<PAGE>
===============================================================================
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 June 30, 1999, or
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
COMMISSION FILE NO. ____________
LITRONIC INC.
(Exact name of registrant as specified in its charter)
DELAWARE 33-0757190
(State or other jurisdiction (I.R.S Employer
of incorporation or organization) Identification No.)
2030 Main Street, Suite 1250
Irvine, California 92614
(Address of principal executive offices) (Zip Code)
(949) 851-1085
(Registrant's telephone number, including area code)
---------------------------------------
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 [_] No [X]
As of August 11, 1999, the registrant had 9,740,631 shares of common stock
outstanding.
================================================================================
<PAGE>
LITRONIC INC.
INDEX
PAGE
----
Part I. FINANCIAL INFORMATION
- ------------------------------
Item 1. Financial Statements 3
Condensed Consolidated Balance Sheets
June 30, 1999 and December 31, 1998 3
Condensed Consolidated Statements of Operations
Three and Six months ended June 30, 1999 and 1998 4
Condensed Consolidated Statements of Cash Flows
Six months ended June 30, 1999 and 1998 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 26
Part II. OTHER INFORMATION 26
- ---------------------------
Item 1. Legal Proceedings
Item 2. Change in Securities and Use of Proceeds
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
2
<PAGE>
PART I. FINANCIAL INFORMATION
- ------------------------------
Item 1. Financial Statements
LITRONIC INC.
Condensed Consolidated Balance Sheets
(in thousands, except share data)
(unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
Assets 1999 1998
- ------ -------- -----------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 9,590 898
Short term investments 6,000 -
Accounts receivable, net 5,810 740
Inventories 547 533
Other current assets 1,172 385
------- ------
Total current assets 23,119 2,556
Property and equipment, net 699 235
Goodwill and other intangibles, net 36,323 -
Other assets 634 -
------- ------
$60,775 2,791
======= ======
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Financing arrangement - IBM Global $ 3,632 -
Current installments of long-term debt 498 580
Accounts payable 2,714 456
Accrued liabilities 1,347 762
------- ------
Total current liabilities 8,191 1,798
Long-term debt 82 5,200
------- ------
Total liabilities 8,273 6,998
------- ------
Commitments and contingencies
Stockholders' equity (deficit):
Preferred stock, $.01 par value; Authorized 5,000,000
shares; no shares issued or outstanding - -
Common stock, $.01 par value; 25,000,000 shares
authorized; 9,740,631 and 3,870,693 shares issued
and outstanding at June 30, 1999 and December 31,
1998, respectively 97 39
Additional paid-in capital 52,779 -
Accumulated deficit (374) (4,246)
------- ------
Total stockholders' equity (deficit) 52,502 (4,207)
------- ------
$60,775 2,791
======= ======
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE>
LITRONIC INC.
Condensed Consolidated Statements of Operations
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
----------------------- ---------------------
June 30, June 30, June 30, June 30,
1999 1998 1999 1998
--------- -------- --------- --------
<S> <C> <C> <C> <C>
Revenues:
Product $ 2,325 1,006 3,210 2,360
License and service 96 518 252 827
Research and
development 326 - 695 -
------- ----- ------ -----
Total revenues $ 2,747 1,524 4,157 3,187
------- ----- ------ -----
Costs and expenses:
Cost of sales - products 2,043 387 2,562 1,054
Cost of sales - license and
service 147 344 275 520
Selling, general and
administrative 1,411 547 2,282 1,212
Research and development 738 294 1,503 634
Amortization of goodwill and
other intangibles 118 - 118 -
------- ----- ------ -----
Operating loss (1,710) (48) (2,583) (233)
Interest expense (124) (121) (237) (231)
Interest income 39 2 44 4
------- ----- ------ -----
Loss before income taxes (1,795) (167) (2,776) (460)
Benefit from income taxes (294) (7) (285) (58)
------- ----- ------ -----
Net loss $(1,501) (160) (2,491) (402)
======= ===== ====== =====
Net loss per share-
basic and diluted $(0.31) (0.04) (0.57) (0.10)
======= ===== ====== =====
Shares used in per share computations-
basic and diluted 4,839 3,871 4,360 3,871
======= ===== ====== =====
</TABLE>
See accompanying notes to condensed consolidated financial statements
4
<PAGE>
LITRONIC INC.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended
--------------------
June 30, June 30,
1999 1998
-------- --------
<S> <C> <C>
Cash flows from operating
activities:
Net loss (2,491) (402)
Adjustments to reconcile net
loss to net cash used in
operating activities:
Depreciation and amortization 231 102
Deferred income tax benefit (285) -
Changes in assets and liabilities:
Accounts receivable (180) 325
Inventories 185 (37)
Other current assets (772) 18
Accounts payable (2,500) (178)
Accrued liabilities (732) (539)
Other assets (294) -
-------- --------
Net cash used in operating
activities (6,838) (711)
-------- --------
Cash flows from investing activities:
Purchases of property and equipment (93) (45)
Purchases of short-term investments (6,000) -
-------- --------
Net cash used in investing
activities (6,093) (45)
-------- --------
Cash flows from financing activities:
Proceeds from sale of common stock,
net of issuance costs $5,377 $ 35,323 -
Proceeds from revolving note payable to bank 2,236 2,995
Proceeds from related party revolving line of credit - 600
Proceeds from long-term debt 2,844 -
Principal payments on long-term debt (18,780) (3,098)
-------- --------
Net cash provided by financing activities 21,623 497
-------- --------
Net increase (decrease) in cash 8,692 (259)
-------- --------
Cash and cash equivalents at beginning of period 898 490
-------- --------
Cash and cash equivalents at end of period $ 9,590 231
======== ========
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest 633 54
Income taxes 2 -
======== ========
</TABLE>
Supplemental disclosures of noncash investing and financing activities:
The Company issued 2,169,938 shares of common stock in connection with the
acquisition of Pulsar. In connection with the acquisition, net assets purchased
were as follows:
<TABLE>
<S> <C> <C>
Merger costs $ (121) -
Fair value of net assets acquired less
liabilities assumed (12,450) -
Goodwill and other intangibles 36,441 -
-------- --------
Market value of common stock issued $ 23,870 -
======== ========
Transfer of accumulated deficit to
additional paid in capital (6,363) -
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE>
LITRONIC INC.
Notes to Condensed Consolidated Financial Statements
June 30, 1999 and 1998
(unaudited)
(in thousands, except per share data)
(1) General Information:
Condensed Consolidated Financial Statements
In the opinion of the Company, the accompanying unaudited condensed consolidated
financial statements contain all adjustments (which are normal recurring
accruals) necessary to present fairly the financial position as of June 30,
1999; the results of operations for the three and six months ended June 30, 1999
and 1998; and the statements of cash flows for the six months ended June 30,
1999 and 1998. Interim results for the three and six months ended June 30, 1999
are not necessarily indicative of the results that may be expected for the year
ending December 31, 1999. The interim financial statements should be read in
conjunction with the Company's consolidated financial statements for the year
ended December 31, 1998 included in the Company's Form S-1 filed in June, 1999.
Public Offering and Reorganization
In June 1999, Litronic completed an initial public offering of common stock of
Litronic Inc., a newly formed corporation with no operations (the "Offering").
Litronic Industries, Inc. also initiated certain events (the "Reorganization")
in connection with the Offering which resulted in it becoming a wholly-owned
subsidiary of Litronic Inc. on June 8, 1999. The Reorganization was accomplished
through a stock-for-stock exchange between Litronic Inc. and Litronic
Industries, Inc. and was accounted for as an "as if pooling of interests" for
entities under common control. Concurrent with the Reorganization, Litronic
Industries, Inc. terminated its Subchapter S corporation status and is subject
to federal and state income taxes.
All of the outstanding shares of Litronic Industries, Inc. were exchanged for
3,870,693 shares of the Company's common stock. Consequently, as of June 8,
1999, the consolidated group includes the operations of Litronic Inc. and its
wholly owned subsidiary Litronic Industries, Inc.
The Company also entered into a stock acquisition agreement with Pulsar Data
Systems, Inc. (Pulsar) which was effected simultaneously with the Offering. All
of the outstanding shares of Pulsar were exchanged for 2,169,938 shares of the
Company's common stock.
Earnings (Loss) Per Share
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards No. ("Statement") 128, "Earnings Per Share."
Statement 128 provides for the calculation of basic and diluted earnings per
share. Basic earnings per share includes no dilution and is computed by dividing
earnings (loss) available to common shareholders by the weighted average number
of common shares outstanding for the period. Diluted earnings per share reflects
the potential dilution of securities that could share in the earnings of an
entity. Such shares, 379,419, are not included since there is a loss as the
effect would be anti-dilutive.
Accounting for Stock Options
The Company applies the provisions of Statement 123, "Accounting for Stock-
Based Compensation," which requires entities to recognize as expense over the
vesting period the fair value as of the date of grant of all
6
<PAGE>
stock based awards. Alternatively, Statement 123 allows entities to apply the
provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations, and to provide pro
forma net income and pro forma net income per share disclosures for employee
stock option grants made in 1996 and future years as if the fair-value-based
method defined in Statement 123 had been applied. The Company has elected to
apply the provisions of APB Opinion No. 25, under which compensation expense
would be recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price, and provide the pro forma
disclosure provisions of Statement 123 in its annual financial statements.
Short-Term Investments
The Company's short-term investments consist of municipal bonds which mature in
90 days or less, and are classified as held-to-maturity. In accordance with
Statement 115, "Accounting for Certain Investments in Debt and Equity
Securities", investments classified as held-to-maturity are reported at
amortized cost. The short-term investment balances at June 30, 1999 is
$6.0 million.
Segment Reporting
As of January 1, 1998, the Company adopted Statement No. 131, Disclosures about
Segments of an Enterprise and Related Information", which requires entities to
report financial and descriptive information about its reportable operating
segments. The Company has historically operated in two business segments,
information security solutions and electronic interconnect products. On
September 30, 1997, the Company sold its Intercon division, which produced
electronic interconnect products. As of December 31, 1998, the Company's
remaining operations pertained only to its information security solution
segment. On June 14, 1999, with the acquisition of Pulsar, the Company expanded
into the network solution market. The six months ended June 30, 1999, only
include fifteen days of operations for Pulsar and as such, the network solution
market is considered individually insignificant for separate detailed disclosure
at June 30, 1999. As of June 30, 1999, the assets of the network solutions
segment are no longer identifiable.
(2) Pro Forma Financial Information Reflecting Pulsar Acquisition
The Company entered into a stock acquisition agreement with Pulsar which was
effected simultaneously with the Offering. This acquisition was contingent upon
the successful completion of the Offering and was completed on June 14, 1999.
Litronic acquired all of the outstanding shares of Pulsar in exchange for
2,169,938 shares of the Company's common stock. The acquisition was accounted
for by the purchase method and, accordingly, the results of operations of Pulsar
have been included in the Company's consolidated financial statements from June
14, 1999. The excess of the purchase price over the fair value of the net assets
acquired less the liabilities assumed, resulted in a total of $36.4 million
recorded as goodwill and intangible assets and is being amortized on a straight-
line basis over 10-15 years. The purchase price of the Pulsar acquisition was
based on the fair market value of the common stock issued at June 14, 1999.
The goodwill and intangibles include the following subcomponents:
Description Cost Useful life (years)
- ----------- ----------- -------------------
Distribution Channel $12,147 15
Customer Base 12,147 10
Goodwill 12,147 15
-----------
36,441
Less accumulated amount (118)
-----------
$36,323
===========
The following unaudited pro forma financial information presents the combined
results of operations of Litronic and Pulsar as if the acquisition had occurred
as of the beginning of 1999 and 1998, after giving effect to certain adjustments
including amortization of goodwill and other intangibles, increased interest
expense on debt assumed and related income tax effects. The pro forma financial
information does not necessarily reflect the results of operations that would
have occurred had Litronic and Pulsar constituted a single entity during such
periods.
<TABLE>
<CAPTION>
Three Six
Months Months Year
Ended Ended Ended
June 30, June 30, December 31,
1999 1999 1998
-------- -------- -----------
<S> <C> <C> <C>
Total revenues $ 10,374 21,732 87,185
======== ======== ========
Net loss (2,570) (5,723) (11,618)
======== ======== ========
Net loss per share, basic and diluted $ (0.26) (0.59) (1.19)
======== ======== ========
</TABLE>
(3) Inventories
A summary of inventories follows:
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
-------- ------------
<S> <C> <C>
Raw materials $ 224 239
Work-in-process 129 25
Finished goods 194 269
------ ----
$ 547 533
====== ====
</TABLE>
7
<PAGE>
(4) Long-term Debt
A summary of long-term debt follows:
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
-------- ------------
<S> <C> <C>
Notes payable to bank secured by substantially all
assets of the Company and personal assets of, and a
guarantee by, the Company's chairman and majority
shareholder, bearing interest at 6.6% payable
monthly, paid on June 14, 1999 $ - 5,200
Revolving note payable to bank with maximum
availability of $20 million, bearing interest at
prime plus 1.5% (9.75% at December 31, 1998) payable
in monthly interest-only payments through maturity on
July 31, 2000; secured by substantially all assets of
the Company and by personal assets of, and a guarantee
by, the Company's chairman and majority shareholder,
renewable at the bank's option for additional one-year
periods - 580
Revolving note payable to bank with maximum
availability of $20 million, bearing interest at
prime plus .625% (8.125% at June 30, 1999) payable
in monthly interest-only payments through maturity
on May 10, 2002; secured by substantially all assets
of the Company; renewable at the bank's option for
additional one-year periods 82 -
Note payable to IBM Global collateralized by
inventory, accounts receivable, machinery and
equipment and the assets of a related party and
guaranteed by the president of the Company; bears
interest at the financial institution's prime
lending rate; 8.5% and 7.75% at December 31, 1998 and
June 30, 1999, respectively
3,632 -
Other 498
------ -------
4,212 5,780
Less current installments 4,130 580
------ -------
82 $ 5,200
====== =======
</TABLE>
Principal maturities of long-term debt are as follows:
<TABLE>
<CAPTION>
June 30,
1999
--------
<S> <C>
2000 $ 82
2001 -
2002 and thereafter -
------
$ 82
======
</TABLE>
8
<PAGE>
The revolving credit agreement of Litronic contains certain covenants and
restrictions, including maintenance of certain financial ratios and a
restriction on future borrowings. As of June 30, 1999, the Company was not in
compliance with one of the covenants and has received a waiver of this covenant.
As of June 30, 1999, the Company had available borrowings of $20 million under
the revolving credit agreement.
(5) Concentration of Risk and Significant Customers
Financial instruments that potentially subject the Company to concentration of
credit risk are trade receivables. Credit risk on trade receivables is limited
as a result of the Company's customer base and their dispersion across different
industries and geographic regions. As of December 31, 1998 and June 30,1999,
accounts receivable included $308,000 and $4.7 million, respectively, due from
the U.S. Government and related agencies. Sales to federal government agencies
represented 42% and 45% of the Company's sales for the six months ended June 30,
1998 and 1999, respectively.
The Company had sales to 5 customers which represented 79% and 58%,
respectively, of total revenue for the six months ended June 30, 1998 and June
30, 1999. No other customers accounted for more than 10% of net revenues during
the six months ended June 30, 1998 and June 30, 1999. Trade accounts receivable
aggregated $493,000 and $1.4 million from the aforementioned major customers as
of December 31, 1998 and June 30, 1999, respectively.
At June 30, 1999, the Company's investment portfolio consisted of $6 million in
various municipal bonds. The Company does not believe that they have a
concentration of investment risk due to the diversification of the investment
portfolio.
(6) 1999 Stock Option Plan
Under the Company's 1999 Stock Option Plan (the 1999 Plan), which was
established in April 1999, the Company granted options to purchase 98,000 shares
at an exercise price of $8.75 per share in June 1999, the fair market value on
the date of grant.
(7) Loss Per Share
In December 1997, The FASB issued Statement 128, Earnings per Share ("EPS").
Statement 128 replaced the calculation of primary and fully diluted EPS with
basic and diluted EPS. Unlike primary EPS, basic EPS excludes any dilutive
effects of common stock equivalents, such as options and warrants. Diluted EPS
is very similar to the previously reported fully diluted EPS. All EPS amounts
for all periods have been restated to conform to the Statement 128 requirements.
The following table illustrates the computation of basic and diluted net
income/(loss) per share (dollars in thousands):
<TABLE>
<CAPTION>
Three Three Six Six
Months Months Months Months
Ended Ended Ended Ended
June June June June
30, 1999 30, 1998 30, 1999 30, 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Numerator:
Numerator for basic and
diluted net loss per
share - net loss $ (1,501) $ (160) $ (2,491) $ (402)
======== ======== ======== ========
Denominator:
Denominator for basic net
loss per share - weighted
average number of common
shares outstanding during
the period 4,839 3,871 4,360 3,871
Incremental common shares
attributable to exercise
of outstanding options - - - -
-------- -------- -------- --------
Denominator for diluted net
loss per share 4,839 3,871 4,360 3,871
======== ======== ======== ========
Basic net loss per share $ (0.31) $ (0.04) $ (0.57) $ (0.10)
======== ======== ======== ========
Diluted net loss per share $ (0.31) $ (0.04) $ (0.57) $ (0.10)
======== ======== ======== ========
</TABLE>
The computation of diluted loss per share for the three months ended June 30,
1999 and 1998 and the six months ended June 30, 1999 and 1998 excluded the
effect of 297,755, 249,680, 289,589 and 124,840, respectively, of incremental
common shares attributable to the exercise of outstanding common stock options
because their effect was antidilutive.
(8) Contingent Liabilities
The Company had cost reimbursable type contracts with the Federal Government.
Consequently, the Company is reimbursed based upon their direct expenses
attributable to the contract, plus a percentage based upon overhead, material
handling, and general and administrative expenses. The overhead, material
handling, and general and administrative rates are estimates. Accordingly, if
the actual rates as determined by the Defense Contract Audit Agency are below
the Company's estimates, a refund for the difference would be due to the Federal
Government. It is management's opinion that no material liability will result
from any cognizant audit agency audits.
During the year ended December 31, 1998, two lawsuits were filed against the
Company by trade vendors claiming approximately $739,000, plus interest,
attorney's fees and costs. These lawsuits were settled as structured payments in
the aggregate amount of approximately $785,000 and the obligations were
classified as notes payable. Payments applied against these notes payable during
the year ended December 31, 1998 totaled approximately $315,000, which included
approximately $15,000 of interest expense. During the quarter ended March 31,
1999, nine lawsuits were filed against the Company by trade vendors and a local
government agency claiming approximately $875,000, plus interest, attorney's
fees and costs. As of March 31, 1999, these lawsuits were settled for an
aggregate amount of approximately $929,000, including approximately $60,000 of
interest, attorney's fees and costs, and the obligations were classified as
accounts payable. Payments applied against these accounts payable during the
quarter ended March 31, 1999 totaled approximately $41,000, which included
approximately $2,000 of interest expense. During the quarter ended March 31,
1999, payments applied against the notes payable relating to the two lawsuits
filed and settled in 1998 totalled approximately $278,000, which included
approximately $8,000 of interest expense. As of June 30, 1999, the majority of
these settlements had been paid.
The Company has been named as a defendant in a lawsuit which claims breach of
contract under which the Company was required to pay $500,000 over a thirty
month period plus a commission on contracts awarded as a result of the
contract. The plaintiff claims damages in an amount in excess of $10 million.
Based upon discussions with counsel, the Company believes that the case is
without merit and intends to vigorously defend against the claim; however, the
outcome of this matter cannot currently be determined. No amounts have been
accrued in the financial statements relating to this matter.
The Company is also involved in various routine legal actions arising in the
normal course of business. After taking into consideration legal counsel's
evaluation of such actions, management is of the opinion that any potential
liability, arising from these claims against the Company not covered by
insurance would be minimal.
As of June 30, 1999, Pulsar had not yet filed the Form 5500 Annual Return/Report
for 1997 for its Employee Retirement Plan. The Form 5500 along with an audit
report was due October 15, 1998. The Company may be assessed penalties by both
the Department of Labor and the Internal Revenue Service for its late filing.
The Company has reserved $50,000 which represents the Company's estimate of the
maximum amount of penalties that could be assessed.
9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements based on our current
expectations, estimates and projections about our industry, management's beliefs
and certain assumptions we have made. Words such as "anticipates," "expects,"
"intend," "plans," "believes," "may," "will," or similar expressions are
intended to identify forward-looking statements. In addition, any statements
that refer to expectations, projections, forecasts or other predictions
regarding future events or circumstances, including any underlying assumptions,
are forward-looking statements. These statements may include, but are not
limited to, statements concerning projected revenues, expenses and income or
loss, the need for additional capital, Year 2000 compliance, acceptance of our
products, growth of the Internet, our ability to identify and consummate
acquisitions and integrate these operations successfully, our ability to
integrate previously acquired businesses successfully, the status of evolving
technologies and their growth potential, our production capacity, and the
outcome of pending and threatened litigation. These statements are not
guarantees or assurances of future performance and are subject to various risks,
uncertainties, and assumptions that are difficult to predict. Therefore, our
actual results could differ materially and adversely from those expressed in any
forward-looking statements. The section labeled "Risk Factors" set forth in this
Form 10Q and similar sections in our other Securities and Exchange Commission
("SEC") filings, including our prospectus filed in June 1999, discuss some of
the important risk factors that may affect our business, results of operations
and financial condition. You should carefully consider those risks, in addition
to the other information in this report and in our other SEC filings, before
deciding to buy or sell our Common Stock. We undertake no obligation to revise
or update publicly any forward-looking statements for any reason.
The information contained in this report is not a complete description of our
business or the risks associated with an investment in our Common Stock. You
should carefully review and consider the various disclosures made by us in this
report and in our materials filed with the SEC, including our prospectus filed
in June 1999, that discuss our business in greater detail and that also disclose
various risks, uncertainties and other factors that may affect our business,
results of operations or financial condition.
COMPANY OVERVIEW
We provide professional Internet data security services and develops and markets
software and microprocessor-based products needed to secure electronic commerce
business transactions and communications over the Internet and other
communications networks based on Internet protocols. To increase our sales
capacity for proprietary products and to capitalize on opportunities in the
rapidly growing Internet-based information technology security market, we
acquired Pulsar Data Systems Inc., a network integration solutions company that
develops large-scale network solutions for commercial and government
organizations in June, 1999.
10
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth the percentage of net revenues represented by
selected items from the unaudited Condensed Consolidated Statements of
Operations. This table should be read in conjunction with the Condensed
Consolidated Financial Statements included elsewhere herein.
<TABLE>
<CAPTION>
Percentage of Net Revenues
Three Months Ended Six Months Ended
--------------------- -------------------
June 30, June 30, June 30, June 30,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Product 84.6% 66.0% 77.2% 74.1%
License and service 3.5 34.0 6.1 25.9
Research and
development 11.9 - 16.7 -
------ ------ ------ ------
Total revenues 100.0 100.0 100.0 100.0
------ ------ ------ ------
Costs and expenses:
Cost of sales - products 74.4 25.4 61.6 33.1
Cost of sales - license and
service 5.4 22.6 6.6 16.3
Selling, general and
administrative 51.4 35.9 54.9 38.0
Research and development 26.9 19.3 36.2 19.9
Amortization of goodwill and
other intangibles 4.3 - 2.8 -
------ ------ ------ ------
Operating loss (62.4) (3.2) (62.1) (7.3)
Interest expense (4.5) (7.9) (5.7) (7.2)
Interest income 1.4 0.1 1.1 0.1
------ ------ ------ ------
Loss before income taxes (65.5) (11.0) (66.7) (14.4)
Benefit from income taxes (10.7) (0.5) (6.9) (1.8)
------ ------ ------ ------
Net loss (54.8)% (10.5)% (59.8)% (12.6)%
====== ====== ====== ======
</TABLE>
Results of operations - comparison of the three months ended June 30, 1999 and
1998
Total revenues. Total revenues increased 80% from $1.5 million during the
three months ended June 30, 1998 to $2.7 million during the three months ended
June 30, 1999. The increase was primarily attributable to sales of products by
Pulsar subsequent to the acquisition of $1.7 million offset by decreased license
and service revenues of $422,000.
During the three months ended June 30, 1998, we derived 36%, 23% and 12% of our
revenue from sales to Lockheed Martin Corporation, the National Security Agency
and U.S. Army Corps of Engineers. During the three months ended June 30, 1999,
we derived 21%, 12%, and 10% of our revenue from sales to Prince Georges County,
the National Security Agency and the National Institute of Health.
Sales to federal government agencies accounted for approximately 35% and 52% of
our sales during the three months ended June 30, 1998 and 1999, respectively.
Product revenue. Product revenue increased 131% from $1.0 million during the
three months ended June 30, 1998 to $2.3 million during the three months ended
June 30, 1999. The increase was primarily attributable to sales of products by
Pulsar subsequent to the acquisition of $1.7 million offset by reduced sales of
our ARGUS 300
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products to the U.S. Army Corps and reader/writers to Lockheed Martin
Corporation under the Defense Messaging System contract.
License and service revenue. License and service revenue decreased from
$518,000 during the three months ended June 30, 1998 to $96,000 during the three
months ended June 30, 1999, primarily due to a decrease of $311,000 in revenue
from the National Security Agency Defense Messaging System support services.
Research and development revenue. Research and development revenue for the
three months ended June 30, 1999 of $326,000 represents amounts earned under a
contract with the National Security Agency under which we are designing a
microprocessor meeting minimum specifications established by the National
Security Agency. We have contracted with others to perform aspects of this
project. All related project costs are expensed as research and development as
incurred. The related research and development costs are not separately
identifiable. Therefore, the corresponding costs of the entire development
effort are included in research and development expenses.
Product gross margin. Product gross margins decreased as a percentage of net
product revenue from 62% during the three months ended June 30, 1998 to 12%
during the three months ended June 30, 1999. The decrease resulted primarily
from sales of low margin products of Pulsar subsequent to the acquisition of
Pulsar and decreased sales of high margin ARGUS data encryption products to the
U.S. Army Corps of Engineers.
License and service gross margin. License and service gross margin decreased
as a percentage of its revenue from 34% during the three months ended June 30,
1998 to (53%) during the three months ended June 30, 1999. This decrease
resulted primarily from a decrease in license and service revenue along with
higher compensation costs associated with the increased emphasis on building our
infrastructure related to professional services capabilities.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased 158% from $547,000 during the three months
ended June 30, 1998 to $1.4 million during the three months ended June 30, 1999.
As a percentage of revenue, selling, general and administrative expenses
increased from 36% during the three months ended June 30, 1998 to 51% during the
three months ended June 30, 1999. Selling, general and administrative expenses
increased primarily due to increased staffing to support business expansion,
inclusion of Pulsar selling, general and administrative expenses for a two week
period, and increased professional fees.
Research and development expenses. Research and development expenses increased
151% from $294,000 during the three months ended June 30, 1998 to $738,000
during the three months ended June 30, 1999. The increase was primarily
attributable to increased costs associated with increased new product
development, including expenses associated with the development efforts of the
Forte microprocessor, which we are designing in conjunction with Atmel
Corporation, and increased staffing to support research and development efforts
including the Forte project. As a percentage of revenue, research and
development expenses increased from 19% during the three months ended June 30,
1998 to 27% during the three months ended June 30, 1999.
Interest expense, net. Interest expense, net, decreased slightly from
$119,000 during the three months ended June 30, 1998 to $85,000 during the three
months ended June 30, 1999. The average borrowings required for operations were
comparable during the three months ended June 30, 1998 and 1999. The net
decrease is due primarily to interest income on cash equivalents and short-term
investments subsequent to the initial public offering.
Income taxes. Before our initial public offering, Litronic Industries Inc. had
elected to be treated as an S corporation under the provisions of Section 1362
of the Internal Revenue Code of 1986. Accordingly, we did not provide for
federal income taxes at the corporate level. We were subject to state taxes on
earnings before taxes. The provision for state income taxes was a credit of
$7,000 for the three months ended June 30, 1998. Subsequent to the initial
public offering, we are taxed as a C
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corporation and therefore we have recognized a tax benefit of $294,000 for the
three months ended June 30, 1999. In assessing the realizability of the net
deferred tax assets classified as non-current assets, management considers
whether it is more likely than not that some or all of the deferred tax assets
will not be realized. Based on our projected earnings, management
believes it is more likely than not that the Company will realize the benefit of
the existing net deferred tax assets at June 30, 1999. The ultimate realization
of deferred tax assets is dependent upon the generation of future taxable
income, however, there can be no assurance that we will generate any
earnings or any specific level of continuing earnings in future years.
Results of operations - comparison of the six months ended June 30, 1999 and
1998
Total revenues. Total revenues increased 30% from $3.2 million during the six
months ended June 30, 1998 to $4.2 million during the six months ended June 30,
1999. The increase was primarily attributable to sales of products by Pulsar
subsequent to the acquisition of $1.7 million and research and development
revenue of $695,000 offset by decreased license and service revenues of
$575,000.
During the six months ended June 30, 1998, we derived 36%, 24% and 19% of our
revenue from sales to Lockheed Martin Corporation, U.S. Army Corps of Engineers
and the National Security Agency. During the six months ended June 30, 1999, we
derived 17%, 17%, and 14% of our revenue from sales to Lockheed Martin
Corporation, the National Security Agency and Prince Georges County.
Sales to federal government agencies accounted for approximately 42% and 45% of
our sales during the six months ended June 30, 1998 and 1999.
Product revenue. Product revenue increased 36% from $2.4 million in the six
months ended June 30, 1998 to $3.2 million in the six months ended June 30,
1999. The increase was primarily attributable to sales of products by Pulsar
subsequent to the acquisition of $1.7 million offset by reduced sales of ARGUS
300 products to the U.S. Army Corps and reader/writers to Lockheed Martin
Corporation under the Defense Messaging System contract of $800,000.
License and service revenue. License and service revenue decreased from
$827,000 during the six months ended June 30, 1998 to $252,000 during the six
months ended June 30, 1999, primarily due to a decrease of $557,000 in revenue
from the National Security Agency Defense Messaging System support services.
Research and development revenue. Research and development revenue for the six
months ended June 30, 1999 of $695,000 represents amounts earned under a
contract with the National Security Agency under which we are designing a
microprocessor meeting minimum specifications established by the National
Security Agency. We have contracted with others to perform aspects of this
project. All related project costs are expensed as research and development as
incurred. The related research and development costs are not separately
identifiable. Therefore, the corresponding costs of the entire development
effort are included in research and development expenses.
Product gross margin. Product gross margins decreased as a percentage of net
product revenue from 55% during the six months ended June 30, 1998 to 20% during
the six months ended June 30, 1999. The decrease resulted primarily from sales
of low margin products of Pulsar subsequent to the acquisition of Pulsar and
decreased sales of ARGUS data encryption products to the U.S. Army Corps of
Engineers.
License and service gross margin. License and service gross margin decreased
as a percentage of its revenue from 37% during the six months ended June 30,
1998 to (9%) during the six months ended June 30, 1999. This decrease resulted
primarily from a decrease in license and service revenues along with higher
compensation costs associated with the increased emphasis on building our
infrastructure related to professional services capabilities.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased 88% from $1.2 million during the six months
ended June 30, 1998 to $2.3 million during the six months ended June 30, 1999.
As a percentage of revenue, selling, general and administrative expenses
increased from 38%
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during the six months ended June 30, 1998 to 55% during the six months ended
June 30, 1999. Selling, general and administrative expenses increased primarily
due to increased staffing to support business expansion, inclusion of Pulsar's
selling, general and administrative for a two week period and increased
professional fees.
Research and development expenses. Research and development expenses increased
137% from $634,000 during the six months ended June 30, 1998 to $1.5 million
during the six months ended June 30, 1999. The increase was primarily
attributable to increased costs associated with increased new product
development, including expenses associated with the development efforts of the
Forte microprocessor, which we are designing in conjunction with Atmel
Corporation, and increased staffing to support research and development efforts
including the Forte project. As a percentage of revenue, research and
development expenses increased from 20% during the six months ended June 30,
1998 to 36% during the six months ended June 30, 1999.
Interest expense, net. Interest expense, net, decreased slightly from
$227,000 during the six months ended June 30, 1998 to $193,000 during the six
months ended June 30, 1999. The average borrowings required for operations were
comparable during the six months ended June 30, 1998 and 1999. The net decrease
is due primarily to interest income on cash equivalents and short-term
investments subsequent to the initial public offering.
Income taxes. Before the initial public offering, Litronic Industries, Inc.
had elected to be treated as an S corporation under the provisions of Section
1362 of the Internal Revenue Code of 1986. Accordingly, we did not provide for
federal income taxes at the corporate level. We were subject to state taxes on
earnings before taxes. The provision for state income taxes was a credit of
$58,000 for the six months ended June 30, 1998. Subsequent to the initial public
offering, we are taxed as a C corporation and therefore has a recognized a tax
benefit of $285,000 for the six months ended June 30, 1999. In assessing the
realizability of the net deferred tax assets classified as non-current assets,
management considers whether it is more likely than not that some or all of the
deferred tax assets will not be realized. Based on the Company's projected
earnings, management believes it is more likely than not that the Company will
realize the benefit of the existing net deferred tax assets at June 30, 1999.
The ultimate realization of deferred tax assets is dependent upon the generation
of future taxable income, however, there can be no assurance that the Company
will generate any earnings or any specific level of continuing earnings in
future years.
LIQUIDITY AND CAPITAL RESOURCES
In June 1999, we completed our initial public offering of common stock. The net
proceeds of the offering were $36,919,000.
In June 1999 we entered into a three-year agreement with Fidelity Funding
permitting borrowings under a new $20.0 million secured revolving line of credit
facility commencing on June 14, 1999. The agreement provides for an annual
interest rate of prime plus .625%; a pledge of substantially all of our personal
and real property as collateral; and maximum borrowings equal to 85% of our
eligible accounts receivable plus the lesser of (a) 50% of the value of our
eligible on-hand inventory or (b) $1.0 million.
We believe that the current availability under our $20.0 million revolving line
of credit and existing cash and cash equivalents, and short term investments,
will be sufficient to satisfy our contemplated cash requirements for at least
the next 12 months, including planned capital expenditures of approximately $1.2
million and an anticipated increase in rent expense of $400,000 per year
following the anticipated relocation of our California headquarters.
Although we believe that we have sufficient capital to fund our activities
for at least the next 12 months, our future capital requirements may vary
materially from those now planned. The amount of capital that we will need in
the future will depend on many factors including, but not limited, to:
. the market acceptance of our products and services
. the levels of promotion and advertising that will be required to launch
new products and services and attain a competitive position in the market
place
. research and development plans
. levels of inventory and accounts receivable
. technological advances
. competitors responses to our products and services
. relationships with partners, suppliers and customers
. our projected capital expenditures
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In addition, we may require additional capital to accommodate planned growth,
hiring, infrastructure and facility needs or to consummate acquisitions of other
businesses, products or technologies.
In the year ended December 31, 1998, our financing requirements were obtained
from bank financing and loans from principal shareholders and affiliates. Some
of our borrowings contain covenants and restrictions, including maintenance of
minimum tangible net worth and working capital, and they prohibit the payment of
dividends. We were in compliance with or had received waivers for these
covenants as of December 31, 1998 and as of June 30, 1999.
During the six months ended June 30, 1999 cash used in operations was $6,838,000
primarily due to a net loss of $2,491,000 and decreases accounts payable of
$2,500,000 and accrued liabilities of $732,000.
During the six months ended June 30, 1999, cash used in investing activities was
$6,093,000 and resulted primarily from short term investment transactions.
During the six months ended June 30, 1999, cash provided by financing activities
was $21,623,000, consisting primarily of net proceeds from the initial public
offering of $35,323,000, and borrowings of $5,080,000 under bank borrowing
agreements. These were offset by repayments of $18,780,000 under bank borrowing
agreements.
YEAR 2000 ISSUES
An issue affecting us and others is the inability of many computer systems and
applications to process the year 2000 date change, the date 9/9/99 and the leap
year 2000. Many currently installed computer systems and software applications
are coded to accept only two digit entries in the date code field. These date
code fields will need to accept entries to distinguish 21st century dates from
20th century dates. The inability to recognize or properly treat the year 2000
issue may cause our systems and applications to process critical
financial and operational information incorrectly.
We have established a committee to determine the extent to which we may be
vulnerable to the year 2000 issue. The committee is responsible for the ongoing
assessment, renovation of, testing, and certification of all business-critical
infrastructure systems and applications software. In the process of its
evaluation of the year 2000 issue, the committee has developed potential
business disruption scenarios and contingency plans. The costs incurred to date
related to the year 2000 issue have related primarily to time spent by employees
in year 2000 compliance matters and have not been significant. We do not believe
future costs will be significant. The following is a description of how we have
categorized and are addressing the year 2000 issue.
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Internal systems
We have evaluated our internal computer systems in an effort to determine
the actions, if any, necessary to make them year 2000 compliant. Our evaluation
has involved testing our systems to ensure that they are year 2000 compliant.
Based on its present review of our systems, the committee has determined that
we do not have a high risk of computer-related internal systems problems from
the year 2000 issue.
Embedded systems
We also recognize that there are risks with respect to embedded systems that
are not necessarily part of our information technology systems but contain
microprocessor chips which may not function properly with the change of date to
the year 2000. The majority of the embedded systems on which we rely in our
day-to-day operations are owned and managed by the lessors of the buildings in
which our offices are located, or by agents of these lessors. We have received
letters from our lessors and, as applicable, their agents indicating the year
2000 compliance of the embedded systems. Based upon these responses we do not
believe there are any year 2000 compliance issues with our embedded systems.
Because we believe that our information technology and embedded systems will be
substantially year 2000 compliant in advance of the year 2000 date change, we
have no contingency plan to address non-compliance. We expect that, as we
complete testing of information technology and embedded systems, we will develop
contingency plans if we determine that any business critical systems will not be
year 2000 compliant.
Outside vendors and customers
Disruptions with respect to the computer systems of vendors or customers,
which are outside our control, could impair our ability to obtain services or
conduct business with our customers. Disruptions of our utilities or
telecommunications systems could have a material adverse effect upon our
financial condition and results of operations. We believe that no other
providers are material to our business. Disruptions of customers' computer
systems could interfere with customers' ability to make timely payments on
accounts, could disrupt our customers' ability to manage the installation
process of our products, which could adversely affect our ability to reach our
milestones, and thus to recognize revenue, and could disrupt other
administrative activities.
The committee has sent year 2000 issue questionnaires to our significant
vendors, suppliers and customers. Although the responses we have received do
not indicate any significant year 2000 issues, we do not have any assurances
that all of our significant vendors, suppliers and customers will take the
necessary steps to ensure that their respective systems will be protected
against the year 2000 issue or that even if such steps are taken, they will be
successful. As we continue to assess the risk of our significant vendors',
customers' and suppliers' systems, we will develop and implement, if necessary,
curative plans and contingency plans to address any year 2000 compliance
issues.
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Our products
We have determined that our products, to the extent that underlying hardware
platforms, operating systems and databases will accommodate the year 2000 date
change, are year 2000 compliant and will accommodate the year 2000 date change.
We anticipate that virtually all of our customers and potential customers
will be required to evaluate their information technology systems with respect
to the year 2000 date change and that some of our customers and potential
customers may incur material costs in connection with this evaluation and any
necessary repairs and replacements. Customers and potential customers may be
required to devote material portions of their information technology budgets to
these evaluations, repairs and replacements, which could materially reduce
their other information technology purchases in 1999, including their purchases
of Litronic's products, particularly as the year 2000 date change draws closer.
We do not have any information as to the degree to which this issue will affect
our customers or potential customers.
Summary
There can be no assurance that any year 2000 issue-related precautions with
respect to our internal information technology systems, embedded systems or our
products will eliminate the numerous and varied risks associated with the year
2000 date change. Further, there is a risk that we will be adversely affected
by the year 2000 issue or related difficulties encountered by vendors or
customers or by any downturn in information technology purchases or in the
economy in general as the year 2000 date change draws nearer. Any of these
risks could adversely affect our business.
Management believes that the most likely worst case scenario related to the
year 2000 issues that we may experience would be either an inability to obtain
inventory components from suppliers or delays in receiving orders or payments
from customers due to year 2000 problems experienced by these third parties.
These events, if experienced, could have a material adverse effect on our
business, results of operations, financial condition and liquidity.
QUARTERLY EARNINGS FLUCTUATIONS
Fluctuations in quarterly operating results
Our quarterly operating results may fluctuate significantly as result of a
variety of factors, many of which are outside our control. These factors
include:
. the length of our customer commitments;
. patterns of information technology spending by customers;
. the timing, size, mix and customer acceptance of our product and service
product offerings and those of our competitors;
. the timing and magnitude of required capital expenditures;
. the need to use outside contractors to complete some assignments; and
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. general economic conditions.
In addition, the sales and implementation cycles associated with our product
sales and network design and implementation activities can, as a result, be
lengthy, potentially lasting from 45 to 90 days. Evaluating customers' data
security needs and designing and implementing custom networks typically
requires significant expenditure of time, capital and other resources.
Customers' purchasing decisions for our products and systems may be subject to
delay due to many factors not within our control, such as the significant
expense of many data security products and network systems, customers' internal
budgeting process, year 2000 concerns and the other procedures customers may
require for the approval of large purchases. Further, the implementation
process is subject to delays resulting from administrative concerns associated
with incorporating new technologies into existing networks, deployment of a new
network system and data migration to the new system.
As a result, comparisons of quarterly results may not be meaningful and
should not be relied upon, nor will they necessarily reflect on future
performance. Fluctuations in quarterly operating results may adversely affect
the trading price of our common stock if our operating results are below the
expectations of public market analysts and investors.
New accounting standards
In June 1998, the Financial Accounting Standards Board issued Statement 133,
Accounting for Derivative Instruments and Hedging Activities. The new statement
established accounting and reporting standards for derivative instruments and
for hedging activities and is effective for all fiscal quarters of fiscal years
beginning after June 15, 2000.
In December 1998, the AICPA issued SOP 98-9. SOP 98-9 amends paragraphs of
SOP 97-2 to require recognition of revenue using the residual method under some
circumstances, and is effective for fiscal years beginning after March 15,
1999.
The adoption of these new standards is not expected to have a material
impact on our consolidated financial statements.
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BUSINESS ENVIRONMENT AND RISK FACTORS
RISK FACTORS
We have a history of losses and may incur future losses.
We may not become profitable or significantly increase our revenue. Litronic
incurred net losses of $1.4 million for the year ended December 31, 1998 and
$2.5 million for the six months ended June 30, 1999. Pulsar incurred net losses
of $8.1 million for the year ended December 31, 1998 and $1.8 million for the
three months ended March 31, 1999. Our pro forma combined statements of
operations, included in the prospectus filed in June, 1999, reflect net losses
of $11.6 million for the year ended December 31, 1998. Our net loss for the
six months ended June 30, 1999 was $5.7 million.
Our inability to integrate, or implement our plans for, the operations of
Pulsar may adversely affect our business.
Our failure to successfully integrate, or implement our plans for, the
operations of Pulsar would significantly diminish the value of the Pulsar
acquisition and adversely affect our future operations. Moreover, integration of
the Pulsar acquisition may place strain on our managerial and financial
resources, which could, in turn, adversely affect our business. To achieve the
full benefits of the Pulsar acquisition, we need to:
. integrate our administrative, financial and engineering resources and
coordinate our marketing and sales efforts;
. roll out our data security products to Pulsar's existing client base;
. successfully complete the implementation of Pulsar's recent shift in
product reselling focus;
. expand Pulsar's professional service offerings; and
. increase sales of Pulsar's products and professional services.
We may not be able to successfully implement any of these plans.
The goodwill and other intangibles acquired in the Pulsar acquisition may have
an adverse impact on our operating results and the market price of our common
stock.
$36.3 million, or 60%, of our assets as of June 30, 1999, consisted of
intangible assets, including goodwill, arising from the acquisition of Pulsar.
This amount, the components of which are amortized over 10 to 15 years,
constitutes a non-cash, non-tax deductible expense in each amortization period
that will reduce net income or increase net loss for that period. The reduction
in our net earnings or an increase in our net loss resulting from the
amortization of goodwill and other intangibles may have an adverse impact on our
operating results and the market price of our common stock. There is also a risk
that we may never realize the value of our intangible assets.
The terms of our loan agreements could limit our ability to implement our
business strategy.
The terms of our loan agreements with our credit providers could limit our
ability to implement our strategy. In addition to substantially prohibiting us
from incurring additional indebtedness, our loan agreements with these creditors
limit or prohibit us from:
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. declaring or paying cash dividends;
. making capital distributions or other payments to stockholders;
. merging or consolidating with another corporation; or
. selling all or substantially all of our assets.
We derive a substantial portion of our revenue from a small number of customers
and, therefore, the loss of even one of these customers could significantly and
negatively impact our operating results.
We depend on a limited number of customers for a substantial portion of our
revenue and many of our contracts with our significant customers are short-term
contracts. The non-renewal of any significant contract upon expiration, or a
substantial reduction in sales to any of our significant customers, would
adversely affect our business unless we were able to replace the revenue we
received from these customers. For the year ended December 31, 1998, we derived
81% of our revenue from three customers. For the six months ended June 30, 1999,
we derived 58% of our revenue from five customers.
Doing business with the U.S. government entails many risks which could adversely
affect us.
Sales to U.S. government agencies accounted for 81% of our revenue for the year
ended December 31, 1998 and 45% of our revenue for the six months ended June 30,
1999. Our sales to these agencies are subject to risks, including:
. early termination of our contracts;
. disallowance of costs upon audit; and
. the necessity to participate in competitive bidding and proposal
processes, which is costly, time consuming and may result in unprofitable
contracts.
In addition, the government may be in a position to obtain greater rights with
respect to our intellectual property than we would grant to other entities.
Government agencies also have the power, based on financial difficulties or
investigations of its contractors, to deem contractors unsuitable for new
contract awards. Because we engage in the government contracting business, we
have been and will be subject to audits and may be subject to investigation by
governmental entities. Failure to comply with the terms of any of our
governmental contracts could result in substantial civil and criminal fines and
penalties, as well as our suspension from future government contracts for a
significant period of time, any of which could adversely affect our business.
If use of the Internet and other communications networks based on Internet
protocols does not continue to grow, demand for our products may not increase.
Increased demand for our products depends in large part on the continued growth
of the Internet and Internet protocol-based networks and the widespread
acceptance and use of these mediums for electronic commerce and communications.
Because electronic commerce and communications over these networks are evolving,
we cannot predict the size of the market and its sustainable growth rate. A
number of factors may affect market size and growth rate, including:
. the use of electronic commerce and communications may not increase, or
may increase more slowly than we expect;
. the Internet infrastructure and communications services to support
electronic commerce may not be able to continue to support the demands
placed on it by continued growth; and
. the growth and reliability of electronic commerce and communications could
be harmed by delays in development or adoption of new standards and
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protocols to handle increased levels of activity or by increased
governmental regulation.
If PKI technology is compromised, our business would be adversely affected.
Many of our products are based on PKI technology. The security afforded by this
technology depends on the integrity of a user's private key, which depends in
part on the application of algorithms, or advanced mathematical factoring
equations. The occurrence of any of the following could result in a decline in
demand for our data security products:
. any significant advance in techniques for attacking PKI systems,
including the development of an easy factoring method or faster, more
powerful computers;
. publicity of the successful decoding of cryptographic messages or the
misappropriation of private keys; and
. government regulation limiting the use, scope or strength of PKI.
If we do not respond to rapid technological changes, our products and service
offerings could become obsolete.
If we are unable to modify existing products and develop new products that are
responsive to changing technology and standards and meet customer needs in a
timely and cost effective manner, our business could be adversely affected. The
markets we serve are characterized by rapidly changing technology, emerging
industry standards and frequent introduction of new products. The introduction
of products embodying new technologies and the emergence of new industry may
render our products obsolete or less marketable. The process of developing our
products and services is extremely complex and requires significant continuing
development efforts.
If we fail to establish and maintain strategic relationships, our ability to
develop and market our products would be adversely affected.
The loss of any of our existing strategic relationships, or the inability to
create new strategic relationships in the future, could adversely affect our
ability to develop and market our products. We depend upon our partners to
develop and market products and to fund and perform their obligations as
contemplated by our agreements with them. We do not control the time and
resources devoted by our partners to these activities. These relationships may
not continue or may require us to spend significant financial, personnel and
administrative resources from time to time. We may not have the resources
available to satisfy our commitments, which may adversely affect our strategic
relationships. Further, our products and services may compete with the products
and services of our strategic partners. This competition may adversely affect
our relationships with our strategic partners, which could adversely affect our
business.
We depend on key management personnel.
Our success will depend largely on the continuing efforts of our executive
officers and senior management, especially those of Kris Shah, our chairman of
the board and chief executive officer, and William W. Davis, Sr., our president
and chief operating officer. Our business may be adversely affected if the
services of any of our key personnel become unavailable to us. We have not
entered into employment agreements with any employees other than Messrs. Shah
and Davis. Even with these agreements, there is a risk that these individuals
will not continue to serve for any particular period of time. While we have
obtained key person life insurance policies on the lives of Messrs. Shah and
Davis, each in the amount of $3.0 million, these amounts may not be sufficient
to offset the loss of their services.
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There is significant competition in our industry for highly skilled employees
and our failure to attract and retain technical personnel would adversely affect
our business.
We may not be able to successfully attract or retain highly skilled employees.
Our inability to hire or retain highly qualified individuals may impede our
ability to develop, install, implement and service our software and hardware
systems, customers and potential customers or efficiently conduct our
operations, all of which may adversely affect our business. The data security
and networking solution industries are characterized by a high level of employee
mobility, and the market for highly qualified individuals in the computer-
related fields is intense. This competition means there are fewer highly
qualified employees available to hire and the costs of hiring and retaining
these individuals are high. Even if we are able to hire these individuals, we
may be unable to retain them. Furthermore, there is increasing pressure to
provide technical employees with stock options and other equity interests, which
may dilute earnings per share.
Potential product defects could subject us to claims from customers.
Products as complex as those we offer may contain undetected errors or result
in failures when first introduced or when new versions are released. Despite our
product testing efforts and testing by current and potential customers, it is
possible that errors will be found in new products or enhancements after
commencement of commercial shipments. The occurrence of product defects or
errors could result in adverse publicity, delay in product introduction,
diversion of resources to remedy defects, loss of or a delay in market
acceptance or claims by customers against us, or could cause us to incur
additional costs, any of which could adversely affect our business.
We may be exposed to potential liability for actual or perceived failure to
provide required products or services.
Because our customers rely on our products for critical security applications,
we may be exposed to potential liability claims for damage caused to an
enterprise as a result of an actual or perceived failure of our products. An
actual or perceived breach of enterprise network or data security systems of one
of our customers, regardless of whether the breach is attributable to our
products or solutions, could adversely affect our business reputation.
Furthermore, our failure or inability to meet a customer's expectations in the
performance of our services, or to do so in the time frame required by the
customer, regardless of our responsibility for the failure, could:
. result in a claim for substantial damages against us by the customer;
. discourage customers from engaging us for these services; and
. damage our business reputation.
In addition, as a professional services provider, a portion of our business
involves employing people and placing them in the workplace of other businesses.
Therefore, we are also exposed to liability for actions taken by our employees
while on assignment.
Problems relating to the year 2000 issue could adversely affect our business.
We are in the process of surveying our major vendors regarding year 2000
compliance. Until we complete our survey we cannot fully assess the year 2000
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status of any of our vendors or suppliers. The failure of our significant
vendors and customers to make their products and systems year 2000 compliant may
adversely affect the performance of our products, which may in turn adversely
affect our business. Customers or third parties might seek indemnification or
damages from us as a result of year 2000 issue-related errors caused by or not
prevented by our products or services. We cannot predict the extent to which we
might be liable for these costs, but it is conceivable in general that year 2000
errors could result in substantial judgments against us or other providers of
information technology. If we were to suffer an adverse judgment as a result of
prior year 2000 noncompliance of our products, it may have an adverse impact on
our business.
Customers' purchasing decisions could be affected by the year 2000 issue as
they may need to expend significant resources to correct their existing systems.
This situation may result in reduced funds available to implement the
infrastructure needed to conduct trusted and secure electronic commerce and
communications over the Internet, intranets and extranets. These factors could
lead to a decline in sales of our products and services, which could, in turn,
adversely affect our business.
The extent of the potential impact of the year 2000 issue generally is not
known, and we cannot predict the likelihood that the year 2000 issue will cause
a significant disruption in the economy as a whole.
We face intense competition from a number of sources.
The markets for our products and services are intensely competitive and, as a
result, we face significant competition from a number of different sources. We
may be unable to compete successfully as many of our competitors are more
established, benefit from greater name recognition and have substantially
greater financial, technical and marketing resources than we have. In addition,
there are several smaller and start-up companies with which we compete from time
to time. We also expect that competition will increase as a result of
consolidation in the information security technology and product reseller
industries.
Third parties could obtain access to our proprietary information or
independently develop similar technologies because of the limited protection for
our intellectual property.
Our business, financial condition and operating results could be adversely
affected if we are unable to protect our intellectual property rights.
Notwithstanding the precautions we take, third parties may copy or obtain and
use our proprietary technologies, ideas, know-how and other proprietary
information without authorization or independently develop technologies similar
or superior to our technologies. In addition, the confidentiality and non-
competition agreements between us and our employees, distributors, and clients
may not provide meaningful protection of our proprietary technologies or other
intellectual property in the event of unauthorized use or disclosure. Policing
unauthorized use of our technologies and other intellectual property is
difficult, particularly because the global nature of the Internet makes it
difficult to control the ultimate destination or security of software or other
data transmitted. Furthermore, the laws of
23
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other jurisdictions may afford little or no effective protection of our
intellectual property rights.
We may face claims of infringement of proprietary rights.
There is a risk that our products infringe the proprietary rights of third
parties. In addition, whether or not our products infringe on proprietary rights
of third parties, infringement or invalidity claims may be asserted or
prosecuted against us and we could incur significant expense in defending them.
If any claims or actions are asserted against us, we may be required to modify
our products or seek licenses for these intellectual property rights. We may not
be able to modify our products or obtain licenses on commercially reasonable
terms, in a timely manner or at all. Our failure to do so could adversely affect
our business.
Our efforts to expand international operations are subject to a number of risks.
We are currently seeking to increase our international sales. Our inability to
maintain or to obtain federal or foreign regulatory approvals relating to the
import or export of our products on a timely basis could adversely affect our
ability to expand our international business. Additionally, our international
operations could be subject to a number of risks, any of which could adversely
affect our future international sales, including:
. increased collection risks;
. trade restrictions;
. export duties and tariffs; and
. uncertain political, regulatory and economic developments.
Our ability to produce the Forte PKIcard on a timely and cost-effective basis
depends on the availability of a computer chip from a third-party supplier, with
whom we do not expect to maintain a supply agreement.
Any inability to receive adequate supplies of Atmel Corporation's specially
designed Forte microprocessor would adversely affect our ability to complete and
sell the Forte PKIcard. We do not anticipate maintaining a supply agreement with
Atmel Corporation for the Forte microprocessor. If Atmel were unable to deliver
the Forte microprocessor for a lengthy period of time or terminated its
relationship with us, we would be unable to produce the Forte PKIcard until we
could design a replacement computer chip for the Forte microprocessor. We
anticipate this would take substantial time and resources to complete.
A small number of stockholders, including our officers and directors, have the
ability to control stockholder votes.
Kris Shah and members of his family, William W. Davis, Sr. and Lillian A. Davis
beneficially own, in the aggregate, approximately 62.0% of our outstanding
common stock. These stockholders, if acting together, have the ability to elect
our directors and to determine the outcome of corporate actions requiring
stockholder approval, irrespective of how other stockholders may vote. This
concentration of ownership may also have the effect of delaying or preventing a
change in control.
24
<PAGE>
There are lawsuits pending and threatened against the Company which could
adversely affect our business if they are resolved against Pulsar.
Lawsuits are pending against and threatened Pulsar which, if resolved against
Pulsar, could materially and adversely affect our business and financial
condition. These lawsuits and threats claim: (a) damages of approximately $10.3
million resulting from Pulsar's alleged breach of a contract for government
contract bid preparation Services, (b) unspecified damages resulting from
alleged race and age discrimination in connection with the termination of a
Pulsar employee and (c) damages by a former employee relating to amounts due
under an employment contract including approximately $200,000 of incentive
compensation and an equity stake in Pulsar.
Our stock price could be extremely volatile.
The trading price of our common stock has been and may continue to be highly
volatile as a result of factors specific to us or applicable to our market and
industry in general. These factors, include:
. variations in our annual or quarterly financial results or those of our
competitors;
. changes by financial research analysts in their recommendations or
estimates of our earnings;
. conditions in the economy in general or in the information technology
service sector in particular;
. announcements of technological innovations or new products or services by
us or our competitors; and
. unfavorable publicity or changes in applicable laws and regulations, or
their judicial or administrative interpretations, affecting us or the
information technology service sectors.
In addition, the stock market has recently been subject to extreme price and
volume fluctuations. This volatility has significantly affected the market
prices of securities issued by many companies for reasons unrelated to the
operating performance of these companies. In the past, following periods of
volatility in the market price of a company's securities, some companies have
been sued by their stockholders. If we were sued, it could result in
substantial costs and a diversion of management's attention and resources,
which could adversely affect our business.
We have anti-takeover defenses that could delay or prevent an acquisition and
could adversely affect the price of our common stock.
Our certificate of incorporation and bylaws contain provisions that may
deter a takeover or a change in control or prevent an acquisition not approved
by our board of directors, or that may adversely affect the price of our common
stock.
The number of shares eligible for future sale and the existence of registration
rights could depress the market for our common stock.
25
<PAGE>
A substantial number of our shares of common stock are tradeable in the public
market. This may adversely affect prevailing market prices for our common stock
and could impair our ability to raise capital through the sale of additional
equity securities. An aggregate of 3,870,693 of the 6,040,631 shares currently
restricted from trading in the public market will become eligible for sale on
September 12, 1999, subject to agreements with the lead underwriters of our
initial public offering restricting their sale for periods of at least six
months. We cannot predict the effect, if any, that sales of these additional
securities or the availability of these additional securities for sale will have
on the market prices prevailing from time to time. In addition, the
representatives of the underwriters of the initial public offering have also
been granted registration rights commencing one year from the date of the
initial public offering providing for the registration under the Securities Act
of the securities issuable upon exercise of the representatives' warrants. The
exercise of these rights could result in substantial expense to us. Furthermore,
if the representatives exercise their registration rights, they will be unable
to make a market in our securities for up to nine days before the initial sales
of the warrants until the discontinuation of sales. If the representatives cease
making a market, the market and market prices for the securities may be
adversely affected and the holders of these securities may be unable to sell
them.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Investment Portfolio
We do not use derivative financial instruments in our held to maturity
investment portfolio. We place our investments in instruments that meet high
credit quality standards, as specified in our investment policy guidelines. The
policy also limits the amount of credit exposure to any one issue, issuer or
type of investment. We do not expect any material loss with respect to our
investment portfolio, and market value approximates cost at June 30, 1999.
The table below provides information about our held to maturity investment
portfolio. For investment securities, the table presents principal cash flows
and related weighted average fixed interest rates by expected maturity dates.
Our investment policy requires that all investments mature in 90 days or less,
with a weighted average maturity of no longer than 90 days.
Principal (notional) amounts, all investments mature before July 31, 1999:
June 30,
1999
----
Cash equivalents $ 8,841
Weighted average rate 4.92%
Short term investments 6,000
Weighted average rate 5.38%
Total portfolio $14,841
Weighted average rate 5.11%
Interest Rate Sensitivity
Of the Company's $4.2 million indebtedness at June 30, 1999, $3.6 million and
$82,000 of such debt bear interest at 7.75% and 8.125%, respectively, which
fluctuate based on changes in prime rate. A 10% change in the underlying prime
rate would result in an approximately $37,000 change in the annual amount of
interest paid on such debt.
PART II. OTHER INFORMATION
- --------------------------
Item 1. Legal Proceedings -
We are involved from time to time in routine litigation that arises in the
ordinary course of business. We are not currently involved in any litigation
which we believe will have a material impact on our results of operations,
financial condition or liquidity, other than the following:
In the course of its business, Pulsar has been extended credit from several
trade vendors for the purchase of supplies, equipment, merchandise and services.
Pulsar's accounts for several of these trade vendors have been past due for a
significant amount of time. As a result, several of these trade vendors have
filed lawsuits against Pulsar seeking to collect the amounts owed by Pulsar. In
addition, a local government agency has filed a claim for back taxes owed by
Pulsar. The aggregate amount claimed under these lawsuits was approximately $1.8
million, plus interest, attorney's fees and costs. Pulsar has entered into
settlements including stipulated judgments covering some of the lawsuits. The
majority of these claims have been paid as of June 30, 1999.
On January 16, 1998, G2 Resources Inc. filed a complaint against Pulsar in
the Circuit Court, Fifteenth Judicial Circuit, Palm Beach County, Florida. G2
claims that Pulsar breached a contract under which G2 agreed to provide services
related to the monitoring of government contracts available for bid and the
preparation and submission of bids on behalf of Pulsar. The contract provides
that Pulsar pay G2 $500,000 in 30 monthly installments of $16,666 and an
additional fee of 2% of the gross dollar amount generated by awards. In its
complaint, G2 alleged that Pulsar failed to make payments under the contract and
claimed damages in excess of $525,000 plus interest, costs and attorneys fees.
In the course of discovery G2 asserted that its losses/costs arising out of its
claim amount to approximately $10.3 million. Pulsar has asserted that G2 failed
to perform the services required under the contract and Pulsar filed a claim for
compensatory damages, interest and attorneys fees against G2. Classical
Financial Services, LLC intervened in the case. Classical claims that G2
assigned its accounts receivable to Classical under a financing program and that
Pulsar breached its obligations to Classical by failing to make payments under
the contract with G2. Pulsar has asserted defenses to Classical's claim. Pulsar
believes that the claims of G2 and Classical against Pulsar are without merit
and intends to continue to vigorously defend against the claims. If G2 or
Classical were to prevail in this lawsuit, our business and financial condition
could be materially adversely affected.
On July 11, 1997, Rudolph Menna filed a complaint against Pulsar and
William W. Davis, Sr. in the U.S. District Court for Northern District of
Georgia, Atlanta Division. Mr. Menna alleges that he was wrongfully terminated
as a Pulsar employee and that Pulsar and Mr. Davis unlawfully discriminated
against him on the basis of race and age. Mr. Menna's complaint seeks an
unspecified amount of damages including back pay, front pay, benefits,
compensatory and punitive damages, interest and attorneys fees. Pulsar and Mr.
Davis have filed an answer denying the material allegations in the complaint.
Pulsar and Mr. Davis believe that Mr. Menna's lawsuit is without merit and
intend to continue to vigorously defend against it. If Mr. Menna were to
prevail in the suit our business and financial condition could be materially
adversely affected.
On April 19, 1999, A&T Marketing Inc. filed a complaint against Pulsar in
the Circuit Court for Prince George's County, Maryland. A&T claims that Pulsar
owes A&T $262,000 plus interest and costs, for software that A&T sold Pulsar in
1998. Pulsar believes it has defenses to A&T's claim and that A&T's claim is
without merit. Pulsar intends to vigorously defend against the claim.
Item 2. Changes in Securities and Use of Proceeds - None.
Item 3. Defaults Upon Senior Securities - None.
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 - None.
26
<PAGE>
SIGNATURES
----------
Pursuant to the requirements 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: August 15, 1999
Litronic Inc.
By: /s/ Kris Shah
---------------------------------------
Kris Shah
Director, Chairman of the Board
and Chief Executive Officer
By: /s/ Thomas W. Seykora
---------------------------------------
Thomas W. Seykora
Chief Financial Officer and principal
accounting officer
EXHIBIT INDEX
Exhibit Number Description
- -------------- -----------
Exhibit 27 Financial Data Schedule
27
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<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 8,246
<SECURITIES> 7,344
<RECEIVABLES> 6,004
<ALLOWANCES> (194)
<INVENTORY> 547
<CURRENT-ASSETS> 23,119
<PP&E> 1,221
<DEPRECIATION> (522)
<TOTAL-ASSETS> 60,775
<CURRENT-LIABILITIES> 8,191
<BONDS> 0
0
0
<COMMON> 97
<OTHER-SE> 52,405
<TOTAL-LIABILITY-AND-EQUITY> 60,775
<SALES> 3,210
<TOTAL-REVENUES> 4,157
<CGS> 2,837
<TOTAL-COSTS> 2,837
<OTHER-EXPENSES> 3,903
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 237
<INCOME-PRETAX> (2,776)
<INCOME-TAX> (285)
<INCOME-CONTINUING> (2,491)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,491)
<EPS-BASIC> (0.57)
<EPS-DILUTED> (0.57)
</TABLE>
