<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
Exchange Act of 1934 for the quarterly period ended October 28, 2000.
[ ] 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 0-26761
NETSILICON, INC.
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-2826579
(State of incorporation) (I.R.S. Employer Identification No.)
411 WAVERLEY OAKS RD., BLDG. 227, WALTHAM, MASSACHUSETTS 02452
(Address of principal executive office)
(781) 647-1234
(Telephone number)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---- ----
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date.
6,632,780 shares of Voting Common Stock, $0.01 par value, as of December 8, 2000
7,150,000 shares of Non-Voting Common Stock, $0.01 par value, as of December 8,
2000
<PAGE> 2
NETSILICON, INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Balance Sheets
October 28, 2000 and January 31, 2000............................................. 3
Condensed Consolidated Statements of Income
Three Months and Nine Months Ended October 28, 2000 and October 31, 1999.......... 4
Condensed Consolidated Statements of Cash Flows
Nine Months Ended October 28, 2000 and October 31, 1999........................... 5
Notes to Condensed Consolidated Financial Statements.............................. 6-8
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................................ 8-24
ITEM 3. Quantitative and Qualitative Disclosure About Market Risk............................ 24
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings.................................................................... 24
ITEM 2. Changes in Securities and Use of Proceeds............................................ 24
ITEM 3. Defaults Upon Senior Securities...................................................... 24
ITEM 4. Submission of Matters to a Vote of Security Holders.................................. 25
ITEM 5. Other Information.................................................................... 25
ITEM 6. Exhibits and Reports on Form 8-K..................................................... 25
Signatures..................................................................................... 25
Exhibit 27.1
</TABLE>
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
<TABLE>
<CAPTION>
NETSILICON, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
OCTOBER 28, 2000 JANUARY 31, 2000
(Unaudited)
---------------- ---------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and equivalents $ 7,091,200 $ 11,096,500
Short-term investments 8,068,100 8,203,700
Accounts receivable, net 5,547,400 2,266,000
Inventory, net 6,604,100 4,322,400
Prepaid expenses and other current assets 1,710,300 798,900
------------ ------------
TOTAL CURRENT ASSETS 29,021,100 26,687,500
PROPERTY AND EQUIPMENT, NET 2,527,600 1,466,400
INTANGIBLE ASSETS, NET 2,499,400 --
OTHER ASSETS 2,117,100 1,626,600
------------ ------------
TOTAL ASSETS $ 36,165,200 $ 29,780,500
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Short-term debt $ -- $ 779,700
Accounts payable 4,392,100 3,013,200
Due to affiliate 223,000 56,900
Other current liabilities, including short term portion of capital lease obligation 3,400,000 3,322,700
------------ ------------
TOTAL CURRENT LIABILITIES 8,015,100 7,172,500
CAPITAL LEASE OBLIGATION - Less current portion -- 125,100
------------ ------------
TOTAL LIABILITIES 8,015,100 7,297,600
------------ ------------
STOCKHOLDERS' EQUITY
Preferred stock, $0.01 par value; 5,000,000 authorized;
none issued -- --
Common stock, $0.01 par value; 35,000,000 authorized; issued and
outstanding:
Voting (6,282,780 and 6,037,500 shares at October 28 and
January 31, respectively) 62,800 60,400
Non-Voting (7,500,000 shares at October 28 and January 31) 75,000 75,000
Additional paid-in capital 28,187,400 24,755,400
Accumulated other comprehensive income (loss) 8,000 (26,400)
Accumulated deficit (183,100) (2,381,500)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY 28,150,100 22,482,900
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 36,165,200 $ 29,780,500
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE> 4
NETSILICON, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
October 28, 2000 October 31, 1999 October 28, 2000 October 31, 1999
---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
NET SALES $10,687,700 $ 10,148,800 $29,554,600 $ 23,478,400
COST OF SALES 4,429,300 4,654,200 12,069,700 11,727,300
----------- ------------ ----------- ------------
GROSS MARGIN 6,258,400 5,494,600 17,484,900 11,751,100
----------- ------------ ----------- ------------
OPERATING EXPENSES
Selling and marketing 2,819,200 2,206,400 8,151,300 5,260,600
Engineering, research and development 1,900,100 1,249,000 4,693,500 2,314,400
General and administrative 1,085,300 1,066,200 3,124,800 2,466,700
----------- ------------ ----------- ------------
TOTAL OPERATING EXPENSES 5,804,600 4,521,600 15,969,600 10,041,700
----------- ------------ ----------- ------------
OPERATING INCOME 453,800 973,000 1,515,300 1,709,400
Interest income (expense) 218,200 (68,100) 683,100 (481,100)
----------- ------------ ----------- ------------
INCOME BEFORE TAXES
ON INCOME 672,000 904,900 2,198,400 1,228,300
Taxes on income -- -- -- --
----------- ------------ ----------- ------------
NET INCOME $ 672,000 $ 904,900 $ 2,198,400 $ 1,228,300
=========== ============ =========== ============
NET INCOME PER COMMON SHARE
Basic $ 0.05 $ 0.08 $ 0.16 $ 0.12
Diluted $ 0.04 $ 0.07 $ 0.14 $ 0.11
SHARES USED IN PER SHARE CALCULATION
Basic 13,719,643 11,768,750 13,636,354 10,589,583
Diluted 15,814,393 12,434,763 15,911,922 10,814,027
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE> 5
NETSILICON, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
October 28, 2000 October 31, 1999
---------------- ----------------
<S> <C> <C>
CASH FLOW FROM OPERATING ACTIVITIES:
Net income $ 2,198,400 $ 1,228,300
Adjustments to reconcile net income to
net cash (used in) provided by operating activities:
Depreciation and amortization 1,179,000 941,400
Changes in operating assets and liabilities, excluding
effect of acquisition:
Accounts receivable (3,189,900) 1,280,300
Inventories (2,281,700) (192,400)
Other current assets (911,400) (150,800)
Accounts payable 1,545,000 454,700
Other current liabilities 10,900 1,811,000
------------ ------------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES (1,449,700) 5,372,500
------------ -------------
CASH FLOW FROM INVESTING ACTIVITIES:
Proceeds from maturity/sale of short-term investments 170,000 --
Purchases of property and equipment (1,669,300) (603,400)
Direct acquisition costs (439,700) --
Software development costs (426,900) (668,100)
Other assets (308,700) 415,500
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES (2,674,600) (856,000)
------------ ------------
CASH FLOW FROM FINANCING ACTIVITIES:
Repayments of affiliate advances -- (4,824,200)
Repayments of short-term debt, net (779,700) (2,551,500)
Payments of capital lease obligation (189,000) (23,400)
Proceeds from issuance of stock (net of issuance costs) -- 22,249,100
Proceeds from exercise of stock options 1,087,700 --
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 119,000 14,850,000
------------ ------------
INCREASE (DECREASE) IN CASH AND EQUIVALENTS (4,005,300) 19,366,500
CASH AND EQUIVALENTS - BEGINNING OF PERIOD 11,096,500 582,600
------------ ------------
CASH AND EQUIVALENTS - END OF PERIOD $ 7,091,200 $ 19,949,100
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE> 6
NETSILICON, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of presentation:
In the opinion of management, the accompanying condensed
consolidated financial statements include all adjustments
necessary for a fair presentation of NETsilicon, Inc.'s (the
"Company") financial position, results of operations and cash
flows for these interim periods. This quarterly information
should be read in conjunction with the audited financial
statements and accompanying notes included in the Company's
2000 Form 10-K as filed with the Securities and Exchange
Commission ("SEC") on May 1, 2000.
The financial statements are prepared in conformity with
generally accepted accounting principles which require
management to make estimates that affect the reported amounts
of assets, liabilities, revenues and expenses, and the
disclosure of contingent assets and liabilities. Actual
results could differ from these estimates.
Certain prior period amounts have been reclassified to conform
to the current period presentation. Included among these
reclasses is the reclassification of amortization of
capitalized software costs from engineering, research and
development costs to cost of sales. These reclassifications
had no effect on net income or stockholders' equity.
Operating results for the interim period are not necessarily
indicative of results that may be expected for the entire
fiscal year.
2. Inventories:
Inventories are stated at the lower of cost (first-in,
first-out) or market. Cost is computed using standard costs,
which approximate actual cost on a first-in, first-out basis.
Inventories consist of:
<TABLE>
<CAPTION>
October 28, January 31,
2000 2000
---------------- ----------------
<S> <C> <C>
Raw material $6,130,400 $2,518,600
Work in process 175,700 1,693,400
Finished goods 298,000 110,400
---------------- ----------------
Total inventory $6,604,100 $4,322,400
================ ================
</TABLE>
3. Earnings per share calculation:
Basic earnings per share is computed based on the weighted
average number of shares outstanding during the period.
Diluted earnings per share is computed based on the weighted
average number of shares outstanding during the period
increased by the effect of dilutive potential common shares
which consist of shares issuable under stock benefit plans
and warrants.
6
<PAGE> 7
The following is a reconciliation of the numerators and
denominators of the basic and diluted per share computations:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------- -------------------------
October 28, October 31, October 28, October 31,
2000 1999 2000 1999
------------ ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net income available to common
shareholders, basic and diluted $672,000 $904,900 $2,198,400 $ 1,228,300
============ =========== =========== ===========
Weighted-average number of
common shares used in basic
earnings per share 13,719,643 11,768,750 13,636,354 10,589,583
Effect of dilutive securities -
stock options 2,094,750 666,013 2,275,568 224,444
------------ ----------- ----------- -----------
Weighted-average number of
common shares and dilutive
potential common stock used in
dilutive earnings per share 15,814,393 12,434,763 15,911,922 10,814,027
============ =========== =========== ===========
</TABLE>
The shares issuable upon exercise of options and warrants
represent the quarterly average of the shares issuable at
exercise net of the shares assumed to have been purchased, at
the average market price for the period, with the assumed
exercise proceeds. Accordingly, options and warrants with
exercise prices in excess of the average market price for
the period are excluded because their effect would be
anti-dilutive.
4. Acquisition
On August 31, 2000, the Company completed the acquisition of
the strategic network technology assets (the "Purchased
Assets") of Pacific Softworks Technology, Inc. ("Pacific"), a
subsidiary of PASW, Inc. (formerly Pacific Softworks, Inc.).
The Purchased Assets, which represent substantially all of the
assets of Pacific, will be used by the Company to develop and
license embedded network protocols, software that enables
electronic devices to communicate over local and wide area
networks.
The purchase price was allocated to the tangible and
intangible assets acquired and liabilities assumed on the
basis of their respective estimated fair values on the
acquisition date, as follows:
<TABLE>
<S> <C>
Completed technology $2,417,700
Workforce 228,700
Fixed assets 103,700
Accounts receivable 91,500
----------
Total purchase price $2,841,600
==========
</TABLE>
The purchase price consisted of 90,000 shares of the common
stock of the Company, valued at $2,271,600, and $570,000 of
acquisition-related costs, including $400,000 for investment
banking fees and fees for legal, accounting and consulting.
The purchased completed technology and workforce assets are
being amortized over three years.
5. Revolving Line of Credit-Bank
On July 31, 2000 the Company obtained a $5,000,000 revolving
line of credit with a bank, which expires May 31, 2001, and is
available to fund working capital. Borrowings under the line
of credit are
7
<PAGE> 8
secured by certain Company assets, including inventory and
accounts receivable, and bear interest at the prime rate plus
0.25% (9.75% at October 28, 2000). The maximum available
credit under the revolving line of credit is equal to the
lesser of $5,000,000 and the then effective borrowing base,
as defined in the bank agreement and calculated as a
percentage of accounts receivable. The agreement requires
that the Company maintain certain financial ratios among
other restrictive covenants. As of October 28, 2000 there
were no borrowings outstanding under the revolving note.
6. Contingencies
On August 31, 2000, Websprocket, LLC filed a suit against the
Company in the United States District Court for the Northern
District of California (Websprocket, LLC v. NETsilicon, Inc.,
Civil Action No. C-00-20915), claiming breach of contract.
The complaint alleges that the Company breached a technology
development contract that was executed between the Company
and Websprocket, LLC in December 1999. Websprocket, LLC seeks
relief including alleged damages of $2,000,000 plus
attorney's fees, a declaration of its rights under the
technology development contract and an injunction requiring
the Company to cease using and return all property of
Websprocket, LLC. We believe we have meritorious defenses to
the claims and intend to contest the lawsuit vigorously. On
or about October 31, 2000, the Company denied the allegations
in Websprocket, LLC's complaint and asserted counterclaims
against Websprocket, LLC that included breach of contract,
fraud, and negligent misrepresentation. An unfavorable
resolution of the action could have a material adverse effect
on the business, results of operations or financial condition
of the Company.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Information provided by the Company from time to time
including statements in this Form 10-Q which are not
historical facts are so-called "forward-looking statements"
that involve risks and uncertainties, made pursuant to the
safe harbor provisions of the Private Securities Litigation
Reform Act of 1995. In particular, statements contained in
Management's Discussion and Analysis of Financial Condition
and Results of Operations which are not historical facts
(including, but not limited to, statements concerning the
plans and objectives of management; expectations for sales
and marketing, research and development and general and
administrative expenses; developments relating to the
Company's product and service offerings, markets and
acquisitions; anticipated trends in the Company's business;
and the Company's expected liquidity and capital resources)
may constitute forward-looking statements. These
forward-looking statements are neither promises nor
guarantees, but are subject to risk and uncertainties that
could cause actual results to differ materially from the
expectations set forth in the forward-looking statements.
Factors that may cause such differences include, but are not
limited to, the factors discussed below, and the other risks
discussed in the Company's Annual Report on Form 10-K for the
fiscal year ended January 31, 2000 and from time to time in
the Company's other filings with the Securities and Exchange
Commission.
OVERVIEW
We develop and market Ethernet microprocessing solutions,
including semiconductor devices and software, designed to
meet the networking requirements of intelligent,
network-enabled devices. We commenced our operations in 1984
as Digital Products, Inc. From our inception, we have
developed and marketed networking products for embedded
systems that enable the connection of electronic devices to
networks.
8
<PAGE> 9
In September 1996, Osicom Technologies, Inc. ("Osicom")
acquired all of our outstanding capital stock from our
stockholders. We were a wholly-owned subsidiary of Osicom from
the date of the acquisition through our initial public
offering in September 1999.
RESULTS OF OPERATIONS
The following table sets forth information derived from our
Statement of Operations expressed as a percentage of net sales
for the three and nine month periods ended October 28, 2000
and October 31, 1999.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
October 28, October 31, October 28, October 31,
2000 1999 2000 1999
--------------- ------------- -------------- -----------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 41.4 45.9 40.8 49.9
--------------- ------------- -------------- -----------
Gross margin 58.6 54.1 59.2 50.1
--------------- ------------- -------------- -----------
Operating expenses:
Selling and marketing 26.4 21.7 27.6 22.4
Engineering, research
and development 17.8 12.3 15.9 9.9
General and
administrative 10.2 10.5 10.6 10.5
--------------- ------------- -------------- -----------
Total operating expenses 54.4 44.5 54.1 42.8
--------------- ------------- -------------- -----------
Operating income 4.2 9.6 5.1 7.3
Interest income (expense) 2.0 (0.7) 2.3 (2.0)
--------------- ------------- -------------- -----------
Income before taxes on
income 6.2 8.9 7.4 5.3
Taxes on income - - - -
--------------- ------------- -------------- -----------
Net income
6.2% 8.9% 7.4% 5.3%
=============== ============= ============== ===========
</TABLE>
Three and Nine Months Ended October 28, 2000 compared to
Three and Nine Months Ended October 31, 1999:
Net sales. Net sales increased to $10.7 million for the three
months ended October 28, 2000 from $10.1 million for the three
months ended October 31, 1999, representing an increase of
5.3%. Net sales increased to $29.6 million for the nine months
ended October 28, 2000 from $23.5 million for the nine months
ended October 31, 1999, an increase of 25.9%.
The increase in net sales was due primarily to an increase in
OEM customers to which we shipped product from 30 for the
period ended October 31, 1999 to 74 for the period ended
October 28, 2000. Furthermore, the increase is attributable to
increased sales to existing OEM imaging customers due to
greater demand for their products and an increase in the
number of projects we have with these customers. Net sales for
the three months ended October 31, 1999 included a significant
order from a new imaging customer related to increased demand
for its product toward the end of calendar year 1999 as a
result of Year 2000 remediation. Backlog for our products and
services was approximately $4.8 million and $7.3 million at
October 28, 2000 and October 31, 1999, respectively, all of
which was scheduled to be shipped within 12 months.
Our embedded networking semiconductor and controller products
accounted for 89.0% and 95.3% of total net sales for the nine
months ended October 28, 2000 and October 31, 1999,
respectively. Software development tools and development
boards accounted for 5.4% of
9
<PAGE> 10
total net sales for the nine months ended October 28, 2000
and 1.7% of total net sales for the prior year nine month
period. Royalty, maintenance and service revenue was 5.6%
and 3.0% of total net sales for the nine months ended October
28, 2000 and October 31, 1999, respectively. Deferred
revenue of $320,800 is included in other current liabilities
at October 28, 2000.
During the nine months ended October 28, 2000, international
sales accounted for 55% of net sales compared to 60% of net
sales for the nine month period ended October 31, 1999.
Cost of sales; gross margin. Costs of goods sold consists
principally of the cost of raw material components and
subcontractor labor assembly from outside manufacturers and
suppliers and amortization of software development costs.
Gross margin increased to $6.3 million, or 58.6% of net
sales, for the three months ended October 28, 2000 from $5.5
million, or 54.1% of net sales, for the three months ended
October 31, 1999, representing an increase of 13.9%. Gross
margin increased 48.8% to $17.5 million, or 59.2% of net
sales, for the nine months ended October 28, 2000 from $11.8
million, or 50.1% of net sales, for the nine months ended
October 31, 1999.
The increases in gross margin percent for the periods ended
October 28, 2000 from the prior year periods were due
primarily to (i) material and subcontractor labor cost
reductions which were partially attributable to the increased
sales volume, (ii) increases in non-recurring engineering fees
related to new OEM imaging projects and royalties and (iii) a
gradual shift in product mix to higher margin intelligent
device market products and a shift from imaging network
interface cards to higher margin imaging semiconductor
devices.
Selling and marketing expenses. Selling and marketing expenses
consist mainly of employee-related expenses, commissions to
sales representatives, trade shows and travel expense. Selling
and marketing expenses increased from $2.2 million, or 21.7%
of net sales, for the three months ended October 31, 1999 to
$2.8 million, or 26.4% of net sales, for the three months
ended October 28, 2000, representing an increase of 27.8%.
Similarly, selling and marketing expenses increased 55.0% to
$8.2 million, or 27.6% of net sales, for the nine months ended
October 28, 2000 from $5.3 million, or 22.4% of net sales, for
the nine months ended October 31, 1999.
The increase was the result of (i) additional sales
commissions due to increased sales volume and the expansion of
our network of manufacturing representatives, distributors and
authorized developers, (ii) additional payroll costs related
to the expansion of our direct sales and marketing teams in
the United States, Europe and Asia from 35 employees in
October 1999 to 53 employees in October 2000, (iii) greater
marketing costs associated with the introduction of new
products, greater participation in trade shows and costs
associated with Internet and web marketing activities. The
increase in headcount from October 1999 to October 2000
includes the addition of three sales and marketing individuals
acquired in connection with our purchase of certain assets of
Pacific Softworks, Inc. ("Pacific") in August 2000.
Engineering, research and development. Engineering, research
and development expenses consist primarily of salaries and the
related costs of employees engaged in research, design and
development activities. Engineering, research and development
expenses increased to $1.9 million, or 17.8% of net sales, for
the three months ended October 28, 2000 from $1.2 million, or
12.3% of net sales, for the three months ended October 31,
1999, representing an increase of 52.1%. Engineering, research
and development expenses increased 102.8% to $4.7 million, or
15.9% of net sales, for the nine months ended October 28, 2000
from $2.3 million, or 9.9% of net sales, for the nine months
ended October 31, 1999.
10
<PAGE> 11
This increase is due primarily to increased payroll costs
associated with an increase in headcount from 34 employees
engaged in research and development activities at October 31,
1999 to 52 employees at October 28, 2000. The increase in
headcount includes the addition of 10 engineers acquired in
connection with our purchase of certain assets of Pacific in
August 2000. In addition, the increase in engineering,
research and development expenses is attributable to increases
in contract labor and consulting costs related to our
investment in product development, including investments in
the development of products supporting the Linux operating
system and Java programming language. Futhermore, the increase
is due to higher recruiting costs, increased depreciation and
amortization of purchased software tools, and amortization of
purchased intangible assets related to our purchase of certain
Pacific assets in August 2000.
General and administrative expenses. General and
administrative expenses consist primarily of salaries,
employee-related expenses, legal expenses, audit fees and
provisions for accounts receivable allowances. General and
administrative expenses increased to $1.09 million, or 10.2%
of net sales, for the three months ended October 28, 2000 from
$1.07 million, or 10.5% of net sales, for the three months
ended October 31, 1999, an increase of 1.8%. General and
administrative expenses increased 26.7% to $3.1 million, or
10.6% of net sales, for the nine months ended October 28, 2000
from $2.5 million, or 10.5% of net sales, for the nine months
ended October 31, 1999. The increase in general and
administrative expenses is attributable to higher payroll
costs related to an increase in headcount in addition to
increased legal, accounting and insurance costs associated
with becoming a public entity and consulting and other costs
associated with the continued development of our MIS group.
Interest income/expense. Interest income includes interest
earned on cash and short-term investment balances. Interest
expense is the result of our borrowings against our line of
credit with our former lender, Coast Business Credit, and the
interest charged by our former sole shareholder, Osicom, for
our borrowings from Osicom. Net interest income was $218,200,
or 2.0% of net sales, and $683,100, or 2.3% of net sales, for
the three and nine months ended October 28, 2000,
respectively, and consisted of interest earned on cash and
short-term investment balances. Net interest expense was
$68,100, or 0.7% of net sales, and $481,100, or 2.0% of net
sales, for the three and six months ended October 31, 1999,
respectively and consisted of interest on borrowings from both
our line of credit and Osicom. The increases in interest
income and the decreases in interest expense from the periods
ended October 1999 to the periods ended October 2000 are the
result of the proceeds raised by the sale of our stock in
conjunction with our initial public offering on September 15,
1999 and our subsequent repayment of amounts due Coast
Business Credit and Osicom.
Provision for income taxes. There was no net provision for
income taxes for the three and nine month periods ended
October 28, 2000 and October 31, 1999 as the provisions were
offset by available net operating loss carryforwards.
Liquidity and Capital Resources
Prior to our public offering in September 1999 we financed
our operations through advances from Osicom and borrowings
under our short-term bank line of credit. The Company received
proceeds, net of offering costs, of approximately $22.2
million as a result of the initial public offering and sale of
our stock. At October 28, 2000 we had working capital of $21.0
million and cash and cash equivalents of $7.1 million.
Our operating activities used cash of $1.4 million and
provided cash of $5.4 million for the nine month periods ended
October 28, 2000 and October 31, 1999, respectively.
11
<PAGE> 12
Cash used by operating activities in the nine month period
ended October 28, 2000 was attributable to increases in
accounts receivable and inventory, offset in part by net
income, an increase in accounts payable and the non-cash
impact of depreciation and amortization. The increase in
accounts receivable and inventory related to the growth in
sales and the demand for our product. The increase in
inventory is also due to larger volume purchases of certain
electronic components that were made to decrease the risk to
our operations of the sharp fluctuations in the market supply
of the components. Cash provided in the nine month period
ended October 31, 1999 was attributable to net income, a
decrease in accounts receivable, an increase in other current
liabilities, and the non-cash impact of depreciation and
amortization.
In order to support our anticipated growth, we expect that our
sales and marketing expenses, engineering, research and
development expenses and general and administrative expenses
each will increase in the fiscal year ending January 31, 2001
and thereafter compared to the amounts of such expenses in the
fiscal year ending January 31, 2000. There can be no assurance
that our available cash and cash flow from operations will be
sufficient to fund such additional expenses.
Our standard payment terms are net 30 days. While we actively
pursue collection within that time, receivables have
frequently taken longer to collect in part because we sell
products to large companies in Asia.
Our investing activities used cash of $2.7 million and
$856,000 during the nine months ended October 28, 2000 and
October 31, 1999, respectively. Cash used in investing
activities during the nine months ended October 28, 2000
related primarily to purchases of $1.7 million of property and
equipment, cash payments for acquisition-related costs
incurred in connection with our purchase of certain Pacific
assets in August 2000 of $439,700 and software development
costs of $426,900. Cash used in investing activities during
the nine months ended October 31, 1999 related primarily to
purchases of $603,400 of property and equipment and software
development costs of $668,100.
On August 31, 2000, we issued 90,000 shares of common stock,
valued at $2.3 million and incurred $570,000 of
acquisition-related costs in connection with the acquisition
of the strategic network technology assets of Pacific. The
total purchase price was $2.8 million and was allocated to
the tangible and intangible assets acquired.
Cash provided by financing activities was $119,000 and $14.9
million during the nine months ended October 28, 2000 and
October 31, 1999, respectively. Cash provided by financing
activities during the period ended October 28, 2000 related
primarily to proceeds from the exercise of stock options of
$1.1 million which were offset in part by the repayment of
short-term debt obligations of $779,700. Cash provided by
financing activities during the period ended October 31, 1999
was attributable primarily to proceeds of $22.2 million from
the sale of common stock in connection with our initial public
offering in September 1999 which were offset in part by
repayments of affiliate advances of $4.8 million and
repayments of short-term debt of $2.6 million.
We anticipate that our available cash resources will be
sufficient to meet our presently anticipated capital
requirements through the next 12 months. Nonetheless, we may
elect to sell additional equity securities or to obtain
additional credit. Our future capital requirements may vary
materially from those now planned and will depend on many
factors, including, but not limited to, the levels at which we
maintain inventory and accounts receivable; the market
acceptance of our products; the levels of promotion and
advertising required to launch products or enter markets and
attain a competitive position in the marketplace; volume
pricing concessions; our business, product, capital
expenditure and research and development plans and technology
roadmap; capital improvements to new and existing facilities;
technological advances; the response of
12
<PAGE> 13
competitors to our products; and our relationships with
suppliers and customers. In addition, we may require an
increase in the level of working capital to accommodate
planned growth, hiring and infrastructure needs. Additional
capital may be required for consummation of any acquisitions
of businesses, products or technologies. We may need to raise
additional funds through public or private financings or
borrowings if existing resources and cash generated from
operations are insufficient to fund our future activities. No
assurance can be given that additional financing will be
available or that, if available, such financing can be
obtained on terms favorable to our shareholders and us. If
additional funds are raised through the issuance of equity
securities, the percentage ownership of then current
stockholders of us will be reduced and such equity securities
may have rights, preferences or privileges senior to those of
holders of our common stock. If adequate funds are not
available to satisfy short- or long-term capital requirements,
we may be required to limit our operations significantly.
Risk Factors
You should carefully consider the following risks before
investing in our common stock. These are not the only risks
facing our company. Additional risks may also impair our
business operations. If any of the following risks come to
fruition, our business, results of operations or financial
condition could be materially adversely affected. In that
case, the trading price of our common stock could decline, and
you may lose all or part of your investment. You should also
refer to the other information set forth in this report, and
incorporated by reference, including our financial statements
and the accompanying notes.
This report contains certain "forward-looking statements"
(statements that are not historical fact) based on our current
expectations, assumptions, estimates and projections about our
company and our industry. These forward-looking statements
involve risks and uncertainties. Our actual results could
differ materially from those anticipated in those
forward-looking statements as a result of many factors, as
more fully described in this section and elsewhere in this
report.
WE HAVE A HISTORY OF LOSSES AND AN ACCUMULATED DEFICIT THAT
MAKE FUTURE OPERATING RESULTS AND PROFITABILITY DIFFICULT TO
PREDICT.
We incurred net losses from continuing operations for the
fiscal years ended January 31, 1997, 1998 and 1999. At January
31, 2000, we had an accumulated deficit of $2.4 million.
Although we were profitable in fiscal year 2000 and for the
first nine months of fiscal year 2001, there can be no
assurance that we will be able to maintain profitability on a
quarterly or annual basis in the future. In addition, revenue
growth is not necessarily indicative of future operating
results and there can be no assurance that we will be able to
sustain revenue growth. We continue to invest significant
financial resources in product development, marketing and
sales, and a failure of such expenditures to result in
significant increases in revenue could have a material adverse
effect on us. Due to the limited history and undetermined
market acceptance of our new products, the rapidly evolving
nature of our business and markets, potential changes in
product standards that significantly influence many of the
markets for our products, the high level of competition in the
industries in which we operate and the other factors described
elsewhere in Risk Factors, there can be no assurance that our
investment in these areas will result in increases in revenue
or that any revenue growth that is achieved can be sustained.
Our history of losses, coupled with the factors described
below, make future operating results difficult to predict. We
and our future prospects must be considered in light of the
risks, costs and difficulties frequently encountered by
emerging companies. As a result, there can be no assurance
that we will be profitable in any future period.
13
<PAGE> 14
THE UNPREDICTABILITY OF OUR QUARTERLY RESULTS MAY ADVERSELY
AFFECT THE TRADING PRICE OF OUR COMMON STOCK.
Our net sales and operating results have in the past and may
in the future fluctuate substantially from quarter to quarter
and from year to year. These results have varied significantly
due to a number of factors, including:
- market acceptance of and demand for our
products and those of our customers;
- unanticipated delays or problems in the
introduction of our products;
- the timing of large customer orders;
- the timing and success of our customers'
development cycles;
- our ability to introduce new products in
accordance with customer design requirements
and design cycles;
- new product announcements or product
introductions by us and our competitors;
- availability and cost of manufacturing
sources for our products;
- the volume of orders that are received and
can be filled in a quarter;
- the rescheduling or cancellation of orders
by customers;
- changes in product mix;
- timing of "design wins" with our customers
and related revenue; and
- changes in currency exchange rates.
Our operating results could also be harmed by:
- the growth rate of markets into which we
sell our products;
- changes in the mix of sales to customers and
sales representatives;
- costs associated with protecting our
intellectual property; and
- changes in product costs and pricing by us
and our competitors.
We budget expenses based in part on future revenue
projections. We may be unable to adjust spending in a timely
manner in response to any unanticipated declines in revenues.
As a result of these and other factors, investors should not
rely solely upon period-to-period comparisons of our operating
results as an indication of future performance. It is likely
that in some future period our operating results or business
outlook will be below the expectations of securities analysts
or investors, which would likely result in a significant
reduction in the market price of the shares of common stock.
OUR FAILURE TO INCREASE SALES TO MANUFACTURERS OF INTELLIGENT
NETWORK-ENABLED DEVICES AND OTHER EMBEDDED SYSTEMS WILL
ADVERSELY AFFECT OUR FINANCIAL RESULTS.
14
<PAGE> 15
Our financial performance and future growth is dependent upon
our ability to sell our products to manufacturers of
intelligent, network-enabled devices and other embedded
systems in various markets, including markets in which
networking solutions for embedded systems have not
historically been sold, such as the industrial automation
equipment, data acquisition and test equipment, Internet
devices and security equipment markets. A substantial portion
of our recent development efforts have been directed toward
the development of new products for markets that are new and
rapidly evolving. There can be no assurance that
- the additional intelligent device markets
targeted by us for our products and services
will develop;
- developers within each market targeted by us
will choose our products and services to
meet their needs;
- we will successfully develop products to
meet the industry-specific requirements of
developers in our targeted markets or that
design wins will result in significant
sales; or
- developers in our targeted markets will gain
market acceptance for their devices which
incorporate our products.
We have limited experience in designing our products to meet
the requirements of developers in these industries. Moreover,
our products and services have, to date, achieved limited
acceptance in these industries.
WE ARE DEPENDENT ON THE IMAGING MARKET FOR A LARGE PORTION OF
OUR REVENUES.
The imaging market has historically accounted for
substantially all of our revenues. In the fiscal years ended
January 31, 2000, 1999 and 1998, 95%, 95% and 100%,
respectively, of our revenues were generated from customers in
the imaging market. Our success has been and continues to be
dependent on the continued success of the imaging
market. Many of our customers face competition from larger,
more established companies which may exert competitive or
other pressures on them. Any decline in sales to the imaging
market would have a material adverse effect on our business,
results of operations and financial condition.
Due in part to an economic slowdown affecting our imaging
customers, we anticipate a decline in imaging revenue in the
fourth quarter of fiscal year 2001 from third quarter imaging
revenue. We expect that the decline in fourth quarter imaging
revenue and the related expected decrease in imaging revenue
growth in the first half of fiscal year 2002 will adversely
effect our results of operations and financial condition.
The imaging market is characterized by declining prices of
existing products. Therefore, continual improvements in
manufacturing efficiencies and the introduction of new
products and enhancements to existing products are required
for us to maintain our gross margins. In response to customer
demands or competitive pressures, or to pursue new product or
market opportunities, we may take certain pricing or marketing
actions, such as price reductions or volume discounts. These
actions could have a material adverse effect on us.
A significant amount of our customers in the imaging market
are headquartered in Japan. Our customers are subject to
declines in their local economies, which have affected them
from time to time in the past and may affect them in the
future. The success of our customers affects their purchases
from us.
OUR HIGHLY CONCENTRATED CUSTOMER BASE INCREASES THE POTENTIAL
ADVERSE EFFECT ON US FROM THE LOSS OF ONE OR MORE CUSTOMERS.
Our products have historically been sold into the imaging
markets for use in products such as printers, scanners, fax
machines, copiers and multi-function peripherals. This market
is highly concentrated. Accordingly, our sales are derived
from a limited number
15
<PAGE> 16
of customers, with the top five OEM customers accounting for
72% and 52% of total revenues for the fiscal years ended 2000
and 1999, respectively. In particular, sales to Ricoh,
Dimatech and Minolta each accounted for 26%, 24% and 13% of
total revenues, respectively, for the fiscal year ended
January 31, 2000. Sales to Minolta, Kyocera and Konica
accounted for 12%, 12% and 11% of total revenues,
respectively, for the fiscal year ended January 31, 1999. We
expect that a small number of customers will continue to
account for a substantial portion of our total revenues for
the foreseeable future. All of our sales are made on the basis
of purchase orders rather than under long-term agreements, and
therefore, any customer could cease purchasing our products at
any time without penalty. The decision of any key customer to
cease using our products or a material decline in the number
of units purchased by a significant customer would have a
material adverse effect on us.
THE LONG AND VARIABLE SALES CYCLE FOR OUR PRODUCTS MAKE IT
MORE DIFFICULT FOR US TO PREDICT OUR OPERATING RESULTS AND
MANAGE OUR BUSINESS.
The sale of our products typically involves a significant
technical evaluation and commitment of capital and other
resources by potential customers, as well as delays frequently
associated with customers' internal procedures to deploy new
technologies within their products and to test and accept new
technologies. For these and other reasons, the sales cycle
associated with our products is typically lengthy, lasting
nine months or longer, and is subject to a number of
significant risks, including customers' internal acceptance
reviews, that are beyond our control. Because of the lengthy
sales cycle and the large size of customer orders, if orders
forecasted for a specific customer for a particular quarter
are not realized in that quarter, our operating results for
that quarter could be materially adversely affected.
OUR RELATIVELY LOW LEVEL OF BACKLOG INCREASES THE POTENTIAL
VARIABILITY OF OUR QUARTERLY OPERATING RESULTS.
Our backlog at the beginning of each quarter typically is not
sufficient to achieve expected sales for the quarter. To
achieve our sales objectives, we are dependent upon obtaining
orders during each quarter for shipment during that quarter.
Furthermore, our agreements with our customers typically
permit them to change delivery schedules. Non-imaging
customers may cancel orders within specified time frames
(typically 30 days or more prior to the scheduled shipment
date under our policies) without significant penalty. Our
customers have in the past built, and may in the future build,
significant inventory in order to facilitate more rapid
deployment of anticipated major products or for other reasons.
Decisions by such customers to reduce their inventory levels
have led and could lead to reductions in their purchases from
us. These reductions, in turn, have caused and could cause
adverse fluctuations in our operating results.
OUR DEPENDENCE ON NEW PRODUCT DEVELOPMENT AND THE RAPID
TECHNOLOGICAL CHANGE THAT CHARACTERIZES OUR INDUSTRY MAKE US
SUSCEPTIBLE TO LOSS OF MARKET SHARE RESULTING FROM
COMPETITORS' PRODUCT INTRODUCTIONS AND SIMILAR RISKS.
The semiconductor and networking industries are characterized
by rapidly changing technologies, evolving industry standards,
frequent new product introductions, short product life cycles
and rapidly changing customer requirements. The introduction
of products embodying new technologies and the emergence of
new industry standards can render existing products obsolete
and unmarketable. Our future success will depend on our
ability to enhance our existing products, to introduce new
products to meet changing customer requirements and emerging
technologies, and to demonstrate the performance advantages
and cost-effectiveness of our products over competing
products. Any failure by us to modify our products to support
new local-area network, or LAN, wide-area
16
<PAGE> 17
network, or WAN, and Internet technologies, or alternative
technologies, or any failure to achieve widespread customer
acceptance of such modified products could have a material
adverse effect on us. In particular, we have dedicated
significant resources to developing products based on the
Linux operating system and on the Java programming language,
and the failure of these products to achieve widespread
acceptance could have a material adverse effect on us.
We have in the past and may in the future experience delays
in developing and marketing product enhancements or new
products that respond to technological change, evolving
industry standards and changing customer requirements. There
can be no assurance that we will not experience difficulties
that could delay or prevent the successful development,
introduction and marketing of these products or product
enhancements, or that our new products and product
enhancements will adequately meet the requirements of the
marketplace and achieve any significant or sustainable degree
of market acceptance in existing or additional markets.
Failure by us, for technological or other reasons, to develop
and introduce new products and product enhancements in a
timely and cost-effective manner would have a material
adverse effect on us. In addition, the future introductions
or announcements of products by us or one of our competitors
embodying new technologies or changes in industry standards
or customer requirements could render our then-existing
products obsolete or unmarketable. There can be no assurance
that the introduction or announcement of new product
offerings by us or one or more of our competitors will not
cause customers to defer the purchase of our existing
products. Such deferment of purchases could have a material
adverse effect on us.
OUR FAILURE TO EFFECTIVELY MANAGE PRODUCT TRANSITIONS COULD
HAVE A MATERIAL ADVERSE EFFECT ON US.
From time to time, we or our competitors may announce new
products, capabilities or technologies that may replace or
shorten the life cycles of our existing products.
Announcements of currently planned or other new products may
cause customers to defer or stop purchasing our products until
new products become available. Furthermore, the introduction
of new or enhanced products requires us to manage the
transition from older product inventories and ensure that
adequate supplies of new products can be delivered to meet
customer demand. Our failure to effectively manage transitions
from older products could have a material adverse effect on
our business, results of operations and financial condition.
OUR FAILURE TO COMPETE SUCCESSFULLY IN OUR HIGHLY COMPETITIVE
MARKET COULD RESULT IN REDUCED PRICES AND LOSS OF MARKET
SHARE.
The markets in which we operate are intensely competitive and
characterized by rapidly changing technology, evolving
industry standards, declining average selling prices and
frequent new product introductions. A number of companies
offer products that compete with one or more elements of our
products. We believe that the competitive factors affecting
the market for our products include product performance, price
and quality, product functionality and features, the
availability of products for existing and future platforms,
the ease of integration with other hardware and software
components of the customer's products, and the quality of
support services, product documentation and training. The
relative importance of each of these factors depends upon the
specific customer involved. There can be no assurance that we
will be able to compete successfully against current and
future competitors, or that competitive factors faced by us
will not have a material adverse effect on us.
We primarily compete with the internal development departments
of large manufacturing companies that have developed their own
networking solutions, as well as established
17
<PAGE> 18
developers of embedded systems software and chips such as Axis
Communications, Echelon, Emulex, Hitachi, Integrated Systems,
Intel, Milan Technology, a division of Digi International,
Motorola, Peerless Systems, Samsung and Wind River. In
addition, we are aware of certain companies which have
recently introduced products that address the markets targeted
by us. We have experienced and expect to continue to
experience increased competition from current and potential
competitors, many of which have substantially greater
financial, technical, sales, marketing and other resources, as
well as greater name recognition and larger customer bases
than ours. In particular, established companies in the
networking or semiconductor industries may seek to expand
their product offerings by designing and selling products
using competitive technology that could render our products
obsolete or have a material adverse effect on our sales.
Increased competition may result in further price reductions,
reduced gross margins and loss of market share.
WE DEPEND ON THIRD-PARTY SOFTWARE THAT WE USE UNDER LICENSES
THAT MAY EXPIRE.
We rely on certain software that we license from third
parties, including software that is integrated with internally
developed software and used in our products to perform key
functions. Our material software license agreements are with
Integrated Systems, which terminates only if we default under
the agreement; with Novell, which is renewable annually at the
option of both parties, and with Peerless Systems, which
expires in 2004 and is subject to year-to-year renewals
thereafter at the option of both parties. These third-party
software licenses may not continue to be available to us on
commercially reasonable terms, and the related software may
not continue to be appropriately supported, maintained or
enhanced by the licensors. The loss of licenses to use, or the
inability of licensors to support, maintain, and enhance any
of such software, could result in increased costs, delays or
reductions in product shipments until equivalent software is
developed or licensed, if at all, and integrated.
WE DEPEND ON MANUFACTURING, ASSEMBLING AND PRODUCT TESTING
RELATIONSHIPS AND ON LIMITED SOURCE SUPPLIERS, AND ANY
DISRUPTIONS IN THESE RELATIONSHIPS MAY CAUSE DAMAGE TO OUR
CUSTOMER RELATIONSHIPS.
We do not have our own semiconductor fabrication assembly or
testing operations or contract manufacturing capabilities.
Instead, we rely upon independent contractors to manufacture
our components, subassemblies, systems and products.
Currently, all of our semiconductor devices are being
manufactured, assembled and tested by Atmel Corporation in
the United States, and we expect that we will continue to
rely upon Atmel to manufacture, assemble and test a
significant portion of our semiconductor devices in the
future. In the past, we experienced a delay in the
introduction of one of our products due to a problem with
Atmel's design tools. While we are in the process of
qualifying other suppliers, any qualification and
pre-production periods could be lengthy and may cause delays
in providing products to customers in the event that the sole
source supplier of the semiconductor devices fails to meet
our requirements. For example, Atmel uses its manufacturing
facilities for its own products as well as those it
manufactures on a contract basis. There is no assurance that
Atmel will have adequate capacity to meet the needs of its
contract manufacturing customers. In addition, semiconductor
manufacturers generally experience periodic constraints on
their manufacturing capacity.
We also rely upon limited-source suppliers for a number of
other components used in our products. There can be no
assurance that these independent contractors and suppliers
will be able to meet our future requirements for manufactured
products, components and subassemblies in a timely fashion. We
generally purchase limited-source components under purchase
orders and have no guaranteed supply arrangements with these
suppliers. In addition, the availability of many of these
components to us is dependent in part on our
18
<PAGE> 19
ability to provide our suppliers with accurate forecasts of
our future requirements. Any extended interruption in the
supply of any of the key components currently obtained from
limited sources would disrupt our operations and have a
material adverse effect on our business, results of operations
and financial condition.
Delays or lost sales have been and could be caused by other
factors beyond our control, including late deliveries by
vendors of components, changes in implementation priorities or
slower than anticipated growth in the market for networking
solutions for embedded systems. Operating results in the past
have also been adversely affected by delays in receipt of
significant purchase orders from customers. In addition, we
have experienced delays as a result of the need to modify our
products to comply with unique customer specifications. In
general, the timing and magnitude of our revenues are highly
dependent upon our achievement of design wins, the timing and
success of our customers' development cycles, and our
customers' product sales. Any of these factors could have a
material adverse effect on our business, results of operations
and financial condition.
THE CYCLICALITY OF THE SEMICONDUCTOR INDUSTRY MAY RESULT IN
SUBSTANTIAL PERIOD-TO-PERIOD FLUCTUATIONS.
Our semiconductor products provide networking capabilities
for intelligent, network-enabled devices and other embedded
systems. The semiconductor industry is highly cyclical and
subject to rapid technological change and has been subject to
significant economic downturns at various times,
characterized by diminished product demand, accelerated
erosion of average selling prices and production
overcapacity. The semiconductor industry also periodically
experiences increased demand and production capacity
constraints. As a result, we may experience substantial
period-to-period fluctuations in future operating results due
to general semiconductor industry conditions, overall
economic conditions or other factors.
OUR ABILITY TO COMPETE COULD BE JEOPARDIZED IF WE ARE UNABLE
TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS.
Our ability to compete depends in part on our proprietary
rights and technology. We have no patents and rely primarily
on a combination of copyright and trademark laws, trade
secrets, confidentiality procedures and contract provisions to
protect our proprietary rights. We generally enter into
confidentiality agreements with our employees, and sometimes
with our customers and potential customers and limit access to
the distribution of our software, hardware designs,
documentation and other proprietary information. There can be
no assurance that the steps taken by us in this regard will be
adequate to prevent the misappropriation of our technology.
While we have filed one patent application and plan to file
various additional applications, such applications may be
denied. Any patents, once issued, may be circumvented by our
competitors. Furthermore, there can be no assurance that
others will not develop technologies that are superior to
ours. Despite our efforts to protect our proprietary rights,
unauthorized parties may attempt to copy aspects of our
products or to obtain and use information that we regard as
proprietary. In addition, the laws of some foreign countries
do not protect our proprietary rights as fully as do the laws
of the United States. There can be no assurance that our means
of protecting our proprietary rights in the United States or
abroad will be adequate or that competing companies will not
independently develop similar technology. Our failure to
adequately protect our proprietary rights could have a
material adverse effect on our business, results of operations
and financial condition.
We exclusively license the right to use the NET+ARM trademark
from ARM Limited according to a royalty-free agreement
expiring in 2008. We depend on ARM to enforce its rights to
the trademark against third-party infringement. There can be
no assurance that ARM will promptly and adequately enforce
these rights which could have a material adverse effect on our
business, results of operations and financial condition.
19
<PAGE> 20
WE COULD BECOME SUBJECT TO CLAIMS AND LITIGATION REGARDING
INTELLECTUAL PROPERTY RIGHTS, WHICH COULD SERIOUSLY HARM US
AND REQUIRE US TO INCUR SIGNIFICANT COSTS.
The semiconductor industry is characterized by frequent
litigation regarding patent and other intellectual property
rights. Although we have not been notified that our products
infringe any third-party intellectual property rights, there
can be no assurance that we will not receive such notification
in the future. Any litigation to determine the validity of
third-party infringement claims, whether or not determined in
our favor or settled by us, would at a minimum be costly and
divert the efforts and attention of our management and
technical personnel from productive tasks, which could have a
material adverse effect on our business, results of operations
and financial condition. There can be no assurance that any
infringement claims by third parties or any claims for
indemnification by customers or end users of our products
resulting from infringement claims will not be asserted in the
future or that such assertions, if proven to have merit, will
not materially adversely affect our business, results of
operations or financial condition. In the event of an adverse
ruling in any such matter, we would be required to pay
substantial damages, cease the manufacture, use and sale of
infringing products, discontinue the use of certain processes
or be required to obtain a license under the intellectual
property rights of the third party claiming infringement.
There can be no assurance that a license would be available on
reasonable terms or at all. Any limitations on our ability to
market our products, or delays and costs associated with
redesigning our products or payments of license fees to third
parties, or any failure by us to develop or license a
substitute technology on commercially reasonable terms could
have a material adverse effect on our business, results of
operations and financial condition.
WE FACE RISKS ASSOCIATED WITH OUR INTERNATIONAL OPERATIONS AND
EXPANSION THAT COULD IMPAIR OUR ABILITY TO GROW OUR REVENUES
ABROAD.
In the fiscal years ended January 31, 2000, 1999 and 1998,
international sales constituted approximately 50%, 51% and 30%
of our net sales, respectively, and approximately 77%, 46% and
31% of our domestic sales, respectively, were to customers
headquartered in Asia. We believe that our future growth is
dependent in part upon our ability to increase sales in
international markets, and particularly to manufacturers
located in Japan, which sell their products worldwide. These
sales are subject to a variety of risks, including
fluctuations in currency exchange rates, tariffs, import
restrictions and other trade barriers, unexpected changes in
regulatory requirements, longer accounts receivable payment
cycles and potentially adverse tax consequences and export
license requirements. In addition, we are subject to the risks
inherent in conducting business internationally, including
political and economic instability and unexpected changes in
diplomatic and trade relationships. In particular, the
economies of certain countries in the Asia-Pacific region are
experiencing considerable economic instability and downturns.
Because our sales to date have been denominated in United
States dollars, increases in the value of the United States
dollar could increase the price in local currencies of our
products in non-US markets and make our products more
expensive than competitors' products denominated in local
currencies. In addition, an integral part of our business
strategy is to form strategic alliances for the manufacture
and distribution of our products with third parties, including
foreign corporations. There can be no assurance that one or
more of the factors described above will not have a material
adverse effect on our business, results of operations and
financial condition.
We intend to expand our presence in Europe to address new
markets. One change resulting from the formation of a European
Economic and Monetary Union ("EMU") required EMU member states
to irrevocably fix their respective currencies to a new
20
<PAGE> 21
currency, the euro, as of January 1, 1999. During the next
three years, business in the EMU member states will be
conducted in both the existing national currency such as the
French franc or the Deutsche mark, and the euro. As a result,
companies operating or conducting business in EMU member
states will need to ensure that their financial and other
software systems are capable of processing transactions and
properly handling these currencies, including the euro. There
can be no assurance that the conversion to the euro will not
have a material adverse effect on our business, results of
operations and financial condition.
IF WE LOSE KEY PERSONNEL IT COULD PREVENT US FROM EXECUTING
OUR BUSINESS STRATEGY.
Our business and prospects depend to a significant degree
upon the continuing contributions of our executive officers
and our key technical personnel. We do not have employment
contracts with any of our key personnel, with the exception
of our Vice President, Industrial Automation, Intelligent
Device Markets Europe; Vice President, Finance, and Chief
Financial Officer; and the Chairman, Chief Executive Officer
and President, and we do not maintain any key-man life
insurance policies. Competition for such personnel is
intense, and there can be no assurance that we will be
successful in attracting and retaining qualified personnel.
Failure to attract and retain key personnel could result in
our failure to execute our business strategy and have a
material adverse effect on us.
ANY FAILURE TO COMPLY WITH SIGNIFICANT REGULATIONS AND
EVOLVING INDUSTRY STANDARDS COULD DELAY INTRODUCTION OF OUR
PRODUCTS, WHICH COULD HURT OUR BUSINESS.
The market for our products is subject to a significant number
of communications regulations and industry standards, some of
which are evolving as new technologies are deployed. In the
United States, our products must comply with various
regulations defined by the Federal Communications Commission
and standards established by Underwriters' Laboratories. Some
of our products may not comply with current industry
standards, and this noncompliance must be addressed in the
design of those products. Standards for networking are still
evolving. As the standards evolve, we may be required to
modify our products or develop and support new versions of our
products. The failure of our products to comply or delays in
compliance, with the various existing and evolving industry
standards could delay introduction of our products, which
could have a material adverse effect on our business, results
of operations and financial condition.
ANY MATERIAL PRODUCT DEFECTS COULD RESULT IN LOSS OF MARKET
SHARE, DELAY OF MARKET ACCEPTANCE OR PRODUCT LIABILITY CLAIMS
OR LOSSES.
Complex products such as those offered by us may contain
undetected or unresolved defects when first introduced or as
new versions are released. The occurrence of material errors
in the future could, and the failure or inability to correct
such errors would, result in the loss of market share, the
delay or loss of market acceptance of our products, material
warranty expense, diversion of engineering and other resources
from our product development efforts, the loss of credibility
with our customers or product recall. The use of our products
for applications in devices that interact directly with the
general public, where the failure of the embedded system could
cause property damage or personal injury, could expose us to
significant product liability claims. Although we have not
experienced any product liability or economic loss claims to
date, the sale and support of our products may entail the risk
of such claims. Any of such occurrences could have a material
adverse effect upon our business, results of operations and
financial condition.
IF WE DO NOT SUCCESSFULLY MANAGE OUR GROWTH, IT COULD HAVE A
MATERIAL ADVERSE EFFECT ON US.
21
<PAGE> 22
We have limited internal infrastructure and any significant
growth would place a substantial strain on our financial and
management personnel and information systems and controls.
Such growth would require us to implement new and enhance
existing financial and management information systems and
controls and add and train personnel to operate such systems
effectively. Our intention to continue to pursue our growth
strategy through efforts to increase sales of existing
products and new products can be expected to place even
greater pressure on our existing personnel and compound the
need for increased personnel, expanded information systems,
and additional financial and administrative control
procedures. There can be no assurance that we will be able to
successfully manage expanding operations. Our inability to
manage our expanded operations effectively could have a
material adverse effect on our business, results of operations
and financial condition.
A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON STOCK COULD BE
SOLD INTO THE PUBLIC MARKET, WHICH COULD DEPRESS OUR STOCK
PRICE.
Sales of a substantial number of shares of common stock in the
public market could adversely affect the market price for our
common stock and reported earnings per share and could make it
more difficult for us to raise funds through equity offerings
in the future.
Subject to applicable federal and securities laws and the
restrictions set forth below, Osicom may sell any and all of
the shares of common stock beneficially owned by it or
distribute any or all such shares of common stock to its
stockholders. Sales or distributions by Osicom of substantial
amounts of common stock in the public market or to its
stockholders, or the perception that such sales or
distribution could occur, could adversely affect the
prevailing market prices for the common stock. Osicom is not
subject to any obligation to retain its shares in NETsilicon.
As a result, there can be no assurance concerning the period
of time during which Osicom will maintain its beneficial
ownership of our common stock. Moreover, there can be no
assurance that, in any transfer by Osicom of a controlling
interest in us, any holders of common stock will be able to
participate in such transaction or will realize any premium
with respect to their shares of common stock.
ANY ACQUISITIONS WE HAVE MADE OR WILL MAKE COULD DISRUPT OUR
BUSINESS AND SERIOUSLY HARM OUR FINANCIAL CONDITION.
We continue to intend to consider investments in complementary
companies, products or technologies. We may buy businesses,
products or technologies in the future. In the event of any
future purchases, we could:
- issue stock that would dilute our current
stockholders' percentage ownership;
- incur debt;
- assume liabilities;
- incur amortization expenses related to
goodwill and other intangible assets; or
- incur large and immediate write-offs.
22
<PAGE> 23
OUR OPERATION OF ANY ACQUIRED BUSINESS WILL ALSO INVOLVE
NUMEROUS RISKS, INCLUDING:
- problems combining the purchased operations,
technologies or products;
- unanticipated costs;
- diversion of management's attention from our
core business;
- adverse effects on existing business
relationships with suppliers and customers;
- risks associated with entering markets in
which we have no or limited prior
experience; and
- potential loss of key employees,
particularly those of the purchased
organizations.
We cannot assure you that we will be able to successfully
integrate any businesses, products, technologies or personnel
that we have acquired or that we might acquire in the future
and any failure to do so could disrupt our business and
seriously harm our financial condition.
BECAUSE THE NASDAQ NATIONAL MARKET IS LIKELY TO EXPERIENCE
EXTREME PRICE AND VOLUME FLUCTUATIONS, THE PRICE OF OUR COMMON
STOCK MAY DECLINE.
The market price of our shares is likely to be highly volatile
and could be subject to wide fluctuations in response to
numerous factors, including the following:
- actual or anticipated variations in our
quarterly operating results or those of our
competitors;
- announcements by us or our competitors of
new products or technological innovations;
- introduction and adoption of new industry
standards;
- changes in financial estimates or
recommendations by securities analysts;
- changes in the market valuations of our
competitors;
- announcements by us or our competitors of
significant acquisitions or partnerships;
and
- sales of our common stock.
Many of these factors are beyond our control and may
negatively impact the market price of our common stock,
regardless of our performance. In addition, the stock market
in general, and the market for technology companies in
particular, has been highly volatile. Our common stock may not
trade at the same levels of shares as that of other technology
companies and shares of technology companies, in general, may
not sustain their current market prices. In the past,
securities class action litigation has often been brought
against
23
<PAGE> 24
a company following periods of volatility in the market price
of its securities. We may be the target of similar litigation
in the future. Securities litigation could result in
substantial costs and divert management's attention and
resources, which could seriously harm our business and
operating results.
PROVISIONS OF OUR CHARTER DOCUMENTS MAY HAVE ANTI-TAKEOVER
EFFECTS THAT COULD PREVENT A CHANGE OF CONTROL.
Provisions of our amended and restated certificate of
incorporation and bylaws could make it more difficult for a
third party to acquire us, even if doing so would be
beneficial to our stockholders.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We own financial instruments that are sensitive to market
risks as part of our investment portfolio. The investment
portfolio is used to preserve our capital until it is required
to fund operations, including our research and development
activities. None of these market-risk sensitive instruments
are held for trading purposes. We do not own derivative
financial instruments in our investment portfolio. The
investment portfolio contains instruments that are subject to
the risk of a decline in interest rates.
Investment Rate Risk. Our investment portfolio includes debt
instruments that primarily have durations of less than one
year. These bonds are subject to interest rate risk, and could
decline in value if interest rates fluctuate. Our investment
portfolio also at times includes certain commercial paper
which is also subject to interest rate risk. Due to the short
duration and conservative nature of these instruments, we do
not believe that we have a material exposure to interest rate
fluctuations.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
On August 31, 2000, Websprocket, LLC filed a suit against the
Company in the United States District Court for the Northern
District of California (Websprocket, LLC v. NETsilicon, Inc.,
Civil Action No. C-00-20915), claiming breach of contract.
The complaint alleges that the Company breached a technology
development contract that was executed between the Company
and Websprocket, LLC in December, 1999. Websprocket, LLC
seeks relief including alleged damages of $2,000,000 plus
attorney's fees, a declaration of its rights under the
technology development contract and an injunction requiring
the Company to cease using and return all property of
Websprocket, LLC. We believe we have meritorious defenses to
the claims and intend to contest the lawsuit vigorously. On
or about October 31, 2000, the Company denied the allegations
in Websprocket, LLC's complaint and asserted counterclaims
against Websprocket, LLC which included breach of contract,
fraud, and negligent misrepresentation. An unfavorable
resolution of the action could have a material adverse effect
on the business, results of operations or financial condition
of the Company.
ITEM 2. Changes in Securities and Use of Proceeds
None
ITEM 3. Defaults Upon Senior Securities
None
24
<PAGE> 25
ITEM 4. Submission of Matters to a Vote of Security Holders
None
ITEM 5. Other Information
None
ITEM 6. Exhibits and Reports on Form 8-K
a) Exhibits
<TABLE>
<CAPTION>
Exhibit Number Description
-------------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
b) Reports on 8-K
September 13, 2000 - Preferred share purchase right dividend
declaration on September 12, 2000 and related Rights Agreement.
September 15, 2000 - Acquisition of certain assets of Pacific
Softworks Technology, Inc. on August 31, 2000.
November 14, 2000 - Amendment No. 1 to Form 8-K filed on
September 15, 2000 related to the acquisition of certain assets
of Pacific Softworks Technology, Inc. The amended document
includes historical audited financial statements of Pacific
Softworks, Inc. as of and for the periods ended December 31, 1999
and 1998 and the unaudited pro forma combined balance sheet as of
July 29, 2000 and unaudited pro forma combined statements of
operations for the six months ended July 29, 2000 and the year
ended January 31, 2000.
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NETsilicon, Inc.
----------------------------------------------
(Registrant)
December 12, 2000 By /s/ Cornelius Peterson, VIII
----------------------------------------------
(Cornelius Peterson, VIII, Chief Executive
Officer and Director)
December 12, 2000 By /s/ Daniel J. Sullivan
----------------------------------------------
(Daniel J. Sullivan, Vice President, Finance,
Chief Financial Officer)
25
