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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, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to ___________.
Commission file number: 1-16027
__________
LANTRONIX, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0362767
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
15353 Barranca Parkway Irvine, California 92618
(Address of principal executive offices and zip code)
__________
(949) 453-3990
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(D) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that 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 [ ]
As of January 31, 2004, 57,500,680 shares of the Registrant's common stock
were outstanding.
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LANTRONIX, INC.
FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2003
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION 3
Item 1. Financial Statements. 3
Unaudited Condensed Consolidated Balance Sheets at December 31, 2003 and June 30, 2003 3
Unaudited Condensed Consolidated Statements of Operations for the
Three and Six Months Ended December 31, 2003 and 2002 4
Unaudited Condensed Consolidated Statements of Cash Flows for the
Six Months Ended December 31, 2003 and 2002 5
Notes to Unaudited Condensed Consolidated Financial Statements. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 14
Risk Factors 26
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 33
Item 4. Controls and Procedures. 33
PART II. OTHER INFORMATION 34
Item 1. Legal Proceedings 34
Item 2. Changes in Securities and Use of Proceeds. 35
Item 3. Defaults Upon Senior Securities 35
Item 4. Submission of Matters to a Vote of Security Holders 35
Item 5. Other Information 36
Item 6. Exhibits and Reports on Form 8-K. 36
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31, JUNE 30,
2003 2003
---------- ----------
ASSETS
- ------------------------------------------
Current assets:
Cash and cash equivalents $ 10,253 $ 7,328
Marketable securities 3,000 6,750
Accounts receivable, net 3,979 3,858
Inventories 5,698 6,011
Deferred income taxes 7,909 7,909
Contract manufacturers receivable, net 1,170 1,744
Prepaid expenses and other current assets 2,002 3,861
---------- ----------
Total current assets 34,011 37,461
Property and equipment, net 1,644 2,541
Goodwill 9,488 11,726
Purchased intangible assets, net 3,122 5,394
Long-term investments 5,045 5,458
Officer loans. 104 104
Other assets 162 172
---------- ----------
Total assets $ 53,576 $ 62,856
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------------
Current liabilities:
Accounts payable $ 2,903 $ 4,801
Accrued payroll and related expenses 1,543 1,367
Due to Gordian - 1,000
Accrued litigation settlement - 1,533
Warranty reserve 1,289 1,193
Restructuring reserve 3,083 3,235
Other current liabilities 3,881 2,634
Convertible note payable 867 -
---------- ----------
Total current liabilities 13,566 15,763
Deferred income taxes 8,509 8,509
Convertible note payable - 867
Stockholders' equity:
Common stock 6 6
Additional paid-in capital.. . . . . . . . 180,167 178,628
Deferred compensation (254) (695)
Accumulated deficit (148,728) (140,424)
Accumulated other comprehensive income 310 202
---------- ----------
Total stockholders' equity 31,501 37,717
---------- ----------
Total liabilities and stockholders' equity $ 53,576 $ 62,856
========== ==========
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,
------------------ -------------------
2003 2002 2003 2002
-------- -------- -------- ---------
Net revenues (A) $12,532 $12,658 $24,762 $ 25,339
Cost of revenues (B) 7,695 7,687 13,807 15,883
-------- -------- -------- ---------
Gross profit 4,837 4,971 10,955 9,456
-------- -------- -------- ---------
Operating expenses:
Selling, general and administrative (C) 5,540 8,208 12,245 16,079
Research and development (C) 1,990 3,117 3,974 5,547
Stock-based compensation (B) (C) 63 335 218 780
Amortization of purchased intangible assets 145 228 289 456
Impairment of goodwill and purchased intangible assets 2,252 - 2,252 -
Restructuring charges - - - 4,929
-------- -------- -------- ---------
Total operating expenses 9,990 11,888 18,978 27,791
-------- -------- -------- ---------
Loss from operations (5,153) (6,917) (8,023) (18,335)
Interest income (expense), net 11 75 35 267
Other income (expense), net (10) (318) (180) (408)
-------- -------- -------- ---------
Loss before income taxes (5,152) (7,160) (8,168) (18,476)
Provision (benefit) for income taxes 103 (38) 136 48
-------- -------- -------- ---------
Net loss $(5,255) $(7,122) $(8,304) $(18,524)
======== ======== ======== =========
Basic and diluted net loss per share $ (0.09) $ (0.13) $ (0.15) $ (0.34)
======== ======== ======== =========
Weighted average shares (basic and diluted) 57,098 53,947 55,693 53,932
======== ======== ======== =========
(A) Includes net revenues from a related party. . . . . . . . $ 491 $ 490 $ 802 $ 957
======== ======== ======== =========
(B) Cost of revenues includes the following:
Amortization of purchased intangible assets $ 596 $ 1,027 $ 1,193 $ 2,055
Impairment of purchased intangible assets 776 - 776 -
Stock-based compensation 10 18 27 37
-------- -------- -------- ---------
$ 1,382 $ 1,045 $ 1,996 $ 2,092
======== ======== ======== =========
(C) Stock-based compensation is excluded from the following:
Selling, general and administrative expenses $ 75 $ 222 $ 188 $ 585
Research and development expenses (12) 113 30 195
-------- -------- -------- ---------
$ 63 $ 335 $ 218 $ 780
======== ======== ======== =========
See accompanying notes.
4
LANTRONIX, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
SIX MONTHS ENDED
DECEMBER 31,
-------------------
2003 2002
-------- ---------
Cash flows from operating activities:
Net loss $(8,304) $(18,524)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation 999 1,360
Amortization of purchased intangible assets 1,482 2,511
Impairment of goodwill and purchased intangible assets 3,028 -
Stock-based compensation. 245 817
Provision for doubtful accounts (81) (246)
Provision for inventory reserves (561) 849
Deferred income taxes - -
Loss on sale of fixed assets 20 -
Equity losses from unconsolidated business 413 654
Restructuring charges - 2,900
Changes in operating assets and liabilities, net of effect from acquisition:
Accounts receivable (40) 1,777
Inventories 874 1,637
Contract manufacturers receivable 574 320
Prepaid expenses and other current assets 1,859 405
Other assets 10 419
Accounts payable. (1,898) (1,396)
Due to related party - (246)
Due to Gordian (1,000) (2,000)
Accrued Lightwave settlement - (2,004)
Warranty reserve 96 277
Restructuring reserve (152) -
Other current liabilities 1,423 (737)
-------- ---------
Net cash used in operating activities (1,013) (11,227)
-------- ---------
Cash flows from investing activities:
Purchases of property and equipment, net (122) (275)
Purchases of marketable securities (302) (9,250)
Acquisition of business, net of cash acquired - (2,114)
Proceeds from sale of marketable securities 4,052 6,963
-------- ---------
Net cash provided by (used in) investing activities 3,628 (4,676)
-------- ---------
Cash flows from financing activities:
Net proceeds from other issuances of common stock 202 142
-------- ---------
Net cash provided by financing activities 202 142
Effect of foreign exchange rates on cash. 108 41
-------- ---------
Increase (decrease) in cash and cash equivalents 2,925 (15,720)
Cash and cash equivalents at beginning of period. 7,328 26,491
-------- ---------
Cash and cash equivalents at end of period. $10,253 $ 10,771
======== =========
See accompanying notes.
5
LANTRONIX, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
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, 2003, and the consolidated results of its operations
for the three and six months ended December 31, 2003 and 2002 and its cash flows
for the six months ended December 31, 2003 and 2002. 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, 2003 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, 2003,
included in the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission ("SEC") on September 29, 2003.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51," ("FIN 46"). FIN 46 requires certain variable
interest entity ("VIE") to be consolidated by the primary beneficiary of the
entity if the equity investors in the entity do not have the characteristics of
a controlling financial interest or do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 is effective for all new VIE's created or
acquired after January 31, 2003. For VIE's created or acquired prior to February
1, 2003, the provisions of FIN 46 must be applied for the first interim or
annual period ending March 15, 2004. The Company is currently reviewing its
investments and other arrangements to determine whether any of its investee
companies are VIEs. The Company believes that its investment in Xanboo described
in Note 8 of the Notes to the Unaudited Consolidated Financial Statements,
"Long-term Investments" is the only entity which could be subject to treatment
as a VIE under FIN 46. However, the Company does not believe that Xanboo will be
determined to be a VIE that would be consolidated, but the Company may be
required to make additional disclosures.
3. NET LOSS PER SHARE
Basic net loss per share is calculated by dividing net loss by the weighted
average number of common shares outstanding during the period. Diluted net loss
per share is calculated by adjusting outstanding shares assuming any dilutive
effects of options. However, for periods in which the Company incurred a net
loss, these shares are excluded because their effect would be to reduce recorded
net loss per share. The following table sets forth the computation of net loss
per share (in thousands, except per share amounts):
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------ -------------------
2003 2002 2003 2002
-------- -------- -------- ---------
Numerator: Net loss $(5,255) $(7,122) $(8,304) $(18,524)
======== ======== ======== =========
Denominator:
Weighted-average shares outstanding 57,430 54,279 56,025 54,264
Less: non-vested common shares outstanding (332) (332) (332) (332)
-------- -------- -------- ---------
Denominator for basic and diluted loss per share 57,098 53,947 55,693 53,932
======== ======== ======== =========
Basic and diluted net loss per share $ (0.09) $ (0.13) $ (0.15) $ (0.34)
======== ======== ======== =========
6
4. MARKETABLE SECURITIES
The Company defines marketable securities as income yielding securities,
which can be readily converted to cash. Marketable securities consist of
obligations of U.S. Government agencies, state, municipal and county
governments' notes and bonds.
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,
2003 2003
-------- --------
Raw materials . . . . . . . . . . . . . . $ 4,332 $ 5,109
Finished goods. . . . . . . . . . . . . . 6,174 7,940
Inventory at distributors . . . . . . . . 1,080 959
-------- --------
11,586 14,008
Reserve for excess and obsolete inventory (5,888) (7,997)
-------- --------
$ 5,698 $ 6,011
======== ========
6. GOODWILL AND PURCHASED INTANGIBLE ASSETS
Goodwill
The changes in the carrying amount of goodwill is as follows (in
thousands):
SIX MONTHS
ENDED YEAR ENDED
DECEMBER 31, JUNE 30,
2003 2003
------------ --------
Balance beginning of period. . . . . . . $ 11,726 $13,811
Goodwill acquired during the period. . . - 2,270
Impairment of goodwill during the period (2,238) (4,355)
------------- --------
Balance end of period. . . . . . . . . . $ 9,488 $11,726
============= ========
Purchased Intangible Assets
The composition of purchased intangible assets is as follows (in
thousands):
DECEMBER 31, 2003 JUNE 30, 2003
----------------- -------------
USEFUL ACCUMULATED ACCUMULATED
LIVES GROSS AMORTIZATION NET GROSS AMORTIZATION NET
--------- ------ -------------- ------ ------ -------------- ------
Existing technology. . 1-5 years $7,090 $ (4,094) $2,996 $8,060 $ (3,094) $4,966
Patent/core technology 5 405 (339) 66 405 (283) 122
Tradename/trademark. . 5 32 (21) 11 32 (18) 14
Non-compete agreements 2-3 140 (91) 49 940 (648) 292
------ -------------- ------ ------ -------------- ------
Total $7,667 $ (4,545) $3,122 $9,437 $ (4,043) $5,394
====== ============== ====== ====== ============== ======
The amortization expense for purchased intangible assets for the six months
ended December 31, 2003 was $1.5 million, of which $1.2 million was amortized to
cost of revenues and $289,000 was amortized to operating expenses. The
amortization expense for purchased intangible assets for the six months ended
December 31, 2002 was $2.5 million, of which $2.1 million was amortized to cost
of revenues and $456,000 was amortized to operating expenses. The estimated
7
amortization expense for the remainder of fiscal 2004 and the next two years are
as follows (in thousands):
COST OF OPERATING
Fiscal year ending June 30: REVENUES EXPENSES TOTAL
--------- --------- ------
2004 (Remainder of fiscal year) $ 1,008 $ 59 $1,067
2005. . . . . . . . . . . . . . 1,431 65 1,496
2006. . . . . . . . . . . . . . 557 2 559
--------- --------- ------
Total . . . . . . . . . . . . . $ 2,996 $ 126 $3,122
========= ========= ======
Impairment of goodwill and purchased intangible assets
During the second fiscal quarter of 2004, the Company identified indicators
of an other than temporary impairment as it related to its Premise Systems, Inc.
("Premise") acquisition of goodwill and purchased intangible assets. The Company
performed an assessment of the value of its goodwill and purchased intangible
assets related to the Premise acquisition in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets" and SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." The Company identified certain conditions including
continued losses and the inability to achieve significant revenues from the
existing home automation and media management software markets as indicators of
asset impairment. These conditions led to operating results and forecasted
future results that were substantially less than had been anticipated. The
Company revised its projections and determined that the projected results
utilizing a discounted cash flow valuation technique would not fully support the
carrying values of the goodwill and purchased intangible assets associated with
the Premise acquisition. Based on this assessment, the Company recorded an
impairment charge of $2.2 million during the second quarter of fiscal 2004 to
write-off the value of the Premise goodwill. Additionally during the second
quarter of fiscal 2004, the Company recorded a $790,000 impairment charge of the
Premise purchased intangible assets of which $14,000 and $776,000 were charged
to operating expenses and cost of revenues, respectively.
7. LONG-TERM INVESTMENTS
Long-term investments consist of a 14.9% and a 15.3% ownership interest in
Xanboo, Inc. ("Xanboo") at December 31, 2003 and June 30, 2003, respectively.
The Company is accounting for this long-term investment under the equity method
based upon the Company's ability, through representation on Xanboo's board of
directors, to exercise significant influence over its operations. The Company's
interest in the losses of Xanboo aggregating $413,000 and $654,000 for the six
months ended December 31, 2003 and 2002, respectively, have been recognized as
other expense in the condensed consolidated statements of operations.
8. RESTRUCTURING RESERVE
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 $5.7 million, which were classified as operating
expenses in the consolidated statement of operations for the year ended June 30,
2003. These restructuring plans resulted in the reduction of approximately 58
regular employees worldwide. The Company recorded workforce reduction charges of
approximately $1.3 million related to severance and fringe benefits for the
terminated employees. The Company recorded charges of approximately $4.4 million
related to the consolidation of excess facilities, relating primarily to lease
terminations, non-cancelable lease costs, write-off of leasehold improvements
and termination of a contractual obligation. The restructuring costs will be
substantially paid in cash over the next five years. The remaining restructuring
reserve is related to facility lease terminations and a contractual settlement.
8
A summary of the activity in the restructuring reserve account is as follows (in
thousands):
CHARGES AGAINST RESERVE
-------------------------
RESTRUCTURING RESTRUCTURING
RESERVE AT RESERVE AT
JUNE 30, DECEMBER 31,
2003 NON-CASH CASH 2003
------------- -------- ------ -------------
Workforce reductions . . . . . . . $ 260 $ - $ - $ 260
Contractual obligations. . . . . . 2,000 - - 2,000
Consolidation of excess facilities 975 - (152) 823
------------- -------- ------ -------------
Total. . . . . . . . . . . . . . . $ 3,235 $ - $(152) $ 3,083
============= ======== ====== =============
9. WARRANTY
Upon shipment to its customers, the Company provides for the estimated cost to
repair or replace products to be returned under warranty. The Company's current
warranty periods generally range from ninety days to two years from the date of
shipment. In addition, the Company also sells extended warranty services which
extend the warranty period for an additional one to three years. The following
table is a reconciliation of the changes to the product warranty liability for
the periods presented:
SIX MONTHS
ENDED YEAR ENDED
DECEMBER 31, JUNE 30,
2003 2003
-------------- ----------
Balance beginning of period . $ 1,193 $ 479
Charged to costs and expenses 435 878
Charged to other expenses (339) (153)
Deductions - (11)
-------------- ----------
Balance end of period . . . . $ 1,289 $ 1,193
============== ==========
10. PROVISION FOR INCOME TAXES AND EFFECTIVE TAX RATE
The Company utilizes the liability method of accounting for income taxes as
set forth in SFAS No. 109, "Accounting for Income Taxes." The Company's
effective tax rate was 2% and 0% for the six month periods ended December 31,
2003 and 2002, respectively. 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, 2003 and 2002, was lower than the
federal statutory rate primarily due to the increase in valuation allowance, as
well as the amortization of stock-based compensation for which no current year
tax benefit was provided. In October 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 will be required to
pay approximately $750,000 in tax and interest to the Internal Revenue Service
and the California Franchise Tax Board, in fiscal 2004. The Company had accrued
for this liability in prior fiscal periods.
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 of which $50,000
was paid upon the closing and $50,000 was to be 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 $50,000 facility fee was reduced to $12,500 and paid.
Prior to any advances being made under the line of credit, the bank is required
9
to complete an initial field examination to determine its borrowing base. The
bank completed its initial field examination during the second quarter of fiscal
2004. The Company's available line of credit at December 31, 2003 was $2.4
million. To date, the Company has not borrowed against this line of credit. The
Company is currently in compliance with the revised financial covenants of the
July 25, 2003 amended line of credit. Pursuant to the line of credit, the
Company is restricted from paying any dividends. The Company has used letters of
credit available under our line of credit totaling approximately $989,000 in
place of cash to fund deposits on leases, tax account deposits and security
deposits.
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 $11,000 and
$9,000 for the six months ended December 31, 2003 and 2002, respectively. The
note is convertible into the Company's common stock at any time, at the election
of the holders, at a $5.00 conversion price. The note is due in August 2004.
12. COMPREHENSIVE LOSS
Statement of Financial Accounting Standards ("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,
-------------------- -------------------
2003 2002 2003 2002
-------- ---------- -------- ---------
Net loss $(5,255) $(7,122) $(8,304) $(18,524)
Other comprehensive loss:
Change in accumulated translation adjustments 97 18 108 41
-------- -------- -------- ---------
Total comprehensive loss $(5,158) $(7,104) $(8,196) $(18,483)
======== ======== ======== =========
13. STOCK-BASED COMPENSATION
The Company has in effect several stock-based plans under which
non-qualified and incentive stock options have been granted to employees,
non-employee board members and other non-employees. The Company also has an
employee stock purchase plan for all eligible employees. The Company accounts
for stock-based awards to employees in accordance with Accounting Principles
Board ("APB") No. 25, "Accounting for Stock Issues to Employees" ("APB 25"), and
related interpretations, and has adopted the disclosure-only alternative of SFAS
No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") and SFAS No.
148, "Accounting for Stock-Based Compensation Transition and Disclosure."
Options granted to non-employees, as defined, have been accounted for at fair
market value in accordance with SFAS No. 123.
In accordance with the disclosure requirements of SFAS No. 123, set forth
below are the assumptions used and pro forma statement of operations data of the
Company giving effect to valuing stock-based awards to employees using the
Black-Scholes option pricing model instead of the guidelines provided by APB No.
25. Among other factors, the Black-Scholes model considers the expected life of
the option and the expected volatility of the Company's stock price in arriving
at an option valuation.
10
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:
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------ -------------------
2003 2002 2003 2002
-------- -------- -------- ---------
Net loss - as reported $(5,255) $(7,122) $(8,304) $(18,524)
Add: Stock-based compensation expense
included in net loss - as reported 73 353 245 817
Deduct: Stock-based compensation expense
determined under fair valuemethod. . . . . . . . . . (830) (1,770) (1,783) (3,692)
-------- -------- -------- ---------
Net loss - pro forma $(6,012) $(8,539) $(9,842) $(21,399)
======== ======== ======== =========
Net loss per share (basic and diluted) - as reported $ (0.09) $ (0.13) $ (0.15) $ (0.34)
======== ======== ======== =========
Net loss per share (basic and diluted) - pro forma $ (0.11) $ (0.16) $ (0.18) $ (0.40)
======== ======== ======== =========
14. LITIGATION SETTLEMENT
On August 23, 2002, a complaint entitled Dunstan v. Lantronix, Inc., et al., was
filed in the Circuit Court of the State of Oregon, County of Multnomah, against
the Company and certain of its current and former officers and directors by the
cofounders of United States Software Corporation ("USSC"). The complaint and
subsequently filed arbitration demand alleged Oregon state law claims for
securities violations, fraud, and negligence, as well as other claims related to
the Company's acquisition of USSC. Plaintiffs sought more than $14.0 million in
damages, interest, attorneys' fees, costs, expenses, and an unspecified amount
of punitive damages. The parties participated in mediation on June 30, 2003, and
subsequently reached an agreement to settle the dispute. Pursuant to the
parties' settlement agreement, the Company released to the plaintiffs
approximately $400,000 in cash and 49,038 shares of the Company's common stock
that had been held in an escrow since December 2000 as part of the acquisition
of USSC. On September 15, 2003, the Company also issued to the plaintiffs
1,726,703 additional shares of its common stock worth approximately $1.5
million, which was recorded in the Company's results of operations as litigation
settlement costs for the year ended June 30, 2003. In exchange, the plaintiffs
released all claims against all defendants.
15. LITIGATION
Government Investigation
The SEC is conducting a formal investigation of the events leading up to
the Company's restatement of its financial statements on June 25, 2002. The
Department of Justice is also conducting an investigation concerning events
related to the restatement.
Class Action Lawsuits
On May 15, 2002, Stephen Bachman filed a class action complaint entitled
Bachman v. Lantronix, Inc., et al., No. 02-3899, in the U.S. District Court for
the Central District of California against the Company and certain of its
current and former officers and directors alleging violations of the Securities
Exchange Act of 1934 and seeking unspecified damages. Subsequently, six similar
actions were filed in the same court. Each of the complaints purports to be a
class action lawsuit brought on behalf of persons who purchased or otherwise
acquired the Company's common stock during the period of April 25, 2001 through
May 30, 2002, inclusive. The complaints allege that the defendants caused the
Company to improperly recognize revenue and make false and misleading statements
about its business. Plaintiffs further allege that the defendants materially
overstated the Company's reported financial results, thereby inflating its stock
price during its securities offering in July 2001, as well as facilitating the
use of its common stock as consideration in acquisitions. The complaints have
subsequently been consolidated into a single action and the court has appointed
a lead plaintiff. The lead plaintiff filed a consolidated amended complaint on
January 17, 2003. The amended complaint now purports to be a class action
brought on behalf of persons who purchased or otherwise acquired the Company's
common stock during the period of August 4, 2000 through May 30, 2002,
inclusive. The amended complaint continues to assert that the Company and the
individual officer and director defendants violated the 1934 Act, and also
includes alleged claims that the Company and its officers and directors violated
the Securities Act of 1933 arising from the Company's Initial Public Offering in
August 2000. The Company filed a motion to dismiss the additional allegations on
11
March 3, 2003. The Court granted the motion, with leave to amend, on December
31, 2003. Plaintiffs have until February 6, 2004 to file an amended complaint.
Derivative Lawsuit
On July 26, 2002, Samuel Ivy filed a shareholder derivative complaint
entitled Ivy v. Bernhard Bruscha, et al., No. 02CC00209, in the Superior Court
of the State of California, County of Orange, against certain of the Company's
current and former officers and directors. On January 7, 2003, the plaintiff
filed an amended complaint. The amended complaint alleges causes of action for
breach of fiduciary duty, abuse of control, gross mismanagement, unjust
enrichment, and improper insider stock sales. The complaint seeks unspecified
damages against the individual defendants on the Company's behalf, equitable
relief, and attorneys' fees.
The Company filed a demurrer/motion to dismiss the amended complaint on
February 13, 2003. The basis of the demurrer is that the plaintiff does not have
standing to bring this lawsuit since plaintiff has never served a demand on the
Company's Board that the Board take certain actions on behalf of the Company. On
April 17, 2003, the Court overruled the Company's demurrer. All defendants have
answered the complaint and generally denied the allegations. Discovery has
commenced, but no trial date has been established.
Employment Suit Brought by Former Chief Financial Officer and Chief Operating
Officer Steven Cotton
On September 6, 2002, Steven 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. Discovery has not commenced and no trial date has been established.
The Company filed a motion to dismiss on October 16, 2002, on the grounds
that Mr. Cotton's complaints are subject to the binding arbitration provisions
in Mr. Cotton's employment agreement. On January 13, 2003, the Court ruled that
five of the six counts in Mr. Cotton's complaint are subject to binding
arbitration. The court is staying the sixth count, for declaratory relief, until
the underlying facts are resolved in arbitration. No arbitration date has been
set.
Securities Claims Brought by Former Shareholders of Synergetic Micro Systems,
Inc. ("Synergetic")
On October 17, 2002, Richard Goldstein and several other former
shareholders of Synergetic filed a complaint entitled Goldstein, et al v.
Lantronix, Inc., et al in the Superior Court of the State of California, County
of Orange, against the Company and certain of its former officers and directors.
Plaintiffs filed an amended complaint on January 7, 2003. The amended complaint
alleges fraud, negligent misrepresentation, breach of warranties and covenants,
breach of contract and negligence, all stemming from its acquisition of
Synergetic. The complaint seeks an unspecified amount of damages, interest,
attorneys' fees, costs, expenses, and an unspecified amount of punitive damages.
On May 5, 2003, the Company answered the complaint and generally denied the
allegations in the complaint. Discovery has commenced but no trial date has been
established.
Suit filed by Lantronix Against Logical Solutions, Inc. ("Logical")
On March 25, 2003, the Company filed in Connecticut state court (Judicial
District of New Haven) a complaint entitled Lantronix, Inc. and Lightwave
Communications, Inc. v. Logical Solutions, Inc., et. al. This is an action for
unfair and deceptive trade practices, unfair competition, unjust enrichment,
conversion, misappropriation of trade secrets and tortuous interference with
contractual rights and business expectancies. The Company sought preliminary and
permanent injunctive relief and damages. The individual defendants are all
former employees of Lightwave Communications, a company that the Company
acquired in June 2001. The Court issued a decision for the defense on December
11, 2003. The Company filed a notice of appeal in the Connecticut Court of
Appeal on December 30, 2003.
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
12
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 condensed consolidated financial statements.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with
the Unaudited Condensed Consolidated Financial Statements and related Notes
thereto contained elsewhere in this Report. The information in this Quarterly
Report on Form 10-Q is not a complete description of our business or the risks
associated with an investment in our common stock. We urge you to carefully
review and consider the various disclosures made by us in this Report and in
other reports filed with the Securities and Exchange Commission ("SEC"),
including our Annual Report on Form 10-K for the fiscal year ended June 30, 2003
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 devices 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: "device networking
solutions," that enable almost any electronic product to be connected to a
network; "IT management solutions," that enable multiple pieces of hardware,
usually IT-related network hardware such as servers, routers, switches, and
similar pieces of equipment to be managed over a network; and "other" products
and services that include legacy older product offerings such as print servers,
KVM and video extension and switching devices, royalty income from legacy
software licenses, and miscellaneous items. The expansion of our business in the
future is directed at the first two of these categories, device networking and
IT management solutions.
Today, our solutions include fully integrated hardware and software
devices, as well as software tools to develop related customer applications.
Because we deal with network connectivity, we provide hardware solutions to
extremely broad market segments, including industrial, medical, commercial,
financial, governmental, retail, building and home automation, and many more.
Our technology is used with products such as networking routers, medical
instruments, manufacturing equipment, bar code scanners, building HVAC systems,
elevators, process control equipment, vending machines, thermostats, security
cameras, temperature sensors, card readers, point of sale terminals, time
clocks, and virtually any product that has some form of standard data control
capability. Our current 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.
14
THE NATURE OF OUR BUSINESS
Currently, we develop our products through engineering and product
development activities of our research and development organization. In prior
years, most engineering and product development was outsourced with independent
contractors. This practice has been discontinued; however some portions of our
engineering are subcontracted as needed. We use outside contract manufacturers
to make our products, which are then taken to market by our marketing and sales
organizations.
We sell our devices through a global network of distributors, system
integrators, value added resellers (VARs), manufacturers' representatives and
original equipment manufacturers (OEMs). In addition, we sell directly to
selected accounts. One customer, Ingram Micro, accounted for approximately 14.3%
and 10.6% of our net revenues for the six months ended December 31, 2003 and
2002, respectively. Accounts receivable attributable to this domestic customer
accounted for approximately 15.8% and 9.7% of total accounts receivable at
December 31, 2003 and June 30, 2003, respectively.
One international customer, transtec AG, which is a related party due to
common ownership by our largest stockholder and former Chairman of our Board of
Directors, Bernhard Bruscha, accounted for approximately 3.2% and 3.8% of our
net revenues for the six months ended December 31, 2003 and 2002, respectively.
No significant accounts receivable balances were due from this related party at
December 31, 2003 and June 30, 2003.
SUMMARY OVERVIEW OF THE SECOND FISCAL QUARTER ENDED DECEMBER 31, 2003
As described in more detail elsewhere in this document, our business
improved during the quarter ended December 31, 2003. Net revenues increased
modestly from the prior quarter from $12.2 million to $12.5 million this
quarter, and our cash, cash equivalents and marketable securities balance
decreased by only $214,000 from $13.5 million at September 30, 2003 to $13.3
million at December 31, 2003, an improvement from the quarterly period ended
September 30, 2003 where our cash, cash equivalents and marketable securities
decreased $611,000. We were pleased that net revenues from our relatively new
XPort device increased to approximately 5.0% of net revenues during the quarter;
we had previously indicated that we expected to achieve this 5.0% milestone in
the quarter ending March 31, 2004.
During the quarter ended December 31, 2003, we incurred a charge of $3.0
million related to the impairment of goodwill and purchased intangible assets
related to our Premise Systems, Inc. ("Premise") acquisition; the net revenues
from this business have been minimal. The home automation and media management
software markets have not developed as expected and there is no certain forecast
of those markets' development or expansion which would increase our net revenues
from these products in the immediate future.
Results for the second fiscal quarter ended December 31, 2003 were impacted
by the impairment charge of $3.0 million related to certain goodwill and
purchased intangible assets of Premise, which was acquired by the company during
fiscal year 2002. The impairment charge included approximately $776,000 charged
to cost of sales and $2.3 million charged to operating expenses. The net loss of
$5.3 million for the quarter ended December 31, 2003 included the impairment
charge of $3.0 million.
The quarter ended December 31, 2003 is part of the momentum and specific
initiatives we have been implementing for some time. Over the past four to six
quarters, there have been significant changes to our operations that have an
impact on our performance quarter to quarter, and over time. For example:
- - In order to simplify and focus our activities, we have reduced our
individual product offerings as measured by stock keeping units ("SKU's")
by over 75%, from approximately 18 months ago. During this period, we have
experienced relatively little decrease in net revenues, which have ranged
from $11.8 million to $12.7 million each quarter. The quarter ended
December 31, 2003 represents the second consecutive quarter of net revenue
growth, albeit relatively modest this quarter.
- - We have consolidated our research and development activities down from as
many as nine separate locations down to three facilities - Redmond,
Washington; Milford, Connecticut; and our Irvine, California headquarters.
Our engineering staff in Irvine has expanded from approximately 7 employees
to approximately 35 over the past 18 months.
- - To continue our initiative to outsource our manufacturing rather than
maintain production facilities, and to achieve cost savings we shut down
all manufacturing activities including a Milford, Connecticut facility in
February 2003. We now use contract manufacturers exclusively to make our
products. The net cost of these and other restructuring activities was
approximately $5.7 million, recognized in the fiscal year ended June 30,
2003.
15
- - We have reduced our headcount from approximately 235 employees to
approximately 190. Approximately 40% of our current employees are new
employees hired within the last 18 months. We have substantially expanded
and increased our senior management team with experienced executives during
the past 18 months.
- - We have built a new expanded sales and distribution organization to take
our products to market. This initiative is tailored to address the multiple
markets in which our products are used.
OUTLOOK
We look forward to increased acceptance of our current products and the net
revenue increase that such acceptance would bring. We are driving our business
to become cash positive and increase our cash and cash equivalents and
marketable securities balances, and thereafter reach profitability. Currently,
we operate our business toward a financial "model" that would yield a cash
break-even in the $14.0 -$15.0 million quarterly revenue range; the model
assumes cash gross margins (gross margin net of non-cash expenses in cost of
sales) of 54%, and research and development and selling, general and
administrative expenses in total in the $9.0 million range each quarter.
Our performance over the past three quarters has resulted in lower cash
usage than this model might indicate. We incur legal expenses that increase and
decrease with activity each quarter, and we have occasional annual expenses we
have to pay. On the other hand, we have benefited from other cash trends and
inflows such as reduced inventory balances, receipts from insurance coverage,
and other efforts to improve cash flow by managing balance sheet accounts. We
have previously indicated guidance that we are managing our business such that
we have a target cash usage in the range of $1.0 million per quarter; as noted,
we have been doing somewhat better than this guidance. During the remainder of
fiscal 2004, we will make payments of approximately $750,000 to the Internal
Revenue Service ("IRS") and California Franchise Tax Board to satisfy our
liability for tax and interest as a result of our completed IRS audit for the
fiscal years ended June 30, 1999, 2000 and 2001. We accrued for this liability
in previous periods.
The achievement of higher future net revenues is possible, we believe, as
the overall market for device networking and IT management devices expands and
the economic climate improves, as well as the increased market acceptance of new
products such as our XPort device and others that will be introduced in
subsequent quarters. This expansion of net revenues is reduced to some extent as
the market for older products decreases primarily because of technological
obsolescence.
Our device networking business is fundamentally directed to the market of
literally hundreds of millions of products that could be networked together
and/or connected to the Internet. We see as inevitable, a world where myriads of
devices are interconnected to enhance their operation, maintenance, or to
provide new functionality. Independent researchers have made varying estimates
as to the size and rate of this expansion. However, networking growth as
evidenced by our net revenue growth or that of our peers is still in the early,
more modest expansion phase. We believe in the coming year that the market
adoption of our networking solutions devices will be initially in the commercial
and industrial markets such as security, medical, factory automation,
refrigeration, and similar devices, rather than into consumer electronics and
devices.
Our IT management business provides 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 emerging from that
recession. While we have not yet achieved a high rate of net revenue growth, we
have confidence in the existence and viability of this target market, and we
continue to develop new, additional products and service offerings to add to
existing offerings. We believe that a high percentage of installed equipment is
not served by remote management devices and solutions at the current time, and
this is an opportunity for us.
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:
16
Revenue Recognition
We do not recognize revenue until all of the following criteria are met:
persuasive evidence of an arrangement exists; delivery has occurred or services
have been rendered; our price to the buyer is fixed or determinable; and
collectibility is reasonably assured. Commencing July 1, 2000, we adopted a new
accounting policy for revenue recognition such that recognition of revenue and
related gross profit from sales to distributors are deferred until the
distributor resells the product. Net revenue from certain smaller distributors
for which point-of-sale information is not available, is recognized one month
after the shipment date. This estimate approximates the timing of the sale of
the product by the distributor to the end user. When product sales revenue is
recognized, we establish an estimated allowance for future product returns based
on historical returns experience; when price reductions are approved, we
establish an estimated liability for price protection payable on inventories
owned by product resellers. Should actual product returns or pricing adjustments
exceed our estimates, additional reductions to revenues would result. Revenue
from the licensing of software is recognized at the time of shipment (or at the
time of resale in the case of software products sold through distributors),
provided we have vendor-specific objective evidence of the fair value of each
element of the software offering and collectibility is probable. Revenue from
post-contract customer support and any other future deliverables is deferred and
recognized over the support period or as contract elements are delivered. Our
products typically carry a ninety day to two year warranty. Although we engage
in extensive product quality programs and processes, our warranty obligation is
affected by product failure rates, use of materials or service delivery costs
that differ from our estimates. As a result, additional warranty reserves could
be required, which could reduce gross margins. Additionally, we sell extended
warranty services which extend the warranty period for an additional one to
three years. Warranty revenue is recognized evenly over the warranty service
period.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. Our
allowance for doubtful accounts is based on our assessment of the collectibility
of specific customer accounts, the aging of accounts receivable, our history of
bad debts and the general condition of the industry. If a major customer's
credit worthiness deteriorates, or our customers' actual defaults exceed our
historical experience, our estimates could change and impact our reported
results. We also maintain a reserve for uncertainties relative to the collection
of officer notes receivable. Factors considered in determining the level of this
reserve include the value of the collateral securing the notes, our ability to
effectively enforce collection rights and the ability of the former officers to
honor their obligations.
Inventory Valuation
Our policy is to value inventories at the lower of cost or market on a
part-by-part basis. This policy requires us to make estimates regarding the
market value of our inventories, including an assessment of excess and obsolete
inventories. We determine excess and obsolete inventories based on an estimate
of the future sales demand for our products within a specified time horizon,
generally three to twelve months. The estimates we use for demand are also used
for near-term capacity planning and inventory purchasing and are consistent with
our revenue forecasts. In addition, specific reserves are recorded to cover
risks in the area of end of life products, inventory located at our contract
manufacturers, 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 in-process
research and development ("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.
17
Strategic Investments
We have made strategic investments in privately held companies for the
promotion of business and strategic investments. Strategic investments with less
than a 20% voting interest are generally carried at cost. We will use the equity
method to account for strategic investments in which we have a voting interest
of 20% to 50% or in which we otherwise have the ability to exercise significant
influence. Under the equity method, the investment is originally recorded at
cost and adjusted to recognize our share of net earnings or losses of the
investee, limited to the extent of our investment in, advances to and adjusted
to recognize our share of net earnings or losses of the investee. From time to
time we are required to estimate the amount of our losses of the investee. Our
estimates are based on historical experience. The value of non-publicly traded
securities is difficult to determine. We periodically review these investments
for other-than-temporary declines in fair value based on the specific
identification method and write down investments to their fair value when an
other-than-temporary decline has occurred. We generally believe an
other-than-temporary decline has occurred when the fair value of the investment
is below the carrying value for two consecutive quarters, absent evidence to the
contrary. Fair values for investments in privately held companies are estimated
based upon the values of recent rounds of financing. Although we believe our
estimates reasonably reflect the fair value of the non-publicly traded
securities held by us, had there been an active market for the equity
securities, the carrying values might have been materially different than the
amounts reported. Future adverse changes in market conditions or poor operating
results of companies in which we have such investments could result in losses or
an inability to recover the carrying value of the investments that may not be
reflected in an investment's current carrying value and which could require a
future impairment charge.
Restructuring Charges.
Over the last several quarters we have undertaken, and we may continue to
undertake, significant restructuring initiatives, which have required us to
develop formalized plans for exiting certain business activities. We have had to
record estimated expenses for lease cancellations, contract termination
expenses, long-term asset write-downs, severance and outplacement costs and
other restructuring costs. Given the significance of, and the timing of the
execution of such activities, this process is complex and involves periodic
reassessments of estimates made at the time the original decisions were made.
Through December 31, 2002, the accounting rules for restructuring costs and
asset impairments required us to record provisions and charges when we had a
formal and committed plan. Beginning January 1, 2003, the accounting rules now
require us to record any future provisions and changes at fair value in the
period in which they are incurred. In calculating the cost to dispose of our
excess facilities, we had to estimate our future space requirements and the
timing of exiting excess facilities and then estimate for each location the
future lease and operating costs to be paid until the lease is terminated and
the amount, if any, of sublease income. This required us to estimate the timing
and costs of each lease to be terminated, including the amount of operating
costs and the rate at which we might be able to sublease the site. To form our
estimates for these costs, we performed an assessment of the affected facilities
and considered the current market conditions for each site. Our assumptions on
future space requirements, the operating costs until termination or the
offsetting sublease revenues may turn out to be incorrect, and our actual costs
may be materially different from our estimates, which could result in the need
to record additional costs or to reverse previously recorded liabilities. Our
policies require us to periodically evaluate the adequacy of the remaining
liabilities under our restructuring initiatives. As management continues to
evaluate the business, there may be additional charges for new restructuring
activities as well as changes in estimates to amounts previously recorded.
Settlement Costs
From time to time, we are involved in legal actions arising in the ordinary
course of business. We cannot assure you that these actions or other third party
assertions against us will be resolved without costly litigation, in a manner
that is not adverse to our financial position, results of operations or cash
flows. As facts concerning contingencies become known, we reassess our position
and make appropriate adjustments to the financial statements. There are many
uncertainties associated with any litigation. If our initial assessments
regarding the merits of a claim prove to be wrong, our results of operations and
financial condition could be materially and adversely affected. In addition, if
further information becomes available that causes us to determine a loss in any
18
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.
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
statements of operations:
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------- ----------------
2003 2002 2003 2002
------- ------- ------- -------
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 61.4 60.7 55.8 62.7
------- ------- ------- -------
Gross profit 38.6 39.3 44.2 37.3
------- ------- ------- -------
Operating expenses:
Selling, general and administrative. . . . . . . . . . 44.2 64.8 49.6 63.5
Research and development . . . . . . . . . . . . . . . 15.9 24.6 16.0 21.9
Stock based-compensation . . . . . . . . . . . . . . . 0.5 2.6 0.9 3.1
Amortization of purchased intangible assets. . . . . . 1.2 1.8 1.2 1.8
Impairment of goodwill and purchased intangible assets 18.0 - 9.1 -
Restructuring charges. . . . . . . . . . . . . . . . . - - - 19.5
------- ------- ------- -------
Total operating expenses 79.7 93.9 76.6 109.7
------- ------- ------- -------
Loss from operations (41.1) (54.6) (32.4) (72.4)
Interest income (expense), net 0.1 0.6 0.1 1.1
Other income (expense), net (0.1) (2.5) (0.7) (1.6)
------- ------- ------- -------
Loss before income taxes (41.1) (56.6) (33.0) (72.9)
Provision (benefit) for income taxes 0.8 (0.3) 0.5 0.2
------- ------- ------- -------
Net loss (41.9)% (56.3)% (33.5)% (73.1)%
======= ======= ======= =======
NET REVENUES
NET REVENUES BY PRODUCT CATEGORY
THREE MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
PRODUCT CATEGORIES 2003 REVENUE 2002 REVENUE VARIANCE VARIANCE
- ------------------ ------- --------- ------- --------- ---------- ---------
Device networking $ 6,975 55.7% $ 6,815 53.8% $ 160 2.3%
IT management 3,290 26.2% 3,390 26.8% (100) (3.0)%
Other 2,267 18.1% 2,453 19.4% (186) (7.6)%
------- --------- ------- --------- ---------- ---------
TOTAL $12,532 100.0% $12,658 100.0% $ (126) (1.0)%
======= ========= ======= ========= ========== =========
SIX MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
PRODUCT CATEGORIES 2003 REVENUE 2002 REVENUE VARIANCE VARIANCE
- ------------------ ------- ------- ---------- ---------
Device networking $13,538 54.7% $13,345 52.7% $ 193 1.4%
IT management 6,348 25.6% 6,426 25.3% (78) (1.2)%
Other 4,876 19.7% 5,568 22.0% (692) (12.4)%
------- --------- ------- --------- ---------- ---------
TOTAL $24,762 100.0% $25,339 100.0% $ (577) (2.3)%
======= ========= ======= ========= ========== =========
The overall decrease in net revenues by product is primarily due to a
decrease in our other product line. The decrease in other product line net
revenues is primarily due to a decrease in our legacy Print Server, United
States Software Corporation and Visualization product lines. We are no longer
investing in the development of these product lines and expect net revenues
related to these product lines to continue to decline in the future as we focus
our investment in device networking and IT management products. Device
networking net revenues for the six months ended December 31, 2003 includes
$158,000 in net revenues from one of our industrial controller product lines
that we exited during the quarter ended September 30, 2003. Device networking
net revenues for the six months ended December 31, 2002 included $1.1 million of
19
net revenues from this exited industrial controller product line. Exiting this
product line represented a $914,000 decrease in our device networking net
revenues which was offset by increases in other device networking products
including our newly introduced XPort product.
NET REVENUES BY REGION
THREE MONTHS ENDED
DECEMBER 31,
------------
GEOGRAPHIC REGION % OF NET % OF NET $ %
(ACCORDING TO SALES BOOKED) 2003 REVENUE 2002 REVENUE VARIANCE VARIANCE
- --------------------------- ------- --------- ------- --------- ---------- ---------
Americas $ 8,631 68.9% $ 9,778 77.2% $ (1,147) (11.7)%
Europe 2,911 23.2% 2,709 21.4% 202 7.5%
Other 990 7.9% 171 1.4% 819 478.9%
------- --------- ------- --------- ---------- ---------
TOTAL $12,532 100.0% $12,658 100.0% $ (126) (1.0)%
======= ========= ======= ========= ========== =========
SIX MONTHS ENDED
DECEMBER 31,
------------
GEOGRAPHIC REGION % OF NET % OF NET $ %
(ACCORDING TO SALES BOOKED) 2003 REVENUE 2002 REVENUE VARIANCE VARIANCE
- --------------------------- ------- --------- ------- --------- ---------- ---------
Americas $17,692 71.4% $19,595 77.3% $ (1,903) (9.7)%
Europe 5,416 21.9% 5,085 20.1% 331 6.5%
Other 1,654 6.7% 659 2.6% 995 151.0%
------- --------- ------- --------- ---------- ---------
TOTAL $24,762 100.0% $25,339 100.0% $ (577) (2.3)%
======= ========= ======= ========= ========== =========
The overall decrease in net revenues by region is primarily due to a
decrease in the Americas region. The decrease in net revenues in the Americas
region is primarily attributable to a decrease in industry technology spending.
Additionally, the decrease is due to our decision to exit one of our industrial
controller product lines, which was sold entirely in the Americas. Net revenues
for the six months ended December 31, 2003 and 2002 included $158,000 and $1.1
million of net revenues from the exited industrial controller product line a
change of $914,000. The increase in other is primarily due to the signing of
several new customers and our increased sales efforts in the Asia Pacific
region.
GROSS PROFIT
THREE MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
------ --------- ------ --------- ---------- ---------
Gross profit $4,837 38.6% $4,971 39.3% $ (134) (2.7)%
====== ========= ====== ========= ========== =========
SIX MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
------- --------- ------ --------- --------- ---------
Gross profit $10,955 44.2% $9,456 37.3% $ 1,499 15.9%
======= ========= ====== ========= ========= =========
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,
2003 and 2002 includes $596,000 and $1.0 million of amortization of purchased
intangible assets, respectively. Cost of revenues for the six months ended
December 31, 2003 and 2002 includes $1.2 million and $2.1 million of
amortization of purchased intangible assets, respectively. At December 31, 2003,
the unamortized balance of purchased intangible assets that will be amortized to
cost of revenues was $3.0 million, of which $1.0 million will be amortized in
the remainder of fiscal 2004, $1.4 million in fiscal 2005 and $557,000 in fiscal
2006. The slight increase in gross profit was mainly attributable to a reduction
in overall inventory in December 2002 which resulted in an increase in
capitalized overhead expense, an overall reduction in payroll and payroll
related costs due to the closing of our Milford, Connecticut facility in
February 2003, a decrease in the amortization of purchased intangible assets due
to the impairment write-down of $3.9 million during the fourth quarter of fiscal
2003, offset by an increase in the impairment of purchased intangible assets due
to the write-off of the Premise purchased intangible assets in the amount of
$776,000 and an increase in warranty expense.
20
SELLING, GENERAL AND ADMINISTRATIVE
THREE MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
------ --------- ------ --------- ---------- ---------
Selling, general and administrative $5,540 44.2% $8,208 64.8% $ (2,668) (32.5)%
====== ========= ====== ========= ========== =========
SIX MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
------- --------- ------- --------- ---------- ---------
Selling, general and administrative $12,245 49.5% $16,079 63.5% $ (3,834) (23.8)%
======= ========= ======= ========= ========== =========
Selling, general and administrative expenses consist primarily of
personnel-related expenses including salaries and commissions, facility
expenses, information technology, trade show expenses, advertising, insurance
proceeds, and professional legal and accounting fees. Selling, general and
administrative expense decreased primarily due to reductions in headcount and
facility costs as a result of our fiscal 2003 restructurings, decrease in legal
and other professional fees offset by an increase in our directors and officers
insurance. The legal fees primarily relate to our defense of the shareholder
lawsuits and the SEC investigation. Legal fees incurred in defense of the
shareholder suits are reimbursable to the extent provided in our directors and
officers liability insurance policies, and subject to the coverage limitations
and exclusions contained in such policies. For the six months ended December 31,
2003, we have been reimbursed $1.5 million of these expenses. We expect to
receive additional reimbursements for legal fees in the future.
RESEARCH AND DEVELOPMENT
THREE MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
------ --------- ------ --------- ---------- ---------
Research and development $1,990 15.9% $3,117 24.6% $ (1,127) (36.2)%
====== ========= ====== ========= ========== =========
SIX MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
------ --------- ------ ---------- ---------
Research and development $3,974 16.0% $5,547 21.9% $ (1,573) (28.4)%
====== ========= ====== ========= ========== =========
Research and development expenses consist primarily of personnel-related
costs of employees, as well as expenditures to third-party vendors for research
and development activities. Research and development expenses decreased
primarily due to our fiscal 2003 restructurings which resulted in the
consolidation of our research and development activities to Redmond, Washington;
Milford, Connecticut; and Irvine, California facilities. Generally, research and
development expenses are expected to increase during the remainder of fiscal
2004 as we increase headcount at our Irvine, California facilities to support
new product development.
STOCK-BASED COMPENSATION
THREE MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
----- --------- ----- --------- ---------- ---------
Stock-based compensation $ 63 0.5% $ 335 2.6% $ (272) (81.2)%
===== ========= ===== ========= ========== =========
21
SIX MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
----- --------- ----- --------- ---------- ---------
Stock-based compensation $ 218 0.9% $ 780 3.1% $ (562) (72.1)%
===== ========= ===== ========= ========== =========
Stock-based compensation generally represents the amortization of deferred
compensation. We recorded no deferred compensation for the six months ended
December 31, 2003 and recorded a reduction to deferred compensation as a result
of employee stock option forfeitures in the amount of $196,000 for the six
months ended December 31, 2003. Deferred compensation represents the difference
between the fair value of the underlying common stock for accounting purposes
and the exercise price of the stock options at the date of grant as well as the
fair market value of the vested portion of non-employee stock options utilizing
the Black-Scholes option pricing model. Deferred compensation also includes the
value of employee stock options assumed in connection with our acquisitions
calculated in accordance with current accounting guidelines. Deferred
compensation is presented as a reduction of stockholders' equity and is
amortized ratably over the respective vesting periods of the applicable options,
which is generally four years.
Included in cost of revenues is stock-based compensation of $10,000 and
$18,000 for the three months ended December 31, 2003 and 2002, respectively and
$27,000 and $37,000 for the six months ended December 31, 2003 and 2002,
respectively. Stock-based compensation decreased primarily due to restructuring
whereby options for which deferred compensation has been recorded were forfeited
by terminated employees. Additionally, the decrease is due to the acceleration
of approximately $239,000 of stock-based compensation in January 2003 as a
result of our completion of a stock option exchange program whereby employees
holding options to purchase our common stock were given the opportunity to
cancel certain of their existing options in exchange for the opportunity to
receive new options. At December 31, 2003, a balance of $254,000 remains and
will be amortized as follows: $151,000 in the remainder of fiscal 2004, $86,000
in fiscal 2005 and $17,000 in fiscal 2006.
AMORTIZATION OF PURCHASED INTANGIBLE ASSETS
THREE MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
----- --------- ----- --------- ---------- ---------
Amortization of purchased intangible assets $ 145 1.2% $ 228 1.8% $ (83) (36.4)%
===== ========= ===== ========= ========== =========
SIX MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
----- --------- ----- --------- ---------- ---------
Amortization of purchased intangible assets $ 289 1.2% $ 456 1.8% $ (167) (36.6)%
===== ========= ===== ========= ========== =========
Purchased intangible assets primarily include existing technology, patents
and non-compete agreements and are amortized on a straight-line basis over the
estimated useful lives of the respective assets, ranging from one to five years.
We obtained independent appraisals of the fair value of tangible and intangible
assets acquired in order to allocate the purchase price. In addition,
approximately $596,000 and $1.0 million of amortization of purchased intangible
assets has been classified as cost of revenues for the three months ended
December 31, 2003 and 2002, respectively and $1.2 million and $2.1 million for
the six months ended December 31, 2003 and 2002, respectively. At December 31,
2003, the unamortized balance of purchased intangible assets that will be
amortized to future operating expense was $126,000, of which $59,000 will be
amortized in the remainder of fiscal 2004, $65,000 in fiscal 2005 and $2,000 in
fiscal 2006.
IMPAIRMENT OF GOODWILL AND PURCHASED INTANGIBLE ASSETS
THREE MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
------ --------- ----- --------- --------- ---------
Impairment of goodwill and purchased
intangible assets $2,252 18.0% $ - 0.0% $ 2,252 100.0%
====== ========= ===== ========= ========= =========
22
SIX MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
------ --------- ----- --------- --------- ---------
Impairment of goodwill and purchased
intangible assets $2,252 9.1% $ - 0.0% $ 2,252 100.0%
====== ========= ===== ========= ========= =========
During the second fiscal quarter of 2004, we identified indicators of an
other than temporary impairment as it related to our Premise acquisition of
goodwill and purchased intangible assets. We performed an assessment of the
value of our goodwill and purchased intangible assets in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets" and SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." We identified certain conditions including
continued losses and the inability to achieve significant revenue from the
existing home automation and media management software markets as indicators of
asset impairment. These conditions led to operating results and forecasted
future results that were substantially less than had been anticipated. We
revised our projections and determined that the projected results utilizing a
discounted cash flow valuation technique would not fully support the carrying
values of the goodwill and purchased intangible assets associated with the
Premise acquisition. Based on this assessment, we recorded an impairment charge
of $2.2 million during the second quarter of fiscal 2004 to write-off the value
of the Premise goodwill. Additionally during the second quarter of fiscal 2004,
we recorded a $790,000 impairment charge of the Premise purchased intangible
assets of which $14,000 and $776,000 were charged to operating expenses and cost
of revenues, respectively.
RESTRUCTURING CHARGES
On September 12, 2002 and March 14, 2003, we announced a restructuring plan
to prioritize our initiatives around the growth areas of our business, focus on
profit contribution, reduce expenses, and improve operating efficiency. These
restructuring plans included a worldwide workforce reduction, consolidation of
excess facilities and other charges. We recorded restructuring costs totaling
$5.7 million, which were classified as operating expenses in the consolidated
statement of operations for the year ended June 30, 2003. These restructuring
plans resulted in the reduction of approximately 58 regular employees worldwide.
We recorded workforce reduction charges of approximately $1.3 million related to
severance and fringe benefits for the terminated employees. We recorded charges
of approximately $4.4 million related to the consolidation of excess facilities,
relating primarily to lease terminations, non-cancelable lease costs, write-off
of leasehold improvements and termination of a contractual obligation. The
restructuring costs will be substantially paid in cash over the next five years.
The remaining restructuring reserve is related to facility lease terminations
and a contractual settlement.
INTEREST INCOME (EXPENSE), NET
THREE MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
----- --------- ----- --------- ---------- ---------
Interest income (expense), net $ 11 0.1% $ 75 0.6% $ (64) (85.3)%
===== ========= ===== ========= ========== =========
SIX MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
----- --------- ----- --------- ---------- ---------
Interest income (expense), net $ 35 0.1% $ 267 1.1% $ (232) (86.9)%
===== ========= ===== ========= ========== =========
Interest income (expense), net consists primarily of interest earned on
cash, cash equivalents and marketable securities. The decrease is primarily due
to lower average investment balances and interest rates. Additionally, the
decrease in the average investment balance is due to increased legal and other
professional fees, settlement of litigation, cash portions of settlements with
owners of some of the businesses we have acquired, the settlement of the Milford
lease obligation included in our restructuring charge, the purchase of a joint
interest in intellectual property from Gordian, our acquisition of Stallion and
to fund current operations.
23
OTHER INCOME (EXPENSE), NET
THREE MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
------ --------- ------ --------- --------- ---------
Other income (expense), net $ (10) (0.1)% $(318) (2.5)% $ 308 96.9%
====== ========= ====== ========= ========= =========
SIX MONTHS ENDED
DECEMBER 31,
------------
% OF NET % OF NET $ %
2003 REVENUES 2002 REVENUES VARIANCE VARIANCE
------ --------- ------ --------- --------- ---------
Other income (expense), net $(180) (0.7)% $(408) (1.6)% $ 228 55.9%
====== ========= ====== ========= ========= =========
The decrease in other expense is primarily attributable to our gain on
foreign currency translation and a reduction in our share of the losses from our
investment in Xanboo.
PROVISION FOR INCOME TAXES AND EFFECTIVE TAX RATE
We utilize the liability method of accounting for income taxes as set forth
in SFAS No. 109, "Accounting for Income Taxes." Our effective tax rate was 2%
for the six months ended December 31, 2003, and 0% for the six months ended
December 31, 2002. The federal statutory rate was 34% for both periods. Our
effective tax rate associated with the income tax expense for the six months
ended December 31, 2003, was lower than the federal statutory rate primarily due
to the increase in valuation allowance, as well as the amortization of
stock-based compensation for which no current year tax benefit was provided. Our
effective tax rate associated with the income tax expense for the six months
ended December 31, 2002, was lower than the federal statutory rate primarily due
to the increase in valuation allowance, as well as the amortization of
stock-based compensation for which no current year tax benefit was provided. In
October 2003, the Internal Revenue Service completed its audit of our federal
income tax returns for the years ended June 30, 1999, 2000 and 2001. As a
result, we will be required to pay approximately $750,000 in tax and interest to
the Internal Revenue Service and the California Franchise Tax Board, in fiscal
2004. We accrued for this liability in prior fiscal periods.
IMPACT OF ADOPTION OF NEW ACCOUNTING STANDARDS
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46, "Consolidation of Variable Interest Entities an
Interpretation of ARB No. 51" ("FIN 46"). FIN 46 requires certain variable
interest entity ("VIE") to be consolidated by the primary beneficiary of the
entity if the equity investors in the entity do not have the characteristics of
a controlling financial interest or do not have sufficient equity at risk for
the entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 is effective for all new VIE's created or
acquired after January 31, 2003. For VIE's created or acquired prior to February
1, 2003, the provisions of FIN 46 must be applied for the first interim or
annual period ending after March 15, 2004. We are currently reviewing our
investments and other arrangements to determine whether any of our investee
companies are VIEs. We believe that our investment in Xanboo described in Note 8
of the Notes to the Unaudited Consolidated Financial Statements, "Long-term
Investments" is the only entity which could be subject to treatment as a VIE
under FIN 46. However, we do not believe that Xanboo will be determined to be a
VIE that would be consolidated, but we may be required to make additional
disclosures.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have financed our operations through the issuance of
common stock and through net cash generated from operations. We consider all
highly liquid investments purchased with original maturities of 90 days or less
to be cash equivalents. Cash and cash equivalents consisting of money-market
funds and commercial paper totaled $10.3 million at December 31, 2003.
Marketable securities are income yielding securities which can be readily
converted to cash. Marketable securities consist of obligations of U.S.
Government agencies, state, municipal and county government notes and bonds and
totaled $3.0 million at December 31, 2003.
Our operating activities used cash of $1.0 million for the six months ended
December 31, 2003. We incurred a net loss of $8.3 million, which includes the
following adjustments: depreciation of $999,000, amortization of purchased
intangible assets of $1.5 million, impairment of goodwill and purchased
intangible assets of $3.0 million, amortization of stock-based compensation of
24
$245,000, equity losses from unconsolidated businesses of $413,000, offset by a
benefit from inventory reserve of $561,000. The changes in our operating assets
consist of a decrease in inventories of $874,000, decrease in contract
manufacturer receivable of $574,000, decrease in prepaid expenses and other
assets of $1.9 million, decrease in accounts payable of $1.9 million, decrease
in restructure reserve of $152,000 and a decrease in the balance due to Gordian
of $1.0 million offset by an increase in other current liabilities of $1.4
million. The decrease in inventories is primarily attributable to a concentrated
effort by management to reduce inventory levels. The decrease in contract
manufacturer receivables is due to improved collections. The decrease in prepaid
expenses and other current assets is primarily due to the Gordian payment
whereby we maintained a time deposit for $1.0 million as well as the maturity of
additional time deposits totaling $682,000. The decreases in accounts payable
and the restructuring reserve are due to the timing of payments to our
suppliers. The decrease in the balance due to Gordian is due to payments in
accordance with the agreement. The increase in other current liabilities is
primarily due to an increase in general liabilities such as audit fees, legal
fees, contractual obligations and inventory purchases.
Cash provided by investing activities was