-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RXf6VTkzRPxyBYRIzWtyjyLDNjz5Jzzmjymd6Irs+IPPFlJQuQ42d8QVe1yDkCYy 9PhydTE6f2Jjm2riCOOzRA== 0001114925-04-000054.txt : 20040928 0001114925-04-000054.hdr.sgml : 20040928 20040927212551 ACCESSION NUMBER: 0001114925-04-000054 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20040630 FILED AS OF DATE: 20040928 DATE AS OF CHANGE: 20040927 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LANTRONIX INC CENTRAL INDEX KEY: 0001114925 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER COMMUNICATIONS EQUIPMENT [3576] IRS NUMBER: 330362767 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-16027 FILM NUMBER: 041048182 BUSINESS ADDRESS: STREET 1: 15353 BARRANCA PARKWAY CITY: IRVINE STATE: CA ZIP: 92618 BUSINESS PHONE: 9494533990 MAIL ADDRESS: STREET 1: 15353 BARRANCA PARKWAY CITY: IRVINE STATE: CA ZIP: 92618 10-K 1 fy04.txt FY04 =============================================================================== UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 2003 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO ________ COMMISSION FILE NUMBER 1-16027 LANTRONIX, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 33-0362767 (STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 15353 BARRANCA PARKWAY, IRVINE, CALIFORNIA 92618 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (949) 453-3990 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- COMMON STOCK, $0.0001 PAR VALUE THE NASDAQ MARKET Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes [ ] No [X] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [ ] No [X] The aggregate market value of the registrant's Common Stock held by non-affiliates based upon the closing sales price of the Common Stock on December 31, 2003, as reported by the Nasdaq National Market, was approximately $31,192,000. Shares of Common Stock held by each current executive officer and director and by each person who is known by the registrant to own 5% or more of the outstanding Common Stock have been excluded from this computation in that such persons may be deemed to be affiliates of the registrant. Share ownership information of certain persons known by the registrant to own greater than 5% of the outstanding common stock for purposes of the preceding calculation is based solely on information on Schedule 13G filed with the Commission and is as of December 31, 2003. This determination of affiliate status is not a conclusive determination for other purposes. As of August 31, 2004, there were 58,154,919 shares of the Registrant's common stock outstanding. =============================================================================== 1 DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive Proxy Statement for the Lantronix, Inc. Annual Meeting of Stockholders scheduled to be held on November 18, 2004 are incorporated by reference into Part II and Part III of this Form 10-K. Certain exhibits filed in connection with the Lantronix, Inc. Registration Statement on Form S-1, originally filed May 19, 2000, and Registration Statement on Form S-1, originally filed June 14, 2001, are incorporated by reference into Part IV of this Form 10-K. LANTRONIX, INC. ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED JUNE 30, 2004
TABLE OF CONTENTS Page ---- PART I ITEM 1. Business 4 ITEM 2. Properties 11 ITEM 3. Legal Proceedings 11 ITEM 4. Submission of Matters to a Vote of Security Holders 13 PART II ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters 14 ITEM 6. Selected Consolidated Financial Data 15 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 16 ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk 37 ITEM 8. Financial Statements and Supplementary Data 37 ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 37 ITEM 9A Controls and Procedures 37 PART III ITEM 10. Directors and Executive Officers of the Registrant 39 ITEM 11. Executive Compensation 39 ITEM 12. Security Ownership of Certain Beneficial Owners and Management 39 ITEM 13. Certain Relationships and Related Transactions 39 ITEM 14. Principal Accountant Fees and Services 39 PART IV ITEM 15. Exhibits, Financial Statements, Schedules and Reports on Form 8-K 40 Officer Certifications II-4
2 FORWARD-LOOKING STATEMENTS THIS DOCUMENT CONTAINS STATEMENTS THAT ARE NOT HISTORICAL FACTS BUT ARE FORWARD-LOOKING STATEMENTS RELATING TO SUCH MATTERS AS ANTICIPATED FINANCIAL PERFORMANCE, BUSINESS PROSPECTS, TECHNOLOGICAL DEVELOPMENTS, NEW PRODUCTS, ENGINEERING AND DEVELOPMENT ACTIVITIES AND SIMILAR MATTERS. SUCH STATEMENTS ARE GENERALLY IDENTIFIED BY THE USE OF FORWARD-LOOKING WORDS AND PHRASES, SUCH AS "INTENDED," "EXPECTS," "ANTICIPATES" AND "IS (OR ARE) EXPECTED (OR ANTICIPATED)." THESE FORWARD-LOOKING STATEMENTS INCLUDE BUT ARE NOT LIMITED TO STATEMENTS CONCERNING INDUSTRY TRENDS, ANTICIPATED DEMAND FOR OUR PRODUCTS, THE IMPACT OF PENDING LITIGATION, OUR STRATEGY, THE POSSIBILITY OF FUTURE INVESTMENTS OR ACQUISITIONS, FUTURE CUSTOMER AND SALES DEVELOPMENTS, MANUFACTURING FORECASTS, INCLUDING THE POTENTIAL BENEFITS OF OUR CONTRACT MANUFACTURERS SOURCING AND SUPPLYING RAW MATERIALS, COMPONENTS AND INTEGRATED CIRCUITS, THE POSSIBILITY OF AN EXPANDING ROLE FOR ORIGINAL EQUIPMENT MANUFACTURERS IN OUR BUSINESS, THE FUTURE COST AND POTENTIAL BENEFITS OF OUR RESEARCH AND DEVELOPMENT EFFORTS, AND LIQUIDITY AND CASH RESOURCES FORECASTS. ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE DISCUSSED IN SUCH FORWARD-LOOKING STATEMENTS, AND OUR STOCKHOLDERS SHOULD CAREFULLY REVIEW THE CAUTIONARY STATEMENTS SET FORTH IN THIS FORM 10-K, INCLUDING FACTORS THAT MAY AFFECT FUTURE RESULTS. WE MAY FROM TIME TO TIME MAKE ADDITIONAL WRITTEN AND ORAL FORWARD-LOOKING STATEMENTS, INCLUDING STATEMENTS CONTAINED IN OUR FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION AND IN OUR REPORTS TO STOCKHOLDERS. WE DO NOT UNDERTAKE TO UPDATE ANY FORWARD-LOOKING STATEMENTS THAT MAY BE MADE FROM TIME TO TIME BY US OR ON OUR BEHALF. 3 PART I ITEM 1. BUSINESS OVERVIEW Lantronix, Inc. ("Lantronix" or "we" or "us") designs, develops and markets devices and software solutions that make it possible to access, manage, control and configure almost any electronic product over the Internet or other networks. We are a leader in providing innovative networking solutions. We were initially formed as "Lantronix," a California corporation, in June 1989. We reincorporated as "Lantronix, Inc.," a Delaware corporation in May 2000. We have a history of providing devices that enable information technology ("IT") equipment to network using standard protocols for connectivity, including fiber optic, Ethernet and wireless. Our first device was a terminal server that allowed "dumb" terminals to connect to a network. Building on the success of our terminal servers, we introduced a complete line of print servers in 1991 that enabled users to inexpensively share printers over a network. Over the years, we have continually refined our core technology and have developed additional innovative networking solutions that expand upon the business of providing our customers network connectivity. With the expansion of networking and the Internet, our technology focus is increasingly broader, so that our device solutions provide a product manufacturer with the ability to network their products within the industrial, service and consumer markets. We provide three broad categories of products: "device networking solutions," that enable almost any electronic product to be connected to a network; "IT management solutions," that enable multiple pieces of hardware, usually IT-related network hardware such as servers, routers, switches, and similar pieces of equipment to be managed over a network; and "non-core" products and services that include visualization solutions, legacy print server's, software revenues, and other miscellaneous products. The expansion of our business in the future is directed at the first two of these categories, device networking and IT management solutions. Today, our solutions include fully integrated hardware and software devices, as well as software tools, to develop related customer applications. Because we deal with network connectivity, we provide hardware solutions to extremely broad market segments, including industrial, medical, commercial, financial, governmental, retail and building automation, and many more. Our technology is used to provide networking capabilities to products such as medical instruments, manufacturing equipment, bar code scanners, building HVAC systems, elevators, process control equipment, vending machines, thermostats, security cameras, temperature sensors, card readers, point of sale terminals, time clocks, and virtually any product that has some form of standard data control capability. Our current product offerings include a wide range of hardware devices of varying size, packaging and, where appropriate, software solutions that allow our customers to network-enable virtually any electronic product. We sell our devices through a global network of distributors, systems integrators, value-added resellers (VARs), manufacturers' representatives and original equipment manufacturers (OEMs). In addition, we sell directly to selected accounts. Our products are sold to distributors, OEMs, VARs, and systems integrators, as well as directly to end-users. One customer, Ingram Micro Inc., accounted for approximately 14%, 11% and 12% of our net revenues for the years ended June 30, 2004, 2003 and 2002, respectively. Another customer, Tech Data Corporation, accounted for approximately 9%, 10% and 11% of our net revenues for the years ended June 30, 2004, 2003 and 2002, respectively. Accounts receivable attributable to these two domestic customers accounted for approximately 13% and 16% of total accounts receivable at June 30, 2004 and 2003, respectively. Our common stock is currently traded on The Nasdaq SmallCap Market under the symbol LTRX. Our worldwide headquarters are located in Irvine, California and we have offices in Milford, Connecticut and worldwide, including; Germany; France; Hong Kong and Japan. We also have employees working from home offices in other areas of the world including the United Kingdom and Netherlands. During the first quarter of fiscal 2004, we closed our European administrative operations handled by our Switzerland office. Since September 2003, European operations have been managed from our Irvine, California facility. We provide information regarding our company and our products on our Internet web site, www.lantronix.com. OUR STRATEGY Our business strategy is based on our proven capability to develop fully integrated networking solutions that increase the value of our customers' products by making it easy to take advantage of features that can be made 4 available when these products are network-enabled. This strategy is accomplished by providing our customers with hardware and software that connects products and systems to a network, and intelligently manages and controls them. Through our 15 years of networking expertise, knowledge of industry trends, and our capability to develop solutions based on open industry standards, we have been able to anticipate our customers' networking technology requirements and offer solutions that enable them to achieve their connectivity objectives. By providing a complete solution of hardware and integrated software, we have been able to provide "turnkey" solutions, eliminating the need for our customers to build expensive design and manufacturing expertise in-house. This results in savings to the customer both in terms of financial investment and time. Our fully integrated hardware, software, and application development tools have enabled us to become a technology and industry leader. We focus on the following key areas: - - Device Networking Solutions - We offer an array of embedded and external device networking solutions that enable integrators and manufacturers of electronic and electro-mechanical products to add network connectivity, manageability, and control to their products. Our customers' products originate from a wide variety of applications, such as blood analyzers that relay critical patient information directly to a hospital's information system, to simple devices such as timeclocks or audio/visual equipment, to improve how these products are managed and controlled. - - IT Management Solutions - We offer off-the-shelf equipment that enables IT professionals to remotely manage network infrastructure equipment and large groups of servers. Our terminal and console management systems solutions provide a comprehensive solution for the remote command and control of today's network infrastructure. - - Non-core Businesses - Over the years, we have innovated or acquired various product lines that are no longer part of our primary, core markets described above. In general, this category of business represents decreasing markets and we minimize research and development in these product lines. Included in this category are visualization solutions, legacy print servers, software and other miscellaneous products. Our strategy is to drive the product development and revenues of our core areas, device networking solutions and IT management solutions. PRODUCTS DEVICE NETWORKING SOLUTIONS We provide manufacturers, integrators, and users with complete device networking solutions that include the technology required for products to be connected, managed and controlled over networks using standard protocols for connectivity, including fiber optic, Ethernet and wireless. As common, everyday products such as lighting, security and audio/visual systems leverage the power of network connectivity, manufacturers and users are realizing the benefits of networking. Our device networking solutions dramatically shorten a manufacturer's development time to implement network connectivity, provide competitive advantages with new features, and greatly reduce engineering and marketing risks. Our hardware solutions include embedded modules (completed boards or intelligent connectors with electronic components and the necessary connectors and software that is mounted within a customer's product), and external hardware modules (with single, multi- or wireless ports), as well as the related real-time operating system and application software that is required to make the devices effective. We also offer application- and industry-specific solutions such as industrial device servers. Our device servers allow a wide range of equipment to be quickly network-enabled without the need for intermediary gateways, workstations, or PCs. This distributed computing approach significantly improves reliability and up-time. Our device servers also eliminate the high cost of ownership associated with networking, which frequently would otherwise require using PCs and workstations to perform connectivity and remote management functions. Our device servers contain high-performance processors capable of not only controlling the attached device, but also of accumulating data and status. Such data can then be formatted by the device server and presented to users via the built in web server, SNMP, e-mail, etc. Device servers are easy to manage using any standard Web browser, due to a built-in HTTP server. In February 2003, we announced the release of our XPort device server, which represents a significant improvement in technology, and a reduction in physical size and price for this type of functionality. The thumb-sized XPort is a self-contained network communications server and miniaturized web site enclosed within a rugged RJ-45 connector package, which can be embedded in virtually any electronic product. Products incorporating XPort have their own address on the World Wide Web and can be accessed from any web browser, including a wireless PC or Internet-enabled cell phone, from anywhere in the world. The XPort can serve up Internet-standard web pages, initiate e-mails for notifications or alerts, and run other applications as defined by the product manufacturer. XPort eliminates the complexity for a product manufacturer to 5 create network connectivity, because the XPort device includes a complete, integrated solution with a 10/100 Base-T Ethernet connection, a reliable and proven operating system, an embedded web server, flexible firmware, a full TCP/IP protocol stack, and optional 256-bit standards-based (AES) encryption. We believe the relatively low price of the XPort, as well as the speed and ease with which a manufacturer can design the device into their products, will make a customer's products more attractive, by providing network connectivity. In March 2004, we introduced WiPort, a wireless (and wired) device server, with substantially the same functionality as XPort, but with an 802.11 wireless configuration, for embedded application to products and situations where a wired Ethernet environment is not available or practical. In August 2004, we introduced WiBox, an external wireless web server that is planned for transition to volume production in the second and third quarters of fiscal 2005. IT MANAGEMENT SOLUTIONS Our IT management solutions provide IT professionals with the tools they need to remotely manage computers and associated systems. IT professionals use our multiport device solutions (including our terminal and console servers) to monitor and run their systems to ensure the performance and availability of critical business information systems, network infrastructure, and telecommunications equipment. The equipment they manage includes routers, switches, servers, phone switches and public branch exchanges that are often located in remote or inaccessible locations. Our console servers provide system administrators and network managers a way to connect with their remote equipment through a universal interface called a console port, helping them work more efficiently without having to leave their desk or office. With remote access, system downtime, and its impact on business, is minimized. Our console servers provide IT professionals with peace-of-mind through extensive security features in some cases, and in some cases, provisions for dial-in access via modem. These solutions are provided in various configurations, and can manage up to 48 devices from one console server. NON-CORE BUSINESSES: VISUALIZATION SOLUTIONS, PRINT SERVERS AND OTHER LEGACY PRODUCTS We offer visualization solutions that provide switching and optical extension of high performance video, audio, keyboard and mouse over long distances within a building or campus environment. Products include FiberLynx video display extenders and keyboard, video, mouse ("KVM") switches, KVM extension systems, and matrix hubs. These products provide a valuable solution for extending and sharing audio, video, keyboard and mouse signals among many users and over large distances without loss of resolution. KVM products enable a single keyboard, monitor and mouse to be switched between multiple computers, providing immediate access and control from a single location. The customers for these devices are typically companies needing to isolate users from the core computing center for security reasons, or have other needs requiring high speed video sources to be shared among many users. Our visualization solutions can be found in government agencies and at customers involved with large scale simulation and display applications. We began our business by providing external print servers that connect various printers to a network for shared printing tasks. Over the years, we have updated and continue to provide print servers that work with a myriad of operating systems and network configurations. The requirement for external print servers is decreasing, as manufacturers have incorporated the networking hardware and software as part of many printers. We acquired a line of low-cost products which we market under the "Stallion" brand. Stallion products' range includes a variety of network servers and a range of multiport serial I/O cards. Various other small categories of our legacy business are included in this category, such as software revenues and other product lines we have discontinued or that are being de-emphasized. 6 The following are approximate revenues for these categories, the definitions of which have been modified slightly as of June 30, 2004, and previous years' data has been modified to conform to the new definitions:
NET REVENUES FOR THE YEARS ENDED JUNE 30, ----------------------------------------- PRODUCT FAMILY PRIMARY PRODUCT FUNCTION 2004 2003 2002 - --------------------------- ---------------------------------------- ----- ----- ----- Device networking solutions Enable almost any electronic product to $ 27.5 $ 24.5 $ 28.7 become network enabled. IT management solutions Allow the user to control equipment by way of $ 12.6 $ 13.1 $ 16.5 the Internet using a wide range of network protocols. This category includes console servers. Non-core products Includes visualization solutions, legacy print $ 8.8 $ 11.8 $ 12.4 servers, software and other miscellaneous products
Financial Accounting Standards Board ("FASB") Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information," establishes standards for disclosures about operating segments in annual consolidated financial statements. It also establishes standards for related disclosures about products and services, geographic areas and major customers. We operate in one segment, networking and Internet connectivity. CUSTOMERS Distributors Our principal customers are our distributors, who are the source of our highest percentage of net revenues. Distributors resell our products to a wide variety of customers including consumers, corporate customers, VARs, etc. We sell to a group of ten major distributors, who operate, in some cases, from multiple warehouses. Our major distributors in the U.S. include: Ingram Micro, Tech Data, KMJ Communications and Arrow Electronics, Inc. In Europe, we distribute directly from a public warehouse located in Belgium which serves, in part, the following major distributors: transtec AG (a related party due to common ownership by our largest shareholder), Sphinx Computer Vertriebs GmbH, Powercorp PTY, LTD, Jade Communications, LTD, Astradis Elecktronik GmbH, and Atlantik Systems GmbH. OEM Manufacturers We have established a broad range of OEM electro-mechanical manufacturing customers in various industries such as industrial automation, medical, security, building automation, consumer and audio/visual. Our OEM customers typically lack the expertise or resources to develop hardware and software required to introduce network solutions to their end-users in a timely manner. To shorten the development cycle to add network connectivity to a product, OEMs can use our external devices to network-enable their installed base of products, while board-level embedded modules are typically used in new product designs. Our capabilities and solutions enable OEMs to focus on their core competencies, resulting in reduced research and development costs, fewer integration problems, and faster time to market. Our module products, including Xport, are particularly useful and adaptable by OEM customers to enable network connectivity to a wide variety of electro-mechanical products. In addition to the features it provides, the advantage is low cost, and the fact that the device can be adapted for use in a wide range of products without the necessity for lengthy engineering processes by the OEM, or the time delays that activity might introduce. End-User Businesses We have established a broad range of end-user customers in various businesses such as airports, retail, universities/education, manufacturing, healthcare/hospitals and financial/banking. End-user businesses require 7 solutions that are simple to install, setup, and operate, and can provide immediate results. Generally, these customers have requirements to connect a diverse range of products and equipment, without modifying existing software and systems. Our external device solutions enable end-users to quickly, securely and easily connect their devices and equipment to networks, extending the life of existing investments. In support of these customers, we provide a number of programs including telephone-based sales and technical support as well as a wide array of Internet-based resources. In many cases, the customer simply has to call in to obtain assistance in identifying which networking device would be most appropriate for its need. After buying the devices from us or one of our distributors, a customer often only has to plug a cable from the device to be managed to our external device, and then plug our device into their network. SALES AND MARKETING We maintain both an inside and a field sales force. We are also represented by manufacturers' representatives, VARs and other resellers throughout the world who call on engineering design and product management teams. We develop marketing programs, products, tools and services specifically geared to meet the needs of our targeted customers. Our sales and marketing force consisted of 82 employees as of June 30, 2004 and 83 employees as of June 30, 2003. We believe that our multi-channel approach provides several advantages. We can engage the customers and end-users through their channel of choice, making our solution available from a variety of sources. Our device networking solutions are principally sold to manufacturers by our worldwide OEM sales force and through our group of manufacturers' representatives. We have continued to expand our use of manufacturers' representatives and other resellers, leveraging their established relationships to bring our device networking solutions to a greater number of customers within the OEM market. We market and sell our IT management solutions and select external device networking solutions through information technology resellers, industry-specific system integrators, VARs and directly to end-user organizations. Resellers and integrators will often obtain our products through distributors. These distributors supply our products to a broad range of VARs, system integrators, direct marketers, government resellers and e-commerce resellers. In turn, these distributor customers market, sell, install, and in most cases, support our solution to the end-users. We are continuing to expand our use of cost-effective, indirect channels. Net revenues generated from sales in the Americas, Europe and other geographic areas including Asia and Japan for the year ended June 30, 2004 were $33.8 million, $11.3 million and $3.8 million, respectively, compared to $37.4 million, $10.4 million and $1.6 million for the year ended June 30, 2003 and $47.7 million, $8.2 million and $1.7 million for the year ended June 30, 2002, respectively. Although the U.S. represents our largest geographic marketplace, approximately 31%, 24% and 17% for the years ended June 30, 2004, 2003 and 2002, respectively of our net sales came from sales to customers outside the U.S. Gross margin on sales of our products in foreign countries, and sales of product that include components obtained from foreign suppliers, can be adversely affected by international trade regulations, including tariffs and antidumping duties, and by fluctuations in foreign currency exchange rates. Information concerning our sales by geographic region can be found in Note 15 to the Audited Consolidated Financial Statements. MANUFACTURING Our manufacturing strategy is to produce reliable, high quality products at competitive prices and to achieve on-time delivery to our customers. To achieve this strategy, we generally contract with others for the manufacturing of our products. This practice enables us to concentrate our resources on design, engineering and marketing where we believe we have greater competitive advantages. We have agreements with multiple contract manufacturers. Our contract manufacturers are located in and around Irvine, Sacramento and Lake Forest, California; Dongguan, China; Tsao Tuen, Nan-to, Taiwan; and Penang, Malaysia. Under these agreements, the manufacturers source and supply most raw materials, components and integrated circuits in accordance with our pre-determined specifications and forecasts, and perform final assembly, functional testing and quality control. We believe that this arrangement decreases our working capital requirements and provides better raw material and component pricing, enhancing our gross and operating margins. Please see "Risk Factors" for a discussion of the risks associated with contract manufacturing. RESEARCH AND DEVELOPMENT Our research and development efforts are focused on the development of technology and products that will enhance our position in the markets we serve. Products are developed in-house and through outside research and development 8 resources. We employed 60 employees in our research and development organization as of June 30, 2004, and 47 employees as of June 30, 2003. Our research and development expenses were $7.8 million, $9.4 million and $8.7 million for the years ended June 30, 2004, 2003 and 2002, respectively. INDUSTRY PARTNERS In keeping with our business strategy, we have engaged a portfolio of partners, consortia, and standards committees in an effort to provide the most complete networking solutions to our customers. We are an active member of several leading professional and industry associations. Membership in these associations provides us with a voice in the development of future standards that are vital to our customers. SOFTWARE DEVELOPER RELATIONS Recruiting and informing third-party software developers is an integral part of our ongoing strategy. We encourage, enable, and support programmers to develop vertical applications using our hardware, firmware and software products. With their help and investment in creating additional applications and markets for our products, we secure a defensible market position and loyal customers in the process. COMPETITION The markets in which we compete are dynamic and highly competitive. We expect competition to intensify in the future. Our current and potential competitors include the following: - - companies with network-enabling technologies, such as Avocent, Echelon, Moxa, Digi International, Cyclades, Quatech, Wind River, Rabbit, MRV (formerly known as iTouch), Rose Electronics, Raritan, Equinox and Zilog; - - companies with equipment for IT management solutions, such as Cyclades, Moxa, Digi International, Sena, Logical Solutions, Cisco, MRV, DPAC Technologies and Perle; and - - companies with significant networking expertise and research and development resources, including Cisco Systems, IBM and Lucent Technologies. The principal competitive factors that affect the market for our products are: - - product quality, technological innovation, compatibility with standards and protocols, reliability, functionality, ease of use, and compatibility; - - prices of the products; and - - potential customers' awareness and perception of our products and of network-enabling technologies. Much of our technology can be reproduced by our competitors without royalties or license fees and could compete with our offerings. In addition, there is a risk that our customers or new entrants to the market could develop and market their own solutions without paying a fee to us. INTELLECTUAL PROPERTY RIGHTS We have developed proprietary methodologies, tools, processes and software in connection with delivering our services. We have not historically relied on patents to protect our proprietary rights, although we have recently begun to build a patent portfolio. We have historically relied on a combination of copyright, trademark, trade secret laws, and contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our proprietary rights. Trade secret and copyright laws afford us only limited protection. We cannot be certain that the steps we have taken in this regard will be adequate to deter misappropriation of our proprietary information or that we will be able to detect unauthorized use and take appropriate steps to enforce our intellectual property rights. An adverse change in the laws protecting intellectual property could harm our business. In addition, we believe that our success will depend principally upon continuing innovation, technical expertise, knowledge of networking, storage and applications, and to a lesser extent, on our ability to protect our proprietary technology. Furthermore, there can be no 9 assurance that our current or future competitors will not develop technologies that are substantially equivalent to ours. LIMITATIONS ON OUR RIGHTS TO INTELLECTUAL PROPERTY Gordian, Inc. ("Gordian") developed certain intellectual property used in our micro serial server line of products. These products represented and continue to represent a significant portion of our net revenues. Under the terms of an agreement dated February 29, 1989, Gordian owned the rights to the intellectual property developed under the agreement and required us to pay royalties based upon gross margin of products sold under the agreement. For the year ended June 30, 2002, we paid Gordian approximately $1.2 million for royalties. No royalties were paid to Gordian for the years ended June 30, 2004 and 2003 as a result of a new Gordian agreement as described below. Our agreement with Gordian was to terminate at the end of the sales life of the products. On May 30, 2002, we signed a new intellectual property agreement with Gordian. The new agreement gives us joint ownership of the Gordian intellectual property that is embodied in the products Gordian has designed for us since 1989. This new agreement provides that we will be able to use the intellectual property to support, maintain and enhance our products. This new agreement extinguishes our obligations to pay royalties for each unit of a Gordian-designed product that we sell as of the effective date. As part of the new agreement, we paid Gordian $6.0 million in three installments. We paid $3.0 million concurrent with the signing of the new agreement, $2.0 million on July 1, 2002, and we made the third and final payment of $1.0 million on July 1, 2003. We also agreed to purchase $1.5 million of engineering and support services from Gordian over the 18-month period that ended November 2003. We are amortizing the intellectual property rights acquired by this new agreement over the remaining life cycles of our products designed by Gordian, or approximately three years. We recorded $1.8 million, $2.5 million and $212,000 of amortization expense in cost of revenues for the years ended June 30, 2004, 2003 and 2002, respectively. UNITED STATES AND FOREIGN GOVERNMENT REGULATION Many of our products and the industries in which they are used are subject to federal, state or local regulation in the United States. In addition, our products are exported worldwide. Therefore, we are subject to the regulation of foreign governments. For example, wireless communication is highly regulated in both the United States and elsewhere. Our products currently employ encryption technology; the export of some encryption software is restricted. At this time our activities comply with existing laws, but we cannot determine whether future, more restrictive laws, if enacted, would adversely affect us. Information regarding risks attendant to our foreign operations is set forth in Part I, Item 7 under the heading "Risk Factors" of this Annual Report on Form 10-K. EMPLOYEES As of June 30, 2004, we had 198 full-time employees consisting of 60 employees in research and development, 82 in sales and marketing departments, 21 in operations departments, and 35 general and administrative employees. We have not experienced any work stoppages and we believe that our relationship with our employees is good. None of our employees are currently represented by a labor union. BACKLOG Normally, we manufacture our products in advance of receiving firm product orders from our customers based upon our forecasts of worldwide customer demand. Most customer orders are placed on an as-needed basis and may be canceled or rescheduled by the customer without significant penalty. Accordingly, backlog as of any particular date is not necessarily indicative of our future sales. Because most of our business is on an as-needed basis and varies slightly, only because of short-term customer requests, we do not track backlog as a metric of our operations. We have no customer orders extending more than several months into the future. AVAILABILITY OF THIS REPORT Our annual report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed or furnished pursuant to Section 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our web site at www.lantronix.com shortly after we ----------------- electronically file such material with the SEC. The public may read and copy any materials we file with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling 1-800-SEC-0330. The SEC also maintains a web site at www.sec.gov that contains reports, proxy, and ----------- information statements, and other information regarding issues that file electronically. We assume no obligation to update or revise forward looking statement in this annual report, whether as a result of new information, future events or otherwise, unless we are required to do so by law. 10 EXECUTIVE OFFICERS OF THE REGISTRANT The following table lists the names, ages and positions held by all our executive officers as of August 31, 2004. There are no family relationships between any director or executive officer and any other director or executive officer of Lantronix. Executive officers serve at the discretion of the Board of Directors. NAME AGE POSITION - ------------------------ --- -------- Marc Nussbaum 48 President and Chief Executive Officer James Kerrigan 68 Chief Financial Officer Katherine McDermott 44 Vice President of Finance and Secretary MARC NUSSBAUM has served as our President and Chief Executive Officer since May 2002 (on an Interim basis until February 2003). From April 2000 to March 2002, Mr. Nussbaum served as Senior Vice President and Chief Technical Officer for MTI Technology Corporation, a developer of enterprise storage solutions. From April 1981 to November 1998, Mr. Nussbaum served in various positions at Western Digital Corporation, a manufacturer of PC components, communication controllers, storage controllers and hard drives. Mr. Nussbaum lead business development, strategic planning and product development activities, serving as Western Digital's Senior Vice President, Chief Technical Officer from 1995 to 1998 and Vice President, Storage Technology and Product Development from 1988 through 1995. Mr. Nussbaum holds a BA degree in physics from the State University of New York. JAMES KERRIGAN has served as our Chief Financial Officer since May 2002 (on an Interim basis until February 2003). From March 2000 to October 2000, he was Chief Financial Officer of Motiva, a privately-owned company that developed, marketed and sold collaboration software systems. From January 1998 to February 1999, he was Chief Financial Officer of Who?Vision Systems, Inc., an incubator company that developed biometric fingerprint devices and software. From April 1995 to March 1997, Mr. Kerrigan was Chief Financial Officer of Artios, Inc., a privately-owned company that designs, manufactures, and sells prototyping hardware and software to the packaging industry. Previously, Mr. Kerrigan has served as chief financial officer for other larger, public companies. He has a BS degree in engineering and a MBA degree from Northwestern University. KATHERINE MCDERMOTT has served as our Vice President of Finance since March 2001 and our Secretary since August 2004. Ms. McDermott joined Lantronix in March 2000 as Corporate Controller. From 1988 through 1999, Ms. McDermott served in a number of senior level finance positions with Bausch & Lomb, Inc., a global health care company. Her most recent positions included Corporate Audit Manager, Plant Controller, and Controller of a wholly owned subsidiary. From 1982 to 1988, Ms. McDermott held various financial positions at a division of General Motors. Ms. McDermott holds a BBA degree in Business Administration from St. Bonaventure University in New York, where she graduated cum laude. She also earned a MBA degree, with a concentration in Finance and Economics, from the Simon School of Business Administration at the University of Rochester. ITEM 2. PROPERTIES We lease a building in Irvine, California that comprises our corporate headquarters and includes administration, sales, marketing, research and development, warehouse and order fulfillment functions. We have smaller sales offices in Milford, Connecticut; Germany; France; Hong Kong and Japan. The foregoing leases comprise an aggregate of approximately 60,000 square feet of which our Irvine facility represents the majority of our square footage. Our Irvine facility has a lease term expiring in July 2005. During the year ended June 30, 2004, we completed facility and organizational restructuring activities that we began in fiscal 2003. In September 2003, we ceased operational activities in Cham, Switzerland, the headquarters of Lantronix International AG, which is our wholly owned subsidiary; now, we support international sales and shipping from our Irvine, California headquarters. In March 2004, we sold our Premise software unit and closed our Redmond, Washington facility. We continue to make payments on our lease obligations for facilities we no longer occupy including our facilities located in Naperville, Illinois, Redmond Washington, Hillsboro, Oregon and Ames, Iowa. The liability for these lease obligations are included in our restructuring reserve at June 30, 2004. ITEM 3. LEGAL PROCEEDINGS Government Investigation The SEC is conducting a formal investigation of the events leading up to our restatement of our financial statements on June 25, 2002. The Department of Justice is also conducting an investigation concerning events related to the restatement. 11 Class Action Lawsuits On May 15, 2002, Stephen Bachman filed a class action complaint entitled Bachman v. Lantronix, Inc., et al., No. 02-3899, in the U.S. District Court for the Central District of California against us and certain of our current directors and former officers alleging violations of the Securities Exchange Act of 1934 and seeking unspecified damages. Subsequently, six similar actions were filed in the same court. Each of the complaints purports to be a class action lawsuit brought on behalf of persons who purchased or otherwise acquired our common stock during the period of April 25, 2001 through May 30, 2002, inclusive. The complaints allege that the defendants caused us to improperly recognize revenue and make false and misleading statements about our business. Plaintiffs further allege that the defendants materially overstated our reported financial results, thereby inflating our stock price during our securities offering in July 2001, as well as facilitating the use of our common stock as consideration in acquisitions. The complaints have subsequently been consolidated into a single action and the court has appointed a lead plaintiff. The lead plaintiff filed a consolidated amended complaint on January 17, 2003. The amended complaint now purports to be a class action brought on behalf of persons who purchased or otherwise acquired our common stock during the period of August 4, 2000 through May 30, 2002, inclusive. The amended complaint continued to assert that we and the individual officer and director defendants violated the 1934 Act, and also includes alleged claims that we and our officers and directors violated the Securities Act of 1933 arising from our Initial Public Offering in August 2000. We filed a motion to dismiss the additional allegations on March 3, 2003. The Court granted the motion, with leave to amend, on December 31, 2003. Plaintiffs filed their second amended complaint February 6, 2004, and we filed a motion to dismiss the additional allegations in the second amended complaint on March 10, 2004. On August 19, 2004, the Court granted in part and denied in part the motion to dismiss. On September 13, 2004, plaintiffs filed their third amended complaint. We have not yet answered the third amended complaint and discovery has not yet commenced. Derivative Lawsuit On July 26, 2002, Samuel Ivy filed a shareholder derivative complaint entitled Ivy v. Bernhard Bruscha, et al., No. 02CC00209, in the Superior Court of the State of California, County of Orange, against certain of our current directors and former officers. On January 7, 2003, the plaintiff filed an amended complaint. The amended complaint alleges causes of action for breach of fiduciary duty, abuse of control, gross mismanagement, unjust enrichment, and improper insider stock sales. The complaint seeks unspecified damages against the individual defendants on our behalf, equitable relief, and attorneys' fees. We filed a demurrer/motion to dismiss the amended complaint on February 13, 2003. The basis of the demurrer is that the plaintiff does not have standing to bring this lawsuit since plaintiff has never served a demand on our Board that the Board take certain actions on our behalf. On April 17, 2003, the Court overruled our demurrer. All defendants have answered the complaint and generally denied the allegations. Discovery has commenced, but no trial date has been established. Employment Suit Brought by Former Chief Financial Officer and Chief Operating Officer Steven Cotton On September 6, 2002, Steven Cotton, our former CFO and COO, filed a complaint entitled Cotton v. Lantronix, Inc., et al., No. 02CC14308, in the Superior Court of the State of California, County of Orange. The complaint alleges claims for breach of contract, breach of the covenant of good faith and fair dealing, wrongful termination, misrepresentation, and defamation. The complaint seeks unspecified damages, declaratory relief, attorneys' fees and costs. We filed a motion to dismiss on October 16, 2002, on the grounds that Mr. Cotton's complaints are subject to the binding arbitration provisions in Mr. Cotton's employment agreement. On January 13, 2003, the Court ruled that five of the six counts in Mr. Cotton's complaint are subject to binding arbitration. The court is staying the sixth count, for declaratory relief, until the underlying facts are resolved in arbitration. No arbitration date has been set. Securities Claims Brought by Former Shareholders of Synergetic Micro Systems, Inc. ("Synergetic") On October 17, 2002, Richard Goldstein and several other former shareholders of Synergetic filed a complaint entitled Goldstein, et al v. Lantronix, Inc., et al in the Superior Court of the State of California, County of Orange, against us and certain of our former officers and directors. Plaintiffs filed an amended complaint on January 7, 2003. The amended complaint alleges fraud, negligent misrepresentation, breach of warranties and covenants, breach of contract and negligence, all stemming from our acquisition of Synergetic. The complaint seeks an unspecified amount of damages, interest, attorneys' fees, costs, expenses, and an unspecified amount of punitive damages. On May 5, 2003, we answered the complaint and generally denied the allegations in the complaint. Discovery has commenced but no trial date has been established. 12 Patent Infringement Litigation On August 10, 2004, Digi International served a complaint on us alleging that certain of our products infringe Digi's U.S. Patent No. 6,446,192. Digi filed the complaint in the U.S. District Court in Minnesota. The complaint seeks both monetary and non-monetary relief. We are still analyzing all of the allegations of the complaint. On August 30, 2004, we served and filed an answer and counterclaim seeking to invalidate U.S. Patent No. 6,446,192 for failure to meet the applicable statutory requirements in Part II of Title 35 of the United States Code including, without limitation, 35 U.S.C. Sec. 102, 103 and 112, as conditions for patentability. The counterclaim seeks both monetary and non-monetary relief. We filed, on May 3, 2004, a complaint against Digi, alleging that certain of Digi's products infringe on our U.S. Patent No. 6,571,305, in the U.S. District Court for the Central District of California. The complaint seeks both monetary and non-monetary relief from Digi's infringement. Digi has filed an answer and counterclaim alleging invalidity of the patent. The Counterclaim seeks both monetary and non-monetary relief. Other From time to time, we are subject to other legal proceedings and claims in the ordinary course of business. We are currently not aware of any such legal proceedings or claims that we believe will have, individually or in the aggregate, a material adverse effect on our business, prospects, financial position, operating results or cash flows. The pending lawsuits involve complex questions of fact and law and likely will continue to require the expenditure of significant funds and the diversion of other resources to defend. Management is unable to determine the outcome of its outstanding legal proceedings, claims and litigation involving us, our subsidiaries, directors and former officers and cannot determine the extent to which these results may have a material adverse effect on our business, results of operations and financial condition taken as a whole. The results of litigation are inherently uncertain, and adverse outcomes are possible. We are unable to estimate the range of possible loss from outstanding litigation, and no amounts have been provided for such matters in the consolidated financial statements. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of our security holders during the fourth quarter of fiscal year ended June 30, 2004. 13 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS PRICE RANGE OF COMMON STOCK Our common stock was traded on The Nasdaq National Market under the symbol "LTRX" from our initial public offering on August 4, 2000 through October 22, 2002. On October 23, 2002 our listing was changed to The Nasdaq SmallCap Market. The number of holders of record of our common stock as of August 31, 2004 was approximately 97. The following table sets forth, for the period indicated, the high and low per share closing prices for our common stock: FISCAL YEAR 2003 HIGH LOW - ------------------ ---- --- First Quarter $1.03 $0.38 Second Quarter 0.92 0.36 Third Quarter 1.08 0.67 Fourth Quarter 0.91 0.49 FISCAL YEAR 2004 HIGH LOW - ------------------ ---- --- First Quarter $1.41 $0.78 Second Quarter 1.32 0.89 Third Quarter 1.86 1.06 Fourth Quarter 2.09 1.18 We believe that a number of factors, including but not limited to quarterly fluctuations in results of operations, may cause the market price of our common stock to fluctuate significantly. See "Management's Discussion and Analysis-Risk Factors." DIVIDEND POLICY We have never declared or paid cash dividends on our common stock. We do not anticipate paying any cash dividends on our common stock in the foreseeable future, and we intend to retain any future earnings for use in the expansion of our business and for general corporate purposes. Pursuant to a line of credit we entered into in January 2002 and have amended on several occasions including July 24, 2004, we are restricted from paying any dividends. EQUITY COMPENSATION PLANS The information required by this item regarding equity compensation plans is incorporated by reference to the information set forth in Item 12 of this Annual Report on Form 10-K. Item 12 of this Annual Report on Form 10-K incorporates by reference the information contained in the sections captioned "Election of Directors" and "Security Ownership of Certain Beneficial Owners and Management" in Lantronix's definitive Proxy Statement for the Annual Meeting of Stockholders to be held November 18, 2004 (the Proxy Statement), a copy of which will be filed with the Securities and Exchange Commission before the meeting date. RECENT SALES OF UNREGISTERED SECURITIES We have not issued unregistered securities since July 1, 2003. Also, we have not repurchased any of our common stock during the fourth quarter of fiscal 2004. 14 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included below. In March 2004, we completed the sale of our Premise business unit that was originally purchased in January 2002. Accordingly, the information set forth in the table below reflects the Premise business unit as a discontinued operation. The consolidated statements of operations data for the years ended June 30, 2004, 2003 and 2002 and the balance sheet data as of June 30, 2004 and 2003, are derived from the audited consolidated financial statements included elsewhere in this report. The consolidated statements of operations data for the years ended June 30, 2001 and 2000, and the balance sheet data as of June 30, 2002, 2001 and 2000, are derived from the audited consolidated financial statements not included elsewhere in this report. The historical results are not necessarily indicative of results to be expected for future periods.
YEARS ENDED JUNE 30, ---------------------------------------------------- 2004 2003 2002 2001 2000 --------- --------- --------- --------- -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENTS OF OPERATIONS DATA: Net revenues $ 48,885 $ 49,389 $ 57,591 $ 48,972 $44,975 Cost of revenues 25,026 36,264 40,281 24,530 21,526 --------- --------- --------- --------- -------- Gross profit 23,859 13,125 17,310 24,442 23,449 --------- --------- --------- --------- -------- Operating expenses: Selling, general and administrative 23,293 28,660 40,538 23,998 16,744 Research and development 7,813 9,430 8,680 4,478 3,186 Stock-based compensation 347 1,453 2,863 3,019 1,093 Amortization of goodwill and purchased intangible assets 148 602 960 1,490 813 Impairment of goodwill and purchased intangible assets - 2,353 50,445 - - Restructuring (recovery) charges (2,093) 5,600 3,473 - - Litigation settlement costs - 1,533 1,912 - - In-process research and development - - - 2,596 - --------- --------- --------- --------- -------- Total operating expenses 29,508 49,631 108,871 35,581 21,826 --------- --------- --------- --------- -------- Income (loss) from operations (5,649) (36,506) (91,561) (11,139) 1,613 Minority interest - - - - (49) Interest income (expense), net 50 248 1,548 2,182 187 Other income (expense), net (5,333) (926) (760) (167) (47) --------- --------- --------- --------- -------- Income (loss) before income taxes and cumulative effect of accounting changes (10,932) (37,184) (90,773) (9,124) 1,704 Provision (benefit) for income taxes (325) 250 (6,665) (1,876) 649 --------- --------- --------- --------- -------- Income (loss) from continuing operations before cumulative effect of accounting changes (10,607) (37,434) (84,108) (7,248) 1,055 Loss from discontinued operations (5,047) (10,115) (3,444) - - --------- --------- --------- --------- -------- Income (loss) before cumulative effect of accounting changes (15,654) (47,549) (87,552) (7,248) 1,055 Cumulative effect of accounting changes: Change in revenue recognition policy, net of income tax benefit of $176 - - - (597) - Adoption of new accounting standard, SFAS No. 142 - - (5,905) - - --------- --------- --------- --------- -------- Net income (loss) $(15,654) $(47,549) $(93,457) $ (7,845) $ 1,055 ========= ========= ========= ========= ======== Basic income (loss) per share from continuing operations before Cumulative effect of accounting changes $ (0.19) $ (0.69) $ (1.63) $ (0.19) $ 0.04 Loss from discontinued operations (0.09) (0.19) (0.07) - - --------- --------- --------- --------- -------- Income (loss) before cumulative effect of accounting changes (0.28) (0.88) (1.70) (0.19) 0.04 Cumulative effect of accounting changes per share: Change in revenue recognition policy, net of income tax benefit of $176 - - - (0.02) - Adoption of new accounting standard, SFAS No. 142 - - (0.12) - - --------- --------- --------- --------- -------- Basic net income (loss) per share $ (0.28) $ (0.88) $ (1.82) $ (0.21) $ 0.04 ========= ========= ========= ========= ======== Diluted income (loss) per share from continuing operations before cumulative effect of accounting changes $ (0.19) $ (0.69) $ (1.63) $ (0.19) $ 0.03 Loss from discontinued operations (0.09) (0.19) (0.07) - - --------- --------- --------- --------- -------- Income (loss) before cumulative effect of accounting changes (0.28) (0.88) (1.70) (0.19) 0.03 Cumulative effect of accounting changes per share: Change in revenue recognition policy, net of income tax benefit of $176 - - - (0.02) - Adoption of new accounting standard, SFAS No. 142 - - (0.12) - - --------- --------- --------- --------- -------- Diluted net income (loss) per share $ (0.28) $ (0.88) $ (1.82) $ (0.21) $ 0.03 ========= ========= ========= ========= ======== Weighted average shares (basic) 56,862 54,329 51,403 36,946 29,274 ========= ========= ========= ========= ======== Weighted average shares (diluted) 56,862 54,329 51,403 36,946 34,178 ========= ========= ========= ========= ========
15
AS OF JUNE 30, -------------- 2004 2003 2002 2001 2000 ---------- ---------- --------- -------- ------- CONSOLIDATED BALANCE SHEET DATA: Cash and cash equivalents $ 9,128 $ 7,328 $ 26,491 $ 15,367 $ 1,988 Marketable securities 3,050 6,750 6,963 1,973 - Working capital 12,087 17,312 39,164 36,963 11,042 Goodwill, net 9,488 9,488 7,218 42,273 - Purchased intangible assets, net 2,056 4,275 11,891 13,328 586 Total assets 37,250 54,947 103,812 116,861 20,210 Retained earnings (accumulated deficit) (156,078) (140,424) (92,875) 582 8,427 Total stockholders' equity 24,791 37,717 82,157 99,496 12,547
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this report. In addition to historical information, the discussion in this report contains forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those anticipated by these forward-looking statements due to factors including, but not limited to, those factors set forth under "Risk Factors" and elsewhere in this report. OVERVIEW Lantronix designs, develops and markets products and software solutions that make it possible to access, manage, control and configure almost any electronic device over the Internet or other networks. We are a leader in providing innovative networking solutions. We were initially formed as "Lantronix," a California corporation, in June 1989. We reincorporated as "Lantronix, Inc.," a Delaware corporation in May 2000. Our products are sold to distributors, OEMs, VARs, and systems integrators, as well as directly to end-users. One customer, Ingram Micro Inc., accounted for approximately 14%, 11% and 12% of our net revenues for the years ended June 30, 2004, 2003 and 2002, respectively. Another customer, Tech Data Corporation, accounted for approximately 9%, 10% and 11% of our net revenues for the years ended June 30, 2004, 2003 and 2002, respectively. Accounts receivable attributable to these two domestic customers accounted for approximately 13% and 16% of total accounts receivable at June 30, 2004 and 2003, respectively. One international customer, transtec AG, which is a related party due to common ownership by our largest stockholder and former Chairman of our Board of Directors, Bernhard Bruscha, accounted for approximately 3%, 4% and 5% of our net revenues for the years ended June 30, 2004, 2003 and 2002, respectively. We also had an agreement with transtec AG for the provision of technical support services at the rate of $7,500 per month which has now been terminated. Included in selling, general and administrative expenses is $90,000 for the year ended June 30, 2002 for these support services. No support services were incurred for the years ended June 30, 2004 and 2003. We have completed a number of acquisitions and investments the purpose of which was to expand our product offerings, increase our technology base and provide a foundation for future growth. In October 2001, we completed the acquisition of Synergetic Micro Systems, Inc. ("Synergetic"), a provider of high performance embedded network communication solutions that complement our external device products. In connection with the acquisition, we paid cash consideration of $2.7 million and issued an aggregate of 2,234,715 shares of our common stock in exchange for all outstanding shares of Synergetic common stock and reserved 615,705 additional shares of common stock for issuance upon exercise of outstanding employee stock options and other rights of Synergetic. In January 2002, we completed the acquisition of Premise, a developer of client-side software applications that complement our device networking products by providing superior management and control capabilities for devices that have been network and internet enabled. Prior to the acquisition, we held shares of Premise representing 19.9% ownership and, in addition, held convertible promissory notes of $1.2 million with interest accrued there-on at the rate of 9.0%. The convertible promissory notes were converted into equity securities of Premise at the closing of the transaction. We issued an aggregate of 1,063,371 shares of our common stock in exchange for all remaining outstanding shares of Premise common stock and reserved 875,000 additional shares of common stock for issuance upon exercise of outstanding employee stock options and other rights of Premise. In connection with the acquisition, we recorded a one-time charge for purchased in-process research and development ("IPR&D") expenses of $1.0 million in our fourth fiscal quarter ended June 30, 2002. In January 2003, we issued an 16 additional 1,063,372 shares of our common stock to the former shareholders of Premise stock in exchange for a release of all claims relating to the acquisition. We also accelerated the vesting of options held by certain former Premise shareholders and released all shares that had been held in the acquisition escrow. See "Discontinued Operations" section below. In August 2002, we completed the acquisition of Stallion, a provider of terminal servers and multiport products. In connection with the acquisition, we paid $1.2 million in cash consideration, of which $200,000 was paid upon the execution of the Letter of Intent dated May 9, 2002, and established a cash escrow account in the amount of $867,000 at the acquisition date to be used in lieu of our common stock, in the event that we were unable to issue registered shares by October 31, 2002. In accordance with the terms of the agreement, we were not able to issue registered shares by October 31, 2002; accordingly, the cash escrow amount of $867,000 was released on November 1, 2002. In addition, we issued two-year notes in the principal amount of $867,000 accruing interest at a rate of 2.5% per annum. The notes were paid to the holders in August 2004. In September and October 2001, we made a strategic investment in Xanboo, a privately-held company that develops technology that allows users to control, command and view their home or business remotely over the Internet. We paid an aggregate of $3.0 million for convertible promissory notes, which converted in January 2002, in accordance with their terms, into Xanboo preferred stock. In addition, we purchased $4.0 million of Xanboo preferred stock in January 2002. Our ownership interest in Xanboo was 14.9%, 15.3% and 15.8% at June 30, 2004, 2003 and 2002, respectively. Our investment in Xanboo is accounted for using the equity method of accounting based on our ability through representation on Xanboo's board of directors to exercise significant influence over its operations. Our losses in Xanboo aggregating $413,000, $1.3 million and $526,000 for the years ended June 30, 2004, 2003 and 2002, respectively, have been recognized as other expense in the accompanying consolidated statement of operations. We periodically review our investments for which fair value is less than cost to determine if the decline in value is other than temporary. If the decline in value is judged to be other than temporary, the cost basis of the security is written down to fair value. We generally believe an other-than-temporary decline has occurred when the fair value of the investment is below the carrying value for two consecutive quarters, absent evidence to the contrary. On the basis of events occurring during the quarter ended June 30, 2004, we performed an analysis and recorded a charge in the amount of $5.0 million, representing a write-off of all remaining value of this non-marketable equity security. This charge is included within the consolidated statements of operations as other expense. Discontinued operations In August 2001, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). SFAS No. 144 supersedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of;" however, it retains the fundamental provisions of that statement related to the recognition and measurement of the impairment of long-lived assets to be "held and used." SFAS No. 144 also supersedes the accounting and reporting provisions of Accounting Principles Board ("APB") Opinion No. 30, "Reporting the Results of Operation's - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions", for the disposal of a segment of a business. Under SFAS No. 144, a component of a business that is held for sale is reported in discontinued operations if (i) the operations and cash flows will be, or have been, eliminated from the ongoing operations of the company and, (ii) the company will not have any significant continuing involvement in such operations. In March 2004, we sold substantially all of the net assets of our Premise business unit for $1.0 million. Additionally, we incurred $383,000 of disposal costs. Impairment of goodwill and purchased intangible assets related to discontinued operations During the second quarter of fiscal 2004, we identified indicators of an other than temporary impairment as it related to our Premise acquisition of goodwill and purchased intangible assets. We performed an assessment of the value of our goodwill and purchased intangible assets in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. 144. We identified certain conditions including continued losses and the inability to achieve significant revenue from the existing home automation and media management software markets as indicators of asset impairment. These conditions led to operating results and forecasted future results that were substantially less than had been anticipated. We revised our projections and determined that the projected results utilizing a discounted cash flow valuation technique would not fully support the carrying values of the goodwill and purchased intangible assets associated with the Premise acquisition. Based on this assessment, we recorded an impairment charge of $2.2 million during the second quarter of fiscal 2004 to write-off the value of the Premise goodwill. Additionally, during the second quarter of fiscal 2004, we recorded a $790,000 impairment charge of the Premise purchased intangible assets of which $14,000 and $776,000 were charged to operating expenses and cost of revenues, respectively. As a result of the sale of the Premise business unit, the goodwill and purchased intangibles, net of Premise at June 30, 2003 have been included as part of discontinued operations. 17 During the third quarter of fiscal 2004, we sold the assets related to our Premise business unit to an undisclosed buyer for $1.0 million cash. After paying all related transaction fees, resolving our lease commitments, and paying other restructuring costs related to the transaction, the transaction had a then-favorable impact on our cash balance of approximately $250,000. For the years ended June 30, 2004, 2003 and 2002, the impact of the Premise business unit resulted in a $5.0 million, $10.1 million and $3.4 million loss, respectively, recorded as discontinued operations in our consolidated statement of operations. The loss from discontinued operations for the year ended June 30, 2004 of $5.0 million includes a negative gross profit of $822,000, primarily due to the $776,000 purchased intangible asset impairment charge, $2.0 million of operating expenses, $590,000 of restructuring charges, a $2.3 million impairment charge of Premise goodwill charged to operating expenses, and a gain on the sale of Premise of $592,000. The loss from discontinued operations for the year ended June 30, 2003 of $10.1 million includes a negative gross profit of $1.2 million primarily due to the $846,000 purchased intangible asset impairment charge, $3.4 million of operating expenses, $111,000 of restructuring charges, a $4.4 million impairment charge of Premise goodwill, and a $1.1 million legal settlement with the former shareholders of Premise. The loss from discontinued operations for the year ended June 30, 2002 of $3.4 million includes a negative gross profit of $174,000, $1.9 million of operating expenses, $383,000 impairment charge of Premise purchased intangible assets charged to operating expenses, and a $1.0 million IPR&D charge as a result of the Premise acquisition. Critical Accounting Policies and Estimates The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenues and expenses during the reporting period. We regularly evaluate our estimates and assumptions related to net revenues, allowances for doubtful accounts, sales returns and allowances, inventory reserves, goodwill and purchased intangible asset valuations, warranty reserves, restructuring costs, litigation and other contingencies. We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected. We believe the following critical accounting policies require us to make significant judgments and estimates in the preparation of our consolidated financial statements: Revenue Recognition We do not recognize revenue until all of the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; our price to the buyer is fixed or determinable; and collectibility is reasonably assured. Commencing July 1, 2000, we adopted a new accounting policy for revenue recognition such that recognition of revenue and related gross profit from sales to distributors are deferred until the distributor resells the product. Net revenue from certain smaller distributors for which point-of-sale information is not available, is recognized one month after the shipment date. This estimate approximates the timing of the sale of the product by the distributor to the end-user. When product sales revenue is recognized, we establish an estimated allowance for future product returns based on historical returns experience; when price reductions are approved, we establish an estimated liability for price protection payable on inventories owned by product resellers. Should actual product returns or pricing adjustments exceed our estimates, additional reductions to revenues would result. Revenue from the licensing of software is recognized at the time of shipment (or at the time of resale in the case of software products sold through distributors), provided we have vendor-specific objective evidence of the fair value of each element of the software offering and collectibility is probable. Revenue from post-contract customer support and any other future deliverables is deferred and recognized over the support period or as contract elements are delivered. Our products typically carry a ninety day to two year warranty. Although we engage in extensive product quality programs and processes, our warranty obligation is affected by product failure rates, use of materials or service delivery costs that differ from our estimates. As a result, additional warranty reserves could be required, which could reduce gross margins. Additionally, we sell extended warranty services which extend the warranty period for an additional one to three years. Warranty revenue is recognized evenly over the warranty service period. 18 Allowance for Doubtful Accounts We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Our allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts, the aging of accounts receivable, our history of bad debts and the general condition of the industry. If a major customer's credit worthiness deteriorates, or our customers' actual defaults exceed our historical experience, our estimates could change and impact our reported results. We also maintain a reserve for uncertainties relative to the collection of officer notes receivable. Factors considered in determining the level of this reserve include the value of the collateral securing the notes, our ability to effectively enforce collection rights and the ability of the former officers to honor their obligations. Inventory Valuation Our policy is to value inventories at the lower of cost or market on a part-by-part basis. This policy requires us to make estimates regarding the market value of our inventories, including an assessment of excess and obsolete inventories. We determine excess and obsolete inventories based on an estimate of the future sales demand for our products within a specified time horizon, generally three to twelve months. The estimates we use for demand are also used for near-term capacity planning and inventory purchasing and are consistent with our revenue forecasts. In addition, specific reserves are recorded to cover risks in the area of end of life products, inventory located at our contract manufacturers, deferred inventory in our sales channel and warranty replacement stock. If our sales forecast is less than the inventory we have on hand at the end of an accounting period, we may be required to take excess and obsolete inventory charges which will decrease gross margin and net operating results for that period. Valuation of Deferred Income Taxes We have recorded a valuation allowance to reduce our net deferred tax assets to zero, primarily due to our inability to estimate future taxable income. We consider estimated future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. If we determine that it is more likely than not that we will realize a deferred tax asset, which currently has a valuation allowance, we would be required to reverse the valuation allowance which would be reflected as an income tax benefit at that time. Goodwill and Purchased Intangible Assets The purchase method of accounting for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of the net tangible and intangible assets acquired, including IPR&D. Goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests. The amounts and useful lives assigned to intangible assets impact future amortization and the amount assigned to IPR&D is expensed immediately. If the assumptions and estimates used to allocate the purchase price are not correct, purchase price adjustments or future asset impairment charges could be required. Impairment of Long-Lived Assets We evaluate long-lived assets used in operations when indicators of impairment, such as reductions in demand or significant economic slowdowns, are present. Reviews are performed to determine whether the carrying values of assets are impaired based on a comparison to the undiscounted expected future cash flows. If the comparison indicates that there is impairment, the expected future cash flows using a discount rate based upon our weighted average cost of capital is used to estimate the fair value of the assets. Impairment is based on the excess of the carrying amount over the fair value of those assets. Significant management judgment is required in the forecast of future operating results that is used in the preparation of expected discounted cash flows. It is reasonably possible that the estimates of anticipated future net revenue, the remaining estimated economic lives of the products and technologies, or both, could differ from those used to assess the recoverability of these assets. In the event they are lower, additional impairment charges or shortened useful lives of certain long-lived assets could be required. Strategic Investments We have made strategic investments in privately held companies for the promotion of business and strategic investments. Strategic investments with less than a 20% voting interest are generally carried at cost. We will use the equity method to account for strategic investments in which we have a voting interest of 20% to 50% or in which we otherwise have the ability to exercise significant influence. Under the equity method, the investment is originally recorded at cost and adjusted to recognize our share of net earnings or losses of the investee, limited to the extent of our investment in the investee. From time to time we are required to estimate the amount of our losses of the investee. Our estimates are based on historical experience. The value of non-publicly traded securities is difficult to determine. We periodically review these investments for other-than-temporary declines in fair value based on the specific identification method and write down investments to their fair value when an 19 other-than-temporary decline has occurred. We generally believe an other-than-temporary decline has occurred when the fair value of the investment is below the carrying value for two consecutive quarters, absent evidence to the contrary. Fair values for investments in privately held companies are estimated based upon the values of recent rounds of financing. Although we believe our estimates reasonably reflect the fair value of the non-publicly traded securities held by us, had there been an active market for the equity securities, the carrying values might have been materially different than the amounts reported. Future adverse changes in market conditions or poor operating results of companies in which we have such investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment's current carrying value and which could require a future impairment charge. During the fourth quarter of 2004, we wrote-off $5.0 million representing the remaining balance of our investment in Xanboo. Subsequent to the write-off of Xanboo, there are no other strategic investments as of June 30, 2004. Restructuring Charge Over the last several quarters we have undertaken, and we may continue to undertake, significant restructuring initiatives, which have required us to develop formalized plans for exiting certain business activities. We have had to record estimated expenses for lease cancellations, contract termination expenses, long-term asset write-downs, severance and outplacement costs and other restructuring costs. Given the significance of, and the timing of the execution of such activities, this process is complex and involves periodic reassessments of estimates made at the time the original decisions were made. Through December 31, 2002, the accounting rules for restructuring costs and asset impairments required us to record provisions and charges when we had a formal and committed plan. Beginning January 1, 2003, the accounting rules now require us to record any future provisions and changes at fair value in the period in which they are incurred. In calculating the cost to dispose of our excess facilities, we had to estimate our future space requirements and the timing of exiting excess facilities and then estimate for each location the future lease and operating costs to be paid until the lease is terminated and the amount, if any, of sublease income. This required us to estimate the timing and costs of each lease to be terminated, including the amount of operating costs and the rate at which we might be able to sublease the site. To form our estimates for these costs, we performed an assessment of the affected facilities and considered the current market conditions for each site. Our assumptions on future space requirements, the operating costs until termination or the offsetting sublease revenues may turn out to be incorrect, and our actual costs may be materially different from our estimates, which could result in the need to record additional costs or to reverse previously recorded liabilities. Our policies require us to periodically evaluate the adequacy of the remaining liabilities under our restructuring initiatives. As management continues to evaluate the business, there may be additional charges for new restructuring activities as well as changes in estimates to amounts previously recorded. Settlement Costs From time to time, we are involved in legal actions arising in the ordinary course of business. We cannot assure you that these actions or other third party assertions against us will be resolved without costly litigation, in a manner that is not adverse to our financial position, results of operations or cash flows. As facts concerning contingencies become known, we reassess our position and make appropriate adjustments to the financial statements. There are many uncertainties associated with any litigation. If our initial assessments regarding the merits of a claim prove to be wrong, our results of operations and financial condition could be materially and adversely affected. In addition, if further information becomes available that causes us to determine a loss in any of our pending litigation, is probable and we can reasonably estimate a range of loss associated with such litigation, then we would record at least the minimum estimated liability. However, the actual liability in any such litigation may be materially different from our estimates, which could result in the need to record additional costs. We record our legal expenses as incurred; reimbursement of legal expenses from insurance or other sources are recorded upon receipt. Recent Accounting Pronouncements In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51," ("FIN 46"). FIN 46 requires certain variable interest entities ("VIE") to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new VIEs created or acquired after January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period ending March 15, 2004. We reviewed our investments and other arrangements and determined that none of our investee companies are VIE's. In May 2003, the FASB issued SFAS No. 150, "Accounting For Certain Financial Instruments with Characteristics of Both Liabilities and Equity" ("SFAS No. 150") which establishes standards for how an issuer of financial instruments classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) if, at inception, the monetary value of the obligation is based solely or predominantly on a fixed monetary amount known at inception, variations in something other than the fair value of the issuer's equity shares or variations inversely related to changes in the fair value of the issuer's equity shares. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the 20 beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have a material impact on our financial position, results of operations or cash flows. Cumulative effect of an accounting change Under the transitional provisions of SFAS No. 142, effective as of July 1, 2002, we completed our initial assessment and concluded that goodwill arising from the acquisition of United States Software Corporation ("USSC"), having a carrying amount of approximately $5.9 million as of July 1, 2001, may be impaired. We engaged an independent valuation company to perform a review of the value of our goodwill related to USSC. Based on the independent valuation, which utilized a discounted cash flow valuation technique, we recorded a $5.9 million charge for the impairment of our USSC goodwill. This amount is reflected as the cumulative effect of adopting the new accounting standard effective July 1, 2001. The following discussion of results of operations includes discussion of continuing operations only. Certain amounts in the 2003 and 2002 consolidated financial statements have been reclassified to conform with current year presentation. CONSOLIDATED RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the percentage of net revenues represented by each item in our consolidated statements of operations:
YEAR ENDED JUNE 30, ---------------------- 2004 2003 2002 ------- ------- -------- Net revenues 100.0% 100.0% 100.0% Cost of revenues 51.2 73.4 69.9 ------- ------- -------- Gross profit 48.8 26.6 30.1 ------- ------- -------- Operating expenses: Selling, general and administrative 47.6 58.0 70.4 Research and development 16.0 19.1 15.1 Stock-based compensation 0.7 2.9 5.0 Amortization of purchased intangible assets 0.3 1.2 1.7 Impairment of goodwill and purchased intangible assets - 4.8 87.6 Restructuring (recovery) charges (4.3) 11.3 6.0 Litigation settlement costs - 3.1 3.3 ------- ------- -------- Total operating expenses 60.4 100.5 189.0 ------- ------- -------- Loss from operations (11.6) (73.9) (159.0) Interest income (expense), net 0.1 0.5 2.7 Other income (expense), net (10.9) (1.9) (1.3) ------- ------- -------- Loss before income taxes and cumulative effect of an accounting change (22.4) (75.3) (157.6) Provision (benefit) for income taxes (0.7) 0.5 (11.6) ------- ------- -------- Loss from continuing operations before cumulative effect of an accounting change (21.7) (75.8) (146.0) Loss from discontinued operations (10.3) (20.5) (6.0) ------- ------- -------- Loss before cumulative effect of an accounting change (32.0) (96.3) (152.0) Cumulative effect of adoption of new accounting standard, SFAS No. 142 - - (10.33) ------- ------- -------- Net loss (32.0)% (96.3)% (162.3)% ======= ======= ========
COMPARISON OF THE YEARS ENDED JUNE 30, 2004 AND 2003 Net Revenues by Product Category
YEAR ENDED JUNE 30, ------------------------------------------------------------- % OF NET % OF NET $ % PRODUCT CATEGORIES 2004 REVENUE 2003 REVENUE VARIANCE VARIANCE - ------------------ ------- --------- ------- --------- ---------- --------- Device networking $27,481 56.2% $24,523 49.6% $ 2,958 12.1% IT management 12,555 25.7% 13,034 26.4% (479) (3.7)% Non-core 8,849 18.1% 11,832 24.0% (2,983) (25.2)% ------- --------- ------- --------- ---------- --------- TOTAL $48,885 100.0% $49,389 100.0% $ (504) (1.0)% ======= ========= ======= ========= ========== =========
The overall decrease in net revenues was primarily attributable to a decrease in net revenues of our non-core and IT management product lines offset by an increase in our device networking product line. Our increase in device networking products included increases from our newly introduced XPort product. The decrease in our IT management product line is primarily due to delays in 21 introducing certain new products. During the fourth quarter of fiscal 2004, we introduced a new line of console servers and we have substantially increased our marketing and sales efforts in our IT management solutions product family. The decrease in our non-core product line was primarily attributable to a decrease in our legacy print server, industrial controller board and Stallion product lines. We are no longer investing in the development of these product lines and expect net revenues related to these product lines to continue to decline in the future as we focus our investment on device networking and IT management products. Net Revenues by Region
YEAR ENDED JUNE 30, ------------------------------------------------------------- % OF NET % OF NET $ % GEOGRAPHIC REGION 2004 REVENUE 2003 REVENUE VARIANCE VARIANCE - ----------------- --------- --------- ----- -------- --------- --------- Americas $ 33,847 69.3% $37,391 75.7% $(3,544) (9.5)% Europe 11,252 23.0% 10,366 21.0% 886 8.5 % Other 3,786 7.7% 1,632 3.3% 2,154 132.0 % --------- --------- ------- ------- -------- ------- TOTAL $ 48,885 100.0% $49,389 100.0% $ (504) (1.0)% ========= ========= ======= ======= ======== =======
The overall decrease in net revenues is primarily due to a decrease in the Americas region. The decrease in net revenues in the Americas region is primarily attributable to our exit of the industrial controller board product line, which was sold entirely in the Americas as well as our decrease in the IT management product family net revenues. The increase in Europe is primarily due to the addition of new customers including three new distributors and several channel customers. The increase in other is primarily due to the signing of several new customers and our increased sales efforts in the Asia Pacific region. Gross Profit
YEAR ENDED JUNE 30, -------- % OF NET % OF NET $ % 2004 REVENUES 2003 REVENUES VARIANCE VARIANCE ------- --------- ------- --------- --------- --------- Gross profit $23,859 48.8% $13,125 26.6% $ 10,734 8.5 % ======= ========= ======= ========= ========= =========
Gross profit represents net revenues less cost of revenues. Cost of revenues consists primarily of the cost of raw material components, subcontract labor assembly from outside manufacturers, amortization of purchased intangible assets, impairment of purchased intangible assets, establishing or relieving inventory reserves for excess and obsolete products or raw materials, overhead and warranty costs. Cost of revenues for the years ended June 30, 2004 and 2003 included $2.1 million and $3.6 million of amortization of purchased intangible assets, respectively. Cost of revenues for the year ended June 30, 2003 includes a $3.1 million impairment charge of purchased intangible assets, in accordance with SFAS No. 144. No impairment charge was recorded for the year ended June 30, 2004. At June 30, 2004, the unamortized balance of purchased intangible assets that will be amortized to future cost of revenues was $2.0 million, of which $1.4 million will be amortized in fiscal 2005 and $557,000 in fiscal 2006. In May 2002, we signed a new agreement with Gordian to acquire a joint interest in the intellectual property that is evident in our products designed by Gordian and to extinguish our obligation to pay royalties on future sales of our products. We paid $6.0 million for this intellectual property and are amortizing this asset to cost of revenues over the remaining life of our products designed by Gordian, or approximately 3 years. Effective May 30, 2002, upon the signing of the new agreement, royalty expenses have been replaced by an amortization of the prepaid royalties and entitlement to the intellectual property that was part of the agreement. Amortization expense related to the new Gordian agreement, included in amortization of purchased intangible assets of $2.1 million, totaled $1.8 million for the year ended June 30, 2004. Amortization expense related to the new Gordian agreement, included in amortization of purchased intangible assets of $3.6 million totaled $2.5 million for the year ended June 30, 2003. The increase in gross profit is primarily attributable to a lower inventory reserve provision in fiscal 2004 compared to fiscal 2003, an overall reduction in payroll and payroll related costs due to the closing of our Milford, Connecticut facility in February 2003, an increase in our capitalized inventory overhead and a decrease in the amortization of purchased intangible assets due to the impairment write-down of $3.1 million during the fourth quarter of fiscal 2003. These decreases were offset by an increase in our warranty expense. 22 Selling, General and Administrative
YEAR ENDED JUNE 30, -------- % OF NET % OF NET $ % 2004 REVENUES 2003 REVENUES VARIANCE VARIANCE ------- --------- ------- --------- ---------- --------- Selling, general and administrative $23,293 47.6% $28,660 58.0% $ (5,367) (18.7)% ======= ========= ======= ========= ========== =========
Selling, general and administrative expenses consist primarily of personnel-related expenses including salaries and commissions, facility expenses, information technology, trade show expenses, advertising, insurance proceeds, and professional legal and accounting fees. Selling, general and administrative expense decreased primarily due to reductions in headcount and facility costs as a result of our fiscal 2003 restructurings, decrease in legal and other professional fees, improvement in our accounts receivable resulting in a reduction of our allowance for doubtful accounts, offset by an increase in our directors and officers liability insurance. The legal fees primarily relate to our defense of the shareholders and various other lawsuits and the SEC investigation. Legal fees incurred in defense of the shareholder suits are reimbursable to the extent provided in our directors and officers liability insurance policies, and subject to the coverage limitations and exclusions contained in such policies. For the years ended June 30, 2004 and 2003, we have been reimbursed $3.0 million and $1.4 million of these expenses. Management expects to receive additional reimbursements from insurance sources for legal fees in fiscal 2005. Research and Development
YEAR ENDED JUNE 30, -------------------------------------------------------------- % OF NET % OF NET $ % 2004 REVENUES 2003 REVENUES VARIANCE VARIANCE --------- --------- ------ --------- ---------- --------- Research and development $ 7,813 16.0% $9,430 19.1% $ (1,617) (17.1)% ========= ========= ====== ========= ========== =========
Research and development expenses consist primarily of personnel-related costs of employees, as well as expenditures to third-party vendors for research and development activities. Research and development expenses decreased primarily due to our fiscal 2003 restructurings which resulted in the consolidation of our research and development activities primarily to our Irvine, California facility. Stock-based compensation
YEAR ENDED JUNE 30, ---------- % OF NET % OF NET $ % 2004 REVENUES 2003 REVENUES VARIANCE VARIANCE ----- --------- ------ --------- ---------- --------- Stock-based compensation $ 347 0.7% $1,453 2.9% $ (1,106) (76.1)% ===== ========= ====== ========= ========== =========
Stock-based compensation expense generally represents the amortization of deferred compensation. We recorded no deferred compensation for the year ended June 30, 2004 and recorded a reduction to deferred compensation as a result of employee stock option forfeitures in the amount of $197,000. Deferred compensation represents the difference between the fair value of the underlying common stock for accounting purposes and the exercise price of the stock options at the date of grant as well as the fair market value of the vested portion of non-employee stock options utilizing the Black-Scholes option pricing model. Deferred compensation also includes the value of employee stock options assumed in connection with our acquisitions calculated in accordance with current accounting guidelines. Deferred compensation is presented as a reduction of stockholders' equity and is amortized ratably over the respective vesting periods of the applicable options, which is generally four years. Included in cost of revenues is stock-based compensation of $48,000 and $89,000 for the years ended June 30, 2004 and 2003, respectively. Stock-based compensation decreased primarily due to the restructuring plan whereby options for which deferred compensation has been recorded were forfeited by terminated employees. Additionally, the decrease is due to the acceleration of approximately $239,000 of stock-based compensation in January 2003 as a result of our completion of a stock option exchange program whereby employees holding options to purchase our common stock were given the opportunity to cancel certain of their existing options in exchange for the opportunity to receive new options. At June 30, 2004, a balance of $103,000 remains and will be amortized as follows: $86,000 in fiscal 2005 and $17,000 in fiscal 2006. 23 Amortization of purchased intangible assets
YEARS ENDED JUNE 30, ----------- % OF NET % OF NET $ % 2004 REVENUES 2003 REVENUES VARIANCE VARIANCE ----- --------- ----- --------- ---------- --------- Amortization of purchased intangible assets $ 148 0.3% $ 602 1.2% $ (454) (75.4)% ===== ========= ===== ========= ========== =========
Purchased intangible assets primarily include existing technology, patents and non-compete agreements and are amortized on a straight-line basis over the estimated useful lives of the respective assets, ranging from one to five years. We obtained independent appraisals of the fair value of tangible and intangible assets acquired in order to allocate the purchase price. In addition, approximately $2.1 million and $3.6 million of amortization of purchased intangible assets have been classified as cost of revenues for the years ended June 30, 2004 and 2003, respectively. During the fourth fiscal quarter of 2004, we completed our annual impairment assessment and determined that no impairment was indicated as the estimated fair values exceeded their respective carrying values. The overall decrease is primarily due to the impairment charge of $2.4 million recorded during the year ended June 30, 2003. At June 30, 2004, the unamortized balance of purchased intangible assets that will be amortized to future operating expense was $67,000 which will be amortized in fiscal 2005. Impairment of goodwill and purchased intangible assets During the fourth quarter of fiscal 2003, we performed an assessment of the value of our purchased intangible assets in accordance with SFAS No. 144. As a result of industry conditions, continued lower market valuations and reduced estimates in information technology capital equipment spending in the future and other factors impacting expected future cash flows, we determined that there were indicators of impairment to the carrying value of our purchased intangible assets recorded as part of our acquisitions. We engaged an independent valuation company to perform a review of the value of our purchased intangible assets. In accordance with SFAS No. 144, we utilized a cash flow estimation approach, comparing the discounted expected future cash flows to the carrying value of the subject assets. Based on the independent valuations, during the fourth quarter of fiscal 2003 we recorded a $5.4 million impairment charge of which $2.4 million and $3.1 million were charged to operating expenses and cost of revenues, respectively. Restructuring (recovery) charges On September 12, 2002 and again on March 14, 2003, we announced a restructuring plan to prioritize our initiatives around the growth areas of our business, focus on profit contribution, reduce expenses and improve operating efficiency. These restructuring plans included a worldwide workforce reduction, consolidation of excess facilities and other charges. We recorded restructuring costs totaling $5.6 million which were classified as operating expenses in the consolidated statements of operations for the year ended June 30, 2003. The restructuring plans resulted in the reduction of approximately 58 regular employees worldwide. We recorded workforce reduction charges of approximately $1.2 million related to severance and fringe benefits for the terminated employees. We recorded charges of approximately $4.4 million related to consolidation of excess facilities, relating primarily to lease terminations, non-cancelable lease costs, write-off of leasehold improvements and termination of a contractual obligation. During the year ended June 30, 2004, approximately $2.1 million of restructuring charges were recovered related to a favorable settlement of a contractual obligation, consolidation of excess facilities and workforce reductions which were previously accrued for in fiscal 2003. The remaining restructuring reserve is related to facility closures in Naperville, Illinois; Hillsboro, Oregon; Redmond, Washington and Ames, Iowa. Payments under the lease obligations will end in fiscal 2007. Litigation settlement costs On August 23, 2002, a complaint entitled Dunstan v. Lantronix, Inc., et al., was filed in the Circuit Court of the State of Oregon, County of Multnomah, against us and certain of our current and former officers and directors by the co-founders of USSC. The parties participated in mediation on June 30, 2003, and subsequently reached an agreement to settle the dispute. The agreement called for us to release to the plaintiffs approximately $400,000 in cash and 49,038 shares of our common stock that had been held in an escrow since December 2000 as part of the acquisition of USSC. The agreement also called for us to issue to the plaintiffs additional shares of our common stock worth approximately $1.5 million, which was recorded in our results of operations as litigation settlement costs for the year ended June 30, 2003. Accordingly, 1,726,703 shares 24 were issued following a fairness determination by the state court in Oregon. In exchange, the plaintiffs released all claims against all defendants. No litigation settlement costs related to this matter were incurred during the year ended June 30, 2004. Interest Income (Expense), Net
YEAR ENDED JUNE 30, ---------- % OF NET % OF NET $ % 2004 REVENUES 2003 REVENUES VARIANCE VARIANCE ----- --------- ----- --------- ---------- --------- Interest income (expense), net $ 50 0.1% $ 248 0.5% $ (198) (79.8)% ===== ========= ===== ========= ========== =========
Interest income (expense), net consists primarily of interest earned on cash, cash equivalents and marketable securities. The decrease is primarily due to lower average investment balances and interest rates. Additionally, the decrease in the average investment balance is due to increased legal and other professional fees, settlement of litigation and contractual obligations, cash portions of settlements with prior owners of some of the businesses we have acquired, the settlement of the Milford lease obligation included in our restructuring charge, the purchase of a joint interest in intellectual property from Gordian, our acquisition of Stallion and to fund current operations. Other Income (Expense), Net
YEAR ENDED JUNE 30, ---------- % OF NET % OF NET $ % 2004 REVENUES 2003 REVENUES VARIANCE VARIANCE -------- --------- ------ --------- --------- --------- Other income (expense), net $(5,333) (10.9)% $(926) (1.9)% $ 4,407 475.9% ======== ========= ====== ========= ========= =========
The increase in other expense is due to our decision to write-off our investment in Xanboo. We periodically review our investments for which fair value is less than cost to determine if the decline in value is other than temporary. If the decline in value is judged to be other than temporary, the cost basis of the security is written down to fair value. We generally believe an other-than-temporary decline has occurred when the fair value of the investment is below the carrying value for two consecutive quarters, absent evidence to the contrary. On the basis of events occurring during the quarter ended June 30, 2004, we performed an analysis and recorded a charge in the amount of $5.0 million, representing a write-off of all remaining value of this non-marketable equity security. This charge is included within the consolidated statements of operations as other expense. Provision (Benefit) for Income Taxes We utilize the liability method of accounting for income taxes as set forth in FASB Statement No. 109, "Accounting for Income Taxes." Our effective tax rate was 3% for the year ended June 30, 2004, and 0% for the year ended June 30, 2003. The federal statutory rate was 34% for both periods. Our effective tax rate associated with the income tax expense for the year ended June 30, 2004, was lower than the federal statutory rate primarily due to the increase in valuation allowance. Our effective tax rate associated with the income tax benefit for the year ended June 30, 2003, was lower than the federal statutory rate primarily due to the increase in valuation allowance and amortization of stock-based compensation for which no benefit was provided. In 2003, the Internal Revenue Service ("IRS") completed its audit of our federal income tax returns for the fiscal years ended June 30, 1999, 2000 and 2001. As a result, we were required to pay approximately $776,000 in tax and interest to the IRS and the California Franchise Tax Board. We accrued $1.3 million for this liability in prior fiscal periods. Based on the final resolution of their examination and related state impact of the IRS examination, we recorded a reduction in our tax contingency reserve of approximately $500,000. We have paid $662,000 of this liability through June 30, 2004 and $114,000 was paid during the quarter ended September 30, 2004. COMPARISON OF THE YEARS ENDED JUNE 30, 2003 AND 2002 Net Revenues NET REVENUES BY PRODUCT CATEGORY
YEAR ENDED JUNE 30, ---------- % OF NET % OF NET $ % PRODUCT CATEGORIES 2003 REVENUE 2002 REVENUE VARIANCE VARIANCE - ------------------ ------- --------- -------- --------- ---------- --------- Device networking $24,523 49.6% $ 28,607 49.8% $ (4,084) (14.3)% ========== IT management 13,034 26.4% 16,528 28.7% (3,494) (21.1)% Non-core 11,832 24.0% 12,456 21.5% (624) (5.0)% ------- --------- -------- --------- ---------- --------- TOTAL $49,389 100.0% $ 57,591 100.0% $ (8,202) (14.3)% ======= ========= ======== ========= ========== =========
25 The overall decrease in net revenues by product is primarily attributable to logistical issues surrounding the restructuring of our Milford, Connecticut operations, whereby we began to outsource our manufacturing to three contract manufacturers, our discontinuance of certain product offerings as well as the overall decrease in industry technology spending year to year. NET REVENUES BY REGION
YEAR ENDED JUNE 30, ---------- % OF NET % OF NET $ % GEOGRAPHIC REGION 2003 REVENUE 2002 REVENUE VARIANCE VARIANCE - ----------------- ------- --------- ------- --------- ---------- --------- Americas $37,391 75.7% $47,691 82.8% $ (10,300) (21.6)% Europe 10,366 21.0% 8,249 14.3% 2,117 25.7% Other 1,632 3.3% 1,651 2.9% (19) (1.2)% ------- --------- ------- --------- ---------- --------- TOTAL $49,389 100.0% $57,591 100.0% $ (8,202) (14.2)% ======= ========= ======= ========= ========== =========
Our net revenues derived from customers located in the Americas decreased primarily due to logistical issues surrounding the restructuring of our Milford, Connecticut operations, whereby we began to outsource our manufacturing to three contract manufacturers, our discontinuance of certain product offerings as well as the overall decrease in industry technology spending year to year. The increase in the Europe region was primarily due to a concentrated effort to improve sales through a stronger sales structure. Gross Profit
YEAR ENDED JUNE 30, ---------- % OF NET % OF NET $ % 2003 REVENUES 2002 REVENUES VARIANCE VARIANCE ------- --------- ------- --------- ---------- --------- Gross profit $13,125 26.6% $17,310 30.1% $ (4,185) (24.2)% ======= ========= ======= ========= ========== =========
Gross profit represents net revenues less cost of revenues. Cost of revenues consists primarily of the cost of raw material components, subcontract labor assembly from outside manufacturers, amortization of purchased intangible assets, establishing inventory reserves for excess and obsolete products or raw materials and overhead costs. As part of an agreement with Gordian, an outside research and development firm, a royalty charge was included in cost of revenues and was calculated based on the related products sold. Gordian royalties were $1.2 million for the year ended June 30, 2002. No royalties were paid for the year ended June 30, 2003 as a result of a new Gordian agreement as described below. Cost of revenues for the years ended June 30, 2003 and 2002 consisted of $3.6 million and $2.2 million of amortization of purchased intangible assets, respectively. Cost of revenues for the years ended June 30, 2003 and 2002 also includes a $3.1 million and $6.4 million impairment charge of purchased intangible assets, respectively, in accordance with SFAS No. 144. In May 2002, we signed a new agreement with Gordian to acquire a joint interest in the intellectual property that is evident in our products designed by Gordian and to extinguish our obligation to pay royalties on future sales of our products. We paid $6.0 million for this intellectual property and are amortizing this asset to cost of revenues over the remaining life of our products designed by Gordian, or approximately 3 years. Effective May 30, 2002, upon the signing of the new agreement, royalty expenses have been replaced by an amortization of the prepaid royalties and entitlement to the intellectual property that was part of the agreement. Amortization expense related to the new Gordian agreement, included in amortization of purchased intangible assets of $3.6 million, totaled $2.5 million for the year ended June 30, 2003. Amortization expense related to the new Gordian agreement, included in amortization of purchased intangible assets of $2.2 million, totaled $212,000 for the year ended June 30, 2002. The overall decrease in gross profit is primarily attributable to a decrease in net revenues, an increase in the amortization of purchased intangible assets relating to technology acquired in our acquisitions, an increase in production expenses related to the closing of our Milford, Connecticut facility and an increase in our reserves for excess and obsolete inventory and warranty. 26 Selling, General and Administrative
YEAR ENDED JUNE 30, ---------- % OF NET % OF NET $ % 2003 REVENUES 2002 REVENUES VARIANCE VARIANCE ------- --------- ------- --------- ---------- --------- Selling, general and administrative $28,660 58.0% $40,538 70.4% $ (11,878) (29.3)% ======= ========= ======= ========= ========== =========
Selling, general and administrative expenses consist primarily of personnel-related expenses including salaries and commissions, facilities expenses, information technology, trade show expenses, advertising, and professional legal and accounting fees. Selling, general and administrative expense decreased primarily due to reductions in headcount and facility costs as a result of our restructurings in the second quarter of fiscal 2002 and the first and third quarters of fiscal 2003, as well as a favorable settlement of a contractual service obligation and a reduction in our allowance for doubtful accounts. These decreases are partially offset by increases in legal and other professional fees. The legal fees primarily relate to our defense of the shareholder lawsuits, government investigations, and the defense of the intellectual property lawsuit, which was settled during the second quarter of fiscal 2003. Legal fees incurred in defense of the shareholder suits are reimbursable to the extent provided in our directors and officers liability insurance policies, and subject to the coverage limitations and exclusions contained in such policies. For the year ended June 30, 2003, we have been reimbursed $1.4 million of these expenses. There were no reimbursements for the year ended June 30, 2002. Research and Development
YEAR ENDED JUNE 30, ---------- % OF NET % OF NET $ % 2003 REVENUES 2002 REVENUES VARIANCE VARIANCE ------ --------- ------ --------- --------- --------- Research and development $9,430 19.1% $8,680 15.1% $ 750 8.6% ====== ========= ====== ========= ========= =========
Research and development expenses consist primarily of personnel-related costs of employees, as well as expenditures to third-party vendors for research and development activities. Research and development expenses increased primarily due to increased personnel-related costs including the acquisitions of Synergetic and Stallion and third-party expenses related to new product development. Stock-based compensation
YEAR ENDED JUNE 30, ---------- % OF NET % OF NET $ % 2003 REVENUES 2002 REVENUES VARIANCE VARIANCE ------ --------- ------ --------- ---------- --------- Stock-based compensation $1,453 2.9% $2,863 5.0% $ (1,410) (49.2)% ====== ========= ====== ========= ========== =========
Stock-based compensation expense generally represents the amortization of deferred compensation. We recorded approximately $73,000 of deferred compensation for the year ended June 30, 2003. Additionally, we recorded deferred compensation forfeitures of $2.6 million for the year ended June 30, 2003. Deferred compensation represents the difference between the fair value of the underlying common stock for accounting purposes and the exercise price of the stock options at the date of grant as well as the fair market value of the vested portion of non-employee stock options utilizing the Black-Scholes option pricing model. Deferred compensation also includes the value of employee stock options assumed in connection with our acquisitions calculated in accordance with current accounting guidelines. Deferred compensation is presented as a reduction of stockholders' equity and is amortized ratably over the respective vesting periods of the applicable options, which is generally four years. Included in cost of revenues is stock-based compensation of $89,000 and $117,000 for the years ended June 30, 2003 and 2002, respectively. The decrease in stock-based compensation for the year ended June 30, 2003 is primarily attributable to the restructuring plan whereby options for which deferred compensation has been recorded are forfeited for terminated employees. 27 Amortization of purchased intangible assets
YEARS ENDED JUNE 30, ---------- % OF NET % OF NET $ % 2003 REVENUES 2002 REVENUES VARIANCE VARIANCE ----- --------- ----- --------- ---------- --------- Amortization of purchased intangible assets $ 602 1.2% $ 960 1.7% $ (358) (37.3)% ===== ========= ===== ========= ========== =========
Purchased intangible assets primarily include existing technology, customer agreements, patents and trademarks and are amortized on a straight-line basis over the estimated useful lives of the respective assets, ranging from one to five years. We obtained independent appraisals of the fair value of tangible and intangible assets acquired in order to allocate the purchase price. The increase in amortization of purchased intangible assets included in cost of revenues is primarily due to the amortization of the intellectual property agreement with Gordian signed in May 2002, and existing technology recorded as part of the Stallion acquisition in August 2002, offset by the impairment write-down of $6.4 million during the fourth quarter of fiscal 2002 as well as the $3.1 million impairment during the fourth quarter of fiscal 2003. The decrease in amortization of purchased intangible assets is primarily due to the impairment write-down of $4.0 million during the fourth quarter of fiscal 2002 as well as the $2.4 million impairment write-down during the fourth quarter of fiscal 2003. Impairment of goodwill and purchased intangible assets We performed the first of the required annual impairment tests of goodwill under the guidelines of SFAS No. 142 effective as of June 1, 2002. As a result of industry conditions, lower market valuations and reduced estimates of information technology capital equipment spending in the future, we determined that there were indicators of impairment to the carrying value of goodwill related to the acquisitions of Lightwave and Synergetic which had carrying values of $39.7 million and $13.9 million, respectively, as of June 30, 2002. During the fourth quarter of fiscal 2002, we engaged an independent valuation company to perform a review of the value of our goodwill and based on the independent valuation we recorded a $46.4 million impairment charge of our goodwill. Additionally, during the fourth quarter of fiscal 2002, we performed a review of the value of our purchased intangible assets in accordance with SFAS No. 144. As a result of industry conditions, lower market valuations and reduced estimates of information technology capital equipment spending in the future, we determined that there were indicators of impairment to the carrying value of our purchased intangible assets related to our acquisitions. During the fourth quarter of fiscal 2002, we engaged an independent valuation company to perform a review of the value of our purchased intangible assets and based on the independent valuation we recorded a $9.8 million impairment charge of which $4.0 million and $5.8 million were charged to operating expenses and cost of revenues, respectively. Additionally, we recorded an impairment charge of $665,000 to cost of revenues related to intellectual property not associated with an acquisition. During the fourth quarter of fiscal 2003, we performed an assessment of the value of our purchased intangible assets in accordance with SFAS No. 144. As a result of industry conditions, continued lower market valuations and reduced estimates in information technology capital equipment spending in the future and other factors impacting expected future cash flows, we determined that there were indicators of impairment to the carrying value of our purchased intangible assets recorded as part of our acquisitions. We engaged an independent valuation company to perform a review of the value of our purchased intangible assets. In accordance with SFAS No. 144, we utilized a cash flow estimation approach, comparing the discounted expected future cash flows to the carrying value of the subject assets. Based on the independent valuations, during the fourth quarter of fiscal 2003 we recorded a $5.4 million impairment charge of which $2.3 million and $3.1 million were charged to operating expenses and cost of revenues, respectively. Restructuring charges On September 12, 2002 and March 14, 2003, we announced restructuring plans to prioritize our initiatives around the growth areas of our business, focus on profit contribution, reduce expenses, and improve operating efficiency. These restructuring plans included a worldwide workforce reduction, consolidation of excess facilities and other charges. We recorded restructuring costs totaling $5.6 million, which were classified as operating expenses in the consolidated statement of operations for the year ended June 30, 2003. These restructuring plans resulted in the reduction of approximately 58 regular employees worldwide. We recorded workforce reduction charges of approximately $1.2 million related to severance and fringe benefits for the terminated employees. We recorded charges of approximately $4.4 million related to the consolidation of excess facilities, relating primarily to lease terminations, non-cancelable lease costs, write-off of leasehold improvements and termination of a contractual obligation. 28 On February 6, 2002, we announced a restructuring plan to prioritize our initiatives around the growth area of our business, focus on profit contribution, reduce expenses, and improve operating efficiency. This restructuring plan included a worldwide workforce reduction, consolidation of excess facilities and other charges. As of June 30, 2002, we recorded restructuring costs totaling $3.5 million. Through June 30, 2003, the February 2002 restructuring plan has resulted in the reduction of approximately 50 regular employees worldwide and we incurred actual workforce reduction charges of approximately $1.9 million related to severance and fringe benefits. Included in the workforce reduction charge was a non-cash stock-based compensation charge in the amount of $595,000 associated with the modification of stock options that were outstanding at the termination date. Property, equipment and other assets that were disposed of or removed from operations resulted in a charge of $1.6 million and consisted primarily of computer software and related equipment, production, engineering and office equipment, and furniture and fixtures. Litigation settlement costs On August 23, 2002, a complaint entitled Dunstan v. Lantronix, Inc., et al., was filed in the Circuit Court of the State of Oregon, County of Multnomah, against us and certain of our current and former officers and directors by the co-founders of USSC. The parties participated in mediation on June 30, 2003, and subsequently reached an agreement to settle the dispute. The agreement called for us to release to the plaintiffs approximately $400,000 in cash and 49,038 shares of our common stock that had been held in an escrow since December 2000 as part of the acquisition of USSC. The agreement also called for us to issue to the plaintiffs additional shares of our common stock worth approximately $1.5 million, which was recorded in our results of operations as litigation settlement costs for the year ended June 30, 2003. Accordingly, 1,726,703 shares were issued following a fairness determination by the state court in Oregon. In exchange, the plaintiffs released all claims against all defendants. We received an informal notice from several holders of our unregistered shares of common stock that were issued in connection with the acquisition of Lightwave. The shares were issued to the holders in a private transaction not registered under the Securities Act of 1933, and therefore could not be sold by the stockholders without a valid registration statement. The stockholders alleged that we failed to honor their rights to have the shares registered and that they were therefore precluded from selling the shares. Effective July 26, 2002, we settled with the stockholders of Lightwave in the amount of $2.0 million in exchange for 240,000 shares of our common stock held in escrow and 208,335 additional shares issued to the former owners of Lightwave on the acquisition date. This settlement resulted in a net charge to our results of operations of approximately $1.9 million for the year ended June 30, 2002 and has been recognized as litigation settlement costs. Interest Income (Expense), Net
YEAR ENDED JUNE 30, ---------- % OF NET % OF NET $ % 2003 REVENUES 2002 REVENUES VARIANCE VARIANCE ----- --------- ------ --------- ---------- --------- Interest income (expense), net $ 248 0.5% $1,548 2.7% $ (1,300) (84.0)% ===== ========= ====== ========= ========== =========
Interest income (expense), net consists primarily of interest earned on cash, cash equivalents and marketable securities. The decrease is primarily due to lower average investment balances and interest rates. Additionally, the decrease in the average investment balance is due to increased expenditures for legal and other professional fees resulting from our financial statement restatements in fiscal 2002 and defense of our lawsuits. Also, the decrease is due to the settlement of the Milford lease obligation included in our restructuring charge, the purchase of a joint interest in intellectual property from Gordian, our acquisition of Stallion and to fund current operations. Other Income (Expense), Net
YEAR ENDED JUNE 30, ---------- % OF NET % OF NET $ % 2003 REVENUES 2002 REVENUES VARIANCE VARIANCE ------ --------- ------ --------- ---------- --------- Other income (expense), net $(926) (1.9)% $(760) (1.3)% $ (166) (21.8)% ====== ========= ====== ========= ========== =========
The increase for the year ended June 30, 2003 is primarily attributable to our share of the losses from our investment in Xanboo. 29 Provision (Benefit) for Income Taxes We utilize the liability method of accounting for income taxes as set forth in FASB Statement No. 109, "Accounting for Income Taxes." Our effective tax rate was 0% for the year ended June 30, 2003, and 7% for the year ended June 30, 2002. The federal statutory rate was 34% for both periods. Our effective tax rate associated with the income tax expense for the year ended June 30, 2003, was lower than the federal statutory rate primarily due to the increase in valuation allowance, as well as the amortization of stock-based compensation for which no current year tax benefit was provided. Our effective tax rate associated with the income tax benefit for the year ended June 30, 2002, was lower than the federal statutory rate primarily due to foreign losses and amortization of stock-based compensation for which no benefit was provided. LIQUIDITY AND CAPITAL RESOURCES Since inception, we have financed our operations through the issuance of common stock and through net cash generated from operations. We consider all highly liquid investments purchased with original maturities of 90 days or less to be cash equivalents. Cash and cash equivalents, consisting of money-market funds and commercial paper, totaled $9.1 million at June 30, 2004. Marketable securities are income yielding securities which can be readily converted to cash. Marketable securities consist of obligations of U.S. Government agencies, state, municipal and county government notes and bonds and totaled $3.1 million at June 30, 2004. Our operating activities used cash of $2.9 million for the year ended June 30, 2004. We incurred a net loss of $15.7 million of which $10.6 million is from continuing operations and $5.1 million is from discontinued operations, which includes the following adjustments: depreciation of $1.7 million, amortization of purchased intangible assets of $2.2 million, amortization of stock-based compensation of $395,000, equity losses from unconsolidated businesses of $413,000, revaluation of a strategic investment of $5.0 million, offset by a recovery in the restructuring reserve of $1.6 million and a deferred tax liability of $600,000. The revaluation of a strategic investment is due to the write-off of our remaining investment in Xanboo due to an other-than temporary impairment. The restructuring reserve recovery is primarily due to the favorable settlement of a contractual obligation. The changes in our operating assets consist of a decrease in accounts receivable of $708,000, decrease in contract manufacturer receivable of $745,000, decrease in prepaid expenses and other current assets of $1.1 million, decrease in net assets of discontinued operations of $3.4 million, increase in warranty reserve of $577,000, increase in other current liabilities of $732,000, which was reduced by a decrease in accounts payable of $725,000, decrease in our liability to Gordian of $1.0 million and a decrease in restructuring reserve of $932,000. The reduction in accounts receivable is primarily due to improved collections from our distributors and European customers. The decrease in contract manufacturer receivables is due to improved collections. The decrease in our prepaid and other current assets is primarily due to the Gordian payment whereby we maintained a time deposit for $1.0 million as well as the maturity of additional time deposits totaling $682,000. Net assets of discontinued operations are due to the sale of the Premise business unit in March 2004. The increase in the warranty reserve is primarily due to the increase in historical actual warranty costs. The increase in other current liabilities is primarily due to an increase in accrued payroll and an increase in general liabilities such as audit fees, legal fees and inventory purchases. The decrease in accounts payable is due to the timing of payments to our suppliers. The decrease in the balance due to Gordian is due to payments in accordance with the agreement. The decrease in the restructuring reserve is due to payments on lease obligations and workforce reductions. Our operating activities used cash of $17.6 million for the year ended June 30, 2003. Cash provided by investing activities was $3.5 million for the year ended June 30, 2004 compared with a $2.1 million usage of cash for the year ended June 30, 2003. We received $4.3 million in proceeds from the sales of marketable securities. We used $552,000 to purchase marketable securities. We also used $248,000 to purchase property and equipment. Cash provided by financing activities was $1.2 million for the year ended June 30, 2004 primarily related to the purchases by the employee stock purchase plan and $500,000 in borrowings under our line of credit. Cash provided by financing activities was $345,000 for the year ended June 30, 2003. In January 2002, we entered into a two-year line of credit with a bank in an amount not to exceed $20.0 million. Borrowings under the line of credit bear interest at either (i) the prime rate or (ii) the LIBOR rate plus 2.0%. We are required to pay a $100,000 facility fee which was reduced to $62,500 and was paid. We were also required to pay a quarterly unused line fee of .125% of the unused line of credit balance. Since establishing the line of credit, we have twice reduced the amount of the line, modified customary financial covenants and adjusted the interest rate to be charged on borrowings to the prime rate plus ..50% and eliminated the LIBOR option. Effective July 25, 2003, we further modified this line of credit, reducing the revolving line to $5.0 million and adjusting the customary affirmative and negative covenants. We are also required to maintain certain financial ratios as defined in the agreement. The agreement has an annual revolving maturity date that renews on the effective date. The agreement was renewed on July 24, 2004 with an amendment to a financial ratio. We are required to pay a $12,500 facility fee for the renewal. Our borrowing base at June 30, 2004, was $3.2 million. In March 2004, we borrowed $500,000 against this line of credit. Additionally, we have used letters of credit available under our line of credit totaling approximately $1.0 million in place of cash to fund deposits on leases, tax account deposits and security deposits. As a result, our available line of credit at June 30, 2004 was $1.6 million. We are currently in compliance with the revised financial covenants of the July 24, 2004 amended line of credit. Pursuant to the line of credit, we are restricted from paying any dividends. The following table summarizes our contractual payment obligations and commitments:
Fiscal Years --------------------- 2005 2006 2007 TOTAL ------ ------ ----- ------ Convertible note payable $ 867 $ - $ - $ 867 Bank line of credit 500 - - 500 Operating leases 1,562 437 162 2,161 ------ ------ ----- ------ Total $2,929 $ 437 $ 162 $3,528 ====== ====== ===== ======
30 In March 2004, we completed the sale of substantially all of the net assets of the Premise business unit with a net book value of approximately $25,000 for $1.0 million. Additionally, we incurred $383,000 of disposal costs. At June 30, 2004, we had purchase obligations which consists of our finished goods purchases from our contract manufacturers and raw materials from our suppliers in the amount of approximately $5.5 million. Additionally, in the first fiscal quarter of 2005, our convertible note will become due. If the notes are not converted to our common stock we will be required to pay up to $867,000. On August 22, 2004, the notes were not converted into our common stock and were paid. Net cash requirements in the first fiscal quarter of 2005 may represent an increase from the average net cash usage of the previous quarters. During the first quarter of fiscal 2005, we expect to use approximately $2.2 to $2.8 million in cash. This increase is primarily the result of payment of our convertible note as discussed above. Additionally, we expect to incur higher expenses for this quarter in marketing, sales and research and development that are related to our product launches, as well as the tax payment also discussed above. We expect to return to a more normal range of cash usage of approximately $1.0 million in the second quarter of fiscal 2005. At June 30, 2004, approximately $2.9 million of our net tangible assets (primarily cash held in foreign bank accounts) were located outside the United States. Such assets are unrestricted with regard to foreign liquidity needs, however, our ability to utilize such assets to satisfy liquidity needs outside of such foreign locations are subject to approval by the foreign location board of directors. We believe that our existing cash, cash equivalents and marketable securities and any available borrowings under our line of credit facility will be adequate to meet our anticipated cash needs through at least the next twelve months. Our future capital requirements will depend on many factors, including the timing and amount of our net revenues, research and development and infrastructure investments, and expenses related to on-going government investigations and pending litigation, which will affect our ability to generate additional cash. If cash generated from operations and financing activities is insufficient to satisfy our working capital requirements, we may need to borrow funds through bank loans, sales of securities, or other means. There can be no assurance that we will be able to raise any such capital on terms acceptable to us, if at all. If we are unable to secure additional financing, we may not be able to develop or enhance our products, take advantage of future opportunities, respond to competition or continue to operate our business. RISK FACTORS You should carefully consider the risks described below before making an investment decision. The risks and uncertainties described below are not the only ones facing our company. Our business operations may be impaired by additional risks and uncertainties of which we are unaware or that we currently consider immaterial. Our business, results of operations or cash flows may be adversely affected if any of the following risks actually occur. In such case, the trading price of our common stock could decline, and you may lose all or part of your investment. VARIATIONS IN QUARTERLY OPERATING RESULTS, DUE TO FACTORS INCLUDING CHANGES IN DEMAND FOR OUR PRODUCTS AND CHANGES IN OUR MIX OF NET REVENUES, COULD CAUSE OUR STOCK PRICE TO DECLINE. Our quarterly net revenues, expenses and operating results have varied in the past and might vary significantly from quarter to quarter in the future. We therefore believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance, and you should not rely on them to predict our future performance or the future performance of our stock price. Our short-term expense levels are relatively fixed and are based on our expectations of future net revenues. If we were to experience a reduction in net revenues in a quarter, we would likely be unable to adjust our short-term expenditures. If this were to occur, our operating results for that quarter would be harmed. If our operating results in future quarters fall below the expectations of market analysts and investors, the price of our common stock would likely fall. Other factors that might cause our operating results to fluctuate on a quarterly basis include: 30 - - changes in the mix of net revenues attributable to higher-margin and lower-margin products; - - customers' decisions to defer or accelerate orders; - - variations in the size or timing of orders for our products; - - short-term fluctuations in the cost or availability of our critical components; - - changes in demand for our products; - - loss or gain of significant customers; - - announcements or introductions of new products by our competitors; - - defects and other product quality problems; and - - changes in demand for devices that incorporate our products. WE ARE CURRENTLY ENGAGED IN MULTIPLE SECURITIES CLASS ACTION LAWSUITS, A STATE DERIVATIVE SUIT, A LAWSUIT BY OUR FORMER CFO AND COO STEVEN V. COTTON, A LAWSUIT BY FORMER SHAREHOLDERS OF OUR SYNERGETIC SUBSIDIARY, AND PATENT INFRINGEMENT LITIGATION ANY OF WHICH, IF IT RESULTS IN AN UNFAVORABLE RESOLUTION, COULD ADVERSELY AFFECT OUR BUSINESS, RESULTS OF OPERATIONS OR FINANCIAL CONDITION. From time to time, we are subject to other legal proceedings and claims in the ordinary course of business. We are currently involved in significant litigation, including multiple security class action lawsuits, a state derivative lawsuit, litigation with a former executive officer and patent infringement litigation. The pending lawsuits involve complex questions of fact and law and likely will continue to require the expenditure of significant funds and the diversion of other resources to defend. We do not know what the outcome of outstanding legal proceedings will be and cannot determine the extent to which these resolutions might have a material adverse effect on our business, results of operations and financial condition taken as a whole. The results of litigation are inherently uncertain, and adverse outcomes are possible. For a more detailed description of pending litigation, see Part 3, Item 1 on page 13. WE MIGHT BECOME INVOLVED IN LITIGATION OVER PROPRIETARY RIGHTS, WHICH COULD BE COSTLY AND TIME CONSUMING. Substantial litigation regarding intellectual property rights exists in our industry. There is a risk that third-parties, including current and potential competitors, current developers of our intellectual property, our manufacturing partners, or parties with which we have contemplated a business combination will claim that our products, or our customers' products, infringe on their intellectual property rights or that we have misappropriated their intellectual property. In addition, software, business processes and other property rights in our industry might be increasingly subject to third-party infringement claims as the number of competitors grows and the functionality of products in different industry segments overlaps. Other parties might currently have, or might eventually be issued, patents that infringe on the proprietary rights we use. Any of these third parties might make a claim of infringement against us. For example, Digi International, ("Digi") has just filed a lawsuit alleging that we infringe their '192 patent. We have filed suit alleging that Digi infringes our '305 patent. Please refer to Part I, Item 3 on page 13 for more information. From time to time in the future we could encounter other disputes over rights and obligations concerning intellectual property. We cannot assume that we will prevail in intellectual property disputes regarding infringement, misappropriation or other disputes. Litigation in which we are accused of infringement or misappropriation might cause a delay in the introduction of new products, require us to develop non-infringing technology, require us to enter into royalty or license agreements, which might not be available on acceptable terms, or at all, or require us to pay substantial damages, including treble damages if we are held to have willfully infringed. In addition, we have obligations to indemnify certain of our customers under some circumstances for infringement of third-party intellectual property rights. If any claims from third-parties were to require us to indemnify customers under our agreements, the costs could be substantial, and our business could be harmed. If a successful claim of infringement were made against us and we could not develop non-infringing technology or license the infringed or similar technology on a timely and cost-effective basis, our business could be significantly harmed. WE HAVE ELECTED TO USE A CONTRACT MANUFACTURER IN CHINA, WHICH INVOLVES SIGNIFICANT RISKS. One of our contract manufacturers is based in China. There are significant risks of doing business in China, including: - - Delivery times are extended due to the distances involved, requiring more lead-time in ordering and increasing the risk of excess inventories. - - We could incur ocean freight delays because of labor problems, weather delays or expediting and customs problems. 32 - - China does not afford the same level of protection to intellectual property as domestic or many other foreign countries. If our products were reverse-engineered or our intellectual property was otherwise pirated-reproduced and duplicated without our knowledge or approval, our revenues would be reduced. - - China and U.S foreign relations have, historically, been subject to change. Political considerations and actions could interrupt our expected supply of products from China. INABILITY, DELAYS IN DELIVERIES OR QUALITY PROBLEMS FROM OUR COMPONENT SUPPLIERS COULD DAMAGE OUR REPUTATION AND COULD CAUSE OUR NET REVENUES TO DECLINE AND HARM OUR RESULTS OF OPERATIONS. Our contract manufacturers and we are responsible for procuring raw materials for our products. Our products incorporate components or technologies that are only available from single or limited sources of supply. In particular, some of our integrated circuits are available from a single source. From time to time in the past, integrated circuits we use in our products have been phased out of production. When this happens, we attempt to purchase sufficient inventory to meet our needs until a substitute component can be incorporated into our products. Nonetheless, we might be unable to purchase sufficient components to meet our demands, or we might incorrectly forecast our demands, and purchase too many or too few components. In addition, our products use components that have in the past been subject to market shortages and substantial price fluctuations. From time to time, we have been unable to meet our orders because we were unable to purchase necessary components for our products. We rely on a number of different component suppliers. Because we do not have long-term supply arrangements with any vendor to obtain necessary components or technology for our products, if we are unable to purchase components from these suppliers, product shipments could be prevented or delayed, which could result in a loss of sales. If we are unable to meet existing orders or to enter into new orders because of a shortage in components, we will likely lose net revenues and risk losing customers and harming our reputation in the marketplace. THE MARKET FOR OUR PRODUCTS IS NEW AND RAPIDLY EVOLVING. IF WE ARE NOT ABLE TO DEVELOP OR ENHANCE OUR PRODUCTS TO RESPOND TO CHANGING MARKET CONDITIONS, OUR NET REVENUES WILL SUFFER. Our future success depends in large part on our ability to continue to enhance existing products, lower product cost and develop new products that maintain technological competitiveness. The demand for network-enabled products is relatively new and can change as a result of innovations or changes. For example, industry segments might adopt new or different standards, giving rise to new customer requirements. Any failure by us to develop and introduce new products or enhancements directed at new industry standards could harm our business, financial condition and results of operations. These customer requirements might or might not be compatible with our current or future product offerings. We might not be successful in modifying our products and services to address these requirements and standards. For example, our competitors might develop competing technologies based on Internet Protocols, Ethernet Protocols or other protocols that might have advantages over our products. If this were to happen, our net revenue might not grow at the rate we anticipate, or could decline. IF OUR RESEARCH AND DEVELOPMENT EFFORTS ARE NOT SUCCESSFUL, OUR NET REVENUES COULD DECLINE AND OUR BUSINESS COULD BE HARMED. For the year ended June 30, 2004, we incurred $7.8 million in research and development expenses, which comprised 16.0% of our net revenues. If we are unable to develop new products as a result of this effort, or if the products we develop are not successful, our business could be harmed. Even if we do develop new products that are accepted by our target markets, we do not know whether the net revenue from these products will be sufficient to justify our investment in research and development. IF A MAJOR CUSTOMER CANCELS, REDUCES, OR DELAYS PURCHASES, OUR NET REVENUES MIGHT DECLINE AND OUR BUSINESS COULD BE ADVERSELY AFFECTED. Our top five customers accounted for 38% of our net revenues for the year ended June 30, 2004. One customer, Ingram Micro, Inc., accounted for approximately 14%, 11% and 12% of our net revenues for the years ended June 30, 2004, 2003 and 2002, respectively. Another customer, Tech Data, accounted for approximately 9%, 10% and 11% of our net revenues for the years ended June 30, 2004, 2003 and 2002, respectively. Accounts receivable attributable to these two domestic customers accounted for approximately 13% and 16% of total accounts receivable at June 30, 2004 and 2003, respectively. The number and timing of 33 sales to our distributors have been difficult for us to predict. While our distributors are customers in the sense they buy our products, they are also part of our product distribution system. To some extent, the business lost for some reason to a distributor would likely be replaced by sales to other customer/distributors in a reasonable period, rather than a total loss of that business such as from a customer who used our products in their business. The loss or deferral of one or more significant sales in a quarter could harm our operating results. We have in the past, and might in the future, lose one or more major customers. If we fail to continue to sell to our major customers in the quantities we anticipate, or if any of these customers terminate our relationship, our reputation, the perception of our products and technology in the marketplace and the growth of our business could be harmed. The demand for our products from our OEM, VAR and systems integrator customers depends primarily on their ability to successfully sell their products that incorporate our device networking solutions technology. Our sales are usually completed on a purchase order basis and we have no long-term purchase commitments from our customers. Our future success also depends on our ability to attract new customers, which often involves an extended process. The sale of our products often involves a significant technical evaluation, and we often face delays because of our customers' internal procedures used to evaluate and deploy new technologies. For these and other reasons, the sales cycle associated with our products is typically lengthy, often lasting six to nine months and sometimes longer. Therefore, if we were to lose a major customer, we might not be able to replace the customer on a timely basis or at all. This would cause our net revenues to decrease and could cause the price of our stock to decline. THE AVERAGE SELLING PRICES OF OUR PRODUCTS MIGHT DECREASE, WHICH COULD REDUCE OUR GROSS MARGINS. In the past, we have experienced some reduction in the average selling prices and gross margins of products and we expect that this will continue for our products as they mature. In the future, we expect competition to increase, and we anticipate this could result in additional pressure on our pricing. Our average selling prices for our products might decline as a result of other reasons, including promotional programs and customers who negotiate price reductions in exchange for longer-term purchase commitments. We also may not be able to increase the price of our products in the event that the prices of components or our overhead costs increase. Changes in exchange rates between currencies might change in such a way or over a period such that we cannot adjust prices to maintain gross margins. If these were to occur, our gross margins would decline. In addition, we may not be able to reduce the cost to manufacture our products to keep up with the decline in prices. UNDETECTED PRODUCT ERRORS OR DEFECTS COULD RESULT IN LOSS OF NET REVENUES, DELAYED MARKET ACCEPTANCE AND CLAIMS AGAINST US. We currently offer warranties ranging from ninety days to two years on each of our products. Our products could contain undetected errors or defects. If there is a product failure, we might have to replace all affected products without being able to book revenue for replacement units, or we may have to refund the purchase price for the units. Because of our recent introduction of our line of device servers, we do not have a long history with which to assess the risks of unexpected product failures or defects for this product line. Regardless of the amount of testing we undertake, some errors might be discovered only after a product has been installed and used by customers. Any errors discovered after commercial release could result in loss of net revenues and claims against us. Significant product warranty claims against us could harm our business, reputation and financial results and cause the price of our stock to decline. THERE IS A RISK THAT THE SEC COULD LEVY FINES AGAINST US, OR DECLARE US TO BE OUT OF COMPLIANCE WITH THE RULES REGARDING OFFERING SECURITIES TO THE PUBLIC. The SEC is investigating the events surrounding the restatement of our financial statements filed on June 25, 2002 for the year ended June 30, 2001 and for the six months ended December 31, 2002. The SEC could conclude that we violated the rules of the Securities Act of 1933 or the Securities and Exchange Act of 1934. In either event, the SEC might levy civil fines against us, or might conclude that we lack sufficient internal controls to warrant our being allowed to continue offering our shares to the public. This investigation involves substantial cost and could significantly divert the attention of management. These costs, and the cost of any fines imposed by the SEC, are not covered by insurance. In addition to sanctions imposed by the SEC, an adverse determination could significantly damage our reputation with customers and vendors, and harm our employees' morale. 34 WE INCORPORATE SOFTWARE LICENSED FROM THIRD PARTIES INTO SOME OF OUR PRODUCTS AND ANY SIGNIFICANT INTERRUPTION IN THE AVAILABILITY OF THESE THIRD-PARTY SOFTWARE PRODUCTS OR DEFECTS IN THESE PRODUCTS COULD REDUCE THE DEMAND FOR, OR PREVENT THE SALE OR USE OF, OUR PRODUCTS. Certain of our products contain components developed and maintained by third-party software vendors or available through the "open source" software community. We also expect that we may incorporate software from third-party vendors and open source software in our future products. Our business would be disrupted if this software, or functional equivalents of this software, were either no longer available to us or no longer offered to us on commercially reasonable terms. In either case, we would be required to either redesign our products to function with alternate third-party software or open source software, or develop these components ourselves, which would result in increased costs and could result in delays in our product shipments. Furthermore, we might be forced to limit the features available in our current or future product offerings. We presently are developing products for use on the Linux platform. The SCO Group (SCO) has filed and threatened to file lawsuits against companies that operate Linux for commercial purposes, alleging that such use of Linux infringes SCOs rights. These allegations may adversely affect the demand for the Linux platform and, consequently, the sales of our Linux-based products. WE PRIMARILY DEPEND ON FIVE THIRD-PARTY MANUFACTURERS TO MANUFACTURE SUBSTANTIALLY ALL OF OUR PRODUCTS, WHICH REDUCES OUR CONTROL OVER THE MANUFACTURING PROCESS. IF THESE MANUFACTURERS ARE UNABLE OR UNWILLING TO MANUFACTURE OUR PRODUCTS AT THE QUALITY AND QUANTITY WE REQUEST, OUR BUSINESS COULD BE HARMED AND OUR STOCK PRICE COULD DECLINE. We outsource substantially all of our manufacturing to five third-party manufacturers, Venture Electronics Services, Varian, Inc., Irvine Electronics, Inc., Uni Precision Industrial Ltd, and Universal Scientific Industrial Company, LTD. Our reliance on these third-party manufacturers exposes us to a number of significant risks, including: - - reduced control over delivery schedules, quality assurance, manufacturing yields and production costs; - - lack of guaranteed production capacity or product supply; and - - reliance on third-party manufacturers to maintain competitive manufacturing technologies. Our agreements with these manufacturers provide for services on a purchase order basis. If our manufacturers were to become unable or unwilling to continue to manufacture our products in required volumes, at acceptable quality, quantity, yields and costs, or in a timely manner, our business would be seriously harmed. As a result, we would have to attempt to identify and qualify substitute manufacturers, which could be time consuming and difficult, and might result in unforeseen manufacturing and operations problems. Moreover, if we shift products among third-party manufacturers, we may incur substantial expenses, risk material delays, or encounter other unexpected issues. For example, in the third quarter of fiscal 2003 we encountered product shortages related to the transition to a third-party manufacturer. This product shortage contributed to our net revenues falling below our publicly announced estimates. In addition, a natural disaster could disrupt our manufacturers' facilities and could inhibit our manufacturers' ability to provide us with manufacturing capacity on a timely basis, or at all. If this were to occur, we likely would be unable to fill customers' existing orders or accept new orders for our products. The resulting decline in net revenues would harm our business. We also are responsible for forecasting the demand for our individual products. These forecasts are used by our contract manufacturers to procure raw materials and manufacture our finished goods. If we forecast demand too high, we may invest too much cash in inventory and we may be forced to take a write-down of our inventory balance, which would reduce our earnings. If our forecast is too low for one or more products, we may be required to pay expedite charges which would increase our cost of revenues or we may be unable to fulfill customer orders, thus reducing net revenues and therefore earnings. BECAUSE WE ARE DEPENDENT ON INTERNATIONAL SALES FOR A SUBSTANTIAL AMOUNT OF OUR NET REVENUES, WE FACE THE RISKS OF INTERNATIONAL BUSINESS AND ASSOCIATED CURRENCY FLUCTUATIONS, WHICH MIGHT ADVERSELY AFFECT OUR OPERATING RESULTS. Net revenues from international sales represented 31%, 24% and 17% of net revenues for the years ended June 30, 2004, 2003 and 2002, respectively. Net revenues from Europe represented 23%, 21% and 14% of our net revenues for the years ended June 30, 2004, 2003 and 2002, respectively. Our revenues in Japan and the People's Republic of China are increasing, as well. We expect that international revenues will continue to represent a significant portion of our net revenues in the foreseeable future. Doing business internationally involves greater expense and many additional risks. For example, because the products we sell abroad and the products and services we buy abroad are priced in foreign currencies, we are affected by fluctuating exchange rates. In the past, we have from time to time lost money because of these fluctuations. We might not successfully protect ourselves against currency rate fluctuations, and our financial performance could be harmed as a result. In addition, we face other risks of doing business internationally, including: 35 - - unexpected changes in regulatory requirements, taxes, trade laws and tariffs; - - reduced protection for intellectual property rights in some countries; - - differing labor regulations; - - compliance with a wide variety of complex regulatory requirements; - - changes in a country's or region's political or economic conditions; - - greater difficulty in staffing and managing foreign operations; and - - increased financial accounting and reporting burdens and complexities. Our international operations require significant attention from our management and substantial financial resources. We do not know whether our investments in other countries will produce desired levels of net revenues or profitability. OUR EXECUTIVE OFFICERS AND TECHNICAL PERSONNEL ARE CRITICAL TO OUR BUSINESS, AND WITHOUT THEM WE MIGHT NOT BE ABLE TO EXECUTE OUR BUSINESS STRATEGY. Our financial performance depends substantially on the performance of our executive officers and key employees. We are dependent in particular on Marc Nussbaum, who serves as our President and Chief Executive Officer, and James Kerrigan, who serves as our Chief Financial Officer. We have no employment contracts with those executives who are at-will employees. We are also dependent upon our technical personnel, due to the specialized technical nature of our business. If we lose the services of Mr. Nussbaum, Mr. Kerrigan or any of our key personnel and are not able to find replacements in a timely manner, our business could be disrupted, other key personnel might decide to leave, and we might incur increased operating expenses associated with finding and compensating replacements. THERE IS A RISK THAT OUR OEM CUSTOMERS WILL DEVELOP THEIR OWN INTERNAL EXPERTISE IN NETWORK-ENABLING PRODUCTS, WHICH COULD RESULT IN REDUCED SALES OF OUR PRODUCTS. For most of our existence, we primarily sold our products to distributors, VARs and system integrators. Although we intend to continue to use all of these sales channels, we have begun to focus more heavily on selling our products to OEMs. Selling products to OEMs involves unique risks, including the risk that OEMs will develop internal expertise in network-enabling products or will otherwise provide network functionality to their products without using our device networking solutions. If this were to occur, our stock price could decline in value and you could lose part or all of your investment. NEW PRODUCT INTRODUCTIONS AND PRICING STRATEGIES BY OUR COMPETITORS COULD ADVERSELY AFFECT OUR ABILITY TO SELL OUR PRODUCTS AND COULD REDUCE OUR MARKET SHARE OR RESULT IN PRESSURE TO REDUCE THE PRICE OF OUR PRODUCTS. The market for our products is intensely competitive, subject to rapid change and is significantly affected by new product introductions and pricing strategies of our competitors. We face competition primarily from companies that network-enable devices, semiconductor companies, companies in the automation industry and companies with significant networking expertise and research and development resources. Our competitors might offer new products with features or functionality that are equal to or better than our products. In addition, since we work with open standards, our customers could develop products based on our technology that compete with our offerings. We might not have sufficient engineering staff or other required resources to modify our products to match our competitors. Similarly, competitive pressure could force us to reduce the price of our products. In each case, we could lose new and existing customers to our competition. If this were to occur, our net revenues could decline and our business could be harmed. WE CARRY INVENTORY AND THERE IS A RISK WE MAY BE UNABLE TO DISPOSE OF THEM. Our products and therefore our inventories are subject to technological risk. At any time either new products may enter the market or prices of competitive products may be introduced with more attractive features or at lower prices than ours. There is a risk that we may be unable to sell our inventory in a timely manner to avoid their becoming obsolete. As of June 30, 2004, our inventories including raw materials, finished goods and inventory at distributors, were valued at $12.7 million and we had excess and obsolete inventory reserves of $6.0 million against these inventories. As of June 30, 2003, our inventories, including raw materials, finished goods and inventory at distributors were valued at $14.0 million and we had reserved $8.0 million against these inventories. In the event we are required to substantially discount our inventory or are unable to sell our inventory in a timely manner, we would be required to increase our reserves and our operating results could be substantially harmed. OUR INTELLECTUAL PROPERTY PROTECTION MIGHT BE LIMITED. We have not historically relied on patents to protect our proprietary rights, although we are now building a patent portfolio. We rely primarily on a combination of laws, such as copyright, trademark and trade secret laws, and contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our proprietary rights. Despite any precautions that we have taken: 36 - - laws and contractual restrictions might not be sufficient to prevent misappropriation of our technology or deter others from developing similar technologies; - - other companies might claim common law trademark rights based upon use that precedes the registration of our marks; - - other companies might assert other rights to market products using our trademarks; - - policing unauthorized use of our products and trademarks is difficult, expensive and time-consuming, and we might be unable to determine the extent of this unauthorized use; - - courts may determine that our software programs use open source software in such a way that deprives the entire programs of intellectual property protection; and - - current federal laws that prohibit software copying provide only limited protection from software pirates. Also, the laws of other countries in which we market and manufacture our products might offer little or no effective protection of our proprietary technology. Reverse engineering, unauthorized copying or other misappropriation of our proprietary technology could enable third-parties to benefit from our technology without paying us for it, which could significantly harm our business. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments for speculative or trading purposes. We place our investments in instruments that meet high credit quality standards, as specified in our investment policy. Information relating to quantitative and qualitative disclosure about market risk is set forth below and in "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources." INTEREST RATE RISK Our exposure to interest rate risk is limited to the exposure related to our cash, cash equivalents, marketable securities and our credit facilities, which is tied to market interest rates. As of June 30, 2004 and 2003, we had cash and cash equivalents of $9.1 million and $7.3 million, respectively, which consisted of cash and short-term investments with original maturities of ninety days or less, both domestically and internationally. As of June 30, 2004 and 2003, we had marketable securities of $3.1 million and $7.0 million, respectively, consisting of obligations of U.S. Government agencies, state, municipal and county government notes and bonds. We believe our marketable securities will decline in value by an insignificant amount if interest rates increase, and therefore would not have a material effect on our financial condition or results of operations. FOREIGN CURRENCY RISK We sell products internationally. As a result, our financial results could be harmed by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. INVESTMENT RISK As of June 30, 2003, we had a net investment of $5.4 million, in Xanboo, a privately held company which can still be considered in the start-up or development stage. We performed an analysis and recorded a charge in the amount of $5.0 million, representing a write-off of all remaining value of this non-marketable equity security. This charge was included within the consolidated statements of operations as other expense. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary data required by this item are incorporated by reference from Part IV, Item 15 of this Form 10-K and are presented beginning on page F-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not Applicable. 37 ITEM 9A. CONTROLS AND PROCEDURES (a) Evaluation of disclosure controls and procedures. We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")) as of the end of our fiscal year. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are sufficiently effective in ensuring that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission's rules and instructions for Form 10-K. (b) Changes in internal controls. There have been no changes in our internal control over financial reporting identified in connection with our evaluation as of the end of our fiscal year that occurred during such quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. We are aware that any system of controls, however well designed and operated, can only provide reasonable, and not absolute, assurance that the objectives of the system are met, and that maintenance of disclosure controls and procedures is an ongoing process that may change over time. 38 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) The information required by Item 10 of this Annual Report on Form 10-K with respect to identification of directors is incorporated by reference from the information contained in the section captioned "Election of Directors" in Lantronix's definitive Proxy Statement for the Annual Meeting of Stockholders to be held November 18, 2004 (the Proxy Statement), a copy of which will be filed with the Securities and Exchange Commission before the meeting date. For information with respect to the executive officers of Lantronix, see "Executive Officers of the Registrant" included in Part I, Item 4 of this report. (b) For information regarding our Directors Code of Ethics and compliance with Section 16(a) of the Securities Exchange Act of 1934, we direct you to the sections entitled Proposal I - Election of Directors, Audit Committee, Code of Ethics and Complaint Procedures and Section 16(a) Beneficial Ownership Reporting Compliance, respectively, in the Proxy Statement we will deliver to our stockholders in connection with our Annual Meeting of Stockholders to be held on November 18, 2004. We are incorporating the information contained in those sections of our Proxy Statement, herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information required by Item 11 of this Annual Report on Form 10-K is incorporated by reference from the information contained in the section captioned "Executive Compensation and Related Information" in the Proxy Statement, which we will deliver to our stockholders in connection with our Annual Meeting of Stockholders to be held on November 18, 2004. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by Item 12 of this Annual Report on Form 10-K is incorporated by reference from the information contained in the sections captioned "Election of Directors" and "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement which we will deliver to our stockholders in connection with our Annual Meeting of Stockholders to be held on November 18, 2004. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Except as set forth below, the information required by Item 13 of this Annual Report on Form 10-K is incorporated by reference from the information contained in the sections captioned "Election of Directors" and "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement which we will deliver to our stockholders in connection with our Annual Meeting of Stockholders to be held on November 18, 2004. Howard Slayen, a member of our Board of Directors also serves as our nominee to the Xanboo Board of Directors. Marc Nussbaum our Chief Executive Officer also served as a nominee to the Xanboo Board of Directors prior to his resignation from the Xanboo board in August 2003. One international customer, transtec AG, which is a related party due to common ownership by our largest stockholder and former Chairman of our Board of Directors, Bernhard Bruscha, accounted for approximately 3%, 4% and 5% of our net revenues for the years ended June 30, 2004, 2003 and 2002, respectively. We also had an agreement with transtec AG for the provision of technical support services at the rate of $7,500 per month, which has now been terminated. Included in selling, general and administrative expenses are $90,000 for the year ended June 30, 2002. No similar expenses were recorded for the years ended June 30, 2004 and 2003. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. The information under the caption "Fees Paid to Independent Auditors," appearing in the Proxy Statement which we will deliver to our stockholders in connection with our Annual Meeting of Stockholders to be held on November 18, 2004, is incorporated herein by reference. 39 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULE AND REPORTS ON 8-K. (a) 1. Consolidated Financial Statement The following financial statement schedule of the Company and related Report of Independent Registered Public Accounting Firm is filed as part of this Form 10-K.
PAGE ---------- Report of Independent Registered Public Accounting Firm. . . . . . . . . . . . . . . . . . . F-1 Consolidated Balance Sheets as of June 30, 2004 and 2003 . . . . . . . . . . . . . . . . . . . . F-2 Consolidated Statements of Operations for the years ended June 30, 2004, 2003 and 2002 . . . . . F-3 Consolidated Statements of Stockholders' Equity for the years ended June 30, 2004, 2003 and 2002 F-4 Consolidated Statements of Cash Flows for the years ended June 30, 2004, 2003 and 2002 . . . . . F-5 Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . F-6 - F-29
2. Financial Statement Schedule The following financial statement schedule of the Company and related Report of Independent Registered Public Accounting Firm is filed as part of this Form 10-K.
PAGE ----- (1) Report of Independent Registered Public Accounting Firm on Financial Statement Schedule. . . . . . . . . . . . . . . . . . . . . . S-1 (2) Schedule II-Consolidated Valuation and Qualifying Accounts. . . . . . . S-2
All other financial statement schedules have been omitted because they are not applicable, not required, or the information is included in the consolidated financial statements or notes thereto. 3. Exhibits The exhibits listed on the accompanying index to exhibits immediately follow the financial statements are filed as part of, or hereby incorporated by reference into, this Form 10-K. (b) Reports on Form 8-K. We filed the following current reports on Form 8-K during the quarter ended June 30, 2004: Form 8-K filed on April 2, 2004, Lantronix, reporting the Company's sale of its Premise software unit assets to an undisclosed buyer for $1.0 million in cash. Form 8-K filed on May 7, 2004 reporting the results of the Company's third fiscal quarter ended March 31, 2004, with selected consolidated balance sheet data and selected unaudited consolidated statement of operations data. 40 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Stockholders Lantronix, Inc. We have audited the accompanying consolidated balance sheets of Lantronix, Inc. as of June 30, 2004 and 2003, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended June 30, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Lantronix, Inc. at June 30, 2004 and 2003, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 2004, in conformity with U.S. generally accepted accounting principles. As discussed in Note 5, effective July 1, 2001, the Company adopted the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets." /s/ ERNST & YOUNG LLP Orange County, California September 10, 2004 F-1 LANTRONIX, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30, -------- 2004 2003 --------- --------- ASSETS Current assets: Cash and cash equivalents $ 9,128 $ 7,328 Marketable securities 3,050 6,750 Accounts receivable (net of allowance for doubtful accounts of $177 and $572 at June 30, 2004 and 2003, respectively) 3,242 3,818 Inventories 6,677 6,011 Contract manufacturers receivable (net of allowance of $38 and $62 at June 30, 2004 and 2003, respectively) 999 1,744 Prepaid expenses and other current assets 1,450 3,834 Assets of discontinued operations - 3,590 ---------- ---------- Total current assets 24,546 33,075 Property and equipment, net 865 2,384 Goodwill 9,488 9,488 Purchased intangible assets, net 2,056 4,275 Long-term investments - 5,458 Officer loans (net of allowance of $4,470 at June 30, 2004 and 2003, respectively) 110 104 Other assets 185 163 ---------- ---------- Total assets $ 37,250 $ 54,947 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 4,049 $ 4,774 Accrued payroll and related expenses 1,599 1,185 Due to Gordian - 1,000 Accrued litigation settlement - 1,533 Warranty reserve 1,770 1,193 Restructuring reserve 752 3,235 Other current liabilities 2,922 2,604 Liabilities of discontinued operations - 239 Convertible note payable 867 - Bank line of credit 500 - ---------- ---------- Total current liabilities 12,459 15,763 Deferred income taxes - 600 Convertible note payable - 867 Commitments and contingencies Stockholders' equity: Preferred stock, $0.0001 par value; 5,000,000 shares authorized; none issued and outstanding - - Common stock, $0.0001 par value; 200,000,000 shares authorized; 58,154,747 and 55,425,774 shares issued and outstanding at June 30, 2004 and 2003, respectively 6 6 Additional paid-in capital 180,712 178,628 Deferred compensation (103) (695) Accumulated deficit (156,078) (140,424) Accumulated other comprehensive gain 254 202 ---------- ---------- Total stockholders' equity 24,791 37,717 ---------- ---------- Total liabilities and stockholders' equity $ 37,250 $ 54,947 ========== ==========
See accompanying notes. F-2 LANTRONIX, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED JUNE 30, -------------------- 2004 2003 2002 --------- --------- --------- Net revenues (A) $ 48,885 $ 49,389 $ 57,591 Cost of revenues (B) 25,026 36,264 40,281 --------- --------- --------- Gross profit 23,859 13,125 17,310 --------- --------- --------- Operating expenses: Selling, general and administrative (C) 23,293 28,660 40,538 Research and development (C) 7,813 9,430 8,680 Stock-based compensation (B) (C) 347 1,453 2,863 Amortization of purchased intangible assets 148 602 960 Impairment of goodwill and purchased intangible assets - 2,353 50,445 Restructuring (recovery) charges (2,093) 5,600 3,473 Litigation settlement costs - 1,533 1,912 --------- --------- --------- Total operating expenses 29,508 49,631 108,871 --------- --------- --------- Loss from operations (5,649) (36,506) (91,561) Interest income (expense), net 50 248 1,548 Other income (expense), net (5,333) (926) (760) --------- --------- --------- Loss before income taxes and cumulative effect of an accounting change (10,932) (37,184) (90,773) Provision (benefit) for income taxes (325) 250 (6,665) --------- --------- --------- Loss from continuing operations before cumulative effect of an accounting change (10,607) (37,434) (84,108) Loss from discontinued operations (5,047) (10,115) (3,444) --------- --------- --------- Loss before cumulative effect of an accounting change (15,654) (47,549) (87,552) Cumulative effect of adoption of new accounting standard, SFAS No. 142 - - (5,905) --------- --------- --------- Net loss $(15,654) $(47,549) $(93,457) ========= ========= ========= Basic and diluted loss per share from continuing operations before cumulative effect of an accounting change $ (0.19) $ (0.69) $ (1.63) Loss from discontinued operations (0.09) (0.19) (0.07) --------- --------- --------- Loss before cumulative effect of an accounting change (0.28) (0.88) (1.70) Cumulative effect of adoption of new accounting standard, SFAS No. 142 - - (0.12) --------- --------- --------- Basic and diluted net loss per share $ (0.28) $ (0.88) $ (1.82) ========= ========= ========= Weighted average shares (basic and diluted) 56,862 54,329 51,403 ========= ========= ========= (A) Includes revenues from related parties $ 1,416 $ 1,845 $ 2,644 ========= ========= ========= (B) Cost of revenues includes the following: Amortization of purchased intangible assets $ 2,071 $ 3,619 $ 2,223 Impairment of purchased intangible assets - 3,082 6,448 Stock-based compensation 48 89 117 --------- --------- --------- $ 2,119 $ 6,790 $ 8,788 ========= ========= ========= (C) Stock-based compensation is excluded from the following: Selling, general and administrative expenses $ 306 $ 1,074 $ 2,086 Research and development expenses 41 379 777 --------- --------- --------- $ 347 $ 1,453 $ 2,863 ========= ========= =========
See accompanying notes. F-3
LANTRONIX, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE DATA) ACCUM- NOTES RETAINED ULATED ADDI- RECEI- EARNINGS OTHER TOTAL COMMON STOCK TIONAL VABLE DEFERRED (ACCUM- COMPRE- STOCK -------------------- PAID-IN FROM COMPEN- ULATED HENSIVE HOLDERS' SHARES AMOUNT CAPITAL OFFICERS SATION DEFICIT) GAIN (LOSS) EQUITY ----------- ------- --------- ---------- ---------- ---------- ------------ ---------- Balance at June 30, 2001 43,301,803 $ 4 $109,871 $ (790) $ (10,020) $ 582 $ (151) $ 99,496 Issuance of common stock in secondary public offering 6,400,500 1 47,085 - - - - 47,086 Stock options exercised 1,073,452 - 1,619 - - - - 1,619 Employee stock purchase plan 178,687 - 437 - - - - 437 Deferred compensation, net - - (1,899) - 1,899 - - - Stock-based compensation - - - - 3,575 - - 3,575 Repayment of notes receivable - - - 513 - - - 513 Provision for notes receivable from officers - - - 249 - - - 249 Purchase transactions 3,298,086 - 22,941 - - - - 22,941 Repurchase of common stock - - (507) - - - - (507) Components of comprehensive loss: Translation adjustment - - - - - - 73 73 Change in net unrealized loss on investment - - - - - - 132 132 Net loss - - - - - (93,457) - (93,457) ---------- Comprehensive loss (93,252) ----------- ------- --------- ---------- ---------- ---------- ------------ ---------- Balance at June 30, 2002 54,252,528 5 179,547 (28) (4,546) (92,875) 54 82,157 Stock options exercised 152,004 - 37 - - - - 37 Repurchase of common stock (448,335) - - - - - - - Employee stock purchase plan 406,205 - 280 - - - - 280 Deferred compensation, net - - (2,310) - 2,548 - - 238 Stock-based compensation - - - - 1,303 - - 1,303 Repayment of notes receivable - - - 28 - - - 28 Premise settlement 1,063,372 1 1,074 - - - - 1,075 Components of comprehensive loss: Translation adjustment - - - - - - 148 148 Net loss - - - - - (47,549) - (47,549) ---------- Comprehensive loss (47,401) ----------- ------- --------- ---------- ---------- ---------- ------------ ---------- Balance at June 30, 2003 55,425,774 6 $178,628 (-) (695) (140,424) 202 37,717 Stock options exercised 496,335 - 359 - - - - 359 Employee stock purchase plan 505,935 - 369 - - - - 369 Deferred compensation, net - - (197) - 197 - - - Stock-based compensation - - - - 395 - - 395 Dunstan settlement 1,726,703 - 1,553 - - - - 1,553 Components of comprehensive loss: Translation adjustment - - - - - - 52 52 Net loss - - - - - (15,654) - (15,654) ---------- Comprehensive loss (15,602) ---------- Balance at June 30, 2004 58,154,747 $ 6 $180,712 $ (-) $ (103) $(156,078) $ 254 $ 24,791 =========== ======= ========= ========== ========== ========== ============ ========== See accompanying notes.
F-4 LANTRONIX, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEARS ENDED JUNE 30, -------------------- 2004 2003 2002 --------- --------- --------- Cash flows from operating activities: Net loss from continuing operations $(10,607) $(37,434) $(90,013) Net loss from discontinued operations (5,047) (10,115) (3,444) Adjustments to reconcile net loss to net cash used in operating activities: Cumulative effect of adoption of new accounting standard, SFAS No. 142 - - 5,905 Depreciation 1,742 2,361 2,465 Amortization of purchased intangible assets 2,219 4,221 3,709 Impairment of goodwill and purchased intangible assets - 5,435 57,276 Stock-based compensation 395 1,542 2,980 Deferred income taxes (600) - (5,594) Provision for officer loans - - 4,403 Loss on sale of long-term investment 31 - - Restructuring (recovery) charges (1,551) 5,600 3,473 Litigation settlement costs - 1,533 1,912 Equity losses from unconsolidated businesses 413 1,303 1,002 Provision for doubtful accounts (164) (473) 1,680 Provision for inventory reserves 368 4,189 3,443 Revaluation of strategic investment 5,007 - 500 Loss on disposal of assets 25 - - Changes in operating assets and liabilities, net of effect from acquisitions: Accounts receivable 708 2,875 2,557 Inventories 199 581 (456) Contract manufacturers receivable 777 (154) - Prepaid expenses and other current assets 1,173 1,729 (1,034) Other assets (28) 148 (2,404) Accounts payable (725) 195 (3,857) Due to related party - (246) (541) Due to Gordian (1,000) (2,000) 3,000 Accrued Lightwave settlement - (2,004) - Warranty reserve 577 714 (83) Restructuring reserve (932) (2,772) Net assets of discontinued operations 3,351 7,108 1,790 Other current liabilities 732 (1,906) (590) --------- --------- --------- Net cash used in operating activities (2,937) (17,570) (12,830) --------- --------- --------- Cash flows from investing activities: Purchases of property and equipment, net (248) (222) (2,750) Purchases of marketable securities (552) (11,000) (9,490) Purchase of intellectual property - - (6,000) Purchases of minority investments - - (7,288) Proceeds from sale of long-term investment 7 Proceeds from sale of marketable securities 4,252 11,250 4,500 Acquisition of businesses, net of cash acquired - (2,114) (4,746) --------- --------- --------- Net cash used in investing activities 3,459 (2,086) (25,774) --------- --------- --------- Cash flows from financing activities: Net proceeds from underwritten offerings of common stock - - 47,085 Net proceeds from other issuances of common stock 726 317 2,057 Proceeds from repayment of notes receivable from officers - 28 513 Borrowings on revolving line of credit 500 - - --------- --------- --------- Net cash provided by financing activities 1,226 345 49,655 Effect of exchange rates on cash 52 148 73 --------- --------- --------- Net increase (decrease) in cash 1,800 (19,163) 11,124 Cash and cash equivalents at beginning of year 7,328 26,491 15,367 --------- --------- --------- Cash and cash equivalents at end of year $ 9,128 $ 7,328 $ 26,491 ========= ========= ========= Supplemental disclosure of cash flow information: Interest paid $ 43 $ 13 $ 49 Income taxes paid $ 485 $ 49 $ 210 See accompanying notes.
F-5 LANTRONIX, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2004 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Company Lantronix, Inc. (the "Company"), incorporated in California in June 1989 and re-incorporated in the State of Delaware in May 2000, is engaged primarily in the design and distribution of networking and Internet connectivity products on a worldwide basis. The actual assembly and a portion of the engineering of the Company's products are outsourced to third parties. The Company has incurred losses from operations and has reported negative operating cash flows. As of June 30, 2004, the Company had an accumulated deficit of $156.1 million and cash, cash equivalents and marketable securities of $12.2 million. The Company has no material financial commitments other than $500,000 in borrowings under a line of credit, $867,000 convertible note payable which was paid in August 2004, operating lease agreements and inventory purchase orders. The Company believes that its existing cash, cash equivalents and marketable securities, and any cash generated from operations will be sufficient to fund its working capital requirements, capital expenditures and other obligations through the next 12 months. Long term the Company may face significant risks associated with the successful execution of its business strategy and may need to raise additional capital in order to fund more rapid expansion, to expand its marketing activities, to develop new or enhance existing services or products, and to respond to competitive pressures or to acquire complementary services, businesses, or technologies. If the Company is not successful in generating sufficient cash flow from operations, it may need to raise additional capital through public or private financing, strategic relationships, or other arrangements. Basis of Presentation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. At June 30, 2004, approximately $2.9 million of the Company's net tangible assets (primarily cash held in foreign bank accounts) were located outside the United States. Such assets are unrestricted with regard to foreign liquidity needs, however, the ability of the Company to utilize such assets to satisfy liquidity needs outside of such foreign locations are subject to approval by the foreign location board of directors. In March 2004, the Company completed the sale of substantially all of the net assets of Premise Systems, Inc. ("Premise") (Note 7). The Company's consolidated financial statements have been presented to reflect Premise as a discontinued operation for all periods. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The industry in which the Company operates is characterized by rapid technological change and short product life cycles. As a result, estimates made in preparing the financial statements include the allowance for doubtful accounts, sales returns and allowances, inventory reserves, allowance for officer loans, strategic investments, goodwill and purchased intangible asset valuations, deferred income tax asset valuation allowances, warranty reserves, restructuring costs, litigation and other contingencies. To the extent there are material differences between estimates and the actual results, future results of operations will be affected. Revenue Recognition The Company does not recognize revenue until all of the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; the Company's price to the buyer is fixed or determinable; and collectibility is reasonably assured. Commencing July 1, 2000, the Company adopted a new accounting policy for revenue recognition such that recognition of revenue and related gross profit from sales to distributors are deferred until the distributor resells the product. Net revenue from certain smaller distributors, for which point-of-sale information is not available, is recognized one month after the shipment date. This estimate approximates the timing of the sale of the product by the distributor to the end user. When product sales revenue is recognized, the Company establishes an estimated allowance for future product returns based on historical returns experience; when price reductions are approved, it establishes an estimated liability for price protection payable on inventories owned by product resellers. Should actual product returns or pricing adjustments exceed the Company's estimates, F-6 additional reductions to revenues would result. Revenue from the licensing of software is recognized at the time of shipment (or at the time of resale in the case of software products sold through distributors), provided the Company has vendor-specific objective evidence of the fair value of each element of the software offering and collectibility is probable. Revenue from post contract customer support and any other future deliverables is deferred and recognized over the support period or as contract elements are delivered. The Company's products typically carry a ninety day to two year warranty. Although the Company engages in extensive product quality programs and processes, its warranty obligation is affected by product failure rates, use of materials or service delivery costs that differ from our estimates. As a result, additional warranty reserves could be required, which could reduce gross margins. Additionally, the Company sells extended warranty services which extend the warranty period for an additional one to three years. Warranty revenue is recognized evenly over the warranty service period. Allowance for Doubtful Accounts The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. The Company's allowance for doubtful accounts is based on its assessment of the collectibility of specific customer accounts, the aging of accounts receivable, the Company's history of bad debts and the general condition of the industry. If a major customer's credit worthiness deteriorates, or the Company's customers' actual defaults exceed its historical experience, its estimates could change and impact its reported results. The Company also maintains a reserve for uncertainties relative to the collection of officer notes receivable. Factors considered in determining the level of this reserve include the value of the collateral securing the notes, our ability to effectively enforce collection rights and the ability of the former officers to honor their obligations. F-7 Concentration of Credit Risk The Company's accounts receivable are derived from revenues earned from customers located throughout North America, Europe and Asia. The Company performs ongoing credit evaluations of its customers' financial condition and maintains allowances for potential credit losses. Credit losses have historically been within management's expectations. The Company generally does not require collateral or other security from its customers. The Company invests its excess cash in deposits with major banks, in U.S. Government agencies, state, municipal and county governments notes and bonds. Fair Value of Financial Instruments The Company's financial instruments consist principally of cash, cash equivalents, marketable securities, accounts receivable, notes receivable, contract manufacturer receivable, accounts payable, convertible debt, bank line of credit and accrued liabilities. The Company believes all of the financial instruments' recorded values approximate current values because of the short maturities of these investments. Marketable Securities The Company classifies its marketable securities as available for sale. Marketable securities consist of obligations of U.S. Government agencies, state, municipal and county governments notes and bonds which can be readily converted to cash. Foreign Currency Translation The financial statements of foreign subsidiaries whose functional currency is not the U.S. dollar have been translated to U.S. dollars in accordance with Statement of Financial Accounting Standards ("SFAS") No. 52, "Foreign Currency Translation." Foreign currency assets and liabilities are remeasured into U.S. dollars at the end-of-period exchange rates. Revenues and expenses are translated at average exchange rates in effect during each period, except for those expenses related to balance sheet amounts, which are translated at historical exchange rates. Exchange gains and losses from foreign currency translations are reported as a component of accumulated other comprehensive gain (loss) within stockholders' equity. Exchange gains and losses from foreign currency transactions are recognized in the consolidated statement of operations and historically have not been material. Cash and Cash Equivalents Cash and cash equivalents consist of cash and short-term investments with original maturities of ninety days or less. Investments The Company accounts for its investments in debt and equity securities with readily determinable fair values that are not accounted for under the equity method of accounting under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Management determines the appropriate classification of such securities at the time of purchase and reevaluates such classification as of each balance sheet date. The investments are adjusted for amortization of premiums and discounts to maturity and such amortization is included in interest income. In September and October 2001, the Company paid an aggregate of $3.0 million to Xanboo Inc. ("Xanboo") for convertible promissory notes, which converted in January 2002, in accordance with their terms, into Xanboo preferred stock. In addition, the Company purchased $4.0 million of Xanboo preferred stock in January 2002. The Company's ownership interest in Xanboo was 14.9% and 15.3% at June 30, 2004 and 2003, respectively. The Company is accounting for this long-term investment under the equity method based upon the Company's ability, through representation on Xanboo's board of directors, to exercise significant influence over its operations. The Company's interest in the losses of Xanboo aggregating $413,000, $1.3 million and $526,000 during the years ended June 30, 2004, 2003 and 2002, respectively, have been recognized as other expense in the accompanying consolidated statement of operations. F-8 The Company periodically reviews its investments for which fair value is less than cost to determine if the decline in value is other than temporary. If the decline in value is judged to be other than temporary, the cost basis of the security is written down to fair value. The Company generally believes an other-than-temporary decline has occurred when the fair value of the investment is below the carrying value for two consecutive quarters, absent evidence to the contrary. On the basis of events occurring during the quarter ended June 30, 2004, the Company performed an analysis and recorded a charge in the amount of $5.0 million, representing a write-off of all remaining value of this non-marketable equity security. This charge was included within the consolidated statements of operations as other expense. During the year ended June 30, 2002, the Company recorded a $500,000 impairment charge related to another non-marketable equity investment resulting from an other-than-temporary decline in its value. This amount was included within the consolidated statements of operations as other expense. Inventories Inventories are stated at the lower of cost (on a first-in, first-out basis) or market. The Company provides reserves for excess and obsolete inventories determined primarily based upon estimates of future demand for the Company's products. Shipping and handling costs are classified as a component of cost of revenues in the consolidated statements of operations. Property and Equipment Property and equipment are carried at cost. Depreciation is provided using the straight-line method over the assets' estimated useful lives ranging from three to five years. Depreciation and amortization of leasehold improvements are computed using the shorter of the remaining lease term or five years. Major renewals and betterments are capitalized, while replacements, maintenance and repairs which do not improve or extend the lives of the respective assets are expensed as incurred. Long-Lived Assets Long-lived assets and certain identifiable intangible assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Capitalized Internal Use Software Costs The Company capitalizes the costs of computer software developed or obtained for internal use in accordance with AICPA Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." Capitalized computer software costs consist of purchased software licenses and implementation costs. At June 30, 2004 and 2003, $75,000 and $734,000, respectively, are included in computer and office equipment in the accompanying consolidated balance sheet. The capitalized software costs are being amortized on a straight-line basis over a period of three years. Amortization for the years ended June 30, 2004, 2003 and 2002 totaled $659,000, $776,000 and $999,000, respectively. Capitalized internal use software with a net carrying amount of approximately $107,000 and $898,000 were written off for the years ended June 30, 2003 and 2002, respectively, as a result of the Company's fiscal 2003 and 2002 restructuring plans (Note 6). No similar write-offs were recorded for the year ended June 30, 2004. Income Taxes Income taxes are computed under the liability method. This method requires the recognition of deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled and are reflected in the consolidated financial statements in the period of enactment. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized. Stock-Based Compensation The Company accounts for stock-based awards to employees in accordance with Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and related interpretations, and has adopted the disclosure-only alternative of SFAS No. 123, "Accounting for Stock-Based Compensation ("SFAS No. 123"), and SFAS No. 148, "Accounting for Stock-Based F-9 Compensation Transition and Disclosure ("SFAS No. 148"). Options granted to non-employees, as defined, have been accounted for at fair market value in accordance with SFAS No. 123. The Company also complies with Financial Accounting Standards Board ("FASB") Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation - An Interpretation of APB Opinion No. 25", ("FIN 44"). FIN 44 clarifies the definition of an employee for purposes of applying APB 25, the criteria for determining whether a plan qualifies as a noncompensatory plan, the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and the accounting for an exchange of stock compensation awards in a business combination. For stock option grants to non-employees who are consultants to the Company, the Company complies with the provisions of Emerging Issues Task Force ("EITF") Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with, Selling Goods or Services" ("EITF 96-18"). EITF 96-18 requires variable plan accounting with respect to such non-employee stock options, whereby compensation associated with such options is measured on the date such options vest, and incorporates the then-current fair market value of the Company's common stock into the option valuation model. Pro forma information regarding net income loss per share is required by SFAS No. 123 and has been determined as if the Company had accounted for its employee stock options under the fair value method of SFAS No. 123. The value of the Company's stock-based awards granted to employees prior to the Company's initial public offering in August 2000 was estimated using the minimum value method, which does not consider stock price volatility. Stock-based awards granted subsequent to the initial public offering have been valued using the Black-Scholes option pricing model. Among other things, the Black-Scholes model considers the expected volatility of the Company's stock price, determined in accordance with SFAS No. 123, in arriving at an option valuation. Estimates and other assumptions necessary to apply the Black-Scholes model may differ significantly from assumptions used in calculating the value of options granted prior to the initial public offering under the minimum value method. The fair value of options granted to employees after the initial public offering have been estimated with the following weighted average assumptions:
YEARS ENDED JUNE 30, -------------------- 2004 2003 2002 ------ ------ ------ Expected life (in years) . . 4.00 4.00 4.00 Volatility . . . . . . . . . 1.24 1.28 1.31 Risk-free interest rate. . . 3.60% 1.90% 4.10% Dividend yield . . . . . . . 0.00% 0.00% 0.00% Weighted average fair value. $1.09 $0.68 $3.81
For pro forma purposes, the estimated value of the Company's stock-based awards to employees is amortized over the vesting period of the underlying instruments. The results of applying SFAS No. 123 to the Company's stock-based awards to employees would approximate the following: YEARS ENDED JUNE 30, ------------------------- 2004 2003 2002 ----- ----- ----- (in thousands, except per share data) Net loss: As reported $(15,654) $(47,549) $(93,457) Pro forma (18,351) (52,311) (97,708) Basic and diluted net loss per share: As reported $ (0.28) $ (0.88) $ (1.82) Pro forma (0.32) (0.96) (1.90) F-10 Loss Per Share Basic and diluted loss per share is calculated by dividing net loss by the weighted average number of common shares outstanding during the year.
YEARS ENDED JUNE 30, ------------------------------- 2004 2003 2002 --------- --------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Numerator: Loss from continuing operations before cumulative effect of an accounting change $(10,607) $(37,434) $(84,108) Loss from discontinued operations (5,047) (10,115) (3,444) --------- --------- --------- Loss before cumulative effect of an accounting change (15,654) (47,549) (87,552) Cumulative effect of adoption of new accounting standard, SFAS No. 142 - - (5,905) --------- --------- --------- Net loss $(15,654) $(47,549) $(93,457) ========= ========= ========= Denominator: Weighted-average shares outstanding 57,194 54,661 51,909 Less: Non-vested common shares outstanding (332) (332) (506) --------- --------- --------- Denominator for basic and diluted loss per share 56,862 54,329 51,403 ========= ========= ========= Basic and diluted loss per share from continuing operations before cumulative effect of an accounting change $ (0.19) $ (0.69) $ (1.63) Loss from discontinued operations (0.09) (0.19) (0.07) --------- --------- --------- Loss before cumulative effect of an accounting change (0.28) (0.88) (1.70) Cumulative effect of adoption of new accounting standard, SFAS No. 142 - - (0.12) --------- --------- --------- Basic and diluted net loss per share $ (0.28) $ (0.88) $ (1.82) ========= ========= =========
Common share equivalents of 1,126,503, 453,053 and 359,222 have been excluded from the diluted net loss per share calculation for the years ended June 30, 2004, 2003 and 2002, respectively, because they were antidilutive as of such dates. These excluded common stock equivalents could be dilutive in the future. Research and Development Costs Costs incurred in the research and development of new products and enhancements to existing products are expensed as incurred. The Company believes its current process for developing products is essentially completed concurrently with the establishment of technological feasibility. Software development costs incurred after the establishment of technological feasibility have not been material and, therefore, have been expensed as incurred. Warranty Upon shipment to its customers, the Company provides for the estimated cost to repair or replace products to be returned under warranty. The Company's current warranty periods generally range from ninety days to two years from the date of shipment. In addition, the Company also sells extended warranty services which extend the warranty period for an additional one to three years. Advertising Costs The Company expenses advertising costs as incurred. Advertising expense was approximately $392,000, $336,000, and $703,000 for the years ended June 30, 2004, 2003 and 2002, respectively. Comprehensive Income SFAS No. 130, "Reporting Comprehensive Income" establishes standards for reporting and displaying comprehensive income (loss), and its components in the consolidated financial statements. Other accumulated comprehensive loss includes foreign currency translation adjustments and unrealized losses on investments. F-11 Segment Information SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" establishes standards for the way companies report information about operating segments in annual financial statements. It also establishes standards for related disclosures about products and services, geographic areas and major customers. The Company has only one reportable segment, networking and internet connectivity. Reclassifications Certain amounts in the 2003 and 2002 consolidated financial statements have been reclassified to conform with current year presentation. Recent Accounting Pronouncements In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51," ("FIN 46"). FIN 46 requires certain variable interest entities ("VIE") to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new VIEs created or acquired after January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period ending March 15, 2004. The Company reviewed its investments and other arrangements and determined that none of its investee companies are VIE's. In May 2003, the FASB issued SFAS No. 150, "Accounting For Certain Financial Instruments with Characteristics of Both Liabilities and Equity" ("SFAS No. 150") which establishes standards for how an issuer of financial instruments classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) if, at inception, the monetary value of the obligation is based solely or predominantly on a fixed monetary amount known at inception, variations in something other than the fair value of the issuer's equity shares or variations inversely related to changes in the fair value of the issuer's equity shares. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have a material impact on the Company's financial position, results of operations or cash flows. 2. BUSINESS COMBINATIONS During fiscal year 2002, the Company completed the acquisitions of Synergetic Micro Systems, Inc. ("Synergetic") and Premise Systems, Inc. ("Premise"). During fiscal year 2003, the Company completed the acquisition of Stallion Technologies PTY, LTD ("Stallion"). These acquisitions have been accounted for under the purchase method of accounting. The consolidated financial statements include the results of operations of these acquisitions after their dates of acquisition. The acquisition of Synergetic provides the Company with high-performance embedded chips to complement its device networking products. The acquisition of Stallion complements the Company's existing multiport and terminal server product lines. F-12 A summary of transactions accounted for using the purchase method of accounting is outlined below:
SHARES TOTAL RESERVED SHARES DATE SHARES FOR OPTIONS ISSUED OR CASH COMPANY ACQUIRED ACQUIRED BUSINESS ISSUED ASSUMED RESERVED CONSIDERATION - ---------------- --------- --------------------- --------- ----------- --------- ------------- Embedded network Communications Synergetic Oct. 2001 solutions provider 2,234,715 615,705 2,850,420 $2.7 million Developer of client side software Premise Jan. 2002 applications 1,063,371 875,000 1,938,371 - Provider of terminal servers and multiport Stallion Aug. 2002 products - - - 2.1 million
The share issuances were exempt from registration pursuant to section 4(2) of the Securities Act of 1933, as amended. Portions of the cash consideration and shares issued were held in escrow pursuant to the terms of the acquisition agreements. The Premise agreement required the Company to issue 1,150,000 shares of common stock in exchange for all remaining shares of Premise. Prior to the acquisition, the Company held shares of Premise representing 19.9% ownership and, in addition, held convertible promissory notes of $1.2 million with interest accrued thereon at the rate of 9.0%. The convertible promissory notes were converted into equity securities of Premise at the closing of the transaction. The Company issued an aggregate of 1,063,371 shares of its common stock in exchange for all remaining outstanding shares of Premise common stock and reserved 875,000 additional shares of common stock for issuance upon exercise of outstanding employee stock options and other rights of Premise. Refer to Note 7 for the discontinued operations of Premise. The Stallion agreement required the Company to pay $1.2 million in cash consideration and establish a cash escrow account in the amount of $867,000 at the acquisition date to be used in lieu of the Company's common stock in the event that the Company was unable to issue registered shares by October 31, 2002. In accordance with the terms of the acquisition agreement, the Company was not able to issue registered shares by October 31, 2002; accordingly, the cash escrow amount of $867,000 was released on November 1, 2002. In addition, the Company issued a two-year note in the principal amount of $867,000, which is due in August 2004 (Note 8). The Company relied on the exemption in Section 4 (2) of the Securities Act of 1933 in that the offering of the convertible note was not a public offering. Allocation of Purchase Consideration For each of the three purchase transactions, the Company obtained independent appraisals of the fair value of the tangible and intangible assets acquired in order to allocate the purchase price. Based upon those appraisals, the purchase price was allocated as follows (in thousands):
NET TANGIBLE ------------- ASSETS (LIABILITIES) PURCHASED DEFERRED DEFERRED TAX TOTAL ----------- ------------- COMPANY ACQUIRED ACQUIRED GOODWILL INTANGIBLES COMPENSATION LIABILITIES IPR&D CONSIDERATION - ---------------- ------------- -------- ----------- ------------ ------------- ----- ------------- Synergetic $ (233) $ 13,952 $ 11,100 $ 203 $ (5,213) $ - $ 19,809 Premise (79) 6,593 3,700 - (1,480) 1,000 9,734 Stallion (93) 2,270 1,500 - (600) - 3,077
The consideration for the purchase transactions was calculated as follows: a) common shares issued were valued based upon the Company's stock price for a short period just before and after the companies reached agreement and the proposed transactions were announced and b) employee stock options were valued in accordance with FIN 44. Net tangible assets acquired in connection with the purchase transactions include the acquisition costs incurred by the Company. Additionally, the net tangible assets of Synergetic reflect an outstanding credit facility aggregating $626,000, which was paid in full by the Company in connection with the terms of the merger agreements. F-13 Unaudited Pro Forma Data The pro forma statements of operations data of the Company set forth below gives effect to the acquisition of Stallion as if it had occurred at the beginning of fiscal 2003 and excludes the discontinued operations of Premise which was acquired in January 2002. The results for the year ended June 30, 2004 includes a full year of operations from the acquisition of Stallion. The following unaudited pro forma statement of operations data includes the amortization of purchased intangible assets and stock-based compensation. This pro forma data is presented for informational purposes only and does not purport to be indicative of the results of future operations of the Company or the results that would have actually occurred had the acquisitions taken place at the beginning of fiscal 2003: YEAR ENDED JUNE 30, 2003 (IN THOUSANDS, EXCEPT PER SHARE DATA) Net revenues $49,712 ================== Net loss $(47,543) ================== Basic and diluted net loss per share $ (0.88) ================== 3. COMPONENTS OF BALANCE SHEET Inventories
JUNE 30, ------------------ 2004 2003 -------- -------- (IN THOUSANDS) Raw materials $ 4,047 $ 5,109 Finished goods 7,368 7,940 Inventory at distributors 1,291 959 -------- -------- 12,706 14,008 Reserve for excess and obsolete inventory (6,029) (7,997) -------- -------- $ 6,677 $ 6,011 ======== ========
Property and Equipment
JUNE 30, ------------------ 2004 2003 -------- -------- (IN THOUSANDS) Computer and office equipment $ 5,873 $ 6,057 Furniture and fixtures 978 964 Production and warehouse equipment 599 469 Transportation equipment 27 33 -------- -------- 7,477 7,523 Accumulated depreciation (6,612) (5,139) -------- -------- $ 865 $ 2,384 ======== ========
F-14 Warranty Reserve
JUNE 30, --------------- 2004 2003 ------ ------- (IN THOUSANDS) Beginning balance $1,193 $ 479 Charged to costs and expenses 1,168 878 Charged to other expenses - (153) Deductions (591) (11) ------ ------- Ending balance $1,770 $1,193 ====== =======
4. OFFICER LOANS The Company had net outstanding notes receivable from officers of $110,000 (net of allowance of $4.5 million) at June 30, 2004 and 2003 primarily related to taxes on exercised stock options. These notes are non-recourse, are secured by 2,573,394 shares of common stock, and are interest bearing at rates ranging from 5.19% to 7.50% per annum. Principal and any unpaid interest are due upon any transfer or disposition of the common stock. One of the note holders is the former Chief Executive Officer who assumed the role of Chief Technology and Strategy Officer of the Company effective May 30, 2002 and resigned from the Company effective September 1, 2002. One of the note holders is one of the Company's outside directors and one of the note holders is the former Chief Operating/Chief Financial Officer who was terminated by the Company on May 3, 2002. The Company reduced the carrying amount of the officer loans by $4.5 million by establishing a reserve for uncertainties relative to collection of the related receivables. Factors considered in determining the level of this reserve include the value of the collateral securing the notes, the ability of the Company to effectively enforce its collection rights and the ability of the former officers to honor their obligations to the Company. As of June 30, 2004, no impairment has been recorded as it relates to the note receivable from the outside director. 5. GOODWILL AND PURCHASED INTANGIBLE ASSETS Goodwill The change in the carrying amount of goodwill is as follows (in thousands): YEARS ENDED JUNE 30, -------------- 2004 2003 ------ ------ Balance as of July 1 $9,488 $7,218 Goodwill acquired during the period - 2,270 ------ ------ Balance as of June 30 $9,488 $9,488 ====== ====== F-15 Purchased Intangible Assets The composition of purchased intangible assets is as follows (in thousands):
JUNE 30, 2004 JUNE 30, 2003 ------------------------------ ------------------------------ USEFUL ACCUMULATED ACCUMULATED LIVES GROSS AMORTIZATION NET GROSS AMORTIZATION NET --------- ------ -------------- ------ ------ -------------- ------ Existing technology 1-5 years $7,090 $ (5,101 ) $1,989 $7,090 $ (3,029) $4,061 Patent/core technology 5 405 (365) 40 405 (283) 122 Tradename/trademark 5 32 (24) 8 32 (18) 14 Non-compete agreements 2-3 140 (121) 19 140 (62) 78 ------ -------------- ------ ------ -------------- ------ Total $7,667 $ (5,611) $2,056 $7,667 $ (3,392) $4,275 ====== ============== ====== ====== ============== ======
The amortization expense for purchased intangible assets for the year ended June 30, 2004 was $2.2 million, of which $2.1 million was amortized to cost of revenues and $148,000 was amortized to operating expenses. The estimated amortization expenses for the next two years are as follows:
COST OF OPERATING REVENUES EXPENSES TOTAL --------- --------- ------ Fiscal year ending June 30: 2005 $ 1,432 $ 67 $1,499 2006 557 - 557 --------- --------- ------ Total $ 1,989 $ 67 $2,056 ========= ========= ======
In acquisitions accounted for using the purchase method, goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the net tangible and intangible assets acquired. Prior to the adoption of SFAS No. 142 "Goodwill and Other Intangible Assets" ("SFAS No. 142"), effective July 1, 2002, goodwill was amortized on a straight-line basis over a seven-year period. Purchased intangible assets are amortized on a straight-line basis over periods ranging from one to five years. In June 2001, the FASB issued SFAS No. 141, "Business Combinations," effective for acquisitions consummated after June 30, 2001, and SFAS No. 142, effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and certain intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests. Other intangible assets will continue to be amortized over their useful lives. In connection with the adoption of SFAS No. 142, the Company completed its initial assessment and concluded that goodwill arising from the acquisition of United States Software Corporation ("USSC"), having a carrying value of approximately $5.9 million as of July 1, 2001, may be impaired. The Company engaged an independent valuation company to perform a review of the value of goodwill related to USSC. Based on the independent valuation, which utilized a discounted cash flow valuation technique, the Company recorded a $5.9 million charge for the impairment of the USSC goodwill. This amount is reflected as the cumulative effect of adopting the new accounting standard effective July 1, 2001. The Company performed the first of the required annual impairment tests of goodwill under the guidelines of SFAS No. 142 effective as of June 1, 2002. As a result of industry conditions, lower market valuations and reduced estimates of information technology capital equipment spending in the future, the Company determined that there were indicators of impairment to the carrying value of goodwill related to the acquisitions of Lightwave and Synergetic which had carrying values of $39.7 million and $13.9 million, respectively, as of June 30, 2002. During the fourth quarter of fiscal 2002, the Company engaged an independent valuation company to perform a review of the value of goodwill and based on the independent valuation the Company recorded a $46.4 million impairment charge on its goodwill. Additionally, during the fourth quarter of 2002, the Company performed a review of the value of its purchased intangible assets in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," ("SFAS No. 144"). As a result of industry conditions, lower market valuations and reduced estimates of information technology capital equipment spending in the future, the Company determined that there were indicators of impairment to the carrying value of its purchased intangible assets related to its F-16 acquisitions. During the fourth quarter of fiscal 2002, the Company engaged an independent valuation company to perform a review of the value of its purchased intangible assets and based on the independent valuation the Company recorded a $9.8 million impairment charge of which $4.0 million and $5.8 million was charged to operating expenses and cost of revenues, respectively. Additionally, the Company recorded an impairment charge of $665,000 related to intellectual property not associated with an acquisition. During the fourth quarter of fiscal 2003, the Company performed an assessment of the value of its purchased intangible assets in accordance with SFAS No. 144. As a result of industry conditions, continued lower market valuations, reduced estimates in information technology capital equipment spending in the future and other factors impacting expected future cash flows, the Company determined that there were indicators of impairment to the carrying value of its purchased intangible assets recorded as part of its acquisitions. The Company engaged an independent valuation company to perform a review of the value of its purchased intangible assets. Based on the independent valuations during the fourth quarter of fiscal 2003, the Company recorded a $5.4 million impairment charge of which $2.3 million and $3.1 million were charged to operating expenses and cost of revenues, respectively. During the fourth quarter of fiscal 2004, the Company completed its annual impairment assessment and determined that no impairment was indicated as the estimated fair values exceeded their respective carrying values. The Company announced on May 30, 2002 that it had signed a new intellectual property agreement with Gordian, Inc., the Company's provider of product designs and engineering services. The agreement gives the Company joint ownership of the Gordian intellectual property that is embodied in the products Gordian has designed for the Company since 1989. The agreement provides that the Company will be able to use the intellectual property to support, maintain and enhance its products. The agreement extinguishes the Company's obligations to pay royalties for each unit of a Gordian-designed product that it sells (Note 13). The intellectual property agreement required the Company to pay Gordian $6.0 million in order to acquire an interest in the Gordian intellectual property, which was paid in three installments. The Company paid $3.0 million concurrent with the signing of the agreement, $2.0 million on July 1, 2002 and the remaining $1.0 million on July 1, 2003. The Company agreed to purchase $1.5 million of engineering and support services from Gordian over the next 18 months. The Company is amortizing the intellectual property rights over the remaining life cycles of the products designed by Gordian, or approximately three years. The Company recorded $1.8 million, $2.5 million and $212,000 of amortization expense included in cost of revenues for the years ended June 30, 2004, 2003 and 2002. 6. RESTRUCTURING CHARGES On February 6, 2002, the Company announced a restructuring plan to prioritize its initiatives around the growth area of its business, focus on profit contribution, reduce expenses, and improve operating efficiency. This restructuring plan included a worldwide workforce reduction, consolidation of excess facilities and other charges. As of June 30, 2002, the Company recorded restructuring costs totaling $3.5 million. Through June 30, 2003, the February 2002 restructuring plan had resulted in the reduction of approximately 50 regular employees worldwide and the Company incurred actual workforce reduction charges of approximately $1.9 million related to severance and fringe benefits. Included in the workforce reduction charge was a non-cash stock-based compensation charge in the amount of $595,000 associated with the modification of stock options that were outstanding at the termination date. Property, equipment and other assets that were disposed of or removed from operations resulted in a charge of $1.6 million and consisted primarily of computer software and related equipment, production, engineering and office equipment, and furniture and fixtures. On September 12, 2002 and March 14, 2003, the Company announced a restructuring plan to prioritize its initiatives around the growth areas of its business, focus on profit contribution, reduce expenses, and improve operating efficiency. These restructuring plans included a worldwide workforce reduction, consolidation of excess facilities and other charges. The Company recorded restructuring costs totaling $5.6 million, which were classified as operating expenses in the Company's consolidated statement of operations for the year ended June 30, 2003. These restructuring plans resulted in the reduction of approximately 58 regular employees worldwide. The Company recorded workforce reduction charges of approximately $1.2 million related to severance and fringe benefits for the terminated employees. The Company recorded charges of approximately $4.4 million related to consolidation of excess facilities, relating primarily to lease terminations, non-cancelable lease costs, write-off of leasehold improvements and terminations of a contractual obligation. During the year ended June 30, 2004, the Company completed the sale of its Premise business unit as more fully disclosed in Note 7. As a result, the Company recorded approximately $670,000 of restructuring charges which are included in discontinued operations of which $633,000 related to certain future lease obligations and $37,000 related to workforce reductions of three Premise employees that were not transferred to the buyer. F-17 During the year ended June 30, 2004, approximately $2.1 million of restructuring charges were recovered related to a favorable settlement of a contractual obligation, consolidation of excess facilities and workforce reductions which were previously accrued for in fiscal year 2003. The remaining restructuring reserve is related to facility closures in Naperville, Illinois, Hillsboro, Oregon, Redmond, Washington and Ames, Iowa. Payments under the lease obligations will end in fiscal 2007. A summary of the activity in the restructuring liability account is as follows (in thousands):
RESTRUCTURING RESTRUCTURING COSTS CASH RESERVE AT INCLUDED IN CHARGES RESTRUCTURING JUNE 30, DISCONTINUED AGAINST RESTRUCTURING RESERVE AT 2003 OPERATIONS RESERVE RECOVERY JUNE 30, 2004 ------------- ------------- ------- ------------- ------------- Workforce reductions . . . . . . . $ 260 $ 21 $ (98) $ (183) $ - Contractual obligations. . . . . . 2,000 - (450) (1,550) - Consolidation of excess facilities 975 521 (384) (360) 752 ------------- ------------- ------- ---------- ------------- Total. . . . . . . . . . . . . . . $3,235 $ 542 $ (932) $ (2,093) $ 752 ============= ============= ======= ============= =============
7. DISCONTINUED OPERATIONS In August 2001, the FASB issued SFAS No. 144. SFAS No. 144 supersedes FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of;" however, it retains the fundamental provisions of that statement related to the recognition and measurement of the impairment of long-lived assets to be "held and used." SFAS No. 144 also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operation's - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("APB 30"), for the disposal of a segment of a business. Under SFAS No. 144, a component of a business that is held for sale is reported in discontinued operations if (i) the operations and cash flows will be, or have been, eliminated from the ongoing operations of the company and, (ii) the company will not have any significant continuing involvement in such operations. In March 2004, the Company completed the sale of substantially all of the net assets of its Premise business unit for $1.0 million. Additionally, the Company incurred $383,000 of disposal costs. The net revenues and loss from discontinued operations are as follows (in thousands):
YEAR ENDED JUNE 30, ---------- 2004 2003 2002 ------------ --------- -------- Net revenues $ 86 $ 120 $ 55 ============ ========= ======== Loss from discontinued operations $ (5,639) $(10,115) $(3,444) Gain on sale of assets of discontinued operations 592 - - ------------ --------- -------- Loss from discontinued operations, net of income taxes of $0 $ (5,047) $(10,115) $(3,444) ============ ========= ========
F-18 The assets and liabilities of the discontinued operations consisted of the following (in thousands):
JUNE 30, 2003 -------------- Accounts receivable, net . . . . . . . . . . $ 40 Prepaid expenses and other current assets. . 27 Property and equipment, net. . . . . . . . . 157 Goodwill . . . . . . . . . . . . . . . . . . 2,238 Purchased intangible assets, net . . . . . . 1,119 Other assets . . . . . . . . . . . . . . . . 9 -------------- Total assets of discontinued operations. . . $ 3,590 ============== Accounts payable . . . . . . . . . . . . . . $ 27 Accrued payroll and related expenses . . . . 182 Other current liabilities. . . . . . . . . . 30 -------------- Total liabilities of discontinued operations $ 239 ==============
The Company performed its annual impairment tests under the guidelines of SFAS No. 142 as of April 1, 2003. The Company compared the carrying value of each reporting unit to its estimated fair value calculated with the assistance of an independent valuation company. An impairment loss was recognized for reporting units where the carrying value of their goodwill exceeded the implied fair value of goodwill. Based on this assessment, the Company recorded a charge of $4.4 million during the fourth quarter of fiscal 2003 to write down the value of goodwill. This amount is included as part of discontinued operations for the year ended June 30, 2004. During the quarter ended December 31, 2003, the Company identified indicators of an other than temporary impairment as it related to its Premise acquisition of goodwill and purchased intangible assets. The Company performed an assessment of the value of its goodwill and purchased intangible assets related to the Premise acquisition in accordance with SFAS No. 142, and SFAS No. 144. The Company identified certain conditions including continued losses and the inability to achieve significant revenues from the existing home automation and media management software markets as indicators of asset impairment. These conditions led to operating results and forecasted future results that were substantially less than had been anticipated. The Company revised its projections and determined that the projected results utilizing a discounted cash flow valuation technique would not fully support the carrying values of the goodwill and purchased intangible assets associated with the Premise acquisition. Based on this assessment, the Company recorded an impairment charge of $2.2 million during the second quarter of fiscal 2004 to write-off the value of the Premise goodwill. Additionally during the quarter ended December 31, 2003, the Company recorded a $790,000 impairment charge of the Premise purchased intangible assets of which $14,000 and $776,000 were charged to operating expenses and cost of revenues, respectively. As a result of the sale of the Premise business unit, the goodwill and purchased intangibles, net of Premise at June 30, 2003, have been included as part of discontinued operations. 8. BANK LINE OF CREDIT AND DEBT In January 2002, the Company entered into a two-year line of credit with a bank in an amount not to exceed $20.0 million. Borrowings under the line of credit bear interest at either (i) the prime rate or (ii) the LIBOR rate plus 2.0%. The Company was required to pay a $100,000 facility fee which was reduced to $62,500 and was paid. The Company was also required to pay a quarterly unused line fee of .125% of the unused line of credit balance. Since establishing the line of credit, the Company has twice reduced the amount of the line, modified customary financial covenants and adjusted the interest rate to be charged on borrowings to the prime rate plus .50% and eliminated the LIBOR option. Effective July 25, 2003, the Company further modified this line of credit, reducing the revolving line to $5.0 million and adjusting the customary affirmative and negative covenants. The Company is also required to maintain certain financial ratios as defined in the agreement. The agreement has an annual revolving maturity date that renews on the effective date. The agreement was renewed on July 24, 2004 with an amendment to a financial ratio. The Company is required to pay a $12,500 facility fee for the renewal. The Company's borrowing base at June 30, 2004 was $3.2 million. In March 2004, the Company borrowed $500,000 against this line of credit. Additionally, the Company has F-19 used letters of credit available under its line of credit totaling approximately $1.0 million in place of cash to fund deposits on leases, tax account deposits and security deposits. As a result, the Company's available line of credit at June 30, 2004 was $1.6 million. The Company is currently in compliance with the revised financial covenants of the July 24, 2004 amended line of credit. Pursuant to the line of credit, the Company is restricted from paying any dividends. The Company issued a two-year note in the principal amount of $867,000 as a result of its acquisition of Stallion (note 2) accruing interest at a rate of 2.5% per annum. Interest expense related to the note totaled approximately $22,000 and $19,000 at June 30, 2004 and 2003, respectively. No similar interest expense was recorded for the year ended June 30, 2002. The notes are convertible into the Company's common stock at any time, at the election of the holders, at a $5.00 conversion price. The notes were due and paid in August 2004 as the holders elected not to convert the notes into the Company's common stock. 9. STOCKHOLDERS' EQUITY Secondary Public Offering In July 2001, the Company completed a public offering of 8,534,000 shares of its common stock, including an underwriter's over-allotment option to purchase an additional 534,000 shares, at an offering price of $8.00 per share. The Company sold 6,000,000 shares and selling stockholders sold 2,000,000 shares of the primary offering. Additionally, the Company sold 400,500 shares and selling stockholders sold 133,500 shares of the over-allotment option. The Company received net proceeds of approximately $47.1 million in connection with this offering. Employee Stock Purchase Plan In May 2000, the Board of Directors approved the 2000 Employee Stock Purchase Plan (the "Purchase Plan") effective upon the completion of the initial public offering. A total of 1,050,000 shares of common stock have been reserved for issuance under the Purchase Plan. The number of shares available for issuance pursuant to the Purchase Plan increases annually commencing in fiscal year 2001. The Purchase Plan permits participants to purchase common stock at six-month intervals through payroll deductions of up to 15% of the participant's compensation, as defined. Amounts deducted and accumulated by the participants are to be used to purchase shares of common stock at the end of each offering period, as defined, at 85% of the lower of the fair market value of the common stock at the beginning or end of the offering period. For the years ended June 30, 2004, 2003 and 2002, 505,935, 406,205 and 178,687 shares were issued under the plan at an average per share price of $0.73, $0.69 and $2.45, respectively. At June 30, 2004, 107,942 shares were available for future issuances under this plan. Reverse Stock Split On November 12, 2002, the Company's shareholders approved a proposal to effect a 3:1 reverse stock split of the Company's outstanding common stock (a "Reverse Stock Split") and authorized the Board of Directors to determine if and when to effectuate a Reverse Stock Split. This authorization expired in November 2003 without being exercised. Stock Option Plans The Company has in effect several stock-based plans under which non-qualified and incentive stock options have been granted to employees, non-employees and board members. The Board of Directors determines eligibility, vesting schedules and exercise prices for options granted under the plans. Options generally have a term of 10 years and vest and become exercisable, generally over a four-year period. Under the Company's 1993 Incentive Stock Option Plan (the "1993 Plan"), the Company has reserved 4,000,000 shares of common stock for the granting of options. Such options are to be granted at or above the fair market value of the Company's common stock on the date of grant. All stock options are to vest over a period determined by the Board of Directors (generally four years) and expire not more than ten years from the date of grant. As of June 30, 2004, 1,412,090 options were available for grant under the 1993 Plan. F-20 Under the Company's 1994 Nonstatutory Stock Option Plan (the "1994 Plan"), the Company has reserved 10,000,000 shares of common stock for grant at prices and vesting periods to be determined by the Company's Board of Directors. In certain cases, the Company has granted options, which became fully vested on the date granted. As of June 30, 2004, 7,142,268 options were available for grant under the 1994 Plan. Under the Company's 2000 Stock Plan (the "2000 Plan"), the Company has reserved 6,000,000 shares of common stock for issuance pursuant to option grants. The number of shares available for issuance increases by 2,000,000 shares annually commencing in calendar year 2002. Each outside director is automatically granted an option to purchase 25,000 shares of common stock annually, subject to certain eligibility requirements. As of June 30, 2004, 440,633 options were available for grant under the 2000 Plan. As a result of the Company's acquisitions, the Company assumed stock options granted under stock option plans established by each acquired company; no additional options will be granted under those plans. As of June 30, 2004, 167,989 shares of common stock were reserved for issuance upon exercise of outstanding options assumed under these stock option plans. A summary of all stock option activity under the plans is as follows:
NUMBER OF WEIGHTED AVERAGE OPTIONS EXERCISE PRICE ----------- ---------------- Outstanding at June 30, 2001 4,150,263 $ 4.17 Granted 4,179,668 5.12 Canceled (1,278,113) 5.49 Exercised (1,073,452) 1.51 ----------- Outstanding at June 30, 2002 5,978,366 5.14 Granted 1,985,361 0.67 Canceled (3,613,674) 6.42 Exercised (152,004) 0.24 ----------- Outstanding at June 30, 2003 4,198,049 2.10 Granted 2,814,899 1.09 Canceled (942,627) 1.52 Exercised (496,335) 0.72 ----------- Outstanding at June 30, 2004 5,573,986 1.81 =========== Exercisable at June 30, 2002 1,823,365 =========== Exercisable at June 30, 2003 2,338,610 =========== Exercisable at June 30, 2004 2,669,069 ===========
The weighted average exercise price of options outstanding and of options exercisable as of June 30, 2004 were as follows:
OUTSTANDING EXERCISABLE ---------------------- --------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED NUMBER OF REMAINING AVERAGE AVERAGE OPTIONS CONTRACTUAL EXERCISE OPTIONS EXERCISE RANGE OF EXERCISE PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE - ------------------------- ----------- ------------ -------- ----------- -------- 0 to $0.29 52,729 3.21 $ 0.13 51,843 $ 0.13 0.55 to $1.00 2,244,728 9.58 0.67 1,168,231 0.65 1.01 to $2.59 2,426,003 8.76 1.57 660,060 2.21 4.00 to $5.89 469,884 3.61 5.06 458,216 5.07 6.00 to $14.00 380,642 4.94 6.29 330,719 6.27
At June 30, 2004, 14,844,908 shares of the Company's common stock are reserved for issuance pursuant to the employee stock purchase and stock option plans. Certain of the Company's employees hold options that were assumed by the Company in connection with its acquisitions of the businesses that previously employed those individuals; in the business combinations that have been F-21 accounted for as purchases, the Company has recorded deferred compensation with respect to those options. Additionally, the Company granted stock options to employees where the option exercise price is less that the estimated fair value of the underlying shares of common stock as determined for financial reporting purposes, as well as the fair market value of the vested portion of non-employee stock options utilizing the Black-Scholes option pricing model. The Company has recorded net deferred compensation forfeitures of $197,000 and $2.5 million, for the years ended June 30, 2004 and 2003, respectively. The Company is amortizing the deferred compensation over the shorter of the period in which the employee provides services or the applicable vesting period, which is generally four years. For the years ended June 30, 2004, 2003 and 2002, stock-based compensation was approximately $395,000, $1.3 million and $3.6 million, respectively. The amount of stock-based compensation in future periods will increase if we grant stock options where the exercise price is less than the quoted market price of the underlying shares or if we assume employee stock options in connection with additional acquisitions of businesses. Deferred compensation is decreased in the period of forfeiture arising from the early termination of an option holder's services. No compensation expense related to stock options that existed for any other period has been recorded. The weighted average grant date fair value of options granted during the years ended June 30, 2004, 2003 and 2002 was $1.09, $0.67 and $5.12, respectively. The weighted average grant date fair value of in the money options granted during the years ended June 30, 2003 and 2002 was $0.65 and $6.77, respectively. The weighted average exercise price of in the money options granted during the years ended June 30, 2003 and 2002 was, $0.50 and $3.26, respectively. The Company did not grant any in the money options during the year ended June 30, 2004. Stock Option Exchange Offer On January 24, 2003, the Company completed an offering to employees whereby employees holding options to purchase the Company's common stock with exercise prices at or above $3.01 per share were given the opportunity to cancel certain of their existing options in exchange for the opportunity to receive new options to purchase the Company's common stock. Each new option shall represent 0.75 of the underlying shares of the options cancelled. Approximately 1,378,124 options with a weighted average exercise price of $9.01 were tendered. On January 27, 2003, those options were cancelled by the Company. The new options were not granted until at least six months and one day after acceptance of the old options for exchange and cancellation and were only granted to those exchange participants who remained as employees at the time of the new grant. The exercise price of the new options was determined based upon the last reported trading price of the Company's common stock on the grant date. On July 28, 2003, the Company granted replacement options to purchase 1,033,593 shares of its common stock to employees who tendered options under the stock option exchange offer, at an exercise price of $0.81 per share. 10. 401(K) PLAN The Company has a savings plan (the "Plan") which is qualified under Section 401(k) of the Internal Revenue Code. Eligible employees may elect to make contributions to the Plan through salary deferrals up to 15% of their base pay, subject to limitations. The Company's contributions are discretionary and are subject to limitations. For the years ended June 30, 2004, 2003 and 2002, the Company contributed $0.50 for each $1.00 of employee salary deferral contributions up to a maximum of 6% of the employee's annual gross wages, subject to limitations. Selling, general and administrative expenses include contributions of approximately $166,000, $192,000 and $202,000 for the years ended June 30, 2004, 2003 and 2002, respectively. 11. LITIGATION SETTLEMENTS Lightwave Settlement The Company received an informal notice from several holders of the Company's unregistered shares of common stock that were issued in connection with the acquisition of Lightwave. The shares were issued to the holders in a private transaction not registered under the Securities Act of 1933, and therefore could not be sold by the stockholders without a valid registration statement. The stockholders alleged that the Company failed to honor their rights to have the shares registered and that they were therefore precluded from selling the shares. Effective July 26, 2002, the Company settled with the stockholders of Lightwave in the amount of $2.0 million in exchange for 240,000 shares of the Company's common stock held in escrow and 208,335 additional shares issued to the former owners of Lightwave on the acquisition date. This settlement resulted in a net charge to the Company's results of operations of approximately $1.9 million for the year ended June 30, 2002 and has been recognized as litigation settlement costs. F-22 Securities Claims and Employment Claims Brought by the Co-Founders of United States Software Corporation On August 23, 2002, a complaint entitled Dunstan v. Lantronix, Inc., et al., was filed in the Circuit Court of the State of Oregon, County of Multnomah, against the Company and certain of its current and former officers and directors by the co-founders of USSC. The complaint alleged Oregon state law claims for securities violations, fraud, and negligence. The original complaint sought not less than $3.6 million in damages, interest, attorneys' fees, costs, expenses, and an unspecified amount of punitive damages. The Company moved to compel arbitration in November 2002, and in a ruling dated February 9, 2003, the court ordered the matter stayed pending arbitration of all claims. The Company filed an arbitration demand on or about February 21, 2003 which included additional claims related to the Company's acquisition of USSC. The arbitration demand sought more than $14.0 million in damages and an unspecified amount in attorneys' fees, costs, expenses, and punitive damages. The parties participated in a mediation on June 30, 2003, and subsequently reached an agreement to settle the dispute. The agreement called for the Company to release to the plaintiffs approximately $400,000 in cash and 49,038 shares of the Company's common stock that had been held in an escrow since December 2000 as part of the acquisition of USSC. The agreement also called for the Company to issue to the plaintiffs additional shares of its common stock worth approximately $1.5 million, which was recorded in the Company's results of operations as litigation settlement costs for the year ended June 30, 2003. Accordingly, 1,726,703 shares were issued following a fairness determination by the state court in Oregon. In exchange, the plaintiffs released all claims against all defendants. 12. INCOME TAXES The income tax provision (benefit) is comprised of the following:
YEARS ENDED JUNE 30, ----------------------- 2004 2003 2002 ------ ----- -------- (IN THOUSANDS) Current: Federal $ 91 $ 18 $(1,423) State 7 100 - Foreign 177 132 352 ------ ----- -------- Total current 275 250 (1,071) Deferred: Federal (476) - (4,127) State (124) - (1,467) Foreign - - - ------ ----- -------- Total deferred (600) - (5,594) Total income tax provision (benefit) $(325) $ 250 $(6,665) ====== ===== ========
United States and foreign income (loss) from continuing operations before taxes are as follows:
YEARS ENDED JUNE 30, -------------------- 2004 2003 2002 --------- --------- --------- (IN THOUSANDS) United States $(11,716) $(40,404) $(87,199) Foreign 784 3,220 (3,574) --------- --------- --------- $(10,932) $(37,184) $(90,773) ========= ========= =========
F-23 The tax effects of temporary differences that give rise to deferred tax assets and liabilities are as follows:
JUNE 30, -------- 2004 2003 --------- --------- (IN THOUSANDS) Deferred tax assets: Reserves not currently deductible $ 4,620 $ 4,790 Inventory capitalization 2,749 3,680 Marketing rights 1,360 - Tax losses and credits 32,446 27,460 --------- --------- 41,175 35,930 Valuation allowance (38,946) (33,075) --------- --------- Total deferred tax assets 2,229 2,855 --------- --------- Deferred tax liabilities: State taxes - (467) Identified intangibles (310) (644) Depreciation (255) (671) Deferred compensation (1,664) (1,673) --------- --------- Total deferred tax liabilities (2,229) (3,455) --------- --------- Net deferred tax assets (liabilities) $ - $ (600) ========= =========
A reconciliation of the income tax provision (benefit) for loss from continuing operations before discontinued operations and cumulative effect of accounting changes to taxes computed at the U.S. federal statutory rate is as follows:
YEARS ENDED JUNE 30, ------------------------------ 2004 2003 2002 -------- --------- --------- (IN THOUSANDS) Federal income tax (benefit) at statutory rate $(3,717) $(12,642) $(30,863) State taxes (net of federal tax benefit) (77) 66 (968) Non deductible goodwill - 1,481 16,176 Change in valuation allowance 4,338 12,646 7,865 Permanent differences 193 10 403 Research and development credit (570) (596) (399) Foreign tax rate variances (90) 411 248 Deferred compensation 84 337 250 In process technology - - 340 Reduction in tax contingency reserve based on IRS exam and other (486) 18 623 -------- --------- --------- $ (325) $ 250 $ (6,665) ======== ========= =========
As of June 30, 2004, the Company has net operating loss carryovers of $69.7 million and $39.0 million for federal and California income tax purposes, respectively. The federal and California net operating loss carryovers begin to expire in years 2021 and 2013, respectively. Approximately $2.3 million of the net operating loss carryforwards resulted from the Company's acquisition of Synergetic (Note 2). For financial reporting purposes, a valuation allowance of approximately $773,000 has been recognized to offset the deferred tax asset related to those carryforwards. If or when realized, a portion of the tax benefit for those items will be applied to reduce goodwill and acquired intangibles related to the acquisition of Synergetic. F-24 The Company has recorded a valuation allowance against its net deferred tax assets of $39.0 million. If or when realized, the tax benefits relating to, and the reversal of, approximately $3.1 million of the valuation allowance will be accounted for as an increase in additional paid-in capital. The valuation allowance was established due to uncertainties surrounding the realization of the deferred tax assets. Due to the "change of ownership" provision of the Tax Reform Act of 1986, utilization of the Company's net operating loss carryforwards and tax credit carryforwards may be subject to an annual limitation against taxable income in future periods. As a result of the annual limitation, a portion of these carryforwards may expire before ultimately becoming available to reduce future income tax liabilities. In 2003, the Internal Revenue Service completed its audit of the Company's federal income tax returns for the years ended June 30, 1999, 2000 and 2001. The Company had accrued for this liability in prior fiscal periods. Based on the final resolution and related state impact of the IRS examination, the Company recorded a reduction in its tax contingency reserve of approximately $500,000. The Company is under current discussions with the Swiss Federal Tax Authorities ("SFTA") regarding the inability of the Company's Swiss subsidiary, Lantronix International AG, to meet certain guidelines as set within a tax ruling that was obtained in May 2001. The ruling provided for reduced Swiss tax rates. The subsidiary was unable to meet the guidelines set forth in the ruling due to slower than planned growth in this subsidiary, consistent with the overall Company, and has since converted the subsidiary to a holding company. At this time, neither the Company nor the SFTA have taken a definitive position regarding resolution of open tax matters. Based on a variety of assumptions and positions possible, the potential future tax exposure in this matter is estimated at $0 to $700,000. The Company has not provided any amounts for this matter in the consolidated financial statements. 13. COMMITMENTS AND CONTINGENCIES Leases The Company leases office equipment and its office and warehouse facilities under noncancelable operating leases. In July 2000, the Company renewed its office and warehouse facility lease in Irvine, California commencing in August 2000 and expiring in July 2005. The following schedule represents minimum lease payments for all noncancelable-operating leases as of June 30, 2004. Fiscal year ending June 30 (in thousands): 2005 $1,562 2006 437 2007 162 ------ Total minimum lease payments $2,161 ====== Facilities rent expense for the years ended June 30, 2004, 2003 and 2002 were $1.3 million, $1.7 million and $1.9 million, respectively. Royalties The Company has historically outsourced a substantial portion of its engineering and production development activities under contract. Certain development contracts contain royalty provisions based upon sales and/or margin activity of the underlying products. Approximately $1.2 million is included in cost of sales in the accompanying consolidated statements of operations for the year ended June 30, 2002, relating to royalties paid on applicable product sales. During the years ended June 30, 2004 and 2003 no accrued royalties or royalty expense was recorded. F-25 The Company announced on May 30, 2002, that it had signed a new intellectual property agreement with Gordian. The agreement extinguishes the Company's obligation to pay royalties for each unit of a Gordian designed product that it sells (Note 5). 14. LITIGATION Government Investigation The Securities and Exchange Commission ("SEC") is conducting a formal investigation of the events leading up to the Company's restatement of its financial statements on June 25, 2002. The Department of Justice is also conducting an investigation concerning events related to the restatement. Class Action Lawsuits On May 15, 2002, Stephen Bachman filed a class action complaint entitled Bachman v. Lantronix, Inc., et al., No. 02-3899, in the U.S. District Court for the Central District of California against the Company and certain of its current and former officers and directors alleging violations of the Securities Exchange Act of 1934 and seeking unspecified damages. Subsequently, six similar actions were filed in the same court. Each of the complaints purports to be a class action lawsuit brought on behalf of persons who purchased or otherwise acquired the Company's common stock during the period of April 25, 2001 through May 30, 2002, inclusive. The complaints allege that the defendants caused the Company to improperly recognize revenue and make false and misleading statements about its business. Plaintiffs further allege that the defendants materially overstated the Company's reported financial results, thereby inflating its stock price during its securities offering in July 2001, as well as facilitating the use of its common stock as consideration in acquisitions. The complaints have subsequently been consolidated into a single action and the court has appointed a lead plaintiff. The lead plaintiff filed a consolidated amended complaint on January 17, 2003. The amended complaint now purports to be a class action brought on behalf of persons who purchased or otherwise acquired the Company's common stock during the period of August 4, 2000 through May 30, 2002, inclusive. The amended complaint continued to assert that the Company and the individual officer and director defendants violated the 1934 Act, and also includes alleged claims that the Company and its officers and directors violated the Securities Act of 1933 arising from the Company's Initial Public Offering in August 2000. The Company has filed a motion to dismiss the additional allegations on March 3, 2003. Plaintiffs filed their second amended complaint February 6, 2004, and the Company filed a motion to dismiss the additional allegations in the second amended complaint on March 10, 2004. On August 19, 2004, the Court granted in part and denied in part the motion to dismiss. On September 13, 2004, Plaintiff's filed their third amended complaint. We have not yet answered the third amended complaint, and discovery has not yet commenced. Derivative Lawsuit On July 26, 2002, Samuel Ivy filed a shareholder derivative complaint entitled Ivy v. Bernhard Bruscha, et al., No. 02CC00209, in the Superior Court of the State of California, County of Orange, against certain of the Company's current and former officers and directors. On January 7, 2003, the plaintiff filed an amended complaint. The amended complaint alleges causes of action for breach of fiduciary duty, abuse of control, gross mismanagement, unjust enrichment, and improper insider stock sales. The complaint seeks unspecified damages against the individual defendants on the Company's behalf, equitable relief, and attorneys' fees. The Company filed a demurrer/motion to dismiss the amended complaint on February 13, 2003. The basis of the demurrer is that the plaintiff does not have standing to bring this lawsuit since plaintiff has never served a demand on the Company's Board that the Board take certain actions on behalf of the Company. On April 17, 2003, the Court overruled the Company's demurrer. All defendants have answered the complaint and generally denied the allegations. Discovery has commenced, but no trial date has been established. Employment Suit Brought by Former Chief Financial Officer and Chief Operating Officer Steve Cotton On September 6, 2002, Steve Cotton, the Company's former CFO and COO, filed a complaint entitled Cotton v. Lantronix, Inc., et al., No. 02CC14308, in the Superior Court of the State of California, County of Orange. The complaint alleges claims for breach of contract, breach of the covenant of good faith and fair dealing, wrongful termination, misrepresentation, and defamation. The complaint seeks unspecified damages, declaratory relief, attorneys' fees and costs. F-26 The Company filed a motion to dismiss on October 16, 2002, on the grounds that Mr. Cotton's complaints are subject to the binding arbitration provisions in Mr. Cotton's employment agreement. On January 13, 2003, the Court ruled that five of the six counts in Mr. Cotton's complaint are subject to binding arbitration. The court is staying the sixth count, for declaratory relief, until the underlying facts are resolved in arbitration. No arbitration date has been set. Securities Claims Brought by Former Shareholders of Synergetic Micro Systems, Inc. On October 17, 2002, Richard Goldstein and several other former shareholders of Synergetic filed a complaint entitled Goldstein, et al v. Lantronix, Inc., et al in the Superior Court of the State of California, County of Orange, against the Company and certain of its former officers and directors. Plaintiffs filed an amended complaint on January 7, 2003. The amended complaint alleges fraud, negligent misrepresentation, breach of warranties and covenants, breach of contract and negligence, all stemming from its acquisition of Synergetic. The complaint seeks an unspecified amount of damages, interest, attorneys' fees, costs, expenses, and an unspecified amount of punitive damages. On May 5, 2003, the Company answered the complaint and generally denied the allegations in the complaint. Discovery has commenced but no trial date has been established. Patent Infringement Litigation On August 10, 2004, Digi International served a complaint on the Company alleging that certain of the Company's products infringe Digi's U.S. Patent No. 6,446,192. Digi filed the complaint in the U.S. District Court in Minnesota. The complaint seeks both monetary and non-monetary relief. The Company is still analyzing all of the allegations of the complaint. On August 30, 2004, the Company served and filed an answer and counterclaim seeking to invalidate U.S. Patent No. 6,446,192 for failure to meet the applicable statutory requirements in Part II of Title 35 of the United States Code including, without limitation, 35 U.S.C. Sec. 102, 103 and 112, as conditions for patentability. The counterclaim seeks both monetary and non-monetary relief. The Company filed, on May 3, 2004, a complaint against Digi, alleging that certain of Digi's products infringe the Company's U.S. Patent No. 6,571,305, in the U.S. District Court for the Central District of California. The Complaint seeks both monetary and non-monetary relief from Digi's alleged infringement. Digi has filed an answer and counterclaim alleging invalidity of the patent. The counterclaim seeks both monetary and non-monetary relief. Other From time to time, the Company is subject to other legal proceedings and claims in the ordinary course of business. The Company is currently not aware of any such legal proceedings or claims that it believes will have, individually or in the aggregate, a material adverse effect on its business, prospects, financial position, operating results or cash flows. The pending lawsuits involve complex questions of fact and law and likely will continue to require the expenditure of significant funds and the diversion of other resources to defend. Management is unable to determine the outcome of its outstanding legal proceedings, claims and litigation involving the Company, its subsidiaries, directors and officers and cannot determine the extent to which these results may have a material adverse effect on the Company's business, results of operations and financial condition taken as a whole. The results of litigation are inherently uncertain, and adverse outcomes are possible. The Company is unable to estimate the range of possible loss from outstanding litigation, and no amounts have been provided for such matters in the consolidated financial statements. 15. GEOGRAPHIC AND SIGNIFICANT CUSTOMER INFORMATION Revenue by Geographic Area Net revenue by geographic area is provided below:
YEAR ENDED JUNE 30, ------------------- 2004 2003 2002 -------------- -------------- -------------- (AMOUNTS IN THOUSANDS) America $33,847 69% $37,391 76% $47,691 83% Europe 11,252 23% 10,366 21% 8,249 14% Other 3,786 8% 1,632 3% 1,651 3% ------- ----- ------- ----- ------- ----- Total net revenues $48,885 100% $49,389 100% $57,591 100% ======= ===== ======= ===== ======= =====
F-27 Significant Customer Information One customer, Ingram Micro, Inc., accounted for approximately 14%, 11% and 12% of the Company's net revenues for the years ended June 30, 2004, 2003 and 2002, respectively. Another customer, Tech Data Corporation, accounted for approximately 9%, 10% and 11% of the Company's net revenues for the years ended June 30, 2004, 2003 and 2002, respectively. Accounts receivable attributable to these two domestic customers accounted for approximately 13% and 16% of total accounts receivable at June 30, 2004 and 2003, respectively. One international customer, a related party due to common ownership by the Company's major stockholder, accounted for approximately 3%, 4% and 5% of the Company's net revenues for the years ended June 30, 2004, 2003 and 2002, respectively. The Company also had an agreement with the same related international customer for the provision of technical support services to the Company at the rate of $7,500 per month, which has now been terminated. Included in selling, general and administrative expenses is $90,000 for the year ended June 30, 2002, for these support services. No support services were incurred for the years ended June 30, 2004 and 2003. 16. QUARTERLY FINANCIAL DATA (UNAUDITED) Set forth below is summarized unaudited quarterly data:
INCOME (LOSS) FROM CONTINUING OPERATIONS Net loss --------- GROSS DILUTED DILUTED Net revenues PROFIT (LOSS) Amount PER SHARE Amount PER SHARE ------------- -------------- --------- ----------- --------- ----------- Fiscal 2004 First quarter $ 12,201 $ 6,156 $ (2,272) $ (0.04) $ 3,049) $ (0.05) Second quarter 12,498 5,644 (1,516) (0.03) (5,255) (4) (0.09) Third quarter 12,310 6,917 116 (0.00) (553) (5) (0.01) Fourth quarter 11,876 5,142 (6,935) (0.12) (6,797) (6) (0.12) ------------- -------------- --------- ----------- --------- ----------- Total $ 48,885 $ 23,859 $(10,607) $ (0.19) $(15,654) $ (0.28)* ============= ============== ========= =========== ========= =========== Fiscal 2003 First quarter $ 12,681 $ 4,605 $(10,358) $ (0.19) $(11,402) (1) $ (0.21) Second quarter 12,603 5,071 (6,250) (0.12) (7,122) (0.13) Third quarter 12,340 3,114 (7,803) (0.14) (9,921) (2) (0.18) Fourth quarter 11,765 335 (13,023) (0.24) (19,104) (3) (0.35) ------------- -------------- --------- ----------- --------- ----------- Totals $ 49,389 $ 13,125 $(37,434) $ (0.69)* $(47,549) $ (0.88)* ============= ============== ========= =========== ========= =========== * Annual per share amounts may not agree to the sum of the quarterly per share amounts due to differences between average shares outstanding during the periods. (1) Includes restructuring charges of $4,929. (2) Includes litigation settlement costs of $1,075 and restructuring charges of $120. (3) Includes impairment of goodwill and purchased intangible assets of $10,637, litigation settlement costs of $1,532 and restructuring charges of $662. (4) Includes impairment of goodwill and purchased intangible assets of $3.0 million. (5) Includes a $2.1 million recovery from previously recorded restructuring reserves. (6) Includes $5.0 million write-off of the Company's investment in Xanboo.
F-28 INDEX TO EXHIBITS
INCORPORATED BY REFERENCE -------------------------------- EXHIBIT FILED NUMBER EXHIBIT DESCRIPTION FORM FILE NO. EXHIBIT FILING DATE HEREWITH --------- -------- ----------- -------- 3.1 Certificate of Incorporation of Registrant . . S - 1 333-37508 3.2 05/19/2000 Bylaws of the registrant as amended 3.4 on October 1, 2002 . . . . . . . . . . . . . . 10-K 001-16027 3.4 10/08/2002 Form of Registrant's common stock. . . . . . . S - 1, 06/13/2000 4.1 certificate. . . . . . . . . . . . . . . . . . Amend. No. 1 333-37508 4.1 Form of Indemnification Agreement entered into by registrant with each of its. . S - 1, 06/13/2000 10.1 directors and executive officers . . . . . . . Amend. No. 1 333-37508 10.1 1993 Stock Option Plan and forms of. . . . . . S - 1, 10.2 agreements thereunder. . . . . . . . . . . . . Amend. No. 1 333-37508 10.2 06/13/2000 1994 Nonstatutory Stock Option Plan. . . . . . S - 1, 10.3 and forms of agreements thereunder . . . . . . Amend. No. 1 333-37508 10.3 06/13/2000 2000 Stock Plan and forms of agreements. . . . S - 1, 10.4 thereunder . . . . . . . . . . . . . . . . . . Amend. No. 1 333-63030 10.4 06/13/2000 S - 1, 10.5 2000 Employee Stock Purchase Plan. . . . . . . Amend. No. 1 333-37508 10.5 06/13/2000 S - 1, 10.6 Form of Warranty . . . . . . . . . . . . . . . Amend. No. 1 333-37508 10.6 06/13/2000 Employment Agreement between registrant 10.7 and Fred Thiel . . . . . . . . . . . . . . . . S - 1 333-37508 10.7 05/19/2000 Employment Agreement between registrant 10.8 and Steve Cotton . . . . . . . . . . . . . . . S - 1 333-37508 10.8 05/19/2000 Employment Agreement between registrant 10.9 and Johannes Rietschel . . . . . . . . . . . . S - 1 333-37508 10.9 05/19/2000 Lease Agreement between registrant and . . . . S - 1, 10.10 The Irvine Company . . . . . . . . . . . . . . Amend. No. 1 333-37508 10.10 06/13/2000 Loan and Security Agreement between. . . . . . S - 1, 10.11 registrant and Silicon Valley Bank . . . . . . Amend. No. 1 333-37508 10.11 06/13/2000 Research and Development Agreement between registrant and Gordian . . . . . . . . S - 1, 10.12 * Confidential treatment pursuant to Rule 406. Amend. No. 1 333-37508 10.12 06/13/2000 Distributor Contract between registrant and Tech Data Corporation. . . . . . . . . . . . . S - 1, 10.13 * Confidential treatment pursuant to Rule 406. Amend. No. 1 333-37508 10.13 06/13/2000 Distributor Contract between registrant and Ingram Micro Inc.. . . . . . . . . . . . . . . S - 1, 10.14 * Confidential treatment pursuant to Rule 406. Amend. No. 1 333-37508 10.14 06/13/2000 Offer to Exchange Outstanding Options, 10.15 dated December 19, 2002. . . . . . . . . . . . Schedule TO 005-60979 99(a)(1) 12/19/2002 21.1 Subsidiaries of registrant . . . . . . . . . . 10 - K 001-16027 21.1 09/28/2001 Consent of Independent Registered Public 23.1 Accounting Firm X 24.1 Power of Attorney (see page II-2) X 31.1 Certificate of Principal Executive Officer X 31.2 Certificate of Principal Financial Officer X Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to 906 of 32.1 Sarbanes Oxley Act of 2002 X
II-1 SIGNATURES Pursuant to the requirements of Section 13 and 15(d) of the Securities Exchange Act of 1934 Lantronix has duly caused this Registration Statement on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Irvine, State of California, on the 27th day of September, 2004. LANTRONIX, INC. By: /s/ JAMES W. KERRIGAN ------------------------ JAMES W. KERRIGAN CHIEF FINANCIAL OFFICER POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints James Kerrigan, his attorney-in-fact, with the power of substitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Form 10-K and to file the same, with all exhibits thereto in all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents or any of them, or his or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report on Form 10-K has been signed by the following persons in the capacities and on the dates indicated. Signature Title Date - ----------------------- -------------------------------------------- ------- /s/ H. K. DESAI Chairman of the Board 9/27/04 - ------------------ H. K. DESAI /s/ MARC H. NUSSBAUM Chief Executive Officer, 9/27/04 - ------------------- President (Principal Executive Officer) MARC H. NUSSBAUM /s/ JAMES W. KERRIGAN Chief Financial Officer 9/27/04 - -------------------- (Principal Financial and Accounting Officer) JAMES W. KERRIGAN /s/ THOMAS W. BURTON Director 9/27/04 - ----------------------- THOMAS W. BURTON /s/ HOWARD T. SLAYEN Director 9/27/04 - ----------------------- HOWARD T. SLAYEN /s/ KATHRYN B. LEWIS Director 9/27/04 - ----------------------- KATHRYN B. LEWIS II-2 EX-23.1 2 auditor_consent.txt CONSENT OF INDEPENDENT AUDITORS Exhibit 23.1 Consent of Independent Registered Public Accounting Firm We consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 333-45182, 333-54870, 333-63000, 333-72322, 333-85238, 333-85230, 333-103395, 333-116726) of our reports dated September 8, 2004, with respect to the consolidated financial statements and schedule of Lantronix, Inc. included in the Annual Report (Form 10-K) for the year ended June 30, 2004. Orange County, California September 23, 2004 EX-24.1 3 power_attorney.txt POWER OF ATTORNEY POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints James Kerrigan, his attorney-in-fact, with the power of substitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Form 10-K and to file the same, with all exhibits thereto in all documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that such attorneys-in-fact and agents or any of them, or his or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report on Form 10-K has been signed by the following persons in the capacities and on the dates indicated. Signature Title Date - ----------------------- -------------------------------------------- ------- /s/ H. K. DESAI Chairman of the Board 9/27/04 - ------------------ H. K. DESAI /s/ MARC H. NUSSBAUM Chief Executive Officer, 9/27/04 - ------------------- President (Principal Executive Officer) MARC H. NUSSBAUM /s/ JAMES W. KERRIGAN Chief Financial Officer 9/27/04 - -------------------- (Principal Financial and Accounting Officer) JAMES W. KERRIGAN /s/ THOMAS W. BURTON Director 9/27/04 - ----------------------- THOMAS W. BURTON /s/ HOWARD T. SLAYEN Director 9/27/04 - ----------------------- HOWARD T. SLAYEN /s/ KATHRYN B. LEWIS Director 9/27/04 - ----------------------- KATHRYN B. LEWIS EX-31.1 4 ceo_certification.txt CERT. OF PRINCIPAL EXECUTIVE OFFICER CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER I, Marc H. Nussbaum, certify that: 1. I have reviewed this annual report on Form 10-K of Lantronix, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: September 27, 2004 /s/ MARC H. NUSSBAUM -------------------- Marc H. Nussbaum President and Chief Executive Officer EX-31.2 5 cfo_certification.txt CERT. OF PRINCIPAL FINANCIAL OFFICER CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER I, James W. Kerrigan, certify that: 1. I have reviewed this annual report on Form 10-K of Lantronix, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: September 27, 2004 /s/ JAMES W. KERRIGAN ---------------------------- James W. Kerrigan Chief Financial Officer EX-32.1 6 cert_906.txt CEO & CFO 906 CERTIFICATION CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 I, Marc H. Nussbaum, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Annual Report of Lantronix, Inc. on Form 10-K for the fiscal year ended June 30, 2004 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Annual Report on Form 10-K fairly presents in all material respects the financial condition and results of operations of Lantronix, Inc. Date: September 27, 2004 By: /s/ MARC H. NUSSBAUM ------------------------- Name: Marc H. Nussbaum Title: President and Chief Executive Officer I, James Kerrigan, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Annual Report of Lantronix, Inc. on Form 10-K for the fiscal year ended June 30, 2004 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Annual Report on Form 10-K fairly presents in all material respects the financial condition and results of operations of Lantronix, Inc Date: September 27, 2004 By: /s/ JAMES W. KERRIGAN -------------------------- Name: James W. Kerrigan Title: Chief Financial Officer EX-99.1 7 auditor_report.txt REPORT OF INDEPENDENT AUDITORS REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON FINANCIAL STATEMENT SCHEDULE The Board of Directors and Stockholders Lantronix, Inc. We have audited the consolidated financial statements of Lantronix, Inc. as of June 30, 2004 and 2003, and for each of the three years in the period ended June 30, 2004, and have issued our report thereon dated September 10, 2004. Our audits also included the financial statement schedule listed in Item 15(a). This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects the information set forth therein. /s/ ERNST & YOUNG LLP Orange County, California September 10, 2004 EX-99.2 8 valuation_schedule.txt SCHED-VALUATION & QUALIFYING ACCOUNTS SCHEDULE II LANTRONIX, INC. CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
BALANCE CHARGED AT (RECOVERED) CHARGED BALANCE BEGINNING TO COSTS AND TO OTHER END OF DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD - ----------------------------------------- ---------- -------------- ---------- ----------- -------- Year ended June 30, 2002: Allowance for doubtful accounts $ 405 $ 1,680 $ 49 $ 668 $ 1,466 Reserve for excess and obsolete inventory 2,490 3,443 39 216 5,756 Warranty reserve 562 220 - 303 479 ---------- -------------- ---------- ----------- -------- Total $ 3,457 $ 5,343 $ 88 $ 1,187 $ 7,701 ========== =============- ========== =========== ======== Year ended June 30, 2003: Allowance for doubtful accounts $ 1,466 $ (743) $ 10 $ 369 $ 572 Reserve for excess and obsolete inventory 5,756 4,189 41 1,989 7,997 Warranty reserve 479 878 (153) 11 1,193 ---------- -------------- ---------- ----------- -------- Total $ 7,701 $ 4,594 $ (102) $ 2,369 $ 9,762 ========== ============== ========== =========== ======== Year ended June 30, 2004: Allowance for doubtful accounts $ 572 $ (109) $ - $ 286 $ 177 Reserve for excess and obsolete inventory 7,997 488 - 2,456 6,029 Warranty reserve 1,193 1,168 - 591 1,770 ---------- -------------- ---------- ----------- -------- Total $ 9,762 $ 1,547 $ - $ 3,333 $ 7,971 ========== ============== ========== =========== ========
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