr. Nussbaum holds a BA degree in physics
from the State University of New York.
JAMES W. KERRIGAN has served as our Chief Financial Officer since May 2002
(on an Interim basis until February 2003). From March 2000 to October 2000, he
was Chief Financial Officer of Motiva, a privately-owned company that developed,
marketed and sold collaboration software systems. From January 1998 to February
1999, he was Chief Financial Officer of Who?Vision Systems, Inc., an incubator
company that developed biometric fingerprint devices and software. From April
1995 to March 1997, Mr. Kerrigan was Chief Financial Officer of Artios, Inc., a
privately-owned company that designs, manufactures, and sells prototyping
hardware and software to the packaging industry. Previously, Mr. Kerrigan has
served as chief financial officer for other larger, public companies. He has a
BS degree in engineering and a MBA degree from Northwestern University.
MICHAEL OSWALD has served as our General Counsel and Secretary since
December 2001. From June 2001 through December 2001, he provided legal services
for clients, including Lantronix, as an independent consultant. From September
1999 to June 2001, he was General Counsel and Chief Administrative Officer at
NowDocs, Inc., a private start-up Internet-enabled document printing and
delivery company located in Aliso Viejo, California. From December 1996 to
November 1999, he was General Counsel to Acuity Corp., a start-up CRM software
producer in Austin, Texas. Mr. Oswald holds a J.D. from Santa Clara University
School of Law, and a BA from the University of California at Riverside.
11
ITEM 2. PROPERTIES
We lease a building in Irvine, California that comprises our corporate
headquarters and includes administration, sales and marketing, research and
development, warehouse and order fulfillment functions. We also lease an office
in Redmond, Washington that provides some sales, research and development and
administrative functions. We have smaller sales offices in Milford, Connecticut;
Germany; Hong Kong and Japan. The foregoing leases comprise an aggregate of
approximately 70,000 square feet. Our principal facilities have lease terms
expiring between 2005 and 2008.
During the year ended June 30, 2003, we undertook substantial facility and
organizational restructuring activities to simplify and consolidate our
operations, worldwide. We shut down our operational activities in Milford,
Connecticut; Ames, Iowa; Naperville, Illinois; Hillsboro, Oregon; and
Villigen-Schwenningen, Germany. By October 2003, we will cease operational
activities in Cham, Switzerland, the headquarters of Lantronix International AG
Switzerland, which is our wholly owned subsidiary; thereafter, we will support
international sales and shipping from our Irvine, California headquarters. With
each of these facility closures, we have either subleased, listed for rent, or
terminated leases and have recorded a charge against our restructuring reserves
during fiscal 2003.
ITEM 3. LEGAL PROCEEDINGS
Government Investigation
The Securities and Exchange Commission ("SEC") is conducting a formal
investigation of the events leading up to our restatement of our financial
statements on June 25, 2002. The Department of Justice is also conducting an
investigation concerning events related to our restatement of financial results.
Class Action Lawsuits
On May 15, 2002, Stephen Bachman filed a class action complaint entitled
Bachman v. Lantronix, Inc., et al., No. 02-3899, in the U.S. District Court for
the Central District of California against us and certain of our current and
former officers and directors alleging violations of the Securities Exchange Act
of 1934 and seeking unspecified damages. Subsequently, six similar actions were
filed in the same court. Each of the complaints purports to be a class action
lawsuit brought on behalf of persons who purchased or otherwise acquired our
common stock during the period of April 25, 2001 through May 30, 2002,
inclusive. The complaints allege that the defendants caused us to improperly
recognize revenue and make false and misleading statements about our business.
Plaintiffs further allege that the defendants materially overstated our reported
financial results, thereby inflating our stock price during our securities
offering in July 2001, as well as facilitating the use of our common stock as
consideration in acquisitions. The complaints have subsequently been
consolidated into a single action and the court has appointed a lead plaintiff.
The lead plaintiff filed a consolidated amended complaint on January 17, 2003.
The amended complaint now purports to be a class action brought on behalf of
persons who purchased or otherwise acquired our common stock during the period
of August 4, 2000 through May 30, 2002, inclusive. The amended complaint
continues to assert that we and the individual officer and director defendants
violated the 1934 Act, and also includes alleged claims that we and these
officers and directors violated the Securities Act of 1933 arising from our
Initial Public Offering in August 2000. We filed a motion to dismiss the
additional allegations on March 3, 2003. The Court has taken the motion under
submission. We have not yet answered, discovery has not commenced, and no trial
date has been established.
Derivative Lawsuit
On July 26, 2002, Samuel Ivy filed a shareholder derivative complaint
entitled Ivy v. Bernhard Bruscha, et al., No. 02CC00209, in the Superior Court
of the State of California, County of Orange, against certain of our current and
former officers and directors. On January 7, 2003, the plaintiff filed an
amended complaint. The amended complaint alleges causes of action for breach of
fiduciary duty, abuse of control, gross mismanagement, unjust enrichment, and
improper insider stock sales. The complaint seeks unspecified damages against
the individual defendants on our behalf, equitable relief, and attorneys' fees.
We filed a demurrer/motion to dismiss the amended complaint on February 13,
2003. The basis of the demurrer is that the plaintiff does not have standing to
bring this lawsuit since plaintiff has never served a demand on our Board that
our Board take certain actions on our behalf. On April 17, 2003, the Court
overruled our demurrer. Discovery has commenced, but no trial date has been
established.
Securities Claims and Employment Claims Brought by the Co-Founders of
United States Software Corporation
On August 23, 2002, a complaint entitled Dunstan v. Lantronix, Inc., et
al., was filed in the Circuit Court of the State of Oregon, County of Multnomah,
against us and certain of our current and former officers and directors by the
co-founders USSC. The complaint alleged Oregon state law claims for securities
violations, fraud, and
12
negligence. The original complaint sought not less than $3.6 million in damages,
interest, attorneys' fees, costs, expenses, and an unspecified amount of
punitive damages. We moved to compel arbitration in November 2002, and in a
ruling dated February 9, 2003, the court ordered the matter stayed pending
arbitration of all claims. Plaintiffs filed an arbitration demand on or about
February 21, 2003 which included additional claims related to our acquisition of
USSC. The arbitration demand sought more than $14.0 million in damages and an
unspecified amount in attorneys' fees, costs, expenses, and punitive damages.
The parties participated in a mediation on June 30, 2003, and subsequently
reached an agreement to settle the dispute. The agreement called for us to
release to the plaintiffs approximately $400,000 in cash and 49,038 shares of
our common stock that had been held in an escrow since December 2000 as part of
the acquisition of USSC. The agreement also called for us to issue to the
plaintiffs additional shares of our common stock worth approximately $1.5
million. Accordingly, 1,726,703 shares were issued following a fairness
determination by the state court in Oregon. In exchange, the plaintiffs
released all claims against all defendants.
Employment Suit Brought by Former Chief Financial Officer and Chief
Operating Officer Steve Cotton
On September 6, 2002, Steve Cotton, our former CFO and COO, filed a
complaint entitled Cotton v. Lantronix, Inc., et al., No. 02CC14308, in the
Superior Court of the State of California, County of Orange. The complaint
alleges claims for breach of contract, breach of the covenant of good faith and
fair dealing, wrongful termination, misrepresentation, and defamation. The
complaint seeks unspecified damages, declaratory relief, attorneys' fees and
costs. Discovery has not commenced and no trial date has been established.
We filed a motion to dismiss on October 16, 2002, on the grounds that Mr.
Cotton's complaints are subject to the binding arbitration provisions in Mr.
Cotton's employment agreement. On January 13, 2003, the Court ruled that five of
the six counts in Mr. Cotton's complaint are subject to binding arbitration. The
court is staying the sixth count, for declaratory relief, until the underlying
facts are resolved in arbitration. No arbitration date has been set.
Securities Claims Brought by Former Shareholders of Synergetic Micro
Systems, Inc.
On October 17, 2002, Richard Goldstein and several other former
shareholders of Synergetic filed a complaint entitled Goldstein, et al v.
Lantronix, Inc., et al in the Superior Court of the State of California, County
of Orange, against us and certain of our former officers and directors.
Plaintiffs filed an amended complaint on January 7, 2003. The amended complaint
alleges fraud, negligent misrepresentation, breach of warranties and covenants,
breach of contract and negligence, all stemming from our acquisition of
Synergetic. The complaint seeks an unspecified amount of damages, interest,
attorneys' fees, costs, expenses, and an unspecified amount of punitive damages.
On May 5, 2003, we answered the complaint and generally denied the allegations
in the complaint. Discovery has not yet commenced and no trial date has been
established.
Suit filed by Lantronix Against Logical Solutions, Inc.
On March 25, 2003, we filed in Connecticut state court (Judicial District
of New Haven) a complaint entitled Lantronix, Inc. and Lightwave Communications,
Inc. v Logical Solutions, Inc., et. al. This is an action for unfair and
deceptive trade practices, unfair competition, unjust enrichment, conversion,
misappropriation of trade secrets and tortuous interference with contractual
rights and business expectancies. We seek preliminary and permanent injunctive
relief and damages. The individual defendants are all former employees of
Lightwave Communications, a company that we acquired in June 2001. The suit is
pending trial.
Other
From time to time, we are subject to other legal proceedings and claims in
the ordinary course of business. We currently are not aware of any such legal
proceedings or claims that we believe will have, individually or in the
aggregate, a material adverse effect on our business, prospects, financial
position, operating results or cash flows.
The pending lawsuits involve complex questions of fact and law and likely
will continue to require the expenditure of significant funds and the diversion
of other resources to defend. We are unable to determine the outcome of its
outstanding legal proceedings, claims and litigation involving us, our
subsidiaries, directors and officers and cannot determine the extent to which
these results may have a material adverse effect on our business, results of
operations and financial condition taken as a whole. The results of litigation
are inherently uncertain, and adverse outcomes are possible. We are unable to
estimate the range of possible loss from outstanding litigation, and no amounts
have been provided fur such matters in the consolidated financial statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Our common stock was traded on The Nasdaq National Market under the symbol
"LTRX" from our initial public offering on August 4, 2000 through October 22,
2002. On October 23, 2002 our listing was changed to The Nasdaq SmallCap Market.
The number of holders of record of our common stock as of August 31, 2003 was
approximately 120. The following table sets forth, for the period indicated, the
high and low per share closing prices for our common stock:
FISCAL YEAR 2002 HIGH LOW
- ---------------- ------ -----
First Quarter $10.20 $5.57
Second Quarter $ 6.45 $4.85
Third Quarter $ 6.93 $2.02
Fourth Quarter $ 2.85 $0.68
FISCAL YEAR 2003 HIGH LOW
- ---------------- ------ -----
First Quarter $ 1.03 $0.38
Second Quarter $ 0.92 $0.36
Third Quarter $ 1.08 $0.67
Fourth Quarter $ 0.91 $0.49
We believe that a number of factors, including but not limited to quarterly
fluctuations in results of operations, may cause the market price of our common
stock to fluctuate significantly. See "Management's Discussion and Analysis-Risk
Factors."
DIVIDEND POLICY
We have never declared or paid cash dividends on our common stock. We do
not anticipate paying any cash dividends on our common stock in the foreseeable
future, and we intend to retain any future earnings for use in the expansion of
our business and for general corporate purposes. Pursuant to a line of credit we
entered into in January 2002 and have amended on June 30, 2002, February 4, 2003
and July 25, 2003, we are restricted from paying any dividends.
EQUITY COMPENSATION PLANS
The information required by this item regarding equity compensation plans
is incorporated by reference to the information set forth in Item 12 of this
Annual Report on Form 10-K. Item 12 of this Annual Report on Form 10-K
incorporates by reference the information contained in the sections captioned
"Election of Directors" and "Security Ownership of Certain Beneficial Owners and
Management" in the Lantronix's definitive Proxy Statement for the Annual Meeting
of Stockholders to be held November 20, 2003 (the Proxy Statement), a copy of
which will be filed with the Securities and Exchange Commission before the
meeting date.
RECENT SALES OF UNREGISTERED SECURITIES
We have issued the following unregistered securities since July 1, 2002:
In January 2003, we issued an aggregate of 1,063,372 shares of our common
stock to the former stockholders of Premise in connection with our Compromise
Settlement and Mutual Release Agreement with the former stockholders of Premise.
In September 2003, we issued an aggregate of 1,726,703 shares of our common
stock to the former co-founders of USSC in connection with our litigation
settlement.
The issuance of securities in January 2003 were deemed to be exempt from
registration under the Securities Act in reliance on Section 4(2) of the
Securities Act. The securities issued in September 2003 were exempt from
registration under the Securities Act in reliance on Section 3(a)(10) of the
Securities Act. There were no underwritten offerings employed in connection with
any of the transactions set forth above.
14
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included below. The consolidated statements of operations data for
the years ended June 30, 2003, 2002 and 2001 and the balance sheet data as of
June 30, 2003 and 2002, are derived from the audited consolidated financial
statements included elsewhere in this report. The consolidated statements of
operations data for the years ended June 30, 2000 and 1999, and the balance
sheet data as of June 30, 2001, 2000 and 1999, are derived from the audited
consolidated financial statements not included elsewhere in this report. The
historical results are not necessarily indicative of results to be expected for
future periods.
YEARS ENDED JUNE 30,
--------------------
2003 2002 2001 2000 1999
--------- --------- --------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net revenues $ 49,509 $ 57,646 $ 48,972 $44,975 $32,980
Cost of revenues 37,603 40,510 24,530 21,526 16,824
--------- --------- --------- -------- --------
Gross profit 11,906 17,136 24,442 23,449 16,156
--------- --------- --------- -------- --------
Operating expenses:
Selling, general and administrative 30,633 41,575 23,998 16,744 9,173
Research and development 10,413 9,225 4,478 3,186 2,615
Stock-based compensation 1,453 2,863 3,019 1,093 -
Amortization of goodwill and purchased intangible assets 1,002 1,263 1,490 813 595
Impairment of goodwill and purchased intangible assets 6,708 50,828 - - -
Restructuring charges 5,711 3,473 - - -
Litigation settlement costs 2,607 1,912 - - -
In-process research and development - 1,000 2,596 - -
--------- --------- --------- -------- --------
Total operating expenses 58,527 112,139 35,581 21,836 12,383
--------- --------- --------- -------- --------
Income (loss) from operations (46,621) (95,003) (11,139) 1,613 3,773
Minority interest - - - (49) (30)
Interest income (expense), net 248 1,546 2,182 187 151
Other income (expense), net (926) (760) (167) (47) (10)
--------- --------- --------- -------- --------
Income (loss) before income taxes and cumulative effect of
accounting changes (47,299) (94,217) (9,124) 1,704 3,884
Provision (benefit) for income taxes 250 (6,665) (1,876) 649 1,098
--------- --------- --------- -------- --------
Income (loss) before cumulative effect of accounting changes (47,549) (87,552) (7,248) 1,055 2,786
Cumulative effect of accounting changes:
Change in revenue recognition policy, net of income
tax benefit of $176 - - (597) - -
Adoption of new accounting standard, SFAS No. 142 - (5,905) - - -
--------- --------- --------- -------- --------
Net income (loss) $(47,549) $(93,457) $ (7,845) $ 1,055 $ 2,786
========= ========= ========= ======== ========
Basic income (loss) per share before cumulative effect of
accounting changes $ (0.88) $ (1.70) $ (0.19) $ 0.04 $ 0.10
Cumulative effect of accounting changes per share:
Change in revenue recognition policy, net of income
tax benefit of $176 - - (0.02) - -
Adoption of new accounting standard, SFAS No. 142 - (0.12) - - -
--------- --------- --------- -------- --------
Basic net income (loss) per share $ (0.88) $ (1.82) $ (0.21) $ 0.04 $ 0.10
========= ========= ========= ======== ========
Diluted income (loss) per share before cumulative effect of
accounting changes $ (0.88) $ (1.70) $ (0.19) $ 0.03 $ 0.10
Cumulative effect of accounting changes per share:
Change in revenue recognition policy,
net of income tax benefit of $176 - - (0.02) - -
Adoption of new accounting standard, SFAS No. 142 - (0.12) - - -
--------- --------- --------- -------- --------
Diluted net income (loss) per share $ (0.88) $ (1.82) $ (0.21) $ 0.03 $ 0.10
========= ========= ========= ======== ========
Weighted average shares (basic) 54,329 51,403 36,946 29,274 26,977
========= ========= ========= ======== ========
Weighted average shares (diluted) 54,329 51,403 36,946 34,178 28,880
========= ========= ========= ======== ========
15
JUNE 30,
--------------
2003 2002 2001 2000 1999
---------- --------- -------- ------- -------
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents $ 7,328 $ 26,491 $ 15,367 $ 1,988 $ 5,833
Marketable securities 6,750 6,963 1,973 - -
Working capital 21,698 45,423 36,963 11,042 8,109
Goodwill, net 11,726 13,811 42,273 - -
Purchased intangible assets, net 5,394 14,681 13,328 586 1,399
Total assets 62,856 103,812 116,861 20,210 17,292
Convertible note payable 867 - - - -
Retained earnings (accumulated deficit) (140,424) (92,875) 582 8,427 7,372
Total stockholders' equity 37,717 82,157 99,496 12,547 10,312
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with our consolidated
financial statements and related notes included elsewhere in this report. In
addition to historical information, the discussion in this report contains
forward-looking statements that involve risks and uncertainties. Actual results
could differ materially from those anticipated by these forward-looking
statements due to factors including, but not limited to, those factors set forth
under "Risk Factors" and elsewhere in this report.
OVERVIEW
Lantronix designs, develops and markets products and software solutions
that make it possible to access, manage, control and configure almost any
electronic device over the Internet or other networks. We are a leader in
providing innovative networking solutions. We were initially formed as
"Lantronix," a California corporation, in June 1989. We reincorporated as
"Lantronix, Inc.," a Delaware corporation in May 2000.
We have a history of providing devices that enable information technology
IT equipment to network using standard protocols for connectivity, including
fiber optic, Ethernet and wireless. Our first product was a terminal server that
allowed "dumb" terminals to connect to a network. Building on the success of our
terminal servers, we introduced a complete line of print servers in 1991 that
enabled users to inexpensively share printers over a network. Over the years, we
have continually refined our core technology and have developed additional
innovative networking solutions that expand upon the business of providing our
customers network connectivity. We provide three broad categories of products:
"device networking solutions," that enable almost any electronic device to be
connected to a network; "IT management solutions," that enable multiple
devices-usually network computing devices such as servers, routers, switches,
and similar equipment to be managed over a network; and software that is either
embedded in the hardware devices that are mentioned above, or stand-alone
application software.
Today, our solutions include fully integrated hardware and software
products, as well as software tools to develop related customer applications.
Because we deal with network connectivity, we have provided products to
extremely broad market segments, including industrial, medical, commercial,
financial, governmental, retail, building and home automation, and many more.
Our technology is used with devices such as networking routers, medical
instruments, manufacturing equipment, bar code scanners, building HVAC systems,
elevators, process control equipment, vending machines, thermostats, security
cameras, temperature sensors, card readers, point of sale terminals, time
clocks, and virtually any device that has some form of standard data control
capability. Our current product offerings include a wide range of hardware
devices of varying size, packaging and, where appropriate, software solutions
that allow our customers to network-enable virtually any electronic device.
16
Our products are sold to distributors, OEMs, VARs, and systems integrators,
as well as directly to end users. One customer, Ingram Micro Inc., accounted for
approximately 11%, 12% and 14% of our net revenues for the years ended June 30,
2003, 2002 and 2001, respectively. Another customer, Tech Data Corporation,
accounted for approximately 10%, 11% and 10% of our net revenues for the years
ended June 30, 2003, 2002 and 2001, respectively. Accounts receivable
attributable to these two domestic customers accounted for approximately 16% and
21% of total accounts receivable at June 30, 2003 and 2002, respectively.
One international customer, transtec AG, which is a related party due to
common ownership by our largest stockholder and former Chairman of our Board of
Directors, Bernhard Bruscha, accounted for approximately 4%, 5% and 9% of our
net revenues for the years ended June 30, 2003, 2002 and 2001, respectively.
Included in the accompanying consolidated balance sheets is approximately
$246,000 due to this related party at June 30, 2002. No significant amount was
due to or from this related party at June 30, 2003. We also had an agreement
with transtec AG for the provision of technical support services at the rate of
$7,500 per month which has now been terminated. Included in selling, general and
administrative expenses is $0, $90,000 and $90,000 for the years ended June 30,
2003, 2002 and 2001, respectively, for these support services.
In July 2001, we completed a public offering of 8,534,000 shares of our
common stock, including an underwriter's over-allotment option to purchase an
additional 534,000 shares, at an offering price of $8.00 per share. We sold
6,000,000 shares and selling shareholders sold 2,000,000 shares of the primary
offering. Additionally, we sold 400,500 shares and selling stockholders sold
133,500 shares of the over-allotment option. We received net proceeds of
approximately $47.1 million in connection with this offering.
We have completed a number of acquisitions and investments since our
initial public offering in August 2000, the purpose of which is to expand our
product offerings, increase our technology base and provide a foundation for
future growth.
In December 2000, we completed the acquisition of USSC, a developer of a
software operating system, protocol stacks and an application development
environment for embedded technology. The total purchase price consisted of $2.5
million in cash and 653,846 shares of our common stock. In addition, we assumed
existing employee stock and issued new options to acquire 133,333 shares of our
common stock at a weighted average exercise price of $1.00 per share. USSC
provides an open standards-based operating system and supports a variety of
processors. We believe the acquisition of USSC helps expand our product offering
and enables us to provide our customers with an integrated software and hardware
embedded solution. Recently, we released from escrow approximately $400,000 and
49,038 shares of our common stock, and issued to the founders of USSC 1,726,703
shares of our common stock, to settle the lawsuit that they filed against us in
Oregon state court in August of 2002.
17
In June 2001, we completed the acquisition of Lightwave, a developer of
multiport and visualization solutions. The purchase price included 3,428,571
shares of our common stock and $12.0 million in cash. In addition, we assumed
options issued to employees and issued options to acquire 870,513 shares of our
common stock at a weighted average exercise price of $3.67 per share. We also
paid off approximately $6.7 million of debt to a creditor of Lightwave. In July
2002, we paid $2.0 million to the former stockholders of Lightwave to settle a
dispute regarding a registration rights agreement entered into pursuant to this
acquisition and also exchanged 240,000 shares of our common stock held in escrow
and 208,335 additional shares held by the former Lightwave stockholders. The
settlement resulted in a net change to our results of operations of
approximately $1.9 million for the year ended June 30, 2002.
In October 2001, we completed the acquisition of Synergetic, a provider of
high performance embedded network communication solutions that complement our
external device products. In connection with the acquisition, we paid cash
consideration of $2.7 million and issued an aggregate of 2,234,715 shares of our
common stock in exchange for all outstanding shares of Synergetic common stock
and reserved 615,705 additional shares of common stock for issuance upon
exercise of outstanding employee stock options and other rights of Synergetic.
Portions of the cash consideration and shares issued are held in escrow pursuant
to the terms of the acquisition agreement.
In January 2002, we completed the acquisition of Premise, a developer of
client-side software applications that complement our device networking products
by providing superior management and control capabilities for devices that have
been network and internet enabled. Prior to the acquisition, we held shares of
Premise representing 19.9% ownership and, in addition, held convertible
promissory notes of $1.2 million with interest accrued there-on at the rate of
9.0%. The convertible promissory notes were converted into equity securities of
Premise at the closing of the transaction. We issued an aggregate of 1,063,371
shares of our common stock in exchange for all remaining outstanding shares of
Premise common stock and reserved 875,000 additional shares of common stock for
issuance upon exercise of outstanding employee stock options and other rights of
Premise. In connection with the acquisition, we recorded a one-time charge for
purchased in-process research and development ("IPR&D") expenses of $1.0 million
in our fourth fiscal quarter ended June 30, 2002. In January 2003, we issued an
additional 1,063,372 shares of our common stock to the former shareholders of
Premise stock in exchange for a release of all claims relating to the
acquisition. We also accelerated the vesting of options held by certain former
Premise shareholders and released all shares that had been held in the
acquisition escrow.
In August 2002, we completed the acquisition of Stallion, a provider of
terminal servers and multiport products. In connection with the acquisition, we
paid $1.2 million in cash consideration, of which $200,000 was paid upon the
execution of the Letter of Intent dated May 9, 2002, and established a cash
escrow account in the amount of $867,000 at the acquisition date to be used in
lieu of our common stock, in the event that we were unable to issue registered
shares by October 31, 2002. In accordance with the terms of the agreement, we
were not able to issue registered shares by October 31, 2002; accordingly, the
cash escrow amount of $867,000 was released on November 1, 2002. In addition, we
issued a two-year note in the principal amount of $867,000 accruing interest at
a rate of 2.5% per annum. The note is due in August 2004.
In September and October 2001, we made a strategic investment in Xanboo, a
privately-held company that develops technology that allows users to control,
command and view their home or business remotely over the Internet. We paid an
aggregate of $3.0 million for convertible promissory notes, which converted in
January 2002, in accordance with their terms, into Xanboo preferred stock. In
addition, we purchased $4.0 million of Xanboo preferred stock in January 2002.
Our ownership interest in Xanboo was 15.3% and 15.8% at June 30, 2003 and 2002,
respectively. Our investment in Xanboo is accounted for using the equity method
of accounting based on our ability through representation on Xanboo's board of
directors to exercise significant influence over its operations. Our losses in
Xanboo aggregating $1.3 million and $526,000 for the years ended June 30, 2003
and 2002, respectively, have been recognized as other expense in the
accompanying consolidated statement of operations. No similar expense was
recognized for the year ended June 30, 2001.
18
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires us to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of net revenues
and expenses during the reporting period. We regularly evaluate our estimates
and assumptions related to net revenues, allowances for doubtful accounts, sales
returns and allowances, inventory reserves, goodwill and purchased intangible
asset valuations, warranty reserves, restructuring costs, litigation and other
contingencies. We base our estimates and assumptions on historical experience
and on various other factors that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. To the extent there are material differences between our
estimates and the actual results, our future results of operations will be
affected.
We believe the following critical accounting policies require us to make
significant judgments and estimates in the preparation of our consolidated
financial statements:
Revenue Recognition
We do not recognize revenue until all of the following criteria are met:
persuasive evidence of an arrangement exists; delivery has occurred or services
have been rendered; our price to the buyer is fixed or determinable; and
collectibility is reasonably assured. Commencing July 1, 2000, we adopted a new
accounting policy for revenue recognition such that recognition of revenue and
related gross profit from sales to distributors are deferred until the
distributor resells the product. Net revenue from certain smaller distributors
for which point-of-sale information is not available, is recognized one month
after the shipment date. This estimate approximates the timing of the sale of
the product by the distributor to the end user. Revenues from product sales to
OEMs, end user customers, other resellers and from sales to distributors prior
to July 1, 2000 generally were recognized upon product shipment, but may have
been deferred to a later date if all revenue recognition criteria were not met
at the date of shipment. When product sales revenue is recognized, we establish
an estimated allowance for future product returns based on historical returns
experience; when price reductions are approved, we establish an estimated
liability for price protection payable on inventories owned by product
resellers. Should actual product returns or pricing adjustments exceed our
estimates, additional reductions to revenues would result. Revenue from the
licensing of software is recognized at the time of shipment (or at the time of
resale in the case of software products sold through distributors), provided we
have vendor-specific objective evidence of the fair value of each element of the
software offering and collectibility is probable. Revenue from post-contract
customer support and any other future deliverables is deferred and recognized
over the support period or as contract elements are delivered. Our products
typically carry a ninety day to five year warranty. Although we engage in
extensive product quality programs and processes, our warranty obligation is
affected by product failure rates, use of materials or service delivery costs
that differ from our estimates. As a result, additional warranty reserves could
be required, which could reduce gross margins. Prior to July 1, 2000, the
effective date of the change in accounting method for recognizing revenue for
sales to distributors, we recorded an estimated allowance for future product
returns for sales to distributors based on historical returns experience when
the related revenue was recorded and provided for appropriate price protection
reserves when pricing adjustments were approved. As indicated above, recognition
of revenue and related gross profit on sales to distributors is now deferred
until the distributor resells the product.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. Our
allowance for doubtful accounts is based on our assessment of the collectibility
of specific customer accounts, the aging of accounts receivable, our history of
bad debts and the general condition of the industry. If a major customer's
credit worthiness deteriorates, or our customers' actual defaults exceed our
historical experience, our estimates could change and impact our reported
results. We also maintain a reserve for uncertainties relative to the collection
of officer notes receivable. Factors considered in determining the level of this
reserve include the value of the collateral securing the notes, our ability to
effectively enforce collection rights and the ability of the former officers to
honor their obligations.
Inventory Valuation
Our policy is to value inventories at the lower of cost or market on a
part-by-part basis. This policy requires us to make estimates regarding the
market value of our inventories, including an assessment of excess and obsolete
inventories. We determine excess and obsolete inventories based on an estimate
of the future sales demand for our products within a specified time horizon,
generally three to twelve months. The estimates we use for demand are also used
for near-term capacity planning and inventory purchasing and are consistent with
our revenue forecasts. In addition, specific reserves are recorded to cover
risks in the area of end of life products, inventory located at our contract
manufacturers, deferred inventory in our sales channel and warranty replacement
stock.
19
If our sales forecast is less than the inventory we have on hand at the end
of an accounting period, we may be required to take excess and obsolete
inventory charges which will decrease gross margin and net operating results for
that period.
Valuation of Deferred Income Taxes
We have recorded a valuation allowance to reduce our net deferred tax
assets to zero, primarily due to our inability to estimate future taxable
income. We consider estimated future taxable income and ongoing prudent and
feasible tax planning strategies in assessing the need for a valuation
allowance. If we determine that it is more likely than not that we will realize
a deferred tax asset, which currently has a valuation allowance, we would be
required to reverse the valuation allowance which would be reflected as an
income tax benefit at that time.
Goodwill and Purchased Intangible Assets
The purchase method of accounting for acquisitions requires extensive use
of accounting estimates and judgments to allocate the purchase price to the fair
value of the net tangible and intangible assets acquired, including IPR&D.
Goodwill and intangible assets deemed to have indefinite lives are no longer
amortized but are subject to annual impairment tests. The amounts and useful
lives assigned to intangible assets impact future amortization and the amount
assigned to IPR&D is expensed immediately. If the assumptions and estimates used
to allocate the purchase price are not correct, purchase price adjustments or
future asset impairment charges could be required.
Impairment of Long-Lived Assets
We evaluate long-lived assets used in operations when indicators of
impairment, such as reductions in demand or significant economic slowdowns, are
present. Reviews are performed to determine whether the carrying values of
assets are impaired based on comparison to the undiscounted expected future cash
flows. If the comparison indicates that there is impairment, the expected future
cash flows using a discount rate based upon our weighted average cost of capital
is used to estimate the fair value of the assets. Impairment is based on the
excess of the carrying amount over the fair value of those assets. Significant
management judgment is required in the forecast of future operating results that
is used in the preparation of expected discounted cash flows. It is reasonably
possible that the estimates of anticipated future net revenue, the remaining
estimated economic lives of the products and technologies, or both, could differ
from those used to assess the recoverability of these assets. In that event,
additional impairment charges or shortened useful lives of certain long-lived
assets could be required.
Strategic Investments
We have made strategic investments in privately held companies for the
promotion of business and strategic investments. Strategic investments with less
than a 20% voting interest are generally carried at cost. We will use the equity
method to account for strategic investments in which we have a voting interest
of 20% to 50% or in which we otherwise have the ability to exercise significant
influence. Under the equity method, the investment is originally recorded at
cost and adjusted to recognize our share of net earnings or losses of the
investee, limited to the extent of our investment in, advances to and adjusted
to recognize our share of net earnings or losses of the investee. From time to
time we are required to estimate the amount of our losses of the investee. Our
estimates are based on historical experience. The value of non-publicly traded
securities is difficult to determine. We periodically review these investments
for other-than-temporary declines in fair value based on the specific
identification method and write down investments to their fair value when an
other-than-temporary decline has occurred. We generally believe an
other-than-temporary decline has occurred when the fair value of the investment
is below the carrying value for two consecutive quarters, absent evidence to the
contrary. Fair values for investments in privately held companies are estimated
based upon the values of recent rounds of financing. Although we believe our
estimates reasonably reflect the fair value of the non-publicly traded
securities held by us, had there been an active market for the equity
securities, the carrying values might have been materially different than the
amounts reported. Future adverse changes in market conditions or poor operating
results of companies in which we have such investments could result in losses or
an inability to recover the carrying value of the investments that may not be
reflected in an investment's current carrying value and which could require a
future impairment charge.
20
Restructuring Charges
Over the last several quarters we have undertaken, and we may continue to
undertake, significant restructuring initiatives, which have required us to
develop formalized plans for exiting certain business activities. We have had to
record estimated expenses for lease cancellations, long-term asset write-downs,
severance and outplacement costs and other restructuring costs. Given the
significance of, and the timing of the execution of such activities, this
process is complex and involves periodic reassessments of estimates made at the
time the original decisions were made. Through December 31, 2002, the accounting
rules for restructuring costs and asset impairments required us to record
provisions and charges when we had a formal and committed plan. Beginning
January 1, 2003, the accounting rules now require us to record any future
provisions and changes at fair value in the period in which they are incurred.
In calculating the cost to dispose of our excess facilities, we had to estimate
our future space requirements and the timing of exiting excess facilities and
then estimate for each location the future lease and operating costs to be paid
until the lease is terminated and the amount, if any, of sublease income. This
required us to estimate the timing and costs of each lease to be terminated,
including the amount of operating costs and the rate at which we might be able
to sublease the site. To form our estimates for these costs, we performed an
assessment of the affected facilities and considered the current market
conditions for each site. Our assumptions on future space requirements, the
operating costs until termination or the offsetting sublease revenues may turn
out to be incorrect, and our actual costs may be materially different from our
estimates, which could result in the need to record additional costs or to
reverse previously recorded liabilities. Our policies require us to periodically
evaluate the adequacy of the remaining liabilities under our restructuring
initiatives. As management continues to evaluate the business, there may be
additional charges for new restructuring activities as well as changes in
estimates to amounts previously recorded.
Recent Accounting Pronouncements
We did not have any outstanding guarantees that were required to be
recorded upon adoption of FIN No. 45. Our product warranties, which are subject
to the disclosure provisions of FIN No. 45, have been disclosed in the
accompanying consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" ("SFAS No. 148"), which amends
SFAS No. 123. SFAS No. 148 amends the disclosure requirements in SFAS No. 123
for stock-based compensation for annual periods ending after December 15, 2002
and interim periods beginning after December 15, 2002. The disclosure
requirements apply to all companies, including those that continue to recognize
stock-based compensation under APB No. 25. Effective for financial statements
for fiscal years ending after December 15, 2002, SFAS No. 148 also provides
three alternative transition methods for companies that choose to adopt the fair
value measurement provisions of SFAS No. 123.
In January 2003 the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities ("FIN 46"). FIN 46 requires the primary beneficiary
of a variable interest entity ("VIE") to consolidate the entity and also
requires majority and significant variable interest investors to provide certain
disclosures. A VIE is an entity in which the equity investors do not have a
controlling interest, equity investors participate in losses or residual
interests of the entity on a basis that differs from its ownership interest, or
the equity investment at risk is insufficient to finance the entity's activities
without receiving additional subordinated financial support from the other
parties. For arrangements entered into with VIEs created prior to January 31,
2003, the provisions of FIN 46 are required to be adopted at the beginning of
the first interim or annual period beginning after June 15, 2003. We are
currently reviewing our investments and other arrangements to determine whether
any of our investee companies are VIEs. We do not expect to identify any
significant VIEs that would be consolidated, but we may be required to make
additional disclosures.
Impact of Adoption of New Accounting Standard
In June 2001, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 141, "Business Combinations" ("SFAS No. 141"), effective for
acquisitions consummated after June 30, 2001, and SFAS No. 142, "Goodwill and
Other Intangible Assets" ("SFAS No. 142"), effective for fiscal years beginning
after December 15, 2001. Under the new rules, goodwill and certain intangible
assets deemed to have indefinite lives will no longer be amortized but will be
subject to annual impairment tests. Other intangible assets will continue to be
amortized over their useful lives.
The following table presents the impact of SFAS No. 142 on net loss and net
loss per share had SFAS No. 142 been in effect for the year ended June 30, 2001
(in thousands, except per share data):
Net loss as reported $(7,845)
Adjustments:
Amortization of goodwill 752
---------
Net adjustments 752
---------
Net loss as adjusted $ (7,093)
=========
Basic and diluted net loss per share-as reported $ (0.21)
=========
Basic and diluted net loss per share-as adjusted $ (0.19)
=========
Impairment of goodwill and purchased intangible assets
Under the transitional provisions of SFAS No. 142, effective as of July 1,
2002, we completed our initial assessment and concluded that goodwill arising
from the acquisition of USSC, having a carrying amount of approximately $5.9
million as of July 1, 2001, may be impaired. We engaged an independent valuation
company to perform a review of the value of our goodwill related to USSC. Based
on the independent valuation, which utilized a discounted cash flow valuation
technique, we recorded a $5.9 million charge for the impairment of our USSC
goodwill. This amount is reflected as the cumulative effect of adopting the new
accounting standard effective July 1, 2001.
We performed the first of the required annual impairment tests of goodwill
under the guidelines of SFAS No. 142 effective as of June 1, 2002. As a result
of industry conditions, lower market valuations and reduced estimates of
information technology capital equipment spending in the future, we determined
that there were indicators of impairment to the carrying value of goodwill
related to the acquisitions of Lightwave and Synergetic which had carrying
values of $39.7 million and $13.9 million, respectively, as of June 30, 2002.
During the fourth quarter of fiscal 2002, we engaged an independent valuation
company to perform a review of the value of our goodwill and based on the
independent valuation we recorded a $46.4 million impairment charge of our
goodwill of which $32.5 million related to Lightwave and $13.9 million related
to Synergetic.
21
Additionally, during the fourth quarter of 2002, we performed a review of
the value of our purchased intangible assets in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets," ("SFAS No.
144"). As a result of industry conditions, lower market valuations and reduced
estimates of information technology capital equipment spending in the future, we
determined that there were indicators of impairment to the carrying value of our
purchased intangible assets related to our acquisitions. During the fourth
quarter of fiscal 2002, we engaged an independent valuation company to perform a
review of the value of our purchased intangible assets and based on the
independent valuation we recorded a $10.2 million impairment charge of which
$969,000, $764,000, $7.6 million and $849,000 related to USSC, Lightwave,
Synergetic and Premise, respectively. Additionally, we recorded an impairment
charge of $665,000 related to intellectual property not associated with an
acquisition.
We performed our annual impairment tests under the guidelines of SFAS No.
142. We compared the carrying value of each reporting unit to our estimated fair
value calculated with the assistance of an independent valuation company. We
estimated the fair value of our reporting units primarily using the income
approach methodology of valuation that includes the discounted cash flow method,
taking into consideration the market approach and certain market multiples as
verification of the values derived using the discounted cash flow methodology.
In addition, publicly available information regarding our market capitalization
was also considered. An impairment loss was recognized for reporting units where
the carrying value of goodwill exceeded the implied fair value of goodwill.
Based on this assessment, we recorded a charge of $4.4 million during the fourth
quarter of fiscal 2003 to write down the value of goodwill. The primary factors
resulting in the impairment charge were the continued significant economic
slowdown in the technology sector affecting both our current operations and
expected future revenue, as well as the decline in valuation of technology
company stocks, including the valuation of our stock.
Additionally, during the fourth quarter of fiscal 2003, we performed an
assessment of the value of our purchased intangible assets in accordance with
SFAS No. 144. As a result of industry conditions, continued lower market
valuations and reduced estimates in information technology capital equipment
spending in the future and other factors impacting expected future cash flows,
we determined that there were indicators of impairment to the carrying value of
our purchased intangible assets recorded as part of our acquisitions. We engaged
an independent valuation company to perform a review of the value of our
purchased intangible assets. In accordance with SFAS No. 144, we utilized a cash
flow estimation approach, comparing the discounted expected future cash flows to
the carrying value of the subject assets. Based on the independent valuations,
during the fourth quarter of fiscal 2003 we recorded a $6.3 million impairment
charge of which $2.4 million and $3.9 million were charged to operating expenses
and cost of revenues, respectively.
Restructuring charges
On September 12, 2002 and again on March 14, 2003, we announced a
restructuring plan to prioritize our initiatives around the growth areas of our
business, focus on profit contribution, reduce expenses and improve operating
efficiency. These restructuring plans included a worldwide workforce reduction,
consolidation of excess facilities and other charges. For the year ended June
30, 2003, we recorded restructuring costs totaling $5.7 million or 11.5% of net
revenues which are classified as operating expenses in the consolidated
statements of operations. The restructuring plans resulted in the reduction of
approximately 58 regular employees worldwide. Through June 30, 2003, we have
incurred actual workforce reduction charges of approximately $1.3 million
related to severance and fringe benefits for the terminated employees
approximately $2.4 million related to consolidation of excess facilities and
$2.0 million for contractual obligations. Property, equipment and other assets
that will be disposed or removed from operations consist primarily of computer
software, services and related equipment, production and office equipment and
furniture and fixtures. The restructuring plan resulted in the closing of the
Milford, Connecticut manufacturing operations, and Ames, Iowa and Singapore
offices.
On February 6, 2002, we announced a restructuring plan to prioritize our
initiatives around areas of our business that we believe represent high-growth
opportunities, focus on profit contribution, reduce expenses, and improve
operating efficiency. This restructuring plan included a worldwide workforce
reduction, consolidation of excess facilities and other charges. As of June 30,
2002, we recorded restructuring costs totaling $3.5 million. Through June 30,
2003, the February 2002 restructuring plan has resulted in the reduction of
approximately 50 regular employees worldwide and we incurred actual worldwide
workforce reduction charge of approximately $1.9 million related to severance
and fringe benefits. Included in this amount is a stock-based compensation
charges in the amount of $595,000 associated with the extension of the exercise
period for stock options that were vested at the termination date. Property and
equipment that was disposed or removed from operations resulted in a charge of
$1.6 million and consisted primarily of computer software and related equipment,
production, engineering and office equipment and furniture and fixtures.
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
of net revenues represented by each item in our consolidated statements of
operations:
YEARS ENDED JUNE 30,
--------------------
2003 2002 2001
------- -------- -------
Net revenues 100.0% 100.0% 100.0%
Cost of revenues 76.0 70.3 50.1
------- -------- -------
Gross profit 24.0 29.7 49.9
------- -------- -------
Operating expenses:
Selling, general and administrative 61.9 72.1 49.0
Research and development 21.0 16.0 9.1
Stock-based compensation 2.9 5.0 6.2
Amortization of goodwill and purchased intangible assets 2.0 2.2 3.0
Impairment of goodwill and purchased intangible assets 13.5 88.2 -
Restructuring charges 11.5 6.0 -
Litigation settlement costs 5.3 3.3 -
In-process research and development - 1.7 5.3
------- -------- -------
Total operating expenses 118.1 194.5 72.6
------- -------- -------
Loss from operations (94.1) (164.8) (22.7)
Interest income (expense), net 0.5 2.7 4.4
Other income (expense), net (1.9) (1.3) (0.3)
------- -------- -------
Loss before income taxes and cumulative effect
of accounting changes (95.5) (163.4) (18.6)
Provision (benefit) for income taxes 0.5 (11.6) (3.8)
------- -------- -------
Loss before cumulative effect of accounting changes (96.0) (151.9) (14.8)
Cumulative effect of accounting changes:
Change in revenue recognition policy, net
of income tax benefit of $176 - - (1.2)
Adoption of new accounting standard, SFAS No. 142 - (10.2) -
------- -------- -------
Net loss (96.0)% (162.1)% (16.0)%
======= ======== =======
22
COMPARISON OF THE YEARS ENDED JUNE 30, 2003 AND 2002
Net Revenues
Net revenues decreased $8.1 million, or 14.1%, to $49.5 million for the
year ended June 30, 2003 from $57.6 million for the year ended June 30, 2002.
The decrease was primarily attributable to a decrease in net revenues of our
device networking solutions, IT management solutions and other products. Device
networking solutions net revenues decreased $3.2 million, or 10.8%, to $26.8
million or 54.1% of net revenues for the year ended June 30, 2003 from $30.0
million or 52.0% of net revenues for the year ended June 30, 2002. IT management
solutions net revenues decreased $3.3 million, or 19.9%, to $13.2 million or
26.7% of net revenues for the year ended June 30, 2003 from $16.5 million or
28.7% of net revenues for the year ended June 30, 2002. Other product net
revenues decreased $1.6 million, or 14.4%, to $9.5 million or 19.2% of net
revenues for the year ended June 30, 2003 from $11.1 million or 19.3% of net
revenues for the year ended June 30, 2002. The overall decrease in net revenues
is primarily attributable to logistical issues surrounding the restructuring of
our Milford, Connecticut operations, whereby we began to outsource our
manufacturing to three contract manufacturers, our discontinuance of certain
product offerings as well as the overall decrease in industry technology
spending year to year.
Net revenues generated from sales in the Americas decreased $10.2 million,
or 21.4%, to $37.5 million or 75.8% of net revenues for the year ended June 30,
2003 from $47.7 million or 82.8% of net revenues for the year ended June 30,
2002. Our net revenues derived from customers located in the Americas decreased
primarily due to logistical issues surrounding the restructuring of our Milford,
Connecticut operations, whereby we began to outsource our manufacturing to three
contract manufacturers, and due to our discontinuance of certain product
offerings as well as the overall decrease in industry technology spending year
to year. Our net revenues derived from customers located in Europe increased
$2.1 million, or 25.7%, to $10.4 million or 20.9% of net revenues for the year
ended June 30, 2003 from $8.2 million or 14.3% of net revenues for the year
ended June 30, 2002. This increase was primarily due to a concentrated effort to
improve European sales through a stronger sales structure. Our net revenues
derived from customers located in other geographic areas decreased slightly to
$1.6 million or 3.3% of net revenues for the year ended June 30, 2003 from $1.7
million or 2.9% of net revenues for the year ended June 30, 2002. We experienced
a slight decline in our quarterly net revenues during fiscal 2003, although we
began to show a year over year quarterly revenue improvement in the fourth
quarter of fiscal 2003.
23
Gross Profit
Gross profit represents net revenues less cost of revenues. Cost of
revenues consists primarily of the cost of raw material components, subcontract
labor assembly from outside manufacturers, amortization of purchased intangible
assets, establishing inventory reserves for excess and obsolete products or raw
materials and overhead costs. As part of an agreement with Gordian, an outside
research and development firm, a royalty charge was included in cost of revenues
and was calculated based on the related products sold. Gordian royalties were
$1.2 million for the year ended June 30, 2002. No royalties were paid for the
year ended June 30, 2003 as a result of a new Gordian agreement as described
below. Cost of revenues for the years ended June 30, 2003 and 2002 consisted of
$4.0 million and $2.4 million of amortization of purchased intangible assets,
respectively. Cost of revenues for the years ended June 30, 2003 and 2002 also
includes a $3.9 million and $6.4 million impairment charge of purchased
intangible assets, respectively, in accordance with SFAS No. 144. At June 30,
2003, the unamortized balance of purchased intangible assets that will be
amortized to future cost of revenues was $5.0 million, of which $2.3 million
will be amortized in fiscal 2004, $1.7 million in fiscal 2005, $816,000 in
fiscal 2006 and $129,000 in fiscal 2007.
In May 2002, we signed a new agreement with Gordian to acquire a joint
interest in the intellectual property that is evident in our products designed
by Gordian and to extinguish our obligation to pay royalties on future sales of
our products. We paid $6.0 million for this intellectual property and are
amortizing this asset to cost of revenues over the remaining life of our
products designed by Gordian, or approximately 3 years. Effective May 30, 2002,
upon the signing of the new agreement, royalty expenses have been replaced by an
amortization of the prepaid royalties and entitlement to the intellectual
property that was part of the agreement. Amortization expense related to the new
Gordian agreement, included in amortization of purchased intangible assets of
$4.0 million totaled $2.5 million for the year ended June 30, 2003. Amortization
expense related to the new Gordian agreement, included in amortization of
purchased intangible assets of $2.4 million totaled $212,000 for the year ended
June 30, 2002.
Gross profit decreased by $5.2 million, or 30.5%, to $11.9 million or 24.0%
of net revenues for the year ended June 30, 2003 from $17.1 million or 29.7% of
net revenues for the year ended June 30, 2002. The overall decrease in gross
profit is primarily attributable to a decrease in net revenues, an increase in
the amortization of purchased intangible assets relating to technology acquired
in our acquisitions, an increase in production expenses related to the closing
of our Milford, Connecticut facility and an increase in our reserves for excess
and obsolete inventory and warranty.
Selling, General and Administrative
Selling, general and administrative expenses consist primarily of
personnel-related expenses including salaries and commissions, facilities
expenses, information technology, trade show expenses, advertising, and
professional legal and accounting fees. Selling, general and administrative
expenses decreased $10.9 million, or 26.2%, to $30.6 million or 61.9% of net
revenues for the year ended June 30, 2003 from $41.6 million or 72.1% of net
revenues for the year ended June 30, 2002. Selling, general and administrative
expense decreased primarily due to reductions in headcount and facility costs as
a result of our restructurings in the second quarter of fiscal 2002 and the
first and third quarters of fiscal 2003, as well as a favorable settlement of a
contractual service obligation and a reduction in our allowance for doubtful
accoun