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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO ___________.
COMMISSION FILE NUMBER: 1-16027
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LANTRONIX, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0362767
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
15353 BARRANCA PARKWAY, IRVINE, CALIFORNIA
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
92618
(ZIP CODE)
------------------------
(949) 453-3990
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Former name, former address and former fiscal year, if changed since last
report: N/A
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(D) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined by Rule 12b-2 of the Exchange Act). Yes |_| No |X|.
As of January 21, 2005 58,238,149 shares of the Registrant's common stock
were outstanding.
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LANTRONIX, INC.
FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2004
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION............................................. 3
Item 1. Financial Statements.............................................. 3
Unaudited Condensed Consolidated Balance Sheets at December 31,
2004 and June 30, 2004......................................... 3
Unaudited Condensed Consolidated Statements of Operations for
the Three and Six Months Ended December 31, 2004 and 2003...... 4
Unaudited Condensed Consolidated Statements of Cash Flows for
the Six Months Ended December 31, 2004 and 2003................ 5
Notes to Unaudited Condensed Consolidated Financial Statements.... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk........ 31
Item 4. Controls and Procedures........................................... 31
PART II. OTHER INFORMATION................................................. 32
Item 1. Legal Proceedings................................................. 32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds....... 32
Item 3. Defaults Upon Senior Securities................................... 32
Item 4. Submission of Matters to a Vote of Security Holders............... 32
Item 5. Other Information................................................. 32
Item 6. Exhibits ......................................................... 32
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
DECEMBER 31, JUNE 30,
2004 2004
----------- -----------
ASSETS
------
Current assets:
Cash and cash equivalents ......................................... $ 7,606 $ 9,128
Marketable securities ............................................. 625 3,050
Accounts receivable, net .......................................... 3,591 3,242
Inventories ....................................................... 6,115 6,677
Contract manufacturers receivable, net ............................ 771 999
Settlement receivable ............................................. 1,200 -
Prepaid expenses and other current assets ......................... 1,289 1,450
----------- -----------
Total current assets ............................................ 21,197 24,546
Property and equipment, net ........................................... 561 865
Goodwill .............................................................. 9,488 9,488
Purchased intangible assets, net ...................................... 1,279 2,056
Officer loans ......................................................... 113 110
Other assets .......................................................... 191 185
----------- -----------
Total assets .................................................... $ 32,829 $ 37,250
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Bank line of credit ............................................... $ 250 $ 500
Accounts payable .................................................. 4,504 4,049
Accrued payroll and related expenses .............................. 1,811 1,599
Warranty reserve .................................................. 1,810 1,770
Restructuring reserve ............................................. 386 752
Accrued settlement ................................................ 1,200 -
Other current liabilities ......................................... 2,785 2,922
Convertible note payable .......................................... - 867
----------- -----------
Total liabilities ............................................... 12,746 12,459
Commitments and contingencies ......................................... - -
Stockholders' equity:
Preferred stock, $0.0001 par value; 5,000,000 shares authorized;
none issued and outstanding .................................... - -
Common stock, $0.0001 par value; 200,000,000 shares authorized;
58,238,149 and 58,154,747 shares issued and outstanding at
December 31, 2004 and June 30, 2004, respectively .............. 6 6
Additional paid-in capital ........................................ 181,231 180,712
Deferred compensation ............................................. (30) (103)
Accumulated deficit ............................................... (161,512) (156,078)
Accumulated other comprehensive income ............................ 388 254
----------- -----------
Total stockholders' equity ...................................... 20,083 24,791
----------- -----------
Total liabilities and stockholders' equity ...................... $ 32,829 $ 37,250
=========== ===========
See accompanying notes.
3
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------- ----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Net revenues (A) ................................................. $ 12,908 $ 12,498 $ 23,953 $ 24,699
Cost of revenues (B) ............................................. 6,652 6,854 12,140 12,899
--------- --------- --------- ---------
Gross profit ..................................................... 6,256 5,644 11,813 11,800
--------- --------- --------- ---------
Operating expenses:
Selling, general and administrative (C) ...................... 6,732 5,192 13,636 11,455
Research and development (C) ................................. 1,423 1,758 3,720 3,545
Stock-based compensation (B) (C) ............................. 107 63 287 218
Amortization of purchased intangible assets .................. 19 45 48 89
--------- --------- --------- ---------
Total operating expenses ......................................... 8,281 7,058 17,691 15,307
--------- --------- --------- ---------
Loss from operations ............................................. (2,025) (1,414) (5,878) (3,507)
Interest income, net ............................................. 7 11 16 35
Other income (expense), net ...................................... 472 (10) 542 (180)
--------- --------- --------- ---------
Loss before income taxes ......................................... (1,546) (1,413) (5,320) (3,652)
Provision for income taxes ....................................... 109 103 170 136
--------- --------- --------- ---------
Loss from continuing operations .................................. (1,655) (1,516) (5,490) (3,788)
Income (loss) from discontinued operations ....................... - (3,739) 56 (4,516)
--------- --------- --------- ---------
Net loss ......................................................... $ (1,655) $ (5,255) $ (5,434) $ (8,304)
========= ========= ========= =========
Basic and diluted net income (loss) per share
Loss from continuing operations .............................. $ (0.03) $ (0.03) $ (0.09) $ (0.07)
Income (loss) from discontinued operations ................... - (0.06) - (0.08)
--------- --------- --------- ---------
Basic and diluted net loss per share ............................. $ (0.03) $ (0.09) $ (0.09) $ (0.15)
========= ========= ========= =========
Weighted average shares (basic and diluted) ...................... 58,149 57,098 58,033 55,693
========= ========= ========= =========
(A) Includes net revenues from related parties ................... $ 296 $ 491 $ 614 $ 802
========= ========= ========= =========
(B) Cost of revenues includes the following:
Amortization of purchased intangible assets ............... $ 364 $ 532 $ 729 $ 1,064
Stock-based compensation .................................. - 10 - 27
--------- --------- --------- ---------
$ 364 $ 542 $ 729 $ 1,090
========= ========= ========= =========
(C) Stock-based compensation is excluded from the following:
Selling, general and administrative expenses .............. $ 91 $ 75 $ 148 $ 188
Research and development expenses ......................... 16 (12) 139 30
--------- --------- --------- ---------
$ 107 $ 63 $ 287 $ 218
========= ========= ========= =========
See accompanying notes.
4
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
SIX MONTHS ENDED
DECEMBER 31,
----------------------
2004 2003
--------- ---------
Cash flows from operating activities:
Net loss .................................................................... $ (5,434) $ (8,304)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation ............................................................. 391 949
Amortization of purchased intangible assets .............................. 777 1,153
Stock-based compensation ................................................. 287 245
Provision for doubtful accounts .......................................... 221 (76)
Provision for inventory reserve .......................................... (69) (561)
Loss on sale of fixed assets ............................................. - 20
Equity losses from unconsolidated businesses ............................. - 413
Restructuring recovery ................................................... (56) -
Changes in operating assets and liabilities:
Accounts receivable ................................................... (570) (71)
Inventories ........................................................... 631 874
Contract manufacturers receivable ..................................... 228 574
Prepaid expenses and other current assets ............................. 161 1,853
Other assets .......................................................... (9) 10
Accounts payable ...................................................... 455 (1,880)
Due to Gordian ........................................................ - (1,000)
Warranty reserve ...................................................... 40 96
Restructuring reserve ................................................. (310) (152)
Other current liabilities ............................................. 75 1,504
Net assets of discontinued operations ................................. - 3,340
--------- ---------
Net cash used in operating activities ....................................... (3,182) (1,013)
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment, net .................................. (82) (122)
Payment of convertible note .............................................. (867) --
Purchases of marketable securities ....................................... (1,000) (302)
Proceeds from sale of marketable securities .............................. 3,425 4,052
--------- ---------
Net cash provided by investing activities ................................... 1,476 3,628
--------- ---------
Cash flows from financing activities:
Net proceeds from issuances of common stock .............................. 306 202
Payment of line of credit ................................................ (250) -
--------- ---------
Net cash provided by financing activities ................................... 56 202
--------- ---------
Effect of foreign exchange rates on cash .................................... 128 108
--------- ---------
Increase (decrease) in cash and cash equivalents ............................ (1,522) 2,925
Cash and cash equivalents at beginning of period ............................ 9,128 7,328
--------- ---------
Cash and cash equivalents at end of period .................................. $ 7,606 $ 10,253
========= =========
See accompanying notes.
5
LANTRONIX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
1. BASIS OF PRESENTATION
The condensed consolidated financial statements included herein are
unaudited. They contain all normal recurring accruals and adjustments which, in
the opinion of management, are necessary to present fairly the consolidated
financial position of Lantronix, Inc. and its subsidiaries (collectively, the
"Company") at December 31, 2004, the consolidated results of its operations for
the three and six months ended December 31, 2004 and 2003, and its cash flows
for the six months ended December 31, 2004 and 2003. All intercompany accounts
and transactions have been eliminated. It should be understood that accounting
measurements at interim dates inherently involve greater reliance on estimates
than at year-end. The results of operations for the three and six months ended
December 31, 2004 are not necessarily indicative of the results to be expected
for the full year or any future interim periods.
These financial statements do not include certain footnotes and financial
presentations normally required under generally accepted accounting principles.
Therefore, they should be read in conjunction with the audited consolidated
financial statements and notes thereto for the year ended June 30, 2004,
included in the Company's Annual Report on Form 10-K/A filed with the Securities
and Exchange Commission ("SEC") on October 12, 2004.
In March 2004, the Company completed the sale of substantially all of the
net assets of Premise Systems, Inc. ("Premise") (Note 8). The Company's
condensed consolidated financial statements have been presented to reflect
Premise as a discontinued operation for all periods presented.
STOCK-BASED COMPENSATION
The Company has in effect several stock-based plans under which
non-qualified and incentive stock options have been granted to employees,
non-employee board members and other non-employees. The Company also has an
employee stock purchase plan for all eligible employees. The Company accounts
for stock-based awards to employees in accordance with APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations, and has
adopted the disclosure-only alternative of SFAS No. 123, and SFAS No. 148,
"Accounting for Stock-Based Compensation-Transition and Disclosure." Options
granted to non-employees, as defined, have been accounted for at fair market
value in accordance with SFAS No. 123.
In accordance with the disclosure requirements of SFAS No. 123, set forth
below are the assumptions used and pro forma statement of operations data of the
Company giving effect to valuing stock-based awards to employees using the
Black-Scholes option pricing model instead of the guidelines provided by APB No.
25. Among other factors, the Black-Scholes model considers the expected life of
the option and the expected volatility of the Company's stock price in arriving
at an option valuation.
The results of applying the requirements of the disclosure-only alternative
of SFAS No. 123 to the Company's stock-based awards to employees would
approximate the following (in thousands, except per share data):
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------- ----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Net loss - as reported ................................................ $ (1,655) $ (5,255) $ (5,434) $ (8,304)
Add: Stock-based compensation expense included in net loss - as
reported, net of related tax effects ............................... 107 73 287 245
Deduct: Stock-based compensation expense determined under fair value
method, net of related tax effects ................................. (370) (830) (816) (1,783)
--------- --------- --------- ---------
Net loss - pro forma .................................................. $ (1,918) $ (6,012) $ (5,963) $ (9,842)
========= ========= ========= =========
Net loss per share (basic and diluted) - as reported .................. $ (0.03) $ (0.09) $ (0.09) $ (0.15)
========= ========= ========= =========
Net loss per share (basic and diluted) - pro forma .................... $ (0.03) $ (0.11) $ (0.10) $ (0.18)
========= ========= ========= =========
6
2. ACCOUNTING PRONOUNCEMENTS
In November 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 151, "Inventory Costs -
An Amendment of ARB No. 43, Chapter 4." This new standard is the result of a
broader effort by the FASB to improve financial reporting by eliminating
differences between generally accepted accounting principles ("GAAP") in the
United States and accounting principles developed by the International
Accounting Standards Board ("IASB"). As part of this effort, the FASB and the
IASB identified opportunities to improve financial reporting by eliminating
certain narrow differences between their existing accounting standards. SFAS No.
151 clarifies that abnormal amounts of idle facility expense, freight handling
costs and spoilage costs should be expensed as incurred and not included in
overhead. Further, SFAS No. 151 requires that allocation of fixed production
overheads to conversion costs should be based on normal capacity of the
production facilities. The provisions in SFAS No. 151 are effective for
inventory costs incurred during fiscal years beginning after June 15, 2005.
Companies must apply the standard prospectively. Management does not expect the
adoption of SFAS No. 151 to have a material impact on the Company's financial
position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 123R, "Share Based Payment," a
revision to SFAS 123, "Accounting for Stock-Based Compensation," and supersedes
APB Opinion No. 25, "Accounting for Stock Issued to Employees," and its related
implementation guidance. SFAS No. 123R establishes standards for the accounting
for transactions in which an entity exchanges instruments for goods or services.
It also addresses transactions in which an entity incurs liabilities in exchange
for goods or services that are based on the fair value of the entity's equity
instruments or that may be settled by the issuance of those equity instruments.
SFAS 123R established the accounting treatment for transactions in which an
entity obtains employee services in share-based payment transactions. SFAS 123R
requires companies to recognize in the statement of operations the grant-date
fair value of stock options and other equity-based compensation issued to
employees. SFAS 123R requires the Company to value the share-based compensation
based on the classification of the share-based award. If the share-based award
is to be classified as a liability, the Company must re-measure the award at
each balance sheet date until the award is settled. If the share-based award is
to be classified as equity, the Company will measure the value of the
share-based award on the date of grant but the award will not be re-measured at
each balance sheet date. SFAS 123R does not change the accounting guidance for
share-based payment transactions with parties other than employees provided in
SFAS 123 as originally issued and EITF Issue No. 96-18, "Accounting for Equity
Instruments that are Issued to Other than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services." SFAS 123R is effective for public
companies that do not file as small business issuers as of the beginning of
interim or annual reporting periods that begin after June 15, 2005 (the
effective date for small business issuers is December 15, 2005). All public
companies must use either the modified prospective or modified retrospective
transition method. Under the modified prospective method, awards that are
granted, modified, or settled after the date of adoption should be measured and
accounted for in accordance with SFAS 123R. Unvested equity classified awards
that were granted prior to the effective date should continue to be accounted
for in accordance to SFAS 123 except that the amounts must be recognized in the
statement of operations. Under the modified retrospective method, the previously
reported amounts are restated (either to the beginning of the year of adoption
or for all periods presented) to reflect SFAS 123 amounts in the statement of
operations. Management is in the process of determining the effect SFAS 123R
will have upon the Company's financial position and statement of operations.
Other recent accounting pronouncements issued by the FASB (including its
Emerging Issues Task Force), the American Institute of Certified Public
Accountants and the Securities and Exchange Commission (the "SEC") did not or
are not believed by management to have a material impact on the Company's
present or future consolidated financial statements.
3. NET LOSS PER SHARE
Basic net loss per share is calculated by dividing net loss from continuing
operations, net income (loss) from discontinued operations, and net loss by the
weighted average number of common shares outstanding during the period. Diluted
net loss per share is calculated by adjusting outstanding shares assuming any
dilutive effects of options. However, for periods in which the Company incurred
a net loss, these shares are excluded because their effect would be to reduce
recorded net loss per share.
4. MARKETABLE SECURITIES
The Company classifies its marketable securities as available for sale.
Marketable securities consist of obligations of municipal bonds which can
readily be converted to cash.
7
5. INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out) or market
and consist of the following (in thousands):
DECEMBER 31, JUNE 30,
2004 2004
--------- ---------
Raw materials ...................................... $ 4,464 $ 4,047
Finished goods ..................................... 6,288 7,368
Inventory at distributors .......................... 1,212 1,291
--------- ---------
11,964 12,706
Reserve for excess and obsolete inventory .......... (5,849) (6,029)
--------- ---------
$ 6,115 $ 6,677
========= =========
6. GOODWILL AND PURCHASED INTANGIBLE ASSETS
The composition of purchased intangible assets is as follows (in
thousands):
DECEMBER 31, 2004 JUNE 30, 2004
---------------------------------- ----------------------------------
USEFUL ACCUMULATED ACCUMULATED
LIVES GROSS AMORTIZATION NET GROSS AMORTIZATION NET
--------- --------- ------------ --------- --------- ------------ ---------
Existing technology ......... 1-5 years $ 7,090 $ (5,829) $ 1,261 $ 7,090 $ (5,101) $ 1,989
Patent/core technology ...... 5 405 (392) 13 405 (365) 40
Tradename/trademark ......... 5 32 (27) 5 32 (24) 8
Non-compete agreements ...... 2-3 140 (140) 0 140 (121) 19
--------- --------- --------- --------- --------- ---------
Total ................. $ 7,667 $ (6,388) $ 1,279 $ 7,667 $ (5,611) $ 2,056
========= ========= ========= ========= ========= =========
The amortization expense for purchased intangible assets for the three
months ended December 31, 2004 was approximately $383,000, of which
approximately $364,000 was amortized to cost of revenues and approximately
$19,000 was amortized to operating expenses. The amortization expense for
purchased intangible assets for the three months ended December 31, 2003 was
approximately $577,000 of which approximately $532,000 was amortized to cost of
revenues and approximately $45,000 was amortized to operating expenses. The
amortization expense for purchased intangible assets for the six months ended
December 31, 2004 was approximately $777,000, of which approximately $729,000
was amortized to cost of revenues and approximately $48,000 was amortized to
operating expenses. The amortization expense for purchased intangible assets for
the six months ended December 31, 2003 was approximately $1.2 million of which
approximately $1.1 million was amortized to cost of revenues and approximately
$100,000 was amortized to operating expenses. The estimated amortization expense
for the remainder of fiscal 2005 and the next year is as follows:
COST OF OPERATING
Fiscal year ending June 30: REVENUES EXPENSES TOTAL
-------- -------- --------
2005 (Remainder of fiscal year) ....... $ 704 $ 16 $ 720
2006 .................................. 557 2 559
-------- -------- --------
Total ................................. $ 1,261 $ 18 $ 1,279
======== ======== ========
The goodwill balance as of both December 31, 2004 and June 30, 2004 was
$9.5 million. Goodwill was recorded as a result of acquisitions over the years.
The current carrying value of goodwill is related to the acquisitions of
Lightwave and Stallion businesses. The Company performs an annual impairment
test of Goodwill under the guidelines of SFAS No. 142 in April.
8
7. RESTRUCTURING RESERVE
A summary of the activity in the restructuring reserve account is as
follows (in thousands):
RESTRUCTURING CASH RESTRUCTURING
RESERVE AT CHARGES RESERVE AT
JUNE 30, AGAINST RESTRUCTURING DECEMBER 31,
2004 RESERVE RECOVERY 2004
--------- --------- --------- ---------
Consolidation of excess facilities .... $ 752 $ (310) $ (56) $ 386
========= ========= ========= =========
On September 12, 2002 and March 14, 2003, the Company announced a
restructuring plan to prioritize its initiatives around the growth areas of its
business, focus on profit contribution, reduce expenses, and improve operating
efficiency. These restructuring plans included a worldwide workforce reduction,
consolidation of excess facilities and other charges. The Company recorded
restructuring costs totaling $5.6 million, which were classified as operating
expenses in the Company's consolidated statement of operations for the year
ended June 30, 2003. These restructuring plans resulted in the termination of
approximately 58 regular employees worldwide. The Company recorded workforce
reduction charges of approximately $1.2 million related to severance and fringe
benefits for the terminated employees. The Company recorded charges of
approximately $4.4 million related to consolidation of excess facilities,
relating primarily to lease terminations, non-cancelable lease costs, and
write-off of leasehold improvements and termination of a contractual obligation.
During the quarter ended March 31, 2004, restructuring charges were
adjusted, including an increase of lease obligations of $409,000 related to the
consolidation of excess facilities from the September 12, 2002 and March 14,
2003 restructuring plans, which were previously accrued for in fiscal year 2003.
The remaining restructuring reserve is related to facility closures in
Naperville, Illinois; Hillsboro, Oregon; and Ames, Iowa. Payments under the
lease obligations will end in fiscal 2007.
8. DISCONTINUED OPERATIONS
In August 2001, the FASB issued SFAS No. 144. SFAS No. 144 supersedes SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of"; however, it retains the fundamental provisions of
that statement related to the recognition and measurement of the impairment of
long-lived assets to be "held and used." SFAS No. 144 also supersedes the
accounting and reporting provisions of APB Opinion No. 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," for the disposal of a segment of a business. Under SFAS No. 144,
a component of a business is held for sale and is reported in discontinued
operations if (i) the operations and cash flows will be, or have been,
eliminated from the ongoing operations of the company, and (ii) the company will
not have any significant continuing involvement in such operations.
In March 2004, the Company completed the sale of substantially all of the
net assets of its Premise business unit for $1.0 million. Additionally, the
Company incurred $383,000 of disposal costs. As a result of the sale of the
Premise business unit, the net goodwill and purchased intangibles of Premise at
December 31, 2003 have been included as part of discontinued operations.
The net revenues and loss from discontinued operations are as follows (in
thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------- ---------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Net revenues .................................................................. $ - $ 33 $ - $ 63
========= ========= ========= =========
Income (loss) from discontinued operations, net of income taxes of $0 ......... $ - $ (3,739) $ 56 $ (4,516)
========= ========= ========= =========
Basic and diluted net income (loss) per share from discontinued operations .... $ - $ (0.06) $ - $ (0.08)
========= ========= ========= =========
9
9. WARRANTY
Upon shipment to its customers, the Company provides for the estimated cost
to repair or replace products to be returned under warranty. The Company's
current warranty periods generally range from ninety days to two years from the
date of shipment. In addition, the Company also sells extended warranty services
which extend the warranty period for an additional one to three years. The
following table is a reconciliation of the changes to the product warranty
liability for the period presented:
SIX MONTHS
ENDED
DECEMBER 31,
2004
---------
Balance beginning of period ........................... $ 1,770
Charged to cost of revenues ........................... 247
Deductions ............................................ (207)
---------
Balance end of period ................................. $ 1,810
=========
10. PROVISION FOR INCOME TAXES AND EFFECTIVE TAX RATE
The Company utilizes the liability method of accounting for income taxes as
set forth in SFAS No. 109, "Accounting for Income Taxes." The Company's
effective tax rate was 3% and 4% for the six month periods ended December 31,
2004 and 2003, respectively. The Company's condensed consolidated financial
statements have been presented to reflect Premise as a discontinued operation
for all periods presented. The federal statutory rate was 34% for both periods.
The effective tax rate associated with the income tax expense for both the six
month periods ended December 31, 2004 and 2003 was lower than the federal
statutory rate primarily due to an increase in the valuation allowance, due to
our inability to estimate future taxable income, and foreign taxes. In 2003, the
Internal Revenue Service completed its audit of the Company's federal income tax
returns for the years ended June 30, 1999, 2000 and 2001. As a result, the
Company paid tax and interest to the IRS and the California Franchise Tax Board
of approximately $222,000, $441,000 and $113,000 in quarters ended March 31,
2004, June 30, 2004 and September 30, 2004, respectively.
The Company is under current discussions with the Swiss Federal Tax
Authorities ("SFTA") regarding the inability of the Company's Swiss subsidiary,
Lantronix International AG, to meet certain guidelines as set within a tax
ruling that was obtained in May 2001. The ruling provided for reduced Swiss tax
rates. The subsidiary was unable to meet the guidelines set forth in the ruling
due to slower than planned growth in this subsidiary, consistent with the
overall Company, and has since converted to a holding company. Based on recent
discussions with the SFTA, the Company estimates the potential tax exposure to
be approximately $53,000, and the Company has provided for this in the
consolidated financial statements for quarter ended December 31, 2004.
11. BANK LINE OF CREDIT AND DEBT
In January 2002, the Company entered into a two-year line of credit with a
bank in an amount not to exceed $20.0 million. Borrowings under the line of
credit bear interest at either, (i) the prime rate or (ii) the LIBOR rate plus
2.0%. The Company was required to pay a $100,000 facility fee which was reduced
to $62,500 and was paid. The Company was also required to pay a quarterly unused
line fee of .125% of the unused line of credit balance. Since establishing the
line of credit, the Company has twice reduced the amount of the line, modified
customary financial covenants, and adjusted the interest rate to be charged on
borrowings to the prime rate plus .50% and eliminated the LIBOR option.
Effective July 25, 2003, the Company further modified this line of credit,
reducing the revolving line to $5.0 million, and adjusting the customary
affirmative and negative covenants. The Company is also required to maintain
certain financial ratios as defined in the agreement. The agreement has an
annual revolving maturity date that renews on the effective date. The agreement
was renewed on July 24, 2004 with an amendment to a financial ratio. The Company
paid a $12,500 facility fee for the renewal. The Company's borrowing base at
December 31, 2004 was $3.6 million. As of December 31, 2004 the Company had
borrowed $250,000 against this line of credit. Additionally, the Company has
used letters of credit available under its line of credit totaling approximately
$451,000 in place of cash to fund deposits on leases, tax account deposits and
security deposits. As a result, the Company's available line of credit at
December 31, 2004 was $2.9 million. The Company is currently in compliance with
the revised financial covenants of the July 24, 2004 amended line of credit.
Pursuant to the line of credit, the Company is restricted from paying any
dividends.
10
The Company issued a two-year note in the principal amount of $867,000 as a
result of its acquisition of Stallion, accruing interest at a rate of 2.5% per
annum. Interest expense related to the note totaled approximately $5,000 and
$11,000 for the six months ended December 31, 2004 and 2003, respectively. The
notes were convertible into the Company's common stock at any time, at the
election of the holders, at a $5.00 conversion price. The notes were due and
paid in August 2004 as the holders elected not to convert the notes into the
Company's common stock.
12. COMPREHENSIVE LOSS
SFAS No. 130, "Reporting Comprehensive Income (Loss)," establishes
standards for reporting and displaying comprehensive income (loss) and its
components in the condensed consolidated financial statements.
The components of comprehensive loss are as follows (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------- ----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Net loss ................................................................. $ (1,655) $ (5,255) $ (5,434) $ (8,304)
Other comprehensive loss:
Change in accumulated translation adjustments, net of taxes of $0 ..... 114 97 133 108
--------- --------- --------- ---------
Total comprehensive loss ................................................. $ (1,541) $ (5,158) $ (5,301) $ (8,196)
========= ========= ========= =========
13. LITIGATION
GOVERNMENT INVESTIGATION
The Securities and Exchange Commission is conducting a formal investigation
of the events leading up to the Company's restatement of its financial
statements on June 25, 2002. The Department of Justice is also conducting an
investigation concerning events related to the restatement.
CLASS ACTION LAWSUITS
Beginning on May 15, 2002, a number of securities class actions were filed
against the Company and certain of its current and former directors and former
officers alleging violations of the federal securities laws. These actions were
consolidated into a single action pending in the United States District Court
for the Central District of California and entitled: In re Lantronix, Inc.
Securities Litigation, Case No. CV 02-3899 GPS (JTLx). After the Court appointed
a lead plaintiff, amended complaints were filed by the plaintiff, and the
defendants filed various motions to dismiss directed at particular allegations.
Through that process, certain of the allegations were dismissed by the Court.
On October 18, 2004, the plaintiff filed the third amended complaint, which
is now the operative complaint in the action. The Complaint alleges violations
of Sections 11 and 15 of the Securities Act of 1933 and violations of Sections
10(b) and 20(a) and Rule 10b-5 of the Securities Exchange Act of 1934. The 1933
Act claims are brought on behalf of all persons who purchased common stock of
Lantronix pursuant or traceable to the Company's August 4, 2000 initial public
offering ("IPO"). The 1934 Act claims are based on alleged misstatements related
to the Company's financial results that were contained in the Registration
Statement and Prospectus for the IPO. The claims brought under the 1934 Act are
brought on behalf of all persons and entities that purchased or acquired
Lantronix securities from November 1, 2000 through May 30, 2002 (the "Class
Period"). The Complaint alleges that defendants issued false and misleading
statements concerning the business and financial condition in order to allegedly
inflate the value of the Company's securities during the Class Period. The
complaint alleges that during the Class Period, Lantronix overstated financial
results through improper revenue recognition and failure to comply with GAAP.
Defendants have filed an answer to the complaint and the case is now in
discovery. The Court has set a trial date in September 2006. While the complaint
does not specify the damages plaintiff may seek on behalf of the purported
classes of shareholders, a recovery by the plaintiff and the plaintiff classes
could have a material adverse impact on the Company.
DERIVATIVE LAWSUIT
On July 26, 2002, Samuel Ivy filed a shareholder derivative complaint
entitled: Ivy v. Bernhard Bruscha, et al., No. 02CC00209, in the Superior Court
of the State of California, County of Orange, against certain of the Company's
current and former directors and former officers. On January 7, 2003, the
plaintiff filed an amended complaint. The amended complaint alleges causes of
action for breach of fiduciary duty, abuse of control, gross mismanagement,
unjust enrichment, and improper insider stock sales. The complaint seeks
unspecified damages against the individual defendants on the Company's behalf,
equitable relief, and attorneys' fees. All defendants have answered the
complaint and generally denied the allegations. Discovery has commenced, but no
trial date has been established.
11
All of the parties except for Steve Cotton have agreed in principle to
settle the action. Specifically, the Company's Board recently approved a
tentative settlement proposal which involves the adoption of certain corporate
governance measures and payment of attorneys' fees and expenses to the
derivative plaintiff's counsel in the amount of $1.2 million. The settling
parties are seeking court approval of the settlement. If Mr. Cotton does not
agree to join the settlement, Plaintiff as part of the settlement has agreed to
seek dismissal of all of the defendants, including Mr. Cotton. The settlement is
subject to a number of conditions, including court approval of the proposed
settlement. We have recorded a liability in our financial statements for the
proposed amount of the settlement. In addition, because the insurance carrier
involved in this suit agreed to pay the entire $1.2 million settlement amount
and, therefore, recovery from the insurance carrier is probable, a receivable
was also recorded for the same amount. Accordingly, there is no impact to the
statement of operations because the amounts of the settlement and the insurance
recovery fully offset each other.
EMPLOYMENT SUIT BROUGHT BY FORMER CHIEF FINANCIAL OFFICER AND CHIEF OPERATING
OFFICER STEVE COTTON
On September 6, 2002, Steve Cotton, the Company's former CFO and COO, filed
a complaint entitled Cotton v. Lantronix, Inc., et al., No. 02CC14308, in the
Superior Court of the State of California, County of Orange. The complaint
alleges claims for breach of contract, breach of the covenant of good faith and
fair dealing, wrongful termination, misrepresentation, and defamation. The
complaint seeks unspecified damages, declaratory relief, attorneys' fees and
costs.
The Company filed a motion to dismiss on October 16, 2002, on the grounds
that Mr. Cotton's complaints are subject to the binding arbitration provisions
in Mr. Cotton's employment agreement. On January 13, 2003, the Court ruled that
five of the six counts in Mr. Cotton's complaint are subject to binding
arbitration. The court is staying the sixth count, for declaratory relief, until
the underlying facts are resolved in arbitration. No arbitration date has been
set.
SECURITIES CLAIMS BROUGHT BY FORMER SHAREHOLDERS OF SYNERGETIC MICRO SYSTEMS,
INC. ("SYNERGETIC")
On October 17, 2002, Richard Goldstein and several other former
shareholders of Synergetic filed a complaint entitled Goldstein, et al. v.
Lantronix, Inc., et al. in the Superior Court of the State of California, County
of Orange, against the Company and certain of its former officers and directors.
Plaintiffs filed an amended complaint on January 7, 2003. The amended complaint
alleges fraud, negligent misrepresentation, breach of warranties and covenants,
breach of contract and negligence, all stemming from its acquisition of
Synergetic. The complaint seeks an unspecified amount of damages, interest,
attorneys' fees, costs, expenses, and an unspecified amount of punitive damages.
On May 5, 2003, the Company answered the complaint and generally denied the
allegations in the complaint. Discovery has commenced and the court has set a
trial date in March 2006.
PATENT INFRINGEMENT LITIGATION
On April 13, 2004, Digi International Inc. ("Digi") filed a complaint
against the Company in the U.S. District Court in Minnesota. The complaint
alleges that certain of the Company's products infringe Digi's U.S. Patent No.
6,446,192. The complaint seeks both monetary and non-monetary relief. The
Company has filed an answer and counterclaim alleging invalidity of the patent.
The counterclaim seeks both monetary and non-monetary relief.
On May 3, 2004, the Company filed a complaint against Digi in the U.S.
District Court for the Central District of California. The complaint alleges
that certain of Digi's products infringe the Company's U.S. Patent No.
6,571,305. The Complaint seeks both monetary and non-monetary relief. Digi has
filed an answer and counterclaim alleging invalidity of the patent. The
counterclaim seeks both monetary and non-monetary relief.
OTHER
From time to time, the Company is subject to other legal proceedings and
claims in the ordinary course of business. The Company is currently not aware of
any such legal proceedings or claims that it believes will have, individually or
in the aggregate, a material adverse effect on its business, prospects,
financial position, operating results or cash flows.
The pending lawsuits involve complex questions of fact and law and likely
will continue to require the expenditure of significant funds and the diversion
of other resources to defend. Management is unable to determine the outcome of
its outstanding legal proceedings, claims and litigation involving the Company,
its subsidiaries, directors and officers and cannot determine the extent to
which these results may have a material adverse effect on the Company's
business, results of operations and financial condition taken as a whole. The
results of litigation are inherently uncertain, and adverse outcomes are
possible. The Company is unable to estimate the range of possible loss from
outstanding litigation, and no amounts have been provided for such matters in
the consolidated financial statements.
12
14. SUBSEQUENT EVENTS
On February 7, 2005, the Company filed a complaint against Digi in the U.S.
District Court for the Eastern District of Texas. The complaint alleges that
certain of Digi's device server and other server products infringe U.S. Patent
No. 4,972,470. The Company is the exclusive licensee of this patent in the
device server field of use. The complaint seeks both monetary and non-monetary
relief.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
You should read the following discussion and analysis in conjunction with
the Unaudited Condensed Consolidated Financial Statements and related Notes
thereto contained elsewhere in this Report. The information in this Quarterly
Report on Form 10-Q is not a complete description of our business or the risks
associated with an investment in our common stock. We urge you to carefully
review and consider the various disclosures made by us in this Report and in
other reports filed with the Securities and Exchange Commission, including our
Annual Report on Form 10-K/A for the fiscal year ended June 30, 2004 and our
subsequent reports on Form 8-K that discuss our business in greater detail.
The section entitled "Risk Factors" set forth below, and similar
discussions in our other SEC filings, discuss some of the important factors that
may affect our business, results of operations and financial condition. You
should carefully consider those factors, in addition to the other information in
this Report and in our other filings with the SEC, before deciding to invest in
our company or to maintain or increase your investment.
This report contains forward-looking statements which include, but are not
limited to, statements concerning projected net revenues, expenses, gross profit
and income (loss), the need for additional capital, market acceptance of our
products, our ability to consummate acquisitions and integrate their operations
successfully, our ability to achieve further product integration, the status of
evolving technologies and their growth potential and our production capacity.
These forward-looking statements are based on our current expectations,
estimates and projections about our industry, our beliefs and certain
assumptions made by us. Words such as "anticipates," "expects," "intends,"
"plans," "believes," "seeks," "estimates," "may," "will" and variations of these
words or similar expressions are intended to identify forward-looking
statements. In addition, any statements that refer to expectations, projections
or other characterizations of future events or circumstances, including any
underlying assumptions, are forward-looking statements. These statements are not
guarantees of future performance and are subject to certain risks, uncertainties
and assumptions that are difficult to predict. Therefore, our actual results
could differ materially and adversely from those expressed in any
forward-looking statements as a result of various factors. We undertake no
obligation to revise or update publicly any forward-looking statements for any
reason.
OVERVIEW
Lantronix designs, develops and markets products and software solutions
that make it possible to access, manage, control and configure almost any
electronic device over the Internet or other networks. We are a leader in
providing innovative networking solutions. We were initially formed as
"Lantronix," a California corporation, in June 1989. We reincorporated as
"Lantronix, Inc.," a Delaware corporation in May 2000.
We have a history of providing devices that enable information technology
("IT") equipment to network using standard protocols for connectivity, including
fiber optic, Ethernet and wireless. Our first device was a terminal server that
allowed "dumb" terminals to connect to a network. Building on the success of our
terminal servers, we introduced a complete line of print servers in 1991 that
enabled users to inexpensively share printers over a network. Over the years, we
have continually refined our core technology and have developed additional
innovative networking solutions that expand upon the business of providing our
customers network connectivity. With the expansion of networking and the
Internet, our technology focus is increasingly broader, so that our device
solutions provide a product manufacturer with the ability to network their
products within the industrial, service and consumer markets.
We provide three broad categories of products: (i) "device networking
solutions" that enable almost any electronic product to be connected to a
network; (ii) "IT management solutions" that enable multiple pieces of hardware,
usually IT-related network hardware such as servers, routers, switches, and
similar pieces of equipment to be managed over a network; and (iii) "non-core"
products and services that include visualization solutions, legacy print
servers, software revenues, and other miscellaneous products. The expansion of
our business in the future is directed at the first two of these categories,
device networking and IT management solutions. In various discussions and
presentations of our business, we refer to device networking and IT management
solutions as our "core" business from the standpoint they represent our focus on
product and business now, and for the immediate future.
13
Today, our solutions include fully integrated hardware and software
devices, as well as software tools to develop related customer applications.
Because we deal with network connectivity, we provide hardware solutions to
extremely broad market segments, including industrial, medical, commercial,
financial, governmental, retail, building automation, and many more. Our
technology is used to provide networking capabilities to products such as
medical instruments, manufacturing equipment, bar code scanners, building HVAC
systems, process control equipment, thermostats, security panels, temperature
sensors, point of sale terminals, time clocks, and many products that have some
form of standard data control capability. Our current product offerings include
a wide range of hardware devices of varying size, packaging and, where
appropriate, software solutions that allow our customers to network-enable
virtually any electronic product.
THE NATURE OF OUR BUSINESS
Currently, we develop our products through engineering and product
development activities of our research and development organization. In prior
years, most engineering and product development were outsourced with independent
contractors. In fiscal 2003, this practice was discontinued; however, some
product development activities such as specialized technical investigations or
qualification testing of new products is still subcontracted from time to time.
We engage outside contract manufacturers to make our products, which are then
taken to market by our marketing and sales organizations.
We sell our devices through distribution partners to a global network of
distributors, value-added resellers ("VARs"), manufacturers' representatives,
system integrators, and original equipment manufacturers ("OEMs"). In addition,
we sell directly to selected accounts. One distribution customer, Ingram Micro,
accounted for approximately 18.1% and 13.9% of our net revenues for the six
months ended December 31, 2004 and 2003, respectively. Another distribution
customer, Tech Data, accounted for approximately 10.8% and 8.8% of our net
revenues for the six months ended December 31, 2004 and 2003, respectively.
Accounts receivable attributable to these domestic customers accounted for
approximately 19.0% and 12.9% of total accounts receivable at December 31, 2004
and June 30, 2004, respectively.
One international customer, transtec AG, which is a related party due to
common ownership by our largest stockholder and former Chairman of our Board of
Directors, Bernhard Bruscha, accounted for approximately 2.6% and 3.3% of our
net revenues for the six months ended December 31, 2004 and 2003, respectively.
DISCONTINUED OPERATIONS
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). SFAS No. 144
supersedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of"; however, it retains the
fundamental provisions of that statement related to the recognition and
measurement of the impairment of long-lived assets to be "held and used." SFAS
No. 144 also supersedes the accounting and reporting provisions of Accounting
Principles Board ("APB") Opinion No. 30, for the disposal of a segment of a
business. Under SFAS No. 144, a component of a business that is held for sale is
reported in discontinued operations if (i) the operations and cash flows will
be, or have been, eliminated from the ongoing operations of the company, and
(ii) the company will not have any significant continuing involvement in such
operations.
In March 2004, we completed the sale of substantially all of the net assets
of our Premise business unit for $1.0 million. Additionally, we incurred
$383,000 of disposal costs. As a result of the sale of the Premise business
unit, the net goodwill and purchased intangibles of Premise at December 31, 2003
have been included as part of discontinued operations.
SUMMARY OVERVIEW OF THE SECOND FISCAL QUARTER ENDED DECEMBER 31, 2004
The following discussion of results of operations includes discussion of
continuing operations only.
SUMMARY OVERVIEW OF THE SECOND FISCAL QUARTER ENDED DECEMBER 31, 2004
As described in more detail elsewhere in this document, our business has
continued to operate in a manner consistent with the fiscal year ended June 30,
2004 and the first fiscal quarter ended September 30, 2004. Net revenues
increased from $11.0 million for the quarter ended September 30, 2004, to $12.9
million this quarter. The increase of $1.9 million from the prior quarter is
primarily due to increased shipments of our device networking product lines.
Revenues of $12.9 million for the quarter ended December 31, 2004 compared to
revenues of $12.5 million for the same quarter a year earlier. The increase of
$.4 million in revenue is primarily due to increased shipments of our device
networking product lines.
14
Our cash, cash equivalents and marketable securities balances decreased by
$1.0 million, from $9.2 million at September 30, 2004 to $8.2 million at
December 31, 2004. We refer to the sum of these components as "cash" for the
purpose of discussing our liquidity. During the fiscal year ended June 30, 2004,
cash usage totaled $1.9 million. Cash usage increased to $3.0 million in the
first fiscal quarter, which included payments for increased marketing and sales
expenses for new product programs, repayment of a note of $867,000 related to
the Stallion acquisition, audit payments and other costs.
Our gross margin was 48.5% for the quarter ended December 31, 2004,
compared to a gross margin of 45.2% for the same quarter a year earlier and a
gross margin of 50.3% for the quarter ended September 30, 2004. The improvement
in gross margin for the quarter ended December 31, 2004 compared to a year
earlier is primarily due to lower costs related to amortization of intangible
assets that are recorded in cost of revenues; amortization expense for the
quarter decreased to approximately $364,000 compared to approximately $532,000 a
year earlier. These lower amortization costs will continue in future quarters.
For the quarter ended December 31, 2004, we had a loss from continuing
operations of $1.7 million, compared to a loss of $1.5 million for the same
quarter a year earlier. Operating expenses related to continuing operations
increased to $8.3 million for the quarter ended December 31, 2004 from $7.1
million for the same quarter a year earlier. The increase in selling general and
administrative is attributable to legal expenses recognized in the periods;
legal expenses in the quarter ended December 31, 2004 were approximately
$792,000, whereas a year earlier legal expenses were a favorable credit of
approximately $283,000. The liability for legal expenses is booked as incurred
and is reduced from time to time by the receipt of actual reimbursement of
expenses related to shareholder lawsuit matters by our insurance carrier.
OUTLOOK
Revenues for our second fiscal quarter ended December 31, 2004 were $12.9
million, in line with or goals for the period. Although revenues for the prior
quarter ended September 30, 2004 were $11.0 million, we view our most recent
results as a validation of a longer-term trend of increased unit shipments of
our products and revenue growth of our core business of device networking and IT
management solutions.
During the quarter ended December 31, 2004, we continued to reduce our
expenses. In January 2005, we further cut back our staff to continue to reduce
operating costs. We also closed a small sales office in Milford, Connecticut in
January. In addition, we are realigning our international sales operations and
have reduced our fixed costs in Japan and Germany. We anticipate that our cost
reduction initiatives implemented between October 2004 through January 2005 has
lowered our estimated cash breakeven point from $14.0-15.0 million in quarterly
revenue to approximately $13.0 million. Achieving cash breakeven is subject to
many factors, including the cost of on-going litigation and our actual operating
expenses and product margins, and may require more or less than $13.0 million in
revenue per quarter.
We are continuing to invest in the development of new and innovative
products, and to support expanded sales and marketing activities to promote our
recently introduced products. During the past several quarters we introduced
several new products we believe will contribute to growth in revenues. These
products include WiPort, a wireless version of our Xport device server; Wibox, a
wireless external device networking solution; Secure Box, AES-encryption device
networking products; a NEBS -compliant secure console server for
telecommunications applications; a SecureLinx Remote KVM product line designed
to remotely connect IT administrators to their Windows-based equipment and an
SLC line of console servers. There can be an extended delay from the time we
introduce a new product until the time we receive significant revenues. This is
due primarily to the nature of our products, which involve the customers design
cycles, our customers own new product introduction processes, or qualification
and other testing programs they may implement as part of their businesses.
Our device networking business fundamentally targets the market of products
that can be networked together and/or connected to the Internet. We see as
inevitable, a world where myriads of devices are interconnected to enhance their
operation, maintenance, or to provide new functionality. Independent researchers
have made varying estimates as to the size and rate of this expansion. However,
we believe that device networking growth as evidenced by our net revenue growth
or that of our peers is still in the early adoption phase. We believe in the
next several years, the market adoption of our networking solution devices will
be strongest in the commercial and industrial markets such as security, medical,
factory automation, and similar markets, rather than in consumer electronics.
Our IT management business provides remote management solutions to our
customers' IT infrastructure of servers, routers, switches, power supplies, and
other devices that comprise their networks. This business was severely impacted
by the recession of the past several years, and we are just beginning to emerge
from that recession. While we have not yet achieved a high rate of net revenue
growth, we have confidence in our position in this market, and we have recently
introduced new products that we believe are achieving recognition in the
marketplace.
15
We have had a target cash usage of approximately $1.0 million per quarter,
while we are operating at the revenue range of $11.0 to $13.0 million. Our
actual cash usage over the previous six quarters has varied due to a variety of
factors, including factors not related to our business revenues for those
quarters. For example, we incur legal expenses that vary each quarter. Moreover,
we have some expenses that we pay once per year, such as insurance premiums or
audit fees. We have benefited from other cash management activities to improve
cash flow by improving balance sheet accounts over these same periods such as
reducing our inventories. During that same period we have received cash from
specific transactions, such as our sale of Premise and our recovery of legal
expenses through insurance reimbursements. We have also exchanged deposits in
the form of cash with letters of credit. Our goal is to continue to manage
expenses and drive revenue increases to achieve cash breakeven, and then
profitability. As of December 31, 2004, we had a balance of cash, cash
equivalents and marketable securities of $8.2 million. We expect to use
approximately $1.5 million in cash for the quarter ending March 31, 2005,
partially as a result of severance, office closing and other costs related to
expense reduction actions taken in the second and third fiscal quarters.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires us to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of net revenues
and expenses during the reporting period. We regularly evaluate our estimates
and assumptions related to net revenues, allowances for doubtful accounts, sales
returns and allowances, inventory reserves, goodwill and purchased intangible
asset valuations, warranty reserves, restructuring costs, litigation and other
contingencies. We base our estimates and assumptions on historical experience
and on various other factors that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. To the extent there are material differences between our
estimates and the actual results, our future results of operations will be
affected.
We believe the following critical accounting policies require us to make
significant judgments and estimates in the preparation of our condensed
consolidated financial statements:
REVENUE RECOGNITION
We do not recognize revenue until all of the following criteria are met:
persuasive evidence of an arrangement exists; delivery has occurred or services
have been rendered; our price to the buyer is fixed or determinable; and
collectibility is reasonably assured. Commencing July 1, 2001, we adopted a new
accounting policy for revenue recognition such that recognition of revenue and
related gross profit from sales to distributors are deferred until the
distributor resells the product. Net revenue from certain smaller distributors,
for which point-of-sale information is not available, is recognized one month
after the shipment date. This estimate approximates the timing of the sale of
the product by the distributor to the end-user. When product sales revenue is
recognized, we establish an estimated allowance for future product returns based
on historical returns experience; when price reductions are approved, we
establish an estimated liability for price protection payable on inventories
owned by product resellers. Should actual product returns or pricing adjustments
exceed our estimates, additional reductions to revenues would result. Revenue
from the licensing of software is recognized at the time of shipment (or at the
time of resale in the case of software products sold through distributors),
provided we have vendor-specific objective evidence of the fair value of each
element of the software offering and collectibility is probable. Revenue from
post-contract customer support and any other future deliverables is deferred and
recognized over the support period or as contract elements are delivered. Our
products typically carry a ninety-day to two-year warranty. Although we engage
in extensive product quality programs and processes, our warranty obligation is
affected by product failure rates, use of materials or service delivery costs
that differ from our estimates. As a result, additional warranty reserves could
be required, which could reduce gross margins. Additionally, we sell extended
warranty services which extend the warranty period for an additional one to
three years. Warranty revenue is recognized evenly over the warranty service
period.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. Our
allowance for doubtful accounts is based on our assessment of the collectibility
of specific customer accounts, the aging of accounts receivable, our history of
bad debts and the general condition of the industry. If a major customer's
credit worthiness deteriorates, or our customers' actual defaults exceed our
historical experience, our estimates could change and impact our reported
results. We also maintain a reserve for uncertainties relative to the collection
of officer notes receivable. Factors considered in determining the level of this
reserve include the value of the collateral securing the notes, our ability to
effectively enforce collection rights and the ability of the former officers to
honor their obligations.
16
INVENTORY VALUATION
Our policy is to value inventories at the lower of cost or market on a
part-by-part basis. This policy requires us to make estimates regarding the
market value of our inventories, including an assessment of excess and obsolete
inventories. We determine excess and obsolete inventories based on an estimate
of the future sales demand for our products within a specified time horizon,
generally three to twelve months. The estimates we use for demand are also used
for near-term capacity planning and inventory purchasing and are consistent with
our revenue forecasts. In addition, specific reserves are recorded to cover
risks in the area of end of life products, inventory located at our contract
manufacturers, deferred inventory in our sales channel and warranty replacement
stock.
If our sales forecast is less than the inventory we have on hand at the end
of an accounting period, we may be required to take excess and obsolete
inventory charges which will decrease gross margin and net operating results for
that period.
VALUATION OF DEFERRED INCOME TAXES
We have recorded a valuation allowance to reduce our net deferred tax
assets to zero, primarily due to our inability to estimate future taxable
income. We consider estimated future taxable income and ongoing prudent and
feasible tax planning strategies in assessing the need for a valuation
allowance. If we determine that it is more likely than not that we will realize
a deferred tax asset, which currently has a valuation allowance, we would be
required to reverse the valuation allowance which would be reflected as an
income tax benefit at that time.
GOODWILL AND PURCHASED INTANGIBLE ASSETS
The purchase method of accounting for acquisitions requires extensive use
of accounting estimates and judgments to allocate the purchase price to the fair
value of the net tangible and intangible assets acquired, including IPR&D.
Goodwill and intangible assets deemed to have indefinite lives are no longer
amortized but are subject to annual impairment tests. The amounts and useful
lives assigned to intangible assets impact future amortization and the amount
assigned to IPR&D is expensed immediately. If the assumptions and estimates used
to allocate the purchase price are not correct, purchase price adjustments or
future asset impairment charges could be required.
IMPAIRMENT OF LONG-LIVED ASSETS
We evaluate long-lived assets used in operations when indicators of
impairment, such as reductions in demand or significant economic slowdowns, are
present. Reviews are performed to determine whether the carrying values of
assets are impaired based on a comparison to the undiscounted expected future
cash flows. If the comparison indicates that there is impairment, the expected
future cash flows, using a discount rate based upon our weighted average cost of
capital, is used to estimate the fair value of the assets. Impairment is based
on the excess of the carrying amount over the fair value of those assets.
Significant management judgment is required in the forecast of future operating
results that is used in the preparation of expected discounted cash flows. It is
reasonably possible that the estimates of anticipated future net revenue, the
remaining estimated economic lives of the products and technologies, or both,
could differ from those used to assess the recoverability of these assets. In
the event they are lower, additional impairment charges or shortened useful
lives of certain long-lived assets could be required.
RESTRUCTURING CHARGE
Over the last several quarters we have undertaken, and we may continue to
undertake, significant restructuring initiatives, which have required us to
develop formalized plans for exiting certain business activities. We have had to
record estimated expenses for lease cancellations, contract terminations,
long-term asset write-downs, severance and outplacement costs and other
restructuring costs. Given the significance and 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.
17
SETTLEMENT COSTS
From time to time, we are involved in legal actions arising in the ordinary
course of business. We cannot assure you that these actions or other third party
assertions against us will be resolved without costly litigation, in a manner
that is not adverse to our financial position, results of operations or cash
flows. As facts concerning contingencies become known, we reassess our position
and make appropriate adjustments to the financial statements. There are many
uncertainties associated with any litigation. If our initial assessments
regarding the merits of a claim prove to be wrong, our results of operations and
financial condition could be materially and adversely affected. In addition, if
further information becomes available that causes us to determine a loss in any
of our pending litigation is probable and we can reasonably estimate a range of
loss associated with such litigation, then we would record at least the minimum
estimated liability. However, the actual liability in any such litigation may be
materially different from our estimates, which could result in the need to
record additional costs. We record our legal expenses as incurred; reimbursement
of legal expenses from insurance or other sources are recorded upon receipt.
RECENT ACCOUNTING PRONOUNCEMENTS
In November 2004 the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 151 "Inventory Costs -
An Amendment of ARB No. 43, Chapter 4". This new standard is the result of a
broader effort by the FASB to improve financial reporting by eliminating
differences between Generally Accepted Accounting Principles ("GAAP") in the
United States and Accounting Principles developed by the International
Accounting Standards Board ("IASB"). As part of this effort, the FASB and the
IASB identified opportunities to improve financial reporting by eliminating
certain narrow differences between their existing accounting standards. SFAS No.
151 clarifies that abnormal amounts of idle facility expense, freight handling
costs and spoilage costs should be expensed as incurred and not included in
overhead. Further, SFAS No. 151 requires that allocation of fixed production
overheads to conversion costs should be based on normal capacity of the
production facilities. The provisions in SFAS No. 151 are effective for
inventory costs incurred during fiscal years beginning after June 15, 2005.
Companies must apply the standard prospectively. Management does not expect the
adoption of SFAS No. 151 to have a material impact on the Company's financial
position, results of operations or cash flows.
In December 2004 the FASB issued SFAS No. 123R, a revision to SFAS No. 123
"Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25
"Accounting for Stock Issued to Employees" and its related implementation
guidance. SFAS No. 123R establishes standards for the accounting for
transactions in which an entity exchanges instruments for goods or services. It
also addresses transactions in which an entity incurs liabilities in exchange
for goods or services that are based on the fair value of the entity's equity
instruments or that may be settled by the issuance of those equity instruments.
SFAS No. 123R established the accounting treatment for transactions in which an
entity obtains employee services in share-based payment transactions. SFAS No.
123R requires companies to recognize in the statement of operations the
grant-date fair value of stock options and other equity-based compensation
issued to employees. SFAS No. 123R requires the Company to value the share-based
compensation based on the classification of the share-based award. If the
share-based award is to be classified as a liability, the Company must
re-measure the award at each balance sheet date until the award is settled. If
the share-based award is to be classified as equity, the Company will measure
the value of the share-based award on the date of grant, but the award will not
be re-measured at each balance sheet date. SFAS No. 123R does not change the
accounting guidance for share-based payment transactions with parties other than
employees provided in SFAS No. 123 as originally issued and EITF Issue No. 96-18
"Accounting for Equity Instruments that are Issued to Other than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services." SFAS No. 123R is
effective for public companies that do not file as small business issuers as of
the beginning of interim or annual reporting periods that begin after June 15,
2005 (the effective date for small business issuer is December 15, 2005). All
public companies must use either the modified prospective or modified
retrospective transition method. Under the modified prospective method, awards
that are granted, modified, or settled after the date of adoption should be
measured and accounted for in accordance with SFAS No. 123R. Unvested equity
classified awards that were granted prior to the effective date should continue
to be accounted for in accordance to SFAS No. 123 except that the amounts must
be recognized in the statement of operations. Under the modified retrospective
method, the previously reported amounts are restated (either to the beginning of
the year of adoption or for all periods presented) to reflect SFAS No. 123
amounts in the statement of operations. Management is in the process of
determining the effect SFAS No. 123R will have upon the Company's financial
position and statement of operations.
Other recent accounting pronouncements issued by the FASB (including its
Emerging Issues Task Force), the American Institute of Certified Public
Accountants and the Securities and Exchange Commission (the "SEC"), did not or
are not believed by management to have a material impact on the Company's
present or future consolidated financial statements.
18
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
of net revenues represented by each item in our condensed consolidated statement
of operations:
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
----------------------- -----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Net revenues ............................................ 100.0% 100.0% 100.0% 100.0%
Cost of revenues ........................................ 51.5 54.8 50.7 52.2
--------- --------- --------- ---------
Gross profit ............................................ 48.5 45.2 49.3 47.8
--------- --------- --------- ---------
Operating expenses:
Selling, general and administrative .................. 52.2 41.5 56.9 46.4
Research and development ............................. 11.0 14.1 15.5 14.4
Stock based compensation ............................. 0.9 0.5 1.2 0.8
Amortization of purchased intangible assets .......... 0.1 0.4 0.2 0.4
--------- --------- --------- ---------
Total operating expenses ................................ 64.2 56.5 73.8 62.0
--------- --------- --------- ---------
Loss from operations .................................... (15.7) (11.3) (24.5) (14.2)
Interest income, net .................................... 0.0 0.1 0.1 0.1
Other income (expense), net ............................. 3.7 (0.1) 2.2 (0.7)
--------- --------- --------- ---------
Loss before income taxes ................................ (12.0) (11.3) (22.2) (14.8)
Provision for income taxes .............................. 0.8 0.8 0.7 0.5
--------- --------- --------- ---------
Loss from continuing operations ......................... (12.8) (12.1) (22.9) (15.3)
--------- --------- --------- ---------
Income (loss) from discontinued operations .............. - (29.9) 0.2 (18.3)
--------- --------- --------- ---------
Net loss ................................................ (12.8)% (42.0)% (22.7)% (33.6)%
========= ========= ========= =========
COMPARISON OF THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2004 AND 2003
The following discussion of results of operations includes discussion of
continuing operations only.
NET REVENUES BY PRODUCT CATEGORY
THREE MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
PRODUCT CATEGORIES 2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
------------------ -------- -------- -------- -------- -------- --------
Device networking ....... $ 8,079 62.6% $ 6,975 55.8% $ 1,104 15.8%
IT management ........... 3,299 25.6% 3,290 26.3% 9 0.3%
Non core ................ 1,530 11.8% 2,233 17.9% (703) (31.5)%
-------- -------- -------- -------- -------- --------
TOTAL ................... $ 12,908 100.0% $ 12,498 100.0% $ 410 3.3%
======== ======== ======== ======== ======== ========
SIX MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
PRODUCT CATEGORIES 2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
------------------ -------- -------- -------- -------- -------- --------
Device networking ....... $ 14,305 59.7% $ 13,494 54.6% $ 811 6.0%
IT management ........... 6,421 26.8% 6,348 25.7% 73 1.1%
Non core ................ 3,227 13.5% 4,857 19.7% (1,630) (33.6)%
-------- -------- -------- -------- -------- --------
TOTAL ................... $ 23,953 100.0% $ 24,699 100.0% $ (746) (3.0)%
======== ======== ======== ======== ======== ========
The increase for the three months ended December 31, 2004 was primarily
attributable to an increase in net revenues from our device networking products,
offset by a decrease in our non-core products. The decrease in our non-core
product net revenues is primarily due to a decrease in our print server,
visualization, and other products. We are no longer investing in the development
of these product lines and expect net revenues related to these products to
continue to decline in the future as we focus our investment in device
networking and IT management products.
19
The decrease for the six months ended December 31, 2004 is primarily
attributable to a decrease in net revenue from our non-core products offset by
an increase in our device networking products. The decrease in our non-core
product net revenues is primarily due to a decrease in our print server,
visualization and other products. We are no longer investing in the development
of these product lines and expect net revenues related to these products to
continue to decline in the future as we focus our investment in device
networking and IT management products.
NET REVENUES BY REGION
THREE MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
GEOGRAPHIC REGION 2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
----------------- --------- --------- --------- --------- --------- ---------
Americas ......................................... $ 8,463 65.6% $ 8,597 68.8% $ (134) (1.6)%
Europe ........................................... 3,412 26.4% 2,911 23.3% 501 17.2%
Other ............................................ 1,033 8.0% 990 7.9% 43 4.3%
--------- --------- --------- --------- --------- ---------
TOTAL ............................................ $ 12,908 100.0% $ 12,498 100.0% $ 410 3.3%
========= ========= ========= ========= ========= =========
SIX MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
GEOGRAPHIC REGION 2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
----------------- --------- --------- --------- --------- --------- ---------
Americas ......................................... $ 15,994 66.8% $ 18,077 73.2% $ (2,083) (11.5)%
Europe ........................................... 6,205 25.9% 5,083 20.6% 1,122 22.1%
Other ............................................ 1,754 7.3% 1,539 6.2% 215 14.0%
--------- --------- --------- --------- --------- ---------
TOTAL ............................................ $ 23,953 100.0% $ 24,699 100.0% $ (746) (3.0)%
========= ========= ========= ========= ========= =========
The overall increase in net revenues for the three months ended December
31, 2004 is primarily due to an increase in the Europe region and, to a lesser
extent, an increase in Other regions, offset by a decrease in the Americas
region. The overall decrease in net revenues for the six months ended December
31, 2004 is primarily due to a decrease in the Americas region offset by an
increase in Europe and to a lesser extent Other regions. The decrease in net
revenues in the Americas region is primarily attributable to lower sales of
non-core products, offset by an increase in core products. We are no longer
investing in the development of these product lines and expect net revenues
related to these product lines to continue to decline in the future as we focus
our investment on device networking and IT management products. The increase in
the European region is primarily due to growth in our device networking
business.
GROSS PROFIT
THREE MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
--------- --------- --------- --------- --------- ---------
Gross profit ..................................... $ 6,256 48.5% $ 5,644 45.2% $ 612 10.8%
========= ========= ========= ========= ========= =========
SIX MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
--------- --------- --------- --------- --------- ---------
Gross profit ..................................... $ 11,813 49.3% $ 11,800 47.8% $ 13 0.1%
========= ========= ========= ========= ========= =========
Gross profit represents net revenues less cost of revenues. Cost of
revenues consists primarily of the cost of raw material components, subcontract
labor assembly from outside manufacturers, amortization of purchased intangible
assets, impairment of purchased intangible assets, establishing or relieving
inventory reserves for excess and obsolete products or raw materials, overhead
and warranty costs. Cost of revenues for the three months ended December 31,
2004 and 2003 includes $364,000 and $532,000 of amortization of purchased
intangible assets, respectively. Cost of revenues for the six months ended
December 31, 2004 and 2003 includes $729,000 and $1.1 million of amortization of
purchased intangible assets, respectively. At December 31, 2004, the unamortized
balance of purchased intangible assets that will be amortized to cost of
revenues was $1.3 million, of which $704,000 will be amortized in the remainder
of fiscal 2005, $557,000 in fiscal 2006. The slight increase in gross profit was
mainly attributable to higher revenues, lower inventory reserves recorded in the
quarter and lower amortization expense of purchased intangible assets.
20
SELLING, GENERAL AND ADMINISTRATIVE
THREE MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
--------- --------- --------- --------- --------- ---------
Selling, general and administrative .............. $ 6,732 52.2% $ 5,192 41.5% $ 1,540 29.7%
========= ========= ========= ========= ========= =========
SIX MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
--------- --------- --------- --------- --------- ---------
Selling, general and administrative .............. $ 13,636 56.9% $ 11,455 46.4% $ 2,181 19.0%
========= ========= ========= ========= ========= =========
Selling, general and administrative expenses consist primarily of
personnel-related expenses including salaries and commissions, facility
expenses, information technology, trade show expenses, advertising, insurance
proceeds, and professional legal and accounting fees. Selling, general and
administrative expense increased primarily due to an increase in legal expenses,
and to a lesser extent, increased selling expense in channel sales and increased
marketing expenses for new product introductions and existing products. These
increases were partially offset by decreases in professional fees as well as
depreciation expense. The legal fees increased due to the timing of
reimbursements from the insurance company. Legal fees incurred in defense of the
shareholder suits are reimbursable to the extent provided in our directors and
officers liability insurance policies, and subject to the coverage limitations
and exclusions contained in such policies. For the three months ended December
31, 2004 and 2003, we have been reimbursed approximately $71,000 and $1.1
million of these expenses, respectively. For the six months ended December 31,
2004 and 2003, we have been reimbursed approximately $179,000 and $1.5 million,
respectively.
Because reimbursement of legal expenses, where covered by insurance, do not
typically occur within the month they are incurred, the net amount of legal
expense incurred in any one quarter may vary significantly from another. Legal
expenses are included in the selling, general and administrative expenses
category. Management expects to receive additional reimbursements from insurance
sources for legal fees in the future.
RESEARCH AND DEVELOPMENT
THREE MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
--------- --------- --------- --------- --------- ---------
Research and development ......................... $ 1,423 11.0% $ 1,758 14.1% $ (335) (19.1)%
========= ========= ========= ========= ========= =========
SIX MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
--------- --------- --------- --------- --------- ---------
Research and development ......................... $ 3,720 15.5% $ 3,545 14.4% $ 175 4.9%
========= ========= ========= ========= ========= =========
Research and development expenses consist primarily of personnel-related
costs of employees, as well as expenditures to third-party vendors for research
and development activities. The decrease in research and development expenses
for the three months ended December 2004 is primarily due to a reduction in
outside services as we finalized our contractual obligations with our outside
R&D firm in the quarter ending December 31, 2003. The increase in Research and
Development for the six months ended December 31, 2004 is primarily due to
increased headcount in R&D as well as some severance pay during the quarter
ending September 30, 2004, partially offset by a reduction in outside R&D costs
as mentioned above.
STOCK-BASED COMPENSATION
THREE MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
--------- --------- --------- --------- --------- ---------
Stock-based compensation ......................... $ 107 0.8% $ 63 0.5% $ 44 69.8%
========= ========= ========= ========= ========= =========
SIX MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
--------- --------- --------- --------- --------- ---------
Stock-based compensation ......................... $ 287 1.2% $ 218 0.9% $ 69 31.7%
========= ========= ========= ========= ========= =========
21
Stock-based compensation generally represents the amortization of deferred
compensation. We recorded no deferred compensation or deferred compensation
forfeitures for the six months ended December 31, 2004. Deferred compensation
represents the difference between the fair value of the underlying common stock
for accounting purposes and the exercise price of the stock options at the date
of grant as well as the fair market value of the vested portion of non-employee
stock options utilizing the Black-Scholes option pricing model. Deferred
compensation also includes the value of employee stock options assumed in
connection with our acquisitions calculated in accordance with current
accounting guidelines. Deferred compensation is presented as a reduction of
stockholders' equity and is amortized ratably over the respective vesting
periods of the applicable options, which is generally four years.
Included in cost of revenues is stock-based compensation of $0 and $10,000
for the three months ended December 31, 2004 and 2003, respectively, and $0 and
$26,000 for the six months ended December 31, 2004 and 2003, respectively.
The increase in stock-based compensation for the six months ended December
31, 2004 is primarily attributable to charges for the valuation of vested
options for two terminated executives, one occurring in the quarter ended
September 30, 2004 and the second in the quarter ended December 31, 2004. At
December 31, 2004, a balance of approximately $30,000 remains. Of the remaining
$30,000 approximately $13,000 will be amortized over the balance of fiscal 2005,
and approximately $17,000 will be amortized in fiscal 2006.
AMORTIZATION OF PURCHASED INTANGIBLE ASSETS
THREE MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
--------- --------- --------- --------- --------- ---------
Amortization of purchased intangible assets ...... $ 19 0.1% $ 45 0.4% $ (26) (57.8)%
========= ========= ========= ========= ========= =========
SIX MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
--------- --------- --------- --------- --------- ---------
Amortization of purchased intangible assets ...... $ 48 0.2% $ 89 0.4% $ (41) (46.1)%
========= ========= ========= ========= ========= =========
Purchased intangible assets primarily include existing technology, patents
and non-compete agreements and are amortized on a straight-line basis over the
estimated useful lives of the respective assets, ranging from one to five years.
We obtained independent appraisals of the fair value of tangible and intangible
assets acquired in order to assist us in allocating the purchase price. In
addition, approximately $364,000 and $532,000 of amortization of purchased
intangible assets has been classified as cost of revenues for the three months
ended December 31, 2004 and 2003, respectively, and $729,000 and $1.1 million
for the six months ended December 31, 2004 and 2003, respectively. The decrease
in amortization of purchased intangible assets is primarily due to assets
becoming fully amortized. At December 31, 2004, the unamortized balance of
p