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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED OCTOBER 31, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to ___________
Commission File No. 0-8419
SBE, INC.
(Exact name of Registrant as specified in its charter)
Delaware 94-1517641
(State or other jurisdiction of (IRS Employer Identification
incorporation or organization) Number)
2305 Camino Ramon, Suite 200, San Ramon, California 94583
(Address of principal executive offices and Zip Code)
(925) 355-2000
(Registrant's Telephone Number, including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock
(Title of Class)
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 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 the 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. |X|
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Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes |_| No |X|
The approximate aggregate market value of the common stock of the
registrant held by non-affiliates of the registrant, based on the closing price
for the registrant's common stock on April 30, 2004 as reported on the Nasdaq
SmallCap Market, was $19,487,267. Shares of Common Stock held by each executive
officer, director and stockholder whose ownership exceeds five percent of Common
Stock outstanding have been excluded because such persons may be deemed to be
affiliates of the registrant. This determination of affiliate status for
purposes of the foregoing calculation is not necessarily a conclusive
determination of affiliate status for other purposes.
The number of shares of the registrant's common stock outstanding as of
December 31, 2004 was 5,159,722.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for the
registrant's Annual Meeting of Stockholders, scheduled for March 22, 2005, have
been incorporated by reference into Part III of this Annual Report on Form 10-K.
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SBE, INC.
FORM 10-K
TABLE OF CONTENTS
PART I
Item 1 Business 4
Item 2 Properties 19
Item 3 Legal Proceedings 19
Item 4 Submission of Matters to a Vote of Security Holders 19
PART II
Item 5 Market for Registrant's Common Equity
and Related Stockholder Matters 21
Item 6 Selected Financial Data 22
Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations 23
Item 7A Quantitative and Qualitative Disclosures about Market Risk 35
Item 8 Financial Statements and Supplementary Data 36
Item 9 Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 36
Item 9A Controls and Procedures 36
PART III
Item 10 Directors and Executive Officers of the Registrant 37
Item 11 Executive Compensation 37
Item 12 Security Ownership of Certain Beneficial Owners
and Management 37
Item 13 Certain Relationships and Related Transactions 37
Item 15 Exhibits, Financial Statement Schedules
and Reports on Form 8-K 38
SIGNATURES 42
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SPECIAL NOTE ON FORWARD LOOKING STATEMENTS
Certain statements set forth in or incorporated by reference in this Annual
Report on Form 10-K constitute "forward-looking statements" within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. These statements include, without limitation, our
expectations regarding our sales to The Hewlett-Packard Company, our
expectations regarding the market for client server networking products, the
adequacy of anticipated sources of cash, planned capital expenditures, the
effect of interest rate increases, and trends or expectations regarding our
operations. Words such as "may," "will," "should," "believes," "anticipates,"
"expects," "intends," "plans," "estimates" and similar expressions are intended
to identify forward-looking statements, but are not the exclusive means of
identifying such statements. Such statements are based on currently available
operating, financial and competitive information and are subject to various
risks and uncertainties. Readers are cautioned that the forward-looking
statements reflect management's estimates only as of the date hereof, and we
assume no obligation to update these statements, even if new information becomes
available or other events occur in the future. Actual future results, events and
trends may differ materially from those expressed in or implied by such
statements depending on a variety of factors, including, but not limited to
those set forth under "Item 1 - Business -- Risk Factors" on page 15 and
elsewhere in this Form 10-K.
PART I
ITEM 1. BUSINESS
OVERVIEW
SBE, Inc. develops and provides network communications and storage solutions for
original equipment manufacturers ("OEM") in the embedded systems marketplace.
Embedded networking technology is hardware or software that serves as a
component within a larger networking or storage device or system such as a
Gigabit Ethernet or a T-1/T-3 input/output ("I/O") network interface card
("NIC") that plugs into an expansion slot in a high-end computer or storage
system. Embedded networking solutions enable the functionality of many commonly
used devices or equipment, such as products and solutions for basic telephone
and internet services, mobile phones, medical equipment and storage networks.
We deliver a product portfolio comprised of standards-based wide area networking
("WAN"), local area networking ("LAN") and storage area network ("SAN") network
interface and intelligent communications controller cards. All of our products
are coupled with enabling Linux or Solaris software drivers. Our products are
designed to be functionally compatible with each other and, since we use
industry standard form factors and technologies, our products are also
compatible with third party standards-based products. This standard scalability
and modularity offers our customers greater flexibility to develop solutions for
unique product configurations and applications.
Our products are developed based on industry standard form factors including
those known as Peripheral Component Interconnect ("PCI"), CompactPCI,
VersaModule Eurocard ("VME"), PCI Mezzanine Card ("PMC"), and PCI Telecom
Mezzanine Card ("PTMC"). Form factors are the shape and size of interface cards
used to expand the functionality of standard computer bus architectures. For
example, a PCI system includes a 32 or 64-bit local bus architecture used to
transfer data from a computer's main microprocessor to peripherals such as hard
disks and video adapter. CompactPCI is an adaptation of the standard PCI on a
larger rugged design and expands the number of available slots for peripheral
devices from four to eight, improves a computer's ability to withstand adverse
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conditions such as extreme vibration and offers "hot swap" capability - allowing
the user to insert and take out the board without turning off the system. A PMC
card plugs on to a standard PCI, CompactPCI, VME or the new AdvancedTCA ("ACTA")
card enabling it to provide differing input/output or computing functions. A
PTMC is a PMC card designed specifically for telecommunication applications.
Our solutions have been integrated into a wide spectrum of applications to
enable network and storage connectivity, including Voice over Internet Protocol
("VoIP"), Wi-Fi, Enhanced 911, enterprise servers, data storage, data messaging,
process control, media gateways, routers, internet access devices, medical
imaging, CAE/automated test equipment, government/military defense systems and
telecommunications networks. We distribute our products worldwide through a
direct sales force, distributors, independent manufacturers' representatives and
value-added resellers.
SBE was incorporated in 1961 as Linear Systems, Inc. In 1976, we completed our
initial public offering. In July 2000, we acquired LAN Media Corporation
("LMC"), a privately held company, to complement and grow our WAN adapter
product line from both a hardware and software perspective. In August 2003, we
acquired the products and technologies of Antares Microsystems to increase the
functionality of our PCI product line. We continue to operate under a single
business unit.
BUSINESS STRATEGY
Our objective is to be a leading provider of high-performance network
communications solutions by delivering reliable, flexible, cost-efficient
products in a timely manner to our customers, thus allowing them to focus on
their core competencies.
During fiscal 2004, we made noteworthy steps in achieving this objective,
including:
o Making our commitment to existing customers our number one priority
As a proponent of continuous improvement, we are always identifying new ways to
better serve our customers. Over the past year, to ensure that we fulfill our
commitments to our customers, we strengthened our operations team, including the
addition of resources in the manufacturing, technical support and quality
departments. In addition, we have implemented a "WebCall" system on our web site
which allows customers to address technical product issues with us at their
convenience, 24 hours a day. Upon implementation of this system in the third
quarter of 2004, the average time to resolution for technical issues has
improved by 50% from one quarter to the next.
o New Product Introductions
In order to meet the ever-changing requirements of the industry and our
customers, we believe it is important to maintain a strong and flexible
portfolio of products designed for easy and quick deployment into a variety of
unique applications.
- TCP/IP Offload Engine ("TOE"). As Ethernet speeds continue to
increase, a progressively higher load is placed on the CPU to
process the messaging traffic and deal with the interface protocol,
leaving little computing power left for user applications. SBE's TOE
board is designed to offload the interface protocol ("TCP/IP stack")
and manage messaging traffic normally processed by the Central
Processing Unit ("CPU"). This interface protocol offloading
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increases user application performance and alleviates networking
bottlenecks. We expect that demand for TOE will continue to increase
as network bandwidth requirements escalate.
- ISCSI (Internet Small Computer System Interface). A new market is
emerging using Ethernet infrastructure allowing "virtual storage"
flexibility and lower costs. Our Internet Protocol ("IP") management
solution bundles our dual port Gigabit Ethernet TOE board with PyX's
enterprise level, high availability iSCSI software protocol. Fully
compliant with IETF iSCSI standards, this iSCSI solution delivers
multi-path migration and Error Recovery Level Two (ERL2)
functionality. Our iSCSI product ensures that there is no single
point of failure on the storage transport layer between any two
iSCSI nodes while simultaneously offloading the network protocol
processing from the CPU.
- Security Offload Engine. In September 2004, we announced the first
in a growing series of board-level encryption solutions designed to
accelerate SSL and IPsec cryptographic operations. These are the two
most common encryption solutions used to provide electronic security
in use today. Our securePMC-L is a PMC-based security offload engine
using Cavium Networks' NITROX Lite security processor, and designed
to meet the United States federal government's mandated security
FIPS 140-2 Level 3 requirements to be used in all government
security related applications.
- Channelized T3 PMC Adapter. We launched the wanPMC-C1T3 WAN adapter
in the first quarter of fiscal 2004. Designed to enable advanced
voice and data applications, such as VoIP, video-on-demand, voice
conferencing, Internet routing, and SAN pipes, our wanPMC-C1T3
integrates a fully channelized, single port T3 interface with an
HDLC/transparent controller on a PMC slot.
- Channelized 24-port T1/E1: In August 2004, we introduced the
wanPTMC-24TE1, a fully channelized 24-port T1/E1 PCI Telecom
Mezzanine Card (PTMC) and Rear Transition Module (RTM) board set.
This solution is designed for high density applications, such as
VoIP gateways, computer telephony softswitches, TDM switches/PBX,
and voice conferencing systems.
- Linux "On Demand". Recognizing the value to our customers, we
continue developing Linux software drivers for SBE products using
internal resources and those from partnering software companies. In
addition to standard enterprise level drivers, we offer products
with "real-time" enhancements.
o Strategic Alliances and Investments
We are committed to expanding our product offerings by entering into strategic
business agreements where we combine our products with those of our partners to
present a cost-effective, completely integrated solution to our customers.
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o PYX TECHNOLOGIES: PyX provides enterprise level iSCSI software
protocol with Error Recovery Level 2 ("ERL2") functionality, tuned
to operate with our TCP/IP Offload Engine card. ERL2 functionality
is required to provide seamless guaranteed delivery of critical data
whenever storage data is transmitted over the Internet.
o TIMESYS: In a collaborative effort, SBE and TimeSys, a pioneer and
leader in Embedded Linux and Java development technologies, continue
to team to provide the high-performance and modularity of SBE's WAN
modules and HighWire carrier-class core processing platforms bundled
with the scalable computing power of TimeSys Linux GPL and
cross-platform development tools.
o CAVIUM NETWORKS: SBE teamed with Cavium to provide board-level
encryption solutions designed to accelerate SSLand IPsec
cryptographic operations and significantly improve secure data
transmissions for Linux and other applications.
o NCOMM: SBE and NComm formed an alliance to provide comprehensive WAN
solutions coupling our WAN hardware interfaces with NComm's
intelligent top-level software drivers and tools. This joint
solution results in significant cost savings for OEMs and speeds up
time-to-market by 6-12 months.
ATCA PARTNER PROGRAM. This is our program to align our PMC and PTMC
interface products with AdvancedTCA ("ATCA") system providers to provide
powerful telecommunications networking solutions. The ACTA products are
based on a new standard industry form factor that has been developed for
use by the telecommunications industry. This form factor allows for greater
flexibility and network transmission speeds.
o DIVERSIFIED TECHNOLOGIES, INC ("DTI"): DTI is integrating multiple
SBE network interface cards with the Diversified Technologies ATCA
system level platforms to build powerful ATCA platforms for service
providers in the telecommunications and networking marketplace.
o GNP: GNP will complement its product mix by bundling SBE's portfolio
of network interface cards into its ready-to-deploy ATCA and
CompactPCI system solutions for its customer base of network
equipment manufacturers and large systems integrators.
o CONCURRENT TECHNOLOGIES, INC ("CONCURRENT"): SBE and Concurrent have
entered into an agreement to merge our PMC-based modules with
Concurrent's ATCA system solutions. This new alliance is expected to
result in expanded market coverage for our products.
In fiscal 2005, we plan to further build on the momentum that has been generated
over the past two years by turning our technology investments into strong,
customer-driven product solutions, continuing to diversify our customer base,
and actively seeking out new market opportunities. Specifically, our key focus
areas for the upcoming year include:
o Build and Strengthen Awareness of Expanded Product Portfolio and
Capabilities within Target Markets
With the recent release of the TOE, Encryption and iSCSI products, we will
present our customers with an enhanced line of board-level I/O choices. We have
launched an aggressive sales and marketing campaign to develop and enhance
awareness of our portfolio of products and capabilities to target audiences. Our
marketing initiatives include print/online advertising, direct marketing, joint
partner marketing, public relations, industry tradeshow presence, and web
marketing.
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o Broaden Market and Customer Diversification
With the expansion of our products, we intend to further penetrate existing
territories and capture opportunities in new markets and applications. In
addition, we evaluate and reinforce our distribution channels to broaden
coverage both domestically and internationally and allow for a wider set of
application and market targets.
o Continue to Invest in New Products and Technologies
Continued investment in new products and technologies is critical in driving the
long-term growth and success of the business. Areas of technological focus over
the next year include:
o Voice over IP ("VoIP") PTMC Solution. Recognizing the opportunities
in the VoIP marketplace, we are engaged in the conceptual research
and planning for a VoIP media gateway solution. In the coming year,
we plan to aggressively execute on our VoIP strategy which leverages
compatibility with current product offerings.
o Expansion of HighWire Line of Intelligent Communications
Controllers. We are in the process of completing development on the
next generation HighWire CompactPCI controller with Intelligent
Platform Management Interface ("IPMI") to the backplane, Ethernet
switch, and dual PTMC support. As with our currently available
platforms, SBE's future processors will be designed to provide
embedded Linux with the intent to offer complete interoperability
with a broad selection of WAN, LAN, and Storage PMCs.
o ATCA Mezzanine Card ("AMC"). ATCA is a new platform that is gaining
significant momentum in the marketplace. It is touted to offer OEMs
in the telecommunications space many benefits, including new levels
of scalability and performance. Our wide range of PMC/PTMC-based WAN
and LAN I/O boards are available for integration into today's ATCA
deployments. When the AMC specification has been ratified, it will
be a natural progression for us to evolve our PMC and PTMC modules
to AMC.
PRODUCTS
We design and provide network interface cards and communication controllers
serving the embedded markets. With the exception of the TOE products, our
network interface adapters are open standards interface adapter cards that
generally do not have a microprocessor onboard ("state machine products"). They
are designed to provide developers of networking and data communications
equipment a simple and cost effective way to integrate WAN, LAN, SCSI, iSCSI,
and/or Fibre Channel interfaces into their systems. All of our products are
supported by communications software developed by SBE and a select group of
third party partners.
Although SBE continues to sell and manufacture products such as Multibus,
VMEbus, and ISA, we emphasize six principal lines of products: WAN adapters,
LAN/Ethernet adapters, storage network interface cards ("NICs"), intelligent
communications controllers, iSCSI software and custom and specialty I/O and CPU
processing protocol offload products such as TOE and Encryption cards.
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WIDE AREA NETWORKING ADAPTERS
A wide area network is a computer network that spans a relatively large
geographical area. Computers connected to a WAN are often connected through
dedicated networks, such as the telephone system, leased lines or satellites.
Our series of WAN adapter products is designed to address the need for WAN
interfaces in data communication products such as those used in internet and
other communications routers, security firewalls, virtual private network
("VPN") servers and VoIP gateways. We provide a broad range of interfaces,
including synchronous serial, T1/E1, High Speed Serial Interface ("HSSI") and T3
in PCI, PMC, and PTMC industry standard form factors.
LOCAL AREA NETWORKING ADAPTERS
A local area network is a computer network spanning a relatively small
geographical area. Often confined to a single building or group of buildings,
most LANs connect workstations and personal computers. Each computer in the LAN
is able to access data and devices, such as printers, located anywhere on the
LAN. There are many different types of LANs but Ethernet is the most common.
Ethernet LAN connectivity is utilized by virtually every market segment in both
the embedded and enterprise space.
Our LAN adapter products are focused on LAN connectivity using high speed
Ethernet technology. We offer single, dual or quad port LAN adapter PCI and PMC
modules that feature connectivity speeds of up to 10 Mb/second, 100 Mb/second or
1000 Mb/second. Our Gigabit Ethernet NICs include trunking and failover. These
features allow our customers' systems to take advantage of static load balancing
and failure recovery within a user-defined communications trunk. It is designed
to distribute traffic across the aggregated links, detects port failures, and
increases throughput. In the event of a link failure, the software will
automatically redistribute outgoing loads across the remaining links.
STORAGE NETWORK INTERFACE CARDS
Our storage NICs are comprised of SCSI and Fibre Channel products. SCSI is a
parallel interface standard used by personal computers and many UNIX systems for
attaching peripheral devices, such as printers and disk drives, to computers.
SCSI interfaces are designed to allow for faster transmission rates than
standard serial ports, which transfer data one bit at a time, and parallel
ports, which simultaneously transfer data more than one bit at a time. Our
series of SCSI host bus adapters are specifically designed for the enterprise
Sun UNIX market. With transfer rates ranging from 40 Megabyte ("MB")/sec to 320
MB/sec, our SCSI adapters have been utilized in data centers and enterprise
environments within the financial, government, manufacturing, and healthcare
sectors. These SCSI boards are also utilized in UNIX-based SCSI tape backup
systems.
Fibre Channel is a serial data transfer architecture developed by a consortium
of computer and mass storage device manufacturers and is now being standardized
by the American National Standards Institute ("ANSI"). Our Fibre Channel host
bus adapters are available in single or dual port, 1-Gigabit or 2-Gigabit
versions with copper and/or optical Gigabit transceivers.
iSCSI STORAGE MANAGEMENT SOLUTIONS
iSCSI is an Internet Protocol based storage networking standard for linking data
storage facilities which was developed by the Internet Engineering Task Force
(IETF). By carrying SCSI commands over IP networks, iSCSI is used to facilitate
data transfers over LAN intranets and to manage storage over long distances
(internet). The iSCSI protocol is among the key technologies expected to help
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further the rapid development of the SAN market space by dramatically increasing
the capabilities and performance of storage data transmission at a fraction of
the cost of current SANs. Because of the ubiquity of IP networks, iSCSI can be
used to transmit data over LANs, WANs, or the Internet and can enable location
independent data storage and retrieval.
Our iSCSI storage management solution bundles SBE's dual port Gigabit Ethernet
TOE board with PyX Technologies' enterprise level, high availability, uniform
iSCSI software protocol. Fully compliant with IETF iSCSI standards, this iSCSI
product delivers multi-path migration and ERL2 functionality. The SBE/PyX
solution uses active/active trunking providing seamless connectivity migration
which supports uninterrupted data flow and aggregation of bandwidth. This means
that requests from a failed communication path can be automatically re-assigned
to active communication paths, allowing iSCSI data to continue to flow
uninterrupted. As a result, the solution ensures that there is no single point
of failure on the storage transport layer between any two iSCSI nodes while
simultaneously offloading the network protocol processing from the CPU.
CPU OFFLOAD ENGINES
o TCP/IP OFFLOAD ENGINE
Today's modern networks incorporate packet communications for a wide
variety of applications linking WANs, LANs, and SANs. TCP/IP is the common
thread throughout and the de-facto packet standard that was developed for
the internet. Ironically, TCP/IP has also become the major bottleneck in
high speed networks.
A TOE is a highly specialized TCP/IP protocol accelerator. Typically, in
the form of a NIC, it is designed to reduce the amount of host CPU cycles
required for TCP/IP processing and maximize Ethernet throughput. This is
accomplished by offloading TCP/IP protocol processing from the host
processor to the hardware on the TOE.
Our dual port Gigabit Ethernet controller with full TCP/IP offload
capabilities for maximizing the performance of demanding TCP-based
applications is designed to reduce the amount of CPU cycles required for
TCP/IP processing while optimizing the Ethernet throughput. Our TOE
solution processes TCP/IP at network speeds, provides full segmentation
and reassembly, terminates multiple simultaneous sessions, and minimizes
transaction latency - all without host intervention.
o SECURITY OFFLOAD ENGINE
The rapid changes of the information age have put increasing security
demands on enterprise networks, such as VPNs, portals and corporate web
sites over the last few years. With the expansion of network boundaries
come the inevitable need for effective solutions to secure these
enterprise connections. In September 2004, we introduced the first in a
growing series of security offload solutions for integration into
Linux-based systems. Based on Cavium Networks' Nitrox Lite, our new
encryption board is designed to accelerate SSL, WLAN and IPsec
cryptographic operations and significantly improve security, performance,
and availability of Linux and other embedded applications.
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INTELLIGENT COMMUNICATIONS CONTROLLERS
The HighWire products are "intelligent," containing their own microprocessors
and memory. This architecture allows our communications controllers to offload
many of the lower-level communications tasks that would typically be performed
by the host platform.
In the telecommunications market, the HighWire series of communications
controller products provide high bandwidth intelligent connectivity to servers
designed to act as gateways and signaling points within communication networks
and network devices. The HighWire co-processing controllers enable operators of
wireline and wireless networks to deliver Intelligent Network ("IN") and
Advanced Intelligent Network ("AIN") services such as Caller ID, voice
messaging, personal number calling, Service Provider Local Number Portability,
and customized routing and billing, as well as digital wireless services such as
Personal Communications Systems ("PCS") and Global System for Mobile
Telecommunications ("GSM"). The HighWire products are designed for integration
with standard server platforms that enable traditional carriers and new telecom
entrants to pursue cost-reduced and performance-enhanced network architectures
based on Internet Protocol ("IP"), broadband or other "packet" technologies.
We offer embedded Linux operating system software that enables several HighWire
products to be combined with any of our WAN and LAN PMC products or other third
party PMC form factor products to provide core computing and connectivity
solutions to the communications, military/government, medical and industrial
control markets. Utilizing our HighWire products in conjunction with other
available PMC modules, such as A-to-D converters or video capture PMC modules,
opens up new opportunities to market the products for factory/process control or
video surveillance applications.
VMEBUS
Our line of legacy VMEbus products continues to be sold to government, military
and industrial customers. Our VME products are intelligent communications
controllers used to provide connectivity between a system such as a
mini-computer or bridge/router and a local or wide area network. Our VMEbus
communications products target four major protocol communications technologies:
Fiber Distributed Data Interface ("FDDI"), Token Ring, Ethernet and high-speed
serial communications.
The following table shows sales by major product type as a percentage of net
sales for fiscal 2004, 2003 and 2002:
Year Ended October 31,
2004 2003 2002
------------------------------------------------
(percentage of net sales)
VME 43% 53% 56%
WAN Adapter 34 30 31
LAN Adapter 8 5 0
Storage NIC 4 2 0
HighWire 11 10 13
------------------------------------------------
100% 100% 100%
================================================
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DISTRIBUTION, SALES, AND MARKETING
We market our WAN, LAN, storage, intelligent communication controller, specialty
I/O and protocol processing offload products to OEMs, distributors and systems
integrators. We sell our products both domestically and internationally, using a
direct sales force as well as independent manufacturers' representatives,
resellers, and distributors. We believe that our direct sales force is well
suited to communicate and promote our products and how they differentiate from
those of our competitors. Since our products represent a complex and technical
sale, our sales force is supported by application engineers who provide
customers with pre-sale technical assistance.
Our internal sales and marketing organization supports our channel marketing
partners by providing sales collateral, such as product data sheets,
presentations, and other sales/marketing resource tools. Our sales staff
solicits prospective customers, provides technical advice with respect to our
products, and works closely with marketing partners to train and educate their
staffs on how to sell, install, and support our product lines.
We have focused our sales and marketing efforts in North America, Europe and
Asia. All of our international sales are negotiated in U.S. dollars.
International sales constituted 12%, 12% and 13% of net sales in fiscal 2004,
2003 and 2002, respectively. International sales are executed in U.S. dollars
and are principally transacted in Europe.
Our direct sales force is based in three locations in the United States and we
conduct our marketing activities from our principal office in San Ramon,
California.
RESEARCH AND DEVELOPMENT
We believe that continued research and development in current and emerging
technologies is critical to maintaining our competitive position in the embedded
and enterprise markets. Many factors are involved in determining the strategic
direction of our product development focus, including trends and developments in
the marketplace, competitive analyses, and feedback from our customers and
strategic partners. We actively support and contribute to standards development
organizations and trade groups, which define and promote existing and emerging
technologies for both the embedded and enterprise arenas. We belong to several
influential industry associations, including VME International Trade Association
("VITA") and PCI Industrial Computers Manufacturers Group ("PICMG").
Our product development efforts are focused principally on our strategic product
lines, providing high bandwidth connectivity and computing solutions that serve
a wide range of networking applications. Leveraging our experience in high-speed
data communications and telecommunications enables us to develop integrated
communications solutions for our customers. We believe that the development of
new internetworking products, high-performance communications controllers and
enabling communications software is essential to expanding our customer base,
penetrating new markets, and retaining existing customers.
During the past four years, we have developed communications products based on
PCI, CompactPCI, PMC, PTMC, and HyperTransport architectures. We have also
redesigned and upgraded certain communications products to take advantage of new
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technologies offering improved product performance and lower costs. In addition,
we have acquired or licensed certain hardware products that have been integrated
principally through the addition of software into our product line.
During fiscal 2004, we continued to focus on further expansion of our line of
standards-based WAN adapters, upgrading/enhancing software drivers, developing
new products based on emerging technologies, such as TCP/IP Offload, Encryption,
and iSCSI. These hardware and software design efforts have enabled us to more
effectively target existing and emerging markets in areas such as VoIP, VPN,
security routers, telecommunications, military/government, medical and
industrial control
During fiscal 2004, 2003 and 2002, we incurred $2.4 million, $1.3 million and
$3.0 million, respectively, in product research and development expenses.
COMMITMENT TO QUALITY
We have been an ISO certified supplier of communications products since 1991. In
December 2001, we achieved certification to the internationally recognized
ISO9001: 2000 Standard. As part of our ongoing commitment to quality, we are
regularly inspected by an audit team from Bureau Veritas Quality International
(NA) Inc. ("BVQI"). These audits ensure that our internal quality system meets
internationally recognized quality management systems standards. We believe that
our customers' success depends on the delivery of high-quality products and
services. Our adherence to ISO standards and resulting quality practices is our
way of guaranteeing that customer expectations are met and exceeded.
MANUFACTURING
We do not engage in any manufacturing activities. Instead, we utilize third
party manufacturers to build our products. We currently have non-exclusive
manufacturing agreements with ProWorks, Inc. and Sonic Manufacturing Technology.
We believe that ProWorks and Sonic are equipped to provide more cost-efficient
and timely product delivery than could otherwise be obtained if we manufactured
our product internally. The use of external manufacturing partners allows us to
better respond to fluctuations in customer demand.
COMPETITION
The market for networking and communications interface products is highly
competitive. Many of our competitors have greater financial resources and are
well established in the space. Competition within the communications market is
fragmented principally by application segment. Our HighWire products compete
with offerings from Radisys Corp, Performance Technologies, Interphase Corp,
Artesyn Technologies, and Adax, along with various other platform and controller
product providers. Our VMEbus, WAN adapter and LAN adapter products compete
primarily with products from Performance Technologies, Motorola, Interphase
Corp., Themis Computers, SBS Technologies and various other companies on a
product-by-product basis. Our SCSI products compete with LSI Logic, Adaptec,
Qlogic and Sun Microsystems. Our Fibre Channel products compete with products
from QLogic Corp and Emulex Corp. Our TOE products compete with QLogic and
-13-
Adaptec. Our encryption solutions compete with Extreme Engineering, Layer N
Networks, and InterfaceMasters. To compete and differentiate ourselves in our
markets, we emphasize the functionality, engineering support, quality and price
of our product in relation to our competitors, as well as our ability to
customize the product to meet the customer's specific application needs.
Additionally, we compete with the internal engineering resources of our
customers. As our customers become successful with their products, they examine
methods to reduce costs and integrate functions. To compete with the internal
engineering resources of our customers, we work jointly with their engineering
staffs to understand each customer's specific system requirements and to
anticipate new product needs versus time-to-market decisions.
INTELLECTUAL PROPERTY
We believe that our ability to innovate in product engineering, sales,
marketing, support, and customer relations, and then to protect this proprietary
technology and knowledge impacts our future success. We rely on a combination of
copyright, trademark, trade secret laws and contractual provisions to establish
and protect our proprietary rights in our products. We currently hold four
patents. We typically enter into confidentiality agreements with our employees,
strategic partners, channel partners and suppliers, and enforce strict
limitations and the access to our proprietary information.
BACKLOG
On October 31, 2004, we had a sales backlog of product orders of approximately
$2.5 million, including $1.0 million in orders from HP, compared to a sales
backlog of product orders of approximately $4.1 million, including $2.0 million
in orders from HP, one year ago. Because customer purchase orders are subject to
changes in customer delivery schedules, cancellation, or price changes, our
backlog as of any particular date may not be representative of actual sales for
any succeeding fiscal period. We do not anticipate any problems in filling our
current backlog.
EMPLOYEES
On December 31, 2004, we had 36 employees. None of our employees is represented
by a labor union. We have experienced no work stoppages. We believe our employee
relations are positive.
We believe that our future success will depend, in part, on our ability to
attract and retain qualified technical (particularly engineering), marketing and
management personnel. Such experienced personnel are in great demand, and we
must compete for their services with other firms, many of which have greater
financial resources.
-14-
RISK FACTORS
Our business is subject to, but not limited to, the risks and uncertainties
described below.
RISKS RELATED TO OUR BUSINESS
WE DEPEND UPON A SMALL NUMBER OF OEM CUSTOMERS. THE LOSS OF ANY OF THESE
CUSTOMERS, OR THEIR FAILURE TO SELL THEIR PRODUCTS, WOULD LIMIT OUR ABILITY TO
GENERATE REVENUES.
In fiscal 2004, most of our sales were derived from a limited number of OEM
customers. In fiscal 2004, 2003 and 2002, sales of VME products to The
Hewlett-Packard Company (previously Compaq Computer) ("HP") accounted for 45%,
45% and 30%, respectively, of our net sales. A substantial portion of such sales
were attributable to sales of VME products pursuant to a long-term supply
agreement with HP that is no longer in effect. We will ship the remaining $1.0
million of the last order for VME products to HP in the first fiscal quarter of
fiscal 2005. We can provide no assurance that we will succeed in obtaining new
orders from existing or new customers sufficient to replace or exceed the net
sales previously attributable to HP.
Orders by our OEM customers are affected by factors such as new product
introductions, product life cycles, inventory levels, manufacturing strategies,
contract awards, competitive conditions and general economic conditions. Our
sales to any single OEM customer are also subject to significant variability
from quarter to quarter. Such fluctuations may have a material adverse effect on
our operating results. A significant reduction in orders from any of our OEM
customers, would have a material adverse effect on our operating results,
financial condition and cash flows. In addition, we anticipate a significant
portion of future sales will be dependent on a few new OEM customers, and there
can be no assurance that we will become a qualified supplier with new OEM
customers or that we will remain a qualified supplier with existing OEM
customers.
THE COMMUNICATIONS AND STORAGE PRODUCTS MARKET IS INTENSELY COMPETITIVE, AND OUR
FAILURE TO COMPETE EFFECTIVELY COULD REDUCE OUR REVENUES AND MARGINS.
We compete directly with traditional vendors of terminal servers, modems, remote
control software, terminal emulation software and application-specific
communications and storage solutions. We also compete with suppliers of routers,
hubs, network interface cards and other data communications and storage
products. In the future, we expect competition from companies offering
client/server access solutions based on emerging technologies such as switched
digital telephone services, iSCSI, SCSI, TOE and other technologies. In
addition, we may encounter increased competition from operating system and
network operating system vendors to the extent such vendors include full
communications and storage capabilities in their products. We may also encounter
future competition from telephony service providers (such as AT&T or the
regional Bell operating companies) that may offer communications services
through their telephone networks.
Increased competition with respect to any of our products could result in price
reductions and loss of market share, which would adversely affect our business,
operating results, financial condition and cash flows. Many of our current and
potential competitors have greater financial, marketing, technical and other
-15-
resources than we do. There can be no assurance that we will be able to compete
successfully with our existing competitors or will be able to compete
successfully with new competitors.
WE HAVE INCURRED OPERATING LOSSES IN THE PAST AND MAY NOT BE PROFITABLE IN THE
FUTURE.
The consolidated financial statements contemplate the realization of assets and
the satisfaction of liabilities in the normal course of business. Although we
had a net loss of $1.7 million for fiscal 2004, we did have net income of
$563,000 for fiscal 2003 and had eight consecutive profitable quarters prior to
the loss in our fourth quarter of fiscal 2004. We generated negative cash flows
from operations of $140,000, $84,000 and $2.7 million for fiscal 2004, 2003 and
2002, respectively We believe our existing cash plus additional cash from our
line of credit and continuing operations will provide sufficient cash flows to
fund our operations through October 31, 2005. However, these our cash flows from
future operations is dependent on projected sales are to a limited number of new
and existing OEM customers and are based on internal and customer provided
estimates of future demand, not firm customer orders. In addition, we must
successfully sell and distribute for our new TOE and iSCSI products. If the
projected sales do not materialize, we will need to reduce expenses further and
potentially raise additional capital through customer prepayments or the
issuance of debt or equity securities. If additional funds are raised through
the issuance of preferred stock or debt, these securities could have rights,
privileges or preferences senior to those of Common Stock, and debt covenants
could impose restrictions on our operations. The sale of equity or debt could
result in additional dilution to current stockholders, and such financing may
not be available to us on acceptable terms, if at all.
OUR OPERATING RESULTS IN FUTURE PERIODS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY
AND MAY FAIL TO MEET THE EXPECTATIONS OF SECURITIES ANALYSTS OR INVESTORS,
CAUSING OUR STOCK PRICE TO FALL.
Our quarterly operating results have fluctuated significantly in the past and
are likely to fluctuate significantly in the future due to several factors, some
of which are outside our control, including timing of significant orders from
OEM customers, fluctuating market demand for, and declines in the average
selling prices of, our products, delays in the introduction of our new products,
competitive product introductions, the mix of products sold, changes in our
distribution network, the failure to anticipate changing customer product
requirements, the cost and availability of components and general economic
conditions. We generally do not operate with a significant order backlog, and a
substantial portion of our revenue in any quarter is derived from orders booked
in that quarter. Accordingly, our sales expectations are based almost entirely
on our internal estimates of future demand and not on firm customer orders.
Due to the adverse economic conditions in the telecommunications industry, our
OEM telecommunications customers may hold excess inventory of our products. A
result of the economic downturn and slowness in recovery of the
telecommunications market is that certain of our customers have cancelled or
delayed many of their new design projects and new product rollouts that included
our products. Due to the current economic uncertainty, our customers now
typically require a "just-in-time" ordering and delivery cycle where they will
place a purchase order with us after they receive an order from their customer.
This "just-in-time" inventory purchase cycle by our customers has made
forecasting of our future sales volumes very difficult.
-16-
Based on the foregoing, we believe that quarterly operating results are likely
to vary significantly in the future and that period-to-period comparisons of our
results of operations are not necessarily meaningful and should not be relied
upon as indications of future performance. Further, it is likely that in some
future quarter our revenue or operating results will be below the expectations
of public market analysts and investors. In such event, the price of our common
stock is likely to fall.
IF WE ARE UNABLE TO KEEP UP WITH THE RAPID TECHNOLOGICAL CHANGES THAT
CHARACTERIZE OUR INDUSTRY, OUR BUSINESS WOULD SUFFER.
The markets for our products are characterized by rapidly changing technologies,
evolving industry standards and frequent new product introductions. Our future
success will depend on our ability to enhance our existing products and to
introduce new products and features to meet and adapt to changing customer
requirements and emerging technologies such as VoIP"), 3G Wireless ("Third
Generation Wireless Services") SATA ("Serial ATA"), SAS (Serial Attached SCSI")
iSCSI , Gigabit Ethernet, 10 Gigabit Ethernet and TOE. There can be no assurance
that we will be successful in identifying, developing, manufacturing and
marketing new products or enhancing our existing products. In addition, there
can be no assurance that services, products or technologies developed by others
will not render our products noncompetitive or obsolete.
We have focused a significant portion of our research and development, marketing
and sales efforts on HighWire, WAN and LAN adapters, Encryption, iSCSI and TOE
products. The success of these products is dependent on several factors,
including timely completion of new product designs, achievement of acceptable
manufacturing quality and yields, introduction of competitive products by other
companies and market acceptance of our products. If the TOE, iSCSI, HighWire and
adapter products or other new products developed by us do not gain market
acceptance, our business, operating results, financial condition and cash flows
would be materially adversely affected.
WE DEPEND ON OUR KEY PERSONNEL. IF WE ARE UNABLE TO RETAIN OUR CURRENT PERSONNEL
AND HIRE ADDITIONAL QUALIFIED PERSONNEL AS NEEDED, OUR BUSINESS WOULD BE HARMED.
We are highly dependent on the technical, management, marketing and sales skills
of a limited number of key employees. We do not have employment agreements with,
or life insurance on the lives of, any of our key employees. The loss of the
services of any key employee could adversely affect our business and operating
results. Our future success will depend on our ability to continue to attract
and retain highly talented personnel to the extent our business grows.
Competition for qualified personnel in the networking industry, and in the San
Francisco Bay Area, is intense. There can be no assurance that we will be
successful in retaining our key employees or that we can attract or retain
additional skilled personnel as required.
BECAUSE OF OUR DEPENDENCE ON SINGLE SUPPLIERS FOR SOME COMPONENTS, WE MAY BE
UNABLE TO OBTAIN AN ADEQUATE SUPPLY OF SUCH COMPONENTS, OR WE MAY BE REQUIRED TO
PAY HIGHER PRICES OR TO PURCHASE COMPONENTS OF LESSER QUALITY.
The chipsets used in most of our products are currently available only from
Motorola or in the case of the TOE products from LeWiz Communications, Inc.. In
addition, certain other components are currently available only from single
suppliers. The inability to obtain sufficient key components as required, or to
develop alternative sources if and as required in the future, could result in
-17-
delays or reductions in product shipments or margins that, in turn, would have a
material adverse effect on our business, operating results, financial condition
and cash flows.
OUR FUTURE CAPITAL NEEDS MAY EXCEED OUR ABILITY TO RAISE CAPITAL OR USE OUR
EXISTING CREDIT LINE WITH A BANK.
The engineering development and marketing of our products is capital-intensive.
While we believe that our existing cash balances and our anticipated cash flow
from operations will satisfy our working capital needs for the next twelve
months, we cannot assure that this will be the case. Declines in our sales or a
failure to keep expenses in line with revenues could require us to seek
additional financing or force us to draw down on our existing line of credit
with a Bank in fiscal 2005. Due to the net loss in our fourth quarter of fiscal
2004, we are not in compliance with our Bank line of credit debt covenants and
may not be able to use that credit line unless the Bank agrees to waive the
covenant violation. In addition, should we experience a significant growth in
customer orders, we may be required to seek additional capital to meet our
working capital needs. There can be no assurance that additional financing, if
required, will be available on reasonable terms or at all. To the extent that
additional capital is raised through the sale of additional equity or
convertible debt securities, the issuance of such securities could result in
additional dilution to our stockholders.
WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WHICH COULD REDUCE ANY
COMPETITIVE ADVANTAGE WE HAVE.
Since we believe that our future success will depend primarily on continuing
innovation, sales, marketing and technical expertise, the quality of product
support and customer relations, we must also protect the proprietary technology
contained in our products. We currently hold two patents and two patent
applications, and also rely on a combination of copyright, trademark, trade
secret laws and contractual provisions to establish and protect proprietary
rights of our products. There can be no assurance that steps taken by us in this
regard will be adequate to deter misappropriation or independent third-party
development of our technology. Although we believe that our products and
technology do not infringe on the proprietary rights of others, there can be no
assurance that third parties will not assert infringement claims against us.
RISKS ASSOCIATED WITH OWNERSHIP OF OUR COMMON STOCK
OUR COMMON STOCK IS AT RISK FOR DELISTING FROM THE NASDAQ SMALLCAP MARKET. IF IT
IS DELISTED, OUR STOCK PRICE AND YOUR LIQUIDITY MAY BE IMPACTED.
Our common stock is currently listed on the Nasdaq SmallCap Market. Nasdaq has
requirements that a company must meet in order to remain listed on the Nasdaq
SmallCap Market. These requirements include maintaining a minimum closing bid
price of $1.00 and minimum stockholders' equity of $2.5 million. Our
stockholders' equity as of October 31, 2004 was $4.3 million. The closing bid
price for our common stock has been below $1.00 for short periods of time in the
past. If the closing bid price of our common stock is below $1.00 for a period
of 30 consecutive trading days, our common stock could be subject to delisting
from the Nasdaq SmallCap Market.
If we fail to maintain the standards necessary to be quoted on the Nasdaq
SmallCap Market and our common stock is delisted, trading in our common stock
would be conducted on the OTC Bulletin Board as long as we continue to file
-18-
reports required by the Securities and Exchange Commission. The OTC Bulletin
Board is generally considered to be a less efficient market than the Nasdaq
SmallCap Market, and our stock price, as well as the liquidity of our Common
Stock, may be adversely impacted as a result.
THE MARKET PRICE OF OUR COMMON STOCK IS LIKELY TO CONTINUE TO BE VOLATILE. YOU
MAY NOT BE ABLE TO RESELL YOUR SHARES AT OR ABOVE THE PRICE AT WHICH YOU
PURCHASED SUCH SHARES.
The trading price of our common stock is subject to wide fluctuations in
response to quarter-to-quarter fluctuations in operating results, the failure to
meet analyst estimates, announcements of technological innovations or new
products by us or our competitors, general conditions in the computer and
communications industries and other events or factors. In addition, stock
markets have experienced extreme price and trading volume volatility in recent
years. This volatility has had a substantial effect on the market prices of
securities of many high technology companies for reasons frequently unrelated to
the operating performance of the specific companies. These broad market
fluctuations may adversely affect the market price of our common stock.
OUR CERTIFICATE OF INCORPORATION AND BYLAWS AND THE DELAWARE GENERAL CORPORATION
LAW CONTAIN PROVISIONS THAT COULD DELAY OR PREVENT A CHANGE IN CONTROL.
Our board of directors has the authority to issue up to 2,000,000 shares of
preferred stock and to determine the price, rights, preferences and privileges
of those shares without any further vote or action by the stockholders. The
rights of the holders of common stock will be subject to, and may be materially
adversely affected by, the rights of the holders of any preferred stock that may
be issued in the future. The issuance of preferred stock could have the effect
of making it more difficult for a third party to acquire a majority of our
outstanding voting stock. Furthermore, certain other provisions of our
certificate of incorporation and bylaws may have the effect of delaying or
preventing changes in control or management, which could adversely affect the
market price of our common stock. In addition, we are subject to the provisions
of Section 203 of the Delaware General Corporation Law, an anti-takeover law.
ITEM 2. PROPERTIES
In December 2001, we relocated our engineering and administrative headquarters
to 15,000 square feet of leased space located in San Ramon, California. The
lease expires in 2006. We expect the facility to satisfy our anticipated needs
for the foreseeable future. In conjunction with the relocation to the new
building, we assigned the lease related to our former 63,000 square foot
engineering and administrative headquarters to a third party. The third party
has assumed payment of the remaining lease payments through the termination of
the original lease term in 2006 and we are a secondary guarantor.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any pending legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of our stockholders in the fourth
quarter of 2004.
-19-
IDENTIFICATION OF EXECUTIVE OFFICERS
Our executive officers and their respective ages and positions as of October 31,
2004 are set forth in the following table. Our Board of Directors accepted the
retirement of Mr. William Heye, Jr. as President and Chief Executive Officer
effective December 31, 2004 and appointed Mr. Dan Grey as his replacement
effective January 1, 2005. Mr. Grey will continue to serve as the Senior vice
President, Sales and Marketing. Executive officers serve at the discretion of
the board of directors. There are no familial relationships between our
directors or our executive officers and any other director or executive officer.
Name Age Position
- --------------------------------------------------------------------------------
William B. Heye, Jr. 66 President and Chief Executive Officer
David W. Brunton 54 Vice President, Finance, Chief Financial
Officer, Treasurer and Secretary
Dan Grey 49 Senior Vice President, Sales and Marketing
Carl Munio 54 Vice President, Engineering
Kirk Anderson 45 Vice President, Operations
Yee-Ling Chin 29 Vice President, Marketing
Mr. Heye joined us in November 1991 as President, Chief Executive Officer and
member of the Board of Directors. Mr. Heye will retire from active management
effective December 31, 2004. From 1989 to November 1991, he served as Executive
Vice President of Ampex Corporation, a manufacturer of high-performance scanning
recording systems, and President of Ampex Video Systems Corporation, a
wholly-owned subsidiary of Ampex Corporation and a manufacturer of professional
video recorders and editing systems for the television industry. From 1986 to
1989, Mr. Heye served as Executive Vice President of Airborn, Inc., a
manufacturer of components for the aerospace and military markets. Prior to
1986, Mr. Heye served in various senior management positions at Texas
Instruments, Inc. in the United States and overseas, including Vice President
and General Manager of Consumer Products and President of Texas Instruments
Asia, Ltd., with headquarters in Tokyo, Japan.
Mr. Brunton joined us in November 2001 as Vice President, Finance, Chief
Financial Officer, Secretary and Treasurer. From 2000 to 2001 he was the Chief
Financial Officer for NetStream, Inc., a telephony broadband network service
provider. From 1997 to 2000, Mr. Brunton was the Chief Financial Officer and
Senior Vice President - Operations for ReSourcePhoenix.com, a financial services
outsource provider. From 1987 to 1997, Mr. Brunton was the Corporate Controller
for the Phoenix American Companies, an equipment leasing, cable TV,
telecommunications and software development company. Mr. Brunton is a certified
public accountant who prior to 1987 was with Arthur Andersen & Co.
Mr. Grey has served as Senior Vice President Sales and Marketing since May 2001.
For the 18 months prior to SBE, he was the Senior Vice President of Sales for
SBS Technologies. From 1999 to 2000, Mr. Grey was Vice President of Sales for
-20-
LAN Media Corporation, a company later acquired by SBE. Mr. Grey was the Western
Regional Sales Manager from 1996 to 1999 for Performance Technologies, Inc. From
1989 to 1996, Mr. Grey served as the Director of Western Sales for SBE. Mr. Grey
will assume the additional positions of President and Chief Executive Officer
effective January 1, 2005.
Mr. Munio joined SBE in August 2003 following SBE's acquisition of Antares
Microsystems. From 1996 to August 2003, Mr. Munio served as CTO for Antares,
where he drove product developments in emerging and existing technologies. Prior
to joining Antares, he was Director of Operations Product Engineering at Sun
Microsystems for over 11 years, and served in a variety of management positions
during a 12-year tenure at Hewlett-Packard.
Mr. Anderson has served as Vice President, Operations since October 2001. He
joined us as Manager of Operations in 1997 and was promoted to Director,
Operations in 1999. Prior to joining us Mr. Anderson was the Manager, Marketing
Logistics for Wesley Jessen from 1994 to 1997 where he was responsible for
logistical planning and manufacturing budgeting and control. Prior to 1994 he
held various management positions in operations, finance and marketing for
several high-tech companies in Silicon Valley, including Vitalink
Communications, a pioneer in internetworking products.
Ms. Chin joined us in July 2003 as Vice President, Marketing. From 1998 to 2003,
she served as Director of Marketing Communications for SBS Technologies.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
Our common stock is quoted on the Nasdaq SmallCap Market under the symbol SBEI.
The following table presents quarterly information on the price range of our
common stock, indicating the high and low bid prices reported by the Nasdaq
SmallCap Market. These prices do not include retail markups, markdowns or
commissions. As of December 31, 2004, there were approximately 394 holders of
record of our common stock.
There are no restrictions on our ability to pay dividends; however, it is
currently the intention of our Board of Directors to retain all earnings, if
any, for use in our business and we do not anticipate paying cash dividends in
the foreseeable future. Any future determination as to the payment of dividends
will depend, among other factors, upon our earnings, capital requirements,
operating results and financial condition.
Fiscal quarter ended
---------------------------------------------------------
Fiscal 2004 January 31 April 30 July 31 October 31
- -----------------------------------------------------------------------------
High $8.49 $7.34 $4.08 $3.19
Low 4.76 3.90 2.81 2.68
Fiscal 2003
High $1.26 $0.95 $2.99 $6.00
Low 0.56 0.64 0.77 2.42
-21-
The following table includes information regarding our equity incentive plans as
of the end of fiscal 2004.
Equity Compensation Plan Information
Number of securities
remaining available for
Number of securities to Weighted-average exercise future issuance under
be issued upon exercise price of outstanding equity compensation plans
of outstanding options, options, warrants (excluding securities
Plan category warrants and rights and rights reflected in column (a))
- ------------- ------------------- ---------- ------------------------
(a) (b) (c)
Equity compensation plans
approved by security
holders 1,319,666 $3.75 1,091,266
Equity compensation plans
not approved by security
holders 617,453 $2.53 26,250
---------- ----- ----------
Total 1,937,119 $3.36 1,117,516
---------- ----- ----------
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and the Notes thereto
included elsewhere in this Form 10-K.
For years ended October 31,
and at October 31 2004 2003 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------
(in thousands, except for per share amounts and number of employees)
Net sales $11,066 $ 7,456 $ 6,898 $ 7,726 $ 29,178
Net income (loss) $(1,679) $ 563 $ (1,731) $(9,896) $ 3,970
Net income (loss) per share - basic $( 0.33) $ 0.13 $ (0.46) $ (2.92) $ 1.24
Net income (loss) per share - diluted $ 1.04 $ (0.33) $ 0.12 $ (0.46) $ (2.92)
Product research and development $ 2,411 $ 1,330 $ 3,027 $ 5,652 $ 5,635
Expenses
Working capital $ 3,970 $ 3,945 $ 2,985 $ 7,595 $ 11,793
Total assets $ 6,173 $ 6,975 $ 5,321 $10,690 $ 17,427
Long-term liabilities $ 139 $ 217 $ 10 $ 4,870 $ 288
Stockholders' equity $ 4,303 $ 5,387 $ 3,696 $ 4,119 $ 13,829
Number of employees 36 32 24 47 87
-22-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
SBE, Inc. architects and provides network communications and storage solutions
to the original equipment manufacturers ("OEM") in the embedded computing and
storage markets. Our solutions enable data communications, telecommunications
and storage solution companies in addition to enterprise class high-end server
clients to rapidly deliver advanced networking and storage products and
services. Our products include wide area network ("WAN"), local area network
("LAN"), Internet Small Computer System Interface ("iSCSI") software, SCSI,
Fibre Channel, intelligent carrier cards, Encryption and TCP/IP Offload Engine
("TOE") cards. These products perform critical computing, processing offload,
Input/Output ("I/O") and storage tasks across both the enterprise server and
embedded markets such as high-end enterprise level servers, Linux super
computing clusters, workstations, media gateways, routers, internet access
devices, home location registers, data messaging applications, network attached
storage ("NAS") and remote storage devices and networks. Our products are
distributed worldwide through a direct sales force, distributors, independent
manufacturers' representatives and value-added resellers. Our business falls
primarily within one industry segment.
Our business is characterized by a concentration of sales to a small number of
OEMs and distributors who provide products and services to the datacom and
telecommunications markets in addition to OEM's and system integrators in the
storage and high-end server markets. Consequently, the timing of significant
orders from major customers and their product cycles cause fluctuation in our
operating results. The Hewlett Packard Company ("HP") is the largest of our
customers and represented 45%, 45% and 30% of net sales in fiscal 2004, 2003 and
2002, respectively. We will ship the remaining $1.0 million of the last order
for VME products to HP in the first fiscal quarter of fiscal 2005. We do not
expect to receive any future purchase orders from HP for our VME products. If
any of our major customers reduces orders for our products, we could lose
revenues and suffer damage to our business reputation. Orders by our OEM
customers are affected by factors such as new product introductions, product
life cycles, inventory levels, manufacturing strategy, contract awards,
competitive conditions and general economic conditions.
During fiscal 2004, we introduced new TOE, iSCSI, Encryption, WAN, and LAN
products that are targeted at large growing enterprise markets such as super
computing clusters, network storage clusters, VPN, security and other
communications devices. Our HighWire products have been focused primarily on the
telecommunications market and the communications activities that are driven by
the convergence of traditional telephony applications with the Internet with
applications like VoIP. While we believe the market for our TOE, iSCSI,
Encryption, HighWire, Adapter and Storage NIC's and software product families is
large, there can be no assurance that we will be able to succeed in penetrating
these markets and diversifying our sales.
Since the fourth quarter of fiscal 2001 we have 24 new design wins, including
two in fiscal 2004, and have added a substantial number of new customers to our
growing base of customers. A design win is defined as a program with an OEM
customer that will generate at least $400,000 in recurring annual net sales
typically within 12 to 18 months after the customer accepts and confirms the use
of our product in their platform. We believe the combination of new customers
and design wins will provide the basis for future sales growth. A variety of
risks such as schedule delays, cancellations and changes in customer markets and
economic conditions can adversely affect a design win before or after production
-23-
is reached. With the current economic climate in the communications equipment
marketplace, design activity has slowed and reaching production volumes is
proving to be elusive for those products that have been designed. In these
difficult economic times, poor customer visibility is causing ordering delays.
These factors often result in a substantial portion of our net sales being
derived from orders placed within the quarter and shipped in the final month of
the quarter.
On October 31, 2004, we had a sales backlog of product orders of approximately
$2.5 million compared to a sales backlog of product orders of approximately $4.1
million one year ago. Included in these backlogs are orders from HP of $1.0
million and $2.0 million, respectively.
The market environment for our products is extremely competitive and we have
limited visibility into customer activity. In spite of this uncertain market, we
have been successful in increasing our adapter revenues 53% and revenues from
our HighWire products 77% during fiscal 2004. One of our primary sales goals is
to diversify our customer base and at the same time provide sources of net sales
to fill the gap that will be left after we process our final shipment of VME
products to HP in the first quarter of fiscal 2005.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Such estimates include levels
of reserves for doubtful accounts, obsolete inventory, warranty costs and
deferred tax assets. Actual results could differ from those estimates.
Our critical accounting policies and estimates include the following:
Revenue Recognition:
Our policy is to recognize revenue for product sales upon shipment of our
products to our customers provided that no significant obligation remains and
collection of the receivable is considered probable. Shipping terms are
generally FOB shipping point.. We defer and recognize service revenue over the
contractual period or as services are rendered. We estimate expected sales
returns and record the amount as a reduction of revenue and cost of goods
("COGS") at the time of shipment. Our policy complies with the guidance provided
by Staff Accounting Bulletin No. 104, Revenue Recognition in Financial
Statements, issued by the Securities and Exchange Commission. Judgments are
required in evaluating the credit worthiness of our customers. Credit is not
extended to customers and revenue is not recognized until we have determined
that collectibility is reasonably assured. Our sales transactions are
denominated in U.S. dollars. The software component of our products is
considered incidental to our products. We, therefore do not recognize software
revenue separately from the product sale.
Our agreements with OEMs, such as HP and Nortel Networks Corp, typically
incorporate clauses reflecting the following understandings:
-24-
- all prices are fixed and determinable at the time of sale;
- title and risk of loss pass at the time of shipment (FOB shipping
point);
- collectibility of the sales price is probable (the OEM is obligated
to pay and such obligation is not contingent on the ultimate sale of
the OEM's integrated solution);
- the OEM's obligation to us will not be changed in the event of theft
or physical destruction or damage of the product;
- we do not have significant obligations for future performance to
directly assist in the resale of the product by the OEMs; and
- there is no contractual right of return other than for defective
products.
Our agreements with our distributors include certain product rotation and price
protection rights. All distributors have the right to rotate slow moving
products once each fiscal quarter. The maximum dollar value of inventory
eligible for rotation is equal to twenty-five percent of our products purchased
by the distributor during the previous quarter. In order to take advantage of
their product rotation rights, the distributors must order and take delivery of
additional SBE products equal to at least the dollar value of the products that
they want to rotate.
Each distributor is also allowed certain price protection rights. If and when we
reduce or plan to reduce the price of any of our products and the distributor is
holding any of the affected products in inventory, we will credit the
distributor the difference in price when it places its next order with us. We
record an allowance for price protection reducing our net sales and accounts
receivable. The allowance is based on the price difference of the inventory held
by our stocking distributors at the time we expect to reduce selling prices.
Reserves for the right of return and restocking are established based on the
requirements of SFAS 48, Revenue Recognition when Right of Return Exists because
we have visibility into our distributor's inventory and have sufficient history
to estimate returns.
During the year ended October 31, 2004 and 2003, $873,000, or 8% of sales and
$191,000 or 3% of our sales were sold to distributors, respectively.
Allowance for Doubtful Accounts:
Our policy is to maintain allowances for estimated losses resulting from the
inability of our customers to make required payments. Credit limits are
established through a process of reviewing the financial history and stability
of each customer. Where appropriate, we obtain credit rating reports and
financial statements of the customer when determining or modifying their credit
limits. We regularly evaluate the collectibility of our trade receivable
balances based on a combination of factors. When a customer's account balance
becomes past due, we initiate dialogue with the customer to determine the cause.
If it is determined that the customer will be unable to meet its financial
obligation to us, such as in the case of a bankruptcy filing, deterioration in
the customer's operating results or financial position or other material events
impacting its business, we record a specific allowance to reduce the related
receivable to the amount we expect to recover.
We also record an allowance for all customers based on certain other factors
including the length of time the receivables are past due and historical
collection experience with customers. We believe our reported allowances are
adequate. If the financial conditions of those customers were to deteriorate,
however, resulting in their inability to make payments, we may need to record
additional allowances which would result in additional general and
-25-
administrative expenses being recorded for the period in which such
determination was made.
Warranty Reserves:
We accrue the estimated costs to be incurred in performing warranty services at
the time of revenue recognition and shipment of the products to the OEMs.
Because there is no contractual right of return other than for defective
products, we can reasonably estimate such returns and record a warranty reserve
at the point of shipment. Our estimate of costs to service our warranty
obligations is based on historical experience and expectation of future
conditions. To the extent we experience increased warranty claim activity or
increased costs associated with servicing those claims, the warranty accrual
will increase, resulting in decreased gross margin.
Inventories:
We are exposed to a number of economic and industry factors that could result in
portions of our inventory becoming either obsolete or in excess of anticipated
usage, or subject to lower of cost or market issues. These factors include, but
are not limited to, technological changes in our markets, our ability to meet
changing customer requirements, competitive pressures in products and prices,
and the availability of key components from our suppliers. Our policy is to
establish inventory reserves when conditions exist that suggest that our
inventory may be in excess of anticipated demand or is obsolete based upon our
assumptions about future demand for our products and market conditions. We
regularly evaluate our ability to realize the value of our inventory based on a
combination of factors including the following: historical usage rates,
forecasted sales or usage, product end-of-life dates, estimated current and
future market values and new product introductions. Purchasing practices and
alternative usage avenues are explored within these processes to mitigate
inventory exposure. When recorded, our reserves are intended to reduce the
carrying value of our inventory to its net realizable value. If actual demand
for our products deteriorates, or market conditions are less favorable than
those that we project, additional inventory reserves may be required. In the
fourth quarter of 2004, we reviewed our inventory balances and increased our
reserves on specific products by $547,000.
Inventories are stated at the lower of cost, using the first-in, first-out
method, or market value.
Acquisitions:
All business acquisitions have been accounted for using the purchase method of
accounting and, accordingly, the statements of income include the results of
each acquired business since the date of acquisition. The assets acquired and
liabilities assumed are recorded at estimates of fair values as determined by
management based on information available. Management considers a number of
factors, including third-party valuations or appraisals, when making these
determinations. We finalize the allocation of purchase price to the fair value
of the assets acquired and liabilities assumed when we obtain information
sufficient to complete the allocation, but in any case, within one year after
acquisition. Our acquisition of Antares in fiscal year ended October 31, 2003
resulted in intangible assets of approximately $1.2 million. These assets were
fully written off in the current year.
-26-
Intangible Assets:
We adopted the Financial Accounting Standards Board ("FASB") Statements of
Financial Accounting Standards ("SFAS") No. 141, Business Combinations and SFAS
No. 142, Goodwill and Other Intangible Assets on accounting for business
combinations and goodwill as of the beginning of fiscal year 2002. Accordingly,
we do not amortize goodwill from acquisitions, but continue to amortize other
acquisition-related intangibles and costs. All of the intangible assets that we
currently own are intellectual property acquired in the Antares acquisition.
For identifiable intangible assets, we amortize the cost over the estimated
useful life and assess any impairment by estimating the future cash flow from
the associated asset in accordance with SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. If the estimated undiscounted cash
flow related to these assets decreases in the future or the useful life is
shorter than originally estimated, we may incur charges for impairment of these
assets. The impairment is based on the estimated discounted cash flow associated
with the asset. An impairment could result if the underlying technology fails to
gain market acceptance, we fail to deliver new products related to these
technology assets, the products fail to gain expected market acceptance or if
market conditions are unfavorable.
Intellectual property costs consist of the allocation of costs associated with
the purchase of current and the design of future products from Antares
Microsystems on August 7, 2003. As required by these rules, we perform an
impairment review annually, or earlier if indicators of potential impairment
exist. The impairment analysis requires significant judgment to identify events
or circumstances that would likely have a significant adverse effect on the fair
value of the intangible asset. Our annual impairment review was completed during
the fourth quarter of fiscal 2004, and we determined that there was considerable
doubt that the remaining unamortized balance of $713,000 of the intangible asset
at October 31, 2004 would be recoverable. The indicators we used to identify
those events and circumstances included: revenue and earnings trends relative to
predefined milestones and overall business prospects; the technological
feasibility of the Antares products; and technologies and the general market
conditions in the market for SUN Microsystems compatible products with which
Antares products compete. Our impairment review was based on a discounted cash
flow approach that uses estimates of future market share and revenues and costs
for the Antares products as well as appropriate discount rates. The estimates
used are consistent with the plans and estimates that we use to manage the
underlying business. We determined that the estimated fair market value of the
balance of the intangible asset related to the Antares acquisition was nominal
and as a result, we recorded an impairment charge of $713,000, during the fourth
fiscal quarter ended October 31, 2004, thus writing off the remaining value of
the intellectual property asset.
The non-cash expense related to the amortization and write-down of the
intellectual property in fiscal 2004 was $1.1 million and consists of $408,000
of regularly scheduled annual amortization expense plus $713,000 write down
related to the impairment valuation analysis. This write-down plus the regularly
scheduled amortization is included in our cost of goods sold. The amortization
expense for the one quarter that we owned Antares in fiscal 2003 was
approximately $102,000.
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Deferred Taxes:
We record a valuation allowance to reduce our deferred taxes to the amount that
is more likely than not to be realized. Based on the uncertainty of future
pre-tax income, we have fully reserved our deferred tax assets as of October 31,
2004. In the event we were to determine that we would be able to realize our
deferred tax assets in the future, an adjustment to the deferred tax asset would
increase income in the period such determination was made.
New Accounting Pronouncements:
In December 2004, the FASB issued SFAS No. 123R that amends SFAS No. 123
Accounting for Stock-Based Compensation, to require public entities (other than
those filing as small business issuers) to report stock-based employee
compensation in their financial statements. Unless modified, we will be required
to comply with the provisions of SFAS No. 123R as of the first interim period
that begins after June 15, 2005 (August 1, 2005 for us). We currently do not
record compensation expense related to our stock-based employee compensation
plans in our financial statements.
RESULTS OF OPERATIONS
The following table sets forth, as a percentage of net sales, certain
consolidated statements of operations data for the fiscal years ended October
31, 2004, 2003 and 2002. These operating results are not necessarily indicative
of our operating results for any future period.
YEAR ENDED OCTOBER 31,
---------------------------------
2004 2003 2002
----- ----- ------
Net sales 100% 100% 100%
Cost of sales 60 37 46
----- ----- ------
Gross profit 40 63 54
Operating expenses:
Product research and development 22 18 44
Sales and marketing 19 20 31
General and administrative 16 23 34
Loan reserve (benefit) (2) (3) 7
Restructuring costs (benefit) -- (2) 6
----- ----- ------
Total operating expenses 55 56 (122)
----- ----- ------
Operating income (loss) (15) 7 (68)
Forfeited deposit, net -- -- 39
Interest and other income -- -- 2
----- ------ ------
Income (loss) before income taxes (15) 7 (27)
Income tax benefit -- -- 2
----- ------ ------
Net income (loss) (15)% 7% (25)%
===== ====== ======
NET SALES
Net sales for fiscal 2003 were $11.1 million, a 48% increase from $7.5 million
for fiscal 2003. Net sales for fiscal 2003 were $7.5 million, an 8% decrease
from $6.9 million in fiscal 2002. The increase in fiscal 2004 as compared to
-28-
fiscal 2003 was primarily attributable to an increase in sales to numerous
customers including our largest, HP. Net sales to HP were $4.9 million in fiscal
2004 as compared to $3.4 million for fiscal 2003 and $2.1 million in fiscal
2002. Sales to HP, primarily of VMEBus products, represented 45% of net sales
for fiscal 2004, compared to 45% during fiscal 2003 and 30% in fiscal 2002. A
substantial portion of such sales were attributable to sales of VME products
pursuant to a long-term supply agreement with HP that is no longer in effect. We
have one remaining order with HP for $1.0 million of VME products that will be
shipped in the first quarter of fiscal 2005. At this time, we do not expect to
receive any future orders for VME products from HP. Nortel Networks was the only
other customer that represented greater than 10% of our sales, accounting for
13% of our sales in fiscal 2004. For fiscal 2003 and 2002, Lockheed Martin was
the only other customer representing 10% or more of our sales, accounting for
11% of net sales in fiscal 2002. In fiscal 2004 after one complete year of
operations, we derived $1.2 million in sales from products we acquired from
Antares compared to $459,000 in Antares product sales from acquisition date,
August 7, 2003 through October 31, 2003.
Sales of our adapter products were $4.9 million for fiscal 2004, as compared to
$2.6 million in fiscal 2003 and $2.1 million in fiscal 2002. Sales of our
HighWire products were $1.3 million in fiscal 2004, as compared to $0.8 million
in fiscal 2003 and $1.0 million in fiscal 2002. Our adapter products are used
primarily in edge-of-the-network applications such as VPN and other routers,
VoIP gateways and security devices, whereas our HighWire products are primarily
targeted at core-of-the-network applications used primarily by
telecommunications central offices. In the future, we expect our net sales to be
generated predominantly by sales of our adapter and encryption products with
Linux and Solaris software, followed by our recently released TOE products and
storage products, primarily iSCSI. We expect to see a continued steady increase
in the sale of our Highwire products due to the recent adoption and release of
OEM products that have incorporated our Highwire series of intelligent carrier
cards. All of our design wins and new customers are for applications using these
product families. In addition, we will continue to sell and support our older
VME products, but expect them to become a declining portion of our future net
sales.
We anticipate that our net sales for fiscal 2005 will increase when compared
with fiscal 2004, as certain of our design wins from the last two year to go
into production and that our customers will increase the rate of product rollout
such as edge of the network routers, VoIP gateways and WiFi applications. As a
result of these design wins moving to production stage, sales of our Adapter
products increased 53% and sales of our Highwire products increase 77% in fiscal
2004 as compared to fiscal 2003. One of our major challenges on a long term
basis continues to be replacement of the net sales of VME products previously
provided to HP. HP (including its predecessors, Tandem Computer and Compaq
Computer), has accounted for a substantial portion of our net sales for the past
five years. We expect to continue to increase the sales of our Adapter and
Highwire products and that these increases as a percentage of total revenue will
replace the sales to HP. Even though the market environment for our customers'
activities continues to be uncertain we have been successful in extending our
reach with new customers. We have been successful in increasing our network of
distributors and value-added resellers in the United States and Europe and have
rolled out some new products such as high density multi-ported adapter cards,
Encryption cards, the TOE product and iSCSI storage software. We have also
entered into some new strategic partnerships that will expand the reach of our
products to a new base of customers using AdvanceTCA ("ATCA") products. We have
-29-
continued to add new customers and design wins over the course of fiscal 2004
and we believe the combination of new customers and past design wins beginning
to go into production will provide future growth in net sales in the
communications, computing and storage marketplaces.
Our sales backlog at October 31, 2004 was $2.5 million, including $1.0 million
from HP, compared to $4.1 million, including $2.0 million from HP, at October
31, 2003. While we anticipate an increase in our sales volume in our Adapter and
Highwire products over the course of fiscal 2005 as certain of our design wins
from the last two year to go into production and our customers gradually return
to new product design and product rollout, there can be no assurances that such
increase will occur. Our customers typically operate on a "just-in-time"
ordering and delivery cycle where they will place a purchase order with us after
they receive an order from their customer. This "just-in-time" inventory
purchase cycle by our customers has made forecasting of our future sales volumes
very difficult. Because our sales are generally concentrated with a small group
of OEM customers, we could experience significant fluctuations in our quarterly
sales volumes due to fluctuating demand from any major customer or delay in the
rollout of any significant new product by a major customer.
International sales constituted 12%, 12% and 13% of net sales in fiscal 2004,
2003 and 2002, respectively. International sales are executed in U.S. dollars
and are principally transacted in Europe.
GROSS PROFIT
Gross profit as a percentage of net sales was 40%, 63% and 54% in fiscal 2004,
2003 and 2002, respectively. Gross profit as a percentage of sales increased in
fiscal 2003 primarily as a result of sales of $409,000 of inventory to HP that
had been fully written down in fiscal 2002 when HP placed its final order for
end-of-life VME products under its then-existing contract. Our gross profit
would have been 58% after excluding the effect of the HP inventory write-down.
The decrease in our gross profit margin in fiscal 2004 is due primarily to lower
than expected gross margins from the Antares product, the addition of $547,000
expense related to the valuation adjustment for slow moving and obsolete
inventory and the inclusion of $408,000 of amortization and $713,000 of
impairment charges relating to the August 2003 intellectual property purchased
with Antares. We expect our gross profit to range between 50% and 53% for fiscal
2005 based on our current product sales prices and cost to manufacture those
products. However, if market and economic conditions, particularly in the
telecommunications sector, deteriorate or fail to recover as expected, gross
profit as a percentage of net sales may decline from the current level.
PRODUCT RESEARCH AND DEVELOPMENT
Product research and development expenses were $2.4 million in fiscal 2004, $1.3
million in fiscal 2003, and $3.0 million in fiscal 2002, representing 22%, 18%
and 44% of net sales, respectively. The increase in fiscal 2004 as compared to
fiscal 2003 is primarily the result of three factors:
o the inclusion of three personnel hired in conjunction with the
Antares acquisition;
o the addition of five additional design engineers hired during the
year;
o a 160% increase in expenditures for new product development.
-30-
The decrease in research and development expense as a percentage of revenue from
fiscal 2002 to fiscal 2003 was the direct result of headcount reductions of
fifteen full-time equivalent personnel combined with other project-related cost
containment measures During fiscal 2004, we began the development of the next
generation of our Highwire products, designed and released several new WAN and
LAN products including three new encryption products, continued development and
released our new TOE product and integrated our TOE product with a partners
enterprise based iSCSI software. We also continued to port our products to new
versions of Linux and Solaris software expanding their market reach. These
hardware and software design efforts have enabled us to more effectively target
enterprise markets such as Internet based storage, TCP offload, VoIP, VPN and
security routers, as well as expand market coverage within the
telecommunications, military/government, medical and industrial control markets.
We expect overall spending for our product research and development to range
between 15% and 18% of net sales in fiscal 2005 as we remain committed to the
development and enhancement of new and existing products. We did not capitalize
any internal software development costs in fiscal 2004, 2003 or 2002.
SALES AND MARKETING
Sales and marketing expenses for fiscal 2004 were $2.2 million, a 47% increase
over fiscal 2003. This increase is primarily related to higher headcount in the
sales and marketing departments for the majority of the year increasing by three
people plus an increases in travel and product marketing activities. We
increased our marketing expenditures by 142% in fiscal 2004 as we attended more
industry trade shows and increased our advertising in industry relevant
magazines. Fiscal 2003 expense was $1.5 million, a 31% decrease over fiscal
2002. The decrease in fiscal 2003 as compared to 2002 is the direct result of
headcount reductions in our sales and marketing departments combined with a
reduction in our overall marketing programs. Sales and marketing programs are
focused on design wins with new customers and, therefore, as new customer sales
increase, sales and marketing expenses will increase. New customers' product
design sales cycles may span over periods as long as twenty-four months. We
expect our sales and marketing expenses to range between 15% and 17% of net
sales in fiscal 2005 as we continue our product marketing efforts, especially
for the TOE and iSCSI products, and attend an increasing number of industry
specific trade shows.
GENERAL AND ADMINISTRATIVE
General and administrative expenses for fiscal 2004 remained constant at $1.8
million as compared to fiscal 2003. Fiscal 2004 includes $259,000 in
compensation expense related to the severance package provide to the company's
retiring president and chief executive officer. Fiscal 2003 expenses decreased
to $1.8 million from $2.4 million in fiscal 2002 or, 26%. The decrease was due
to headcount from eight to five individuals and expense containment measures,
primarily rent and depreciation, put into place in the fourth quarter of fiscal
2002, with the cost savings fully realized in fiscal 2003 and 2004. We expect
general and administrative expense for fiscal 2005 to increase from fiscal 2004
levels partly due to the increase in insurance and expenses related to
compliance with the Sarbanes-Oxley Act. General and administrative expenses are
expected to range between 12% and 15% of sales for fiscal 2005.
-31-
LOAN RESERVE (BENEFIT)
On November 6, 1998, we made a loan to our retiring President and CEO which was
used by him to exercise an option to purchase 139,400 shares of our common stock
and related taxes. The loan, as amended, was collateralized by shares of our
common stock, bore interest at a rate of 2.48% per annum and was due on December
14, 2003.
On October 31, 2002, we determined that it was probable that we would be unable
to fully recover the balance of the loan on its due date of December 14, 2003.
Accordingly, a valuation allowance of $474,000 was recorded against the loan at
October 31, 2002.
During the fourth quarter of fiscal 2003, the officer repaid $362,800 of the
loan and as a result, we recognized a benefit of $235,000 related to the
reversal of the loan impairment charge taken by us in fiscal 2002. During the
first quarter of fiscal 2004, the officer repaid the remaining loan balance in
full and as a result, we recorded a benefit of $239,000 relating to the reversal
of the remaining loan impairment charge.
RESTRUCTURING COSTS(BENEFIT)
In response to the economic slowdown, we implemented restructuring plans in
fiscal 2002 and recorded restructuring charges of $446,000. Restructuring costs
for fiscal 2002 were comprised of severance costs associated with staff
reductions totaling $115,000, leasehold improvements and equipment write-downs
related to the abandonment of our Madison, Wisconsin office of $185,000 and
estimated losses related to future rents, net of estimated future recoveries
from potential sublease, of $146,000. We reduced our headcount from 47 employees
to 24 employees during fiscal 2002.
In the third quarter of fiscal 2003, we recognized a restructuring benefit of
$154,000 after the final settlement of costs associated with prior real estate
and equipment leases.
As of October 31, 2004 and 2003, $21,000 and $58,000 of the restructuring costs
were included in other current liabilities, respectively.
INTEREST AND OTHER INCOME
Interest and other income in fiscal 2004 decreased slightly from 2003 due to
lower average cash balances in fiscal 2004 coupled with lower average interest
rates. Fiscal 2003 income decreased slightly from fiscal 2002 due to lower
average cash balances in fiscal 2003 coupled with lower average interest rates.
A refundable deposit associated with a multi-year supply agreement with HP of
$4.9 million was received in April 2001. This deposit was refundable as we
delivered certain quantities of products to HP over a four year period ending in
2005. The supply contact was restructured in fiscal 2002 to include a final
purchase order for $1.6 million of our products to be shipped to HP in the first
two quarters of fiscal 2003 and the forfeiture by HP of $4.4 million of the $4.9
million refundable deposit. Under the agreement, we are required to retain for
future production or repair all VCOM finished goods and spare parts inventory
through October 31, 2005 unless notified otherwise by HP. Concurrent with the
forfeiture of the $4.4 million refundable deposit, we recorded a reserve of $1.7
million related to the potentially obsolete inventory we held at October 31,
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2002. The $2.7 million of forfeiture of the refundable deposit net of inventory
reserve is presented under "Forfeited deposit, net" on the fiscal 2002
Consolidated Statements of Operations.
INCOME TAXES
On March 9, 2002, the Job Creation and Workers Assistance Act of 2002 extended
the net operating loss carryback from two to five years for losses generated in
tax years ending in 2001 and 2002. As a result, we recorded a benefit for income
taxes of $22,000 in the second quarter of fiscal 2003 and a tax benefit of
$91,000 in fiscal 2002 due to refunds of federal income taxes related to this
Act. The net benefit recorded for the 2003 and 2002 periods were $17,000 and
$177,000, respectively. In fiscal 2002 we also filed amended federal and state
tax returns to claim $86,000 in research and development credits related to LAN
Media Corporation ("LMC"), a company we acquired in July 2000. Our effective tax
rate was 0%, 0% and (8)% in fiscal 2004, 2003 and 2002, respectively. We
recorded valuation allowances in fiscal 2004 and 2003 for deferred tax assets
due to the uncertainty of realization. In the event of future taxable income,
our effective income tax rate in future periods could be lower than the
statutory rate as such tax assets are realized.
NET INCOME (LOSS)
As a result of the factors discussed above, we recorded a net loss of $1.7
million in fiscal 2004 compared to net income of $563,000 in fiscal 2003 and a
net loss of $1.7 million in fiscal 2002.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following table sets forth a summary of our material contractual obligations
and commercial commitments as of October 31, 2004:
Payments due by period (Dollars in thousands)
---------------------------------------------------
Less than 1-3 3-5 More than
Contractual Obligations Total 1 year Years Years 5 Years
------- ------- ------- ------- -------
Building leases $ 1,649 $ 963 $ 686 $ -- $ --
Reimbursements from lease
assignment (902) (637) (265) -- --
------- ------- ------- ------- -------
Total net lease payments $ 747 $ 326 $ 421 $ -- $ --
======= ======= ======= ======= =======
In connection with the acquisition of Antares, we committed to issue 98,945
shares of our Common Stock in 10,000 and 20,000 share increments beginning
January 2004 and ending March 2005 to a selling shareholder of Antares. During
fiscal 2004, we issued 30,000 shares of our Common Stock of a committed 98,945
to an employee who was one of the owners of Antares Microsystems, Inc. pursuant
to the original purchase agreement. We will issue the remaining 68,945 during
fiscal 2005. The value of the Common Stock issued in fiscal 2004 under this
commitment was $85,600.
In connection with the retirement of Mr. William Heye, Jr. as the company's
President and Chief Executive Officer, the Company will pay Mr. Heye $250,000 at
the rate of $20,833 each month for the period January 1, 2005 through December
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31, 2005. The commitment to pay $250,000 has been accrued as of October 31, 2004
and is included in General and Administrative expense and Accrued Payroll and
Employee Benefits liability.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any transactions, arrangements, or other relationships with
unconsolidated entities that are reasonably likely to affect our liquidity or
capital resources other than the operating leases noted above. We have no
special purpose or limited purpose entities that provide off-balance sheet
financing, liquidity, or market or credit risk support; or engage in leasing,
hedging, research and development services, or other relationships that expose
us to liability that is not reflected on the face of the financial statements.
LIQUIDITY AND CAPITAL RESOURCES
Our liquidity is dependent on many factors, including sales volume, operating
profit and the efficiency of asset use and turnover. Our future liquidity will
be affected by, among other things:
- actual versus anticipated sales of our products;
- our actual versus anticipated operating expenses and results of
ongoing cost control actions;
- the timing of product shipments, which occur primarily during the
last month of each quarter;
- our actual versus anticipated gross profit margin;
- our ability to raise additional capital, if necessary; and
- our ability to secure credit facilities, if necessary.
We had cash and cash equivalents of $1.8 million and $1.4 million on October 31,
2004 and October 31, 2003, respectively. In fiscal 2004, $140,000 of cash was
used by operating activities, primarily as a result of net losses, the reversal
of a valuation allowance on a loan from an officer and an increase in inventory.
The cash receipt from the repayment of the loan is included in the financing
activities section of the cash flow statement. Cash was provided by the
inclusion of $1.1 million of amortization expense and the write-down of the
intellectual property plus $420,000 of amortization and depreciation expense
related to property and equipment and capitalized software included in the $1.7
million net loss. Cash flow was also provided by a $150,000 decrease in our
accounts receivable. Working capital (current assets less current liabilities)
at October 31, 2004 was $3.9 million, as compared to $4.0 million at October 31,
2003.
In fiscal 2004, we purchased $87,000 of fixed assets, consisting primarily of
computers and engineering equipment. Purchased software costs amounting to
$136,000 were capitalized in fiscal 2004. We expect to slightly increase our
levels of capital expenditures in fiscal 2005 in order to purchase test and
design equipment upgrades.
We received $18,000 in fiscal 2004 from payments related to common stock
purchases made by employees pursuant to the employee stock purchase plan and
$233,000 from proceeds related the exercise of employee stock options, for a
total of $251,000.
-34-
On December 19, 2003 we received cash proceeds of $116,000 from Puglisi & Co.
for the purchase of 70,000 shares of our Common Stock pursuant to a warrant they
received in conjunction with a private placement of common stock transaction
that was completed in fiscal 2003.
During the fourth quarter of fiscal 2003, our retiring president and CEO sold
139,400 shares of our common stock and used the proceeds from the stock sale to
repay $362,800 of an outstanding $743,800 loan we made to the officer. In
November 2003 the loan was repaid in full when we received an additional loan
payment of $381,000 from proceeds from the sale of stock.
On May 13, 2004, we renewed our working capital line of credit for twelve months
until May 14, 2005. The credit line is secured by a first lien on all our assets
and carries a floating annual interest rate equal to the bank's prime rate of
4.75%, at October 31, 2004, plus 1.50%. Draw-downs on the credit line are based
on a formula equal to 80% of our domestic accounts receivable. As of October 31,
2004, due to the net loss for our fourth fiscal quarter of 2004, we are not in
compliance with all the covenants of our credit line. The Bank agreed to waive
the non-compliance with this covenant. We have not drawn down on this line of
credit and have no amounts payable at October 31, 2004.
We believe the projected revenue during fiscal 2005 will generate sufficient
cash flows to fund our operations through October 31, 2005 and beyond. Our
projected future quarterly operational cash flow breakeven point is expected to
be $2.7 million to $2.8 million in net sales at an expected 50% to 53% gross
margin. Our current year's sales to HP of $4.9 million at a gross margin of 73%
are expected to significantly decline. Our projected sales are based on a
combination of increasing demand for existing products and market acceptance of
recently released products to a limited number of new and existing OEM customers
and are based on internal and customer provided estimates of future demand, not
firm customer orders. If the projected sales do not materialize, we will need to
reduce expenses further and raise additional capital through customer
prepayments or the issuance of debt or equity securities. If additional funds
are raised through the issuance of preferred stock or debt, these securities
could have rights, privileges or preferences senior to those of our common
stock, and debt covenants could impose restrictions on our operations. The sale
of equity or debt could result in additional dilution to current stockholders,
and such financing may not be available to us on acceptable terms, if at all.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our cash and cash equivalents are subject to interest rate risk. We invest
primarily on a short-term ba