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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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 MARCH 31, 2001,
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NO. 000-26227
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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)
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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 May 10, 2001, the registrant had 9,747,526 shares of common stock
outstanding.
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LITRONIC INC.
INDEX
PAGE
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements............................................. 3
Condensed Consolidated Balance Sheets--December 31, 2000 and
March 31, 2001................................................... 3
Condensed Consolidated Statements of Operations--Three months
ended March 31, 2000 and 2001.................................... 4
Condensed Consolidated Statements of Cash Flows--Three months
ended March 31, 2000 and 2001.................................... 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....... 20
PART II. OTHER INFORMATION
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
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LITRONIC INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
ASSETS
DECEMBER 31, MARCH 31,
2000 2001
----------- ---------
Current assets:
Cash and cash equivalents ................................. $ 4,120 $ 3,885
Accounts receivable (net of allowance for doubtful accounts
of $268 and $235 as of December 31, 2000 and March 31,
2001, respectively) ..................................... 4,137 1,719
Inventories ............................................... 695 728
Prepaid expenses .......................................... 542 516
Other current assets ...................................... 325 385
-------- --------
Total current assets .................................... 9,819 7,233
Property and equipment, net ................................. 823 666
Other assets ................................................ 343 204
Goodwill and other intangibles, net ......................... 783 760
-------- --------
$ 11,768 $ 8,863
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current installments of long-term debt .................... $ 1,986 $ 1,149
Accounts payable .......................................... 1,392 1,865
Accrued liabilities ....................................... 1,366 1,269
Deferred revenue .......................................... 217 217
-------- --------
Total current liabilities ............................... 4,961 4,500
-------- --------
Long-term debt, less current installments ................. 19 --
Deferred revenue .......................................... 240 188
-------- --------
Total liabilities ....................................... 5,220 4,688
Shareholders' 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 9,743,573 and
9,747,526 shares at December 31, 2000 and March 31,
2001, respectively ...................................... 97 97
Additional paid-in capital ................................ 52,834 52,837
Accumulated deficit ....................................... (46,383) (48,759)
-------- --------
Total shareholders' equity .............................. 6,548 4,175
-------- --------
$ 11,768 $ 8,863
======== ========
See accompanying notes to condensed consolidated financial statements.
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LITRONIC INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
----------------------
MARCH 31, MARCH 31,
2000 2001
--------- ---------
Revenues:
Product ...................................... $ 4,351 $ 4,144
License and service .......................... 371 334
------- -------
Total revenues ............................. 4,722 4,478
------- -------
Costs and expenses:
Cost of sales--product ....................... 3,619 3,066
Cost of sales--license and service ........... 168 133
Selling, general and administrative .......... 2,380 1,773
Research and development ..................... 1,322 1,843
Amortization of goodwill and other intangibles 703 23
------- -------
Operating loss ................................. (3,470) (2,360)
Interest expense (income), net ................. (14) 16
------- -------
Loss before income taxes ....................... (3,456) (2,376)
Provision for income taxes ..................... 5 --
------- -------
Net loss ....................................... $(3,461) $(2,376)
======= =======
Net loss per share--basic and diluted .......... $ (0.35) $ (0.24)
======= =======
Shares used in per share computations--basic
and diluted .................................. 9,872 9,747
======= =======
See accompanying notes to condensed consolidated financial statements.
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LITRONIC INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
---------------------
MARCH 31, MARCH 31,
2000 2001
------- ---------
Cash flows from operating activities:
Net loss ....................................... $(3,461) $(2,376)
Adjustments to reconcile net loss to net cash
used in operating activities:
Provision for losses on receivables ........... 69 61
Depreciation and amortization ................. 832 218
Changes in assets and liabilities:
Accounts receivable ........................... 3,131 2,357
Inventories ................................... (230) (33)
Prepaid expense................................ 161 26
Other current assets .......................... (9) (60)
Other assets .................................. -- 139
Accounts payable .............................. 559 473
Accrued liabilities ........................... (51) (97)
Deferred revenue .............................. (3) (52)
------- -------
Net cash provided by operating activities ... 998 656
------- -------
Cash flows used in investing activities:
Purchases of property and equipment ............ (139) (38)
------- -------
Cash flows from financing activities:
Stock options exercised ........................ 11 3
Borrowings on revolving note payable ........... -- 5,395
Repayment of insurance financing ............... (163) (130)
Principal payments on revolving line of credit . (318) (6,121)
------- -------
Net cash used in financing activities ........ (470) (853)
------- -------
Net increase (decrease) in cash ................ 389 (235)
Cash and cash equivalents at beginning of period . 6,441 4,120
------- -------
Cash and cash equivalents at end of period ....... $ 6,830 $ 3,885
======= =======
Supplemental disclosures of cash flow Information:
Cash paid during the period for:
Interest ..................................... $ 64 $ 17
Income taxes ................................. 5 --
======= =======
See accompanying notes to condensed consolidated financial statements.
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LITRONIC INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2000 AND 2001
(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
March 31, 2001; the results of operations for the three months ended March 31,
2000 and 2001; and the statements of cash flows for the three months ended March
31, 2000 and 2001. Interim results for the three months ended March 31, 2001 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2001. The interim financial statements should be read in
conjunction with the Company's consolidated financial statements for the year
ended December 31, 2000, included in the Company's Form 10-K/A, filed in April
2001.
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 $23 for the three months
ended March 31, 2001.
The Company applies Statement of Financial Accounting Standards No.
("Statement") 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of." Statement 121 requires that long-lived
assets and certain identifiable intangibles be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Under the provisions of Statement 121, if the sum of the
expected future cash flows (undiscounted and without interest charges) is less
than the carrying value of the asset, an impairment loss is recognized. The
amount of impairment, if any, is measured as the amount by which the carrying
amount of the asset exceeds the fair value of the asset. The estimate of fair
value considers prices for similar assets and the results of valuation
techniques to the extent available in the circumstances. The Company engaged the
services of an independent valuation firm to do a valuation of Pulsar. This
valuation was undertaken because the Company determined the integration of
Pulsar would not be completed as planned, and the anticipated operating
synergies would not be realized. Based on the results of the independent
valuation, the Company recorded an impairment charge of $31.4 million in the
fourth quarter of 2000, related to unamortized goodwill and other intangible
assets acquired in the purchase of Pulsar. The remaining unamortized intangible
assets acquired in the purchase of Pulsar will be amortized over the remainder
of the original 10 year useful life.
(2) INVENTORIES
A summary of inventories follows:
DECEMBER 31, MARCH 31,
2000 2001
------------ ---------
Raw materials................. $258 $461
Work-in-process............... 86 39
Finished goods................ 351 228
---- ----
$695 $728
==== ====
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(3) LONG TERM DEBT
A summary of long-term debt follows:
DECEMBER 31, MARCH 31,
2000 2001
------------ ---------
Revolving note payable to bank with maximum availability
of $5 million, bearing interest at prime plus .625%
(10.125% at December 31, 2000 and 8.625% at March 31,
2001) interest payable monthly through maturity on
May 10, 2002; secured by substantially all assets of
the Company .............................................. 1,509 782
Note payable for insurance financing due in nine monthly
payments beginning July 9, 1999 at an annual percentage
rate of 5.93% ............................................ -- --
Note payable for insurance financing due in nine monthly
payments beginning July 9, 2000 at an annual percentage
rate of 7.15% ............................................ 12 --
Note payable for insurance financing due in eighteen monthly
payments beginning July 9, 2000 at an annual percentage
rate of 8.18% ............................................ 484 367
------ ------
2,005 1,149
Less current installments .................................. 1,986 1,149
------ ------
$ 19 $ --
====== ======
In June 1999 the Company entered into a three-year lending agreement with
Guaranty Business Credit Corporation ("GBCC") permitting borrowings under a
$20.0 million secured revolving line of credit facility that commenced on June
14, 1999. The agreement provided 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 was for borrowings up to $20.0 million,
under the terms of the agreement the amount of borrowing available to the
Company was subject to a maximum borrowing limitation based on eligible
collateral. Eligible collateral consisted 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 that was actually available to the Company
at any particular time may have been significantly less than the full $20.0
million credit facility due to the maximum borrowing limitation calculation. The
agreement with GBCC included a number of covenants and restrictions that the
Company was required to adhere to. These covenants and restrictions included
maintenance of minimum levels of working capital, tangible net worth, and
profitability. In addition, the agreement did not allow the Company to pay
dividends. At March 31, 2001 the maximum borrowings available to the Company
based on the maximum borrowing limitation calculation was $1.1 million.
Borrowings related to this agreement are included in current installments of
long-term debt in the condensed consolidated financial statements.
On April 18, 2001 the Company and GBCC amended the revolving line of credit
facility. Under the terms of the amended agreement the maximum borrowings are
$5.0 million, eligible collateral excludes inventory, and the advance rate is
35%. In addition, certain of the financial covenants and requirements were
adjusted. Changes in the amended agreement related to the definition of maximum
borrowing, eligible collateral and the advance rate were effective on April 18,
2001, changes related to financial covenants and requirements were effective as
of March 31, 2001. The Company was in compliance with the adjusted covenants at
March 31, 2001. If the changes related to the definition of eligible collateral
and the advance rate had been effective at March 31, 2001, the maximum
borrowings available to the Company would have been $576,000, which is $206,000
less than actual borrowing at March 31, 2001.
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(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 March 31, 2000 and 2001,
accounts receivable included $3,515 and $978, respectively, due from the U.S.
Government and related agencies. Sales to federal government agencies
represented 78% and 55% of the Company's total revenues for the three months
ended March 31, 2000 and 2001, respectively.
The Company had sales to three customers, each of which is an agency of the
U.S. Government, that represented 23%, 16% and 14%, respectively, of total
revenues for the three months ended March 31, 2000. The Company had sales to one
customer that represented 11% of total revenues for the three months ended March
31, 2001. No other customers accounted for more than 10% of total revenues
during the three months ended March 31, 2000 and 2001. Trade accounts receivable
totaled $2,689 and $348 from these major customers as of March 31, 2000 and
2001, respectively.
At March 31, 2001, the Company's investment portfolio consisted of $3.6
million in cash equivalents. The Company does not believe that it has a
concentration of investment risk. All amounts are invested in a money market
account with a major financial services firm.
(5) 1999 STOCK OPTION PLAN
During the quarter ended March 31, 2001, the Company granted options to
purchase 51,000, 13,000 and 3,000 shares at exercise prices of $2.50, $3.56 and
$4.81 per share, the then current fair market value, respectively, under the
Company's 1999 Stock Option Plan (the "1999 Plan"), that was established in
April 1999. During the quarter ended March 31, 2000, the Company granted options
to purchase 20,000 shares at an exercise price of $8.72 per share, the then
current fair market value, under the 1999 Plan. During the first quarter of
2000, an amendment was approved by the board of directors increasing the number
of shares of Common Stock subject to the 1999 Plan from 600,000 to 1,500,000.
The amendment was submitted to the stockholders and approved in June 2000.
(6) LOSS PER SHARE
The computation of diluted net loss per share for the three months ended
March 31, 2000 and 2001 excluded the dilutive effect of 678,021 and 908,742,
respectively, of incremental common shares attributable to the exercise of
outstanding common stock options and warrants as a result of the antidilutive
effect.
(7) 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 had cost reimbursable type contracts with the Federal
Government. Consequently, the Company is reimbursed based upon the direct
expenses attributable to the contract, plus a percentage based upon overhead,
material handling, and general administrative expenses. The overhead, material
handling, and general 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 contract audits.
We are involved from time to time in various litigations that arise 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.
On January 16, 1998, G2 Resources Inc. (G2) filed a complaint against
Pulsar in the Circuit Court, Fifteenth Judicial Circuit, Palm Beach County,
Florida. G2 claimed 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
provided 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
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claim amounted to approximately $10.3 million. Pulsar 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 claimed 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 asserted defenses to Classical's claim. On April
20, 2001, a court hearing was held and G2's complaint against Pulsar was
dismissed without prejudice on the basis of no prosecution activity for more
than 12 months. Since the complaint was dismissed without prejudice, either G2
or Classical could file a new complaint. The Company believes that the previous
claims made by G2 and Classical against Pulsar were without merit and that any
similar claims that G2 or Classical might bring against Pulsar in the future
would also be without merit. If G2 or Classical were to make similar claims in
the future the Company intends to vigorously defend against any such claims.
(8) BUSINESS SEGMENTS AND PRODUCT LINES
In 1998 and prior to the acquisition of Pulsar in June 1999, the Company
operated in one business segment. Subsequent to the acquisition of Pulsar, 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 segments as of and for the quarters ended March 31,
2000 and 2001.
THREE MONTHS ENDED
----------------------
MARCH 31, MARCH 31,
2000 2001
--------- ---------
Revenue
Information Security Products and Services.............. $1,420 $1,950
Network Solutions Market................................ 3,302 2,528
====== ======
Cost of sales
Information Security Products and Services............. 533 922
Network Solutions Market............................... 3,254 2,277
====== ======
MARCH 31, MARCH 31,
2000 2001
--------- ---------
Identifiable assets
Information Security Products and Services............ $ 963 $1,439
Network Solutions Market.............................. 37,626 1,706
======= ======
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.
During the quarters ended March 31, 2000 and 2001, the Company had four
distinct product lines: network deployment products, data security products,
license and service, and electric security systems. Following is a summary of
total revenues by product line.
THREE MONTHS ENDED
---------------------
MARCH 31, MARCH 31,
2000 2001
--------- ---------
Network deployment products.............................. $3,240 $2,528
Data security products................................... 1,111 1,616
License and service...................................... 309 334
Electric security systems................................ 62 --
------ ------
Total net product, license and service revenues..... $4,722 $4,478
====== ======
In July 2000 the Company discontinued the electric security systems product
line. The Company has not and does not anticipate incurring any significant
expense as the result of this decision.
(9) BIZ INTERACTIVE ZONE MERGER
On February 9, 2001, the Company signed a term sheet to merge with
privately held BIZ Interactive Zone, Inc. ("BIZ"), a provider of Internet
security solutions for finance, health care, business, e-commerce and
entertainment. Consummation of the transaction is subject to the execution of a
definitive agreement, approval by Litronic's and BIZ's stockholders and other
normal closing conditions. The proposed merger will be accounted for under the
purchase method of accounting. The Company anticipates that the merger will be
completed in the third quarter of 2001.
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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, 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 "Business Environment and Risk Factors" set forth in this
Form 10-Q and similar sections in our other Securities and Exchange Commission
("SEC") filings 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 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.
GENERAL
We provide professional Internet data security services and develop and
market software and microprocessor-based products needed to secure electronic
commerce and communications over the Internet and other communications networks
based on Internet protocols. Our primary technology offerings use public key
infrastructure ("PKI"), which is the standard technology for securing
Internet-based commerce and communications. In addition, Pulsar, a wholly owned
subsidiary, is an established computer and networking product reseller that
focuses on resales to government agencies, large corporate accounts and state
and local governments. We acquired Pulsar in June 1999 in exchange for 2,169,938
shares of our common stock.
In February 2001, we signed a Term Sheet with BIZ Interactive Zone, Inc.,
or BIZ, relating to our proposed merger whereby Litronic Merger Corp., a
Delaware corporation and a wholly owned subsidiary of the Company, will merge
with and into BIZ. BIZ will become a wholly owned subsidiary of Litronic. On
February 12, 2001, we issued a press release regarding our proposed merger with
BIZ. We expect the merger to be completed in the third quarter of 2001.
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.
PERCENTAGE OF
TOTAL REVENUES
THREE MONTHS ENDED
---------------------
MARCH 31, MARCH 31,
2000 2001
--------- ---------
Revenues:
Product ........................... 92.1% 92.5%
License and service ............... 7.9 7.5
----- -----
Total revenues .................... 100.0 100.0
----- -----
Costs and expenses:
Cost of sales--product ............ 76.6 68.5
Cost of sales--license and service 3.6 3.0
Selling, general and administrative 50.4 39.6
Research and development .......... 28.0 41.1
Amortization of goodwill and other
intangibles ...................... 14.9 0.5
----- -----
Operating loss ...................... (73.5) (52.7)
Interest expense (income), net ...... (0.3) 0.3
----- -----
Loss before income taxes ............ (73.2) (53.0)
Provision for income taxes .......... 0.1 0.0
----- -----
Net loss ............................ (73.3)% (53.0)%
===== =====
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RESULTS OF OPERATIONS -- COMPARISON OF THE THREE MONTHS ENDED MARCH 31,
2000 AND 2001
TOTAL REVENUES. Total revenues decreased 5.2% from $4.7 million during the
three months ended March 31, 2000 to $4.5 million during the three months ended
March 31, 2001. The decrease was primarily attributable to a $774,000 decrease
in revenues related to the network solutions market that was partially offset by
a $530,000 increase in revenues related to information security products and
services.
During the three months ended March 31, 2000, we derived 23%, 16%, and 14%
of our revenue from sales to the U.S. Immigration, NSA and the National
Institute of Health, respectively. During the three months ended March 31, 2001,
we derived 11% of our sales from Gradkell Computers, Inc. Sales to Federal
government agencies accounted for approximately 78% and 55% of our sales during
the three months ended March 31, 2000 and 2001, respectively.
PRODUCT REVENUE. Product revenue decreased 5% from $4.4 million during the
three months ended March 31, 2000 to $4.1 million during the three months ended
March 31, 2001. The decrease was primarily attributable to a $712,000 decrease
in revenues related to network deployment products that was partially offset by
a $505,000 increase in revenues related to data security products.
LICENSE AND SERVICE REVENUE. License and service revenue decreased 10% from
$371,000 during the three months ended March 31, 2000 to $334,000 during the
three months ended March 31, 2001. The decrease was primarily attributable to a
$62,000 decrease in revenues related to electric security systems that was
partially offset by an increase of $25,000 in licenses and services related to
information security products and services. In July 2000 the Company
discontinued the electric security systems product line.
PRODUCT GROSS MARGIN. Product gross margins increased as a percentage of
net product revenue from 17% during the three months ended March 31, 2000 to 26%
during the three months ended March 31, 2001. The increase was primarily
attributable to an increase in the percentage of revenue related to data
security products as compared to the revenue related to network deployment
products. During the three months ended March 31, 2001, network deployment
products, sold by Pulsar, represented 61% of total product revenue as compared
to data security products that represented 39% of product revenue. During the
three months ended March 31, 2000, network deployment products, sold by Pulsar,
represented 74% of total product revenue as compared to data security products
that represented 26% of product revenue. Margins from the sale of network
deployment products are significantly lower than margins from the sale of data
security products.
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 March 31, 2000 to 60% during the three months ended March 31,
2001. This increase was primarily attributable to the discontinued electric
security systems product line. Gross margins related to the electric security
systems product line were significantly less than those related to the other
types of licenses and services that we provide.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative ("S,G&A") expenses decreased 26% from $2.4 million during the
three months ended March 31, 2000 to $1.8 million during the three months ended
March 31, 2001. The decrease was primarily attributable to reduced S,G&A related
payroll expenses at Pulsar. The average S,G&A headcount at Pulsar decreased by
23 or 49% during the three months ended March 31, 2001 as compared to the three
months ended March 31, 2000. As a percentage of revenue, S,G&A expenses
decreased from 50% during the three months ended March 31, 2000 to 40% during
the three months ended March 31, 2001. The percentage decrease was also
primarily attributable to reduced S,G&A related payroll expenses at Pulsar. In
an effort to reduce future expenses we have implemented a cost reduction program
that is discussed in the Liquidity and Capital Resources section below.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased 39% from $1.3 million during the three months ended March 31, 2000 to
$1.8 million during the three months ended March 31, 2001. The increase was
primarily attributable to increased staffing related to product development
including development efforts related to the Forte smart card, Maestro, ProFile
Manager, NetSign and our new CypherServer 440. As a percentage of revenue,
research and development expenses increased from 28% during the three months
ended March 31, 2000 to 41% during the three months ended March 31, 2001. The
percentage increase was primarily attributable to the actual increase in
research and development expenses combined with a decrease in total revenues. In
an effort to reduce future expenses we have implemented a cost reduction program
that is discussed in the Liquidity and Capital Resources section below.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES. In June 1999, we acquired
Pulsar. All of the outstanding shares of Pulsar were exchanged for 2,169,938
shares of our common stock. The acquisition was accounted for using the purchase
method of accounting. In the fourth quarter of 2000 we determined the
integration of Pulsar would not be completed as planned and the anticipated
operating synergies would not be realized, therefore, we are currently exploring
various alternatives for the Pulsar operations. As a result, in accordance with
Statement 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of", we analyzed the recoverability of the
goodwill and other intangibles relating to the acquisition of Pulsar. In order
to evaluate the recoverability of the remaining goodwill and other intangible
assets, we engaged the services of an
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independent valuation firm to perform a valuation. During the fourth quarter of
2000, based on the results of the independent valuation, we recorded an
impairment charge of $31.4 million related to unamortized intangible assets
acquired in the purchase of Pulsar. Based on the independent valuation,
management believes that after the impairment charge of $31.4 million, no
further impairment exists. The remaining unamortized intangible assets acquired
in the purchase of Pulsar will be amortized over the remainder of their 10-year
life.
The amortization of goodwill and other intangibles decreased 97% from
$703,000 during the three months ended March 31, 2000 to $23,000 during the
three months ended March 31, 2001. The decrease is primarily attributable to the
reduction of goodwill that occurred as the result of the impairment charge the
we recorded in the fourth quarter of 2000.
INTEREST EXPENSE (INCOME), NET. Net interest income changed $30,000 from
$14,000 net interest income during the three months ended March 31, 2000 to
$16,000 net interest expense during the three months ended March 31, 2001. The
change was primarily attributable to a reduction in interest income of $22,000
and an increase in interest expense of $8,000. The reduction in interest income
was primarily the result of lower cash balances and the increase in interest
expense was the result of increased borrowings.
INCOME TAXES. Tax expense of $5,000 was recognized during the three months
ended March 31, 2000 and was related to minimum franchise tax payments paid to
the state of California. We did not recognize any tax benefit from operating
losses in the three months ended March 31, 2000. No income tax expense or
benefit was recognized during the three months ended March 31, 2001 as the
realizability of the tax benefit is not more likely than not.
LIQUIDITY AND CAPITAL RESOURCES
In June 1999 we entered into a three-year lending agreement with Guaranty
Business Credit Corporation ("GBCC") permitting borrowings under a $20.0 million
secured revolving line of credit facility that commenced on June 14, 1999. The
agreement provided 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 was for borrowings up to $20.0 million, under the terms of
the agreement the amount of borrowing available to us was subject to a maximum
borrowing limitation based on eligible collateral. Eligible collateral consisted
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 that
was actually available to us at any particular time may have been significantly
less than the full $20.0 million credit facility due to the maximum borrowing
limitation calculation. The agreement with our lender included a number of
covenants and restrictions that we were required to adhere to. These covenants
and restrictions included maintenance of minimum levels of working capital,
tangible net worth, and profitability. In addition, the agreement did not allow
us to pay dividends. At March 31, 2001 the maximum borrowings available to us
based on the maximum borrowing limitation calculation was $1.1 million. Our
borrowings related to this agreement are included in current installments of
long-term debt in the condensed consolidated financial statements.
On April 18, 2001 we and our lender amended the revolving line of credit
facility. Under the terms of the amended agreement the maximum borrowings are
$5.0 million, eligible collateral excludes inventory, and the advance rate is
35%. In addition, certain of the financial covenants and requirements were
adjusted. Changes in the amended agreement related to the definition of maximum
borrowing, eligible collateral and the advance rate were effective on April 18,
2001, changes related to financial covenants and requirements were effective as
of March 31, 2001. We were in compliance with the adjusted covenants at March
31, 2001. If the changes related to the definition of eligible collateral and
the advance rate had been effective at March 31, 2001, the maximum borrowings
available to us would have been $576,000, which is $206,000 less than actual
borrowing at March 31, 2001.
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Cash provided by operations decreased $342,000 during the three months
ended March 31, 2001 as compared to the three months ended March 31, 2000. The
decrease in cash provided by operations was primarily attributable to a decrease
in the reduction of accounts receivable during the three months ended March 31,
2001 of $774,000 as compared to the three months ended March 31, 2000. During
the three months ended March 31, 2000, improved collection efforts enabled us to
collect a large amount of aged account balances, which provided a positive
impact on cash collections during the quarter, and more timely collection of
current accounts. During the three months ended March 31, 2001, with improved
collection efforts in place throughout the year, we did not have a backlog of
aged account balances similar to the prior year.
Cash used in investing activities decreased $101,000 during the three
months ended March 31, 2001 as compared to the three months ended March 31,
2000. The decrease was attributable to a decrease in the amount of property and
equipment purchased .
Cash used in financing activities increased $383,000 during the three
months ended March 31, 2001 as compared to the three months ended March 31,
2000. The increase was primarily attributable to a net increase in debt
repayments.
We believe that existing cash and cash equivalents and the current
availability under our amended $5.0 million revolving line of credit will be
sufficient to satisfy our contemplated cash requirements for the next twelve
months. Our amended $5.0 million revolving line of credit facility contains
various covenants and restrictions including those noted above. If we do not
maintain our amended $5.0 million revolving line of credit, or receive waivers
for future covenant violations, we may seek additional capital from one or more
of the following sources:
o Company merger -- In February 2001, we signed a Term Sheet with BIZ
Interactive Zone, Inc. ("BIZ") relating to our proposed merger. We will
be the surviving entity after the proposed merger is complete and will
be renamed SSP Solutions, Inc. We anticipate that the combined entity
will be in a more favorable position to access capital markets. If the
merger is not completed in a timely manner or not at all, we may seek
additional capital on terms less favorable than if the merger were
completed in a timely manner.
o Additional equity capital -- We may seek additional equity capital.
Equity capital, if available, may be issued at a discount to market
resulting in dilution to current stockholders. In addition, providers of
new equity capital may require additional concessions in order for them
to provide needed capital to the Company.
o Additional commitment -- Our chief executive officer and majority
shareholder has committed, if necessary, to providing the personal
financial resources required to enable us to meet all of our financial
obligations as they become due through January 1, 2002.
On May 9, 2001, we announced the implementation of a cost reduction program
with the objective of lowering annualized expenses by $2.5 - $3.0 million. The
cost reduction program was implemented in response to the general economic
slowdown so that our cost structure would be better aligned with overall market
conditions. The cost reductions include an approximate 20% decrease in workforce
and the reduction of discretionary spending where appropriate. The cost
reductions were not limited to one particular area but were spread throughout
our company. The cost reductions related to workforce will have an immediate
impact while the reductions in discretionary spending will be realized at the
time such expenses are not incurred.
We plan to begin shipping our new CypherServers in mid-2001. Our operating
forecast assumes the CypherServer product launch goes as planned and anticipated
sales of the CypherServers are realized. If the product launch is delayed or if
the anticipated CypherServer sales are not realized, it may be necessary for us
to make additional expense reductions beyond those already made.
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:
o the market acceptance of our products and services
o 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
o research and development plans
o levels of inventory and accounts receivable
o technological advances
o competitors' responses to our products and services
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o relationships with partners, suppliers and customers
o our projected capital expenditures
o the proposed merger with BIZ and successful integration
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.
BUSINESS ENVIRONMENT AND RISK FACTORS
THE ANTICIPATED BENEFITS OF OUR PROPOSED MERGER WITH BIZ MAY NOT BE REALIZED
In February 2001, we signed a term sheet with BIZ relating to our proposed
merger. Even though we expect that our merger with BIZ will result in mutual
benefits, those benefits may not be realized due to a number of factors:
o If the merger is not completed in a timely manner or not at all, we may
seek additional capital on terms less favorable than if the merger were
completed in a timely manner.
o The anticipated management and operational synergies of the proposed
merger may not be realized.
o The anticipated increase in sales resulting from the combined efforts
and combined distribution channels may not be realized.
o Potential adverse short-term effects on operating results, primarily as
a result of increased costs resulting from the integration of the
operation of the two companies may adversely affect our earnings.
o Difficulties in creating and maintaining uniform standards, controls,
procedures and policies may adversely affect the operations of the two
companies.
If we are unable to successfully integrate the operations of BIZ after the
merger, our business, financial condition and operating results may be adversely
affected.
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY
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:
o the length of our customer commitments
o patterns of information technology spending by customers
o the timing, size, mix and customer acceptance of our product and service
product offerings and those of our competitors
o the timing and magnitude of required capital expenditures
o 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.
Future capital requirements may vary materially from those now planned. If
our future capital requirements increase significantly, we may not be able to
raise sufficient 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:
o the market acceptance of our products and services
o 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
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o research and development plans
o levels of inventory and accounts receivable
o technological advances
o competitors' responses to our products and services
o relationships with partners, suppliers and customers
o our projected capital expenditures
o the proposed merger with BIZ
If we do need to raise additional capital it may be on terms that are
unfavorable to us and may result in dilution to current shareholders.
If we are unable to raise additional capital to fund our operations, it may
be necessary for us to restructure our business operations or implement other
cost-cutting measures. Such a plan to cut costs may improve our cash flow but it
may also inhibit our growth, as we may not have the personnel and resources to
implement our business strategies and expand our operations.
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 $3.5 million and $2.4 million for the three months ended
March 31, 2000 and 2001, respectively.
HEADCOUNT REDUCTIONS IMPLEMENTED AS PART OF A COST REDUCTION STRATEGY MAY
INHIBIT FUTURE GROWTH.
The headcount reductions we may have made along with any additional
headcount reductions we may make in the future could inhibit our future growth.
Our ability to respond in a timely manner as future business opportunities arise
depends on having highly skilled employees available. If our staffing levels are
not adequate to respond as future business opportunities arise and if we are not
able to hire additional employees due to the constraints of our overall cost
reduction strategy our business could be adversely affected.
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 credit arrangements and have had to negotiate with our lenders for
waivers or forbearance agreements for these violations. Although we have
received waivers in the past, we may not be able to obtain waivers of future
covenant violations.
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 the following unless we first obtain their consent:
o declaring or paying cash dividends
o making capital distributions or other payments to stockholders
o merging or consolidating with another corporation
o selling all or substantially all of our assets
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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 three months ended March 31, 2000 we
derived 53% of our consolidated revenue from three customers and during the
three months ended March 31, 2001 we derived 11% 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 63% of our consolidated
revenue for the three months ended March 31, 2001. Our sales to these agencies
are subject to risks, including:
o early termination of our contracts;
o disallowance of costs upon audit; and
o 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 THE 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:
o the use of electronic commerce and communications may not increase, or
may increase more slowly than we expect;
o 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
o 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:
o any significant advance in techniques for attacking PKI systems,
including the development of an easy factoring method or faster, more
powerful computers
o publicity of the successful decoding of cryptographic messages or the
misappropriation of private keys
o government regulation limiting the use, scope or strength of PKI
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OUR INABILITY TO FIND ALTERNATIVE SUPPLIERS OF COMPONENTS MAY ADVERSELY AFFECT
OUR BUSINESS.
Some of the components incorporated into our products are produced by other
vendors. We currently purchase some of these components from a single supplier,
thus presenting a risk that they may not be available on commercially reasonable
terms in the future or at all. Our inability to develop alternative sources, if
necessary, may require us to redesign certain products which could result in
delays or reductions in product shipments that could adversely affect our
business.
IF WE DO NOT RESPOND TO RAPID TECHNOLOGICAL CHANGES, OUR PRODUCT 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. 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 a key person life insurance policy 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 service.
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.
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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:
o result in a claim for substantial damages against us by the customer
o discourage customers from engaging us for these services
o 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.
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 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.
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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:
o increased collection risks
o trade restrictions
o export duties and tariffs
o uncertain political, regulatory and economic developments
o inability to protect our intellectual property rights
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.
A SMALL NUMBER OF STOCKHOLDERS, INCLUDING OUR OFFICERS AND DIRECTORS, WILL HAVE
THE ABILITY TO CONTROL STOCKHOLDER VOTES.
Kris Shah and members of his family presently beneficially own, in the
aggregate, approximately 55% 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.
LAWSUITS MAY BE FILED AGAINST US THAT COULD ADVERSLEY AFFECT OUR BUSINESS IF
THEY ARE RESOLVED AGAINST US.
We are involved from time to time in 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. See "Part II - Other Information, 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:
o variations in our annual or quarterly financial results or those of our
competitors
o company issued earnings announcements that vary from consensus analyst
estimates
o changes by financial research analysts in their recommendations or
estimates of our earnings
o conditions in the economy in general or in the information technology
service sector in particular
o announcements of technological innovations or new products or services
by us or our competitors
o unfavorable publicity or changes in applicable laws and regulations, or
their judicial or administrative interpretations, affecting us or the
information technology service sectors
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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 were also
granted registration rights, which commenced in June 2000 and provided 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.
THE CURRENT CALIFORNIA ENERGY CRISIS COULD ADVERSELY AFFECT OUR BUSINESS
Our headquarters and principal operations are located in Orange County,
California. California has recently found itself in a utility crisis caused, in
part, by a lack of affordable power sources and the financial instability of
several of its primary power suppliers. Orange County has undergone several
periods of "rolling blackouts," a technique used by our power provider to
conserve its resources. Although our operations have not been halted as a
result of these conservation measures, potential suspensions of our operations
due to power disruptions could result in materially higher costs and lost
revenues, either of which would materially adversely impact our business,
financial condition and results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
We entered into an agreement with GBCC permitting us to borrow under a
$20.0 million secured revolving line of credit facility in June 1999. On April
18, 2001, the agreement was amended and now allows maximum borrowings of $5.0
million. Changes in the amended agreement related to the definition of maximum
borrowing, eligible collateral and the advance rate were effective on April 18,
2001, changes related to financial covenants and requirements were effective as
of March 31, 2001. Under the both the original agreement and the amended
agreement, we are subject to an annual interest rate of the prime rate plus
0.625%. Future operating results could be adversely affected by increases in
interest rates that occur while significant borrowings are outstanding. We had
outstanding borrowings of $782,000 related to this line of credit at March 31,
2001. A 10% change in the underlying prime rate would result in an approximately
$7,000 change in the annual amount of interest paid on such debt.
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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.
On January 16, 1998, G2 Resources Inc. (G2) filed a complaint against
Pulsar in the Circuit Court, Fifteenth Judicial Circuit, Palm Beach County,
Florida. G2 claimed 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
provided 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 amounted to approximately $10.3 million. Pulsar 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 asserted defenses to Classical's claim. On April
20, 2001, a court hearing was held and G2's complaint against Pulsar was
dismissed without prejudice on the basis of no prosecution activity for more
than 12 months. Since the complaint was dismissed without prejudice, either G2
or Classical could file a new complaint. We believe that the previous claims
made by G2 and Classical against Pulsar were without merit and that any similar
claims that G2 or Classical might bring against Pulsar in the future would also
be without merit. If G2 or Classical were to make similar claims in the future
we intend to vigorously defend against any such 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
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
None.
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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: May 15, 2001 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
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