ITEM 1. BUSINESS
Extended Systems provides distributed and mobile computing solutions that address the needs of the virtual enterprise. The Company designs, develops, markets and sells two product families: distributed connectivity products and mobile systems products. The Company's distributed connectivity products include a virtual private networking server, an Internet access server, network print servers and a database management system with remote access capabilities. The Company's mobile systems products include wireless connectivity products that comply with IrDA standards, infrared software and port replicators that connect portable computers to desktop peripherals and the network.
The Company was founded in 1984. Its initial products consisted of intelligent printer sharing devices that allowed PC users to share printers before local area networks were widely used. In 1991, the Company began introducing a series of products that addressed the distributed and mobile computing needs of businesses. These products included the ExtendNet line of print servers and the JetEye infrared wireless connectivity adapter. In 1993, the Company further expanded its product offerings by introducing the Advantage Database Server database management system. From 1993 to 1997, the Company introduced enhanced versions of its existing products, adding to their functionality and management capabilities and enabling their operation in different network environments. In addition, the Company began the development of a number of new products to address the distributed and mobile computing needs of the emerging virtual enterprise. In 1997, the Company introduced three new product lines: the ExtendNet VPN (Virutal Private Network), the ExtendNet IAS (Internet Access Server) and a line of port replicator products.
INDUSTRY BACKGROUND
During the last decade, businesses and other organizations have moved from centralized computer systems to distributed local and wide area networks based on client/server architectures. The proliferation of these distributed networks has enabled the enterprise-wide deployment of mission-critical applications beyond the traditional on-site facilities of the organization. As a result, both mobile and local employees have greater access to business-critical information. The corporation has evolved into a "virtual enterprise" characterized by resource and information sharing among employees, suppliers, distributors and customers throughout the world. The challenges faced by the virtual enterprise include providing reliable and secure network connectivity to an increasingly mobile workforce, ensuring that mobile connectivity is cost-effective and effectively managing its increasingly complex distributed network.
As the mobile workforce continues to grow, there is increasing demand to access business networks from multiple locations, including different locations within the organization's main office, remote offices and various locations while traveling, such as hotels and airports. International Data Corporation ("IDC") forecasts that the market for remote access servers will increase from $1.9 billion in 1996 to $7.6 billion in 2001, and IDC expects
the installed base of remote access server ports to increase from 4.2 million in 1996 to 60.5 million in 2001. Increased demand for mobile connectivity has been driven by higher demand for access to communication and mission-critical applications across the network, as well as by the proliferation of innovative mobile computing devices. As PC manufacturers have introduced notebook computers with powerful new features and computing power comparable to desktop computers, many organizations have replaced desktop systems with notebook computers as the primary computer for employees. IDC reported that 74% of all notebook computers sold in 1997 served as the user's primary computer. In addition, small devices such as personal digital assistants ("PDAs"), pagers and organizers with advanced communications capabilities are becoming commonplace among today's workforce.
As the number of mobile computing devices has increased, the speed and reliability of network connections for such devices have significantly improved. Infrared technology has emerged as a cost-effective method of providing wireless network connectivity for notebook computers without the need for bulky cables and wired connections. The Infrared Data Association ("IrDA"), a consortium of more than 160 companies that includes most computer industry leaders, has developed a single, international standard for infrared connectivity. A majority of the notebook computer models sold today by major PC manufacturers contain an infrared port, based upon the IrDA standard, that enables the wireless connectivity of the computer to the network, other computers, printers and other devices through an infrared connection.
The emergence of mobile computing presents a number of challenges for businesses. Mobile users wish to connect to the network from many locations, including those within an organization's facilities such as conference rooms, shared offices and warehouses. Providing flexible network access for mobile users in these locations typically requires that users physically connect their mobile computer to the network in every location at which they desire network access, which is cumbersome and error-prone. Providing network access to remote users who dial in to the network may also be very expensive, as businesses must maintain large numbers of dedicated modems and telephone lines and often incur substantial long distance and other telephone toll charges. In addition, the quality and speed of the telephone lines used by remote users are often inconsistent, particularly when connecting across international boundaries. Finally, as organizations permit mobile access to their networks, network security becomes critically important.
In recent years, the Internet has significantly affected the way in which organizations communicate, both externally with other organizations and internally within organizations. Numerous Internet service providers ("ISPs") have made access to the Internet by businesses and individuals easy and cost- effective throughout the world. Large enterprises are increasingly incorporating "intranets" that employ Internet data formats and communications protocols into their private networks to connect geographically dispersed networks or users. Businesses have begun to use the Internet as a "virtual" private network ("VPN") to link remote locations and as a substitute for expensive wide area networks that use private, leased telephone lines. The use of VPNs is expected to grow significantly in the future. Infonetics Research forecasts that the market for VPN products and services will grow from $205 million in 1997 to $11.9 billion in 2001. The security issues initially faced by organizations when enabling remote network access become more acute when the Internet serves as a gateway for the organization's network.
As the dependence on networks to provide access to mission-critical applications increases and the scale and complexity of networks grow, effective network management becomes an increasingly difficult, yet crucial, task. The organization must effectively coordinate the various hardware and software components to effectively manage devices such as PCs, notebook computers, printers, servers and personal digital assistants that communicate within the network. Organizations seek hardware and software solutions that provide a high degree of functionality, conform to standard industry specifications and integrate easily into the network environment. In addition, mobile connectivity provides an added degree of complexity which the organization must effectively manage to ensure the success of the "virtual enterprise."
THE EXTENDED SYSTEMS SOLUTION
Extended Systems provides distributed and mobile computing solutions that address the needs of the virtual enterprise. The Company's distributed connectivity products include a virtual private networking server, an
Internet access server, print servers and a database management system with remote access capabilities. The Company's mobile systems products include IrDA-compliant wireless connectivity products, infrared software and port replicators that connect portable computers to desktop peripherals and the network.
The Company's solution provides the following advantages to the virtual enterprise:
- ENABLE MOBILE COMPUTING WITHIN AN ORGANIZATION. The Company's JetEye infrared wireless connectivity products enable mobile users to easily access networks or peripherals while moving between offices and conference rooms without the need for bulky cables and wired connections. The Company's port replicator products provide portable computers quick, cost-effective access to desktop peripherals and the network.
- ENABLE MOBILE CONNECTIVITY OUTSIDE THE ORGANIZATION. The Company's ExtendNet VPN product enables a business to extend its network environment beyond physical connections to the LAN or WAN, permitting seamless, secure access to the network by mobile users over the Internet. ExtendNet IAS provides remote offices and small businesses with Internet connectivity, allowing multiple users to easily access a single Internet connection while intelligently managing usage to reduce costs. These products are designed to address users' needs for mobile access and access to the Internet and result in cost savings to businesses by significantly reducing remote access toll charges and by reducing the number of modems and telephone lines and the level of administration needed to support remote access and Internet access.
- ENABLE DISTRIBUTED APPLICATIONS. The Advantage Database Server is a scalable, high performance database management system that enables organizations to extend applications and databases across the distributed network and, when coupled with the Advantage Internet Server, over the Internet. The ExtendNet print server products enable the effective deployment of complex printing applications across distributed networks worldwide.
- ENABLE EFFECTIVE NETWORK INTEGRATION. The Company's network products permit effective management of devices locally and across the virtual enterprise. The Company's products share a common industry standard Simple Network Management Protocol ("SNMP") architecture that enables network administrators to effectively manage the Company's products within the network environment to address the evolving needs of today's virtual enterprises.
PRODUCTS
The Company meets the needs of virtual enterprises with two product families: Distributed Connectivity products and Mobile Systems products.
DISTRIBUTED CONNECTIVITY
The Distributed Connectivity product family consists of four product lines: ExtendNet Virtual Private Network Servers, ExtendNet Internet Access Servers, Advantage Database Management Servers and network print servers.
ExtendNet VPN provides corporate MIS groups with a more cost-effective, scalable means to connect mobile workers to LAN applications. VPN technology enables a corporation to use the Internet to communicate securely between mobile users and the LAN. For companies with multiple locations, telecommuters, mobile workers or the need to exchange information with corporate partners, the VPN provides a secure alternative to traditional remote access solutions such as X.25, leased lines, frame relay, 800 numbers and long distance modem dial-in. ExtendNet VPN also addresses the issues involved in scaling mobile users to higher-speed communications such as 56K modems, ISDN, frame relay and T-1 communications.
ExtendNet IAS allows multiple users to share one connection to the Internet via an ISP, providing an easy, cost-effective and secure way for remote and branch offices to connect to the Internet. ExtendNet IAS
includes firewall security, e-mail and intelligent Internet connection management. ExtendNet IAS also provides a number of communications options, enabling the user to scale the device's capacity to the environment, such as ISDN, analog and frame relay connections.
Advantage Database Server ("ADS") is a high performance database management system that brings client/server functionality to PC database applications. ADS allows developers to work with easy to use development tools and methodology, but replaces the traditional PC database model with a client/server architecture. ADS works in both Novell Netware and Windows NT server environments and improves multi-user performance by intelligently allocating database operations between the client and the server. ADS protects database files against network failure and user error through a centralized storage management system and provides data security through encryption and file hiding. ADS includes a client interface, supporting common application development tools such as Delphi, Visual Objects and Visual Basic, as well as any applications with an ODBC interface.
Advantage Internet Server provides a secure, seamless and reliable method for running Advantage Database applications across the Internet. Advantage Database applications can easily be migrated to remote users without recoding to HTML.
Advantage Development Tool Kits provide database application developers and VARs with a set of software tools to develop, debug and deploy reliable applications running in an ADS environment.
ExtendNet print servers consist of five core products: (i) PrintTRAK, (ii)ExtendNet for 100 Base-T, (iii) ExtendNet stand-alone, (iv) ExtendNet for LaserJets and (v) PocketPrintServer. The ExtendNet print servers enable the deployment of complex printing applications across global networks, while permitting comprehensive management of network printers from any location on the network.
PrintTRAK enables the user to monitor the activity of one or more printers in the Windows NT network. PrintTRAK provides tools to track and report printer, paper and consumable usage via the network. The rapid deployment of color, laser and high-quality printers in many organizations has been accompanied by a sharp increase in related costs of consumables and supplies. With PrintTRAK, these costs can now be tracked accurately, reported and, if desired, billed to the department or end user. Professional organizations, such as law firms and consulting firms, can also use PrintTRAK's project-based accounting capabilities to bill specific printing costs to the relevant client or project.
MOBILE SYSTEMS
The Mobile Systems product family consists of three product lines: infrared wireless connectivity products, IrDA connectivity software and mobile connectivity products.
The infrared wireless connectivity product line was introduced in 1991 and today consists of three core products: (i) JetEye Net, (ii) JetEye Printer and (iii) JetEye PC.
JetEye Net allows mobile computing users to easily attach to an Ethernet or Token Ring network. End users requiring a high degree of mobility within an organization rely on JetEye Net to provide fast network access, without cumbersome cables, lost network interface cards or broken connectors.
The JetEye Printer was introduced in 1991, and initially allowed handheld computers to print by means of an infrared beam to a printer. The JetEye Printer has since been enhanced to support the IrDA standard and to support notebook computers that are equipped with an IrDA port.
The JetEye PC enables IrDA communications from portable computers equipped with a serial port. The JetEye PC is used for data transfers, file synchronization and software updates between mobile devices or portable PCs and desktop computers.
Through the acquisition of Counterpoint, the Company expanded its Mobile Systems product family to include IrDA Connectivity Software. The IrDA Connectivity Software product line consists of three core products: (i) QuickBeam, (ii) JetBeam and (iii) IrLite. QuickBeam is an infrared file transfer application which enables mobile data exchange between portable devices or from portable devices to desktop PCs. JetBeam is a complete set of IrDA infrared communication applications designed for use with Windows 95, Windows NT and Windows 98. The IrLite Development Kit is infrared communication software designed to enable the integration of IrDA capability into portable systems. The IrLite Development Kit provides robust infrared communications with a compact code base.
The Company's Mobile Connectivity product line consists of two core products: Port Replicators and Port Replicators with Ethernet. The port replicators connect notebook computers to external peripherals such as a monitor, keyboard, mouse and printer. Similar solutions provided by PC manufacturers typically are costly, have limited features and are late to market. Recognizing the market opportunity, the Company developed a product that is cost-effective and easy to use. With minor modifications, the Company's port replicators can be used with a wide variety of notebook computers.
TECHNOLOGY
The Company's core technological competencies are in the areas of embedded systems software and microcontroller hardware design. In addition, the Company's engineers have a high degree of expertise in supporting network hardware topologies, software transport protocols and application-layer networking. The Company's software development group has placed particular emphasis on the development of network management tools for multi-protocol networking.
The Company has maintained an active program to develop and deploy new enterprise networking technologies across its product lines. The Company has focused product development efforts upon such enterprise networking capabilities as Novell NEST/NDS and Windows NT enterprise services. In addition, the Company was an early and active supporter of industry standard SNMP-based management capabilities for easy control of devices over the network. Today, end users use these technologies to deploy and maintain worldwide access to key network resources.
With the emergence of the Internet as a commercial network, the Company has deployed key virtual private networking capabilities for the support of mobile and distributed workforces over the Internet. The Company has embedded an implementation of the Point-to-Point Tunneling Protocol ("PPTP") into ExtendNet VPN. The Company has also developed other technologies that will enable it to develop additional VPN products. The Company's secure embedded real-time operating system and virtual private networking software are integrated in flash memory within the ExtendNet VPN, which enables users to upgrade the product remotely. Unlike competing VPN products implemented with open operating systems running on standard server platforms, the embedded operating system of ExtendedNet VPN deters hackers and prevents tampering with the system. The Company believes that a real-time embedded operating system and dedicated hardware platforms are key differentiators in constructing effective and secure VPN solutions.
The ExtendNet VPN solution also provides multi-protocol networking support for end users deploying both TCP/IP-based and SPX/IPX-based network systems. SPX/IPX is the transport protocol utilized by Novell's NetWare network operating system. In contrast to competing products based on other VPN technologies, such as IPSec, ExtendNet VPN permits virtual private networking in the multi-protocol networking environments common in many corporate settings.
The Company will continue to enhance its product lines with additional advanced network management capabilities. Currently, ExtendNet print servers, ExtendNet IAS and ExtendNet VPN incorporate web-based management agents that permit the monitoring and control of these devices via browser software tools. In an effort to advance its network management support, the Company is contributing to the development of next-generation secure management capabilities such as an encrypted version of SNMP.
The Advantage Database Server implements technologies for enhancing the execution of client/server database transactions across a network. This includes algorithms for "burst-mode" transmission of data records across the LAN or WAN, which speeds the flow of data between server and client. ADS capabilities include transaction processing, filter optimization, enhanced locking algorithms and support for a variety of communications protocols.
The Company designs its products to adhere to industry standards and widely accepted protocols, and is active in the organizations that develop and maintain these standards and protocols. The Company was a founding contributor to the IrDA standards committee and is currently represented on the IrDA executive committee. Today more than 160 companies are active participants in the IrDA, and are developing a broad range of mobile products that are IrDA-compliant. The Company believes that IrDA infrared connectivity, due to its benign, low cost, low power consumption, high speed and device independent characteristics, will become an increasingly important technology in permitting the seamless connection of mobile devices to each other and to the virtual enterprise.
Through the Company's efforts, standards such as the IrLAN protocol (co-developed with Microsoft Corporation and Hewlett-Packard) were proposed, developed, ratified and adopted for network connectivity to notebook computers. The Company has been actively guiding IrOBEX, which is an object-oriented standard for transferring files, graphics and other data by infrared transmission. The Company's QuickBeam and JetBeam products implement a communications application using IrOBEX.
The Company has been aggressively developing new applications for OEM and corporate customers based on its IrDA technology, including inventory management, data logging, network access, computer docking and data communications products. The Company believes that these technologies and applications will have even broader applicability to connectivity for mobile workforces in the coming years.
SALES AND MARKETING
The Company markets and sells its products worldwide through multiple indirect channels, primarily distributors and resellers, and a substantial majority of net revenue in 1998, 1997 and 1996 was derived from sales to distributors and resellers. Certain of the Company's products, in particular its JetEye IrDA products, IrDA connectivity software, and ExtendNet print servers, are also sold to OEMs. The Company supports its indirect channels with its own sales and marketing organization.
The Company conducts its North American sales and marketing activities primarily from its offices in Boise, Idaho and Bozeman, Montana. The Company's in-house sales and marketing staff is largely responsible for generating end user demand for the Company's products by soliciting prospective customers, providing technical advice with respect to the Company's products and working closely with distributors to sell the Company's products. The Company's sales and marketing staff actively participates with distributors and resellers in the selling process, which provides end users with the level of support needed for the successful integration of solutions in enterprise networks.
In international markets, the Company markets and sells its products through its sales subsidiaries in France, Germany and the United Kingdom. In addition, the Company has distribution agreements with companies located in more than 25 foreign countries, including Japan, The Netherlands, Brazil, Canada and Germany. In 1998, 1997 and 1996, international sales represented 44%, 44% and 38%, respectively, of net revenue, and the Company expects that international sales will continue to represent a substantial portion of its net revenue for the foreseeable future.
The Company's key distributors include Ingram Micro and Tech Data. In 1998, 1997 and 1996, sales to Ingram Micro accounted for 23%, 19% and 16%, respectively, of the Company's net revenue. Sales to Tech Data accounted for 11% of the Company's net revenue in 1998. The Company's key OEM customers include printer manufacturers and manufacturers of notebook computers, PDAs, digital cameras and other mobile computing devices. The Company intends to increase its sales to OEMs in the future.
The Company provides most of its distributors and resellers with limited product return rights for stock rotation. Stock rotation rights permit distributors to return products to the Company for credit against an offsetting purchase order, but are limited based upon amounts purchased by a given distributor during the preceding quarter. The Company also provides most of its distributors and resellers with price protection rights. Price protection rights require that the Company grant retroactive price adjustments for inventories of the Company's products held by distributors or resellers if the Company lowers its prices for such products.
The timing and volume of customer orders are difficult to forecast because the Company's customers typically require prompt delivery of products and a substantial majority of the Company's sales are booked and shipped in the same quarter. Accordingly, the Company typically operates with a relatively small order backlog. Further, sales are generally made pursuant to standard purchase orders that can be rescheduled, reduced or canceled with little or no penalty. The Company believes that its backlog at any given time is not a meaningful indicator of future net revenue.
SERVICE AND SUPPORT
The Company believes that service and support are critical components of end user satisfaction and the success of the Company's business. The Company's commitment to service and support enables it to interact regularly with network administrators and to identify and respond to their needs on an ongoing basis. The Company maintains service and support personnel in Bozeman, Montana and Boise, Idaho. In addition, the Company's foreign sales subsidiaries and international distributors provide service and support to foreign end users. The Company offers a wide range of customer support services under the ExtendAssist Program. It includes a technical support hotline to provide a range of telephone support to its distributors, dealers and end user customers through a toll-free number. In addition, the Company maintains a technical support group comprised of engineers and technicians, 24-hour automated support, and an on-line bulletin board which contains in depth technical information. Through ExtendAssist, the Company's engineering staff provides technical support via e-mail. The Company also provides on-line services to distribute technical advice and software updates.
RESEARCH AND DEVELOPMENT
The Company believes that its future success will depend in large part on its ability to develop, introduce and manufacture new products and enhance existing products, allowing it to offer its customers products that achieve higher levels of performance and reliability. The Company's research and development efforts are currently focused on infrared communications, networking protocols, enterprise network management tools, client/server data management, Internet connectivity and new networking and mobile connectivity platforms.
During fiscal 1998, 1997 and 1996, research and development expenses were $6.4 million, $5.3 million and $4.4 million, respectively. The Company anticipates that it will continue to commit substantial resources to research and development in the future.
MANUFACTURING
The Company focuses its manufacturing efforts on cost-effectively producing high-quality products. The Company's manufacturing operations are located in Boise, Idaho and consist mainly of materials procurement, final assembly, testing, quality assurance and shipping. In 1998, the Company made an investment in Parallax Research to expand its low cost manufacturing opportunities in Singapore. The only product assembly performed by the Company is final assembly, which consists of the integration of major components into a final product and the preparation of that product for shipment. The Company performs testing and quality assurance of certain products at its Boise facilities and plans to expand its in-house automated testing efforts as its product volume increases. The Company has received ISO 9001 certification, which the Company believes is crucial in order to sell its products internationally.
The Company subcontracts other manufacturing functions, including the production of its printed circuit boards. Certain of the Company's products are manufactured in their entirety by third parties. For example, the
ExtendNet IAS is manufactured by Apexx Technology, Inc. In addition, the Company's port replicator and in-air and in-car charger products are manufactured by Mobility Electronics.
The Company relies on third-party suppliers for components used in its products. Certain of the components used in the Company's products, including certain semiconductor components and infrared transmission components, are currently available from a limited number of suppliers. Disruption in service by any of the Company's manufacturers or the Company's suppliers could lead to supply constraints or delays in the delivery of the Company's products.
COMPETITION
The markets for the Company's products are intensely competitive, and are characterized by frequent new product introductions, rapidly changing technology and standards, constant price pressure and competition for distribution channels. The principal competitive factors in the Company's markets include brand-name awareness, price, product performance, reliability, breadth of product line, sales and distribution capability and technical support and service. Certain of these factors are outside the Company's control. There can be no assurance that the Company will be able to compete successfully in the future with respect to these or any other competitive factors or that competition will not have a material adverse effect on the Company's business and results of operations.
The Company's principal competitors in the market for print servers include Hewlett-Packard, Intel Corporation, Lexmark International, Inc. and Emulex Corporation. In the market for infrared mobile computing products, the Company's competitors include a number of companies which have hardware or software solutions. As the market for infrared connectivity matures, the Company may face increased competition from the major PC manufacturers, who may choose to develop infrared solutions for use with their own products. The Company currently faces limited direct competition from major applications and operating systems software vendors who may choose to incorporate infrared connectivity functionality into their software, thereby potentially reducing the need for OEMs to include the Company's products in their notebook and desktop PCs. The Company's ExtendNet IAS product currently competes with the product offerings of Bay Networks, Inc., as well as those of a number of smaller companies. The Company's ExtendNet VPN product currently competes with software-based solutions offered by Microsoft Corporation and others. As the market for these distributed connectivity products matures, the Company expects to face direct competition from other large computer networking and software companies. The Company's Advantage Database Server product currently competes with low-end database products from companies such as Microsoft Corporation and Oracle Corporation, in addition to smaller competitors offering data management software. The Company's port replicator products face competition from PC manufacturers who develop port replicators for their own PCs. The Company faces indirect competition from existing and potential customers that provide internally developed solutions. As a result, the Company must demonstrate to prospective customers the advantages of the Company's products over internally developed solutions.
In addition to direct competition, the Company's products face competition from alternative technological solutions. For example, the Company's IrDA mobile computing products face indirect competition from alternatives such as radio frequency connectivity and non-IrDA infrared solutions. The Company's ExtendNetVPN products face indirect competition from the major computer networking companies which provide extended Ethernet solutions for wide area and local area networks.
Many of the companies with which the Company competes or may in the future compete, including the internal development groups of its current and potential customers, have substantially greater financial, marketing, technical, sales and support resources and may have more brand name recognition than the Company. The Company expects that, in order to remain competitive, it may have to decrease its sales prices on certain products, which could materially and adversely affect the Company's business and results of operations.
INTELLECTUAL PROPERTY
The Company relies on a combination of patent, copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect its proprietary intellectual property rights. The Company seeks to protect its software, documentation and other written materials under trade secret and copyright laws, which afford only limited protection. The Company currently has three issued United States patents that expire in 2006 and beyond and has five patent applications pending. The Company has registered nine trademarks in the United States, including "JetEye" and "ExtendNet." The Company's future success is dependent in part upon its proprietary technology.
The Company has entered into source code and design document escrow agreements with a limited number of its customers requiring release of design details in certain circumstances. Such agreements generally provide that such parties will have a limited, non-exclusive right to use such code in the event that there is a bankruptcy proceeding by or against the Company, if the Company ceases to do business or if the Company fails to meet its support obligations. The Company also provides its source code to foreign language translation service providers and consultants to the Company in limited circumstances.
As is common in its industry, the Company has from time to time received notification from other companies of intellectual property rights held by those companies upon which the Company's products may infringe.
EMPLOYEES
As of June 30, 1998, the Company had 277 full-time equivalent employees, including 65 in research and development, 135 in sales, marketing and customer support, 45 in manufacturing and 32 in administration. None of the Company's employees is represented by a labor union or is subject to a collective bargaining agreement with respect to his or her employment with the Company. The Company believes that its relations with its employees are good. The Company's future success will depend, in part, upon its ability to attract and retain qualified personnel. Competition for qualified personnel in the Company's industry is intense, and there can be no assurance that the Company will be successful in retaining its key employees or that it will be able to attract skilled personnel as the Company grows.
ITEM 2.
ITEM 2. PROPERTIES
The Company owns its corporate headquarters facility in Boise, Idaho which consists of approximately 100,000 square feet of space located on 24 acres of land which are also owned by the Company. This space is used for research and development, manufacturing, sales and marketing, customer support and administration. In addition, the Company owns a facility of approximately 20,000 square feet in Bozeman, Montana. This facility is used primarily for customer support and sales and marketing. The Company believes that its current facilities in Boise and Bozeman are adequate to meet its needs for at least the next 12 months. The Company also leases a number of sales, support and development offices in the United States and Europe. The Company believes that existing field sales, support and development facilities are adequate to meet its current requirements and that suitable additional or substitute space will be available as needed to accommodate expansion of the Company's operations. The Company plans to continue to expand its field sales, support and development facilities worldwide where appropriate. See Notes to Consolidated Financial Statements for information regarding the Company's lease obligations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Not applicable.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding the executive officers and directors of the Company as of September 28, 1998.
STEVEN D. SIMPSON has served as the Company's President and Chief Executive Officer and as a director since January 1996. From January 1995 to January 1996, Mr. Simpson served as the Company's Executive Vice President of Sales and Marketing. Prior to joining the Company, Mr. Simpson was employed by Hewlett-Packard from 1978 to 1994. From 1991 to 1994, Mr. Simpson was General Manager of the Boise LaserJet Printer Division.
KARLA K. ROSA has served as the Company's Vice President of Finance since December 1997 and as Chief Financial Officer since April 1996. From January 1996 to April 1996, Ms. Rosa was the Company's Assistant Controller, from April 1992 to January 1996 Ms. Rosa was Treasury Manager and from December 1991 to April 1996, Ms. Rosa was Tax Director. Prior to joining the Company, Ms. Rosa was a manager in the Los Angeles and Boise offices of Arthur Andersen & Co. Ms. Rosa is a Certified Public Accountant.
HOLMES T. LUNDT has served as the Company's Vice President of Corporate Research and Development and Business Development since January 1996. From December 1994 to January 1996, Mr. Lundt was the Company's Vice President of Research and Development, from October 1993 to December 1994, Mr. Lundt was Vice President of Marketing and from January 1991 to October 1993, Mr. Lundt was Business Unit Manager of Network Printing. Mr. Lundt joined the Company in 1984.
SCOTT J. RITCHIE has served as the Company's Vice President of Operations since he joined the Company in December 1995. From May 1978 to November 1995, Mr. Ritchie was employed by Hewlett-Packard and held a number of positions in manufacturing and material management, most recently as Materials Manager in the Disk Memory Division.
THOMAS C. WHITE has served as the Company's Vice President of Sales and Marketing since January 1996. From June 1995 to January 1996, Mr. White was the Company's Vice President of North American Sales. From July 1993 to June 1995, Mr. White was National Account Director for MicroAge Computer Centers, Inc. ("MicroAge"). Prior to joining MicroAge, Mr. White spent seven years at Apple Computer, where he served as Large Enterprise Manager.
BRADLEY J. SURKAMER has served as the Company's Vice President of Technical Support and Third-Party Marketing since January 1996. From January 1995 to January 1996, Mr. Surkamer was the Company's Manager of Technical and Third Party Marketing. From 1991 to January 1995, Mr. Surkamer was the Company's Manager of Sales and Marketing.
RAYMOND A. SMELEK has served as the Company's Chairman of the Board of Directors since June 1995 and he has been a Director of the Company since June 1994. From June 1994 to February 1996, Mr. Smelek was the Company's President and Chief Executive Officer. Prior to joining the Company, Mr. Smelek was employed by
Hewlett-Packard and held a number of positions, most recently as Vice President and General Manager of the Mass Storage Group. Mr. Smelek is also a director of Inference Corporation.
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's Common Stock began trading on the Nasdaq National Market on March 4, 1998 under the symbol "XTND". The following table sets forth the high and low trading prices of the Company's Common Stock for the quarter ended:
According to records of the Company's transfer agent, the Company had approximately 186 shareholders of record as of September 21, 1998. Because many of such shares are held by brokers and other institutions on behalf of shareholders, the Company is unable to estimate the total number of shareholders represented by these record holders. On September 21, 1998, the last reported sale price on the Nasdaq National Market for the Company's Common Stock was $6.25. The market for the Company's Common Stock is highly volatile. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Factors That May Affect Future Results and Market Price of Stock--Stock Price Volatility."
The Company has not declared or paid any dividends on its Common Stock since September 1994. The Company currently anticipates that it will retain all future earnings for use in the operation and expansion of its business and does not anticipate paying any cash dividends in the foreseeable future.
On March 4, 1998, the Company commenced and completed its initial public offering (the "Offering") of 1,300,000 shares of its Common Stock, $0.001 par value per share, at a public offering price of $8.00 per share pursuant to a Registration Statement on Form S-1 (File No. 333-42709) filed with the Securities and Exchange Commission (the "Commission"). All of the shares registered were sold. Volpe Brown Whelan and Company and Needham and Company, Inc. were the managing underwriters of the Offering. Aggregate gross proceeds to the Company from the Offering (prior to deduction of underwriting discounts and commissions and expenses of the Offering) were $10.4 million. In addition to the above, selling shareholders sold 482,500 shares of Common Stock, including the exercise of the underwriters' over-allotment option consisting of 232,500 shares.
The Company paid underwriting discounts and commissions of $728,000 and other expenses of approximately $1.1 million in connection with the Offering and the net proceeds to the Company in the Offering were $8.6 million.
From March 4, 1998, the effective date of the Registration Statement, to June 30, 1998, the approximate amount of net proceeds used were $666,000 for investments in strategic business partners. None of such payments consisted of direct or indirect payments to directors, officers, 10% shareholders or affiliates of the Company.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following consolidated selected financial data should be read in conjunction with the Company's Consolidated Financial Statements and related Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included herein. (In thousands, except per share amounts.)
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The Company's operating results have fluctuated significantly in the past and are likely to fluctuate significantly in the future on a quarterly and an annual basis. Prior growth rates that the Company has experienced in net revenue and net income should not be considered indicative of future growth rates. Factors that could cause the Company's future operating results to fluctuate include the level of demand for the Company's products, the Company's success in developing new products, the timing of new product introductions and product enhancements by the Company and its competitors, market acceptance of the Company's new and enhanced products, the emergence of new industry standards, the timing of customer orders, the mix of products sold, competition, the mix of distribution channels through which the Company's products are sold and general economic conditions, including instability caused by the European monetary union. Many of such factors are beyond the Company's control.
The growth in net revenue for 1998 was principally due to increased unit sales of port replicator products and ExtendNet print servers, increased Infrared license and non-recurring engineering ("NRE") revenue, increased unit sales of ExtendNet VPN and ExtendNet IAS products which were first introduced in October 1997, and increased revenue from North American sales of Advantage Database products. While unit sales of ExtendNet print servers increased, the increase was offset in part by a decline in the average selling price of ExtendNet print servers due to higher sales of lower priced print servers as a percentage of sales and a decline in print server royalty revenues. Increased revenue was partially offset by declining unit sales in the Printer Sharing business, and by decreased international sales of Advantage Database Server products.
The increase in net revenue in 1997 from 1996 was primarily attributable to higher unit sales of ExtendNet print servers, Advantage Database Servers and infrared connectivity devices, as well as the introduction of the Company's port replicators in February 1997. The Company also experienced increased royalty, license and NRE revenue in 1997. The higher unit sales of ExtendNet print servers were offset in part by a decline in the average selling price of these products due to relatively higher sales of lower priced print servers, as well as by declining unit sales in the Company's printer sharing business.
In 1998, 1997 and 1996, 54%, 64% and 57%, respectively, of the Company's net revenue was derived from sales of ExtendNet print servers. The Company believes that this product line will continue to grow but will decline as a percentage of the Company's net revenue as the Company's recently introduced products for distributed and mobile connectivity achieve market acceptance. While the Company believes that sales of ExtendNet print servers will
continue to account for a significant portion of the Company's net revenue and gross profit, the Company's future results of operations will be highly dependent upon the success of its recently introduced products.
In its port replicator business, the Company faces competition from the PC manufacturers who develop port replicators for their own PCs. Sales of the Company's port replicator products are impacted by the availability of competitive products in the marketplace. To the extent competitive products are available, decreased demand for the Company's products could have a material effect on the growth of the Company's port replicator business.
The Company derives a substantial portion of its net revenue from international sales, principally through its international sales subsidiaries and a limited number of distributors. In 1998 and 1997, international sales represented 44% of net revenue and, in 1996, international sales represented 38% of net revenue. The Company expects that international sales will continue to represent a substantial portion of its net revenue for the foreseeable future. If any significant international distributor were to cease purchasing products or were to significantly reduce its orders from the Company for any reason, the Company's business and operating results could be materially adversely affected. International sales are subject to a number of risks, including changes in foreign government regulations, export license requirements, tariffs and taxes, other trade barriers, fluctuation in currency exchange rates, difficulty in collecting accounts receivable, difficulty in staffing and managing foreign operations and political and economic instability.
The Company markets and sells a majority of its products through multiple indirect channels, primarily distributors and resellers. Certain of the Company's products, in particular its ExtendNet print servers, JetEye IrDA products and infrared software, are sold to OEMs, and the Company intends to increase sales to OEMs in the future. The Company supports its indirect channels with its own sales and marketing organization. The Company's key distributors include Ingram Micro and Tech Data. In 1998, 1997 and 1996, sales to Ingram Micro accounted for 23%, 19% and 16% of the Company's net revenue, respectively. Sales to Tech Data accounted for 11% of the Company's net revenue in 1998. The loss of, or reduction in sales to, any of the Company's key customers could have a material adverse affect on the Company's business and results of operations. The Company provides price protection rights and limited product return rights for stock rotation to most of its distributors and resellers.
The markets for the Company's products are characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions and short product life cycles. The Company's future success will depend to a substantial degree upon its ability to enhance its existing products and to develop and introduce, on a timely and cost-effective basis, new products and features that meet changing customer requirements and emerging and evolving industry standards. The introduction of new or enhanced products also requires the Company to manage the transition from older products in order to minimize disruption in customer ordering patterns, to avoid excessive levels of older product inventories and to ensure that adequate supplies of new products can be delivered to meet customer demand. There can be no assurance that the Company will successfully develop, introduce or manage the transition to new products.
The decrease in gross margin for 1998 was principally due to a shift in product mix. Sales of port replicator products and Internet Access Server products, which have a lower relative gross margin, were a higher percentage of sales in 1998 as compared to 1997. The decrease was also due to lower gross margins on ExtendNet print server products caused by a shift in the print server product mix to lower priced print servers and reduced print server royalty and NRE revenue. This decrease was offset in part by strong royalty, license and NRE revenue in the Infrared product line.
Gross margin increased in 1997 from 1996 due primarily to increased sales of higher margin products, in particular, the Advantage Database Server, as well as higher royalty, license and NRE revenue in 1997.
The Company's cost of net revenue consists primarily of costs associated with components, outsourced manufacturing of certain subassemblies, and in-house labor associated with assembly, testing, shipping and quality assurance. The Company's gross margin is affected by a number of factors, including product mix, competitive product pricing pressures, manufacturing costs and component costs. The Company anticipates that its gross margin may decline in the future as a result of shifts in the Company's product mix and competitive pricing pressure. In particular, the Company expects that its gross margin on sales of ExtendNet print servers will decline as a result of a shift in product mix toward lower priced print servers and competitive pricing pressures. The Company seeks to mitigate the effects of declining prices by improving product design and reducing costs, primarily manufacturing and component costs.
The increase in research and development expense for 1998 was principally due to increased staffing in the Infrared and ExtendNet VPN development groups. Research and development expenses in 1997 increased from 1996 as a result of increased staffing for the ExtendNet VPN and Counterpoint infrared software development groups.
The increase in marketing and sales expenses for 1998 was principally due to increased promotional activities associated with the port replicator, Internet Access Server, ExtendNet print server, and Infrared products, as well as increased sales activities both at the European subsidiaries and the North American sales groups. Marketing and sales expenses in 1997 increased from 1996 as a result of promotional costs associated with the introduction of ExtendNet VPN and increased staffing in marketing and sales.
The increase in general and administrative expenses for 1998 was principally due to increased administrative expenses at the Company's subsidiaries, increased stock option compensation expense, and increased fees for professional services, some of which are attributable to being a public company. General and administrative expenses in 1997 increased from 1996 as a result of increased administrative staffing and expenses associated with the Company's subsidiaries.
The decrease in other expense, net for 1998 was principally due to decreased foreign currency losses and a $180,000 non-recurring write down of a minority investment in 1997. Other expense, net increased in 1997 from 1996 due to such write down of the minority investment in 1997, as well as foreign currency losses experienced by the Company's international sales subsidiaries in 1997.
The increase in interest expense in both periods presented was principally due to an increase in the balance of the Company's long-term debt.
The increase in the provision for income taxes for 1998 was primarily due to higher income before taxes, offset by a decrease in the effective tax rate. The provision for income taxes increased in 1997 from 1996 because of an increase in taxable income in 1997 and an increase in the Company's effective tax rate.
LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL CONDITION
Cash and cash equivalents were $15.0 million at June 30, 1998, an increase of $8.4 million over the balance at June 30, 1997. The increase from prior fiscal year-end is primarily due to proceeds from the Company's initial public offering in March 1998.
Historically, the Company has funded its operations primarily through cash generated from operations. The increase in net cash provided by operating activities reflects increased net income, offset primarily by increased accounts receivable and inventory.
Accounts receivable increased to $8.8 million at the end of 1998 from $6.9 million at the end of 1997. The increase was primarily due to increased levels of business. Days sales outstanding in receivables were 53 days at the end of both 1998 and 1997.
Inventory increased to $6.0 million at the end of 1998 from $3.9 million at the end of 1997. The increase in inventory over the prior year was primarily due to increased levels of business and an increase in finished goods inventory of port replicator products, caused by slower than expected sales of port replicator products during the fourth quarter of 1998. The Company maintains an allowance for obsolete inventory; however, there can be no assurance that changes in customer buying patterns will not result in future inventory write-downs.
Net cash used by investing activities in 1998 consisted largely of capital expenditures for the expansion of the Company's Boise facility, replacement of internal information systems and equipment and related software associated with increased staffing. In addition, the Company made investments in Parallax Research and CF Company in the form of notes receivable. The Company intends to continue making such investments in select strategic business partners.
The Company currently plans to incur aggregate capital expenditures of approximately $1.0 million during 1999, primarily for software, system improvements, personal computers, technology equipment, office furnishings and building improvements.
Net cash provided by financing activities for 1998 consisted primarily of net proceeds from the Company's initial public offering in March 1998.
See "Long-term Debt" in the Notes to the Consolidated Financial Statements for a description of the Company's convertible debt and available sources of financing.
The Company believes that its existing working capital and borrowing capacity, coupled with the funds generated from the Company's operations, will be sufficient to fund its anticipated working capital, capital expenditures and debt payment requirements through 1999. In the longer term, the Company may require additional sources of liquidity to fund future growth. Such sources of liquidity may include additional equity offerings or debt financing. In the normal course of business, the Company evaluates acquisitions of businesses, products and technologies that complement the Company's business. The Company has no present commitments or agreements with respect to any such transaction, however, the Company may acquire businesses, products or technologies in the future. There can be no assurance that the Company will not require additional financing in the future or, if the Company were required to obtain additional financing in the future, that sources of capital will be available on terms favorable to the Company, if at all.
In April 1997, the Company acquired Counterpoint, a provider of advanced infrared connectivity, by issuing 400,000 shares of the Company's Common Stock in exchange for all of the outstanding common shares of Counterpoint. The acquisition of Counterpoint enables the Company to offer vertically integrated solutions for OEM customers. The merger was accounted for as a pooling of interests. Accordingly, the Company's financial statements include Counterpoint in 1997 and 1996. The Company intends to pursue additional strategic acquisitions of, or strategic investments in, companies with complementary products, technologies or distribution networks in order to broaden its product lines and to provide a more complete virtual enterprise network solution.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit year entries to distinguish 21st century dates from 20th century dates. To address such "Year 2000" issues, the Company established a Year 2000 Project Team which is currently in phase three of its five-phase plan to assess the Company's Year 2000 compliance. In prior phases, the Company identified three key areas critical to successful Year 2000 compliance: products, financial and information systems and third-party relationships. In the current phase, the Company successfully completed testing of current products and does not believe there is significant risk of noncompliance. In addition, the Company replaced or upgraded its core financial, manufacturing and sales systems in the prior two years which were certified as Year 2000 compliant prior to installation. To date, the Company has not incurred significant costs related to Year 2000 compliance. The Company's assessment of the readiness of third-party business partners, including significant vendors and customers, for Year 2000 compliance is scheduled for completion in December of 1998. The Company has not completed a detailed analysis of the cost which may be incurred to address Year 2000 issues. At this time, the Company cannot reasonably estimate the potential impact on its financial position and results of operations if key suppliers, customers and other business partners do not become Year 2000 compliant on a timely basis.
Because many companies may need to upgrade or replace computer systems and software to comply with Year 2000 requirements, the Company believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues as companies expend significant resources to upgrade their current software systems for Year 2000 compliance. These expenditures may result in reduced funds available to purchase products such as those offered by the Company, which could have a material adverse effect on the Company's business and results of operations.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
IN ADDITION TO THE RISK FACTORS DISCUSSED ELSEWHERE IN THIS FORM 10-K, THE FOLLOWING ARE IMPORTANT FACTORS WHICH COULD CAUSE ACTUAL RESULTS OR EVENTS TO DIFFER MATERIALLY FROM THOSE CONTAINED IN ANY FORWARD LOOKING STATEMENTS MADE BY OR ON BEHALF OF THE COMPANY.
POTENTIAL FLUCTUATIONS IN OPERATING RESULTS. The Company's operating results have fluctuated significantly in the past and are likely to fluctuate significantly in the future on a quarterly and an annual basis. Prior growth rates that the Company has experienced in net revenue and net income should not be considered indicative of future growth rates. Factors that could cause the Company's future operating results to fluctuate include the level of demand for the Company's products, the Company's success in developing new products, the timing of new product introductions and product enhancements by the Company and its competitors, market acceptance of the Company's new and enhanced products, the emergence of new industry standards, the timing of customer orders, the mix of products sold, competition, the mix of distribution channels through which the Company's products are sold and general economic conditions. Many of such factors are beyond the Company's control.
The Company typically operates with a relatively small order backlog. As a result, quarterly sales and operating results depend in large part on the volume and timing of orders received within the quarter, which are difficult to forecast. A significant portion of the Company's expense levels is fixed in advance, based in large part on the Company's forecasts of future revenue. If revenue is below expectations in any given quarter, the adverse impact of the shortfall on the Company's operating results may be magnified by the Company's inability to adjust spending to compensate for the shortfall. Therefore, a shortfall in actual revenue as compared to estimated revenue could have a material adverse effect on the Company's business and results of operations.
A substantial majority of the Company's net revenue results from the sale of products to distributors and original equipment manufacturers ("OEMs"), which sales are difficult to predict and may have lower margins than sales through other channels. Sales through such channels may contribute to increased fluctuations in operating results. A significant portion of the Company's revenue in any quarter is typically derived from sales to a limited number of distributors. Any significant deferral of purchases of the Company's products by its distributors could have a material adverse effect on the Company's business and results of operations in any particular period.
The Company has experienced some degree of seasonality of net revenue, and the Company expects to continue to experience seasonality in the future. Net revenue in the first fiscal quarter typically is lower than net revenue in the fourth fiscal quarter, reflecting lower sales in Europe and certain other regions in the summer months when business activities are reduced.
As a result of the foregoing factors, the Company's operating results may be subject to significant volatility. It is likely that in a future period the Company will fail to achieve anticipated operating results. Any shortfall in net revenue, gross margin or net income from levels expected by securities analysts in any period could have an immediate and significant adverse effect on the trading price of the Company's Common Stock.
DEPENDENCE ON RECENTLY INTRODUCED PRODUCTS. The Company's future results of operations will be highly dependent upon the success of recently introduced products, including the ExtendNet VPN, ExtendNet IAS, Advantage Database Server Version 5.0, and certain models of port replicators and ExtendNet print servers. Newly introduced products are subject to a number of risks, including failure to achieve market acceptance and poor product performance. The Company is unable to predict with any degree of certainty the rate of market acceptance of these newly introduced products. No assurance can be given that any of such products will not require additional development work, enhancement, testing or refinement before they achieve market acceptance. If such new and recently introduced products have performance, reliability, quality or other shortcomings, then such products could fail to achieve market acceptance and the Company may experience reduced orders, higher manufacturing costs, delays in collecting accounts receivable and additional warranty and service expenses, which in each case could have a material adverse effect on the Company's business and results of operations.
RISKS ASSOCIATED WITH NEW AND EVOLVING MARKETS. The markets for distributed and mobile network connectivity products are still emerging, and there can be no assurance that they will continue to grow or that, even if the markets grow, the Company's products that address these markets will be successful. The Company's success in generating significant revenue in these evolving markets will depend upon, among other things, its ability to demonstrate the benefits of its technology to potential distributors, OEMs and end users, to maintain and enhance its relationships with leading distributors and to expand successfully its distribution channels. The success of the ExtendNet VPN and ExtendNet IAS products will rely, to a large degree, on the increased use of the Internet by businesses as replacements for, or enhancements to, their private networks.
There can be no assurance that businesses will develop sufficient confidence in the Internet to deploy the Company's products to a significant degree. The inability of the Company to continue to penetrate the existing markets for distributed and mobile network connectivity products or the failure of current markets to grow or new markets to develop or be receptive to the Company's products could have a material adverse effect on the Company's business and results of operations. The emergence of markets for the Company's products will be affected by a number of factors beyond the Company's control. For example, the Company's products are designed to conform to certain standard infrared and networking specifications. There can be no assurance that these specifications will be widely adopted or that competing specifications will not emerge which will be preferred by the Company's customers. In addition, there can be no assurance that infrared technology itself will be adopted as the standard or preferred technology for wireless connectivity or that manufacturers of personal computers will elect to bundle the infrared technology in their products. The emergence of markets for the Company's products is critically dependent upon continued expansion of the market for mobile computing devices and the timely introduction and successful marketing and sale of mobile computing products such as notebook computers and personal digital assistants, of which there can be no assurance.
PRODUCT CONCENTRATION. In 1998, 1997 and 1996, 54%, 64% and 57%, respectively, of the Company's net revenue was derived from sales of ExtendNet print servers. The Company believes that this product line will continue to account for a significant portion of the Company's net revenue and gross profit. The Company expects that its gross margin on sales of ExtendNet print servers will continue to decline as a result of a shift in product mix toward lower priced print servers and competitive pricing pressures. The Company's future operating results, particularly in the near term, are dependent upon the continued market acceptance of ExtendNet print servers. There can be no assurance that ExtendNet print servers will continue to meet with market acceptance or that the Company will be successful in developing, introducing or marketing new or enhanced products. A decline in the demand for ExtendNet print servers, as a result of competition, technological change or other factors, or the failure to successfully develop, introduce or market new or enhanced products could have a material adverse effect on the Company's business and results of operations. The life cycle of ExtendNet print servers is difficult to estimate because of, among other factors, the presence of strong competitors in the market and the likelihood of future competition.
RELIANCE ON DISTRIBUTION CHANNELS. The Company sells its products, domestically and internationally, primarily to distributors and resellers, and to a lesser extent to OEM customers. The Company's success depends on the continued sales efforts of its network of distributors and resellers. The loss of, or reduction in sales to, any of the Company's key customers could have a material adverse affect on the Company's business and results of operations.
The Company provides most of its distributors and resellers with limited product return rights for stock rotation. There can be no assurance that the Company will not experience significant returns in the future or that it will have made adequate allowances to offset such returns. The Company also provides most of its distributors and resellers with price protection rights. Price protection rights require that the Company grant retroactive price adjustments for inventories of the Company's products held by distributors or resellers if the Company lowers its prices for such products. The short life cycles of the Company's products and the difficulty in predicting future sales increase the risk that new product introductions, price reductions by the Company or its competitors or other factors affecting the markets in which the Company competes could result in significant product returns. In addition, new product introductions by competitors or other market factors could require the Company to reduce prices in a manner or at a time which has a material adverse impact upon the Company's business and results of operations.
The Company intends to continue to enhance and diversify its international and domestic distribution channels. None of the Company's distributors or OEMs is obligated to purchase the Company's products except pursuant to current purchase orders. The Company's ability to achieve future revenue growth will depend in large part on its success in recruiting and training sufficient sales personnel, distributors, value added resellers ("VARs") and OEM customers. Sales to OEMs involve a number of potential risks, including lengthy sales cycles and potential competition from OEM customers. Certain of the Company's existing distributors currently distribute, or may in the future distribute, the product lines of the Company's competitors. There can be no assurance that the Company will be able to attract, train and retain a sufficient number of its existing or future third-party distributors or direct sales personnel, that such third-party distributors will recommend, or continue to recommend, the Company's products or that the Company's distributors will devote sufficient resources to market and provide the necessary customer support for such products. The Company's OEM customers may in the future incorporate competing products into their systems or internally develop competing solutions. In the event that the Company's OEM customers reduce their purchases of the Company's products, the Company's future growth would be adversely affected. All of these factors could have a material adverse effect on the Company's business and results of operations.
COMPETITION. The markets for the Company's products are intensely competitive, and are characterized by frequent new product introductions, rapidly changing technology and standards, constant price pressure and competition for distribution channels. The principal competitive factors in the Company's markets include product performance, reliability, price, breadth of product line, sales and distribution capability and technical support and service. Certain of these factors are outside the Company's control. There can be no assurance that the Company will be able to compete successfully in the future with respect to these or any other competitive factors or that competition will not have a material adverse effect on the Company's business and results of operations.
RISKS OF INTERNATIONAL SALES AND OPERATIONS. The Company derives a substantial portion of its net revenue from international sales, principally through its international sales subsidiaries and a limited number of distributors. The Company expects that international sales will continue to represent a substantial portion of its net revenue for the foreseeable future. If any significant international distributor were to cease purchasing products or were to significantly reduce its orders from the Company for any reason, the Company's business and operating results could be materially and adversely affected. International sales are subject to a number of risks, including changes in foreign government regulations, export license requirements, tariffs and taxes, other trade barriers, fluctuations in currency exchange rates, difficulty in collecting accounts receivable, difficulty in staffing and managing foreign operations and political and economic instability, including instability caused by the European monetary union. Many of such factors are beyond the Company's control.
A substantial portion of the Company's international sales are typically denominated in U.S. dollars. As a result, fluctuations in currency exchange rates could cause the Company's products to become relatively more expensive to customers in a particular country, leading to a reduction in sales or profitability in that country. The Company operates sales subsidiaries in France, Germany and the United Kingdom. The sales made through these subsidiaries are primarily denominated in local currencies. Accordingly, the Company's international operations impose a risk upon its business as a result of exchange rate fluctuations. There can be no assurance that exchange rate fluctuations will not have a material adverse effect on the Company's business and results of operations. Payment cycles for international customers are typically longer than those for customers in the United States. There can be no assurance that foreign markets will continue to develop or that the Company will receive additional orders to supply its products for use in foreign markets.
RISKS ASSOCIATED WITH NEW PRODUCT DEVELOPMENT. The markets for the Company's products are characterized by rapidly changing technologies, evolving industry standards, frequent new product introductions and short product life cycles. The Company's future success will depend to a substantial degree upon its ability to enhance its existing products and to develop and introduce, on a timely and cost-effective basis, new products and features that meet changing customer requirements and emerging and evolving industry standards. The Company budgets research and development expenses based on planned product introductions and enhancements; however, actual expenses may differ significantly from budget. The product development process involves a number of risks. The development of new, technologically advanced hardware and software products is a complex and
uncertain process requiring high levels of innovation, as well as the accurate anticipation of technological and market trends. The introduction of new or enhanced products also requires the Company to manage the transition from older products in order to minimize disruption in customer ordering patterns, to avoid excessive levels of older product inventories and to ensure that adequate supplies of new products can be delivered to meet customer demand. There can be no assurance that the Company will successfully develop, introduce or manage the transition to new products. The Company has in the past experienced, and is likely in the future to experience, delays in the introduction of new products, due to factors internal and external to the Company. Any future delays in the introduction or shipment of new or enhanced products, the inability of such products to achieve market acceptance or problems associated with new product transitions could adversely affect the Company's business and results of operations.
RISKS ASSOCIATED WITH THIRD-PARTY MANUFACTURERS AND SUPPLIERS. The Company's future success will depend, in significant part, on its ability to continue to have third parties manufacture its products successfully, cost-effectively and in sufficient volumes to meet customer demand. The Company maintains a limited in-house manufacturing capability for performing materials procurement, final assembly, testing, quality assurance and shipping. The Company relies primarily on independent subcontractors to manufacture its products, and the Company intends to increase its reliance upon third-party manufacturers in the future.
Certain of the Company's products are manufactured in their entirety by third parties. For example, the ExtendNet IAS is manufactured by Apexx Technology, Inc. In addition, the Company's port replicator and in-air and in-car charger products are manufactured by Mobility Electronics. The reliance on third-party manufacturers involves a number of risks, including the potential inability to obtain an adequate supply of products and reduced control over delivery schedules, product quality and product cost. In addition, from time to time the Company has agreed with certain suppliers that the Company will purchase certain components exclusively from such suppliers. Because the manufacturing of the Company's products can involve long lead times, in the event of unanticipated increases in demand for the Company's products, the Company could be unable to manufacture certain products in a quantity sufficient to meet its customers' demands. The Company also relies on third party suppliers for components used in its products. Certain of the components used in the Company's products, including certain semiconductor components and infrared transmission components, are currently available from a limited number of suppliers. Any inability to obtain adequate deliveries or other circumstances that would require the Company to seek alternative manufacturers could affect the Company's ability to ship its products on a timely basis, which could damage relationships with current and prospective customers and end users and could therefore have a material adverse affect on the Company's business and results of operations.
DEPENDENCE ON LICENSED TECHNOLOGY. The Company licenses technology on a non-exclusive basis from several companies for use with its products and anticipates that it will continue to do so in the future. The inability of the Company to continue to license this technology or to license other necessary technology for use with its products, or substantial increases in royalty payments pursuant to third-party licenses, could have a material adverse effect on the Company's business and results of operations. In addition, the effective implementation of the Company's products depends upon the successful operation of this licensed software in conjunction with the Company's products, and therefore any undetected errors in products resulting from such software may prevent the implementation or impair the functionality of the Company's products, delay new product introductions and injure the Company's reputation. Such problems could have a material adverse effect on the Company's business and results of operations.
PRODUCT ERRORS; PRODUCT LIABILITY. Software and hardware products as complex as those offered by the Company typically contain undetected errors when first introduced or as new versions are released. Testing of the Company's products is particularly challenging because it is difficult to simulate the wide variety of computing environments in which the Company's customers may deploy these products. Accordingly, there can be no assurance that, despite testing by the Company and by current and potential customers, errors will not be found after commencement of commercial shipments. Any such errors, or "bugs," could result in dissatisfied customers and the loss of or delay in market acceptance of the new product, any of which could have a material adverse effect upon the Company's business and results of operations. Although to date the Company has not experienced any product liability claims, there can be no assurance that the Company will not face product liability claims in the
future. A successful product liability claim brought against the Company could have a material adverse effect upon the Company's business and results of operations.
MANAGEMENT OF GROWTH. Any future growth experienced by the Company is likely to place a significant strain on the Company's administrative, operational and financial resources and to increase demands on the Company's systems and controls. Future growth may also result in an increase in the scope of responsibility for management personnel. The Company anticipates that growth and expansion will require it to recruit, hire, train and retain a substantial number of new engineering, executive, sales and marketing personnel. As is the case with many technology companies, in the current employment environment the Company has experienced difficulty in recruiting qualified personnel, and continued difficulty in this regard could limit the Company's ability to grow. In order to manage its growth successfully, the Company will continue to expand and improve its operational, management and financial systems and controls. There can be no assurance that the Company will successfully implement such systems and controls on a timely basis. If the Company's management is unable to manage growth effectively, the Company's business and results of operations could be materially adversely affected.
RISKS ASSOCIATED WITH ACQUISITIONS BY THE COMPANY. In April 1997, the Company acquired Counterpoint Systems Foundry, Inc. ("Counterpoint"), a provider of advanced infrared connectivity software. As part of its growth strategy, the Company intends to pursue the acquisition of other companies that either complement or expand its existing business. The Company is continually evaluating potential acquisition opportunities, which may be material in size and scope. Acquisitions involve a number of risks and difficulties, including the expansion into new markets and business areas, the diversion of management's attention to the assimilation of the operations and personnel of the acquired companies, the integration of the acquired companies' management information systems with those of the Company, potential adverse short-term effects on the Company's operating results, the amortization of acquired intangible assets and the need to present a unified corporate image. In addition, acquisitions could result in the need to expend substantial amounts of cash. While the Company believes that it has sufficient funds to finance its operations for at least the next twelve months, to the extent that such funds are insufficient to fund the Company's activities, including any potential acquisitions, the Company may need to raise additional funds through public or private equity or debt financing or from other sources. The sale of additional equity or convertible debt may result in additional dilution to the Company's shareholders and such securities may have rights, preferences or privileges senior to those of the Company's Common Stock. There can be no assurance that additional equity or debt financing will be available or that, if available, it can be obtained on terms favorable to the Company or its shareholders.
There can be no assurance that the Company will be successful in identifying acquisition candidates, that the Company will have adequate resources to consummate any acquisition, that any acquisition by the Company will or will not occur, that if any acquisition does occur it will not have a material adverse effect on the Company's business and results of operations or that any such acquisition will be successful in enhancing the Company's business.
PROPRIETARY RIGHTS AND RISKS OF INFRINGEMENT. There can be no assurance that any patent, trademark or copyright owned by the Company will not be invalidated, circumvented or challenged, that the rights granted thereunder will provide competitive advantages to the Company or that any of the Company's pending or future patent applications will be issued with the scope of the claims sought by the Company, if at all. Further, there can be no assurance that others will not develop technologies that are similar or superior to the Company's technology, duplicate the Company's technology or design around the patents owned by the Company. Effective intellectual property protection may be unavailable or limited in certain foreign countries. There can be no assurance that the steps taken by the Company will prevent misappropriation of its technology by foreign companies.
If the Company were found to be infringing on the intellectual property rights of any third party, the Company could be subject to liabilities for such infringement, which could be material. As a result, the Company could be required to seek licenses from other companies or to refrain from using, manufacturing or selling certain products or using certain processes. Although holders of patents and other intellectual property rights often offer licenses to their patent or other intellectual property rights, no assurance can be given that licenses would be offered, that the terms of any offered license would be acceptable to the Company or that the failure to obtain a license would not adversely affect the Company's business and results of operations.
In order to protect its proprietary rights, the Company may in the future initiate proceedings against third parties. Any litigation, whether brought by or against the Company, could result in the incurrence of significant expenses by the Company. In addition, any such litigation could result in a diversion of management's time and efforts. A claim by the Company against a third party could prompt a counterclaim by the third party against the Company, which could have an adverse effect on the Company's intellectual property rights. Any of the foregoing could result in a material adverse effect on the Company's business and results of operations.
DEPENDENCE ON KEY PERSONNEL. The Company's future success will depend to a significant degree upon the continuing contributions of its key management, engineering, sales and marketing personnel. The Company does not maintain any key person life insurance policies. The loss of key management or technical personnel could adversely affect the Company. The Company believes that its future success will depend in large part upon its ability to attract and retain highly-skilled management, engineering, sales and marketing personnel. In particular, the Company is currently attempting to recruit new engineering personnel; however, there can be no assurance that the Company will be successful at hiring or retaining these personnel. Failure to recruit, hire, train and retain key personnel would limit future growth and could have a material adverse effect on the Company's business and results of operations.
STOCK PRICE VOLATILITY. The trading price of the Company's Common Stock could be subject to wide fluctuations in response to quarter-to-quarter variations in operating results, announcements of technological innovations or new products by the Company or its competitors, general conditions in the computer industry, changes in earnings estimates or recommendations by analysts, or other events or factors. In addition, the public stock markets have experienced extreme price and trading volume volatility in recent months. This volatility has significantly affected the market prices of securities of many technology companies for reasons that may be unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock.
ITEM 7A
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
All of the Company's long-term debt is at fixed interest rates and, therefore, the fair value of these instruments is affected by changes in market interest rates. The Company believes that the market risk arising from its holdings of financial instruments is minimal.
The Company derives a substantial portion of its revenue from international sales, principally through its international subsidiaries in Germany, the United Kingdom and France, and through a limited number of independent distributors. Sales made by the Company's foreign subsidiaries are generally denominated in the foreign country's currency. Fluctuations in exchange rates between the U.S. dollar and other foreign currencies could materially affect the Company's financial condition and results of operations. To the extent that the Company implements hedging activities in the future with respect to foreign currency transactions, there can be no assurance that the Company will be successful in such hedging activities.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted in Item 14 of this Form 10-K.
ITEM 9.
ITEM 9. DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item regarding the Company's directors is incorporated by reference to the Company's definitive Proxy Statement for its 1998 Annual Meeting of Shareholders to be held on November 5, 1998 (the "Proxy Statement").
The information required by this Item regarding the Company's executive officers is incorporated by reference to Item 4A of Report.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to the Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Not applicable.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS
The following financial statements are filed as a part of this report:
2. FINANCIAL STATEMENT SCHEDULES
All schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.
3. EXHIBITS
____________ (1) Incorporated by reference from the Registrant's Registration Statement on Form S-1 (File No. 333-42709) filed with the Commission on March 4, 1998.
(2) Incorporated by reference from the Company's Quarterly Report on Form 10-Q filed with the Commission on May 14, 1998.
* Filed herewith.
(b) REPORTS ON FORM 8-K
Not applicable.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Extended Systems Incorporated
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, shareholders' equity and cash flows present fairly, in all material respects, the financial position of Extended Systems Incorporated and its subsidiaries at June 30, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Boise, Idaho July 27,1998 except as to the Contingencies Note, the date of which is September 2, 1998.
EXTENDED SYSTEMS INCORPORATED CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED JUNE 30, (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
EXTENDED SYSTEMS INCORPORATED CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
EXTENDED SYSTEMS INCORPORATED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED JUNE 30, (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
EXTENDED SYSTEMS INCORPORATED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED JUNE 30, (IN THOUSANDS)
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS
EXTENDED SYSTEMS INCORPORATED Notes to Consolidated Financial Statements
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Extended Systems Incorporated provides distributed and mobile computing solutions that address the needs of the virtual enterprise.
BASIS OF PRESENTATION. The consolidated financial statements include Extended Systems Incorporated, a Delaware corporation, and its wholly owned subsidiaries (the "Company"). All significant intercompany accounts and transactions have been eliminated. Certain reclassifications have been made to the prior year consolidated financial statements to conform to the 1998 presentation.
FOREIGN CURRENCY. The Company translates the accounts of its foreign subsidiaries using the local foreign currency as the functional currency. The assets and liabilities of the foreign subsidiaries are translated into U.S. dollars using exchange rates in effect at the balance sheet date. Gains and losses from this translation process are reflected as a component of shareholders' equity. Revenue and expenses are translated into U.S. dollars using the average exchange rate for the period. The Company recognized net foreign exchange losses of $83,000, $275,000 and $37,000 for the years ended June 30, 1998, 1997 and 1996, respectively.
USE OF ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting periods. Actual results could differ from those estimates.
EARNINGS PER SHARE are calculated pursuant to Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share" and Securities and Exchange Commission Staff Accounting Bulletin No. 98. Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares outstanding increased by the additional common shares that would be outstanding if the potential dilutive common shares had been issued. Diluted earnings per share computations exclude stock options and potential shares for convertible debt to the extent that their effect would have been antidilutive.
REVENUE on hardware products is recognized when products are shipped to customers, including when products are shipped to distributors and resellers. On April 1, 1998, the Company adopted American Institute of Certified Public Accountants Accounting Standards Executive Committee Statement of Position ("SOP") 97-2, "Software Revenue Recognition." Such adoption did not have a material effect on the financial position or results of operations of the Company. Under SOP 97-2, revenue earned under software license agreements is recognized when there is persuasive evidence of a contract, software has been delivered to the customer and accepted, payment is due within twelve months, collectibility is probable and there are no significant obligations remaining. The Company does not provide any material postcontract customer support.
CASH EQUIVALENTS are highly liquid investments with original maturities of three months or less.
INVENTORIES of purchased parts and finished goods are valued at the lower of cost (principally standard cost, which approximates actual cost on a first-in, first-out basis) or market.
RESEARCH AND DEVELOPMENT COSTS are expensed as incurred.
ADVERTISING COSTS are expensed as incurred.
EXTENDED SYSTEMS INCORPORATED Notes to Consolidated Financial Statements, continued
DEFERRED INCOME TAXES are recognized currently for the tax consequences in future years of temporary differences between the tax and financial reporting bases of assets and liabilities at the enacted tax rates. The provision for income taxes includes taxes payable for the period and the change during the period in deferred tax assets and liabilities.
RECENTLY ISSUED ACCOUNTING STANDARDS. In June 1997, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 130, "Reporting Comprehensive Income," which establishes standards for reporting and displaying comprehensive income and its components (revenues, expenses, gains and losses) in the financial statements. This statement requires that an enterprise classify items of other comprehensive income by their nature in a financial statement and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a balance sheet. This statement is effective for fiscal years beginning after December 15, 1997.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information," which establishes standards for public business enterprises to report information about operating segments in annual financial statements and requires those enterprises to report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. This statement requires that a public business enterprise report financial and descriptive information about its reportable operating segments on the basis that it is used internally for evaluating segment performance and deciding how to allocate resources to segments. This statement is effective for financial statements for periods beginning after December 15, 1997.
Management is currently evaluating the effects of adopting SFAS No. 130 and No. 131.
POOLING OF INTERESTS
On April 23, 1997, Counterpoint Systems Foundry, Inc. ("Counterpoint") merged with the Company through the issuance of 400,000 shares of the Company's common stock in exchange for all of the outstanding common stock of Counterpoint.
The merger qualified as a tax-free reorganization and was accounted for as a pooling of interests. Accordingly, the Company's financial statements include Counterpoint for 1997 and 1996 (in thousands):
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and depreciated using the straight-line method over estimated useful lives of 7 to 15 years for land improvements, 7 to 40 years for buildings, 3 to 5 years for computer equipment and 5 to 10 years for furniture and fixtures. Depreciation and amortization of property and equipment were $1,142,000 for 1998, $935,000 for 1997, and $731,000 for 1996.
EXTENDED SYSTEMS INCORPORATED Notes to Consolidated Financial Statements, continued
Property and equipment at June 30 were as follows (in thousands):
LEASES
The Company leases certain office space and equipment. Total lease expense was $209,000 in 1998, $172,000 in 1997 and $133,000 in 1996. The minimum future lease commitments for all operating leases are $152,000 in 1999, $130,000 in 2000, $95,000 in 2001 and $8,000 in 2002.
INCOME TAXES
The provision for income taxes consisted of the following (in thousands):
The tax effects of temporary differences and carryforwards which give rise to the net deferred tax liability were as follows as of June 30 (in thousands):
EXTENDED SYSTEMS INCORPORATED Notes to Consolidated Financial Statements, continued
The effective income tax rate varies from the federal statutory rate of 34% as follows:
LONG-TERM DEBT
Long-term debt consisted of the following at June 30 (in thousands):
The cost and accumulated depreciation of equipment under capital lease were $723,000 and $120,000, respectively, as of June 30, 1998. The lease agreement requires the Company to maintain certain financial ratios.
Aggregate maturities of long-term debt are as follows for the year ended June 30 (in thousands):
The zero coupon promissory notes were issued on September 30, 1992 for $4,000,000, have a maturity value in September 1999 of $7,625,000 and may be converted at anytime at the option of the holders into a total of 495,810 shares of common stock. If held to maturity, the promissory notes will yield 9.25%.
EXTENDED SYSTEMS INCORPORATED Notes to Consolidated Financial Statements, continued
The 10% promissory notes were issued September 30, 1992 and may be converted at anytime prior to maturity in September 1999 at the option of the holders into a total of 61,977 shares of common stock. Interest is paid annually in arrears.
Both the zero coupon and the 10% promissory notes are subordinated in right of payment to future senior indebtedness of the Company.
In the event of a change in control, as defined in the promissory note agreements, or the sale of substantially all of the assets of the Company, the holders may require redemption of the zero coupon and 10% promissory notes at the issue price plus accrued original issue discount. In addition, the Company's outstanding convertible promissory notes limit the Company's ability to pay dividends in the event of payment default or impaired capital.
The Company has a right of first refusal to purchase the zero coupon and the 10% promissory notes or, if converted, the stock.
The Company has a $5 million uncollateralized bank revolving line of credit that expires on October 31, 2000. Interest on borrowings is at the bank's prime rate. The line of credit requires the Company to maintain certain financial ratios. There were no borrowings under this line as of June 30, 1998 or 1997.
CONTINGENCIES
Substantially all of the Company's products are warranted against material and workmanship defects for periods of two to five years from the date of shipment. Warranty costs associated with sales through June 30, 1998 are not expected to be material, therefore, no accrual has been made for such costs.
The Company sold shares of its common stock to employees and others which were not made pursuant to a registration statement filed under the Securities Act of 1933 as amended or any filings pursuant to the laws of any of the states in which such sales occurred ("State Blue Sky Laws"). Appropriate exemptions from the registration and qualification provisions of the Securities Act and State Blue Sky Laws may not have been available. As a result, on June 24, 1998, the Company made a Rescission Offer and purchasers of these securities were entitled to a return of the consideration paid for their stock at applicable statutory rates. However, the amount of the rescission offer to substantially all of such purchasers was less than the estimated fair market value of the Common Stock. The Rescission Offer expired on July 24, 1998. Acceptances of the Rescission Offer did not have a material impact on the financial position or cash flows of the Company.
SHAREHOLDERS' EQUITY
On January 22, 1998, the Company's shareholders approved a 2-for-3 reverse stock split of the Company's Common Stock and a change in the par value from $0.10 to $0.001.
In connection with the issuance of the subordinated promissory notes, the Company reserved 557,787 shares of common stock for issuance upon conversion of the notes.
The Company has three incentive stock option plans, adopted in 1984, 1994, and 1998. Regular employees are eligible for options under these plans. Options granted before December 24, 1997 generally vest 20 % per year over a period of five years from the date of grant. Options granted December 24, 1997 and after vest over a period of four years, vesting 25 % the first year and 1/48 per month thereafter. The exercise price generally is equal to the fair market value of the Company's common stock on the date of grant or at a price determined by the Directors of the Company. For the 1984 and 1994 plans, unexercised options generally lapse ten years after issuance or upon the date the option holder ceases to be an employee
EXTENDED SYSTEMS INCORPORATED Notes to Consolidated Financial Statements, continued
of the Company. Options granted under the 1998 plan lapse ten years after issuance or 90 days after the option holder ceases to be an employee of the Company. Shares available for grant under these plans totaled 1,578,150 and 2,046,000 at June 30, 1998 and 1997, respectively. On December 24, 1997, the Company granted to employees options to purchase 330,421 shares of Common Stock with an exercise price of $8.00 per share. The weighted average fair value was $11.00 per share. The Company recognized $119,000 of compensation expense related to these options in 1998.
The Company also has a restricted stock option plan, adopted in 1987. Regular, full-time employees and directors of the Company are eligible for options under this plan. Terms of the options are determined at the date of grant. Unexercised options generally lapse ten years after issuance or upon the date the option holder ceases to be an employee or director of the Company. Unearned compensation related to these options is recorded at the date of the award based on the market value of the shares and is amortized over the periods during which the restrictions lapse. The plan terminated in September 1997.
During 1997, the Company granted restricted stock options to purchase shares to key employees. As of June 30, 1998, options to purchase 92,031 shares are outstanding, including options to purchase an estimated 36,583 shares which are dependent upon the Company meeting certain future performance criteria. These options vest over periods of up to 3 years. The weighted-average exercise price of the options was $.15 per share and the weighted-average fair value was $7.43 per share. The Company recognized $295,000 and $99,000 of compensation expense related to these options in 1998 and 1997, respectively.
During 1995, the Company granted restricted stock options to purchase 26,667 shares to a key employee with no minimum service periods. The weighted-average exercise price of the options was $.15 per share and the weighted-average fair value was $10.89 per share. In 1995, the Company also granted restricted stock options to two key employees to purchase an estimated maximum of 32,427 shares at exercise prices below the fair market value of the stock. These options vest over periods of 3 to 4 years from date of grant. The weighted-average exercise price was $.15 per share and the weighted-average fair value of the options was $10.42 per share. The Company recognized $15,000, $62,000 and $102,000 of compensation expense related to these options in 1998, 1997 and 1996, respectively.
The Company adopted a director stock plan in 1998. Directors of the Company are eligible for options under this plan. Options are granted at 100% of the fair market value of the Common Stock on the grant date. An initial grant of 15,000 shares per director will vest over a period of three years vesting one third the first year and 1/36 per month thereafter. Subsequent grants of 7,500 shares will be automatically granted to directors each year provided that such directors have served on the Board for at least 6 months. These subsequent options vest in full on the first anniversary date of the date of grant. Unexercised options lapse ten years after issuance or upon the date the option holder ceases to be a director of the Company. Shares available for grant under this plan totaled 205,000 at June 30, 1998.
The Company adopted an employee stock purchase plan in 1998. The plan is implemented by 24-month offering periods beginning on or after the first trading day or after June 30 and December 31 each year, except for the first offering period which commenced on the first trading day of the Company's Common Stock, March 4, 1998. Each offering period contains up to four purchase periods of approximately six months duration. All persons employed by the Company on an enrollment date (the first day of an offering period) are eligible to participate in the purchase plan, provided, however that no employee shall be granted an option under the purchase plan that would result in the employee owning capital stock or options of the Company possessing more than 5% of the total combined voting power of the Company. The purchase plan permits eligible employees to purchase common stock through payroll deductions of up to 15% of an employee's compensation, except that no participant's right to purchase shares may accrue at a rate which exceeds $25,000 each calendar year. The price of stock purchased under the purchase plan is 85% of the lower of the fair market value of the common stock on the first day of an offering period or the last day of each six month purchase period. Employees may end their participation
EXTENDED SYSTEMS INCORPORATED Notes to Consolidated Financial Statements, continued
at any time during a purchase period, and they will be paid their payroll deduction to date. Shares available for purchase under this plan totaled 673,561 at June 30, 1998.
The Company has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation". Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant date as prescribed by SFAS No.123, net income would have decreased to the pro forma amounts indicated below (in thousands):
The fair value of options at date of grant was estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions:
Stock option activity is summarized as follows:
The weighted-average remaining contractual life of options outstanding at June 30, 1998 was 6.32 years. The weighted-average exercise price of options exercisable at June 30, 1998, 1997 and 1996 was
EXTENDED SYSTEMS INCORPORATED Notes to Consolidated Financial Statements, continued
$8.59, $8.36 and $8.19, respectively. The weighted-average exercise prices which were equal to the market price at the date of grant were $7.62, $8.04 and $5.66 for the years ended June 30, 1998, 1997 and 1996, respectively.
EARNINGS PER SHARE
In December 1997, the Company adopted SFAS No. 128, "Earnings per Share," which requires the presentation of basic earnings per share and diluted earnings per share on the face of the income statement. SFAS No. 128 required restatement of all prior earnings per share data presented.
EXTENDED SYSTEMS INCORPORATED Notes to Consolidated Financial Statements, continued
GEOGRAPHIC DATA AND MAJOR CUSTOMERS
The Company's foreign operations were as follows for the years ended June 30 (in thousands):
Sales between geographic areas are accounted for at prices which provide a profit and are in accord with regulations of the governing tax authority. Export net revenues for 1998, 1997 and 1996 were $22.1 million, $17.5 million and $13.0 million, respectively. Sales to one customer accounted for 23%, 19% and 16% of the Company's net revenue in 1998, 1997 and 1996, respectively. Sales to another customer accounted for 11% of net revenue in 1998.
FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF RISK
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and trade accounts receivable. Cash balances held in financial institutions may at times, exceed federally insured amounts. A concentration of credit risk may exist with respect to trade accounts receivable, as primarily all customers are North American and European distributors and manufacturers of computer equipment. The Company performs ongoing credit evaluations on customers and generally does not require collateral. The Company has not experienced significant losses related to receivables.
The carrying amount of debt is considered to be a reasonable approximation of its fair value. Such estimate of fair value was made in accordance with the requirements of SFAS No. 107, "Disclosure about Fair Value of Financial Instruments." The fair value estimate was based on market information available to management as of June 30, 1998. The use of different market assumptions and estimation methodologies could have a material effect on the estimated fair value amounts.
EMPLOYEE BENEFIT PLANS
The Company established the Extended Systems Incorporated 401(k) Investment Plan, a defined contribution benefit plan, effective January 1991. All regular employees are eligible to participate. For all participants having completed six months of service, the Company makes dollar-for-dollar matching contributions to the participants account up to a maximum of 3% of the participant's annual pretax
EXTENDED SYSTEMS INCORPORATED Notes to Consolidated Financial Statements, continued
compensation. The Company's contributions to the plan for the years ended June 30, 1998, 1997 and 1996 were $259,000, $200,000 and $163,000, respectively.
The Company has an employee stock ownership plan. All regular employees credited with at least 1,000 hours of service by the end of the plan year are eligible to participate. No contributions were made for the years ended June 30, 1998, 1997 or 1996.
UNAUDITED QUARTERLY FINANCIAL DATA
Quarterly financial data are as follows for the quarters in the years ended June 30 (in thousands):
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in Boise, Idaho, on September 28, 1998.
Extended Systems Incorporated
By: /s/ Steven D. Simpson ------------------------------------- Steven D. Simpson President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Registrant and in the capacities indicated on September 28, 1998.
SIGNATURE TITLE
/s/ Steven D. Simpson President, Chief Executive Officer and Director - ------------------------- (Principal Executive Officer) Steven D. Simpson
/s/ Karla K. Rosa Vice President, Finance, and Chief Financial Officer - ------------------------- (Principal Financial and Accounting Officer) Karla K. Rosa
Director - ------------------------- Raymond A. Smelek
Director - ------------------------- Gregory M. Avis
/s/ John M. Russell Director - ------------------------- John M.. Russell
/s/ S. Scott Wald Director - ------------------------- S. Scott Wald
/s/ Douglas B. Winterrowd Director - ------------------------- Douglas B. Winterrowd