Item 1.
Business
Our Company
We are a leading provider of innovative products and solutions for the mobile electronics industry. We utilize our proprietary technology to design and develop products that make mobile electronic devices more efficient and cost effective, thus enabling professionals and consumers higher utilization of their mobile devices and the ability to access information more readily.
We have created a broad base of branded and private-label products that focus on providing power, enhancing handheld devices and expanding peripheral computer interface (PCI) capabilities. We primarily sell our products through OEMs such as International Business Machines Corporation (IBM), Dell Inc., Symbol Technologies, Inc., Gateway, Inc. and Apple Computer, Inc.; private-label resellers such as Kensington Technology Group and Targus Group International; distributor Ingram Micro Inc.; retailers such as RadioShack Corporation; resellers such as CDW Corporation and Insight Enterprises, Inc.; and directly to end users through our iGo® brand website, www.igo.com.
Our power products, marketed either under a private-label or our iGo brand, include our range of AC, DC and combination AC/DC universal power adapters. JuiceTM, an iGo branded product, allows users to charge a variety of their electronic devices from AC power sources located in a home, office or hotel room as
well as DC power sources located in automobiles, planes and trains. In addition, our high power Juice products can be used, in combination with our optional peripheral powering system, to simultaneously charge both a portable computer and another peripheral device such as a mobile phone or smart handheld device.
Our other key product categories are handheld solutions, and expansion and docking. Our handheld solutions primarily include charging cradles for handheld devices that allow users to have a direct connection to a network environment. Handheld solutions also include our QuickofficeTM and other software suites that provide word processing, spreadsheet and presentation program capabilities to the users of smartphones and personal digital assistants, or PDAs, that utilize Palm or Symbian operating systems. In addition, our software allows users to edit and sync Microsoft Office documents. Our expansion and docking products include devices designed to increase the storage capacity and computing capability of portable, desktop or server computers.
We believe our competitive advantages include our extensive intellectual property portfolio, the innovative designs and multi-function capabilities of our products, and our broad OEM, private-label reseller and distribution relationships. For example, our Juice family of power products is gaining wide market acceptance and represented a significant component of our revenue growth in 2003. We intend to continue developing and marketing innovative products and solutions for the mobile electronic device user.
Our Industry
Over the past two decades, technological advancements in the electronics industry have greatly expanded mobile device capabilities. Mobile electronic devices, many of which can be used for both business and personal purposes, include portable computers, mobile phones, smartphones, PDAs, handheld devices, digital cameras, camcorders, portable DVD players, MP3 players, and portable game consoles. The popularity of these devices is benefiting from reductions in size, weight and cost and improvements in functionality, storage capacity and reliability. In addition, advances in wireless connectivity technologies, such as Bluetooth and Wi-Fi, have enabled remote access to data networks and the Internet.
Increased functionality and the ability to access and manage information remotely are driving the proliferation of mobile electronic devices and applications. As the work force becomes more mobile and spends more time away from traditional work settings, users have sought out and become reliant on tools that provide management of critical information and access to wireless voice and data networks. Each of these mobile electronic devices needs to be powered and connected when in the home, the office, or on the road, and can be accessorized, representing an opportunity for one or more of our products.
Market for Our Products. Our products support mobile electronic devices in several market categories.
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Mobile Phone Market. According to IDC, the worldwide market for mobile phones is expected to grow at a compounded annual growth rate, or CAGR, of about 8.2% from 535.9 million units in 2003 to about 793.9 million units in 2008. The U.S. market is expected to grow at a CAGR of about 3.3% from 74.7 million units in 2003 to about 87.8 million units in 2008.
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Smart Handheld Device Market. According to IDC, the worldwide market for smart handheld devices, which includes smartphones, PDAs, and other handheld devices, is expected to grow at a CAGR of about 43.8% from 20.0 million units in 2003 to about 85.5 million units in 2007 and the U.S. market for smart handheld devices is expected to grow at a CAGR of about 38.3% from 6.8 million units in 2003 to about 25.1 million units by 2007.
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Portable Computer Market. According to IDC, the worldwide market for portable computers is expected to grow at a CAGR of about 18.5% from 39.7 million units in 2003 to about 78.4 million units in 2007. The U.S. market is expected to grow at a CAGR of about 24.0% from 14.0 million units in 2003 to about 33.1 million units in 2007. We expect these trends to continue.
Industry Challenges. As mobile electronic devices gain widespread acceptance, users will continue to confront limitations on their use, driven by such things as battery life, charging flexibility, compatibility issues, connectivity needs and performance requirements. Furthermore, as users seek to manage multiple devices in their daily routine, the limitations of any one of these functions will tend to be exacerbated.
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Power. Mobile electronic device users, by definition, largely require the use of their devices while away from their home or office. Many mobile electronic devices offer designs and form factors that support portability and travel comfort; however, these mobile devices have limited battery life, which necessitates the need to frequently connect to a power source to operate the device or recharge the battery. A number of factors limit the efficient use and charging of these devices:
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Most power adapters are compatible with either AC-only power sources located in places such as a home, office or hotel room, or DC-only power sources such as those located in automobiles, planes, and trains;
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The majority of power adapters are model-specific requiring a mobile user to carry a dedicated power adapter for each device;
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Mobile electronic devices are generally packaged with only one power adapter and many users purchase additional power adapters for convenience and ease of use; and
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Mobile electronic device users tend to carry multiple devices and at times only one power source is available, such as an automobile’s cigarette lighter, limiting a user’s ability to recharge multiple devices.
Mobile electronic device users, who usually have limited available space in their briefcase or luggage, desire solutions that make their mobile experience more convenient. We believe this creates the need for universal power adapters that have the ability to simultaneously charge multiple mobile electronic devices.
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Handheld Solutions. Handheld devices continue to face challenges with respect to their ability to interface directly with a network and across various software operating systems. Traditional handheld connectivity devices, known as cradles, offer limited options to communicate with networks, computer peripherals and display devices without the presence of a portable or desktop computer. Additionally, commonly used software applications, such as Microsoft Office, are not available on handheld devices using the Palm or Symbian operating systems. We believe the need exists for solutions to address both the connectivity problems and software compatibility issues associated with handheld devices.
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Expansion and Docking. PCI slots are commonly used to expand and extend computing capabilities. Computer manufacturers only provide a limited number of PCI slots in their products, limiting the space available to add additional PCI cards. In addition to expanding PCI slots, portable computer users also often wish to connect to external devices when using their portable computers in a fixed setting. We believe this provides an opportunity for solutions that conveniently and efficiently expand the availability of PCI slots and provide a one-step procedure to connect external devices to portable computers.
Our Solutions
We focus on providing a broad range of solutions that satisfy the overall needs of the mobile electronic device user. Our power, handheld and expansion and docking solutions each address particular challenges as follows:
Power. Our innovative power solutions eliminate the need for mobile electronic device users to carry multiple power adapters to operate and charge their devices. Our AC/DC combination power adapters work with any available power source, including the AC wall outlet in a home, office or hotel room, or the DC cigarette lighter plug in an automobile, airplane, or train. Our patented tip technology allows a user to carry a few lightweight tips in combination with a single adapter to charge a variety of devices, including a substantial portion of the portable computers, mobile phones, smartphones, PDAs, and other mobile electronic devices currently in the market. Further, device users can simultaneously charge multiple devices by using a single adapter and the appropriate tips with our optional 12-watt peripheral powering system, or PPS.
Handheld Solutions. Our leading handheld hardware products are cradles for handheld devices that provide connectivity to a network without the need for a computer and are particularly beneficial where
handheld devices are the user’s primary computing device. Uses include inventory management, logistics and pharmaceutical field trials. Our Quickoffice software suite provides users of smartphones and PDAs that utilize Palm or Symbian operating systems with word processing, spreadsheet, and presentation software capability. In addition, the software allows users to edit and sync Microsoft Word, PowerPoint and Excel documents. We believe that our handheld solutions effectively fill gaps in the offering of the leading handheld device OEMs and software vendors.
Expansion and Docking. We offer a variety of PCI slot expansion products for portable computers, desktop computers and servers. In addition, we offer docking stations for portable computers. These solutions allow the users to cost effectively expand the capability of their existing computing devices and connect to external devices thereby increasing portability, flexibility and performance needed for high-end computing applications without requiring duplicative or redundant hardware. We provide these products to a range of industries, including audio/ video editing, test and measurement, industrial automation, broadcast and telephony.
Our Strategy
We intend to capitalize on our current strategic position in the mobile electronic device market by continuing to introduce innovative high-technology products that suit the needs of a broad range of users in each of our major product areas. It is our goal to be a market leader in each of the product solution categories in which we will compete, and to offer mobile users unique, innovative solutions. Elements of our strategy include:
Continue To Develop Innovative Products. We have a history of designing and developing highly differentiated products to serve the needs and enhance the experience of mobile electronic device users. We intend to continue to develop and market a broad range of highly differentiated products, like our family of power adapters, that address additional markets in which we choose to compete. We also intend to protect our intellectual property position in these markets by aggressively filing for additional patents on an ongoing basis.
Expand Our OEM Relationships. We have relationships with original equipment manufacturers, or OEMs such as IBM, Dell, Symbol, Gateway and Apple where we provide branded and private-label products for a broad range of end-market applications. We intend to continue to expand and strengthen our relationships by designing and manufacturing high quality products to meet the exacting specifications required by our OEM customers.
Leverage Our Strategic Relationships. During 2003 and early in 2004, we entered into strategic relationships with RadioShack, Kensington and Targus to private-label our existing products and co-develop next generation products. We expect that these relationships will significantly increase the availability and exposure of our products, particularly among large national and international retailers such as RadioShack, BestBuy, CompUSA, Circuit City, Wal-Mart, Office Depot and Staples.
Capitalize On Our Strong Distribution Channels. We currently sell our products worldwide through leading distributors including Ingram Micro. We intend to leverage these powerful distribution relationships to enable an efficient distribution channel to provide broad availability of our products.
Pursue Strategic Acquisitions. We intend to continue to evaluate opportunities to acquire complementary businesses, technologies and products that address the mobile electronic device market. We also plan to pursue acquisitions that will enable us to more rapidly develop and bring to market advanced technology, to expand distribution capabilities and/or to penetrate other targeted markets or geographic locations.
Our Products
We provide a broad range of products designed to satisfy the power and connectivity needs experienced by the mobile electronic device user while traveling, at home or in the office. Our products provide customers with solutions specifically in three aspects of mobile computing: versatile power sourcing and charging, increased handheld device functionality and computer expansion and docking. The following is a description of
our primary products by category, which are sold both under our own brand and the private-label brands of our OEMs, and to private-label reseller, distribution and retail customers.
Power. In early 2003, we introduced a combination AC/DC universal power adapter for portable computers, called Juice, which works with any available power source, including the AC wall outlet in a home, office or hotel room, or the DC cigarette lighter plug in an automobile, airplane or train. In addition, we offer a range of DC-only power adapters, more commonly known as auto/air adapters, and a range of AC-only power adapters. This family of power adapter products utilizes our patented tip technology which allows a single power adapter to plug into a substantial portion of the portable computers, mobile phones, smartphones, PDAs, and other handheld devices currently in the market. When our power adapters are combined with our optional 12 watt peripheral powering system, or PPS, the user can simultaneously charge multiple mobile electronic devices, eliminating the need to carry multiple charging adapters.
In addition, we are developing a family of power adapters specifically for various mobile electronic products with lower power requirements, such as mobile phones, smartphones, PDAs, digital cameras, camcorders, portable DVD players, MP3 players, and portable game consoles, including a DC cigarette lighter adapter, an AC mobile adapter, and a combination AC/DC adapter.
The following table highlights the key features of power products that we currently offer.
The following table highlights the key features of power products that are currently in development.
We also develop a range of custom power products for our OEM and private label partners, including unique products that have been, or are being, developed for OEM’s such as IBM, Dell and private-label partners such as Kensington and Targus. Sales of power products represented approximately 54%, 26% and 46% of our total revenue for the years ended December 31, 2003, 2002 and 2001, respectively.
Handheld Solutions. We offer a family of hardware and software solutions that expand the connectivity, flexibility and functionality of handheld and other electronic devices, including smartphones and PDAs.
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Hardware Products. We produce innovative cradles for handheld devices that provide a charging station and direct network connectivity eliminating the need for first connecting to a desktop or portable computer. These cradles enable the use of handheld devices in applications such as inventory management, logistics and pharmaceutical field trials. Our hardware solutions also include our PitchTM product, which allows a user to connect a handheld device to various peripheral devices such as keyboards, mice, and video displays. Pitch also allows a user to conduct presentations directly from a smartphone or PDA, allowing professionals who regularly conduct presentations to use a light-weight handheld device instead of their portable computer. Sales of handheld hardware products represented
approximately 19%, 29% and 0% of our total revenue for the years ended December 31, 2003, 2002 and 2001, respectively.
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Software Products. We offer a software suite called Quickoffice that provides word processing, spreadsheet and presentation program capabilities to the users of smartphone or PDA devices. In addition, the software allows users to edit and sync Microsoft Word, PowerPoint and Excel documents on their handheld devices. Quickoffice is compatible with Palm OS and Symbian, a leading operating system for smartphones. Our software is currently offered as a bundle option with smartphones offered by Nokia, Sony Ericsson, Kyocera, palmOne, Inc., and Samsung Electronics; with PDA devices offered by Sony and AlphaSmart, Inc.; and with Intellisync Corporation’s corporate e-mail software. Sales of handheld software products represented less than 10% of our total revenue for each of the years ended December 31, 2003, 2002 and 2001.
Expansion and Docking. We offer a variety of PCI slot expansion products for portable computers, desktop computers and servers, including PCI to PCI expansion, CardBus to PCI expansion, Switched Fabric Expansion, Split Bridge® and other non-enclosed links and board sets, and Serial PCI and SBus products. These solutions allow the user to cost effectively expand the capability of their computing device, permitting the application of solutions that were not previously possible or that were prohibitively expensive. For example, our expansion products can be used to add necessary storage or PCI capability to an existing server, eliminating the need to purchase additional servers.
Our family of PCI expansion products also provides users of PCI-based systems the portability, flexibility and performance needed for high-end computing applications. We provide these products to a range of industries, including audio/video editing, test and measurement, industrial automation, broadcast, telephony and others that can now have scalable systems that could not previously be used in mobile settings because of system limitations. Sales of expansion and docking products represented approximately 13%, 22% and 27% of our total revenue for the years ended December 31, 2003, 2002 and 2001, respectively.
Accessories. In addition to our other products, we market a number of mobile device accessories such as port replicators, monitor stands, mobile phone accessories and portable computer stands. Sales of accessories and other products represented approximately 10%, 18% and 25% of our total revenue for the years ended December 31, 2003, 2002 and 2001, respectively.
Sales and Marketing
We market and sell our products on a worldwide basis to OEMs, private-label resellers, distributors, resellers, retailers and direct to end users through our iGo website. Our OEM and private-label reseller sales organization is primarily aligned along our core product lines: power, handheld solutions and expansion and docking. In addition, our distribution channel sales team focuses on selling our iGo branded products throughout North America.
We implement a variety of marketing activities to aggressively market our family of products. Such activities include participation in major trade shows, key OEM and distribution catalogs, distribution promotions, reseller and information technology manager advertising, on-line advertising and banner ads, direct mail and bundle advertisements with OEMs and distribution channel partners. In addition, we pursue a strong public relations program to educate the market regarding our products.
Customers
We sell to OEMs, private-label resellers, distributors, resellers, retailers and directly to end users through our iGo website. Our customers include:
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These customers purchase from us through a distributor or private-label reseller.
As a group, the OEMs and private-label resellers, and distributors and retailers listed in the table above accounted for 36% and 29%, respectively, of revenue for the year ended December 31, 2003, compared to 48% and 5% for the year ended December 31, 2002. Our distributors sell a wide range of our products to value-added resellers, system integrators, cataloguers, major retail outlets and certain OEM fulfillment outlets worldwide.
During 2003 and early in 2004, we entered into strategic relationships with RadioShack, Kensington and Targus to private-label our existing products and co-develop next generation products. We expect that these relationships will increase the availability and exposure of our products, particularly among large national and international electronics and office products retailers.
IBM, which purchases brand labeled power products and monitor stands, accounted for 14% of our revenue for the year ended December 31, 2003 and 20% for the year ended December 31, 2002. Symbol, which purchases serial and modem cradles for handheld devices, accounted for 10% of our revenue for the year ended December 31, 2003 and 20% for the year ended December 31, 2002. RadioShack, a retailer of consumer electronic devices, accounted for 15% of our revenue for the year ended December 31, 2003. Ingram Micro, which is a distributor of mobile electronic devices, accounted for 11% of our revenue for the year ended December 31, 2003. No other customer accounted for greater than 10% of sales for the year ended December 31, 2003. International sales were approximately 14% of revenue for each of the years ended December 31, 2003 and 2002. The principal international market we serve is Europe.
As is generally the practice in our industry, a portion of our sales to distributors and resellers is generally under terms that provide for certain stock balancing return privileges and price protection. Accordingly, we make a provision for estimated sales returns and other allowances related to those sales. Returns, which are netted against our reported revenue, were approximately 4% of revenue for the year ended December 31, 2003 and 5% for the year ended December 31, 2002.
Research and Development
Our research and development efforts focus primarily on enhancing our current products and developing innovative new products to address a variety of mobile electronic device needs and requirements. We work with customers, prospective customers and outsource partners to identify and implement new solutions intended to meet the current and future needs of the markets we serve.
As of December 31, 2003, our research and development group consisted of 30 people who are responsible for hardware and software design, test and quality assurance. Electrical design services are provided to us by several of our outsource partners under the supervision of our in-house research and development group. Industrial design services are provided to us primarily by Hotwire Development, LLC, who also works with our in-house design team to generate innovative product concepts. Amounts spent on research and development for the years ended December 31, 2003, 2002 and 2001 were $4.8 million, $5.8 million, and $5.6 million, respectively.
Manufacturing and Logistics
In order to manufacture our products cost-effectively, we have implemented a strategy to outsource substantially all of the manufacturing services for our products. Our internal activities are focused on design, low-volume manufacturing and quality testing and our outsourced manufacturing providers are focused on high-volume manufacturing and logistics.
For example, Hipro Electronics Co., Ltd., a leading designer, developer and manufacturer of a variety of power adapter products based in Taiwan, currently manufactures Juice, our combination AC/DC universal power adapter. In contrast, we focus our internal manufacturing activity on our expansion products, which are low-volume products that require custom engineering support.
We purchase the principal components of our products from outside vendors. The terms of supply contracts are negotiated by us or our manufacturing partners with each vendor. We believe that our present vendors have sufficient capacity to meet our supply requirements and that alternative production sources for most components are generally available without interruption. However, several vendors, including those that provide components for certain of our handheld hardware products, are sole sourced.
The majority of our OEM and private-label products are shipped by our outsource manufacturers to our OEM and private-label reseller customers or their fulfillment hubs. We employ the services of an outsource logistics company to efficiently manage the packaging and shipment of our iGo branded products. The logistics company breaks down and packages the iGo branded products for our various distribution channels.
Competition
The market for our products is intensely competitive, subject to rapid change and sensitive to new product introductions or enhancements and marketing efforts by industry participants. The principal competitive factors affecting the markets for our product offerings include corporate and product reputation, innovation with frequent product enhancement, breadth of integrated product line, product design, functionality and features, product quality, performance, ease-of-use, support and price.
Although we believe that our products compete favorably with respect to such factors, there can be no assurance that we can maintain our competitive position against current or potential competitors, especially those with greater financial, marketing, service, support, technical or other competitive resources. However, we believe that our innovative products, coupled with our strategic relationships with key OEMs, private-label resellers, distributors, resellers and retailers provide us a competitive advantage in the marketplace.
Our power products primarily compete with products offered by specialized third party mobile computing accessory companies, including American Power Conversion, Belkin, Comarco (who distributes via Belkin), Lind, and RRC Power Solutions. In addition, we compete with the internal design efforts of our OEM and non-OEM customers. Our handheld solutions generally compete with products offered by specialized third party accessory companies, including Data Viz. Our expansion products primarily compete with products offered by SBS Communications.
Proprietary Rights
We primarily rely on a combination of patent protection, copyright and trademark laws, trade secrets, nondisclosure agreements and technical measures to protect our proprietary rights. We file domestic and
foreign patent applications to protect our technological position and new product development. As of March 2, 2004 we held 34 U.S. patents and 7 foreign patents and had 62 patents pending.
In general, our patents cover a variety of aspects of the technology utilized in our power, handheld and expansion and docking product lines. We currently license different aspects of our proprietary rights to third parties pursuant to strategic alliances, which often include cross-licensing arrangements.
We typically enter into confidentiality agreements with our employees, distributors, customers and potential customers, and limit access to, and distribution of, our product design documentation and other proprietary information. Moreover, we enter into non-competition agreements with employees, except where restricted by law, whereby the employees are prohibited from working for our competitors for a period of one year after termination of their employment and from sharing confidential information with them as long as the information remains confidential.
Employees
As of December 31, 2003, we had 123 full-time employees, 122 who are located in the United States and 1 who is located in Europe, including 28 employed in operations, 30 in engineering, 37 in sales and marketing and 28 in administration. We engage temporary employees from time to time to augment our full time employees, generally in operations. None of our employees are covered by a collective bargaining agreement. We believe we have good relationships with our employees.
Available Information
Our website is located at http://www.mobilityelectronics.com. We make available free of charge, on or through our website, our annual, quarterly and current reports, and any amendments to those reports, as soon as reasonably practicable after electronically filing such reports with the Securities and Exchange Commission (SEC). Information contained on our website is not part of this report or any other report filed with the SEC.
EXECUTIVE OFFICERS OF THE COMPANY
The following table shows the name, age and position of each of our executive officers as of March 4, 2004:
Charles R. Mollo is one of our founders and has been Chief Executive Officer and Chairman of the Board of Directors since our formation in May 1995, and President since July 1999, having previously served as President between March 1997 and June 1998. From September 1992 to May 1995, Mr. Mollo was the director of the Wireless Telephone Products Division of Andrew Corporation, a communications equipment services and systems company. From September 1986 to July 1992, Mr. Mollo was the Vice President of Corporate Development of Alliance Telecommunications Corporation, a wireless telecommunications company. Between 1980 and 1986, Mr. Mollo was a Vice President of Meadows Resources, Inc., where he managed a venture capital and investment portfolio of approximately $150 million. In the past, he has served on the boards of a number of companies, including Alliance Telecommunications Corporation. Mr. Mollo holds a bachelor’s degree in Electrical Engineering from Manhattan College, a master’s degree in Electrical Engineering from Newark College of Engineering and an MBA from the University of New Mexico.
Joan W. Brubacher began working for us in 1998 as our Senior Financial Analyst, was appointed Controller in 1999 and promoted to Vice President in 2000. She was appointed to the position of Vice President and Chief Financial Officer in 2001 and Executive Vice President and Chief Financial Officer in 2002. Prior to joining us, Ms. Brubacher served as Chief Financial Officer for Phase Laser Systems, Inc., an electronics development/ manufacturing firm. Previously, she served as Chief Financial Officer and subse-
quently as Chief Operating Officer for Laserex, Inc., a laser pointer manufacturing company. Ms. Brubacher began her career with the international public accounting firm Ernst & Whinney (now Ernst & Young) and holds a bachelor’s degree in Business Administration with concentration in Accounting from Kansas State University.
Timothy S. Jeffries joined us in 2002 as Vice President of Worldwide Sales. Mr. Jeffries was appointed Executive Vice President of Worldwide Sales & Services in August 2002, and was appointed Executive Vice President, Global Sales, Marketing & Services in February 2003. He was appointed Executive Vice President and Chief Operating Officer in May 2003. Prior to joining us, Mr. Jeffries served as Vice President, Client Solutions for Viacore, Inc., from 2000 to 2001. Previously, he served as Vice President, Vendor Sales, and later Vice President, Product Management, for Ingram Micro, Inc., a computer products distribution company, from 1997 to 1999. Mr. Jeffries has also held several sales and marketing leadership roles in the high technology industry with companies such as Intelligent Electronics, Inc. and Novell, Inc. Mr. Jeffries holds a bachelor’s degree in Political Science from Santa Clara University and an MBA from Duke University.
RISK FACTORS
Risks Related to Our Business
If our revenue is not sufficient to absorb our expenses, we will not be profitable in the future.
We have experienced significant operating losses since inception and, as of December 31, 2003, have an accumulated deficit of $104.1 million. We intend to make expenditures, specifically in research and development, on an ongoing basis, primarily from cash generated from operations and, if available, from lines of credit, as we develop and introduce new products and expand into new markets. If we do not achieve revenue growth sufficient to absorb our planned expenses, we will experience additional losses in future periods. In addition, there can be no assurance that we will achieve or sustain profitability.
Our future success is dependent on market acceptance of our power products. If acceptance of these products does not continue to grow, we will be unable to increase or sustain our revenue, and our business will be severely harmed. If we do not gain market acceptance of our products and technology, we will be unable to achieve anticipated revenue or maintain revenue.
If we do not achieve widespread market acceptance of our power products and technology, we may not maintain our existing revenue or achieve anticipated revenue. For example, we currently derive a material portion of our revenue from the sale of our recently introduced Juice product. Juice is a power charging product, which is a combination AC/DC power adapter for portable computers, PDAs, and mobile phones. Combination AC/DC power adapters represent a new product category in the mobile electronics industry. We anticipate that a material portion of our revenue in the foreseeable future will be derived from Juice and similar power products in this new market category that we are currently developing or plan to develop. We can give no assurance that this market category will develop sufficiently to cover our expenses and costs or that we will be able to develop similar power products. Moreover, our power products may not achieve widespread market acceptance if:
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we fail to complete development of these products in a timely manner;
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we fail to achieve the performance criteria required of these products by our customers; or
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competitors introduce similar or superior products.
In addition, the retail version of the Juice product includes a universal feature that allows a single version of the product to be used with almost any portable computer. If portable computer manufacturers choose to design and manufacture their products in such a way as to limit the use of universal devices with their computers, it could reduce the applicability of a universal device and limit market acceptance of the product at the retail level.
Our operating results are subject to significant fluctuations, and if our results are worse than expected, our stock price could fall.
Our operating results have fluctuated in the past, and may continue to fluctuate in the future. It is likely that in some future quarter or quarters our operating results will be below the expectations of securities analysts and investors. If this happens, the market price for our common stock may decline significantly. The factors that may cause our operating results to fall short of expectations include:
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the timing of our new product and technology introductions and product enhancements relative to our competitors or changes in our or our competitors’ pricing policies;
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market acceptance of our power, handheld solutions, and expansion and docking products;
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the size and timing of customer orders;
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delay or failure to fulfill orders for our products on a timely basis;
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distribution of or changes in our revenue among OEMs, private-label resellers and distribution partners;
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our inability to accurately forecast our contract manufacturing needs;
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difficulties with new product production implementation or supply chain;
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our suppliers’ ability to perform under their contracts with us;
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product defects and other product quality problems which may result from the development of new products;
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the degree and rate of growth of the markets in which we compete and the accompanying demand for our products;
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our ability to expand our internal and external sales forces and build the required infrastructure to meet anticipated growth; and
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seasonality of sales.
Many of these factors are beyond our control. For these reasons, you should not rely on period-to-period comparisons and short-term fluctuations of our financial results to forecast our future long-term performance.
If we fail to continue to introduce new products and product enhancements that achieve broad market acceptance on a timely basis, we will not be able to compete effectively, and we will be unable to increase or maintain our revenue.
The market for our products is highly competitive and in general is characterized by rapid technological advances, changing customer needs and evolving industry standards. If we fail to continue to introduce new products and product enhancements that achieve broad market acceptance on a timely basis, we will not be able to compete effectively, and we will be unable to increase or maintain our revenue. Our future success will depend in large part upon our ability to:
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develop, in a timely manner, new products and services that keep pace with developments in technology and customer requirements;
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meet potentially new manufacturing requirements and cover potentially higher manufacturing costs of new products;
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deliver new products and services through appropriate distribution channels; and
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respond effectively to new product announcements by our competitors by quickly introducing competing products.
We may not be successful in developing and marketing, on a timely and cost-effective basis, either enhancements to existing products or new products that respond to technological advances and satisfy
increasingly sophisticated customer needs. We depend upon Hotwire Development, LLC to assist us in generating innovative product concepts. If we fail to maintain our relationship with Hotwire, we may not be successful in developing innovative product concepts. If we fail to introduce or sell innovative new products, our operating results may suffer. In addition, if new industry standards emerge that we do not anticipate or adapt to, our products could be rendered obsolete and our business could be materially harmed. Alternatively, any delay in the development of technology upon which our products are based could result in our inability to introduce new products as planned. The success and marketability of technology and products developed by others is beyond our control.
We have experienced delays in releasing new products in the past, which resulted in lower quarterly revenue than expected. For example, the introduction in early 2003 of our AC/DC power combination product, Juice, was delayed approximately 13 weeks due to necessary modifications required to meet safety certification and production start up requirements. Further, our efforts to develop new and similar products could be delayed due to unanticipated manufacturing requirements and costs. Delays in product development and introduction could result in:
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loss of or delay in revenue and loss of market share;
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negative publicity and damage to our reputation and brand;
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decline in the average selling price of our products and decline in our overall gross margins; and
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adverse reactions in our sales and distribution channels.
The average selling prices of our products may decrease over their sales cycles, especially upon the introduction of new products, which may negatively affect our gross margins.
Our products may experience a reduction in the average selling prices over their respective sales cycles. Further, as we introduce new or next generation products, sales prices of previous generation products may decline substantially. In order to sell products that have a falling average selling price and maintain margins at the same time, we need to continually reduce product and manufacturing costs. To manage manufacturing costs, we must collaborate with our third-party manufacturers to engineer the most cost-effective design for our products. There can be no assurances we will be successful in our efforts to reduce these costs. In order to do so, we must carefully manage the price paid for components used in our products as well as manage our freight and inventory costs to reduce overall product costs. If we are unable to reduce the cost of older products as newer products are introduced, our average gross margins may decline.
We depend on large purchases from a few significant customers, and any loss, cancellation or delay in purchases by these customers could cause a shortfall in revenue.
We have historically derived a substantial portion of our revenue from a relatively small number of customers. Our five largest customers comprised 58% of our revenue for the year ended December 31, 2003. These customers typically do not have minimum purchase requirements and can stop purchasing our products at any time or with very short notice. In addition, most customer agreements are short term and non-exclusive and provide for purchases on a purchase order basis. We expect that a small number of customers will continue to represent a substantial percentage of our sales.
For example, RadioShack accounted for 15% of our revenue and IBM accounted for 14% of our revenue for the year ended December 31, 2003. In the event RadioShack, IBM or any of our other major customers reduce, delay or cancel orders with us, and we are not able to sell our products to new customers at comparable levels, our revenue could decline significantly. In addition, any difficulty in collecting amounts due from one or more key customers would negatively impact our result of operations.
Our success depends in part upon sales to OEMs, whose unpredictable demands and requirements may subject us to potential adverse revenue fluctuations.
We expect that we will continue to be dependent upon a limited number of OEMs for a significant portion of our revenue in future periods. No OEM is presently obligated either to purchase a specified amount of products or to provide us with binding forecasts of product purchases for any period. Our products are typically one of many related products used by portable computer users. Demand for our products is therefore subject to many risks beyond our control, including, among others:
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competition faced by our OEM customers in their particular end markets;
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market acceptance of our technology and products by our OEM customers;
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technical challenges which may or may not be related to the components supplied by us;
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the technical, sales and marketing and management capabilities of our OEM customers; and
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the financial and other resources of our OEM customers.
The reduction, delay or cancellation of orders from our significant OEM customers, or the discontinuance of the use of our products by our end users may subject us to potential adverse revenue fluctuations.
Our success is dependent in part upon our relationships with strategic private-label resellers.
During the second quarter of 2003, we entered into relationships with Kensington and Fellowes to sell our power products on a private-label basis. At the end of the fourth quarter of 2003, however, we terminated our relationship with Fellowes because of its failure to place required minimum orders under our agreement, as well as other reasons. Our relationships with strategic private-label resellers are critical to our success. For example, we had expected significant sales of our power products to Fellowes in the fourth quarter of 2003, and because these sales did not materialize, our revenues during this quarter fell below our expectations. In addition, the failure to meet our revenue expectations will, and has, had a negative impact on the price of our common stock. During the first quarter of 2004, we entered into a relationship with Targus to sell our power products on a private-label basis. If Kensington or Targus fail to execute as we anticipate, our revenues will suffer and we will experience additional losses in future periods.
Under the terms of our agreements with Kensington and Targus, our direct access to international markets or to certain U.S. markets has been limited. These agreements provide that we may not enter into any more than two broad-based distribution agreements, thereby currently prohibiting us from entering into any other broad-based distribution agreements. Accordingly, our success will depend in part upon Kensington and Targus’ ability and willingness to effectively and widely distribute and market our products. For example, because both the Kensington and Targus distribution chains include large retailers such as Circuit City, CompUSA, and Fry’s Electronics, we are precluded from distributing to these retailers directly. If Kensington and Targus do not purchase the volume of products that we anticipate, our results of operations will suffer.
Success of the relationship with private-label resellers, such as Kensington and Targus, will also depend in part upon their success in marketing and selling our products on a private-label basis outside of the United States. The international sales by our private-label resellers are subject to a number of risks that could limit sales of our products. These risks include:
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the impact of possible recessionary environments in foreign economies;
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political and economic instability;
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unexpected changes in regulatory requirements;
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export restriction and availability of export licenses; and
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tariffs and other trade barriers.
We outsource the manufacturing and fulfillment of our products, which limits our control of the manufacturing process and may cause a delay in our ability to fill orders.
Most of our products are produced under contract manufacturing arrangements with several manufacturers in China, Taiwan and the United States. Our reliance on third party manufacturers exposes us to risks, which are not in our control, and our revenue could be negatively impacted. Any termination of or significant disruption in our relationship with our manufacturers may prevent us from filling customer orders in a timely manner, as we generally do not maintain large inventories of our products, and will negatively impact our revenue.
Our use of contract manufacturers reduces control over product quality and manufacturing yields and costs. We depend upon our contract manufacturers to deliver products that are free from defects, competitive in cost and in compliance with our specifications and delivery schedules. Moreover, although arrangements with such manufacturers may contain provisions for warranty obligations on the part of contract manufacturers, we remain primarily responsible to our customers for warranty obligations. Disruption in supply, a significant increase in the cost of the assembly of our products, failure of a contract manufacturer to remain competitive in price, the failure of a contract manufacturer to comply with any of our procurement needs or the financial failure or bankruptcy of a contract manufacturer could delay or interrupt our ability to manufacture or deliver our products to customers on a timely basis. In addition, a recurrence of the Severe Acute Respiratory Syndrome, or SARS, outbreak in China could result in quarantines or closures of our third party manufacturers or their suppliers.
Hipro Electronics Company, Ltd. is currently the exclusive manufacturer of our Juice products. Our agreement with Hipro does not permit us to second source our Juice product from any other manufacturer. On occasion, however, OEMs require a relationship with a second qualified manufacturer. Accordingly, unless Hipro allows us to secure a second source for such customers or we are not able to find a manufacturer willing to operate in a back-up relationship to Hipro in circumstances where Hipro can not meet our manufacturing needs, our exclusive arrangement may prevent us from working with some OEMs. In addition, Hipro manufactures our products on a purchase order basis and does not dedicate manufacturing capacity to us. Any disruption in our relationship with Hipro and/or the inability of Hipro to meet our manufacturing needs could harm our business. In order to replace Hipro we would have to identify and qualify an alternative supplier. This process could take several months to complete and would significantly impair our ability to fulfill customer orders.
We generally provide our third-party contract manufacturers with a rolling forecast of demand which they use to determine our material and component requirements. Lead times for ordering materials and components vary significantly and depend on various factors, such as the specific supplier, contract terms and demand and supply for a component at a given time. Some of our components have long lead times. For example, certain electronic components used in our Juice product have lead times that range from six to ten weeks. If our forecasts are less than our actual requirements, our contract manufacturers may be unable to manufacture products in a timely manner. If our forecasts are too high, our contract manufacturers will be unable to use the components they have purchased on our behalf, which may require us to purchase the components from them before they are used in the manufacture of our products.
We rely on a contract fulfillment provider to warehouse our iGo branded finished goods inventory and to ship our iGo branded products to our customers. We do not have a long-term contract with our fulfillment provider. Any termination of or significant disruption in our relationship with our fulfillment provider may prevent customer orders from being fulfilled in a timely manner, as it would require that we relocate our finished goods inventory to another warehouse facility and arrange for shipment of products to our customers.
Our reliance on sole sources for key components may inhibit our ability to meet customer demand.
The principal components of our products are purchased from outside vendors. Several of these vendors are the sole source of supply of the components that they supply. Examples of sole source critical components include two different programmable microprocessors used in various models of our handheld hardware
products. We do not have long term supply agreements with the manufacturers of these components or with our contract manufacturers. We obtain both components and products under purchase orders.
We depend upon our suppliers to deliver components that are free from defects, competitive in functionality and cost and in compliance with our specifications and delivery schedules. Disruption in supply, a significant increase in the cost of one or more components, failure of a supplier to remain competitive in functionality or price, the failure of a supplier to comply with any of our procurement needs or the financial failure or bankruptcy of a supplier could delay or interrupt our ability to manufacture or deliver our products to customers on a timely basis.
Any termination of or significant disruption in our relationship with our suppliers may prevent us from filling customer orders in a timely manner as we generally do not maintain large inventories of components or products. In the event that a termination or disruption were to occur, we would have to find and qualify an alternative source. The time it would take to complete this process would vary based upon the size of the supplier base and the complexity of the component or product. Delays could range from as little as a few days to six months, and, in some cases, a suitable alternative may not be available at all.
If we fail to protect our intellectual property, our business and ability to compete could suffer.
Our success and ability to compete are dependent upon our internally developed technology and know-how. We rely primarily on a combination of patent protection, copyright and trademark laws, trade secrets, nondisclosure agreements and technical measures to protect our proprietary rights. While we have certain patents and patents pending, there can be no assurance that patents pending or future patent applications will be issued or that, if issued, those patents will not be challenged, invalidated or circumvented or that rights granted thereunder will provide meaningful protection or other commercial advantage to us. Moreover, there can be no assurance that any patent rights will be upheld in the future or that we will be able to preserve any of our other intellectual property rights.
We typically enter into confidentiality, noncompete or invention assignment agreements with our key employees, distributors, customers and potential customers, and limit access to, and distribution of, our product design documentation and other proprietary information. There can be no assurance that our confidentiality agreements, confidentiality procedures, noncompetition agreements or other factors will be adequate to deter misappropriation or independent third-party development of our technology or to prevent an unauthorized third party from obtaining or using information that we regard as proprietary. Litigation has been, and will in the future be, necessary to defend our intellectual property rights, which has in the past and could in the future result in substantial cost to, and divisions of efforts by, us.
We may be subject to intellectual property infringement claims that are costly to defend and could limit our ability to use certain technologies in the future.
The laws of some foreign countries do not protect or enforce proprietary rights to the same extent as do the laws of the United States. In addition, under current law, certain patent applications filed with the United States Patent and Trademark Office before November 29, 2000 may be maintained in secrecy until a patent is issued. Patent applications filed with the United States Patent and Trademark Office on or after November 29, 2000, as well as patent applications filed in foreign countries, may be published some time after filing but prior to issuance. The right to a patent in the United States is attributable to the first to invent, not the first to file a patent application. We cannot be sure that our products or technologies do not infringe patents that may be granted in the future pursuant to pending patent applications or that our products do not infringe any patents or proprietary rights of third parties. In the event that any relevant claims of third-party patents are upheld as valid and enforceable, we could be prevented from selling our products or could be required to obtain licenses from the owners of such patents or be required to redesign our products to avoid infringement. There can be no assurance that such licenses would be available or, if available, would be on terms acceptable to us or that we would be successful in any attempts to redesign our products or processes to avoid infringement. Our failure to obtain these licenses or to redesign our products would have a material adverse effect on our business.
There can be no assurance that our competitors will not independently develop technology similar to existing proprietary rights of others. We expect that our products will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. There can be no assurance that third parties will not assert infringement claims against us in the future or, if infringement claims are asserted, that such claims will be resolved in our favor. Any such claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms favorable to us, if at all. In addition, litigation may be necessary in the future to protect our trade secrets or other intellectual property rights, or to determine the validity and scope of the proprietary rights of others. Such litigation could result in substantial costs and diversion of resources. For example, we recently settled a lawsuit with Comarco, Inc. in which each party made patent infringement claims against the other. We incurred significant costs in the lawsuit and devoted substantial time and efforts of certain employees and members of management to this lawsuit.
Acquisitions could have negative consequences, which could harm our business.
We have acquired, and may pursue opportunities to acquire businesses, products or technologies that complement or expand our current capabilities. Acquisitions could require significant capital infusions and could involve many risks including, but not limited to, the following:
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difficulties in assimilating and integrating the operations, products and workforce of the acquired companies;
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acquisitions may negatively impact our results of operations because they may require large one-time charges or could result in increased debt or contingent liabilities, adverse tax consequences, substantial depreciation or deferred compensation charges, or the amortization or write down of amounts related to deferred compensation, goodwill and other intangible assets;
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acquisitions may be dilutive to our existing stockholders;
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acquisitions may disrupt our ongoing business and distract our management; and
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key personnel of the acquired company may decide not to work for us.
We may not be able to identify or consummate any future acquisitions on acceptable terms, or at all. If we do pursue any acquisitions, it is possible that we may not realize the anticipated benefits from such acquisitions.
We may not be able to adequately manage our anticipated growth, which could impair our efficiency and negatively impact operations.
Our success depends on our ability to manage growth effectively. If we do not effectively manage this growth, we may not be able to operate efficiently or maintain the quality of our products. Either outcome could materially and adversely affect our operating results. As we continue to develop new products and bring them to market, we will be required to manage multiple projects, including the design and development of products and their transition to high volume manufacturing. This will place a significant strain on our operational, financial and managerial resources and personnel, our management information systems, and our operational and financial controls. To effectively manage our growth we must:
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increase research and development resources;
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install and implement adequate controls and management information systems in an effective, efficient and timely manner;
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increase the managerial skills of our supervisors;
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maintain and strengthen our relationships with our contract manufacturers and fulfillment provider; and
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more effectively manage our supply chain.
We have experienced returns of our products, which could in the future harm our reputation and negatively impact our operating results.
In the past, some of our customers have returned products to us because the product did not meet their expectations, specifications and requirements. These returns were 4% of revenue for the year ended December 31, 2003 and 5% of revenue for the year ended December 31, 2002. It is likely that we will experience some level of returns in the future and, as our business grows, this level may be more difficult to estimate. A portion of our sales to distributors is generally under terms that provide for certain stock balancing privileges. Under the stock balancing programs, some distributors are permitted to return up to 20% of their prior quarter’s purchases, provided that they place a new order for equal or greater dollar value of the amount returned. We have not historically experienced significant stock balance returns.
Also, returns may adversely affect our relationship with those customers and may harm our reputation. This could cause us to lose potential customers and business in the future. We record a reserve for future returns at the time revenue is recognized. We believe the reserve is adequate given our historical level of returns. If returns increase, however, our reserve may not be sufficient and operating results could be negatively affected.
We may have design quality and performance issues with our products that may adversely affect our reputation and our operating results.
A number of our products are based on new technology and the designs are complex. As such, they may contain undetected errors or performance problems, particularly during new or enhanced product launches. Despite product testing prior to introduction, our products have in the past, on occasion, contained errors that were discovered after commercial introduction. Errors or performance problems may also be discovered in the future. Any future defects discovered after shipment of our products could result in loss of sales, delays in market acceptance or product returns and warranty costs. We attempt to make adequate allowance in our new product release schedule for testing of product performance. Because of the complexity of our products, however, our release of new products may be postponed should test results indicate the need for redesign and retesting, or should we elect to add product enhancements in response to customer feedback. In addition, third-party products, upon which our products are dependent, may contain defects which could reduce or undermine the performance of our products and adversely affect our operating results.
We may incur product liability claims which could be costly and could harm our reputation.
The sale of our products involves risk of product liability claims against us. We currently maintain product liability insurance, but our product liability insurance coverage is subject to various coverage exclusions and limits and may not be obtainable in the future on terms acceptable to us, or at all. We do not know whether claims against us with respect to our products, if any, would be successfully defended or whether our insurance would be sufficient to cover liabilities resulting from such claims. Any claims successfully brought against us could harm our business.
If we are unable to hire additional qualified personnel as necessary or if we lose key personnel, we may not be able to successfully manage our business or achieve our objectives.
We believe our future success will depend in large part upon our ability to identify, attract and retain highly skilled managerial, engineering, sales and marketing, finance and operations personnel. Competition for personnel in the technology industry is intense, and we compete for personnel against numerous companies, including larger, more established companies with significantly greater financial resources. There can be no assurance we will be successful in identifying, attracting and retaining personnel.
Our success also depends to a significant degree upon the continued contributions of our key management, engineering, sales and marketing, finance and manufacturing personnel, many of whom would be difficult to replace. In particular, we believe that our future success depends on Charles R. Mollo, Chief Executive Officer and President, Joan W. Brubacher, Executive Vice President and Chief Financial Officer and Timothy S. Jeffries, Executive Vice President and Chief Operating Officer. We do not maintain key person life insurance on any of our executive officers. Except for Messrs. Mollo and Jeffries and Ms. Brubacher, we do not have employment contracts covering any of our senior management. The loss of the services of any of our key personnel, the inability to identify, attract or retain qualified personnel in the future or delays in hiring required personnel could make it difficult for us to manage our business and meet key objectives, such as timely product introductions.
We may not be able to secure additional financing to meet our future capital needs.
We expect to expend significant capital to further develop our products, increase awareness of our brand names and to expand our operating and management infrastructure as needed to support our anticipated growth. We may use capital more rapidly than currently anticipated. Additionally, we may incur higher operating expenses and generate lower revenue than currently expected, and we may be required to depend on external financing to satisfy our operating and capital needs, including the repayment of our debt obligations. We may be unable to secure additional debt or equity financing on terms acceptable to us, or at all, at the time when we need such funding. If we do raise funds by issuing additional equity or convertible debt securities, the ownership percentages of existing stockholders would be reduced, and the securities that we issue may have rights, preferences or privileges senior to those of the holders of our common stock or may be issued at a discount to the market price of our common stock which would result in dilution to our existing stockholders. If we raise additional funds by issuing debt, we may be subject to debt covenants, such as the debt covenants under our secured credit facility, which could place limitations on our operations including our ability to declare and pay dividends. Our inability to raise additional funds on a timely basis would make it difficult for us to achieve our business objectives and would have a negative impact on our business, financial condition and results of operations.
Risks Related to Our Industry
Intense competition in the market for mobile electronic devices could adversely affect our revenue and operating results.
The market for mobile electronic devices in general is intensely competitive, subject to rapid changes and sensitive to new product introductions or enhancements and marketing efforts by industry participants. We expect to experience significant and increasing levels of competition in the future. There can be no assurance that we can maintain our competitive position against current or potential competitors, especially those with greater financial, marketing, service, support, technical or other competitive resources. Recently, we settled a patent infringement suit with Comarco, one of our competitors in power products, that resulted in a cross license, which does not include the right to sub-license, relating to our respective power product technology. As a result, Comarco may be positioned to develop and market power products that are substantially similar to our products.
We currently compete with the internal design efforts of both our OEM and non-OEM customers. These OEMs, as well as a number of our non-OEM competitors, have larger technical staffs, more established and larger marketing and sales organizations and significantly greater financial resources than we do. There can be no assurance that such competitors will be unable to respond as quickly to new or emerging technologies and changes in customer requirements, devote greater resources to the development, sale and promotion of their products better than we do or develop products that are superior to our products or that achieve greater market acceptance.
Our future success will depend, in part, upon our ability to increase sales in our targeted markets. There can be no assurance that we will be able to compete successfully with our competitors or that the competitive pressures we face will not have a material adverse effect on our business. Our future success will depend in
large part upon our ability to increase our share of our target market and to sell additional products and product enhancements to existing customers. Future competition may result in price reductions, reduced margins or decreased sales.
Should the market demand for mobile electronic devices decrease, we may not achieve anticipated revenue.
The demand for the majority of our products and technology is primarily driven by the underlying market demand for mobile electronic devices. Should the growth in demand for mobile electronic devices be inhibited, we may not be able to increase or sustain revenue. Industry growth depends in part on the following factors:
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increased demand by consumers and businesses for mobile electronic devices; and
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the number and quality of mobile electronic devices in the market.
The market for our products and services depends on economic conditions affecting the broader information technology market. Prolonged weakness in this market has caused in the past and may cause in the future customers to reduce their overall information technology budgets or reduce or cancel orders for our products. In this environment, our customers may experience financial difficulty, cease operations and fail to budget or reduce budgets for the purchase of our products and services. This, in turn, may lead to longer sales cycles, delays in purchase decisions, payment and collection, and may also result in downward price pressures, causing us to realize lower revenue and operating margins. In addition, general economic uncertainty and the recent general decline in capital spending in the information technology sector make it difficult to predict changes in the purchasing requirements of our customers and the markets we serve. We believe that, in light of these events, some businesses have and may continue to curtail or suspend capital spending on information technology. These factors may cause our revenue and operating margins to decline.
If our products fail to comply with domestic and international government regulations, or if these regulations result in a barrier to our business, our revenue could be negatively impacted.
Our products must comply with various domestic and international laws, regulations and standards. For example, the shipment of our products from the countries in which they are manufactured to other international or domestic locations requires us to obtain export licenses and to comply with possible import restrictions of the countries in which we sell our products. In the event that we are unable or unwilling to comply with any such laws, regulations or standards, we may decide not to conduct business in certain markets. Particularly in international markets, we may experience difficulty in securing required licenses or permits on commercially reasonable terms, or at all. In addition, we are generally required to obtain both domestic and foreign regulatory and safety approvals and certifications for our products. Failure to comply with existing or evolving laws or regulations, including export and import restrictions and barriers, or to obtain timely domestic or foreign regulatory approvals or certificates could negatively impact our revenue.
Risks Related to our Common Stock
Our common stock price has been volatile, which could result in substantial losses for stockholders.
Our common stock is currently traded on the Nasdaq National Market. We have in the past experienced, and may in the future experience, limited daily trading volume. The trading price of our common stock has been and may continue to be volatile. The market for technology companies, in particular, has at various times experienced extreme volatility that often has been unrelated to the operating performance of particular companies. These broad market and industry fluctuations may significantly affect the trading price of our common stock, regardless of our actual operating performance. The trading price of our common stock could be affected by a number of factors, including, but not limited to, changes in expectations of our future performance, changes in estimates by securities analysts (or failure to meet such estimates), quarterly fluctuations in our sales and financial results and a variety of risk factors, including the ones described elsewhere in this prospectus. Periods of volatility in the market price of a company’s securities sometimes
result in securities class action litigation. If this were to happen to us, such litigation would be expensive and would divert management’s attention. In addition, if we needed to raise equity funds under adverse conditions, it would be difficult to sell a significant amount of our stock without causing a significant decline in the trading price of our stock.
Our stock price may decline if additional shares are sold in the market.
As of March 4, 2004, we had 27,664,795 shares of common stock outstanding. All of our outstanding shares are currently available for sale in the public market, some of which are subject to volume and other limitations under the securities laws. Future sales of substantial amounts of shares of our common stock by our existing stockholders in the public market, or the perception that these sales could occur, may cause the market price of our common stock to decline. We may be required to issue additional shares upon exercise of previously granted options and warrants that are currently outstanding.
As of March 4, 2004, we had 2,186,551 shares of common stock issuable upon exercise of stock options under our 1996 stock option plan, of which 796,751 options were exercisable as of March 4, 2004; 97,637 shares were available for future issuance under our 1996 stock option plan; 129,685 shares were issuable under options granted outside our plan, of which 14,685 were exercisable as of March 4, 2004; 1,816,903 shares of common stock were issuable under our Employee Stock Purchase Plan; warrants to purchase 255,777 shares of common stock; and 340,628 shares of common stock issuable upon the conversion of 312,991 shares of Series C preferred stock convertible at a 1-to-1.08830 basis. Increased sales of our common stock in the market after exercise of currently outstanding options could exert significant downward pressure on our stock price. These sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price we deem appropriate.
Our executive officers, directors and principal stockholders have substantial influence over us.
As of March 4, 2004, our executive officers, directors and principal stockholders together beneficially own approximately 11.3% of the outstanding shares of common stock. As a result, these stockholders, acting together, may be able to exercise substantial influence over all matters requiring approval by our stockholders, including the election of directors and approval of significant corporate transactions. The concentration of ownership may also have the effect of delaying or preventing a change in our control that may be viewed as beneficial by the other stockholders.
In addition, our certificate of incorporation does not provide for cumulative voting with respect to the election of directors. Consequently, our present directors, executive officers, principal stockholders and our respective affiliates may be able to control the election of the members of the board of directors. Such a concentration of ownership could have an adverse effect on the price of the common stock, and may have the effect of delaying or preventing a change in control, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices.
Provisions of our certificate of incorporation and bylaws could make a proposed acquisition that is not approved by our board of directors more difficult.
Some provisions of our certificate of incorporation and bylaws could make it more difficult for a third party to acquire us even if a change of control would be beneficial to our stockholders. These provisions include:
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authorizing the issuance of preferred stock, with rights senior to those of the common stockholders, without common stockholder approval;
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prohibiting cumulative voting in the election of directors;
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a staggered board of directors, so that no more than two of our five directors are elected each year; and
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limiting the persons who may call special meetings of stockholders.
Our stockholder rights plan may make it more difficult for others to obtain control over us, even if it would be beneficial to our stockholders.
In June 2003, our board of directors adopted a stockholders rights plan. Pursuant to its terms, we have distributed a dividend of one right for each outstanding share of common stock. These rights cause substantial dilution to the ownership of a person or group that attempts to acquire us on terms not approved by our board of directors and may have the effect of deterring hostile takeover attempts. These provisions could discourage a future takeover attempt which individual stockholders might deem to be in their best interests or in which shareholders would receive a premium for their shares over current prices.
Delaware law may delay or prevent a change in control.
We are subject to the provisions of Section 203 of the Delaware General Corporation Law. These provisions prohibit large stockholders, in particular a stockholder owning 15% or more of the outstanding voting stock, from consummating a merger or combination with a corporation unless this stockholder receives board approval for the transaction or 66 2/3% of the shares of voting stock not owned by the stockholder approve the merger or transaction. These provisions could discourage a future takeover attempt which individual stockholders might deem to be in their best interests or in which shareholders would receive a premium for their shares over current prices.
Item 2.
Item 2.
Properties
Our corporate offices are located in Scottsdale, Arizona. This facility consists of approximately 24,000 square feet of leased space pursuant to a lease for which the current term expires on September 30, 2008. Additionally, we lease offices in San Diego, California, Boise, Idaho, and Dallas, Texas. Each of these offices supports our selling, research and development, and general administrative activities. Our San Diego facility is also utilized for light assembly of computer peripheral products. Our warehouse and product fulfillment operations are conducted at a third-party location in Memphis, Tennessee. We believe our facilities are suitable and adequate for our current business activities for the remainder of the lease terms.
Item 3.
Item 3.
Legal Proceedings
Holmes Lundt, et al., plaintiffs, and Jason Carnahan, et. al., intervenors, v. Mobility Electronics, Inc., Portsmith, Inc., Charles R. Mollo, Joan W. Brubacher, Jeffrey R. Harris, Robert P. Dilworth, Larry M. Carr, William O. Hunt, Jerre L. Stead and Darryl Baker, pending in the District Court of the Fourth Judicial District of Idaho, Ada County, Cause No. CV-0C-0302562D. This lawsuit initially was commenced on April 2, 2003, by Holmes Lundt, former President and CEO of Portsmith, Inc., our wholly-owned subsidiary, and his wife, but additional plaintiffs were added, and several of our officers and directors were added as defendants. In their current pleading, the plaintiffs are alleging breach of the Portsmith merger agreement and Mr. Lundt’s employment agreement, wrongful termination of Mr. Lundt, fraudulent misrepresentation, securities fraud, breach of an alleged covenant of good faith and fair dealing, civil conspiracy, and are seeking monetary damages and/or rescission of the Portsmith merger agreement. On February 11, 2004, the court permitted the intervenors to intervene in the lawsuit and the intervenors in turn dismissed a separate lawsuit they had commenced on December 30, 2003. In their current pleading, the intervenors assert claims against the Company, Portsmith, Mr. Mollo and Ms. Brubacher, for breach of contract, breach of an alleged covenant of good faith and fair dealing, unjust enrichment, declaratory judgment, fraud, misrepresentation, concealment, breach of fiduciary duty, constructive trust, conversion, and constructive fraud. Intervenors are seeking monetary damages and/or the recovery of unspecified shares of the Company’s common stock. Among other things, plaintiffs and intervenors dispute that we appropriately calculated and paid the earn-out consideration called for by the Portsmith merger agreement. We intend to vigorously defend against the claims as well as pursue our own claims against the plaintiffs and intervenors.
On February 10, 2004, a stockholder class-action lawsuit was filed against the Company and two of its executive officers in the United States District Court for the District of Arizona. A second stockholder class-action lawsuit was filed on February 20, 2004 against the Company and the same two executive officers in the
same United States District Court for the District of Arizona. These lawsuits assert claims for securities fraud under Sections 10(b), 20(a) and Rule 10b-5 of the Securities Exchange Act of 1934, on behalf of a purported class of persons who purchased our publicly traded securities between September 2, 2003 and January 5, 2004. The complaints generally allege that various public statements made by or on behalf of us were false or misleading when made, that the individual defendants were allegedly aware of material non-public information at the time that they engaged in transactions in our common stock and that members of the purported stockholder class suffered damages when the market price of our common stock declined following disclosure of the information that allegedly had not been previously disclosed. The complaints seek to proceed on behalf of the alleged class described above, seek monetary damages in an unspecified amount and seek recovery of plaintiffs’ costs and attorneys’ fees. We intend to vigorously defend against these claims.
We are from time to time involved in various legal proceedings incidental to the conduct of our business. We believe that the outcome of all such pending legal proceedings will not in the aggregate have a material adverse effect on our business, financial condition, results of operations or liquidity.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of stockholders during the fourth quarter of 2003.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity and Related Stockholder Matters
Our common stock has been traded on the Nasdaq National Market under the symbol “MOBE” since our initial public offering on June 30, 2000. Prior to that time, there was no public market for our common stock. The following sets forth, for the period indicated, the high and low bid prices for our common stock as reported by the Nasdaq National Market.
As of February 27, 2004, we had 324 holders of record of our common stock.
We have never paid cash dividends on our common stock, and it is the current intention of management to retain earnings to finance the growth of our business. We are currently restricted from paying dividends in accordance with the terms of our bank line of credit. Future payment of cash dividends will depend upon financial condition, results of operations, cash requirements, tax treatment, and certain corporate law requirements, loan covenant requirements, as well as other factors deemed relevant by our Board of Directors.
On December 1, 2003, we issued 70,000 shares of our common stock to InVision Wireless, LLC, valued at $11.36 per share, or $795,000, in connection with our acquisition of the hardware business of InVision Software Inc. and InVision Wireless, LLC. This issuance was made in reliance upon the exemption from registration available under Section 4(2) of the Securities Act of 1933 as a transaction by an issuer not involving any public offering.
We incorporate by reference the Equity Compensation Plan Information contained under the heading “Executive Compensation - Securities Authorized for Issuance Under Equity Compensation Plans,” from our definitive Proxy Statement to be delivered to our shareholders in connection with the 2004 Annual Meeting of Shareholders scheduled for May 26, 2004.
Item 6.
Item 6.
Selected Consolidated Financial Data
The following selected consolidated financial data should be read together with our consolidated financial statements and notes thereto, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the other information contained in this Form 10-K. The selected financial data presented below under the captions “Consolidated Statements of Operations Data” and “Consolidated Balance Sheet Data” as of and for each of the years in the five-year period ended December 31, 2003 are derived from our consolidated financial statements, which consolidated financial statements have been audited by KPMG LLP, independent certified public accountants. The consolidated financial statements as of December 31, 2003 and 2002 and for each of the years in the three-year period ended December 31, 2003, are derived from our consolidated financial statements, included elsewhere in this Form 10-K.
(1)
See “Critical Accounting Policies and Estimates - Goodwill” under Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read together with our selected consolidated financial data and the consolidated financial statements and notes thereto contained in this report. The following discussion contains forward-looking statements. Our actual results may differ significantly from the results discussed in these forward-looking statements. Please see the “Disclosure Concerning Forward-Looking Statements” and “Risk Factors” above for a discussion of factors that may affect our future results.
Overview
Increased functionality and the ability to access and manage information remotely are driving the proliferation of mobile electronic devices and applications. The popularity of these devices is benefiting from reductions in size, weight and cost and improvements in functionality, storage capacity and reliability. Each of these devices needs to be powered and connected when in the home, the office, or on the road, and can be accessorized, representing an opportunity for one or more of our products.
We use our proprietary technology to design and develop products that make mobile electronic devices more efficient and cost effective, thus enabling professionals and consumers higher use of these mobile electronic devices and the ability to access information more readily. Our products include power, handheld and expansion and docking products.
We sell our products to OEMs, private-label resellers, distributors, resellers, retailers and end-users. We recently entered into strategic reseller agreements with Kensington and Targus to market and distribute our power products on a private-label basis. We sell to retailers such as RadioShack and through distributors such as Ingram Micro. We also sell directly to end users through our company websites and provide customized solutions to corporate customers. Direct sales to OEMs and private-label resellers accounted for approximately 45% for the year ended December 31, 2003 and 62% of revenue for the year ended December 31, 2002. Sales through retailers and distributors accounted for approximately 45% of revenue for the year ended December 31, 2003 and 12% of revenue for the year ended December 31, 2002. The balance of our revenue during these periods was derived from direct sales to end users. In the future, we expect that we will be dependent upon a relatively small number of customers for a significant portion of our revenue, including most notably RadioShack, Targus, Kensington, IBM, Dell, Symbol, and Ingram Micro.
Our early focus was on the development of DC power adapters and remote peripheral component interface, or PCI, bus technology and products based on our proprietary Split Bridge® technology. We invested heavily in our leading edge Split Bridge technology. While we have had some success with Split Bridge in the corporate portable computer market with sales of universal docking stations, it became clear in early 2002 that this would not be the substantial opportunity we originally envisioned. While we continue to produce and sell products and selectively evaluate opportunities using our Split Bridge technology, we are no longer committing substantial resources to this technology.
In 2002, we repositioned ourselves as a provider of power and connectivity products for mobile electronic devices, including portable computers, PDAs, mobile phones, smartphones, digital cameras and DVD players. Through a combination of acquisitions and internal development, we created a much broader base of innovative products for use with mobile electronic devices by capitalizing on our base of technology and distribution channels.
Our long-term goal is to establish an industry standard for all electronic device power adapters based on our patented tip technology. We also believe there are long-term growth opportunities for our handheld products and technology related to the new smartphones that are being introduced by the major phone manufacturers.
Our 2004 development efforts are focused significantly on the development of our Juice family of power adapter products. In particular, we are collaborating with RadioShack to develop and market a line of power adapters, including cigarette lighter adapters, mobile AC adapters, and low power universal AC/ DC adapters, specifically designed for the low power mobile electronics device market. Each of these devices will
incorporate our patented tip technology and the combination AC/ DC adapter will also allow users to simultaneously charge an ancillary device with our optional PPS accessory.
Our ability to execute successfully on our near and long-term objectives depends largely upon the general market acceptance of our tip technology which allows users to charge multiple devices with a single adapter and our ability to protect this technology through our intellectual property. Additionally, we must execute on the customer relationships that we have developed and continue to design, develop, manufacture and market new and innovative technology and products that are embraced by these customers and the overall market in general.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make a number of estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities.
On an on-going basis, we evaluate our estimates, including those related to bad debt expense, warranty obligations and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:
Revenue Recognition. Revenue from product sales is recognized upon shipments and transfers of ownership from us or our contract manufacturers to the customers. Allowances for sales returns and credits are provided for in the same period the related sales are recorded. Should the actual return or sales credit rates differ from our estimates, revisions to the estimated allowance for sales returns and credits may be required.
Our recognition of revenue from product sales to distributors, resellers and retailers, or the “distribution channel,” is affected by agreements we have giving certain customers rights to return up to 20% of their prior quarter’s purchases, provided that they place a new order for equal or greater dollar value of the amount returned. We also have agreements with certain customers that allow them to receive credit for subsequent price reductions, or “price protection.” At the time we recognize revenue, upon shipment and transfer of ownership, we reduce our measurements of those sales and the related cost of sales by our estimates of future returns and price protection by recording an allowance for sales returns in the amount of the difference between the sales price and the cost of goods sold as a reduction of accounts receivable. Gross sales to the distribution channel accounted for approximately 45% for the year ended December 31, 2003 and 12% of revenue for the year ended December 31, 2002.
For our products, a historical correlation exists between the amount of distribution channel inventory and the amount of returns that actually occur. The greater the inventory held by our distributors, the more product returns we expect. For each of our products, we monitor levels of product sales and inventory at our distributors’ warehouses and at retailers as part of our effort to reach an appropriate accounting estimate for returns. In estimating returns, we analyze historical returns, current inventory in the distribution channel, current economic trends, changes in consumer demand, introduction of new competing products and acceptance of our products.
In recent years, as a result of a combination of the factors described above, we have reduced our gross sales to reflect our estimated amounts of returns and price protection. It is also possible that returns could increase rapidly and significantly in the future. Accordingly, estimating product returns requires significant management judgment. In addition, different return estimates that we reasonably could have used would have had a material impact on our reported sales and thus have had a material impact on the presentation of the
results of operations. For those reasons, we believe that the accounting estimate related to product returns and price protection is a critical accounting estimate.
Inventory Valuation. Inventories consist of finished goods and component parts purchased both partially and fully assembled. We have all normal risks and rewards of our inventory held by contract manufacturers. Inventories are stated at the lower of cost (first-in, first-out method) or market. Inventories include material and overhead costs. Overhead costs are allocated to inventory based on a percentage of material costs. We monitor usage reports to determine if the carrying value of any items should be adjusted due to lack of demand for the items. We make a downward adjustment to the value of our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.
Goodwill Valuation. In conjunction with the implementation of Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets”, (SFAS No. 142), we performed a goodwill impairment evaluation as of January 1, 2002 relating to the goodwill that was recorded at December 31, 2001. Based on the results of that impairment evaluation, we determined the recorded goodwill at December 31, 2001 of approximately $5.6 million was fully impaired. We recorded the impairment write-down as a cumulative effect of change in accounting principle in accordance with the new accounting standard.
As a result of our acquisitions of Portsmith, Cutting Edge Software and iGo during 2002, we have recorded additional goodwill of approximately $13.0 million as of December 31, 2003. In accordance with SFAS No. 142, we evaluated the newly acquired goodwill for impairment and determined that the recorded goodwill was not impaired as of December 31, 2003.
The impairment evaluation process is based on both a discounted future cash flow approach and a market comparable approach. The discounted cash flow approach uses our estimates of future market growth rates, market share, revenue and costs, as well as appropriate discount rates. If we fail to achieve our assumed revenue growth rates or assumed gross margin, we may incur charges for impairment of goodwill in the future. For these reasons, we believe that the accounting estimate related to goodwill impairment is a critical accounting estimate.
Results of Operations
The following table sets forth certain consolidated financial data for the periods indicated expressed as a percentage of total revenue for the periods indicated:
Comparison of Years Ended December 31, 2003, 2002, and 2001
Revenue. Revenue generally consists of sales of products, net of returns and allowances. To date, our revenues have come predominantly from power adapters, handheld products, expansion and docking products, and accessories. The following table summarizes the year-over-year comparison of our revenue for the periods indicated:
The 2003 increase in revenue is primarily due to the introduction of our new combination AC/ DC universal power adapter in January 2003. As a result, sales of power products increased by $19.6 million, or 241.7%, to $27.8 million during the year ended December 31, 2003 as compared to $8.1 million for the year ended December 31, 2002.
The 2002 increase in revenue was primarily a result of our acquisitions of Portsmith, Cutting Edge Software and iGo during 2002. Approximately $9.7 million of the increase was due to sales of handheld hardware and software products through our Portsmith and Cutting Edge Software subsidiaries, which we acquired in February and August 2002, respectively. Approximately $3.8 million of the increase was due to sales of AC and DC power adapters, batteries and accessories through our iGo subsidiary, which we acquired in September 2002. These increases were partially offset by a decrease of approximately $7.3 million in sales of AC and DC power adapters primarily due to the termination of our distribution agreement with Targus in December 2001. We entered into a new distribution agreement with Targus in February 2004. Sales of accessories decreased by approximately $3.0 million during 2002 as a result of general economic conditions
that contributed to a slow down in sales of computers and computer-related products and accessories during that time period.
Cost of revenue. Cost of revenue generally consists of costs associated with components, outsourced manufacturing and in-house labor associated with assembly, testing, packaging, shipping and quality assurance, depreciation of equipment and indirect manufacturing costs. The following table summarizes the year-over-year comparison of our cost of revenue for the periods indicated:
The 2003 increase in cost of revenue was due primarily to the 65.5% volume increase in revenue. Cost of revenue as a percentage of revenue decreased to 65.3% for the year ended December 31, 2003 from 76.7% for the year ended December 31, 2002. The reduction in cost of revenue as a percentage of revenue is primarily attributable to the spreading of fixed overhead expenses over increases in sales volumes and the introduction of new higher-margin power products during 2003.
The 2002 decrease in cost of revenue was primarily due to a $3.8 million charge to cost of revenue for excess and obsolete inventory and abandoned tooling for the year ended December 31, 2001. This decrease was partially offset by a similar charge for excess and obsolete inventory of $1.2 million during 2002. Cost of revenue as a percentage of revenue decreased to 76.7% for the year ended December 31, 2002 from 90.7% for the year ended December 31, 2001. Excluding the charges for excess and obsolete inventory and abandoned tooling, cost of revenues as a percentage of revenue was 75.0% and 78.6% for the years ended December 31, 2002 and 2001, respectively. The reduction in cost of revenues as a percentage of revenue was primarily attributable to the spreading of fixed overhead expenses over increases in sales volumes.
Gross profit. The following table summarizes the year-over-year comparison of our gross profit for the periods indicated:
Gross margins increased to 34.7% for the year ended December 31, 2003 from 23.3% for the year ended December 31, 2002. The increase in gross margins was primarily due to the introduction of the new higher-margin combination AC/ DC power adapter product in January 2003. Gross profit was also positively impacted by the spreading of fixed overhead expenses over increases in sales volumes.
Gross margins increased to 23.3% for the year ended December 31, 2002 from 9.3% for the year ended December 31, 2001. The increase in gross margins was due primarily to a $3.8 million charge to cost of revenue for excess and obsolete inventory and abandoned tooling for the year ended December 31, 2001, offset by a similar charge of approximately $1.2 million during 2002. Excluding these charges, gross profit was 27.3% and 22.5% for the years ended December 31, 2002 and 2001, respectively. Gross profit was also positively impacted by the change in product mix during 2002.
Sales and marketing. Sales and marketing expenses generally consist of salaries, commissions and other personnel related costs of our sales, marketing and support personnel, advertising, public relations, promotions, printed media and travel. The following table summarizes the year-over-year comparison of our sales and marketing expenses for the periods indicated:
The 65.5% increase in revenue for the year ended December 31, 2003 as compared to the year ended December 31, 2002, was primarily a result of increased sales through distribution channels which did not require a corresponding increase in sales and marketing expenses. As a result, sales and marketing expenses as a percentage of revenue decreased to 13.9% for the year ended December 31, 2003 from 22.6% for the year ended December 31, 2002.
The 2002 decrease in sales and marketing expenses primarily resulted from a reduction in marketing programs due to our decision to focus our marketing efforts on what we deemed to be the most productive sales channels. As a percentage of revenue, sales and marketing expenses decreased to 22.6% for the year ended December 31, 2002 from 28.7% for the year ended December 31, 2001.
Research and development. Research and development expenses consist primarily of salaries and personnel-related costs, outside consulting, lab costs and travel related costs of our product development group. The following table summarizes the year-over-year comparison of our research and development expenses for the periods indicated:
While research and development expenses for the year ended December 31, 2003 decreased as compared to the year ended December 31, 2002, research and development expenses in 2002 included $620,000 of in-process research and development recorded in connection with the acquisition of Cutting Edge Software and $400,000 associated with the write-down of certain tooling equipment which was never used in production. Excluding these charges, research and development expense for 2002 was $4.8 million which is consistent with research and development expenses for 2003.
Excluding the $1.0 million of charges in 2002, research and development expenses for the year ended December 31, 2002 decreased as compared to the year ended December 31, 2001 due to reductions in engineering expenses and staff as a result of the development of Split Bridge technology, which was largely developed in 2000 and the early part of 2001.
General and administrative. General and administrative expenses consist primarily of salaries and other personnel-related expenses of our finance, human resources, information systems, corporate development and other administrative personnel, as well as facilities, professional fees, depreciation and amortization and related expenses. The following table summarizes the year-over-year comparison of our general and administrative expenses for the periods indicated:
The increase in general and administrative expenses for the year ended December 31, 2003 compared to the year ended December 31, 2002 is due primarily to costs incurred in connection with litigation of a patent infringement matter that was settled in July 2003 of approximately $750,000 and an increase of approximately $200,000 in bad debt expense resulting from the increase in sales and accounts receivable during 2003. The balance of the increase was primarily due to information system consolidation and integration efforts relating to our acquisitions of Portsmith, Cutting Edge, and iGo in 2002. General and administrative expenses as a percentage of revenue decreased to 18.2% for the year ended December 31, 2003 from 26.2% for the year ended December 31, 2002.
For the year ended December 31, 2001, general and administrative expenses included a write-off of a $3.0 million loan to a strategic partner and also included goodwill amortization of $600,000 relating to the acquisition of Magma in October 2000. Excluding the 2001 write-off and goodwill amortization, general and administrative expenses for the year ended December 31, 2002 increased approximately $1.8 million, primarily due to severance and termination costs and increases in general and administrative expenses, including personnel, facilities, travel and telecommunications as a result of the acquisitions of Portsmith, Cutting Edge Software and iGo. Excluding the 2001 charge and goodwill amortization, general and administrative expenses as a percentage of total revenue increased to 26.2% for the year ended December 31, 2002 from 22.4% for the year ended December 31, 2001.
Interest, net. Interest, net consists primarily of interest earned on our cash balances and short-term investments, net of interest expense. Interest expense relates to our line of credit entered into in October 2002. The following table summarizes the year-over-year comparison of interest, net for the periods indicated:
The decreases for the years ended December 31, 2003 and 2002 were primarily due to a reduction in interest income due to decreases in average cash balances in both 2003 and 2002 and an increase in interest expense due to interest paid on borrowings under our line of credit in 2003. For the year ended December 31, 2003, interest expense was $171,000 and interest income was $144,000. Interest expense was less than $5,000 for the year ended December 31, 2002.
Income taxes. We have incurred losses from inception to date; therefore, no provision for income taxes was required for the years ended December 31, 2003, 2002, and 2001. Based on historical operating losses and projections for future taxable income, it is more likely than not that we will not fully realize the benefits of the net operating loss carryforwards. Thus, we have not recorded a tax benefit from our net operating loss carryforwards for the year ended December 31, 2003.
Operating Outlook
For 2004, we anticipate revenues of at least $80 million, or at least a 53% increase from 2003, with both revenues and profitability trending progressively higher each quarter. Our 2004 outlook is based on the following expectations:
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An IDC forecasted portable computer growth rate for the U.S. of 38% in 2004.
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A full year of revenue from our combination AC/ DC power adapter programs with IBM and Dell, compared to nine months and less than one month, respectively, in 2003.
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A full year of revenue from sales of power adapters designed for use with portable computers to RadioShack, compared to approximately six months of revenue in 2003.
•
A full year of revenue from sales of power adapters to Kensington’s domestic and international channels, compared to six months and three months, respectively, in 2003.
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Nearly a full year of revenue from sales of power adapters to Targus’ domestic and international channels, compared to no revenue in 2003 from either channel.
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A half year of revenue from sales of power adapters designed for use with lower-power mobile electronic devices to RadioShack, other Mobility distribution channels, and potential new distribution channels, compared to no revenue contribution in 2003.
•
Modest growth in sales of handheld hardware and software products and expansion and docking products.
We expect gross margin to increase slightly for 2004 from our 34.7% gross margin for 2003. In the first half of 2004, we expect our gross margin percentage to be at, or slightly below, our 2003 gross margin percentage as a result of our anticipated product mix which includes a higher mix of OEM product sales at typically lower gross margins. However, we expect our gross margin percentage to increase in the second half of the year as we begin to sell power adapters designed for use with lower-power mobile electronic devices to RadioShack. Revenue relating to the sales of these products to RadioShack will be recognized on a net basis resulting in a gross margin of 100% as RadioShack will be our contract manufacturer and a customer for these products. As a result, we will only recognize revenue equal to the mark-up on the resale of these products to RadioShack, with no associated cost of goods sold.
We believe that operating expenses will increase by approximately 14-18% during 2004, although we anticipate that they will trend down as a percentage of revenue. We expect sales and marketing expenses to remain relatively consistent, or to increase slightly, as our anticipated revenue growth continues to come from distribution channels that do not require additional investment in sales and marketing expenses. Research and development expenses are expected to increase significantly during 2004 as we continue to aggressively develop new power and handheld hardware and software products. We also expect general and administrative expenses to increase in 2004 primarily as a result of increased expenses associated with Sarbanes-Oxley compliance and expenses associated with litigation in which we are currently involved.
We do not expect to record any income tax expense or benefit related to net operating loss carryforwards during 2004.
We are currently a party to various legal proceedings. We do not believe that the ultimate outcome of these legal proceedings will have a material adverse effect on our financial position or overall trends in results of operations. However, litigation is subject to inherent uncertainties and unfavorable rulings could occur. An unfavorable ruling could include money damages or the issuance of additional securities which would further dilute our existing stockholders. If an unfavorable ruling were to occur in any specific period, such a ruling could have a material adverse impact on the results of operations of that period, or future periods.
As a result of our planned research and development efforts, we expect to further expand our intellectual property position by aggressively filing for additional patents on an ongoing basis. A portion of these costs are recorded as research and development expense as incurred and a portion are amortized as general and
administrative expense. We may also incur additional legal and related expenses associated with the defense and enforcement of our intellectual property portfolio, which could increase our general and administrative expenses beyond those currently planned.
Liquidity and Capital Resources
The following table sets forth for the period presented certain consolidated cash flow information (in thousands):
Cash and Cash Flow. Our cash balances are held in the United States and the United Kingdom. Our intent is that the cash balances will remain in these countries for future growth and investments and we will meet any liquidity requirements in the United States through ongoing cash flows, external financing, or both. Our primary use of cash has been to fund our operating losses, working capital requirements, acquisitions and capital expenditures necessitated by our growth. The growth of our business has required, and will continue to require, investments in accounts receivable and inventories. Our primary sources of liquidity have been funds provided by issuances of equity securities and borrowings under our line of credit.
•
Net cash used in operating activities. Cash was used in operating activities for the year ended December 31, 2003 primarily to fund operating losses and working capital necessary to support our growing revenue base. Specifically, cash was used to fund accounts receivable and inventory growth that resulted from our 65.5% increase in revenues in 2003 as compared to 2002. In 2004, we expect to generate positive cash flow from operating activities from expected operating income, offset partially by cash used to fund further working capital needs. Our consolidated cash flow operating metrics are as follows:
The improvement in DSOs during 2003 compared to 2002, as well as the decline in DSOs during 2002 compared to 2001, is primarily as a result of a shift in customer mix. We anticipate further improvement in DSOs during 2004 as we continue to leverage our key OEM, private-label reseller and retail customer relationships. The reduction in inventory turns was primarily as a result of growth in handheld hardware product inventory during 2002 and 2003. We expect to reduce our levels of handheld hardware product inventory during 2004.
•
Net cash used in investing activities. For the year ended December 31, 2003, net cash used in investing activities was primarily for the purchase of property and equipment. We anticipate future investment in capital equipment, primarily for tooling equipment to be used in the production of new products.
•
Net cash (used in) provided by financing activities. Net cash provided by financing activities for the year ended December 31, 2003 was primarily from net proceeds from the sale of 2,400,000 shares of
common stock of $13.8 million, the sale of Series E and Series F preferred stock of $1.2 million, exercises of stock options and warrants of $1.9 million, and collections of stock subscription receivables of $1.3 million. Although we expect to generate cash flows from operations sufficient to support our operations, we may issue additional shares of stock in the future to generate cash for growth opportunities.
As of December 31, 2003, we had approximately $95 million of federal, foreign and state net operating loss carryforwards which expire at various dates. We anticipate that the sale of common stock in our initial public offering coupled with prior sales of common stock will cause an annual limitation on the use of our net operating loss carryforwards pursuant to the change in ownership provisions of Section 382 of the Internal Revenue Code of 1986, as amended. This limitation is expected to have a material effect on the timing of our ability to use the net operating loss carryforward in the future. Additionally, our ability to use the net operating loss carryforward is dependent upon our level of future profitability, which cannot be determined.
Financing Facilities. In October 2002, we entered into a $10.0 million bank line of credit. The line bears interest at prime plus 2.0%, which was 6.0% as of December 31, 2003, interest only payments due monthly, with final payment of interest and principal due on July 31, 2004. The line of credit is secured by all of our assets and subject to financial covenants, with which we were in compliance as of December 31, 2003. We had no outstanding balance against this line of credit as of December 31, 2003. Under the terms of the line, we can borrow up to 80% of eligible accounts receivable. At December 31, 2003, our net borrowing base capacity was $5.0 million. During 2004, we expect to negotiate a new line of credit with terms that are substantially similar to our existing line of credit.
Contractual Obligations. In our day-to-day business activities, we incur certain commitments to make future payments under contracts such as operating leases and purchase orders. Maturities under these contracts are set forth in the following table as of December 31, 2003, in thousands:
Off-Balance Sheet Arrangements. We have no off-balance sheet financing arrangements.
Acquisitions. Our strategy includes the possible acquisition of other businesses to expand or complement our operations. The magnitude, timing and nature of any future acquisitions will depend on a number of factors, including the availability of suitable acquisition candidates, the negotiation of acceptable terms, our financial capabilities and general economic and business conditions. Financing of future acquisitions would result in the utilization of cash, incurrence of additional debt, or both.
Liquidity Outlook. Based on our projections for 2004, we believe that our existing cash and cash equivalents will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months. If we require additional capital resources to grow our business internally or to acquire complementary technologies and businesses at any time in the future, we may use our line of credit or seek to sell additional equity or debt securities. The sale of additional equity or convertible debt securities would result in more dilution to our stockholders. However, upon the expiration of our existing line of credit arrangement on July 31, 2004, financing arrangements may not be available to us, or may be available in amounts or on terms that are not acceptable to us.
Recent Accounting Pronouncements
On May 15, 2003, the Financial Accounting Standards Board issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. The Statement requires issuers to classify as liabilities (or assets in some circumstance) three classes of freestanding financial instruments that embody obligations for the issuer. Generally, the Statement is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after September 15, 2003. We adopted the provisions of the Statement on July 1, 2003. There was no impact from the adoption of this statement.
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“Interpretation 46”) which was then revised in December 2003. Interpretation 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The recognition and measurement provisions of Interpretation 46 are effective for newly created variable interest entities formed after January 31, 2003, and for existing variable interest entities, on the first interim or annual reporting period beginning after December 15, 2003. We adopted the provisions of Interpretation 46 for existing variable interest entities on July 1, 2003. As of December 31, 2003, we do not have any variable interest entities.
In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in periods beginning after June 15, 2003. We have adopted the provisions of EITF Issue No. 00-21 on July 1, 2003, which did not have a material effect on our consolidated financial statements.
In December 2003, the Securities and Exchange Commission (“SEC”) issued staff accounting bulleting No. 104 (“SAB 104”) “Revenue Recognition,” which codifies, revises and rescinds certain sections of Staff Accounting Bulletin No. 101 “Revenue Recognition,” in order to make this interpretive guidance consistent with current authoritative accounting guidance and SEC rules and regulations. The changes noted in SAB 104 did not have a material effect on our consolidated financial statements.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
We are exposed to certain market risks in the ordinary course of our business. These risks result primarily from changes in foreign currency exchange rates and interest rates. In addition, our international operations are subject to risks related to differing economic conditions, changes in political climate, differing tax structures and other regulations and restrictions.
To date we have not utilized derivative financial instruments or derivative commodity instruments. We do not expect to employ these or other strategies to hedge market risk in the foreseeable future. We invest our cash in money market funds, which are subject to minimal credit and market risk. We believe that the market risks associated with these financial instruments are immaterial.
See “Liquidity and Capital Resources” for further discussion of our financing facilities and capital structure. Market risk, calculated as the potential change in fair value of our cash and cash equivalents and line of credit resulting from a hypothetical 1.0% (100 basis point) change in interest rates, was not material at December 31, 2003.
Item 8.
Item 8.
Financial Statements and Supplementary Data
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
INDEPENDENT AUDITORS’ REPORT
The Board of Directors
Mobility Electronics, Inc.
We have audited the accompanying consolidated balance sheets of Mobility Electronics, Inc. and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards 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. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mobility Electronics, Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
As described in Note 2 of the consolidated financial statements, Mobility Electronics, Inc. and subsidiaries adopted the provisions of Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets, as of January 1, 2002.
/s/ KPMG LLP
Phoenix, Arizona
February 4, 2004
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes to consolidated financial statements.
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME (LOSS)
See accompanying notes to consolidated financial statements.
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2003, 2002 and
(1) Nature of Business
Mobility Electronics, Inc. and subsidiaries (collectively, “Mobility” or the “Company”) formerly known as Electronics Accessory Specialists International, Inc., was formed on May 4, 1995. Mobility was originally formed as a limited liability corporation; however, in August 1996 the Company became a C Corporation incorporated in the State of Delaware.
Mobility designs, develops, manufactures and/or distributes AC and DC power adapters, portable computer docking stations, handheld device cradles, handheld software, monitor stands and other portable computing products and solutions. Mobility also designs, develops and markets connectivity and remote PCI bus technology and products for the computer industry and a broad range of related embedded processor applications. Mobility distributes products in the United States of America, Canada and Europe.
(2) Summary of Significant Accounting Policies
(a) Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make a number of estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to bad debts, sales returns, inventories, warranty obligations, and contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
The Company believes its critical accounting policies, consisting of revenue recognition, inventory valuation and goodwill valuation affect its more significant judgments and estimates used in the preparation of its consolidated financial statements. These policies are discussed below.
(b) Principles of Consolidation
The 2001 consolidated financial statements include the accounts of Mobility and its wholly owned subsidiaries, Magma, Inc. and Mobility Europe Holdings, Inc. The 2002 and 2003 consolidated financial statements include the accounts of Mobility and its wholly owned subsidiaries, Magma, Inc., Portsmith, Inc., from February 1, 2002 (date of acquisition) and Mobility 2001 Limited, Cutting Edge Software, Inc. from August 20, 2002 (date of acquisition) and iGo Direct Corporation from September 3, 2002 (date of acquisition) collectively to December 31, 2002 and 2003, respectively. All significant intercompany balances and transactions have been eliminated in consolidation.
(c) Revenue Recognition
The Company recognizes net revenue when the earnings process is complete, as evidenced by an agreement with the customer, transfer of title and acceptance, if applicable, as well as fixed pricing and probable collectibility. Revenue from product sales is recognized upon shipment and transfer of ownership from the Company or contract manufacturer to the customer. Allowances for sales returns and credits are provided for in the same period the related sales are recorded. Should the actual return or sales credit rates differ from the Company’s estimates, revisions to the estimated allowance for sales returns and credits may be required. Revenue from software and technology license fees is recognized over the term of the respective sales or license agreement. Certain license agreements contain no stated termination date, whereby the
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Company recognizes the revenue over the estimated life of the license. Should the actual life differ from the estimates, revisions to the estimated life may be required.
(d) Cash and Cash Equivalents
All short-term investments purchased with an original maturity of three months or less are considered to be cash equivalents. Cash and cash equivalents include cash on hand and amounts on deposit with financial institutions.
(e) Accounts Receivable
Accounts receivable consist of trade receivables from customers and short-term notes receivable. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of the Company’s customers to make required payments. The allowance is assessed on a regular basis by management and is based upon management’s periodic review of the collectibility of the receivables with respect to historical experience. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. The Company also maintains an allowance for sales returns and credits in the amount of the difference between the sales price and the cost of goods sold based on management’s periodic review and estimate of returns. Should the actual return or sales credit rates differ from the Company’s estimates, revisions to the estimated allowance for sales returns and credits may be required.
(f) Inventories
Inventories consist of finished goods and component parts purchased partially and fully assembled for computer accessory items. The Company has all normal risks and rewards of its inventory held by contract manufacturers. Inventories are stated at the lower of cost (first-in, first-out method) or market. Inventories include material and overhead costs. Overhead costs are allocated to inventory based on a percentage of material costs. The Company monitors usage reports to determine if the carrying value of any items should be adjusted due to lack of demand for the items. The Company adjusts down the inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.
(g) Property and Equipment
Property and equipment are stated at cost. Depreciation on furniture, fixtures and equipment is provided using the straight-line method over the estimated useful lives of the assets ranging from two to seven years. Tooling is capitalized at cost and is depreciated over a two-year period.
(h) Goodwill
Beginning in 2002, with the adoption of FASB Statement No. 142, “Goodwill and Other Intangible Assets” (“Statement 142”), goodwill is no longer amortized but instead tested for impairment at least annually. Prior to 2002, goodwill was amortized using the straight-line method over its estimated period of benefit. In 2002, the carrying value of goodwill exceeded the fair value of the reporting unit and the Company recorded an impairment loss of $5,627,000.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(i) Intangible Assets
Intangible assets include the cost of patents, trademarks and non-compete agreements, as well as identifiable intangible assets acquired through business combinations including trade names, customer lists and software technology. Intangible assets are amortized on a straight-line basis over their estimated economic lives of two to 10 years. We periodically evaluate the recoverability of intangible assets and take into account events or circumstances that warrant revised estimates of useful lives or that indicate that an impairment exists. All of the Company’s intangible assets are subject to amortization.
(j) Warranty Costs
The Company provides limited warranties on certain of its products for periods generally not exceeding three years. The Company accrues for the estimated cost of warranties at the time revenue is recognized. The accrual is based on the Company’s actual claim experience. Should actual warranty claim rates, or service delivery costs differ from our estimates, revisions to the estimated warranty liability would be required.
(k) Income Taxes
The Company utilizes the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. While the Company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event the Company was to determine that it would be able to realize its deferred tax assets in the future in excess of the net recorded amount, an adjustment to the valuation allowance and deferred tax benefit would increase income in the period such determination was made.
(l) Net Loss per Common Share
Basic loss per share is computed by dividing loss available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted loss per share reflects the potential dilution that could occur if securities or contracts to issue common stock were exercised or converted to common stock or resulted in the issuance of common stock that then shared in the earnings or loss of the Company. The assumed exercise of outstanding stock options and warrants have been excluded from the calculations of diluted net loss per share as their effect is antidilutive.
(m) Employee Stock Options
The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations in accounting for its employee stock options and to adopt the “disclosure only” alternative treatment under Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (Statement 123). Statement 123 requires the use of fair value option valuation models that were not developed for use in valuing employee stock options. Under Statement 123, deferred compensation is recorded for the excess of the fair value of the stock on the date of the option grant, over the exercise price of the option. The deferred compensation is amortized over the vesting period of the option.
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Had the Company determined compensation cost based on the fair value at the grant date for its stock options under Statement 123, the Company’s net loss and net loss per share would have been increased to the pro forma amount indicated below (amounts in thousands, except per share):
(n) Fair Value of Financial Instruments
The Company’s financial instruments include cash equivalents, accounts receivable, accounts payable and notes payable. Due to the short-term nature of cash equivalents, accounts receivable and accounts payable, the fair value of these instruments approximates their recorded value. In the opinion of management, based upon current information, the fair value of notes payable approximates market value. The Company does not have material financial instruments with off-balance sheet risk, with the exception of operating leases. See Note 10.
(o) Research and Development
The cost of research and development is charged to expense as incurred.
(p) Foreign Currency Translation
The financial statements of the Company’s foreign subsidiary are measured using the local currency as the functional currency. Assets and liabilities of this subsidiary are translated at exchange rates as of the balance sheet date. Revenues and expenses are translated at average rates of exchange in effect during the year. The resulting cumulative translation adjustments have been recorded as comprehensive income (loss), a separate component of stockholders’ equity.
(q) Segment Reporting
The Company is engaged in the business of the sale of computer peripheral products. While the Company’s chief operating decision maker (CODM) evaluates revenues and gross profits based on products lines, routes to market and geographies (see Note 15), the CODM only evaluates operating results for the Company taken as a whole. As a result, in accordance with FASB Statement No. 131, “Disclosures about Segments of an Enterprise and Related Information”, the Company has determined it has one operating business segment, the sale of computer peripheral products.
(r) Reclassifications
Certain amounts included in the 2002 and 2001 consolidated financial statements have been reclassified to conform to the 2003 financial statement presentation.
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(s) Recently Issued Accounting Pronouncements
On May 15, 2003, the Financial Accounting Standards Board issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics ofBoth Liabilities and Equity. The Statement requires issuers to classify as liabilities (or assets in some circumstance) three classes of freestanding financial instruments that embody obligations for the issuer. Generally, the Statement is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period beginning after September 15, 2003. The Company adopted the provisions of the Statement on July 1, 2003. There was no impact from the adoption of this statement.
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“Interpretation 46”) which was then revised in December 2003. Interpretation 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The recognition and measurement provisions of Interpretation 46 are effective for newly created variable interest entities formed after January 31, 2003, and for existing variable interest entities, on the first interim or annual reporting period beginning after December 15, 2003. The Company adopted the provisions of Interpretation 46 for existing variable interest entities on July 1, 2003. As of December 31, 2003, the Company does not have any variable interest entities.
In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in periods beginning after June 15, 2003. The Company adopted the provisions of EITF Issue No. 00-21 on July 1, 2003, which did not have a material effect on its consolidated financial statements.
In December 2003, the Securities and Exchange Commission (“SEC”) issued staff accounting bulleting No. 104 (“SAB 104”) “Revenue Recognition,” which codifies, revises and rescinds certain sections of Staff Accounting Bulletin No. 101 “Revenue Recognition,” in order to make this interpretive guidance consistent with current authoritative accounting guidance and SEC rules and regulations. The changes noted in SAB 104 did not have a material effect on the Company’s consolidated financial statements.
(3) Acquisitions
(a) Mobility Europe Holdings, Inc.
On January 1, 2001, the Company purchased essentially all of the assets of its European distributor for $282,000 cash and assumed its leases, employee contracts and other business contracts in order to better facilitate the sale of the Company’s products in Europe. The European operations have been organized as Mobility 2001 Limited, a subsidiary of Mobility Europe Holdings, Inc., which was formed in January 2001 under the laws of the state of Delaware and is owned entirely by the Company. Mobility Europe Holdings, Inc. is now called Portsmith, Inc. The acquisition has been accounted for as a purchase and, accordingly, the purchase price has been allocated to the assets acquired based upon the estimated fair values at the date of acquisition. No goodwill resulted from the purchase.
(b) CNF Mobile Solutions
On May 18, 2001 the Company acquired certain assets, including a product line, inventory related to that product line, and patent rights, of CNF Mobile Solutions, a manufacturer of computer peripheral products, for $685,000 cash. $585,000 of the total purchase price has been capitalized as inventory and intangibles and the remaining $100,000 has been recorded as a component of operating expenses. The acquisition has been
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
accounted for as a purchase and, accordingly, the purchase price has been allocated to the assets acquired based upon the estimated fair values at the date of acquisition. No goodwill resulted from the purchase.
(c) Portsmith
As of February 1, 2002, the Company acquired Portsmith, Inc. (“Portsmith”) through a merger of Portsmith with the Company’s subsidiary, Mobility Europe Holdings, Inc., now Portsmith, Inc. Portsmith provides connectivity solutions for handheld devices. Under the terms of the merger agreement, the Company issued 800,000 shares of its common stock, valued at $1.35 per common share, to the former Portsmith stockholders of which 400,000 shares were held in escrow. The release of the escrowed shares to the former Portsmith stockholders was contingent upon certain performance criteria of Portsmith during the first year after the acquisition, which was achieved. Accordingly, the escrowed shares were released in December 2002. In addition, earn-out payments were made during 2003 to the former Portsmith stockholders based upon Portsmith’s performance during the first year after the acquisition, through December 31, 2002, and the fair market value of Portsmith as of December 31, 2002. Earn-out payments may be made in cash or shares of stock, at the Company’s discretion, with total shares of common stock issued to former Portsmith stockholders not to exceed 3,023,863 shares. In the event the parties were not able to come to an agreement relative to the earn-out, the fair market value would be determined by an Independent Financial Expert as defined in the agreement. Based on the results of that valuation, the Company determined it owed $6,594,000 to former Portsmith stockholders in aggregate earn-out consideration. The aggregate consideration was reduced by $484,000, representing an amount owed by a former Portsmith stockholder to the Company, resulting in total net earn-out consideration of $6,110,000. The Company determined it would pay the earn-out in shares of Company common stock. Based on the market price of $5.86 per share of the Company’s common stock as of the date of the final determination, as defined in the agreement, the Company issued 1,042,664 shares of common stock representing payment of earn-out consideration during 2003. At December 31, 2002, the Company recorded a liability in the amount of $725,000 as an estimate of the performance component of the earn-out, as this component was determinable as of December 31, 2002. The difference between the $6,110,000 paid during 2003 and the $725,000 liability recorded at December 31, 2002 of $5,385,000 has been recorded as goodwill during 2003. The actual earn-out consideration paid by the Company exceeded the Company’s estimated earn-out liability at December 31, 2002 as the actual consideration paid during 2003 also included the fair market value component of the earn-out, which was not determinable as of December 31, 2002.
Richard C. Liggitt, a former stockholder of Portsmith, filed a claim against Portsmith and certain of its officers and directors alleging (a) fraud in connection with merger negotiations that led to the execution of a merger agreement between a company owned by Mr. Liggitt and Portsmith, (b) wrongful termination of his employment with Portsmith, and (c) breach of the implied covenant of good faith and fair dealing under his employment agreement with Portsmith. During November 2002, the parties reached a settlement. Under the terms of the settlement, the Company paid $10,000 upon approval of the settlement by the Court. Contemporaneously, the Company agreed to pay Mr. Liggitt an aggregate of $990,000 in exchange for cancellation of all of Mr. Liggitt’s rights as a former shareholder of Portsmith under the merger agreement between the Company and Portsmith, including, but not limited to, the 53,647 shares of the Company’s common stock Mr. Liggitt received in connection with the merger, the 53,646 shares of the Company’s common stock that had been held in escrow that Mr. Liggitt would have otherwise been entitled to receive and Mr. Liggitt’s share in any potential earn-out payments. The $990,000 was paid in the form of a convertible subordinated promissory note bearing interest at four percent per year, payable in quarterly installments of principal and interest beginning in January 2003, through December 2005. During 2003, the Company made one principal installment payment of $82,500 against the promissory note. In June 2003, the outstanding principal of the promissory was converted by Mr. Liggitt into 302,500 shares of the Company’s common stock, at a conversion price of $3.00 per share (see Note 11). In connection with this settlement, the potential earn-
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
outs under the merger agreement between the Company and Portsmith were reduced by $480,000, plus a certain additional amount for fees and expenses and a tax settlement, and Mr. Liggitt’s share of the potential earn-outs was eliminated.
The acquisition has been accounted for as a purchase and, accordingly, the purchase price has been allocated to the assets acquired and the liabilities assumed, based upon the estimated fair values at the date of acquisition. Based on the initial consideration, goodwill of $1,783,000 was recorded as a result of the transaction.
The initial purchase price of $1,487,000, plus acquisition costs of $122,000, was allocated as follows (amounts in thousands):
Based on earn-out payments and other adjustments made during 2003, goodwill increased by $5,385,000 in connection with the Portsmith acquisition (see Note 6).
(d) Cutting Edge Software
As of August 20, 2002, the Company acquired Cutting Edge Software, Inc. (“Cutting Edge Software”) through a merger of Cutting Edge Software with a subsidiary of the Company, CES Acquisition, Inc., and the subsequent merger of such subsidiary with another subsidiary of the Company, CES II Acquisition, Inc., now Cutting Edge Software, Inc. Cutting Edge Software provides software solutions for handheld devices. Under the terms of the merger agreement, the Company paid cash of $1,547,500 and issued 796,394 shares of its common stock, valued at $1.8835 per common share, to the former Cutting Edge Software stockholder. In addition, earn out payments may be made to such stockholder depending upon Cutting Edge Software’s performance during each of the five years following the acquisition date. The earn-out payments are to be made 50% in cash and 50% in shares of company stock, with total shares of common stock issued to the former Cutting Edge Software stockholder not to exceed 3,263,800 shares.
The acquisition has been accounted for as a purchase and, accordingly, the purchase price has been allocated to the assets acquired and the liabilities assumed, based upon the estimated fair values at the date of acquisition. Goodwill of $1,958,000 was recorded as a result of the transaction.
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The purchase price of $3,047,500, plus acquisition costs of $221,000, was allocated as follows (amounts in thousands):
The Company recorded $620,000 in expense upon the consummation of the acquisition relating to in-process research and development acquired from Cutting Edge Software.
Through December 31, 2003, the Company has not made any earn-out payments in connection with its acquisition of Cutting Edge Software.
(e) iGo
On September 3, 2002, the Company completed its acquisition of iGo Corporation (“iGo”), as announced on March 25, 2002 and as amended on July 18, 2002, through the merger of iGo Corporation with the Company’s subsidiary, IGOC Acquisition, Inc., now iGo Direct Corporation. iGo is a direct marketer of computer peripheral equipment. Under the terms of the merger agreement, the Company paid cash of $3,250,000 and issued 2,600,000 shares of its common stock, valued at $1.305 per common share, to the former iGo stockholders. Additional consideration of $1,000,000 and 500,000 shares of the Company’s common stock may also be paid to the former iGo stockholders on the first anniversary date of the merger, the payment of which is contingent upon certain performance criteria. As of December 31, 2003, the Company has determined that the contingent performance criteria indicated in the merger agreement was not achieved. Accordingly, no additional consideration has been paid to the former iGo stockholders.
The acquisition has been accounted for as a purchase and, accordingly, the purchase price has been allocated to the assets acquired and the liabilities assumed, based upon the estimated fair values at the date of acquisition. Goodwill of $4,524,000 was recorded as a result of the transaction.
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The purchase price of $6,643,000, plus acquisition costs of $1,100,000, was allocated as follows (amounts in thousands):
The consolidated financial statements as of December 31, 2002 include the accounts of Portsmith, Cutting Edge Software and iGo and results of operations since the dates of acquisition. The following summary, prepared on a pro forma basis, presents the results of operations as if the acquisitions had occurred on January 1, 2001 (unaudited amounts in thousands, except per share data).
The pro forma results are not necessarily indicative of what the actual consolidated results of operations might have been if the acquisitions had been effective at the beginning of 2001 or as a projection of future results.
(f) Invision Software and Invision Wireless
On December 1, 2003 the Company acquired certain assets, including a software license, customer relationships, and consulting/employment agreements relating to the handheld hardware business of Invision Software, Inc. and Invision Wireless LLC, for 70,000 shares of common stock, valued at $11.36 per share, or $795,000. In addition, earn-out payments may be made to Invision Software and Invision Wireless, up to a maximum of 150,000 shares of common stock at the rate of 15,000 shares for each $10 million in revenue from the sales of certain handheld hardware products during the three year period following the close date of the acquisition. Other earn-out consideration may be earned and paid in quarterly cash installments based on 15% of sales of certain other handheld hardware products during the same three year period following the close date of the acquisition. The acquisition has been accounted for as a purchase and, accordingly, the purchase price has been allocated to the assets acquired and the liabilities assumed, based upon the estimated fair
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
values at the date of acquisition. The fair value of the assets acquired of $1,642,000 exceeds the initial consideration of $795,000 by $847,000. Accordingly, the Company has recorded a current liability of $396,000 and a non-current liability of $451,000, which will be reduced by future earn-out payments or reversed to income if the earn-out criteria are not met. The purchase price of $1,642,000 has been allocated to amortizable intangible assets. No goodwill has been recorded as a result of this transaction. This acquisition is not considered material to the Company’s consolidated financial statements; accordingly, the pro forma results presented above do not reflect the impact of this acquisition.
(4) Inventories
Inventories consist of the following (amounts in thousands):
(5) Property and Equipment
Property and equipment consists of the following (amounts in thousands):
(6) Goodwill
On January 1, 2002, the Company adopted Statement 142. Under this accounting standard, goodwill and intangible assets with indefinite lives are no longer subject to amortization but are tested for impairment at least annually. Amortization is still required for identifiable intangible assets with finite lives.
Statement 142 also requires the completion of the transitional impairment test of the recorded goodwill as of the date this accounting standard is adopted. The Company completed the first step of the transitional impairment test during the year ended December 31, 2002, noting an indication of impairment associated with the recorded goodwill balance of $5,627,000 as of January 1, 2002. As part of the transitional impairment test, the Company identified one reporting unit within its one operating business segment. The Company then completed the second step of the transitional impairment test. The Company recorded a goodwill impairment loss of $5,627,000 as a result of completing its transitional impairment test, and recognized this loss as the effect of a change in accounting principle as of January 1, 2002 in accordance with Statement 142. This impairment loss was determined based on a comparison of the fair value of the Company with its carrying amount, including goodwill that resulted from prior business acquisitions. The results of the comparison and
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
loss measurement indicated that goodwill existing at the date of adoption of this accounting standard was fully impaired.
As a result of the acquisitions of Portsmith, Cutting Edge Software and iGo during 2002, the Company recorded additional goodwill of $8,265,000.
The changes in the carrying amount of goodwill follows (amounts in thousands):
In accordance with Statement 142, the Company evaluated this goodwill for impairment as of December 31, 2002 and 2003 and determined its recorded goodwill is not impaired as of December 31, 2002 and 2003.
The following table presents net loss attributable to common stockholders and net loss per share as if the non-amortization provisions of Statement 142 had been applied on January 1, 2001 (amounts in thousands, except per share data).
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(7) Intangible Assets
Intangible assets consist of the following at December 31, 2003 and 2002 (amounts in thousands):
Aggregate amortization expense for identifiable intangible assets totaled $719,000 and $607,000 for the years ended December 31, 2003 and 2002, respectively. Estimated amortization expense for each of the five succeeding years ended December 31 is as follows (amounts in thousands):
(8) Line of Credit
In October 2002, the Company entered into a $10,000,000 line of credit with a bank. The line bears interest at prime plus 2.0% (6.0% at December 31, 2003), interest only payments are due monthly, with final payment of interest and principal due on July 31, 2004. The line of credit is secured by all assets of the Company. The Company had no outstanding balance against the line of credit at December 31, 2003 and 2002. The line of credit is subject to financial covenants. The Company is currently in compliance with the covenants.
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(9) Long-Term Debt and Other Non-current Liabilities
Long-term debt and other non-current liabilities consist of the following (amounts in thousands):
In connection with the settlement of a lawsuit, the Company entered into a $990,000 convertible subordinated promissory note bearing interest at four percent per year, payable in quarterly installments of principal of $82,500 beginning in January 2003, through December 2005. The outstanding principal of the promissory note may be converted at any time into shares of the Company’s common stock, at a conversion price of $3.00 per share. In June 2003, the note payable was converted into 302,500 shares of common stock.
In connection with its acquisition of Portsmith, the Company recorded a long-term liability in the amount of $725,000 as an estimate of a component of earn-out, as this component was determinable and issuable as of December 31, 2002. The earn-out is made up of two components. The first is calculated using a formula based on Portsmith’s revenue and net income performance, adjusted for certain items, for the year 2002. The second component of the earn-out is based on a percentage of the fair market value of Portsmith as a stand-alone entity as of December 31, 2002, as mutually agreed upon by the Company and the former Portsmith stockholders. In the event the parties are not able to come to an agreement, the fair market value will be determined by an Independent Financial Expert as defined in the agreement. Earn-out payments may be made in cash or shares of stock, at the Company’s discretion. In August 2003, the Company determined it would pay the earn-out in shares of Company common stock and issued an aggregate of 1,042,664 shares of common stock to former Portsmith stockholders in payment of earn-out consideration. The actual earn-out consideration paid by the Company exceeded the Company’s estimated earn-out liability at December 31, 2002 as the actual consideration paid during 2003 also included the fair market value component of the earn-out, which was not determinable as of December 31, 2002.
In connection with its acquisition of certain assets of Invision Software and Invision Wireless, the Company recorded a liability of $847,000, which represents the excess of the fair value of assets acquired over the initial consideration paid for those assets. This liability will be reduced by earn-out payments when the contingent consideration is earned. Accordingly, the Company has recorded a current portion of this liability of $396,000 based on its estimate of contingent consideration to be earned during 2004.
In connection with its settlement of litigation with General Dynamics during 2003, the Company obtained a ten year trademark license from General Dynamics in exchange for $400,000, plus $1,000 in interest charges. During 2003, the Company made a $201,000 installment payment. Future installments are payable as follows: $125,000 on January 15, 2004, which has been recorded as a current liability, $25,000 on January 15, 2005, $25,000 on January 15, 2006, and $25,000 on January 15, 2007.
(10) Lease Commitments
The Company has entered into various non-cancelable operating lease agreements for its office facilities and office equipment. Existing facility leases require monthly rents plus payment of property taxes, normal
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
maintenance and insurance on facilities. Rental expense for the operating leases was $1,061,000, $855,000 and $1,000,000 during the years ended 2003, 2002, and 2001, respectively.
A summary of the minimum future lease payments for the years ending after December 31 follows (amounts in thousands):
(11) Income Taxes
The Company has generated net operating losses for both financial and income tax reporting purposes since inception. At December 31, 2003, the Company had net operating loss carryforwards for federal income tax purposes of approximately $91,000,000 and approximately $4,500,000 for foreign income tax purposes, which, subject to annual limitations, are available to offset future taxable income, if any. The federal net operating loss carryforwards expire between 2011 and 2023. The Company has generated net operating loss carryforwards for state income tax purposes of approximately $72,000,000, which will expire between 2004 and 2008.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The temporary differences that give rise to deferred tax assets and liabilities at December 31, 2003 and 2002 are as follows (amounts in thousands):
The valuation allowance for deferred tax assets as of December 31, 2003 and 2002 was $36,702,000 and $38,632,000, respectively. The net change in the total valuation allowance for the year ended December 31, 2003 was a decrease of $1,930,000 and for the year ended December 31, 2002 was an increase of $7,658,000. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon generation of future taxable income during the periods in which those temporary differences become deductible. In addition, due to the frequency of equity transactions by the Company, it is possible the use of the net operating loss carryforward may be limited in accordance with Section 382 of the Internal Revenue Code. A determination as to this limitation will be made at a future date as the net operating losses are utilized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will not realize the benefits of these deductible differences.
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(12) Stockholders’ Equity
(a)
Convertible Preferred Stock
Series C preferred stock is convertible into shares of common stock. The initial conversion rate was one for one, but is subject to change if certain events occur. Generally, the conversion rate will be adjusted if the Company issues any non-cash dividends on outstanding securities, splits its securities or otherwise effects a change to the number of its outstanding securities. The conversion rate will also be adjusted if the Company issues additional securities at a price that is less than the price that the Series C preferred stockholders paid for their shares. Such adjustments will be made according to certain formulas that are designed to prevent dilution of the Series C preferred stock. The Series C preferred stock can be converted at any time at the option of the holder, and will convert automatically, immediately prior to the consummation of a firm commitment public offering of common stock pursuant to a registration statement filed with the Securities and Exchange Commission having a per share price equal to or greater than $24.00 per share and a total gross offering amount of not less than $15,000,000. The rate of conversion was 1-to-1.0883 as of December 31, 2003.
During 2002, 132,446 shares of Series C preferred stock were converted into 103,070 shares of common stock at an average conversion rate of 1-to-0.77820. During 2003, 220,382 shares of Series C preferred stock were converted into 241,785 shares of common stock at an average rate of 1-to-1.09712. At December 31, 2003, 329,866 shares of Series C preferred stock were outstanding.
The Company may not pay any cash dividends on its common stock while any Series C preferred stock remains outstanding without the consent of the Series C preferred stockholders. Holders of Series C preferred stock are entitled to vote on all matters submitted for a vote of the holders of common stock. Holders will be entitled to one vote for each share of common stock into which one share of Series C preferred stock could then be converted. In the event of liquidation or dissolution, the holders of Series C preferred stock will be entitled to receive the amount they paid for their stock, plus accrued and unpaid dividends out of the Company’s assets legally available for such payments prior to the holders of securities junior to the Series C preferred stock receiving payments.
In January 2003, the Company issued and sold 865,051 shares of newly designated Series E preferred stock, par value $0.01 per share (“Series E Stock”), at a purchase price of $0.7225 per share, and 729,407 shares of newly designated Series F preferred stock, par value $0.01 per share (“Series F Stock”), at a purchase price of $0.85 per share. In connection with this sale, the Company also issued warrants to purchase an aggregate of 559,084 shares of common stock, par value $0.01 per share, of the Company. The warrants issued to holders of Series E Stock permit them to purchase an aggregate of 216,263 shares of common stock, at an exercise price of $0.867 per share (the “Series E Warrants”), and the warrants issued to holders of Series F Stock permit them to purchase an aggregate of 342,821 shares of common stock, at an exercise price of $1.02 per share (the “Series F Warrants”). The Series E Stock was purchased by a single non-affiliated investor, while the Series F Stock was purchased by certain officers and directors of the Company and their affiliates.
All of the Series E Warrants have been exercised and converted into 216,263 shares of common stock, and no Series E Warrants were outstanding at December 31, 2003. As of December 31, 2003, there were 232,233 Series F Warrants outstanding and exercisable for 232,233 shares of common stock.
At the date of issuance of the Series E and Series F shares, a non-cash beneficial conversion adjustment of $445,000, which represents a 15% discount to the fair value of the common stock at the date of issuance of the Series E shares and an estimate of the fair value of the Series E and Series F Warrants using the Black-Scholes model, was recorded in the 2003 consolidated financial statements as an increase and decrease to additional paid-in capital. The beneficial conversion adjustment resulted in an increase to net loss attributable to common stockholders of $445,000, or $0.02 per common share. The beneficial conversion adjustment was
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
recorded upon the issuance of the Series E and Series F convertible preferred stock, as the Series E and Series F shares were immediately convertible upon issuance.
The following assumptions were used to determine the Black-Scholes value of the Series E and Series F Warrants: (1) expected life of 3 years, (2) risk-free interest rate of 3.0%, (3) dividend yield of 0%, and (4) volatility of 100%.
As the closing price of the Company’s common stock was greater than or equal to $2.00 per share for ten consecutive trading days on June 6, 2003, all issued and outstanding shares of Series E and Series F preferred stock automatically converted into 1,594,458 shares of common stock at a conversion rate of 1-to-1. Dividends on Series E and F preferred stock of $20,000 were accrued at June 6, 2003. No shares of Series E and Series F preferred stock were outstanding at December 31, 2003.
(b)
Common Stock
Holders of shares of common stock are entitled to one vote per share on all matters submitted to a vote of the Company’s stockholders. There is no right to cumulative voting for the election of directors. Holders of shares of common stock are entitled to receive dividends, if and when declared by the board of directors out of funds legally available therefore, after payment of dividends required to be paid on any outstanding shares of preferred stock. Upon liquidation, holders of shares of common stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to the liquidation preferences of any outstanding shares of preferred stock. Holders of shares of common stock have no conversion, redemption or preemptive rights.
(c)
Stock Subscription and Deferred Compensation
During 2001, the Company entered into a promissory note in the principal sum of $76,200 with a consultant to finance his purchase of 60,000 shares of common stock at a purchase price of $1.28 per share. The Company recorded compensation expense of $21,000 during 2001 as a result of this transaction. During 2003, the Company entered into an agreement with this consultant to forgive the balance of the promissory note over a service period of time from May 2003 through June 2004. During 2003, the Company reduced the principal balance of the promissory note by $36,480 and recorded compensation expense of $36,480. At December 31, 2003, the outstanding principal balance of the promissory note is $39,720.
During 2001, the Company entered into promissory notes in the principal sum of $598,000 with two executives of the Company and one related party to finance their purchase of 206,898 shares of common stock at a composite purchase price of $2.90 for one share of common stock. During 2003, the remaining principal balance of each of these promissory notes was repaid.
During 2002, the Company entered into promissory notes in the principal sum of $280,000 with four executives of the Company to finance their purchase of 200,000 shares of common stock at a composite purchase price of $1.40 for one share of common stock. During 2003, one promissory note, in the principal amount of $70,000, was repaid. At December 31, 2003, three promissory notes, secured by 150,000 shares of common stock, in the principal sum of $210,000 remain outstanding.
During 2002, in connection with its acquisition of iGo, the Company acquired a promissory note in the principal sum of $230,000 with a former iGo shareholder, which is secured by 115,865 shares of common stock. During 2003, the remaining principal balance of this promissory note was repaid.
During 2003, in connection with its acquisition of Portsmith, the Company recorded various promissory notes it had acquired in the principal sum of $203,000. During 2003, several promissory notes, in the principal sum of $161,000, were repaid. At December 31, 2003, five promissory notes, in the principal sum of $42,000 remain outstanding.
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
During 2003, the Company entered into a promissory note in the principal sum of $195,000 with a consultant to finance his purchase of 30,000 shares of common stock at a purchase price of $6.50 per share.
(13) Employee Benefit Plans
(a) Retirement Plan
The Company has a defined contribution 401(k) plan for all employees. Under the 401(k) plan, employees are permitted to make contributions to the plan in accordance with IRS regulations. The Company may make discretionary contributions as approved by the Board of Directors. The Company contributed $177,000, $114,000 and $36,000 during 2003, 2002 and 2001, respectively.
(b)
Stock Options and Warrants
In 1995, the Board granted stock options to employees to purchase 132,198 shares of common stock. Later in 1996, the Company adopted an Incentive Stock Option Plan (the Plan) pursuant to the Internal Revenue Code. During 2002, the Plan was amended to increase the aggregate number of shares of common stock for which options may be granted or for which stock grants may be made to 3,000,000. Options become exercisable over varying periods up to five years and expire at the earlier of termination of employment or up to seven years after the date of grant. During 2002, in connection with its acquisition of Cutting Edge Software, the Company’s Board of Directors authorized the issuance of options to purchase 150,000 shares of common stock to certain Cutting Edge Software employees. The options under both the Plan and Board approved were granted at the fair market value of the Company’s stock at the date of grant as determined by the Company’s Board of Directors. There were 101,171 shares available for grant under the Plan as of December 31, 2003.
The per share weighted average fair value of stock options granted under the Plan for the years ended December 31, 2003, 2002 and 2001, was $5.14, $1.38 and $2.21, respectively, based on the date of grant using the Black-Scholes method with the following weighted average assumptions:
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table summarizes information regarding stock option activity for the years ended December 31, 2001, 2002 and 2003:
The following table summarizes information about the stock options outstanding at December 31, 2003:
During 2001, the Company issued warrants to purchase 75,000 shares of common stock in connection with a technology license agreement. These warrants, valued at $71,000, using the Black-Scholes pricing model, are exercisable at $1.38 per share. The value of these warrants has been recorded as a component of other assets to be amortized to research and development expense over the term of the related license agreement.
During 2001, 76,500 warrants were exercised to acquire 76,500 shares of common stock at $0.02 per share for total net proceeds of $2,000.
During 2001, 564,944 warrants expired. At December 31, 2001, 526,666 unexercised warrants remained outstanding at exercise prices ranging from $0.01 to $7.00 per share.
During 2002, 176,707 warrants were exercised to acquire 176,707 shares of common stock at $0.02 per share for total net proceeds of $4,000.
During 2002, 130,973 warrants expired. At December 31, 2002, 218,986 unexercised warrants remained outstanding at exercise prices ranging from $0.69 to $5.75 per share.
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
During 2003, the Company issued warrants to purchase an aggregate of 559,084 shares of common stock, par value $0.01 per share, in connection with the private placement of shares of Series E and Series F Preferred Stock. Warrants issued to holders of Series E Stock permit them to purchase an aggregate of 216,263 shares of common stock, at an exercise price of $0.867 per share (the “Series E Warrants”), and the warrants issued to holders of Series F Stock permit them to purchase an aggregate of 342,821 shares of common stock, at an exercise price of $1.02 per share (the “Series F Warrants”). At the date of issuance of the Series E and Series F shares, a non-cash beneficial conversion adjustment of $445,000, which represents a 15% discount to the fair value of the common stock at the date of issuance of the Series E shares and an estimate of the fair value of the Series E and Series F Warrants using the Black-Scholes model, was recorded in the 2003 consolidated financial statements as an increase and decrease to additional paid-in capital. The beneficial conversion adjustment resulted in an increase to net loss attributable to common stockholders of $445,000, or $0.02 per common share. The beneficial conversion adjustment was recorded upon the issuance of the Series E and Series F convertible preferred stock, as the Series E and Series F shares were immediately convertible upon issuance. The following assumptions were used to determine the Black-Scholes value of the Series E and Series F Warrants: (1) expected life of 3 years, (2) risk-free interest rate of 3.0%, (3) dividend yield of 0%, and (4) volatility of 100%.
All of the Series E Warrants have been exercised and converted into 216,263 shares of common stock, and no Series E Warrants were outstanding at December 31, 2003. As of December 31, 2003, there were 232,233 Series F Warrants outstanding and exercisable for 232,233 shares of common stock.
During 2003, the Company issued 5,000 warrants to a bank in connection with an amendment to its line of credit agreement. These warrants, valued at $25,000, using the Black-Scholes pricing model, are exercisable at $7.59 per share. The value of these warrants has been recorded as a component of other assets to be amortized to interest expense over the term of the line of credit agreement.
During 2003, 200,442 warrants expired. At December 31, 2003, 255,777 unexercised warrants remained outstanding at exercise prices ranging from $1.02 to $7.59 per share.
(c)
Employee Stock Purchase Plan
The Company established an Employee Stock Purchase Plan (the “Purchase Plan”) in October 2001, under which 2,000,000 shares of common stock have been reserved for issuance. Eligible employees may purchase a limited number of shares of the Company’s common stock at 85% of the market value at certain plan-defined dates. In 2001, 25,795 shares were issued under the Purchase Plan for net proceeds of $17,000. In 2002, 78,928 shares were issued under the Purchase Plan for net proceeds of $83,000. In 2003, 78,374 were issued under the Purchase Plan for net proceeds of $102,000. At December 31, 2003, 1,816,903 shares were available for issuance under the Purchase Plan.
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(14) Net Loss per Share
The computation of basic and diluted net loss per share (EPS) follows (in thousands, except per share amounts):
(15) Concentration of Credit Risk, Significant Customers and Business Segments
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and trade accounts receivable. The Company places its cash with high credit quality financial institutions and generally limits the amount of credit exposure to the amount of FDIC coverage. However, periodically during the year, the Company maintains cash in financial institutions in excess of the FDIC insurance coverage limit of $100,000. The Company performs ongoing credit evaluations of its customers’ financial condition but does not typically require collateral to support customer receivables. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information.
Four customers accounted for 15%, 14%, 11% and 10% of net sales for the year ended December 31, 2003. Two customers each accounted for 20% of net sales for the year ended December 31, 2002. Two customers accounted for 34% and 33% of net sales for the year ended December 31, 2001.
Four customers’ accounts receivable balances accounted for 22%, 14%, 12% and 11% of net accounts receivable at December 31, 2003. Three customers’ accounts receivable balances accounted for 32%, 19% and 11% of net accounts receivable at December 31, 2002.
Export sales were approximately 14%, 14% and 31% of the Company’s net sales for the years ended December 31, 2003, 2002 and 2001, respectively. The principal international market served by the Company was Europe.
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company is engaged in the business of the sale of computer peripheral products. While the Company’s chief operating decision maker (CODM) evaluates revenues and gross profits based on products lines, routes to market and geographies, the CODM only evaluates operating results for the Company taken as a whole. As a result, in accordance with FASB Statement No. 131, “Disclosures about Segments of an Enterprise and Related Information”, the Company has determined it has one operating business segment, the sale of computer peripheral products.
The following tables summarize the Company’s revenues by product line, as well as its revenues by geography.
(16) Contingencies
Holmes Lundt, et al., plaintiffs, and Jason Carnahan, et. al., intervenors, v. Mobility Electronics, Inc., Portsmith, Inc., Charles R. Mollo, Joan W. Brubacher, Jeffrey R. Harris, Robert P. Dilworth, Larry M. Carr, William O. Hunt, Jerre L. Stead and Darryl Baker, pending in the District Court of the Fourth Judicial District of Idaho, Ada County, Cause No. CV-0C-0302562D. This lawsuit initially was commenced on April 2, 2003, by Holmes Lundt, former President and CEO of Portsmith, Inc., the Company’s wholly-owned subsidiary, and his wife, but additional plaintiffs were added, and several of the Company’s officers and directors were added as defendants. In their current pleading, the plaintiffs are alleging breach of the Portsmith merger agreement and Mr. Lundt’s employment agreement, wrongful termination of Mr. Lundt, fraudulent misrepresentation, securities fraud, breach of an alleged covenant of good faith and fair dealing, civil conspiracy, and are seeking monetary damages and/or rescission of the Portsmith merger agreement. On February 11, 2004, the court permitted the intervenors to intervene in the lawsuit and the intervenors in turn dismissed a separate lawsuit they had commenced on December 30, 2003. In their current pleading, the intervenors assert claims against the Company, Portsmith, Mr. Mollo and Ms. Brubacher, for breach of contract, breach of an alleged covenant of good faith and fair dealing, unjust enrichment, declaratory judgment, fraud, misrepresentation, concealment, breach of fiduciary duty, constructive trust, conversion, and constructive fraud. Intervenors are seeking monetary damages and/or the recovery of unspecified shares of the Company’s common stock. Among other things, plaintiffs and intervenors dispute that the Company appropriately calculated and paid the earn-out consideration called for by the Portsmith merger agreement.
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company intends to vigorously defend against the claims as well as pursue its own claims against the plaintiffs and intervenors.
On February 10, 2004, a stockholder class-action lawsuit was filed against the Company and two of its executive officers in the United States District Court for the District of Arizona. A second stockholder class-action lawsuit was filed on February 20, 2004 against the Company and the same two executive officers in the same United States District Court for the District of Arizona. These lawsuits assert claims for securities fraud under Sections 10(b), 20(a) and Rule 10b-5 of the Securities Exchange Act of 1934, on behalf of a purported class of persons who purchased the Company’s publicly traded securities between September 2, 2003 and January 5, 2004. The complaints generally allege that various public statements made by or on behalf of the Company were false or misleading when made, that the individual defendants were allegedly aware of material non-public information at the time that they engaged in transactions in the Company’s common stock and that members of the purported stockholder class suffered damages when the market price of the Company’s common stock declined following disclosure of the information that allegedly had not been previously disclosed. The complaints seek to proceed on behalf of the alleged class described above, seek monetary damages in an unspecified amount and seek recovery of plaintiffs’ costs and attorneys’ fees. The Company intends to vigorously defend against these claims.
The Company is from time to time involved in various legal proceedings incidental to the conduct of its business. The Company believes that the outcome of all such pending legal proceedings will not in the aggregate have a material adverse effect on its business, financial condition, results of operations or liquidity.
(17) Related Party Transactions
The Company previously had an agreement with a related entity under which this entity provided management services. The Company discontinued its agreement with this related party effective August 31, 2003. The Company paid the consultant approximately $8,000, $10,000 and $20,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
During 2001, the Company sold 206,898 shares of common stock to two officers of the Company and an affiliate of an officer at a purchase price of $2.90 per share. Each investor paid $690 in cash (or $2,070 in total) and executed and delivered to the Company a three-year Promissory Note, in the original principal amount of $199,311 each (or $597,933 in total), and bearing interest at a rate of 6.33% per annum. During 2003, each promissory note was paid in full.
During 2002, the Company sold 200,000 shares of common stock to four executives at a purchase price of $1.40 per share. Each investor executed and delivered to the Company a three-year Promissory Note, in the original principal amount of $70,000 each (or $280,000 in total) and bearing interest at a rate of 6% per annum. Each Promissory Note is secured by the shares of common stock issued. During 2003, one promissory note was paid in full. The outstanding notes are reflected as contra equity on the statement of stockholders’ equity.
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(18) Supplemental Financial Information
A summary of additions and deductions related to the allowances for accounts receivable for the years ended December 31, 2003, 2002 and 2001 follows (amounts in thousands):
MOBILITY ELECTRONICS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(19) Quarterly Financial Data (Unaudited)
A summary of the quarterly data for the years ended December 31, 2003 and 2002 follows (amounts in thousands, except per share amounts):
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A.
Controls and Procedures
Based upon their evaluations of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were adequate and designed to ensure that information required to be disclosed by us in this report is recorded, processed, summarized and reported by the filing date of this report, and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. There has been no change in our internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART III
Item 10.
Item 10.
Executive Officers, Directors and Key Employees
The response to this Item regarding our directors and compliance with Section 16(a) of the Exchange Act by our officers and directors will be contained in the Proxy Statement for the 2004 Annual Meeting of Shareholders under the captions “Proposal No. 1 Election of Directors”, “Executives and Executive Compensation”, “Section 16(a) Beneficial Ownership Reporting Compliance”, and “Principal Stockholders” and is incorporated by reference herein.
The information required by this Item for our executive officers is set forth under Part I of this Annual Report on Form 10-K, under the subheading “Executive Officers of the Company”.
We have adopted a Code of Business Conduct and Ethics that applies to all of our directors, officers and employees. A copy of the Code of Business Conduct and Ethics is posted on our Internet website at www.mobilityelectronics.com. If we make any amendment to, or grant any waivers of, a provision of the Code of Business Conduct and Ethics that applies to our principal executive officer, principal financial officer principal accounting officer or controller, or persons performing similar functions, where such amendment or waiver is required to be disclosed under applicable SEC rules, we intend to disclose such amendment or waiver and the reasons therefore on our Internet website at www.mobilityelectronics.com.
Item 11.
Item 11.
Executive Compensation
The response to this Item will be contained in the Proxy Statement for the 2004 Annual Meeting of Shareholders under the captions “Director Compensation Committee Report”, “Executive Compensation” and is incorporated by reference herein.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The response to this Item will be contained in the Proxy Statement for the 2004 Annual Meeting of Shareholders under the caption “Principal Stockholders” and is incorporated by reference herein.
Item 13.
Item 13.
Certain Relationships and Related Transactions
The response to this Item will be contained in the Proxy Statement for the 2004 Annual Meeting of Shareholders under the caption “Certain Relationships and Related Transactions” and is incorporated by reference herein.
Item 14.
Item 14.
Principal Accountant Fees and Services
The response to this item will be contained in the Proxy Statement for the 2004 Annual Meeting of Shareholders under the caption “Independent Public Accountants” and is incorporated by reference herein.
PART IV
Item 15.
Item 15.
Exhibits, Financial Statements, Schedules and Reports on Form 8-K
(a)(1)(2) Financial Statements.
See the Index to Consolidated Financial Statements and Financial Statement Schedule in Part II, Item 8.
(b) Reports on Form 8-K.
We filed the following report on Form 8-K during the quarter ended December 31, 2003:
•
Form 8-K dated October 22, 2003, furnishing under Items 7 and 12 our press release, dated October 22, 2003, announcing our results of operations for the quarter ended September 30, 2003.
(c) Exhibits.
The Exhibit Index and required Exhibits are immediately following the Signatures to this Form 10-K are filed as part of, or hereby incorporated by reference into, this Form 10-K.
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 following persons in the capacities indicated on March 5, 2004.
MOBILITY ELECTRONICS, INC.
/s/ CHARLES R. MOLLO
Charles R. Mollo
President, Chief Executive Officer and
Chairman of the Board (Principal Executive Officer)
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities indicated on March 5, 2004.
EXHIBIT INDEX
*
Filed herewith
**
Each of these agreements is identical in all material respects except for the Purchasers.
***
Schedules and similar attachments have been omitted from these agreements. The registrant will furnish supplementally a copy of any omitted schedule or attachment to the Commission upon request.
+ Management or compensatory plan or agreement.
(1)
Previously filed as an exhibit to Current Report on Form 8-K dated October 17, 2000.
(2)
Previously filed as an exhibit to Form 10-K for the year ended December 31, 2001.
(3)
Previously filed as an exhibit to Registration Statement No. 333-99845 on Form S-3 dated September 19, 2002.
(4)
Previously filed as an exhibit to Form 10-K for the year ended December 31, 2002.
(5)
Previously filed as an exhibit to Registration Statement No. 333-30264 dated February 11, 2000.
(6)
Previously filed as an exhibit to Amendment No. 2 to Registration Statement No. 333-30264 on Form S-1 dated May 4, 2000.
(7)
Previously filed as an exhibit to Amendment No. 1 to Registration Statement No. 333-30264 on Form S-1 dated March 28, 2000.
(8)
Previously filed as an exhibit to Current Report on Form 8-K filed on January 14, 2003.
(9)
Previously filed as an exhibit to Current Report on Form 8-K filed on June 19, 2003.
(10)
Previously filed as an exhibit to Amendment No. 3 to Registration Statement No. 333-30264 on Form S-1 dated May 18, 2000.
(11)
Previously filed as an exhibit to Registration Statement No. 333-108623 on Form S-3 filed on September 9, 2003.
(12)
Previously filed as an exhibit to Form 10-Q for the quarter ended September 30, 2003.
(13)
Previously filed as an exhibit to Registration Statement No. 333-69336 on Form S-8 filed on September 13, 2001.
(14)
Previously filed as an exhibit to Form 10-K for the period ended December 31, 2000.
(15)
Previously filed as an exhibit to Form 10-Q for the quarter ended June 30, 2003.
(16)
Previously filed as an exhibit to Amendment No. 1 to Registration Statement No. 333-99845 on Form S-3 dated November 21, 2002.
(17)
Previously filed as an exhibit to Form 10-Q for the quarter ended September 30, 2002.
(18)
Previously filed as an exhibit to Form 10-Q for the quarter ended September 30, 2001.
(19)
Previously filed as an exhibit to Current Report on Form 8-K dated February 7, 2003.
(20)
Previously filed as an exhibit to Form 10-Q for the quarter ended June 30, 2002.
All other schedules and exhibits are omitted because they are not applicable or because the required information is contained in the Financial Statements or Notes thereto.