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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER 1-16027
LANTRONIX, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0362767
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
15353 BARRANCA PARKWAY, IRVINE, CALIFORNIA 92618
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(949) 453-3990
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
COMMON STOCK, $0.0001 PAR VALUE THE NASDAQ MARKET
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes [ ] No [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of the registrant's Common Stock held by
non-affiliates based upon the closing sales price of the Common Stock on
December 31, 2003, as reported by the Nasdaq National Market, was approximately
$31,192,000. Shares of Common Stock held by each current executive officer and
director and by each person who is known by the registrant to own 5% or more of
the outstanding Common Stock have been excluded from this computation in that
such persons may be deemed to be affiliates of the registrant. Share ownership
information of certain persons known by the registrant to own greater than 5% of
the outstanding common stock for purposes of the preceding calculation is based
solely on information on Schedule 13G filed with the Commission and is as of
December 31, 2003. This determination of affiliate status is not a conclusive
determination for other purposes.
As of August 31, 2004, there were 58,154,919 shares of the Registrant's common
stock outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the Lantronix, Inc. Annual
Meeting of Stockholders scheduled to be held on November 18, 2004 are
incorporated by reference into Part II and Part III of this Form 10-K.
Certain exhibits filed in connection with the Lantronix, Inc. Registration
Statement on Form S-1, originally filed May 19, 2000, and Registration Statement
on Form S-1, originally filed June 14, 2001, are incorporated by reference into
Part IV of this Form 10-K.
LANTRONIX, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED JUNE 30, 2004
TABLE OF CONTENTS
Page
----
PART I
ITEM 1. Business 4
ITEM 2. Properties 11
ITEM 3. Legal Proceedings 11
ITEM 4. Submission of Matters to a Vote of Security Holders 13
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters 14
ITEM 6. Selected Consolidated Financial Data 15
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 16
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk 37
ITEM 8. Financial Statements and Supplementary Data 37
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 37
ITEM 9A Controls and Procedures 37
PART III
ITEM 10. Directors and Executive Officers of the Registrant 39
ITEM 11. Executive Compensation 39
ITEM 12. Security Ownership of Certain Beneficial Owners and Management 39
ITEM 13. Certain Relationships and Related Transactions 39
ITEM 14. Principal Accountant Fees and Services 39
PART IV
ITEM 15. Exhibits, Financial Statements, Schedules and Reports on Form 8-K 40
Officer Certifications II-4
2
FORWARD-LOOKING STATEMENTS
THIS DOCUMENT CONTAINS STATEMENTS THAT ARE NOT HISTORICAL FACTS BUT ARE
FORWARD-LOOKING STATEMENTS RELATING TO SUCH MATTERS AS ANTICIPATED FINANCIAL
PERFORMANCE, BUSINESS PROSPECTS, TECHNOLOGICAL DEVELOPMENTS, NEW PRODUCTS,
ENGINEERING AND DEVELOPMENT ACTIVITIES AND SIMILAR MATTERS. SUCH STATEMENTS ARE
GENERALLY IDENTIFIED BY THE USE OF FORWARD-LOOKING WORDS AND PHRASES, SUCH AS
"INTENDED," "EXPECTS," "ANTICIPATES" AND "IS (OR ARE) EXPECTED (OR
ANTICIPATED)." THESE FORWARD-LOOKING STATEMENTS INCLUDE BUT ARE NOT LIMITED TO
STATEMENTS CONCERNING INDUSTRY TRENDS, ANTICIPATED DEMAND FOR OUR PRODUCTS, THE
IMPACT OF PENDING LITIGATION, OUR STRATEGY, THE POSSIBILITY OF FUTURE
INVESTMENTS OR ACQUISITIONS, FUTURE CUSTOMER AND SALES DEVELOPMENTS,
MANUFACTURING FORECASTS, INCLUDING THE POTENTIAL BENEFITS OF OUR CONTRACT
MANUFACTURERS SOURCING AND SUPPLYING RAW MATERIALS, COMPONENTS AND INTEGRATED
CIRCUITS, THE POSSIBILITY OF AN EXPANDING ROLE FOR ORIGINAL EQUIPMENT
MANUFACTURERS IN OUR BUSINESS, THE FUTURE COST AND POTENTIAL BENEFITS OF OUR
RESEARCH AND DEVELOPMENT EFFORTS, AND LIQUIDITY AND CASH RESOURCES FORECASTS.
ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE DISCUSSED IN SUCH
FORWARD-LOOKING STATEMENTS, AND OUR STOCKHOLDERS SHOULD CAREFULLY REVIEW THE
CAUTIONARY STATEMENTS SET FORTH IN THIS FORM 10-K, INCLUDING FACTORS THAT MAY
AFFECT FUTURE RESULTS. WE MAY FROM TIME TO TIME MAKE ADDITIONAL WRITTEN AND ORAL
FORWARD-LOOKING STATEMENTS, INCLUDING STATEMENTS CONTAINED IN OUR FILINGS WITH
THE SECURITIES AND EXCHANGE COMMISSION AND IN OUR REPORTS TO STOCKHOLDERS. WE DO
NOT UNDERTAKE TO UPDATE ANY FORWARD-LOOKING STATEMENTS THAT MAY BE MADE FROM
TIME TO TIME BY US OR ON OUR BEHALF.
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PART I
ITEM 1. BUSINESS
OVERVIEW
Lantronix, Inc. ("Lantronix" or "we" or "us") designs, develops and markets
devices and software solutions that make it possible to access, manage, control
and configure almost any electronic product over the Internet or other networks.
We are a leader in providing innovative networking solutions. We were initially
formed as "Lantronix," a California corporation, in June 1989. We reincorporated
as "Lantronix, Inc.," a Delaware corporation in May 2000.
We have a history of providing devices that enable information technology
("IT") equipment to network using standard protocols for connectivity, including
fiber optic, Ethernet and wireless. Our first device was a terminal server that
allowed "dumb" terminals to connect to a network. Building on the success of our
terminal servers, we introduced a complete line of print servers in 1991 that
enabled users to inexpensively share printers over a network. Over the years, we
have continually refined our core technology and have developed additional
innovative networking solutions that expand upon the business of providing our
customers network connectivity. With the expansion of networking and the
Internet, our technology focus is increasingly broader, so that our device
solutions provide a product manufacturer with the ability to network their
products within the industrial, service and consumer markets.
We provide three broad categories of products: "device networking solutions,"
that enable almost any electronic product to be connected to a network; "IT
management solutions," that enable multiple pieces of hardware, usually
IT-related network hardware such as servers, routers, switches, and similar
pieces of equipment to be managed over a network; and "non-core" products and
services that include visualization solutions, legacy print server's, software
revenues, and other miscellaneous products. The expansion of our business in the
future is directed at the first two of these categories, device networking and
IT management solutions.
Today, our solutions include fully integrated hardware and software
devices, as well as software tools, to develop related customer applications.
Because we deal with network connectivity, we provide hardware solutions to
extremely broad market segments, including industrial, medical, commercial,
financial, governmental, retail and 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, 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.
We sell our devices through a global network of distributors, systems
integrators, value-added resellers (VARs), manufacturers' representatives and
original equipment manufacturers (OEMs). In addition, we sell directly to
selected accounts.
Our products are sold to distributors, OEMs, VARs, and systems integrators,
as well as directly to end-users. One customer, Ingram Micro Inc., accounted for
approximately 14%, 11% and 12% of our net revenues for the years ended June 30,
2004, 2003 and 2002, respectively. Another customer, Tech Data Corporation,
accounted for approximately 9%, 10% and 11% of our net revenues for the years
ended June 30, 2004, 2003 and 2002, respectively. Accounts receivable
attributable to these two domestic customers accounted for approximately 13% and
16% of total accounts receivable at June 30, 2004 and 2003, respectively.
Our common stock is currently traded on The Nasdaq SmallCap Market under
the symbol LTRX.
Our worldwide headquarters are located in Irvine, California and we have
offices in Milford, Connecticut and worldwide, including; Germany; France; Hong
Kong and Japan. We also have employees working from home offices in other areas
of the world including the United Kingdom and Netherlands. During the first
quarter of fiscal 2004, we closed our European administrative operations handled
by our Switzerland office. Since September 2003, European operations have been
managed from our Irvine, California facility.
We provide information regarding our company and our products on our
Internet web site, www.lantronix.com.
OUR STRATEGY
Our business strategy is based on our proven capability to develop fully
integrated networking solutions that increase the value of our customers'
products by making it easy to take advantage of features that can be made
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available when these products are network-enabled. This strategy is accomplished
by providing our customers with hardware and software that connects products and
systems to a network, and intelligently manages and controls them. Through our
15 years of networking expertise, knowledge of industry trends, and our
capability to develop solutions based on open industry standards, we have been
able to anticipate our customers' networking technology requirements and offer
solutions that enable them to achieve their connectivity objectives. By
providing a complete solution of hardware and integrated software, we have been
able to provide "turnkey" solutions, eliminating the need for our customers to
build expensive design and manufacturing expertise in-house. This results in
savings to the customer both in terms of financial investment and time.
Our fully integrated hardware, software, and application development tools
have enabled us to become a technology and industry leader. We focus on the
following key areas:
- - Device Networking Solutions - We offer an array of embedded and external
device networking solutions that enable integrators and manufacturers of
electronic and electro-mechanical products to add network connectivity,
manageability, and control to their products. Our customers' products
originate from a wide variety of applications, such as blood analyzers that
relay critical patient information directly to a hospital's information
system, to simple devices such as timeclocks or audio/visual equipment, to
improve how these products are managed and controlled.
- - IT Management Solutions - We offer off-the-shelf equipment that enables IT
professionals to remotely manage network infrastructure equipment and large
groups of servers. Our terminal and console management systems solutions
provide a comprehensive solution for the remote command and control of
today's network infrastructure.
- - Non-core Businesses - Over the years, we have innovated or acquired various
product lines that are no longer part of our primary, core markets
described above. In general, this category of business represents
decreasing markets and we minimize research and development in these
product lines. Included in this category are visualization solutions,
legacy print servers, software and other miscellaneous products.
Our strategy is to drive the product development and revenues of our core
areas, device networking solutions and IT management solutions.
PRODUCTS
DEVICE NETWORKING SOLUTIONS
We provide manufacturers, integrators, and users with complete device networking
solutions that include the technology required for products to be connected,
managed and controlled over networks using standard protocols for connectivity,
including fiber optic, Ethernet and wireless. As common, everyday products such
as lighting, security and audio/visual systems leverage the power of network
connectivity, manufacturers and users are realizing the benefits of networking.
Our device networking solutions dramatically shorten a manufacturer's
development time to implement network connectivity, provide competitive
advantages with new features, and greatly reduce engineering and marketing
risks. Our hardware solutions include embedded modules (completed boards or
intelligent connectors with electronic components and the necessary connectors
and software that is mounted within a customer's product), and external hardware
modules (with single, multi- or wireless ports), as well as the related
real-time operating system and application software that is required to make the
devices effective. We also offer application- and industry-specific solutions
such as industrial device servers.
Our device servers allow a wide range of equipment to be quickly
network-enabled without the need for intermediary gateways, workstations, or
PCs. This distributed computing approach significantly improves reliability and
up-time. Our device servers also eliminate the high cost of ownership associated
with networking, which frequently would otherwise require using PCs and
workstations to perform connectivity and remote management functions. Our device
servers contain high-performance processors capable of not only controlling the
attached device, but also of accumulating data and status. Such data can then be
formatted by the device server and presented to users via the built in web
server, SNMP, e-mail, etc. Device servers are easy to manage using any standard
Web browser, due to a built-in HTTP server.
In February 2003, we announced the release of our XPort device server,
which represents a significant improvement in technology, and a reduction in
physical size and price for this type of functionality. The thumb-sized XPort is
a self-contained network communications server and miniaturized web site
enclosed within a rugged RJ-45 connector package, which can be embedded in
virtually any electronic product. Products incorporating XPort have their own
address on the World Wide Web and can be accessed from any web browser,
including a wireless PC or Internet-enabled cell phone, from anywhere in the
world. The XPort can serve up Internet-standard web pages, initiate e-mails for
notifications or alerts, and run other applications as defined by the product
manufacturer. XPort eliminates the complexity for a product manufacturer to
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create network connectivity, because the XPort device includes a complete,
integrated solution with a 10/100 Base-T Ethernet connection, a reliable and
proven operating system, an embedded web server, flexible firmware, a full
TCP/IP protocol stack, and optional 256-bit standards-based (AES) encryption. We
believe the relatively low price of the XPort, as well as the speed and ease
with which a manufacturer can design the device into their products, will make a
customer's products more attractive, by providing network connectivity.
In March 2004, we introduced WiPort, a wireless (and wired) device server,
with substantially the same functionality as XPort, but with an 802.11 wireless
configuration, for embedded application to products and situations where a wired
Ethernet environment is not available or practical. In August 2004, we
introduced WiBox, an external wireless web server that is planned for transition
to volume production in the second and third quarters of fiscal 2005.
IT MANAGEMENT SOLUTIONS
Our IT management solutions provide IT professionals with the tools they
need to remotely manage computers and associated systems.
IT professionals use our multiport device solutions (including our terminal
and console servers) to monitor and run their systems to ensure the performance
and availability of critical business information systems, network
infrastructure, and telecommunications equipment. The equipment they manage
includes routers, switches, servers, phone switches and public branch exchanges
that are often located in remote or inaccessible locations.
Our console servers provide system administrators and network managers a
way to connect with their remote equipment through a universal interface called
a console port, helping them work more efficiently without having to leave their
desk or office. With remote access, system downtime, and its impact on business,
is minimized. Our console servers provide IT professionals with peace-of-mind
through extensive security features in some cases, and in some cases, provisions
for dial-in access via modem. These solutions are provided in various
configurations, and can manage up to 48 devices from one console server.
NON-CORE BUSINESSES: VISUALIZATION SOLUTIONS, PRINT SERVERS AND OTHER LEGACY
PRODUCTS
We offer visualization solutions that provide switching and optical
extension of high performance video, audio, keyboard and mouse over long
distances within a building or campus environment. Products include FiberLynx
video display extenders and keyboard, video, mouse ("KVM") switches, KVM
extension systems, and matrix hubs. These products provide a valuable solution
for extending and sharing audio, video, keyboard and mouse signals among many
users and over large distances without loss of resolution. KVM products enable a
single keyboard, monitor and mouse to be switched between multiple computers,
providing immediate access and control from a single location. The customers for
these devices are typically companies needing to isolate users from the core
computing center for security reasons, or have other needs requiring high speed
video sources to be shared among many users. Our visualization solutions can be
found in government agencies and at customers involved with large scale
simulation and display applications.
We began our business by providing external print servers that connect
various printers to a network for shared printing tasks. Over the years, we have
updated and continue to provide print servers that work with a myriad of
operating systems and network configurations. The requirement for external print
servers is decreasing, as manufacturers have incorporated the networking
hardware and software as part of many printers.
We acquired a line of low-cost products which we market under the
"Stallion" brand. Stallion products' range includes a variety of network servers
and a range of multiport serial I/O cards. Various other small categories of our
legacy business are included in this category, such as software revenues and
other product lines we have discontinued or that are being de-emphasized.
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The following are approximate revenues for these categories, the
definitions of which have been modified slightly as of June 30, 2004, and
previous years' data has been modified to conform to the new definitions:
NET REVENUES FOR THE YEARS ENDED JUNE 30,
-----------------------------------------
PRODUCT FAMILY PRIMARY PRODUCT FUNCTION 2004 2003 2002
- --------------------------- ---------------------------------------- ----- ----- -----
Device networking solutions Enable almost any electronic product to $ 27.5 $ 24.5 $ 28.7
become network enabled.
IT management solutions Allow the user to control equipment by way of $ 12.6 $ 13.1 $ 16.5
the Internet using a wide range of network
protocols. This category includes console
servers.
Non-core products Includes visualization solutions, legacy print $ 8.8 $ 11.8 $ 12.4
servers, software and other miscellaneous
products
Financial Accounting Standards Board ("FASB") Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information,"
establishes standards for disclosures about operating segments in annual
consolidated financial statements. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
We operate in one segment, networking and Internet connectivity.
CUSTOMERS
Distributors
Our principal customers are our distributors, who are the source of our
highest percentage of net revenues. Distributors resell our products to a wide
variety of customers including consumers, corporate customers, VARs, etc. We
sell to a group of ten major distributors, who operate, in some cases, from
multiple warehouses. Our major distributors in the U.S. include: Ingram Micro,
Tech Data, KMJ Communications and Arrow Electronics, Inc. In Europe, we
distribute directly from a public warehouse located in Belgium which serves, in
part, the following major distributors: transtec AG (a related party due to
common ownership by our largest shareholder), Sphinx Computer Vertriebs GmbH,
Powercorp PTY, LTD, Jade Communications, LTD, Astradis Elecktronik GmbH, and
Atlantik Systems GmbH.
OEM Manufacturers
We have established a broad range of OEM electro-mechanical manufacturing
customers in various industries such as industrial automation, medical,
security, building automation, consumer and audio/visual. Our OEM customers
typically lack the expertise or resources to develop hardware and software
required to introduce network solutions to their end-users in a timely manner.
To shorten the development cycle to add network connectivity to a product, OEMs
can use our external devices to network-enable their installed base of products,
while board-level embedded modules are typically used in new product designs.
Our capabilities and solutions enable OEMs to focus on their core competencies,
resulting in reduced research and development costs, fewer integration problems,
and faster time to market.
Our module products, including Xport, are particularly useful and adaptable
by OEM customers to enable network connectivity to a wide variety of
electro-mechanical products. In addition to the features it provides, the
advantage is low cost, and the fact that the device can be adapted for use in a
wide range of products without the necessity for lengthy engineering processes
by the OEM, or the time delays that activity might introduce.
End-User Businesses
We have established a broad range of end-user customers in various
businesses such as airports, retail, universities/education, manufacturing,
healthcare/hospitals and financial/banking. End-user businesses require
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solutions that are simple to install, setup, and operate, and can provide
immediate results. Generally, these customers have requirements to connect a
diverse range of products and equipment, without modifying existing software and
systems.
Our external device solutions enable end-users to quickly, securely and
easily connect their devices and equipment to networks, extending the life of
existing investments. In support of these customers, we provide a number of
programs including telephone-based sales and technical support as well as a wide
array of Internet-based resources. In many cases, the customer simply has to
call in to obtain assistance in identifying which networking device would be
most appropriate for its need. After buying the devices from us or one of our
distributors, a customer often only has to plug a cable from the device to be
managed to our external device, and then plug our device into their network.
SALES AND MARKETING
We maintain both an inside and a field sales force. We are also represented
by manufacturers' representatives, VARs and other resellers throughout the world
who call on engineering design and product management teams. We develop
marketing programs, products, tools and services specifically geared to meet the
needs of our targeted customers. Our sales and marketing force consisted of 82
employees as of June 30, 2004 and 83 employees as of June 30, 2003.
We believe that our multi-channel approach provides several advantages. We
can engage the customers and end-users through their channel of choice, making
our solution available from a variety of sources.
Our device networking solutions are principally sold to manufacturers by
our worldwide OEM sales force and through our group of manufacturers'
representatives. We have continued to expand our use of manufacturers'
representatives and other resellers, leveraging their established relationships
to bring our device networking solutions to a greater number of customers within
the OEM market.
We market and sell our IT management solutions and select external device
networking solutions through information technology resellers, industry-specific
system integrators, VARs and directly to end-user organizations. Resellers and
integrators will often obtain our products through distributors. These
distributors supply our products to a broad range of VARs, system integrators,
direct marketers, government resellers and e-commerce resellers. In turn, these
distributor customers market, sell, install, and in most cases, support our
solution to the end-users. We are continuing to expand our use of
cost-effective, indirect channels.
Net revenues generated from sales in the Americas, Europe and other
geographic areas including Asia and Japan for the year ended June 30, 2004 were
$33.8 million, $11.3 million and $3.8 million, respectively, compared to $37.4
million, $10.4 million and $1.6 million for the year ended June 30, 2003 and
$47.7 million, $8.2 million and $1.7 million for the year ended June 30, 2002,
respectively. Although the U.S. represents our largest geographic marketplace,
approximately 31%, 24% and 17% for the years ended June 30, 2004, 2003 and 2002,
respectively of our net sales came from sales to customers outside the U.S.
Gross margin on sales of our products in foreign countries, and sales of product
that include components obtained from foreign suppliers, can be adversely
affected by international trade regulations, including tariffs and antidumping
duties, and by fluctuations in foreign currency exchange rates. Information
concerning our sales by geographic region can be found in Note 15 to the Audited
Consolidated Financial Statements.
MANUFACTURING
Our manufacturing strategy is to produce reliable, high quality products at
competitive prices and to achieve on-time delivery to our customers. To achieve
this strategy, we generally contract with others for the manufacturing of our
products. This practice enables us to concentrate our resources on design,
engineering and marketing where we believe we have greater competitive
advantages.
We have agreements with multiple contract manufacturers. Our contract
manufacturers are located in and around Irvine, Sacramento and Lake Forest,
California; Dongguan, China; Tsao Tuen, Nan-to, Taiwan; and Penang, Malaysia.
Under these agreements, the manufacturers source and supply most raw materials,
components and integrated circuits in accordance with our pre-determined
specifications and forecasts, and perform final assembly, functional testing and
quality control. We believe that this arrangement decreases our working capital
requirements and provides better raw material and component pricing, enhancing
our gross and operating margins. Please see "Risk Factors" for a discussion of
the risks associated with contract manufacturing.
RESEARCH AND DEVELOPMENT
Our research and development efforts are focused on the development of
technology and products that will enhance our position in the markets we serve.
Products are developed in-house and through outside research and development
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resources. We employed 60 employees in our research and development organization
as of June 30, 2004, and 47 employees as of June 30, 2003. Our research and
development expenses were $7.8 million, $9.4 million and $8.7 million for the
years ended June 30, 2004, 2003 and 2002, respectively.
INDUSTRY PARTNERS
In keeping with our business strategy, we have engaged a portfolio of
partners, consortia, and standards committees in an effort to provide the most
complete networking solutions to our customers. We are an active member of
several leading professional and industry associations. Membership in these
associations provides us with a voice in the development of future standards
that are vital to our customers.
SOFTWARE DEVELOPER RELATIONS
Recruiting and informing third-party software developers is an integral
part of our ongoing strategy. We encourage, enable, and support programmers to
develop vertical applications using our hardware, firmware and software
products. With their help and investment in creating additional applications and
markets for our products, we secure a defensible market position and loyal
customers in the process.
COMPETITION
The markets in which we compete are dynamic and highly competitive. We
expect competition to intensify in the future. Our current and potential
competitors include the following:
- - companies with network-enabling technologies, such as Avocent, Echelon,
Moxa, Digi International, Cyclades, Quatech, Wind River, Rabbit, MRV
(formerly known as iTouch), Rose Electronics, Raritan, Equinox and Zilog;
- - companies with equipment for IT management solutions, such as Cyclades,
Moxa, Digi International, Sena, Logical Solutions, Cisco, MRV, DPAC
Technologies and Perle; and
- - companies with significant networking expertise and research and
development resources, including Cisco Systems, IBM and Lucent
Technologies.
The principal competitive factors that affect the market for our products
are:
- - product quality, technological innovation, compatibility with standards and
protocols, reliability, functionality, ease of use, and compatibility;
- - prices of the products; and
- - potential customers' awareness and perception of our products and of
network-enabling technologies.
Much of our technology can be reproduced by our competitors without
royalties or license fees and could compete with our offerings. In addition,
there is a risk that our customers or new entrants to the market could develop
and market their own solutions without paying a fee to us.
INTELLECTUAL PROPERTY RIGHTS
We have developed proprietary methodologies, tools, processes and software
in connection with delivering our services. We have not historically relied on
patents to protect our proprietary rights, although we have recently begun to
build a patent portfolio. We have historically relied on a combination of
copyright, trademark, trade secret laws, and contractual restrictions, such as
confidentiality agreements and licenses, to establish and protect our
proprietary rights.
Trade secret and copyright laws afford us only limited protection. We
cannot be certain that the steps we have taken in this regard will be adequate
to deter misappropriation of our proprietary information or that we will be able
to detect unauthorized use and take appropriate steps to enforce our
intellectual property rights. An adverse change in the laws protecting
intellectual property could harm our business. In addition, we believe that our
success will depend principally upon continuing innovation, technical expertise,
knowledge of networking, storage and applications, and to a lesser extent, on
our ability to protect our proprietary technology. Furthermore, there can be no
9
assurance that our current or future competitors will not develop technologies
that are substantially equivalent to ours.
LIMITATIONS ON OUR RIGHTS TO INTELLECTUAL PROPERTY
Gordian, Inc. ("Gordian") developed certain intellectual property used in
our micro serial server line of products. These products represented and
continue to represent a significant portion of our net revenues. Under the terms
of an agreement dated February 29, 1989, Gordian owned the rights to the
intellectual property developed under the agreement and required us to pay
royalties based upon gross margin of products sold under the agreement. For the
year ended June 30, 2002, we paid Gordian approximately $1.2 million for
royalties. No royalties were paid to Gordian for the years ended June 30, 2004
and 2003 as a result of a new Gordian agreement as described below. Our
agreement with Gordian was to terminate at the end of the sales life of the
products.
On May 30, 2002, we signed a new intellectual property agreement with
Gordian. The new agreement gives us joint ownership of the Gordian intellectual
property that is embodied in the products Gordian has designed for us since
1989. This new agreement provides that we will be able to use the intellectual
property to support, maintain and enhance our products. This new agreement
extinguishes our obligations to pay royalties for each unit of a
Gordian-designed product that we sell as of the effective date.
As part of the new agreement, we paid Gordian $6.0 million in three
installments. We paid $3.0 million concurrent with the signing of the new
agreement, $2.0 million on July 1, 2002, and we made the third and final payment
of $1.0 million on July 1, 2003. We also agreed to purchase $1.5 million of
engineering and support services from Gordian over the 18-month period that
ended November 2003. We are amortizing the intellectual property rights acquired
by this new agreement over the remaining life cycles of our products designed by
Gordian, or approximately three years. We recorded $1.8 million, $2.5 million
and $212,000 of amortization expense in cost of revenues for the years ended
June 30, 2004, 2003 and 2002, respectively.
UNITED STATES AND FOREIGN GOVERNMENT REGULATION
Many of our products and the industries in which they are used are subject
to federal, state or local regulation in the United States. In addition, our
products are exported worldwide. Therefore, we are subject to the regulation of
foreign governments. For example, wireless communication is highly regulated in
both the United States and elsewhere. Our products currently employ encryption
technology; the export of some encryption software is restricted. At this time
our activities comply with existing laws, but we cannot determine whether
future, more restrictive laws, if enacted, would adversely affect us.
Information regarding risks attendant to our foreign operations is set forth in
Part I, Item 7 under the heading "Risk Factors" of this Annual Report on Form
10-K.
EMPLOYEES
As of June 30, 2004, we had 198 full-time employees consisting of 60
employees in research and development, 82 in sales and marketing departments, 21
in operations departments, and 35 general and administrative employees. We have
not experienced any work stoppages and we believe that our relationship with our
employees is good. None of our employees are currently represented by a labor
union.
BACKLOG
Normally, we manufacture our products in advance of receiving firm product
orders from our customers based upon our forecasts of worldwide customer demand.
Most customer orders are placed on an as-needed basis and may be canceled or
rescheduled by the customer without significant penalty. Accordingly, backlog as
of any particular date is not necessarily indicative of our future sales.
Because most of our business is on an as-needed basis and varies slightly, only
because of short-term customer requests, we do not track backlog as a metric of
our operations. We have no customer orders extending more than several months
into the future.
AVAILABILITY OF THIS REPORT
Our annual report on Form 10-K, Quarterly Reports on Form 10-Q, Current
Reports on Form 8-K and amendments to reports filed or furnished pursuant to
Section 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are
available free of charge on our web site at www.lantronix.com shortly after we
-----------------
electronically file such material with the SEC. The public may read and copy any
materials we file with the SEC at the SEC's Public Reference Room at 450 Fifth
Street, NW, Washington, DC 20549. The public may obtain information on the
operation of the Public Reference Room by calling 1-800-SEC-0330. The SEC also
maintains a web site at www.sec.gov that contains reports, proxy, and
-----------
information statements, and other information regarding issues that file
electronically. We assume no obligation to update or revise forward looking
statement in this annual report, whether as a result of new information, future
events or otherwise, unless we are required to do so by law.
10
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table lists the names, ages and positions held by all our
executive officers as of August 31, 2004. There are no family relationships
between any director or executive officer and any other director or executive
officer of Lantronix. Executive officers serve at the discretion of the Board of
Directors.
NAME AGE POSITION
- ------------------------ --- --------
Marc Nussbaum 48 President and Chief Executive Officer
James Kerrigan 68 Chief Financial Officer
Katherine McDermott 44 Vice President of Finance and Secretary
MARC NUSSBAUM has served as our President and Chief Executive Officer since
May 2002 (on an Interim basis until February 2003). From April 2000 to March
2002, Mr. Nussbaum served as Senior Vice President and Chief Technical Officer
for MTI Technology Corporation, a developer of enterprise storage solutions.
From April 1981 to November 1998, Mr. Nussbaum served in various positions at
Western Digital Corporation, a manufacturer of PC components, communication
controllers, storage controllers and hard drives. Mr. Nussbaum lead business
development, strategic planning and product development activities, serving as
Western Digital's Senior Vice President, Chief Technical Officer from 1995 to
1998 and Vice President, Storage Technology and Product Development from 1988
through 1995. Mr. Nussbaum holds a BA degree in physics from the State
University of New York.
JAMES KERRIGAN has served as our Chief Financial Officer since May 2002 (on
an Interim basis until February 2003). From March 2000 to October 2000, he was
Chief Financial Officer of Motiva, a privately-owned company that developed,
marketed and sold collaboration software systems. From January 1998 to February
1999, he was Chief Financial Officer of Who?Vision Systems, Inc., an incubator
company that developed biometric fingerprint devices and software. From April
1995 to March 1997, Mr. Kerrigan was Chief Financial Officer of Artios, Inc., a
privately-owned company that designs, manufactures, and sells prototyping
hardware and software to the packaging industry. Previously, Mr. Kerrigan has
served as chief financial officer for other larger, public companies. He has a
BS degree in engineering and a MBA degree from Northwestern University.
KATHERINE MCDERMOTT has served as our Vice President of Finance since March
2001 and our Secretary since August 2004. Ms. McDermott joined Lantronix in
March 2000 as Corporate Controller. From 1988 through 1999, Ms. McDermott served
in a number of senior level finance positions with Bausch & Lomb, Inc., a global
health care company. Her most recent positions included Corporate Audit Manager,
Plant Controller, and Controller of a wholly owned subsidiary. From 1982 to
1988, Ms. McDermott held various financial positions at a division of General
Motors. Ms. McDermott holds a BBA degree in Business Administration from St.
Bonaventure University in New York, where she graduated cum laude. She also
earned a MBA degree, with a concentration in Finance and Economics, from the
Simon School of Business Administration at the University of Rochester.
ITEM 2. PROPERTIES
We lease a building in Irvine, California that comprises our corporate
headquarters and includes administration, sales, marketing, research and
development, warehouse and order fulfillment functions. We have smaller sales
offices in Milford, Connecticut; Germany; France; Hong Kong and Japan. The
foregoing leases comprise an aggregate of approximately 60,000 square feet of
which our Irvine facility represents the majority of our square footage. Our
Irvine facility has a lease term expiring in July 2005.
During the year ended June 30, 2004, we completed facility and
organizational restructuring activities that we began in fiscal 2003. In
September 2003, we ceased operational activities in Cham, Switzerland, the
headquarters of Lantronix International AG, which is our wholly owned
subsidiary; now, we support international sales and shipping from our Irvine,
California headquarters. In March 2004, we sold our Premise software unit and
closed our Redmond, Washington facility. We continue to make payments on our
lease obligations for facilities we no longer occupy including our facilities
located in Naperville, Illinois, Redmond Washington, Hillsboro, Oregon and Ames,
Iowa. The liability for these lease obligations are included in our
restructuring reserve at June 30, 2004.
ITEM 3. LEGAL PROCEEDINGS
Government Investigation
The SEC is conducting a formal investigation of the events leading up to
our restatement of our financial statements on June 25, 2002. The Department of
Justice is also conducting an investigation concerning events related to the
restatement.
11
Class Action Lawsuits
On May 15, 2002, Stephen Bachman filed a class action complaint entitled
Bachman v. Lantronix, Inc., et al., No. 02-3899, in the U.S. District Court for
the Central District of California against us and certain of our current
directors and former officers alleging violations of the Securities Exchange Act
of 1934 and seeking unspecified damages. Subsequently, six similar actions were
filed in the same court. Each of the complaints purports to be a class action
lawsuit brought on behalf of persons who purchased or otherwise acquired our
common stock during the period of April 25, 2001 through May 30, 2002,
inclusive. The complaints allege that the defendants caused us to improperly
recognize revenue and make false and misleading statements about our business.
Plaintiffs further allege that the defendants materially overstated our reported
financial results, thereby inflating our stock price during our securities
offering in July 2001, as well as facilitating the use of our common stock as
consideration in acquisitions. The complaints have subsequently been
consolidated into a single action and the court has appointed a lead plaintiff.
The lead plaintiff filed a consolidated amended complaint on January 17, 2003.
The amended complaint now purports to be a class action brought on behalf of
persons who purchased or otherwise acquired our common stock during the period
of August 4, 2000 through May 30, 2002, inclusive. The amended complaint
continued to assert that we and the individual officer and director defendants
violated the 1934 Act, and also includes alleged claims that we and our officers
and directors violated the Securities Act of 1933 arising from our Initial
Public Offering in August 2000. We filed a motion to dismiss the additional
allegations on March 3, 2003. The Court granted the motion, with leave to amend,
on December 31, 2003. Plaintiffs filed their second amended complaint February
6, 2004, and we filed a motion to dismiss the additional allegations in the
second amended complaint on March 10, 2004. On August 19, 2004, the Court
granted in part and denied in part the motion to dismiss. On September 13, 2004,
plaintiffs filed their third amended complaint. We have not yet answered the
third amended complaint and discovery has not yet commenced.
Derivative Lawsuit
On July 26, 2002, Samuel Ivy filed a shareholder derivative complaint
entitled Ivy v. Bernhard Bruscha, et al., No. 02CC00209, in the Superior Court
of the State of California, County of Orange, against certain of our current
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 our behalf, equitable relief, and attorneys' fees.
We filed a demurrer/motion to dismiss the amended complaint on February 13,
2003. The basis of the demurrer is that the plaintiff does not have standing to
bring this lawsuit since plaintiff has never served a demand on our Board that
the Board take certain actions on our behalf. On April 17, 2003, the Court
overruled our 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, our former CFO and COO, filed a
complaint entitled Cotton v. Lantronix, Inc., et al., No. 02CC14308, in the
Superior Court of the State of California, County of Orange. The complaint
alleges claims for breach of contract, breach of the covenant of good faith and
fair dealing, wrongful termination, misrepresentation, and defamation. The
complaint seeks unspecified damages, declaratory relief, attorneys' fees and
costs.
We filed a motion to dismiss on October 16, 2002, on the grounds that Mr.
Cotton's complaints are subject to the binding arbitration provisions in Mr.
Cotton's employment agreement. On January 13, 2003, the Court ruled that five of
the six counts in Mr. Cotton's complaint are subject to binding arbitration. The
court is staying the sixth count, for declaratory relief, until the underlying
facts are resolved in arbitration. No arbitration date has been set.
Securities Claims Brought by Former Shareholders of Synergetic Micro Systems,
Inc. ("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 us and certain of our former officers and directors.
Plaintiffs filed an amended complaint on January 7, 2003. The amended complaint
alleges fraud, negligent misrepresentation, breach of warranties and covenants,
breach of contract and negligence, all stemming from our acquisition of
Synergetic. The complaint seeks an unspecified amount of damages, interest,
attorneys' fees, costs, expenses, and an unspecified amount of punitive damages.
On May 5, 2003, we answered the complaint and generally denied the allegations
in the complaint. Discovery has commenced but no trial date has been
established.
12
Patent Infringement Litigation
On August 10, 2004, Digi International served a complaint on us alleging
that certain of our products infringe Digi's U.S. Patent No. 6,446,192. Digi
filed the complaint in the U.S. District Court in Minnesota. The complaint seeks
both monetary and non-monetary relief. We are still analyzing all of the
allegations of the complaint. On August 30, 2004, we served and filed an answer
and counterclaim seeking to invalidate U.S. Patent No. 6,446,192 for failure to
meet the applicable statutory requirements in Part II of Title 35 of the United
States Code including, without limitation, 35 U.S.C. Sec. 102, 103 and 112, as
conditions for patentability. The counterclaim seeks both monetary and
non-monetary relief.
We filed, on May 3, 2004, a complaint against Digi, alleging that certain
of Digi's products infringe on our U.S. Patent No. 6,571,305, in the U.S.
District Court for the Central District of California. The complaint seeks both
monetary and non-monetary relief from Digi's infringement. Digi has filed an
answer and counterclaim alleging invalidity of the patent. The Counterclaim
seeks both monetary and non-monetary relief.
Other
From time to time, we are subject to other legal proceedings and claims in
the ordinary course of business. We are currently not aware of any such legal
proceedings or claims that we believe will have, individually or in the
aggregate, a material adverse effect on our business, prospects, financial
position, operating results or cash flows.
The pending lawsuits involve complex questions of fact and law and likely will
continue to require the expenditure of significant funds and the diversion of
other resources to defend. Management is unable to determine the outcome of its
outstanding legal proceedings, claims and litigation involving us, our
subsidiaries, directors and former officers and cannot determine the extent to
which these results may have a material adverse effect on our business, results
of operations and financial condition taken as a whole. The results of
litigation are inherently uncertain, and adverse outcomes are possible. We are
unable to estimate the range of possible loss from outstanding litigation, and
no amounts have been provided for such matters in the consolidated financial
statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during the
fourth quarter of fiscal year ended June 30, 2004.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
PRICE RANGE OF COMMON STOCK
Our common stock was traded on The Nasdaq National Market under the symbol
"LTRX" from our initial public offering on August 4, 2000 through October 22,
2002. On October 23, 2002 our listing was changed to The Nasdaq SmallCap Market.
The number of holders of record of our common stock as of August 31, 2004 was
approximately 97. The following table sets forth, for the period indicated, the
high and low per share closing prices for our common stock:
FISCAL YEAR 2003 HIGH LOW
- ------------------ ---- ---
First Quarter $1.03 $0.38
Second Quarter 0.92 0.36
Third Quarter 1.08 0.67
Fourth Quarter 0.91 0.49
FISCAL YEAR 2004 HIGH LOW
- ------------------ ---- ---
First Quarter $1.41 $0.78
Second Quarter 1.32 0.89
Third Quarter 1.86 1.06
Fourth Quarter 2.09 1.18
We believe that a number of factors, including but not limited to quarterly
fluctuations in results of operations, may cause the market price of our common
stock to fluctuate significantly. See "Management's Discussion and Analysis-Risk
Factors."
DIVIDEND POLICY
We have never declared or paid cash dividends on our common stock. We do
not anticipate paying any cash dividends on our common stock in the foreseeable
future, and we intend to retain any future earnings for use in the expansion of
our business and for general corporate purposes. Pursuant to a line of credit we
entered into in January 2002 and have amended on several occasions including
July 24, 2004, we are restricted from paying any dividends.
EQUITY COMPENSATION PLANS
The information required by this item regarding equity compensation plans
is incorporated by reference to the information set forth in Item 12 of this
Annual Report on Form 10-K. Item 12 of this Annual Report on Form 10-K
incorporates by reference the information contained in the sections captioned
"Election of Directors" and "Security Ownership of Certain Beneficial Owners and
Management" in Lantronix's definitive Proxy Statement for the Annual Meeting of
Stockholders to be held November 18, 2004 (the Proxy Statement), a copy of which
will be filed with the Securities and Exchange Commission before the meeting
date.
RECENT SALES OF UNREGISTERED SECURITIES
We have not issued unregistered securities since July 1, 2003. Also, we
have not repurchased any of our common stock during the fourth quarter of fiscal
2004.
14
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included below. In March 2004, we completed the sale of our Premise
business unit that was originally purchased in January 2002. Accordingly, the
information set forth in the table below reflects the Premise business unit as a
discontinued operation. The consolidated statements of operations data for the
years ended June 30, 2004, 2003 and 2002 and the balance sheet data as of June
30, 2004 and 2003, are derived from the audited consolidated financial
statements included elsewhere in this report. The consolidated statements of
operations data for the years ended June 30, 2001 and 2000, and the balance
sheet data as of June 30, 2002, 2001 and 2000, are derived from the audited
consolidated financial statements not included elsewhere in this report. The
historical results are not necessarily indicative of results to be expected for
future periods.
YEARS ENDED JUNE 30,
----------------------------------------------------
2004 2003 2002 2001 2000
--------- --------- --------- --------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Net revenues $ 48,885 $ 49,389 $ 57,591 $ 48,972 $44,975
Cost of revenues 25,026 36,264 40,281 24,530 21,526
--------- --------- --------- --------- --------
Gross profit 23,859 13,125 17,310 24,442 23,449
--------- --------- --------- --------- --------
Operating expenses:
Selling, general and administrative 23,293 28,660 40,538 23,998 16,744
Research and development 7,813 9,430 8,680 4,478 3,186
Stock-based compensation 347 1,453 2,863 3,019 1,093
Amortization of goodwill and purchased intangible assets 148 602 960 1,490 813
Impairment of goodwill and purchased intangible assets - 2,353 50,445 - -
Restructuring (recovery) charges (2,093) 5,600 3,473 - -
Litigation settlement costs - 1,533 1,912 - -
In-process research and development - - - 2,596 -
--------- --------- --------- --------- --------
Total operating expenses 29,508 49,631 108,871 35,581 21,826
--------- --------- --------- --------- --------
Income (loss) from operations (5,649) (36,506) (91,561) (11,139) 1,613
Minority interest - - - - (49)
Interest income (expense), net 50 248 1,548 2,182 187
Other income (expense), net (5,333) (926) (760) (167) (47)
--------- --------- --------- --------- --------
Income (loss) before income taxes and cumulative effect of
accounting changes (10,932) (37,184) (90,773) (9,124) 1,704
Provision (benefit) for income taxes (325) 250 (6,665) (1,876) 649
--------- --------- --------- --------- --------
Income (loss) from continuing operations before cumulative
effect of accounting changes (10,607) (37,434) (84,108) (7,248) 1,055
Loss from discontinued operations (5,047) (10,115) (3,444) - -
--------- --------- --------- --------- --------
Income (loss) before cumulative effect of accounting changes (15,654) (47,549) (87,552) (7,248) 1,055
Cumulative effect of accounting changes:
Change in revenue recognition policy, net of income tax
benefit of $176 - - - (597) -
Adoption of new accounting standard, SFAS No. 142 - - (5,905) - -
--------- --------- --------- --------- --------
Net income (loss) $(15,654) $(47,549) $(93,457) $ (7,845) $ 1,055
========= ========= ========= ========= ========
Basic income (loss) per share from continuing operations before
Cumulative effect of accounting changes $ (0.19) $ (0.69) $ (1.63) $ (0.19) $ 0.04
Loss from discontinued operations (0.09) (0.19) (0.07) - -
--------- --------- --------- --------- --------
Income (loss) before cumulative effect of accounting changes (0.28) (0.88) (1.70) (0.19) 0.04
Cumulative effect of accounting changes per share:
Change in revenue recognition policy, net of income tax
benefit of $176 - - - (0.02) -
Adoption of new accounting standard, SFAS No. 142 - - (0.12) - -
--------- --------- --------- --------- --------
Basic net income (loss) per share $ (0.28) $ (0.88) $ (1.82) $ (0.21) $ 0.04
========= ========= ========= ========= ========
Diluted income (loss) per share from continuing operations before
cumulative effect of accounting changes $ (0.19) $ (0.69) $ (1.63) $ (0.19) $ 0.03
Loss from discontinued operations (0.09) (0.19) (0.07) - -
--------- --------- --------- --------- --------
Income (loss) before cumulative effect of accounting changes (0.28) (0.88) (1.70) (0.19) 0.03
Cumulative effect of accounting changes per share:
Change in revenue recognition policy, net of income tax
benefit of $176 - - - (0.02) -
Adoption of new accounting standard, SFAS No. 142 - - (0.12) - -
--------- --------- --------- --------- --------
Diluted net income (loss) per share $ (0.28) $ (0.88) $ (1.82) $ (0.21) $ 0.03
========= ========= ========= ========= ========
Weighted average shares (basic) 56,862 54,329 51,403 36,946 29,274
========= ========= ========= ========= ========
Weighted average shares (diluted) 56,862 54,329 51,403 36,946 34,178
========= ========= ========= ========= ========
15
AS OF JUNE 30,
--------------
2004 2003 2002 2001 2000
---------- ---------- --------- -------- -------
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents $ 9,128 $ 7,328 $ 26,491 $ 15,367 $ 1,988
Marketable securities 3,050 6,750 6,963 1,973 -
Working capital 12,087 17,312 39,164 36,963 11,042
Goodwill, net 9,488 9,488 7,218 42,273 -
Purchased intangible assets, net 2,056 4,275 11,891 13,328 586
Total assets 37,250 54,947 103,812 116,861 20,210
Retained earnings (accumulated deficit) (156,078) (140,424) (92,875) 582 8,427
Total stockholders' equity 24,791 37,717 82,157 99,496 12,547
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with our consolidated
financial statements and related notes thereto included elsewhere in this
report. In addition to historical information, the discussion in this report
contains forward-looking statements that involve risks and uncertainties. Actual
results could differ materially from those anticipated by these forward-looking
statements due to factors including, but not limited to, those factors set forth
under "Risk Factors" and elsewhere in this report.
OVERVIEW
Lantronix designs, develops and markets products and software solutions
that make it possible to access, manage, control and configure almost any
electronic device over the Internet or other networks. We are a leader in
providing innovative networking solutions. We were initially formed as
"Lantronix," a California corporation, in June 1989. We reincorporated as
"Lantronix, Inc.," a Delaware corporation in May 2000.
Our products are sold to distributors, OEMs, VARs, and systems integrators,
as well as directly to end-users. One customer, Ingram Micro Inc., accounted for
approximately 14%, 11% and 12% of our net revenues for the years ended June 30,
2004, 2003 and 2002, respectively. Another customer, Tech Data Corporation,
accounted for approximately 9%, 10% and 11% of our net revenues for the years
ended June 30, 2004, 2003 and 2002, respectively. Accounts receivable
attributable to these two domestic customers accounted for approximately 13% and
16% of total accounts receivable at June 30, 2004 and 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%, 4% and 5% of our
net revenues for the years ended June 30, 2004, 2003 and 2002, respectively. We
also had an agreement with transtec AG for the provision of technical support
services at the rate of $7,500 per month which has now been terminated. Included
in selling, general and administrative expenses is $90,000 for the year ended
June 30, 2002 for these support services. No support services were incurred for
the years ended June 30, 2004 and 2003.
We have completed a number of acquisitions and investments the purpose of
which was to expand our product offerings, increase our technology base and
provide a foundation for future growth.
In October 2001, we completed the acquisition of Synergetic Micro Systems,
Inc. ("Synergetic"), a provider of high performance embedded network
communication solutions that complement our external device products. In
connection with the acquisition, we paid cash consideration of $2.7 million and
issued an aggregate of 2,234,715 shares of our common stock in exchange for all
outstanding shares of Synergetic common stock and reserved 615,705 additional
shares of common stock for issuance upon exercise of outstanding employee stock
options and other rights of Synergetic.
In January 2002, we completed the acquisition of Premise, a developer of
client-side software applications that complement our device networking products
by providing superior management and control capabilities for devices that have
been network and internet enabled. Prior to the acquisition, we held shares of
Premise representing 19.9% ownership and, in addition, held convertible
promissory notes of $1.2 million with interest accrued there-on at the rate of
9.0%. The convertible promissory notes were converted into equity securities of
Premise at the closing of the transaction. We issued an aggregate of 1,063,371
shares of our common stock in exchange for all remaining outstanding shares of
Premise common stock and reserved 875,000 additional shares of common stock for
issuance upon exercise of outstanding employee stock options and other rights of
Premise. In connection with the acquisition, we recorded a one-time charge for
purchased in-process research and development ("IPR&D") expenses of $1.0 million
in our fourth fiscal quarter ended June 30, 2002. In January 2003, we issued an
16
additional 1,063,372 shares of our common stock to the former shareholders of
Premise stock in exchange for a release of all claims relating to the
acquisition. We also accelerated the vesting of options held by certain former
Premise shareholders and released all shares that had been held in the
acquisition escrow. See "Discontinued Operations" section below.
In August 2002, we completed the acquisition of Stallion, a provider of
terminal servers and multiport products. In connection with the acquisition, we
paid $1.2 million in cash consideration, of which $200,000 was paid upon the
execution of the Letter of Intent dated May 9, 2002, and established a cash
escrow account in the amount of $867,000 at the acquisition date to be used in
lieu of our common stock, in the event that we were unable to issue registered
shares by October 31, 2002. In accordance with the terms of the agreement, we
were not able to issue registered shares by October 31, 2002; accordingly, the
cash escrow amount of $867,000 was released on November 1, 2002. In addition, we
issued two-year notes in the principal amount of $867,000 accruing interest at a
rate of 2.5% per annum. The notes were paid to the holders in August 2004.
In September and October 2001, we made a strategic investment in Xanboo, a
privately-held company that develops technology that allows users to control,
command and view their home or business remotely over the Internet. We paid an
aggregate of $3.0 million for convertible promissory notes, which converted in
January 2002, in accordance with their terms, into Xanboo preferred stock. In
addition, we purchased $4.0 million of Xanboo preferred stock in January 2002.
Our ownership interest in Xanboo was 14.9%, 15.3% and 15.8% at June 30, 2004,
2003 and 2002, respectively. Our investment in Xanboo is accounted for using the
equity method of accounting based on our ability through representation on
Xanboo's board of directors to exercise significant influence over its
operations. Our losses in Xanboo aggregating $413,000, $1.3 million and $526,000
for the years ended June 30, 2004, 2003 and 2002, respectively, have been
recognized as other expense in the accompanying consolidated statement of
operations. We periodically review our investments for which fair value is less
than cost to determine if the decline in value is other than temporary. If the
decline in value is judged to be other than temporary, the cost basis of the
security is written down to fair value. 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. On the basis of events occurring during the quarter ended June 30,
2004, we performed an analysis and recorded a charge in the amount of $5.0
million, representing a write-off of all remaining value of this non-marketable
equity security. This charge is included within the consolidated statements of
operations as other expense.
Discontinued operations
In August 2001, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS No. 144"). SFAS No. 144 supersedes FASB Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of;" however, it retains the fundamental provisions of that
statement related to the recognition and measurement of the impairment of
long-lived assets to be "held and used." SFAS No. 144 also supersedes the
accounting and reporting provisions of Accounting Principles Board ("APB")
Opinion No. 30, "Reporting the Results of Operation's - Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions", 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 sold substantially all of the net assets of our Premise
business unit for $1.0 million. Additionally, we incurred $383,000 of disposal
costs.
Impairment of goodwill and purchased intangible assets related to
discontinued operations
During the second quarter of fiscal 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 SFAS
No. 142, "Goodwill and Other Intangible Assets" and SFAS No. 144. 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. As a result of
the sale of the Premise business unit, the goodwill and purchased intangibles,
net of Premise at June 30, 2003 have been included as part of discontinued
operations.
17
During the third quarter of fiscal 2004, we sold the assets related to our
Premise business unit to an undisclosed buyer for $1.0 million cash. After
paying all related transaction fees, resolving our lease commitments, and paying
other restructuring costs related to the transaction, the transaction had a
then-favorable impact on our cash balance of approximately $250,000. For the
years ended June 30, 2004, 2003 and 2002, the impact of the Premise business
unit resulted in a $5.0 million, $10.1 million and $3.4 million loss,
respectively, recorded as discontinued operations in our consolidated statement
of operations.
The loss from discontinued operations for the year ended June 30, 2004 of
$5.0 million includes a negative gross profit of $822,000, primarily due to the
$776,000 purchased intangible asset impairment charge, $2.0 million of operating
expenses, $590,000 of restructuring charges, a $2.3 million impairment charge of
Premise goodwill charged to operating expenses, and a gain on the sale of
Premise of $592,000.
The loss from discontinued operations for the year ended June 30, 2003 of
$10.1 million includes a negative gross profit of $1.2 million primarily due to
the $846,000 purchased intangible asset impairment charge, $3.4 million of
operating expenses, $111,000 of restructuring charges, a $4.4 million impairment
charge of Premise goodwill, and a $1.1 million legal settlement with the former
shareholders of Premise.
The loss from discontinued operations for the year ended June 30, 2002 of
$3.4 million includes a negative gross profit of $174,000, $1.9 million of
operating expenses, $383,000 impairment charge of Premise purchased intangible
assets charged to operating expenses, and a $1.0 million IPR&D charge as a
result of the Premise acquisition.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires us to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of net revenues
and expenses during the reporting period. We regularly evaluate our estimates
and assumptions related to net revenues, allowances for doubtful accounts, sales
returns and allowances, inventory reserves, goodwill and purchased intangible
asset valuations, warranty reserves, restructuring costs, litigation and other
contingencies. We base our estimates and assumptions on historical experience
and on various other factors that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. To the extent there are material differences between our
estimates and the actual results, our future results of operations will be
affected.
We believe the following critical accounting policies require us to make
significant judgments and estimates in the preparation of our consolidated
financial statements:
Revenue Recognition
We do not recognize revenue until all of the following criteria are met:
persuasive evidence of an arrangement exists; delivery has occurred or services
have been rendered; our price to the buyer is fixed or determinable; and
collectibility is reasonably assured. Commencing July 1, 2000, we adopted a new
accounting policy for revenue recognition such that recognition of revenue and
related gross profit from sales to distributors are deferred until the
distributor resells the product. Net revenue from certain smaller distributors
for which point-of-sale information is not available, is recognized one month
after the shipment date. This estimate approximates the timing of the sale of
the product by the distributor to the end-user. 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.
18
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. Our
allowance for doubtful accounts is based on our assessment of the collectibility
of specific customer accounts, the aging of accounts receivable, our history of
bad debts and the general condition of the industry. If a major customer's
credit worthiness deteriorates, or our customers' actual defaults exceed our
historical experience, our estimates could change and impact our reported
results. We also maintain a reserve for uncertainties relative to the collection
of officer notes receivable. Factors considered in determining the level of this
reserve include the value of the collateral securing the notes, our ability to
effectively enforce collection rights and the ability of the former officers to
honor their obligations.
Inventory Valuation
Our policy is to value inventories at the lower of cost or market on a
part-by-part basis. This policy requires us to make estimates regarding the
market value of our inventories, including an assessment of excess and obsolete
inventories. We determine excess and obsolete inventories based on an estimate
of the future sales demand for our products within a specified time horizon,
generally three to twelve months. The estimates we use for demand are also used
for near-term capacity planning and inventory purchasing and are consistent with
our revenue forecasts. In addition, specific reserves are recorded to cover
risks in the area of end of life products, inventory located at our contract
manufacturers, deferred inventory in our sales channel and warranty replacement
stock.
If our sales forecast is less than the inventory we have on hand at the end
of an accounting period, we may be required to take excess and obsolete
inventory charges which will decrease gross margin and net operating results for
that period.
Valuation of Deferred Income Taxes
We have recorded a valuation allowance to reduce our net deferred tax
assets to zero, primarily due to our inability to estimate future taxable
income. We consider estimated future taxable income and ongoing prudent and
feasible tax planning strategies in assessing the need for a valuation
allowance. If we determine that it is more likely than not that we will realize
a deferred tax asset, which currently has a valuation allowance, we would be
required to reverse the valuation allowance which would be reflected as an
income tax benefit at that time.
Goodwill and Purchased Intangible Assets
The purchase method of accounting for acquisitions requires extensive use
of accounting estimates and judgments to allocate the purchase price to the fair
value of the net tangible and intangible assets acquired, including IPR&D.
Goodwill and intangible assets deemed to have indefinite lives are no longer
amortized but are subject to annual impairment tests. The amounts and useful
lives assigned to intangible assets impact future amortization and the amount
assigned to IPR&D is expensed immediately. If the assumptions and estimates used
to allocate the purchase price are not correct, purchase price adjustments or
future asset impairment charges could be required.
Impairment of Long-Lived Assets
We evaluate long-lived assets used in operations when indicators of
impairment, such as reductions in demand or significant economic slowdowns, are
present. Reviews are performed to determine whether the carrying values of
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.
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 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
19
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. During the fourth quarter of 2004, we wrote-off $5.0
million representing the remaining balance of our investment in Xanboo.
Subsequent to the write-off of Xanboo, there are no other strategic investments
as of June 30, 2004.
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 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
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 January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51," ("FIN 46"). FIN 46
requires certain variable interest entities ("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 VIEs created or acquired after January 31, 2003. For VIEs
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. We
reviewed our investments and other arrangements and determined that none of our
investee companies are VIE's.
In May 2003, the FASB issued SFAS No. 150, "Accounting For Certain
Financial Instruments with Characteristics of Both Liabilities and Equity"
("SFAS No. 150") which establishes standards for how an issuer of financial
instruments classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability (or an
asset in some circumstances) if, at inception, the monetary value of the
obligation is based solely or predominantly on a fixed monetary amount known at
inception, variations in something other than the fair value of the issuer's
equity shares or variations inversely related to changes in the fair value of
the issuer's equity shares. SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
20
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 did not have a material impact on our financial
position, results of operations or cash flows.
Cumulative effect of an accounting change
Under the transitional provisions of SFAS No. 142, effective as of July 1,
2002, we completed our initial assessment and concluded that goodwill arising
from the acquisition of United States Software Corporation ("USSC"), having a
carrying amount of approximately $5.9 million as of July 1, 2001, may be
impaired. We engaged an independent valuation company to perform a review of the
value of our goodwill related to USSC. Based on the independent valuation, which
utilized a discounted cash flow valuation technique, we recorded a $5.9 million
charge for the impairment of our USSC goodwill. This amount is reflected as the
cumulative effect of adopting the new accounting standard effective July 1,
2001.
The following discussion of results of operations includes discussion of
continuing operations only. Certain amounts in the 2003 and 2002 consolidated
financial statements have been reclassified to conform with current year
presentation.
CONSOLIDATED RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
of net revenues represented by each item in our consolidated statements of
operations:
YEAR ENDED JUNE 30,
----------------------
2004 2003 2002
------- ------- --------
Net revenues 100.0% 100.0% 100.0%
Cost of revenues 51.2 73.4 69.9
------- ------- --------
Gross profit 48.8 26.6 30.1
------- ------- --------
Operating expenses:
Selling, general and administrative 47.6 58.0 70.4
Research and development 16.0 19.1 15.1
Stock-based compensation 0.7 2.9 5.0
Amortization of purchased intangible assets 0.3 1.2 1.7
Impairment of goodwill and purchased intangible assets - 4.8 87.6
Restructuring (recovery) charges (4.3) 11.3 6.0
Litigation settlement costs - 3.1 3.3
------- ------- --------
Total operating expenses 60.4 100.5 189.0
------- ------- --------
Loss from operations (11.6) (73.9) (159.0)
Interest income (expense), net 0.1 0.5 2.7
Other income (expense), net (10.9) (1.9) (1.3)
------- ------- --------
Loss before income taxes and cumulative effect of an accounting change (22.4) (75.3) (157.6)
Provision (benefit) for income taxes (0.7) 0.5 (11.6)
------- ------- --------
Loss from continuing operations before cumulative effect of an accounting change (21.7) (75.8) (146.0)
Loss from discontinued operations (10.3) (20.5) (6.0)
------- ------- --------
Loss before cumulative effect of an accounting change (32.0) (96.3) (152.0)
Cumulative effect of adoption of new accounting standard, SFAS No. 142 - - (10.33)
------- ------- --------
Net loss (32.0)% (96.3)% (162.3)%
======= ======= ========
COMPARISON OF THE YEARS ENDED JUNE 30, 2004 AND 2003
Net Revenues by Product Category
YEAR ENDED
JUNE 30,
-------------------------------------------------------------
% OF NET % OF NET $ %
PRODUCT CATEGORIES 2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
- ------------------ ------- --------- ------- --------- ---------- ---------
Device networking $27,481 56.2% $24,523 49.6% $ 2,958 12.1%
IT management 12,555 25.7% 13,034 26.4% (479) (3.7)%
Non-core 8,849 18.1% 11,832 24.0% (2,983) (25.2)%
------- --------- ------- --------- ---------- ---------
TOTAL $48,885 100.0% $49,389 100.0% $ (504) (1.0)%
======= ========= ======= ========= ========== =========
The overall decrease in net revenues was primarily attributable to a
decrease in net revenues of our non-core and IT management product lines offset
by an increase in our device networking product line. Our increase in device
networking products included increases from our newly introduced XPort product.
The decrease in our IT management product line is primarily due to delays in
21
introducing certain new products. During the fourth quarter of fiscal 2004, we
introduced a new line of console servers and we have substantially increased our
marketing and sales efforts in our IT management solutions product family. The
decrease in our non-core product line was primarily attributable to a decrease
in our legacy print server, industrial controller board and Stallion product
lines. We are no longer investing in the development of these product lines and
expect net revenues related to these product lines to continue to decline in the
future as we focus our investment on device networking and IT management
products.
Net Revenues by Region
YEAR ENDED
JUNE 30,
-------------------------------------------------------------
% OF NET % OF NET $ %
GEOGRAPHIC REGION 2004 REVENUE 2003 REVENUE VARIANCE VARIANCE
- ----------------- --------- --------- ----- -------- --------- ---------
Americas $ 33,847 69.3% $37,391 75.7% $(3,544) (9.5)%
Europe 11,252 23.0% 10,366 21.0% 886 8.5 %
Other 3,786 7.7% 1,632 3.3% 2,154 132.0 %
--------- --------- ------- ------- -------- -------
TOTAL $ 48,885 100.0% $49,389 100.0% $ (504) (1.0)%
========= ========= ======= ======= ======== =======
The overall decrease in net revenues is primarily due to a decrease in the
Americas region. The decrease in net revenues in the Americas region is
primarily attributable to our exit of the industrial controller board product
line, which was sold entirely in the Americas as well as our decrease in the IT
management product family net revenues. The increase in Europe is primarily due
to the addition of new customers including three new distributors and several
channel customers. The increase in other is primarily due to the signing of
several new customers and our increased sales efforts in the Asia Pacific
region.
Gross Profit
YEAR ENDED
JUNE 30,
--------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
------- --------- ------- --------- --------- ---------
Gross profit $23,859 48.8% $13,125 26.6% $ 10,734 8.5 %
======= ========= ======= ========= ========= =========
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 years ended June 30, 2004 and 2003
included $2.1 million and $3.6 million of amortization of purchased intangible
assets, respectively. Cost of revenues for the year ended June 30, 2003 includes
a $3.1 million impairment charge of purchased intangible assets, in accordance
with SFAS No. 144. No impairment charge was recorded for the year ended June 30,
2004. At June 30, 2004, the unamortized balance of purchased intangible assets
that will be amortized to future cost of revenues was $2.0 million, of which
$1.4 million will be amortized in fiscal 2005 and $557,000 in fiscal 2006.
In May 2002, we signed a new agreement with Gordian to acquire a joint
interest in the intellectual property that is evident in our products designed
by Gordian and to extinguish our obligation to pay royalties on future sales of
our products. We paid $6.0 million for this intellectual property and are
amortizing this asset to cost of revenues over the remaining life of our
products designed by Gordian, or approximately 3 years. Effective May 30, 2002,
upon the signing of the new agreement, royalty expenses have been replaced by an
amortization of the prepaid royalties and entitlement to the intellectual
property that was part of the agreement. Amortization expense related to the new
Gordian agreement, included in amortization of purchased intangible assets of
$2.1 million, totaled $1.8 million for the year ended June 30, 2004.
Amortization expense related to the new Gordian agreement, included in
amortization of purchased intangible assets of $3.6 million totaled $2.5 million
for the year ended June 30, 2003. The increase in gross profit is primarily
attributable to a lower inventory reserve provision in fiscal 2004 compared to
fiscal 2003, an overall reduction in payroll and payroll related costs due to
the closing of our Milford, Connecticut facility in February 2003, an increase
in our capitalized inventory overhead and a decrease in the amortization of
purchased intangible assets due to the impairment write-down of $3.1 million
during the fourth quarter of fiscal 2003. These decreases were offset by an
increase in our warranty expense.
22
Selling, General and Administrative
YEAR ENDED
JUNE 30,
--------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
------- --------- ------- --------- ---------- ---------
Selling, general and administrative $23,293 47.6% $28,660 58.0% $ (5,367) (18.7)%
======= ========= ======= ========= ========== =========
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, improvement in our accounts receivable resulting in
a reduction of our allowance for doubtful accounts, offset by an increase in our
directors and officers liability insurance. The legal fees primarily relate to
our defense of the shareholders and various other 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 years ended June 30, 2004 and 2003, we have
been reimbursed $3.0 million and $1.4 million of these expenses. Management
expects to receive additional reimbursements from insurance sources for legal
fees in fiscal 2005.
Research and Development
YEAR ENDED
JUNE 30,
--------------------------------------------------------------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
--------- --------- ------ --------- ---------- ---------
Research and development $ 7,813 16.0% $9,430 19.1% $ (1,617) (17.1)%
========= ========= ====== ========= ========== =========
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 primarily to our
Irvine, California facility.
Stock-based compensation
YEAR ENDED
JUNE 30,
----------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
----- --------- ------ --------- ---------- ---------
Stock-based compensation $ 347 0.7% $1,453 2.9% $ (1,106) (76.1)%
===== ========= ====== ========= ========== =========
Stock-based compensation expense generally represents the amortization of
deferred compensation. We recorded no deferred compensation for the year ended
June 30, 2004 and recorded a reduction to deferred compensation as a result of
employee stock option forfeitures in the amount of $197,000. 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 $48,000 and
$89,000 for the years ended June 30, 2004 and 2003, respectively. Stock-based
compensation decreased primarily due to the restructuring plan 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 June 30, 2004, a balance of $103,000 remains and will be amortized
as follows: $86,000 in fiscal 2005 and $17,000 in fiscal 2006.
23
Amortization of purchased intangible assets
YEARS ENDED
JUNE 30,
-----------
% OF NET % OF NET $ %
2004 REVENUES 2003 REVENUES VARIANCE VARIANCE
----- --------- ----- --------- ---------- ---------
Amortization of purchased intangible assets $ 148 0.3% $ 602 1.2% $ (454) (75.4)%
===== ========= ===== ========= ========== =========
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 $