<PAGE> 1
================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
Form 10-Q
[LOGO OF LITRONIC]
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000,
Or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NO. 000-26227
----------------
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.)
17861 CARTWRIGHT ROAD, 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 [X] No [ ]
As of November 14, 2000, the registrant had 9,885,146 shares of common
stock outstanding.
================================================================================
<PAGE> 2
LITRONIC INC.
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements............................................ 3
Condensed Consolidated Balance Sheets--December 31, 1999 and
September 30, 2000.............................................. 3
Condensed Consolidated Statements of Operations--Three and nine
months ended, September 30, 1999 and 2000....................... 4
Condensed Consolidated Statements of Cash Flows--Nine months
ended September 30, 1999 and 2000............................... 5
Notes to Condensed Consolidated Financial Statements............ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk...... 21
PART II. OTHER INFORMATION............................................... 21
Item 1. Legal Proceedings............................................... 21
Item 2. Changes in Securities and Use of Proceeds....................... 21
Item 3. Defaults upon Senior Securities................................. 21
Item 4. Submission of Matters to a Vote of Security Holders............. 21
Item 5. Other Information............................................... 21
Item 6. Exhibits and Reports on Form 8-K................................ 21
2
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LITRONIC INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1999 2000
------------ -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ................................... $ 6,441 $ 4,554
Restricted cash ............................................. 612 --
Accounts receivable (net of allowance for doubtful accounts
of $390 and $313 as of December 31, 1999 and September 30,
2000, respectively) ....................................... 7,141 10,930
Inventories ................................................. 796 1,456
Prepaid expenses ............................................ 360 582
Other current assets ........................................ 343 478
Note receivable - related party ............................. 70 75
-------- --------
Total current assets ...................................... 15,763 18,075
Property and equipment, net ................................... 646 990
Other assets .................................................. -- 481
Goodwill and other intangibles, net ........................... 34,695 32,909
-------- --------
$ 51,104 $ 52,455
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current installments of long-term debt ...................... $ 481 $ 5,399
Accounts payable ............................................ 1,250 4,517
Accrued liabilities ......................................... 1,411 1,476
Deferred revenue ............................................ 29 217
-------- --------
Total current liabilities ................................. 3,171 11,609
Long-term debt, less current installments ..................... -- 134
Deferred revenue .............................................. -- 292
-------- --------
Total liabilities ......................................... 3,171 12,035
Stockholders' equity:
Preferred stock, $.01 par value; Authorized 5,000,000 shares;
no shares issued or outstanding ........................... -- --
Common stock, $.01 par value; Authorized 25,000,000 shares;
issued and outstanding 9,856,944 at December 31, 1999 and
9,885,146 shares at September 30, 2000 .................... 99 99
Additional paid-in capital .................................. 52,812 52,832
Accumulated deficit ......................................... (4,978) (12,511)
-------- --------
Total stockholders' equity ................................ 47,933 40,420
-------- --------
Commitments and contingencies
$ 51,104 $ 52,455
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
3
<PAGE> 4
LITRONIC INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------------- ------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1999 2000 1999 2000
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues:
Product .............................................. $ 15,574 $ 14,559 $ 18,784 $ 27,329
License and service .................................. 451 552 703 1,554
Research and development ............................. 103 -- 798 --
-------- -------- -------- --------
Total revenues ..................................... 16,128 15,111 20,285 28,883
-------- -------- -------- --------
Costs and expenses:
Cost of sales--product ............................... 13,152 12,181 15,677 22,183
Cost of sales--license and service ................... 201 170 238 566
Selling, general and administrative .................. 2,355 2,232 4,682 7,415
Research and development ............................. 1,123 1,476 2,856 4,202
Amortization of goodwill and other intangibles ....... 709 711 827 2,117
-------- -------- -------- --------
Operating loss ......................................... (1,412) (1,659) (3,995) (7,600)
Other expense (income), net ............................ (33) (7) 161 (73)
-------- -------- -------- --------
Loss before income taxes ............................... (1,379) (1,652) (4,156) (7,527)
Provision for (benefit from) income taxes .............. -- -- (285) 6
-------- -------- -------- --------
Net loss ............................................... $ (1,379) $ (1,652) $ (3,871) $ (7,533)
======== ======== ======== ========
Net loss per share--basic and diluted .................. $ (0.14) $ (0.17) $ (0.63) $ (0.76)
======== ======== ======== ========
Shares used in per share computations--basic and diluted 9,742 9,885 6,154 9,878
======== ======== ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
4
<PAGE> 5
LITRONIC INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
------------------------------
SEPTEMBER 30, SEPTEMBER 30,
1999 2000
------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net loss ..................................................... $ (3,871) $ (7,533)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization .............................. 1,062 2,610
Deferred income tax benefit ................................ (285) --
Changes in assets and liabilities:
Accounts receivable ........................................ (5,184) (3,789)
Inventories ................................................ 11 (660)
Prepaid expenses ........................................... (493) (222)
Other current assets ....................................... (974) (135)
Note receivable - related party ............................ -- (5)
Other assets ............................................... (292) (481)
Accounts payable ........................................... (2,133) 3,267
Accrued liabilities ........................................ (419) (266)
Deferred revenue ........................................... (74) 480
-------- --------
Net cash used in operating activities ...................... (12,652) (6,734)
-------- --------
Cash flows used in investing activities:
Purchases of property and equipment ........................ (182) (837)
Restricted cash related to line of credit .................. -- 612
-------- --------
Net cash used in investing activities ...................... (182) (225)
-------- --------
Cash flows from financing activities:
Stock options exercised .................................... -- 20
Borrowings on revolving note payable to bank ............... -- 10,743
Proceeds from insurance financing .......................... -- 748
Repayment on insurance financing ........................... -- (294)
Proceeds from sale of common stock, net of issuance costs .. 35,323 --
Proceeds from revolving note payable to bank ............... 9,142 --
Proceeds from long-term debt ............................... 2,844 --
Principal payments on revolving line of credit and long-term
notes payable to bank .................................... (29,563) (6,145)
-------- --------
Net cash provided by financing activities .................. 17,746 5,072
-------- --------
Net increase (decrease) in cash ............................ 4,912 (1,887)
Cash and cash equivalents at beginning of period ............. 898 6,441
-------- --------
Cash and cash equivalents at end of period ................... $ 5,810 $ 4,554
======== ========
Supplemental disclosures of cash flow Information:
Cash paid during the period for:
Interest ................................................. $ 607 $ 223
Income taxes ............................................. 2 6
======== ========
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:
Merger costs ................................................. $ (121) --
Fair value of net assets acquired less liabilities assumed ... (12,450) (331)
Goodwill and other intangibles ............................... 36,441 --
-------- --------
Market value of common stock issued .......................... $ 23,870 $ (331)
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
5
<PAGE> 6
LITRONIC INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(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
December 31, 1999 and September 30, 2000; the results of operations for the
three and nine months ended September 30, 1999 and 2000; and the statements of
cash flows for the nine months ended September 30, 1999 and 2000. Interim
results for the three and nine months ended September 30, 2000 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2000. The interim financial statements should be read in
conjunction with the Company's consolidated financial statements for the year
ended December 31, 1999, included in the Company's Form 10-K, filed in March
2000.
Goodwill and Other Intangibles
The Company amortizes intangible assets relating to businesses acquired and
costs in excess of the fair value of net assets of businesses acquired
("goodwill and other intangibles") using the straight-line method over the
estimated useful lives of the intangible assets and business acquired.
Amortization of goodwill and other intangibles was $827 and $2,117 for the nine
months ended September 30, 1999 and September 30, 2000, respectively.
Long-lived assets and certain identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by comparison of the carrying amount of an asset to
future undiscounted net cash flows expected to be generated by the asset. If
such assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell.
In June 1999, the Company acquired Pulsar Data Systems ("Pulsar"). All of
the outstanding shares of Pulsar were exchanged for 2,169,938 shares of the
Company's common stock. The acquisition was accounted for using the purchase
method of accounting. To date the integration of Pulsar has not been completed
as planned. Management is currently exploring various alternatives for the
Pulsar operations. During the quarter ended September 30, 2000, management began
analyzing the recoverability of the goodwill and other intangibles relating to
the acquisition of Pulsar. Management anticipates completing this analysis
during the fourth quarter of the fiscal year 2000. Such an analysis could result
in the conclusion that the cash flows of Pulsar will not fully support the
recoverability of the goodwill and other intangibles. If such a conclusion is
reached, management would consider various options regarding the Pulsar
operations, including a restructuring or sale of some or all of Pulsar's
operations. In addition, such a conclusion could possibly result in an
impairment charge relating to some or all of the carrying value of the goodwill
and other intangibles.
Reclassifications
Certain reclassifications have been made to the 1999 condensed consolidated
financial statements to conform to the 2000 presentation.
(2) INVENTORIES
A summary of inventories follows:
DECEMBER 31, SEPTEMBER 30,
1999 2000
------------ -------------
Raw materials............... $ 190 $ 252
Work-in-process............. 136 27
Finished goods.............. 470 1,177
----- ------
$ 796 $1,456
===== ======
6
<PAGE> 7
(3) LONG TERM DEBT
A summary of long-term debt follows:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1999 2000
------------ -------------
<S> <C> <C>
Revolving note payable to bank with maximum availability of $20
million, bearing interest at prime plus .625% (9.125% at December
31, 1999 and 10.125% at September 30, 2000) interest payable
monthly through maturity on May 10, 2002; secured by substantially
all assets of the Company ........................................... $ 312 $4,910
Note payable for insurance financing due in nine monthly payments
beginning July 9, 1999 at an annual percentage rate of 5.93% ........ 169 --
Note payable for insurance financing due in nine monthly payments
beginning July 9, 2000 at an annual percentage rate of 7.15% ........ -- 599
Note payable for insurance financing due in eighteen monthly
payments beginning July 9, 2000 at an annual percentage rate of 8.18% -- 24
------ ------
481 5,533
Less current installments ............................................ 481 5,399
------ ------
$ -- $ 134
====== ======
</TABLE>
The Company's $20 million revolving credit agreement contains certain
covenants and restrictions, including maintenance of certain financial ratios
and a restriction on future borrowings. The credit agreement also prohibits the
payment of dividends. As of September 30, 2000, the Company was not in
compliance with certain covenants, and has obtained a waiver of these covenants.
The amounts due under this agreement of $4,910 have been classified as current
liabilities in the accompanying balance sheet. Although the credit facility is
for borrowings up to $20.0 million, under the terms of the agreement the amount
of borrowing available to the Company is subject to a maximum borrowing
limitation based on eligible collateral. Eligible collateral consists of 85% of
eligible accounts receivable plus the lesser of (a) 50% of the value of eligible
on-hand inventory or (b) $1.0 million. As a result, the amount actually
available to the Company at any particular time may be significantly less than
the full $20.0 million credit facility due to the maximum borrowing limitation
calculation. At December 31, 1999, the bank required the Company to maintain a
$612 cash deposit at the bank. For balance sheet presentation purposes, the
funds were reflected as restricted cash at December 31, 1999, as the Company had
no access to the funds. Beginning in the second quarter of 2000, the bank no
longer required the Company to maintain a cash deposit.
The Company has entered into insurance premium financing agreements with
Cananwill, Inc. for the payment of certain insurance premiums. The premiums
being financed cover policy periods from twelve to twenty-four months. The
insurance premium agreements payable in nine installments cover a policy period
of twelve months and the insurance premium agreement payable in eighteen
installments covers a policy period of twenty-four months. These insurance
premium finance agreements are secured by the proceeds of the policies being
financed.
(4) 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, 1999 and
September 30, 2000, accounts receivable included $5,386 and $10,429,
respectively, due from the U.S. Government and related agencies. Sales to
federal government agencies represented 75% and 79% of the Company's total
revenues for the nine months ended September 30, 1999 and 2000, respectively.
The Company had sales to two customers, which represented 34% of total
revenues for the nine months ended September 30, 1999. The Company had sales to
one customer, which was an agency of the U.S. Government and represented 42% of
the total revenues for the nine months ended September 30, 2000. No other
customers accounted for more than 10% of total revenues during the nine months
ended September 30, 1999 and September 30, 2000. Trade accounts receivable
totaled $1.4 million and $8 million from these major customers as of December
31, 1999 and September 30, 2000, respectively.
(5) LOSS PER SHARE
In December 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 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 computation of diluted net loss per share for the three and nine months
ended September 30, 1999 and 2000 excluded the dilutive effect of 360,647 and
728,195, respectively, of incremental common shares attributable to the exercise
of outstanding common stock options and warrants as a result of the antidilutive
effect.
7
<PAGE> 8
(6) CONTINGENT LIABILITIES
As the Company provides engineering and other services to various government
agencies, it is subject to retrospective audits, which may result in adjustments
to amounts recognized as revenues, and the Company may be subject to
investigation by governmental entities. Failure to comply with the terms of any
governmental contracts could result in civil and criminal fines and penalties,
as well as suspension from future government contracts. The Company is not aware
of any adjustments, fines or penalties, which could have a material adverse
effect on its financial position or results of operations.
The Company has 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 were 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 contract audits.
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 would be minimal.
(7) BUSINESS SEGMENTS AND PRODUCT LINES
Prior to the acquisition of Pulsar in June 1999, the Company operated in one
business segment. Subsequent to the acquisition, the Company operates in two
industry segments, the information security segment and the network solutions
segment. Following are the revenues, cost of sales, and identifiable assets of
these.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------- ----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1999 2000 1999 2000
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenue
Data Security Products and Services $ 1,309 $ 2,148 $ 3,792 $ 5,706
Network Solutions Market 14,819 12,963 16,493 23,177
======= ======= ======= =======
Cost of Sales
Data Security Products and Services 584 684 1,451 1,926
Network Solutions Market 12,769 11,667 14,464 20,823
======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1999 2000
------------ -------------
<S> <C> <C>
Identifiable Assets
Data Security Products and Services $ 798 $ 1,482
Network Solutions Market 41,684 43,347
======= =======
</TABLE>
As the Chief Operating Decision Maker does not review operating expenses by
segment beyond cost of sales or assets, except as identified, additional segment
information is not available.
Through September 30, 2000, the Company had four distinct product lines and
services: network deployment products, data security products, license and
service, and electric security systems. Following is a summary of total
revenues by product line.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------- ----------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1999 2000 1999 2000
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Network deployment products .......................... $14,715 $12,936 $16,389 $22,936
Data security products ............................... 859 1,623 2,395 4,393
License and service .................................. 450 525 1,397 1,313
Electric security systems ............................ 104 27 104 241
------- ------- ------- -------
Total net product, license and service revenues . $16,128 $15,111 $20,285 $28,883
======= ======= ======= =======
</TABLE>
In July 2000, the Company decided to discontinue the electric security
systems product line. The Company does not anticipate incurring any significant
expenses as the result of this decision. For the three and nine months ended
September 30, 2000, revenues generated by the electric security systems product
line were $27 and $241, respectively. Due to the winding-down of the electric
security systems product line, revenues generated during the three month period
ended September 30, 2000 related to the recognition of revenue earned on
contracts entered into prior to June 30, 2000. The Company has not entered into
any new contracts since its decision to discontinue this product line.
8
<PAGE> 9
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 10-Q 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
Litronic Inc. provides professional Internet data security services and
develops and markets software and microprocessor-based products that serve to
secure electronic commerce and communications over the Internet and other
communications networks based on Internet protocols. Our primary technology
offerings utilize a computer security technology known as public key
infrastructure, or PKI, which is the standard technology for securing
Internet-based commerce and communications. PKI helps ensure the integrity and
privacy of information being transmitted and verifies the identity, authenticity
and authority of the sender and the recipient of that information. In June 1999,
we acquired Pulsar Data Systems, Inc., or Pulsar, a network solutions company
that specializes in deploying large-scale network solutions to organizations
primarily in the government sector.
RESULTS OF OPERATIONS
The following table sets forth the percentage of total 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 TOTAL REVENUES
----------------------------------------------------------------------
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------------- -------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1999 2000 1999 2000
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues:
Product ...................................... 96.6% 96.3% 92.6% 94.6%
License and service .......................... 2.8 3.7 3.5 5.4
Research and development ..................... 0.6 -- 3.9 --
----- ----- ----- -----
Total revenues ............................... 100.0 100.0 100.0 100.0
----- ----- ----- -----
Costs and expenses:
Cost of sales--products ...................... 81.6 80.6 77.3 76.8
Cost of sales--license and service ........... 1.2 1.1 1.1 2.0
Selling, general and administrative .......... 14.6 14.8 23.1 25.7
Research and development ..................... 7.0 9.8 14.1 14.5
Amortization of goodwill and other intangibles 4.4 4.7 4.1 7.3
----- ----- ----- -----
Operating loss ................................. (8.8) (11.0) (19.7) (26.3)
Other expense (income), net .................... (0.2) (0.0) 0.8 (0.2)
----- ----- ----- -----
Loss before income taxes ....................... (8.6) (11.0) (20.5) (26.1)
Provision for (benefit from) income taxes ...... -- -- (1.4) 0.0
----- ----- ----- -----
Net loss ....................................... (8.6)% (11.0)% (19.1)% (26.1)%
===== ===== ===== =====
</TABLE>
9
<PAGE> 10
RESULTS OF OPERATIONS -- COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30,
1999 AND 2000
TOTAL REVENUE. Total revenues decreased 6% from $16.1 million during the
three months ended September 30, 1999 to $15.1 million during the three months
ended September 30, 2000. The decrease was primarily attributable to a $1.8
million decrease in network deployment revenue and a $800,000 increase in data
security product revenue.
During the three months ended September 30, 1999, we derived 31% and 12% of
our revenue from sales to the U.S. Immigration and Naturalization Service and
the U.S. Department of State. During the three months ended September 30, 2000,
we derived 55% of our revenue from sales to the U.S. Immigration &
Naturalization Service. Sales to Federal government agencies accounted for
approximately 84% and 91% of our sales during each of the three months ended
September 30, 1999 and 2000.
PRODUCT REVENUE. Product revenue decreased 7% from $15.6 million during the
three months ended September 30, 1999 to $14.6 million during the three months
ended September 30, 2000. The decrease was primarily attributable to a $1.8
million decrease in network deployment revenue and an increase in data security
product revenue of $800,000.
LICENSE AND SERVICE REVENUE. License and service revenue increased 22% from
$451,000 during the three months ended September 30, 1999 to $552,000 during the
three months ended September 30, 2000. The increase was primarily attributable
to the completion of the Bank of America service and software contract during
the three months ended September 30, 2000.
RESEARCH AND DEVELOPMENT REVENUE. Research and Development revenue
represents amounts earned under a contract with the NSA for the design of a
microprocessor meeting minimum specifications established by the NSA. We had
contracted with others to perform aspects of the project. All related project
costs were expensed as research and development was incurred. Regardless of the
results of the development efforts, the amounts received from the NSA are
nonrefundable. The related research and development costs were not separately
identifiable. Therefore, the corresponding costs of the entire development
effort were included in research and development expenses. Research and
development revenue was $103,000 during the three months ended September 30,
1999, whereas, no research and development revenue was earned during the three
months ended September 30, 2000. The contract that resulted in research and
development revenue was completed in 1999 and no further research and
development revenue is currently anticipated under this contract.
PRODUCT GROSS MARGIN. Product gross margin as a percentage of net product
revenue of 16% for the three months ended September 30, 2000 was comparable to
the three months ended September 30, 1999. Margins on network deployment
products decreased from 14% during the three months ended September 30, 1999 to
10% during the three months ended September 30, 2000. The decrease in gross
margins on network deployment products was primarily attributable to a reduction
in manufacturers rebate programs combined with lower margin pricing extended to
a major customer who represented 55% of network deployment revenue for the three
months ended September 30, 2000. Margins on data security products increased
from 45% during the three months ended September 30, 1999 to 62% during the
three months ended September 30, 2000. The increase in gross margins on data
security products was primarily attributable to an increase in sales volume,
selling price and a cost reduction related to a particular product within the
data security product line.
LICENSE AND SERVICE GROSS MARGIN. License and service gross margin increased
as a percentage of license and service revenue from 55% during the three months
ended September 30, 1999 to 69% during the three months ended September 30,
2000. The increase was primarily attributable to changes in the mix of software
licenses as compared to professional services. Software licenses have very low
cost of sales associated with them, where as professional services require a
significant amount of programmer time resulting in an increase in cost of
sales - license and service.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses decreased 5% from $2.4 million during the three months
ended September 30, 1999 to $2.2 million during the three months ended September
30, 2000. The decrease was primarily attributable to the reduction in selling,
general and administrative expenses associated with Pulsar. As a
10
<PAGE> 11
percentage of total revenues, selling, general and administrative expenses were
15% during both the three months ended September 30, 1999 and the three months
ended September 30, 2000.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased 31% from $1.1 million during the three months ended September 30, 1999
to $1.5 million during the three months ended September 30, 2000. The increase
was primarily attributable to increased staffing related to product development,
including development efforts related to the Forte microprocessor, Maestro,
ProFile Manager, NetSign and token reader/writers. As a percentage of total
revenues, research and development expenses increased from 7% during the three
months ended September 30, 1999 to 10% during the three months ended September
30, 2000. The percentage increase was primarily attributable to increased
research and development staffing.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES. Amortization of goodwill and
other intangibles increased less than 1% from $709,000 during the three months
ended September 30, 1999 to $711,000 during the three months ended September 30,
2000. Amortization of goodwill and other intangibles is related to the
acquisition of Pulsar in June 1999.
In June 1999, the Company acquired Pulsar Data Systems ("Pulsar"). All of
the outstanding shares of Pulsar were exchanged for 2,169,938 shares of the
Company's common stock. The acquisition was accounted for using the purchase
method of accounting. To date the integration of Pulsar has not been completed
as planned. Management is currently exploring various alternatives for the
Pulsar operations. During the quarter ended September 30, 2000, management began
analyzing the recoverability of the goodwill and other intangibles relating to
the acquisition of Pulsar. Management anticipates completing this analysis
during the fourth quarter of the fiscal year 2000. Such an analysis could result
in the conclusion that the cash flows of Pulsar will not fully support the
recoverability of the goodwill and other intangibles. If such a conclusion is
reached, management would consider various options regarding the Pulsar
operations, including a restructuring or sale of some or all of Pulsar's
operations. In addition, such a conclusion could possibly result in an
impairment charge relating to some or all of the carrying value of the goodwill
and other intangibles.
OTHER EXPENSE (INCOME), NET. Net other income changed $26,000 from $33,000
of income during the three months ended September 30, 1999 to $7 interest income
during the three months ended September 30, 2000. The change was primarily
attributable to an increase in interest expense of $32,000 and an increase in
interest and rental income of $4,000.
RESULTS OF OPERATIONS -- COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30,
1999 AND 2000
Our revenues and expenses for the nine months ended September 30, 2000
include the results of Pulsar's operations for nine months as a result of our
acquisition in June 1999, whereas the nine months ended September 30, 1999, only
include approximately three months of Pulsar's operations. Therefore, revenue
and expenses are not comparable from period to period.
TOTAL REVENUE. Total revenues increased 42% from $20.3 million during the
nine months ended September 30, 1999 to $28.9 million during the nine months
ended September 30, 2000. The increase was primarily attributable to an $8.5
million increase in total product related revenue.
During the nine months ended September 30, 1999, we derived 24% and 10% of
our revenue from sales to U.S. Immigration and Naturalization Service and the
U.S. Department of State. During the nine months ended September 30, 2000, we
derived 42% of our revenue from sales to the U.S. Immigration and Naturalization
Service. Sales to Federal government agencies accounted for approximately 75%
and 79% of our sales during the nine months ended September 30, 1999 and 2000,
respectively.
PRODUCT REVENUE. Product revenue increased 45% from $18.8 million during the
nine months ended September 30, 1999 to $27.3 million during the nine months
ended September 30, 2000. The increase was primarily attributable to an $8.5
million increase in network deployment product related revenue.
LICENSE AND SERVICE REVENUE. License and service revenue increased 121% from
$703,000 during the nine months ended September 30, 1999 to $1.6 million during
the nine months ended September 30, 2000. The increase was primarily
attributable to the completion of the Bank of America service and software
contract during the nine months ended September 30, 2000.
RESEARCH AND DEVELOPMENT REVENUE. Research and Development revenue
represents amounts earned under a contract with the NSA for the design of a
microprocessor meeting minimum specifications established by the NSA. We had
contracted with others to perform aspects of the project. All related project
costs were expensed as research and development was incurred. Regardless of the
results of the development efforts, the amounts received from the NSA are
nonrefundable. The related research and development costs were not separately
11
<PAGE> 12
identifiable. Therefore, the corresponding costs of the entire development
effort were included in research and development expenses. Research and
development revenue was $798,000 during the nine months ended September 30,
1999, whereas, no research and development revenue was earned during the nine
months ended September 30, 2000. The contract that resulted in research and
development revenue was completed in 1999 and no further research and
development revenue is currently anticipated under this contract.
PRODUCT GROSS MARGIN. Product gross margins increased as a percentage of
net product revenue from 17% during the nine months ended September 30, 1999 to
19% during the nine months ended September 30, 2000. Margins on network
deployment products decreased from 13% during the nine months ended September
30, 1999 to 10% during the nine months ended September 30, 2000. The decrease in
gross margins on network deployment products was primarily attributable to a
reduction in manufacturers rebate programs combined with lower margin pricing
extended to a major customer who represented 42% of network deployment revenue
for the nine months ended September 30, 2000. Margins on data security products
increased from 45% during the nine months ended September 30, 1999 to 60% during
the nine months ended September 30, 2000. The increase in gross margins on data
security products was primarily attributable to an increase in sales volume,
selling price and a cost reduction related to a particular product within the
data security product line.
LICENSE AND SERVICE GROSS MARGIN. License and service gross margin decreased
as a percentage of license and service revenue from 66% during the nine months
ended September 30, 1999 to 64% during the nine months ended September 30, 2000.
The decrease was primarily attributable to residual costs incurred, which were
associated with the close of the electric security systems line of business.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased 58% from $4.7 million during the nine months
ended September 30, 1999 to $7.4 million during the nine months ended September
30, 2000. The increase was primarily attributable to the additional selling,
general and administrative expenses associated with Pulsar. As a percentage of
total revenues, selling, general and administrative expenses increased from 23%
during the nine months ended September 30, 1999 to 26% during the nine months
ended September 30, 2000. The percentage increase was primarily attributable to
increased staffing and additional expenses associated with being a public
company as a result of the Company's IPO in June 1999.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased 47% from $2.9 million during the nine months ended September 30, 1999
to $4.2 million during the nine months ended September 30, 2000. The increase
was primarily attributable to increased staffing related to product development,
including development efforts related to the Forte microprocessor, Maestro,
ProFile Manager, NetSign and token reader/writers. As a percentage of total
revenues, research and development expenses increased during the nine months
ended September 30, 1999 by less than 1% as compared to the nine months ended
September 30, 2000. The percentage increase was primarily attributable to
increased staffing.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES. Amortization of goodwill and
other intangibles increased 156% from $827,000 during the nine months ended
September 30, 1999 to $2.1 million during the nine months ended September 30,
2000. Amortization of goodwill and other intangibles is related to the
acquisition of Pulsar in June 1999.
In June 1999, the Company acquired Pulsar Data Systems ("Pulsar"). All of
the outstanding shares of Pulsar were exchanged for 2,169,938 shares of the
Company's common stock. The acquisition was accounted for using the purchase
method of accounting. To date the integration of Pulsar has not been completed
as planned. Management is currently exploring various alternatives for the
Pulsar operations. During the quarter ended September 30, 2000, management began
analyzing the recoverability of the goodwill and other intangibles relating to
the acquisition of Pulsar. Management anticipates completing this analysis
during the fourth quarter of the fiscal year 2000. Such an analysis could result
in the conclusion that the cash flows of Pulsar will not fully support the
recoverability of the goodwill and other intangibles. If such a conclusion is
reached, management would consider various options regarding the Pulsar
operations, including a restructuring or sale of some or all of Pulsar's
operations. In addition, such a conclusion could possibly result in an
impairment charge relating to some or all of the carrying value of the goodwill
and other intangibles.
OTHER EXPENSE (INCOME), NET. Net other expense changed $234,000 from
$161,000 net expense during the nine months ended September 30, 1999 to $73,000
net income during the nine months ended September 30, 2000. The change was
primarily attributable to a $78,000 reduction in interest expense and a $156,000
increase in interest and rental income.
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. Subsequent to the initial public offering, we are taxed
as a C corporation. A tax benefit of $285,000 was recognized during the nine
months ended September 30, 1999 as compared to $6,000 of tax expense that was
recognized during the nine months ended September 30, 2000. The tax expense of
$6,000 was related to minimum state franchise taxes.
12
<PAGE> 13
LIQUIDITY AND CAPITAL RESOURCES
In June 1999, we completed our initial public offering of common stock. The
net proceeds of the offering were $35.3 million.
In June 1999, we also entered into a three-year agreement with Guaranty
Business Credit Corporation (formerly 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%; and a pledge of substantially all of our personal and real property
as collateral. Although the credit facility is for borrowings up to $20.0
million, under the terms of the agreement the amount of borrowing available to
the Company is subject to a maximum borrowing limitation based on eligible
collateral. Eligible collateral consists of 85% of eligible accounts receivable
plus the lesser of (a) 50% of the value of eligible on-hand inventory or (b)
$1.0 million. As a result, the amount actually available to the Company at any
particular time may be significantly less than the full $20.0 million credit
facility due to the maximum borrowing limitation calculation. Our borrowings
related to this agreement are included in the current portion of long-term debt
on the balance sheet.
Our debt facilities contain covenants and restrictions, including
maintenance of minimum tangible net worth and working capital, prohibition of
payment of dividends, and a requirement that net profit for each of the calendar
quarters for 1999 and 2000 shall not exceed a negative $1.5 million, and the net
profit for each calendar quarter thereafter shall equal or exceed $500,000. As
of September 30, 2000, the Company was not in compliance with certain covenants,
and has obtained a waiver of these covenants. We anticipate future covenant
violations for which it will be necessary for us to seek waivers from the
lender. There is no guarantee that such waivers, if needed, will be provided.
During the nine months ended September 30, 1999 cash used in operations was
$12.7 million as compared to $6.7 million used in operations during the nine
months ended September 30, 2000. The decrease in cash used in operations was
primarily attributable to:
- a net loss during the nine months ended September 30, 1999 of $3.9
million as compared to a net loss of $7.5 million during the nine months
ended September 30, 2000. The increase in the loss during the nine
months ended September 30, 2000 as compared to the nine months ended
September 30, 1999 was primarily attributable to: increased selling,
general and administrative expenses related to Pulsar, increased
depreciation and amortization expense related to the Pulsar acquisition,
and increased research and development expenses related to data security
product development. The decrease in cash used in operating activities
during the nine months ended September 30, 2000 as compared to the nine
months ended September 30, 1999 was primarily impacted by an increase in
accounts receivable, offset by an increase in accounts payable and an
increase in depreciation and amortization expense, as follows:
- an increase in accounts receivable during the nine months ended
September 30, 1999 of $5.2 million as compared to an increase in
accounts receivable of $3.8 million during the nine months ended
September 30, 2000. The increase in accounts receivable during the nine
months ended September 30, 2000 was primarily attributable to a
significant amount of sales recorded in the month of August 2000.
- a decrease in accounts payable during the nine months ended September
30, 1999 of $2.1 million as compared to an increase in accounts payable
of $3.3 million during the nine months ended September 30, 2000. The
increase in accounts payable during the nine months ended September 30,
2000, was primarily attributable to the Company's decision to manage
vendor payments in order to have a positive impact on cash flows.
- depreciation and amortization expense of $1.1 million during the nine
months ended September 30, 1999 as compared to depreciation and
amortization expense of $2.6 million during the nine months ended
September 30, 2000. The increase in depreciation and amortization
expense during the nine months ended September 30, 2000 as compared to
the nine months ended September 30, 1999 was attributable to increased
amortization of goodwill and other intangibles related to the
acquisition of Pulsar.
During the nine months ended September 30, 2000, cash used in investing
activities was $225,000 attributable to the purchase of equipment partially
offset by restricted cash related to the line of credit. During the nine months
ended September 30, 2000, cash provided by financing activities was $5.1 million
primarily attributable to borrowings of $10.7 million under our revolving line
of credit less principal repayments of $6.1 million and borrowings of $748,000
related to the financing of insurance premiums less principal repayments of
$294,000.
13
<PAGE> 14
We believe that existing cash and cash equivalents and the current
availability under our $20.0 million revolving line of credit will be sufficient
to satisfy our contemplated cash requirements for at least the next 12 months.
Our $20.0 million revolving line of credit facility contains various covenants
and restrictions including those noted above. As of September 30, 2000, the
Company was not in compliance with certain covenants, and has obtained a waiver
of these covenants. It will be necessary for us to seek waivers from the lender
for future covenant violations that occur. There is no guarantee that such
waivers, if needed, will be provided. If we do not maintain our $20 million
revolving line of credit or receive waivers for future covenant violations, we
will need to obtain additional capital to fund our operations by seeking other
sources of funding.
In addition to maintaining our $20 million revolving line of credit in
order to fund our operations 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
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.
New Accounting Standards
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. ("SFAS") 133, "Accounting for
Derivative Instruments and Hedging Activities". SFAS 133 establishes accounting
and reporting standards for derivative instruments, hedging activities, and
exposure definition. SFAS 133 requires an entity to recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. Derivatives that are not hedges must be
adjusted to fair value through earnings. If a derivative is a hedge, depending
on the nature of the hedge, changes in fair value will either be offset against
the change in fair value of the hedged assets, liabilities, or firm commitments
through earnings, or recognized in other comprehensive income until the hedged
item is recognized in earnings. In June 1999, the FASB issued SFAS 137,
"Accounting for Derivative Instruments and Hedging Activities -- Deferral of the
Effective Date of FASB Statement No. 133", which defers the effective date of
SFAS 133 to all fiscal quarters for fiscal years beginning after June 15, 2000.
In June 2000, the FASB issued SFAS 138 "Accounting for Certain Derivative
Instruments and Certain Hedging Activities, an amendment of FASB Statement No.
133" ("SFAS 138"). Although we continue to review the effect of the
implementation of SFAS 133 and SFAS 138, we do not currently believe their
adoption will have a material impact on our consolidated financial position or
overall trends in results of operations, and do not believe adoption will result
in significant changes to our financial risk management practices.
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin ("SAB") No. 101 "Revenue Recognition in Financial
Statements". The objective of this SAB is to provide further guidance on revenue
recognition issues in the absence of authoritative literature addressing a
specific arrangement or a specific industry. We are required to follow the
guidance in the SAB, as amended, no later than the fourth quarter of fiscal year
2000, including the retroactive restatement of any affected quarters in 2000.
The SEC has recently issued further guidance with respect to adoption of
specific issues addressed by SAB 101. The Company is currently assessing the
impact, if any, SAB 101 may have on our consolidated financial position or
results of operations.
In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation - an interpretation of APB
Opinion No. 25" ("FIN 44"). This Interpretation clarifies the definition of
employee for purposes of applying Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25"), the criteria for
determining whether a plan qualifies as a noncompensatory plan, the accounting
consequence of various modifications to the terms of a previously fixed stock
option or award, and the accounting for an exchange of stock compensation
awards in a business combination. This Interpretation is effective July 1, 2000,
but certain conclusions in this Interpretation cover specific events that occur
after either December 15, 1998, or January 12, 2000. The Company believes that
the impact of FIN 44 will not have a material effect on its financial position
or results of operations.
14
<PAGE> 15
BUSINESS ENVIRONMENT AND RISK FACTORS
Fluctuations in Quarterly Operating Results
Our quarterly operating results may fluctuate significantly as a 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; and
- the need to use outside contractors to complete some assignments.
AN INCREASE IN OUR FUTURE CAPITAL REQUIREMENTS COULD ADVERSELY AFFECT OUR
ABILITY TO FUND OUR OPERATIONS.
Although we believe that we have sufficient capital to fund our operations
for at least the next 12 months, our future capital requirements may vary
materially from those now planned. If our future capital requirements increase
significantly, we may have insufficient capital to fund our operations. 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
WE HAVE A HISTORY OF LOSSES AND MAY INCUR FUTURE LOSSES.
We may not become profitable or significantly increase our revenue. We
incurred net losses of $7.1 million for the year ended December 31, 1999 and
$7.5 million for the nine months ended September 30, 2000.
OUR INABILITY TO INTEGRATE, OR IMPLEMENT OUR PLANS FOR, THE OPERATIONS OF PULSAR
MAY ADVERSELY AFFECT OUR BUSINESS.
Our failure to successfully integrate, implement our plans, or identify a
viable alternative for the operations of Pulsar, would significantly diminish
the value of the Pulsar acquisition. Moreover, integration of, or exploring
various alternatives for the Pulsar acquisition may place strain on our
managerial and financial resources, which could, in turn, adversely affect our
business. We may not be able to successfully implement any of our plans. If we
are not able to implement our plans we will consider various options regarding
the Pulsar operations, including a restructuring or sale of some or all of
Pulsar's operations.
15
<PAGE> 16
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.
Approximately $32.9 million, or 63%, of our consolidated assets as of
September 30, 2000, consisted of intangible assets, including goodwill, arising
from the acquisition of Pulsar. This amount, the components of which will be
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.
We are analyzing and will continue to periodically analyze the
recoverability of the goodwill and other intangibles relating to the acquisition
of Pulsar based on the cash flows being generated by Pulsar. Such an analysis
could result in the conclusion that the cash flows of Pulsar will not fully
support the recoverability of the goodwill and other intangibles. If such a
conclusion is reached, we will consider various options regarding the Pulsar
operations, including a restructuring or sale of some or all of Pulsar's
operations. In addition, such a conclusion could possibly result in an
impairment charge relating to some or all of the carrying value of the goodwill
and other intangibles related to the Pulsar acquisition.
A DEFAULT UNDER OUR SECURED CREDIT ARRANGEMENTS COULD RESULT IN A FORECLOSURE OF
OUR ASSETS BY OUR CREDITORS.
All of our assets are pledged as collateral to secure portions of our debt.
This means that if we default on our secured debt obligations our indebtedness
could become immediately due and payable and the lenders could foreclose on our
assets. From time to time we have been in violation of financial covenants under
our existing credit arrangements and have had to negotiate with our lenders for
waivers or forbearance agreements for these violations. We anticipate future
covenant violations for which it will be necessary for us to seek waivers from
the lender. There is no guarantee that such waivers, if needed, will be
provided.
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:
- 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 nonrenewal 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. During the nine months ended September 30, 2000,
we derived 42% of our consolidated revenue from one customer.
DOING BUSINESS WITH THE U.S. GOVERNMENT ENTAILS MANY RISKS, WHICH COULD
ADVERSELY AFFECT US.
Sales to U.S. government agencies accounted for 80% of our consolidated
revenue during the nine months ended September 30, 2000. 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.
16
<PAGE> 17
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 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
standards 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.
17
<PAGE> 18
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. Our business may be adversely affected if the
services of any of our key personnel become unavailable to us. 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 life of
our current chief executive officer in the amount of $3.0 million, this amount
may not be sufficient to offset the loss of his services.
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 the ones 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.
18
<PAGE> 19
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 start-up companies that 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 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 PKI card 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 PKI card. 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 PKI card until we
could design a replacement computer chip for the Forte microprocessor. We
anticipate this would take substantial time and resources to complete.
19
<PAGE> 20
SMALL NUMBER OF STOCKHOLDERS, INCLUDING OUR OFFICERS AND DIRECTORS, WILL HAVE
THE ABILITY TO CONTROL STOCKHOLDER VOTES.
Kris Shah, members of his family, and Lillian A. Davis presently
beneficially own, in the aggregate, approximately one half of our outstanding
common stock. These stockholders, if acting together, would 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.
THERE ARE LAWSUITS PENDING AGAINST US, WHICH COULD ADVERSELY AFFECT OUR BUSINESS
IF THEY ARE RESOLVED AGAINST PULSAR.
Lawsuits are pending against Pulsar which, if resolved against Pulsar, could
materially and adversely affect our business and financial condition. See "Part
II, Item 1, Legal Proceedings."
OUR STOCK PRICE IS EXTREMELY VOLATILE.
The trading price of our common stock is 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;
- company issued earnings announcements that vary from consensus analyst
estimates;
- 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.
The possibility that a substantial number of additional shares of common
stock may become tradable in the public market in the future may adversely
affect prevailing market prices for our common stock and could impair our
ability to raise capital through the sale of equity securities. The shares that
are restricted from trading, pursuant to agreement with the underwriter in our
initial public offering, became available for sale in June 2000 and over
succeeding 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 in our initial public offering have also
been granted registration rights commencing in June 2000 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.
20
<PAGE> 21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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 September 30, 2000.
At September 30, 2000, our investment portfolio consisted of cash
equivalents. Currently the carrying value of these investments approximates
market value. However, the fair market value of these investments is subject to
interest rate risk. If market interest rates were to change 10% from levels
existing at September 30, 2000, the change in the fair market value of our
investment portfolio would not be material to the Company's consolidated
financial position, results of operations or liquidity.
INTEREST RATE AND FOREIGN CURRENCY SENSITIVITY
The Company entered into a three-year agreement with Guaranty Business
Credit Corporation (formerly Fidelity Funding) permitting borrowings under a $20
million secured revolving credit facility at an annual interest rate of prime
plus .625%. The Company has $4.9 million outstanding indebtedness at September
30, 2000 under the Fidelity Funding Agreement. A 10% change in the underlying
prime rate would result in an approximately $49,000 change in the annual amount
of interest paid on such debt.
The Company has no operations that transact in foreign currencies and
therefore is not exposed to financial market risk resulting from fluctuations in
foreign currency exchange rates.
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
that we believe will have a material impact on our results of operations,
financial condition or liquidity, other than the following:
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. In July 2000, the Company paid A&T Marketing, Inc. $162,500 and settled
any and all claims.
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
Effective September 18, 2000, William W. Davis, Sr., resigned his positions
as an officer and director of the Company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 -- Financial Data Schedule.
(b) Reports on Form 8-K
No such reports were filed during the three months ended September 30.
21
<PAGE> 22
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: November 14, 2000 LITRONIC INC.
By /s/ KRIS SHAH
-------------------------------------
Kris Shah
Director, Chairman of the Board
and Chief Executive Officer
By /s/ ROY E. LUNA
-------------------------------------
Roy E. Luna
Chief Financial Officer and
Principal Accounting Officer
22
<PAGE> 23
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
27.1 Financial Data Schedule
