10-Q 1 d10q.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2001 [_] 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: 000-31863 COMPUTER ACCESS TECHNOLOGY CORPORATION (exact name of registrant as specified in its charter) Delaware 77-0302527 (State or other jurisdiction of incorporation or (I.R.S. Employer Identification No.) organization) 2403 Walsh Avenue, Santa Clara California 95051 (Address of principal executive offices) (Zip Code)
(408) 727-6600 (Registrant's telephone number, including area code) Common Stock, $0.001 par value (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [_] As of October 31, 2001, there were 18,820,497 shares of the registrant's Common Stock outstanding. 1 Part I - FINANCIAL INFORMATION Item 1. Financial Statements COMPUTER ACCESS TECHNOLOGY CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited in thousands)
December 31, September 30, 2000 2001 ------------ ------------- ASSETS Current assets: Cash and cash equivalents.................................... $ 47,411 $ 47,660 Short-term investments ...................................... 285 -- Trade accounts receivable, net .............................. 2,452 1,263 Related party receivable .................................... 756 651 Inventories ................................................. 799 923 Deferred tax assets ......................................... 390 378 Other current assets ........................................ 771 1,961 -------- -------- Total current assets .................................... 52,864 52,836 Property and equipment, net ..................................... 832 1,281 Other assets .................................................... 196 101 -------- -------- $ 53,892 $ 54,218 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ............................................ $ 543 $ 424 Accrued expenses ............................................ 3,179 1,265 -------- -------- Total current liabilities .............................. 3,722 1,689 Deferred rent ................................................... 13 4 -------- -------- Total liabilities ...................................... 3,735 1,693 -------- -------- Stockholders' equity: Common Stock ................................................ 18 19 Additional paid-in capital .................................. 54,029 53,320 Deferred stock-based compensation ........................... (7,853) (3,406) Retained earnings ........................................... 3,963 2,592 -------- -------- Total stockholders' equity ............................ 50,157 52,525 -------- -------- $ 53,892 $ 54,218 ======== ========
See accompanying notes. 2 COMPUTER ACCESS TECHNOLOGY CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited in thousands, except per share amounts)
Three Month Period Ended Nine Month Period Ended September 30, September 30, ----------------------- ---------------------- 2000 2001 2000 2001 -------- -------- -------- -------- Revenue .............................................................. $ 5,926 $ 3,554 $ 14,708 $ 13,376 Cost of revenue (inclusive of amortization of deferred stock- based compensation of $163 and $(19) in the three month period ended September 30, 2000 and 2001, respectively, and of $275 and $327 in the nine month period ended September 30, 2000 and 2001, respectively) ................................... 1,423 740 3,591 3,218 -------- -------- -------- -------- Gross profit ......................................................... 4,503 2,814 11,117 10,158 -------- -------- -------- -------- Operating expenses: Research and development (exclusive of amortization of deferred stock-based compensation of $773 and $478 in the three month period ended September 30, 2000 and 2001, respectively, and of $1,109 and $1,954 in the nine month period ended September 30, 2000 and 2001, respectively) ................................................... 1,285 1,831 3,167 5,540 Sales and marketing (exclusive of amortization of deferred stock-based compensation of $379 and $(196) in the three month period ended September 30, 2000 and 2001, respectively, and of $789 and $164 in the nine month period ended September 30, 2000 and 2001, respectively) ................................................... 523 798 1,626 2,175 General and administrative (exclusive of amortization of deferred stock-based compensation of $460 and $184 in the three month period ended September 30, 2000 and 2001, respectively, and of $486 and $966 in the nine month period ended September 30, 2000 and 2001, respectively) ................................................... 498 733 931 2,297 Amortization of deferred stock-based compensation ................. 1,612 466 2,384 3,084 -------- -------- -------- -------- Total operating expenses ..................................... 3,918 3,828 8,108 13,096 -------- -------- -------- -------- Income (loss) from operations ........................................ 585 (1,014) 3,009 (2,938) Interest income ...................................................... 110 419 266 1,593 -------- -------- -------- -------- Income (loss) before provision (benefit) for income taxes ............ 695 (595) 3,275 (1,345) Provision (benefit) for income taxes ................................. 947 (681) 2,272 26 -------- -------- -------- -------- Net income (loss) .................................................... $ (252) $ 86 $ 1,003 $ (1,371) ======== ======== ======== ======== Net income (loss) per share: Basic ............................................................ $ (0.02) $ 0.00 $ 0.07 $ (0.07) ======== ======== ======== ======== Diluted .......................................................... $ (0.02) $ 0.00 $ 0.06 $ (0.07) ======== ======== ======== ======== Weighted average shares outstanding Basic ............................................................ 14,485 18,783 14,485 18,702 ======== ======== ======== ======== Diluted .......................................................... 14,485 19,176 15,525 18,702 ======== ======== ======== ========
See accompanying notes. 3 COMPUTER ACCESS TECHNOLOGY CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited in thousands)
Nine Month Period Ended September 30, ----------------------- 2000 2001 --------- -------- Cash flows from operating activities: Net income (loss) ....................................................... $ 1,003 $ (1,371) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization ........................................ 97 322 Provision for doubtful accounts ...................................... 26 1 Amortization of deferred stock-based compensation .................... 2,659 3,411 Fair value of stock options in exchange for services ................. -- 25 Changes in assets and liabilities: Accounts receivable ............................................... (1,009) 1,293 Inventories ....................................................... (468) (124) Deferred tax assets ............................................... (681) 12 Other assets ...................................................... (1,170) (1,095) Accounts payable .................................................. 285 (119) Accrued expenses .................................................. 3,639 (1,914) Deferred rent ..................................................... (6) (9) -------- -------- Net cash provided by operating activities .................. 4,375 432 -------- -------- Cash flows from investing activities: Acquisition of property and equipment ................................... (379) (771) (Purchase) sale of short-term investments ................................ (382) 285 Acquisition of other assets ............................................. (125) -- -------- -------- Net cash used in investing activities ...................... (886) (486) -------- -------- Cash flows from financing activities: Proceeds from exercise of stock options ................................. 222 166 Proceeds from employee stock purchase plan .............................. -- 137 -------- -------- Net cash provided by financing activities .................. 222 303 -------- -------- Net increase in cash and cash equivalents .................................. 3,711 249 Cash and cash equivalents at beginning of period ........................... 4,195 47,411 -------- -------- Cash and cash equivalents at end of period ................................. $ 7,906 $ 47,660 ======== ======== Supplemental information: Cash paid for income taxes ................................................. $ 2,348 $ -- ======== ========
See accompanying notes. 4 COMPUTER ACCESS TECHNOLOGY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Business Computer Access Technology Corporation is a provider of advanced verification systems and connectivity products for existing and emerging digital communications standards. Our products are used by semiconductor, device, system and software companies at each phase of their products' lifecycles from development through production and market deployment. We have expertise in the USB, USB 2.0, IEEE 1394, Bluetooth, InfiniBand, Serial ATA and Ethernet standards and are actively engaged with our customers throughout their development and production processes. Utilizing our easy to use, color-coded software, the CATC Trace, our development products generate, capture, filter and analyze high speed communications traffic, allowing our customers to quickly discover and correct persistent and intermittent errors and flaws in their product design. Our production products are used in manufacturing to ensure that products comply with standards and operate with other devices as well as to assist system manufacturers in downloading software onto new computers. Our connectivity products are devices that translate communications traffic between USB and Ethernet and enable reliable, uninterrupted service for broadband Internet access. These connectivity products also allow for simple installation and incorporate an application specific integrated circuit, or ASIC, and our proprietary embedded software and software drivers. Interim Financial Information and Basis of Presentation The accompanying unaudited condensed consolidated financial statements as of September 30, 2001, and for the three and nine month periods ended September 30, 2001 and 2000, have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial statements and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) and include the accounts of Computer Access Technology Corporation and its wholly-owned subsidiary (collectively, "Computer Access Technology Corporation" or the "Company"). Intercompany accounts and transactions have been eliminated in consolidation. Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been condensed or omitted pursuant to SEC rules and regulations. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the consolidated financial position at September 30, 2001, the consolidated operating results for the three and nine month periods ended September 30, 2001 and 2000 and consolidated cash flows for the nine month periods ended September 30, 2001 and 2000. These unaudited condensed consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements and notes for the year ended December 31, 2000. The unaudited condensed consolidated balance sheet at December 31, 2000 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles in the United States of America for complete financial statements. 5 COMPUTER ACCESS TECHNOLOGY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Concentrations of credit risk Revenue and accounts receivable of each customer comprising more than 10% of revenue or receivables are summarized as follows: Nine Month Period Ended September 30, -------------------------------- 2000 2001 ------------- -------------- Revenue: Company A ............................... 19% 28% December 31, September 30, 2000 2001 ------------- -------------- Accounts receivable: Company A ............................... 22% 31% Company B ............................... 15% -- Company C ............................... 6% 15% NOTE 2 - COMPREHENSIVE INCOME Comprehensive income is defined as changes in equity of a company from transactions, other events and circumstances, excluding transactions resulting from investments by owners and distributions to owners. There is no difference between net income and comprehensive income for the Company in any of the periods presented. NOTE 3 - STOCK-BASED COMPENSATION In connection with certain stock option grants in 2000, 1999 and 1998, the Company recorded deferred stock-based compensation totaling $14,393,000 which represents the difference between the exercise price and the deemed fair value at the date of grant, which is being recognized over the vesting period of the related options. Amortization of deferred stock-based compensation was $447,000 and $3,411,000 in the quarter ended September 30, 2001 and the nine month period ended September 30, 2001, respectively, of which $(19,000) and $327,000 was included in cost of revenue in the quarter ended September 30, 2001 and the nine month period ended September 30, 2001, respectively. Amortization of deferred stock-stock based compensation includes adjustments of compensation expenses recorded for unvested shares subsequently forfeited. Amortization of deferred stock-based compensation was $1,775,000 and $2,659,000 in the quarter ended September 30, 2000 and the nine month period ended September 30, 2000, respectively, of which $163,000 and $275,000 was included in cost of revenue in the quarter ended September 30, 2000 and the nine month period ended September 30, 2000, respectively. Amortization of deferred stock-based compensation on grants prior to December 31, 2000 is estimated to be approximately $806,000 in the quarter ending December 31, 2001 and $1,803,000, $709,000 and $88,000 in the years ending December 31, 2002, 2003 and 2004, respectively, and may change due to the granting of additional options or the cancellation of existing grants in future periods. NOTE 4 - NET INCOME (LOSS) PER SHARE The Company computes net income (loss) per share in accordance with SFAS No. 128, Earnings per Share, and SEC Staff Accounting Bulletin ("SAB") No. 98. Under the provisions of SFAS No. 128 and SAB No. 98, basic net income (loss) per share is computed by dividing net income (loss) for the period by the weighted average number of shares of common stock outstanding during the period. The calculation of diluted net (loss) income per share excludes potential common stock if its effect is antidilutive. Potential common stock consists of incremental common shares issuable upon the exercise of stock options. 6 COMPUTER ACCESS TECHNOLOGY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS The following table sets forth the computation of basic and diluted net income (loss) per share for the periods indicated (in thousands except per share data):
Three Month Period Ended Nine Month Period Ended September 30, September 30, ------------------------------- ---------------------------- 2000 2001 2000 2001 -------------- ------------ ------------- ---------- Numerator: Net income (loss) ............................... $ (252) $ 86 $ 1,003 $ (1,371) ============== ============ ============= ========== Denominator: Weighted average shares outstanding ............. 14,485 18,783 14,485 18,702 -------------- ------------ ------------- ---------- Denominator for basic calculation ............... 14,485 18,783 14,485 18,702 Dilutive effect of stock options ................ -- 393 1,040 -- -------------- ------------ ------------- ---------- Denominator for diluted calculation ............. 14,485 19,176 15,525 18,702 ============== ============ ============= ========== Net income (loss) per share: Basic ........................................... $ (0.02) $ 0.00 $ 0.07 $ (0.07) ============== ============ ============= ========= Diluted ......................................... $ (0.02) $ 0.00 $ 0.06 $ (0.07) ============== ============ ============= ========== Total common stock equivalents, related to options outstanding, excluded from the computation of earnings per share as their effect is antidilutive ............................. 1,167 575 -- 1,055 ============== ============ ============= ==========
NOTE 5 - INVENTORIES Inventories consist of the following (in thousands): December 31, September 30, 2000 2001 ------------ ------------- Raw materials ................................. $ 361 $ 405 Work in progress .............................. 160 218 Finished goods ................................ 278 300 ------------ ------------- $ 799 $ 923 ============ ============= NOTE 6 - INCOME TAXES The reconciliation between the effective tax rate and statutory federal income tax rate is shown in the following table: 7 COMPUTER ACCESS TECHNOLOGY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Three Month Period Ended Nine Month Period Ended September 30, September 30, ------------------------ ----------------------- 2000 2001 2000 2001 -------- --------- --------- --------- Statutory federal income tax rate ....................... 34.0% 34.0% 34.0% 34.0% State taxes, net of federal income tax benefit .......... (0.5) 18.6 5.4 2.2 Amortization of deferred stock-based compensation ....... 103.9 75.6 31.2 (41.5) Research and development credit ......................... (2.2) (0.5) (2.1) 6.1 Other ................................................... 1.0 (13.2) 0.9 (2.7 -------- -------- --------- --------- Effective tax rate .................................. 136.2% 114.5% 69.4% (1.9)% -------- -------- --------- ---------
NOTE 7 - REPORTABLE SEGMENTS AND GEOGRAPHIC INFORMATION The Company has three reportable segments categorized by product type: development products, production products and connectivity products. The development products are advanced verification systems that assist hardware and software manufacturers in the efficient design of reliable and interoperable systems and devices. Production products are production verification systems and connectivity solutions designed to assist hardware and software manufacturers in volume production of reliable devices and systems. Connectivity products are designed to assist broadband Internet service providers in delivering convenient and dependable service and device manufacturers in producing reliable products. The Company has no inter-segment revenue. The Company analyzes segment revenue and cost of revenue, but does not allocate operating expenses, including stock-based compensation, or assets to segments. Accordingly, the Company has presented only revenue and gross profit by segment. Segment information (in thousands):
Unallocated Stock-based Development Production Connectivity Compensation Products Products Products Expense Total ----------- ---------- ------------ ------------ -------- Three Month Period Ended September 30, 2000 Segment revenue from external customers ...... $ 4,125 $ 839 $ 962 $ -- $ 5,926 Segment gross profit ......................... $ 3,555 $ 766 $ 345 $ (163) $ 4,503 Three Month Period Ended September 30, 2001 Segment revenue from external customers ...... $ 2,781 $ 453 $ 320 $ -- $ 3,554 Segment gross profit ......................... $ 2,382 $ 334 $ 79 $ 19 $ 2,814 Nine Month Period Ended September 30, 2000 Segment revenue from external customers ...... $ 8,153 $ 3,596 $ 2,959 $ -- $14,708 Segment gross profit ......................... $ 7,109 $ 3,077 $ 1,206 $ (275) $11,117 Nine Month Period Ended September 30, 2001 Segment revenue from external customers ...... $10,120 $ 1,437 $ 1,819 $ -- $13,376 Segment gross profit ......................... $ 8,794 $ 1,116 $ 575 $ (327) $10,158
8 COMPUTER ACCESS TECHNOLOGY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Geographic information (in thousands): Long-Lived Revenue Assets ------- ---------- Three Month Period Ended September 30, 2000 North America ................................... $ 2,871 Europe .......................................... 873 Asia ............................................ 2,130 Rest of world ................................... 52 ------- Total ......................................... $ 5,926 ======= Three Month Period Ended September 30, 2001 North America ................................... $ 1,379 $1,040 Europe .......................................... 475 241 Asia ............................................ 1,694 -- Rest of world ................................... 6 -- ------- ------ Total ......................................... $ 3,554 $1,281 ======= ====== Nine Month Period Ended September 30, 2000 North America ................................... $ 8,728 Europe .......................................... 2,006 Asia ............................................ 3,896 Rest of world ................................... 78 ------- Total ......................................... $14,708 ======= Nine Month Period Ended September 30, 2001 North America ................................... $ 5,831 $1,040 Europe .......................................... 1,983 241 Asia ............................................ 5,493 -- Rest of world ................................... 69 -- ------- ------ Total ......................................... $13,376 $1,281 ======= ====== Revenues are attributed to countries based on delivery locations. Sales to foreign customers accounted for 51.6% and 61.2% of revenue during the quarters ended September 30, 2000 and 2001, respectively, and 40.7% and 56.4% for the nine months ended September 30, 2000 and 2001, respectively. NOTE 8 - RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 143 ("SFAS 143"), "Accounting for Asset Retirement Obligations," which addresses financial accounting and reporting for certain obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The provisions of SFAS No. 143 are required to be applied starting with fiscal years beginning after June 15, 2002. We believe the adoption of the provisions of this statement will not have a material effect on the Company's consolidated financial statements. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations." SFAS 141 requires the purchase method of accounting for business combinations initiated after September 30, 2001 and eliminates the pooling-of-interests method. We believe that the adoption of SFAS 141 will not have a significant impact on our consolidated financial statements. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets," which is effective for fiscal years beginning after March 15, 2001. SFAS 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the standard includes provisions upon adoption for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the testing for impairment of existing 9 COMPUTER ACCESS TECHNOLOGY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS goodwill and other intangibles. We believe that the adoption of SFAS 142 will not have a significant impact on our consolidated financial statements. In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144 (SFAS No.144), Accounting for the Impairment or Disposal of Long-Lived Assets, which is required to be applied starting with years beginning after December 15, 2001. SFAS 144 requires, amongst other things, the application model for long-lived assets that are impaired or to be disposed of by sale. The adoption of SFAS 144 is not expected to have a significant impact on our consolidated financial statements. 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The following information should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in Item 1 of this report and "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in our Form 10-K as filed with the Securities and Exchange Commission on March 12, 2001. This report contains forward-looking statements within the meaning of the federal securities laws. These statements may contain words such as "expects," "anticipates," "intends," "plans," "believes," "estimates," or other wording indicating future results. Forward-looking statements are subject to risks and uncertainties. Actual results may differ materially from the results discussed in forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, those discussed under "Risk Factors" following "Recent Accounting Pronouncements" below, and elsewhere in this report. We undertake no obligation to revise or update any forward-looking statements to reflect any event or circumstance that may arise after the date of this report. Overview We are a provider of advanced verification systems and connectivity products for existing and emerging digital communications standards such as USB, IEEE 1394, Bluetooth wireless technology, InfiniBand, Serial ATA and Ethernet. Our products are used by semiconductor, device, system and software companies at each phase of their products' lifecycles from development through production and market deployment. Our verification systems consist of development and production products that accurately monitor communications traffic and diagnose operational problems to ensure that products comply with standards and operate with other devices as well as to assist system manufacturers in downloading software onto new computers. Our connectivity products enable reliable, uninterrupted service for broadband Internet access. We currently outsource most of the manufacturing of our verification systems and connectivity products so that we may concentrate our resources on the design, development and marketing of our existing and new products. We report our revenue and gross profit in three business segments: development, production and connectivity products. In the quarter ended September 30, 2001, our revenue from our development products was $2.8 million, from production products was $453,000 and from connectivity products was $320,000. Historically, we have generated a majority of our revenue across all segments from products for the USB standard. Revenue from our USB products accounted for approximately 59.4% of our revenue in the quarter ended September 30, 2001, of which 23.0% was from our USB 2.0 products. We sell our products on a purchase order basis. We have adopted Statement of Position, or SOP, 97-2, Software Revenue Recognition. Under SOP 97-2, we recognize revenue to resellers and end users upon shipment provided that there is persuasive evidence of an arrangement, the product has been delivered, the fee is fixed and determinable and collection of the resulting receivable is reasonably assured. When we have shipped products but some elements essential to the functionality of the products have not been completed, revenue and associated cost of revenue are deferred until all remaining elements have been delivered. As a result, our revenue trends are dependent on the timing of delivery of these essential elements. Our products are typically sold with a one-year parts and labor repair warranty. In June 2001 we began to offer maintenance and support contracts for our products. Maintenance revenue is deferred and recognized ratably over the maintenance period. Provisions for warranty costs are recorded at the time products are shipped. Product returns to date have not been significant. We sell our products to technology, infrastructure and application companies through our direct sales force and indirectly through our distributors and resellers. Historically, a substantial portion of our revenue has been derived from customers outside of the United States. In the quarter ended September 30, 2001, 61.2% of our revenue was derived from international customers, of which 31.8% was derived from customers based in Japan, 15.8% was derived from customers based in other parts of Asia, and 13.4% was derived from customers based in Europe. International revenue increased as a percentage of total revenue in the quarter ended September 30, 2001, primarily due to the general economic slowdown, which has been exacerbated by the impact of the September 11, 2001 terrorist attack, in the United States. All of our revenue and accounts receivable are denominated in U.S. dollars. Although seasonality affects many of our target markets, to date our revenues and financial condition as a whole have not been materially impacted by seasonality. The development of emerging communications standards and technological change have influenced and are likely to continue to influence our quarterly and annual revenue and results of operations. Our product development and marketing strategies are focused on working closely with the promoter companies and communications standards groups to gain early access to new communications standards and technologies. We have invested significantly in the research and development and marketing of our products for emerging communications standards, often before these standards have gained widespread industry acceptance and in advance of generating substantial revenue related to these investments. Additionally, the rate and timing of customer orders may vary significantly from month to month. Accordingly, if sales of our products do not occur when we expect and we are unable to predict or adjust our estimates on a timely basis, our expenses may increase as a percentage of revenue. 11 The overall economic environment continues to create uncertainties for us and our customers. We have experienced continuing weakness in each of our business segments over the last nine months as a result of slowing growth in the global economy and delays in orders as a result of reduced spending by many of our customers, which has been exacerbated by the September 11, 2001 terrorist attack. Our near term financial results have been and may continue to be affected by our decision to accelerate sales, marketing and research and development spending in the first nine months of 2001. Results of Operations The following table presents selected consolidated financial data for the periods indicated as a percentage of revenue:
Three Month Period Ended Nine Month Period Ended September 30, September 30, ------------------------- ----------------------- 2000 2001 2000 2001 ----------- ---------- ---------- ---------- Consolidated Statement of Income Data: Revenue ......................................................... 100.0% 100.0% 100.0% 100.0% Cost of Revenue ................................................. 24.0 20.8 24.4 24.1 ----------- ---------- ---------- ---------- Gross profit .................................................... 76.0 79.2 75.6 75.9 ----------- ---------- ---------- ---------- Operating expenses: Research and development ...................................... 21.7 51.5 21.5 41.4 Sales and marketing ........................................... 8.8 22.5 11.1 16.3 General and administrative .................................... 8.4 20.6 6.3 17.2 Amortization of deferred stock-based compensation ............. 27.2 13.1 16.2 23.0 ----------- ---------- ---------- ---------- Total operating expenses ..................................... 66.1 107.7 55.1 97.9 ----------- ---------- ---------- ---------- Income (loss) from operations ................................... 9.9 (28.5) 20.5 (22.0) Interest income ................................................. 1.9 11.8 1.8 11.9 ----------- ---------- ---------- ---------- Income before provision (benefit) for income taxes .............. 11.8 (16.7) 22.3 (10.1) Provision (benefit) for income taxes ............................ 16.0 (19.1) 15.5 0.2 ----------- ---------- ---------- ---------- Net income (loss) ............................................... (4.2)% 2.4% 6.8% (10.3)% =========== ========== ========== ==========
Comparison of Quarters Ended September 30, 2000 and 2001 Revenue. Our revenue was $3.6 million in the quarter ended September 30, 2001 and $5.9 million in the quarter ended September 30, 2000. This represents a decrease of 40.0% from the quarter ended September 30, 2000 to the quarter ended September 30, 2001. The decrease in revenue was due primarily to decreases in our sales of certain development products, production products and connectivity products of $2.4 million, $541,000 and $631,000, respectively, offset by sales of our new development products, which represented $1.1 million. Revenue from international customers decreased by 28.8%, while domestic revenue decreased by 52.0%. International revenue represented 61.2% of our revenue in the quarter ended September 30, 2001, as compared to 51.6% in the quarter ended September 30, 2000. Revenue from Japan, through our distributor Toyo, represented 31.8% of our total revenue in the quarter ended September 30, 2001, as compared to 26.7% in the quarter ended September 30, 2000. Cost of Revenue and Gross Profit. Our gross profit was $2.8 million in the quarter ended September 30, 2001 and $4.5 million in the quarter ended September 30, 2000. This represents a decrease of 37.5% from the quarter ended September 30, 2000 to the quarter ended September 30, 2001. The dollar decrease was primarily the result of decreased unit sales of development, production and connectivity products, offset by a decrease in the amortization of deferred stock-based compensation of $182,000. Our gross margin was 79.2% in the quarter ended September 30, 2001 and 76.0% in the quarter ended September 30, 2000. This represents an increase of 3.2% from the quarter ended September 30, 2000 to the quarter ended September 30, 2001. This increase in gross margin was due primarily to the change in the mix of our revenue by business segment. Our lower margin business segments, production products and connectivity products, decreased as a percentage of revenue by 1.4% and 7.2%, respectively, and our higher margin business segment, development products, increased as a percentage of revenue by 8.6%. This was primarily offset by reduced margins for our production products, due to higher costs associated with low volume initial product releases, and lower margins for our connectivity products, due to competitive pricing pressure. Excluding amortization of deferred stock-based compensation, our gross margin would have been 78.6% in the quarter ended September 30, 2001 and 78.7% in the quarter ended September 30, 2000. 12 Research and Development. Our research and development expenses were $1.8 million in the quarter ended September 30, 2001 and $1.3 million in the quarter ended September 30, 2000. This represents an increase of 42.5% from the quarter ended September 30, 2000 to the quarter ended September 30, 2001. Research and development expenses represented 51.5% of revenue in the quarter ended September 30, 2001 and 21.7% of revenue in the quarter ended September 30, 2000. The dollar increase was primarily due to an increase in personnel and related costs of $374,000. The percentage of revenue increase was primarily due to a decrease in revenue and an increase in personnel and related costs. Sales and Marketing. Our sales and marketing expenses were $798,000 in the quarter ended September 30, 2001 and $523,000 in the quarter ended September 30, 2000. This represents an increase of 52.6% from the quarter ended September 30, 2000 to the quarter ended September 30, 2001. Sales and marketing expenses represented 22.5% of revenue in the quarter ended September 30, 2001 and 8.8% of revenue in the quarter ended September 30, 2000. The dollar increase was primarily due to increases in personnel and related costs of approximately $236,000. The percentage of revenue increase was primarily due to a decrease in revenue and increases in personnel and related costs. General and Administrative. Our general and administrative expenses were $733,000 in the quarter ended September 30, 2001 and $498,000 in the quarter ended September 30, 2000. This represents an increase of 47.2% from the quarter ended September 30, 2000 to the quarter ended September 30, 2001. General and administrative expenses represented 20.6% of revenue in the quarter ended September 30, 2001 and 8.4% of revenue in the quarter ended September 30, 2000. The dollar increase was primarily due to an increase in professional services of $165,000. The percentage of revenue increase was primarily due to a decrease in revenue and an increase in professional services. Interest Income. Interest income was $419,000 in the quarter ended September 30, 2001 and $110,000 in the quarter ended September 30, 2000. This represents an increase of 280.9% from the quarter ended September 30, 2000 to the quarter ended September 30, 2001. The increase was the result of the investment of additional excess cash balances and the proceeds from our initial public offering in November 2000. Provision (benefit) for Income Taxes. Benefit for income taxes was $681,000 in the quarter ended September 30, 2001 and the provision for income taxes was $947,000 in the quarter ended September 30, 2000. The tax benefit for the quarter reflects the true-up adjustment of our year-to-date tax provision based on our revised estimate of our expected effective annual tax rate. These amounts represent a decrease of 171.9% from the quarter ended September 30, 2000 to the quarter ended September 30, 2001. Our effective tax rate decreased from 136.2% in the quarter ended September 30, 2000 to 114.5% in the quarter ended September 30, 2001, due primarily to a decrease in the amortization of deferred stock-based compensation, an increase in our expected research and development tax credit for the year and the effect of annual accounting adjustments associated with an estimate of the effective tax rate for the full year. Our effective tax rate after excluding the effect of amortization of deferred stock-based compensation was 460.1% in the quarter ended September 30, 2001 and 38.3% in the quarter ended September 30, 2000. Net Income (loss). Our net income was $86,000 in the quarter ended September 30, 2001 and our net loss was $252,000 in the quarter ended September 30, 2000. Our net income represented 2.4% of revenue in the quarter ended September 30, 2001 and our net loss represented 4.2% of revenue in the quarter ended September 30, 2000. The net income in the quarter ended September 30, 2001 was primarily the result of reduced amortization of stock-based compensation, increased interest income, and the benefit for income taxes, offset by reduced revenue and increased operating costs excluding the amortization of deferred stock-based compensation. Our net income before the effect of the amortization of deferred stock-based compensation was $533,000 in the quarter ended September 30, 2001 and $1.5 million in the quarter ended September 30, 2000. Amortization of Deferred Stock-based Compensation. Amortization of deferred stock-based compensation represents the difference between the exercise price and the deemed fair value at the date of grant, in connection with certain stock option grants in 2000, 1999 and 1998, which is being recognized over the vesting period of the related options. Amortization of deferred stock-based compensation was $447,000 in the quarter ended September 30, 2001, of which $(19,000) was included in cost of revenue during that period. Amortization of deferred stock-based compensation was $1.8 million in the quarter ended September 30, 2000, of which $163,000 was included in cost of revenue during that period. Amortization of deferred stock-based compensation on grants prior to December 31, 2000 is estimated to be approximately $806,000 in the quarter ending December 31, 2001, and $1,803,000, $709,000 and $88,000 in the years ending December 31, 2002, 2003 and 2004, respectively, and may change due to the granting of additional options or the cancellation of existing grants in future periods. 13 The following table sets forth net income and net income per share, both after excluding the amortization of deferred stock-based compensation (in thousands, except per share amounts).
Three Month Period Ended September 30, --------------------------- 2000 2001 ----------- ----------- Net income, excluding amortization of deferred compensation ............. $ 1,523 $ 533 Net income per share, excluding amortization of deferred compensation Basic ................................................................ $ 0.11 $ 0.03 Diluted .............................................................. $ 0.10 $ 0.03 Weighted average shares outstanding Basic ................................................................ 14,485 18,783 Diluted .............................................................. 15,652 19,176
Comparison of Nine Months Ended September 30, 2000 and 2001 Revenue. Our revenue was $13.4 million in the nine months ended September 30, 2001 and $14.7 million in the nine months ended September 30, 2000. This represents a decrease of 9.1% from the nine months ended September 30, 2000 to the nine months ended September 30, 2001. The decrease in revenue was due primarily to decreases in our sales of certain development products, production products and connectivity products of $1.5 million, $2.1 million and $1.1 million, respectively, offset by sales of our new development products, which represented $3.4 million. Revenue from international customers increased by 26.2%, while domestic revenue decreased by 33.2%. International revenue represented 56.4% of our revenue in the nine months ended September 30, 2001, as compared to 40.7% in the nine months ended September 30, 2000. Revenue from Japan, through our distributor Toyo, represented 27.7% of our total revenue in the nine months ended September 30, 2001, as compared to 18.5% in the nine months ended September 30, 2000. Cost of Revenue and Gross Profit. Our gross profit was $10.2 million in the nine months ended September 30, 2001 and $11.1 million in the nine months ended September 30, 2000. This represents a decrease of 8.6% from the nine months ended September 30, 2000 to the nine months ended September 30, 2001. The dollar decrease was primarily the result of a decrease in unit sales of production and connectivity products and an increase in amortization of deferred stock-based compensation of $52,000, partially offset by an increase in unit sales of our development products. Our gross margin was 75.9% in the nine months ended September 30, 2001 and 75.6% in the nine months ended September 30, 2000. This represents a increase of 0.3% from the nine months ended September 30, 2000 to the nine months ended September 30, 2001. This increase in gross margin was due primarily to the change in the mix of our revenue by business segment. Our higher margin business segment, development products, increased as a percentage of revenue by 20.2%, and our lower margin business segments, production products and connectivity products, decreased as a percentage of revenue by 13.7% and 6.5%, respectively. This was primarily offset by reduced margins for our development products, due to higher costs associated with low volume initial product releases, and lower margins for our connectivity products, due to competitive pricing pressure. Excluding amortization of deferred stock-based compensation, our gross margin would have been 78.4% in the nine months ended September 30, 2001 and 77.5% in the nine months ended September 30, 2000. Research and Development. Our research and development expenses were $5.5 million in the nine months ended September 30, 2001 and $3.2 million in the nine months ended September 30, 2000. This represents an increase of 74.9% from the nine months ended September 30, 2000 to the nine months ended September 30, 2001. Research and development expenses represented 41.4% of revenue in the nine months ended September 30, 2001 and 21.5% of revenue in the nine months ended September 30, 2000. The dollar increase was primarily due to an increase in personnel and related costs of $2.1 million. The percentage of revenue increase was primarily due to a decrease in revenue and an increase in personnel and related costs. Sales and Marketing. Our sales and marketing expenses were $2.2 million in the nine months ended September 30, 2001 and $1.6 million in the nine months ended September 30, 2000. This represents an increase of 33.8% from the nine months ended September 30, 2000 to the nine months ended September 30, 2001. Sales and marketing expenses represented 16.3% of revenue in the nine months ended September 30, 2001 and 11.1% of revenue in the nine months ended September 30, 2000. The dollar increase was primarily due to increases in personnel and related costs of approximately $483,000. The percentage of revenue increase was primarily due to a decrease in revenue and increases in personnel and related costs. 14 General and Administrative. Our general and administrative expenses were $2.3 million in the nine months ended September 30, 2001 and $931,000 in the nine months ended September 30, 2000. This represents an increase of 146.7% from the nine months ended September 30, 2000 to the nine months ended September 30, 2001. General and administrative expenses represented 17.2% of revenue in the nine months ended September 30, 2001 and 6.3% of revenue in the nine months ended September 30, 2000. The dollar increase was primarily due to an increase in professional services of $746,000, primarily legal fees, the addition of management and administrative personnel and related costs of $280,000, and an increase in insurance of $214,000. The percentage of revenue increase was primarily due to a decrease in revenue and an increase in professional service, primarily legal fees, the addition of management and administrative personnel and related costs and an increase in insurance as a result of being a publicly trade company. Interest Income. Interest income was $1.6 million in the nine months ended September 30, 2001 and $266,000 in the nine months ended September 30, 2000. This represents an increase of 498.9% from the nine months ended September 30, 2000 to the nine months ended September 30, 2001. The increase was the result of the investments of additional excess cash balances and the proceeds from our initial public offering in November 2000. Provision for Income Taxes. Provision for income taxes was $26,000 in the nine months ended September 30, 2001 and $2.3 million in the nine months ended September 30, 2000. These amounts represent a decrease of 98.9% from the nine months ended September 30, 2000 to the nine months ended September 30, 2001. Our effective tax rate decreased from 69.4% in the nine months ended September 30, 2000 to (1.9)% in the nine months ended September 30, 2001 due primarily to an increase in the amortization of deferred stock-based compensation, offset by an increase in our expected research and development tax credit for the year and the effect of annual accounting adjustments associated with an estimate of the effective tax rate for the full year. Our effective tax rate after excluding the effect of amortization of deferred stock-based compensation was 1.3% in the nine months ended September 30, 2001 and 38.3% in the nine months ended September 30, 2000. Net Income (loss). Our net loss was $1.4 million in the nine months ended September 30, 2001 and our net income was $1.0 million in the nine months ended September 30, 2000. Our net loss represented 10.3% of revenue in the nine months ended September 30, 2001 and our net income represented 6.8% of revenue in the nine months ended September 30, 2000. The net loss in the nine months ended September 30, 2001 was primarily the result of reduced revenue and increased operating costs, offset by the reduced provision for income taxes and increased interest income. Net income before the effect of the amortization of deferred stock-based compensation was $2.0 million in the nine months ended September 30, 2001 and $3.7 million in the nine months ended September 30, 2000. Amortization of Deferred Stock-based Compensation. Amortization of deferred stock-based compensation represents the difference between the exercise price and the deemed fair value at the date of grant, in connection with certain stock option grants in 2000, 1999 and 1998, which is being recognized over the vesting period of the related options. Amortization of deferred stock-based compensation was $3.4 million in the nine months ended September 30, 2001, of which $327,000 was included in cost of revenue during that period. Amortization of deferred stock-based compensation was $2.7 million in the nine months ended September 30, 2000, of which $275,000 was included in cost of revenue during that period. Amortization of deferred stock-based compensation on grants prior to December 31, 2000 is estimated to be approximately $806,000 in the quarter ending December 31, 2001, and $1,803,000, $709,000 and $88,000 in the years ending December 31, 2002, 2003 and 2004, respectively, and may change due to the granting of additional options or the cancellation of existing grants in future periods. 15 The following table sets forth net income and net income per share, both after excluding the amortization of deferred stock-based compensation (in thousands, except per share amounts).
Nine Month Period Ended September 30, ----------------------------- 2000 2001 ------------ ------------ Net income, excluding amortization of deferred compensation...................... $ 3,662 $ 2,040 Net income per share, excluding amortization of deferred compensation Basic......................................................................... $ 0.25 $ 0.11 Diluted....................................................................... $ 0.24 $ 0.11 Weighted average shares outstanding Basic......................................................................... 14,485 18,702 Diluted....................................................................... 15,525 19,294
Liquidity and Capital Resources Our operating cash flow requirements have generally increased reflecting the expanding scope and level of our activities. Since our inception, we have financed our operations primarily through cash flows from operating activities. In November 2000, we received net proceeds of $38.3 million from the initial public offering of our common stock. As of September 30, 2001, our principal sources of liquidity were $47.7 million in cash and cash equivalents. In the nine months ended September 30, 2001, cash provided by operating activities of $432,000 primarily consisted of an increase in amortization of deferred stock-based compensation of $3.4 million, a decrease in accounts receivable of $1.3 million, depreciation expense of $322,000, the fair value of stock options issued in exchange for services of $25,000 and a decrease in deferred tax assets of $12,000, offset by a net loss of $1.4 million, a decrease in accrued expenses of $1.9 million, an increase in other assets of $1.1 million, an increase in the level of inventory of $124,000 and a decrease in accounts payable of $119,000. The decrease in accrued expenses primarily related to decreased income tax accruals of $2.3 million offset by increased accrued expenses from operations of $358,000. Cash used in investing activities was $486,000, related to capital expenditures of $771,000, offset by the proceeds from the sale of short-term investments of $285,000. Cash provided by financing activities was $303,000, related to the proceeds from the exercise of stock options of $166,000 and to the sale of stock pursuant to our stock purchase plan of $137,000. In the nine months ended September 30, 2000, cash provided by operating activities of $4.4 million primarily consisted of net income of $1.0 million, an increase in accrued expenses of $3.6 million, the amortization of deferred stock-based compensation of $2.7 million and an increase in accounts payable of $285,000, offset by increases in other assets of $1.2 million, accounts receivable of $1.0 million, deferred tax assets of $681,000 and the level of inventory of $468,000. Cash used in investing activities of $886,000 primarily related to the purchase of short-term investments of $382,000 and capital expenditures of $379,000. Cash provided by financing activities was $222,000, related to the proceeds from the exercise of stock options. As of September 30, 2001, we had cash and cash equivalents of $47.7 million, working capital of $51.0 million and no debt. We believe that the net proceeds from our initial public offering in November 2000, together with funds generated from operations, will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months. Thereafter, we may find it necessary to obtain additional equity or debt financing. If we are required to raise additional funds, we may not be able to do so on acceptable terms or at all. In addition, if we issue new securities, stockholders might experience dilution or the holders of the new securities might have rights, preferences or privileges senior to those of existing stockholders. RISK FACTORS We continue to face uncertainty relating to economic conditions affecting our customers. We face uncertainty in the degree to which the current economic slowdown will negatively affect growth and capital spending by our existing and potential customers. We continue to experience instances of customers delaying or deferring orders for our products, and longer lead times needed to close our customer sales. If global economic conditions do not improve, or if 16 there is a worsening in the global economic slowdown, we may continue to experience adverse impacts on our business, operating results and financial condition. Any adverse developments relating to the economic slowdown may make the occurrence of one or more of the factors discussed under "Risk Factors" in this report more likely to occur. The recent terrorist attacks are unprecedented events that have created many economic and political uncertainties, some of which may harm our business and prospects and our ability in general to conduct business in the ordinary course. Terrorist attacks in New York and Washington, D.C. in September 2001 have disrupted commerce throughout the world. The continued threat of terrorism and the resulting military, economic and political response and heightened security measures may cause significant disruption to commerce throughout the world. To the extent that this disruption results in a general decrease in our customers' spending, our business and results of operations could be materially and adversely affected. We also may experience delays in receiving payments from customers that have been affected by the attacks, which, in turn, would harm our cash flow. We are unable to predict whether the threat of terrorism or the responses thereto will result in any long-term commercial disruptions or if such activities or responses will have a long-term adverse effect on our business, results of operations or financial condition. These and other developments arising out of the attacks may make the occurrence of one or more of the factors discussed under "Risk Factors" in this report more likely to occur. Our future operating results are unpredictable and are likely to fluctuate from quarter to quarter and, if we fail to meet the expectations of securities analysts or investors, our stock price would likely decline significantly. Our quarterly and annual operating results have fluctuated in the past and are likely to fluctuate significantly in the future due to a number of factors, some of which are wholly or partially outside of our control. Many of these risks are described in the following risk factors. Accordingly, we believe that period-to-period comparisons of our results of operations are not meaningful and should not be relied upon as indications of future performance. Some of the factors that could cause our quarterly or annual operating results to fluctuate include: . the amount and timing of our operating expenses and capital expenditures; . changes in the volume of our product sales and pricing concessions on volume sales; . the timing, reduction, deferral or cancellation of customer orders or purchases; . seasonality in some of our target markets; . the effectiveness of our product cost reduction efforts; . variability of our customers' product lifecycles; . changes in the average selling prices of our products; and . cancellations, changes or delays of deliveries to us by our manufacturers and suppliers. If our operating results fall below the expectations of securities analysts or investors, the trading price of our common stock would likely decline significantly. If we fail to keep up with rapid technological change and evolving industry standards, our products could become less competitive or obsolete. The markets for our products are characterized by rapid technological change, frequent new product introductions, changes in customer requirements and evolving industry standards. Our products may cease to be competitive if we fail to introduce new products or product enhancements that address these changes, meet new customer requirements and support new standards. To continue to introduce new products or product enhancements on a timely basis, we must: . identify emerging technological trends in our target markets, including new communications standards; . accurately define and design new products or product enhancements to meet market needs; . develop or license the underlying core technologies necessary to create new products and product enhancements; and 17 . respond effectively to technological changes and product introductions by others. If we are unable to identify, develop, manufacture, market or support new or enhanced products successfully or on a timely basis, our competitors could gain market share or our new products or product enhancements might not gain market acceptance. Further, we might not be able to respond effectively to product announcements by competitors, technological changes or emerging industry standards. We depend upon widespread market acceptance of our USB products, and our revenue will decline if the market does not continue to accept these products. We currently derive a substantial majority of our revenue from sales of our USB products. Revenue from sales of our USB products accounted for approximately 59.4% of our revenue in the quarter ended September 30, 2001. We expect that revenue from these products will continue to account for a substantial portion of our revenue for the foreseeable future. If the market does not continue to accept our USB products, our revenue will decline significantly. Factors that may affect the market acceptance of our current USB products include the continued growth of the markets for USB compliant devices as well as the performance and pricing of our USB products and the availability, functionality and price of competing products. Companies must also modify their products to support new versions of USB as they are developed, such as USB 2.0. Many of these factors are beyond our control. In addition, in order to maintain widespread market acceptance, we must continue to differentiate ourselves from the competition through our technical expertise, product offerings and brand name recognition. Failure of our USB products to maintain market acceptance would adversely impact our revenue. If we devote resources to developing products for communications standards that ultimately are not widely accepted, our business could be harmed. We may incur significant expenses and dedicate significant time and resources in developing products for emerging communications standards that may not gain broad acceptance. For example, we spent four years from 1992 to 1995 developing products for the ACCESS.bus technology, a standard designed to connect peripheral devices to computers, which did not gain market acceptance. The failure of a standard for which we devote resources to gain widespread acceptance, or our failure to be first to market with products that address a particular standard, would likely harm our business. If we fail to maintain and expand our relationships with the core or promoter companies in our target markets, we may have difficulty developing and marketing our products. It is important to our success to maintain and expand our relationships with companies that are leaders in developing new communications standards in our target markets. We believe that we need to work closely with these core or promoter companies to gain valuable insights into the market demands for new products, to obtain early access to new communications standards as they are developed and to help us design new products. We will need to maintain our relationships with leading technology and infrastructure companies, as well as expand our relationships with leaders in markets that are new for us. Generally, we do not enter into formal contracts that obligate these companies to work or share their technology with us. Industry leaders could choose to work with other companies as they develop new communications standards in the future. If we fail to maintain and expand our industry relationships, we could lose the opportunity for first-mover advantage with respect to emerging standards and it would be more difficult for us to develop and market products that address these standards. If our target markets do not accept our products for emerging communications standards, our revenue growth could suffer. Our future growth depends upon our ability to sell advanced verification systems and connectivity products for emerging communications standards such as Bluetooth wireless technology. However, our products may not gain widespread acceptance by customers. The success of our products depends upon volume production of computer, communications and consumer electronic products that use a particular standard and the acceptance of these products by consumers. The markets for emerging standards products have only recently begun to develop and are rapidly evolving. As a result, it is difficult to predict their potential size or future growth rate. There is significant uncertainty as to whether these markets ultimately will develop at all or, if they do develop, whether they will develop rapidly. If the markets for a particular emerging communications standard fail to develop or develop more slowly than expected, or if our products do not achieve widespread market acceptance by customers in these markets, our business would be significantly harmed. Delays in the development of new products or product enhancements could harm our operating results and our competitive position. The development of new, technologically advanced products is a complex and uncertain process requiring high levels of innovation and highly skilled engineering and development personnel, as well as accurate anticipation of technological and 18 market trends. Although we have not experienced any material product development delays in the past, these types of delays could occur in the future. To the extent that we do not introduce the first product for an emerging standard or customers defer or cancel orders with the expectation of a new product or product enhancement release, our operating results could suffer. Product development delays may result from numerous factors, including: . changing product specifications and customer requirements; . difficulties in hiring and retaining necessary technical personnel; . difficulties in allocating engineering resources and overcoming resource limitations; . difficulties with contract manufacturers or suppliers of key components; . changing market or competitive product requirements; and . unanticipated engineering complexities. If we are unable to meet the design and market introduction schedules for our new products or product enhancements, our operating results and competitive position may suffer. Variations in our revenue may cause fluctuations in our operating results. We may experience a delay in generating or recognizing revenue for a number of reasons. Historically, we have had little backlog and our revenue in any quarter has depended upon orders booked and shipped in that quarter. Furthermore, our customers may delay scheduled delivery dates and cancel orders without significant penalty. In addition, even if we ship orders, generally accepted accounting principles may require us to defer recognition of revenue from those orders until a later date. Because we budget our operating expenses on anticipated revenue trends and a high percentage of our expenses is fixed in the short term, any delay in generating forecasted revenue could have a significant negative impact on our operating results. Shifts in our product mix may result in declines in gross margins. Our gross margins vary among our products, with our gross margins generally being higher on our advanced verification systems than on our connectivity products. Our overall gross margins might fluctuate from period to period as a result of shifts in product mix, the channels through which we sell our products, the introduction of new products and product costs. Decreases in average selling prices of our products may reduce gross margins and revenue. The average selling prices of our products may decrease in the future in response to product introductions or enhancements by us or our competitors, or as a result of other factors, including discounts given on volume purchase orders or pricing pressures. For example, we recently reduced the prices of certain of our connectivity products in response to competitive pricing pressure. We anticipate that we will need to continue to develop and introduce on a timely basis new products that incorporate features that can be sold at higher average selling prices. Failure to do so would likely cause our revenue and gross margins to decline. Continued competition in our markets may lead to a reduction in our prices, revenue and market share. The markets for advanced verification and connectivity products for emerging communications standards are highly competitive. We compete with multiple companies in various markets, including Yokagawa in the markets for products for the 1394 standard, Tektronix in the markets for products for the Bluetooth wireless technology and Finisar in the markets for products for the InfiniBand standard. Any of our competitors may develop technologies that address our targeted markets more effectively and at a lower cost. In addition, these competitors may enter into strategic alliances or business combinations that increase their ability to innovate and address our markets. We may also face competition from other equipment manufacturers, such as Agilent, National Instruments and Rhode & Schwartz. Many of these companies have substantially greater financial, technical, marketing and distribution resources and brand name recognition than we have. We expect that more companies, including some of our customers, will enter our markets. If these companies develop products that compete with our products or form alliances with or acquire companies offering competing products, even if those products do not have capabilities comparable to our products, they would be significant 19 competitors and their activities could cause us to reduce our prices. Increased competition could result in significant price erosion, reduced revenue, lower margins and loss of market share, any of which would significantly harm our business. We depend on contract manufacturers for substantially all of our manufacturing requirements and if these manufacturers fail to provide us with adequate supplies of high-quality products, our competitive position, reputation and business could be harmed. We currently rely on four contract manufacturers for all of our manufacturing requirements except for the final assembly, testing and quality assurance on our lower volume, higher margin products. We do not have long-term contracts with any of these manufacturers. As a result, our manufacturers could refuse to continue to manufacture all or some of our products that we require or change the terms under which they manufacture our products. We have experienced delays in product shipments from some of our contract manufacturers in the past, which in turn forced us to delay product shipments to our customers. We may in the future experience similar delays or other problems, such as inferior quality and insufficient quantity of products, any of which could significantly harm our business. Our contract manufacturers may not be able to meet our future requirements for timely delivery of products of sufficient quality and quantity. We intend to introduce new products and product enhancements regularly, which will require that we rapidly achieve volume production by coordinating our efforts with those of our suppliers and contract manufacturers. The inability of our contract manufacturers to provide us with adequate supplies of high quality products or the loss of any of our contract manufacturers would cause a delay in our ability to fulfill orders while we obtain a replacement manufacturer. If we are unable to forecast our supply needs accurately, our costs may increase or we may not be able to ship products in a timely manner. We purchase components used in the manufacture of our products from several key sources. We depend on these sources to deliver necessary components in a timely manner based on twelve-month rolling forecasts that we provide. Lead times for materials and components that we order vary significantly and depend on factors such as specific supplier requirements, contract terms and current market demand for particular components. If we overestimate our component requirements, we may develop excess inventory, which would increase our costs. If we underestimate our component requirements, we may not be able to fulfill customer orders. We depend on sole source suppliers for several key components of our products, and we may lose sales if they fail to meet our needs. We obtain some parts, components and packaging used in our products from sole sources of supply. For example, we obtain field programmable gate array integrated circuits from Altera, ASICs from LSI Logic through Wyle Electronics, certain Bluetooth components from Ericsson, semiconductor devises from Agilent, and micro-controllers from Intel, SMSC and Cypress Semiconductor. If suppliers are unable to meet our demand for sole source components at reasonable costs and if we are unable to obtain an alternative source or the price for an alternative source is prohibitive, our ability to maintain timely and cost-effective production of our products would be harmed. In addition, because we rely on purchase orders rather than long-term contracts with our suppliers, including our sole source suppliers, we cannot predict with certainty our ability to obtain components in the longer term. If we are unable to obtain components or receive a smaller allocation of components than is necessary to manufacture products in quantities sufficient to meet demand, customers could choose to purchase competing products. If our distributors and resellers do not actively sell our products, our product sales may decline. We sell a substantial portion of our products through distributors and resellers, including Toyo, our distributor in Japan, which accounted for approximately 31.8% of our revenue in the quarter ended September 30, 2001. Our distributors and resellers generally offer products from multiple manufacturers. Accordingly, there is a risk that these distributors and resellers may give higher priority to selling products from other suppliers and reduce their efforts to sell our products. Our distributors and resellers may not market our products effectively or continue to devote the resources necessary to provide us with effective sales, marketing and technical support. Our distributors and resellers may on occasion build inventories in anticipation of substantial growth in sales and, if growth does not occur as rapidly as anticipated, may decrease the quantity of products ordered from us in subsequent quarters. A slowdown in orders from our distributors could reduce our revenue in any given quarter and give rise to fluctuations in our operating results. In addition, our sales to Toyo and our other distributors are made on the basis of purchase orders rather than a long-term commitment. The loss of any one of our major distributors, or the delay of significant orders from these distributors, could result in decreased revenue. 20 If we are unable to hire and retain additional sales, marketing, engineering, operations and finance personnel, our growth will be impaired. To grow our business successfully and maintain a high level of quality, we will need to recruit, retain and motivate additional highly skilled sales, marketing, engineering, operations and finance personnel. If we are not able to hire and retain a sufficient number of qualified employees, our growth will be impaired. In particular, as a company focused on the development of complex products, we will need to hire additional hardware and software developers and engineers and project managers of various experience levels in order to keep pace with technological change and develop products that meet the needs of rapidly evolving markets. Competition for skilled employees, particularly in the San Francisco Bay Area, is intense. We may have even greater difficulty recruiting potential employees if prospective employees perceive the equity component of our compensation package to be less valuable as a result of market fluctuations in the price of our common stock. The loss of key management personnel, on whose knowledge, leadership and technical expertise we rely, would harm our ability to execute our business plan. Our success depends heavily upon the continued contributions of our key management personnel, whose knowledge, leadership and technical expertise would be difficult to replace. For example, as we previously reported in June 2001, Dan Wilnai, our president and chief executive officer, announced his intention to retire. All of our executive officers and key personnel are employees at will. We maintain no key person insurance on any of our personnel. If we were to lose the services of any of our key personnel and were unable to hire qualified replacements, our ability to execute our business plan would be harmed. In addition, employees who leave our company may subsequently compete against us. If we fail to manage our growth effectively, our business could suffer. Our ability to offer products and implement our business plan successfully in a rapidly evolving market requires an effective planning and management process. We decreased our headcount by 4.4% in the quarter ended September 30, 2001. Even though our headcount decreased slightly in the quarter ended September 30, 2001, we expect that our headcount will increase in future quarters and that we will need to continue to improve our financial and managerial controls, reporting systems and procedures. For example, we are in the process of migrating our operations to a new enterprise resource planning system that affects almost every facet of our business operations. Typically, these conversions negatively affect a company's near-term ability to conduct business due to problems such as historical data conversion errors, personnel training time associated with the new system, delays in implementation or unforeseen technical problems during conversion. If problems arise during this transition, we could experience delays in or lack of shipping, an inability to support our existing customer base, delays in paying vendors, delays in collecting from customers, an inability to place or receive product orders or other operational problems. If this were to occur, our profitability or financial position could be negatively impacted. If we are not able to manage our growth effectively and efficiently, the quality of our products, our ability to retain key personnel and our operating results could suffer. Our products may contain defects that cause us to incur significant costs, divert our attention from product development efforts and result in a loss of customers. Highly complex products such as our verification systems and connectivity products frequently contain defects when they are first introduced or as new versions are released. Although none of our products has contained any material defects in the past, our products may contain defects of this nature in the future. If any of our products contains defects or have reliability, quality or compatibility problems, our reputation may be damaged and customers may be reluctant to buy our products. As a result, our ability to retain existing customers or attract new customers could be harmed. In addition, these defects could interrupt or delay sales to our customers. We may have to invest significant capital and other resources to alleviate these problems. If any of these problems remains undiscovered until after we have commenced commercial production of a new product, we may be required to incur additional development costs and product recall, repair or replacement costs. These problems may also result in claims against us by our customers or others. In addition, these problems may divert our technical and other resources from other development efforts. If we are unable to expand our direct sales operations and our distributor and reseller channels or successfully manage our expanded sales organization, our ability to increase our revenue will be harmed. Historically, we have relied on a limited direct sales organization, supported by third-party resellers, to sell our products domestically and on third-party distributors to sell our products internationally. We intend to develop and expand our direct sales organization in North America and our indirect distribution channels internationally. We may not be able to expand our direct sales organization successfully, and the cost of any expansion may exceed the revenue generated from expansion. In addition, if we fail to develop relationships with significant distributors or resellers, or if our current distributors or resellers are not successful in their sales or marketing efforts, sales of our products may decrease. 21 Any acquisitions that we undertake could be difficult to integrate, disrupt our business, dilute stockholder value and harm our operating results. We expect to review opportunities to buy other businesses or technologies that would complement our current products, expand the breadth of our markets or enhance our technical capabilities or that might otherwise offer growth opportunities. While we have no current agreements or negotiations underway, we may buy businesses, product lines or technologies in the future. If we make any future acquisitions, we could issue stock that would dilute the percentage ownership of our existing stockholders, incur substantial debt or assume contingent liabilities. To date, we have not acquired any other business or technologies. Potential acquisitions also involve numerous risks, including: . problems in assimilating the purchased operations, technologies or products; . costs or accounting charges associated with the acquisition; . diversion of management's attention from our existing business; . adverse effects on existing business relationships with suppliers and customers; . risks associated with entering markets in which we have little or no prior experience; and . potential loss of key employees of purchased businesses. Economic,political and other risks associated with international sales and operations could adversely affect our sales. Because we sell our products worldwide and have a research and development facility in Israel, our business is subject to risks associated with doing business internationally. We recognized 61.2% of our revenue from sales to international customers in the quarter ended September 30, 2001. We anticipate that revenue from international operations will continue to represent a substantial portion of our revenue. In addition, several of our manufacturers' facilities and suppliers are located outside the United States. Accordingly, our future results could be harmed by a variety of factors, including: . changes in foreign currency exchange rates; . changes in a specific country's or region's political or economic conditions, particularly in emerging markets; . trade protection measures and import or export licensing requirements; . potentially negative consequences from changes in tax laws; . difficulty in staffing and managing widespread operations; . differing labor regulations; . differing protection of intellectual property; and . unexpected changes in regulatory requirements. Our headquarters and our contract manufacturers are located in Northern California, Asia and other areas where natural disasters may occur. Currently, our corporate headquarters and some of our contract manufacturers are located in Northern California and our other contract manufacturers are located in Asia. Northern California and Asia historically have been vulnerable to natural disasters and other risks, such as earthquakes, fires, floods, power loss and telecommunication failure, which at times have disrupted the local economy and posed physical risks to our and our manufacturers' properties. We also maintain facilities in San Diego, California and Netanya, Israel. We do not have redundant, multiple site capacity in the event of a natural disaster. Any failure to protect our intellectual property adequately may significantly harm our business. To date, we protect our proprietary processes, software, know-how and other intellectual property and related rights through copyrights, trademarks and maintenance of trade secrets, including entering into confidentiality agreements. Our success 22 and ability to compete depend in part on our proprietary technology. We currently do not have any patents. Although we have five patents pending, patents may not issue as a result of these or other patent applications. Any patents that ultimately issue may be successfully challenged by others or invalidated, or may not provide us with a significant competitive advantage. Third parties may breach confidentiality agreements or other protective contracts into which we have entered, and we may not be able to enforce our rights in the event of these breaches. We may be required to spend significant resources to monitor and police our intellectual property rights, including pursuing remedies in court. We may become involved in legal proceedings against other parties, which may also cause other parties to assert claims against us. We report material pending legal proceedings, if any, under the separate caption "Part II, Item 1. Legal Proceedings" elsewhere in this report. However, in the future, we may not be able to detect infringement and may lose competitive position in our markets before we do so. In addition, competitors may design around our technologies or develop competing technologies. The laws of other countries in which we market 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. Claims that we infringe third-party intellectual property rights could result in significant expenses or restrictions on our ability to sell our products. Our industry is characterized by uncertain and conflicting intellectual property claims and frequent intellectual property litigation, especially regarding patent rights. To date, we have not received any letters, and we do not have any other reason to believe, that our products infringe any other party's intellectual property rights. However, we cannot be certain that our products do not and will not infringe issued patents or other intellectual property rights of others. Historically, patent applications in the United States have not been publicly disclosed until the patent is issued, and we may not be aware of filed patent applications that relate to our products or technology. If patents are later issued in connection with these applications, we may be liable for infringement. From time to time, other parties may assert patent, copyright and other intellectual property rights to technologies and in various jurisdictions that are important to our business. Any claims asserting that our products infringe or may infringe proprietary rights of third parties, including claims arising through our contractual indemnification of our customers, regardless of their merit or resolution, would likely be costly and time-consuming, result in costly litigation, divert the efforts of our technical and management personnel, cause product shipment delays or require us to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on terms acceptable to us, or at all. Changes in current laws or regulations or the imposition of new laws or regulations could impede the sale of our products. In the United States, substantial portions of the telecommunications industry, we and many of our customers and their products are subject to regulations and standards set by the Federal Communications Commission, or FCC. Internationally, many of our customers and their products may also be required to comply with regulations established by authorities in various countries. We are required to determine to what extent our products may be subject to FCC standards and regulations and to what extent we are required to obtain authorizations from the FCC directly or from a third-party authorized by the FCC to issue such authorizations. We are also required to maintain in good standing any equipment authorization we receive from the FCC or an FCC-approved party. In addition, the regulations in force both in the United States and in foreign jurisdictions may change. Failure to comply with regulations established by regulatory authorities or to obtain timely domestic or foreign regulatory approvals or certificates could significantly harm our business. The energy crisis in California may cause our operating results to suffer. California is in the midst of an energy crisis that could disrupt our operations and increase our expenses. Suppliers of electric power have on some occasions implemented, and may in the future continue to implement, rolling blackouts throughout California. We currently do not have backup generators or alternate sources of power in the event of a blackout, and our current insurance does not provide coverage for any damages our customers or we may suffer as a result of any interruption in the power supply. If blackouts interrupt our power supply, we would be temporarily unable to continue operations at our facilities in California. Any such interruption in our ability to continue operations at our facilities could damage our reputation, harm our ability to retain existing customers and to obtain new customers, and result in lost revenue, any of which could substantially harm our business and results of operations. Item 3. Quantitative and Qualitative Disclosures About Market Risk The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities in which we invest may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with an interest rate fixed at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline. As of September 30, 2001, all of our investments were in money market funds, certificates of deposit or high quality commercial paper. 23 Part II - OTHER INFORMATION Item 1. Legal Proceedings On December 29, 2000, we filed in the United States District Court for the Northern District of California a complaint against Catalyst Enterprises, Inc., alleging trademark and trade dress infringement, copyright infringement and unfair competition and seeking damages and attorneys' fees. The case is referred to as Computer Access Technology Corporation v. Catalyst Enterprises, Inc., Case No. C 00 4852 DLJ. Catalyst responded to the complaint on April 6, 2001 by denying each of the substantive claims and asserting federal and state unfair competition counterclaims, and requesting an award of attorneys' fees. We answered the counterclaims on September 27, 2001, and denied all the substantive claims of Catalyst's counterclaims. The case is set for trial on July 1, 2002. On March 28, 2001, we filed a motion for preliminary injunction against Catalyst. The Court denied this motion by order entered June 13, 2001. We filed a notice of appeal to the 9th Circuit Court of Appeals on July 12, 2001. The parties stipulated to a continuance of the briefing schedule for the appeal, and our opening brief is now due on December 4, 2001. We cannot predict the outcome of this matter at this time. Item 5. Other Information On October 29, 2001, we announced the hiring of Keith Perry as our new vice president, sales and customer services. 24 Item 6. Exhibits and Reports on Form 8-K a. Exhibits. Exhibit No. Document Name ----------- ------------- 3.1* Amended and Restated Certificate of Incorporation of the Registrant. 3.2* Bylaws of the Registrant. 4.1* Specimen Certificate of the Registrant's common stock. * Previously filed as an exhibit to the Registrant's Registration Statement on Form S-1 (Registration No. 333-43866) as filed with the SEC on August 16, 2000, as subsequently amended, and incorporated in this quarterly report by reference. b. Reports on Form 8-K. None 25 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date November 14, 2001 Computer Access Technology Corporation By: /s/ Dennis W. Evans ------------------------------------------------ Dennis W. Evans Vice President, Chief Financial Officer and Secretary (Principal Financial Officer and Principal Accounting Officer) 26