o Confidential,
for Use
of the Commission Only (as permitted by Rule
14a-6(e)(2))
ý Definitive
Proxy Statement
o Definitive
Additional
Materials
ý Soliciting
Material Under Rule 14a-12
SBE,
INC.
(Name
of
Registrant as Specified In Its Charter)
Not
applicable
(Name
of
Person(s) Filing Proxy Statement, if Other than the Registrant)
Payment
of Filing Fee (Check the appropriate box):
o
No
fee required.
ý Fee
computed on table below per Exchange Act Rules 14a-6(i)(1) and
0-11.
(1)
Title
of each class of securities to which transaction applies: Common
Stock,
par value $0.001 per share, of the Registrant (the “Common
Stock”).
(2)
Aggregate
number of securities to which transaction applies: N/A
(3)
Per
unit price or other underlying value of transaction computed pursuant
to
Exchange Act Rule 0-11: N/A
(4)
Proposed
maximum aggregate value of transaction: $3,000,000
(5)
Total
fee paid: $600
ý
Fee
paid previously with preliminary materials.
o
Check
box if any part of the fee is offset as provided by Exchange Act
Rule
0-11(a)(2) and identify the filing for which the offsetting fee was
paid
previously. Identify the previous filing by registration statement
number,
or the form or schedule and the date of its filing.
You
are
cordially invited to attend the Special Meeting of Stockholders of SBE, Inc.
to
be held on March 29, 2007 at SBE’s offices located at 4000 Executive Parkway,
Suite 200, San Ramon, California94583. The meeting will begin promptly at
9:00 a.m., local time.
The
items
of business to be considered at the meeting are listed in the following Notice
of Special Meeting and are more fully addressed in the proxy statement included
with this letter. The items you will be asked to approve at the meeting relate
to the proposed sale of our embedded business to One Stop Systems, Inc. and
an
amendment to our Amended and Restated Certificate of Incorporation to effect
a
stock combination (reverse stock split) pursuant to which every five shares
of
outstanding common stock would be reclassified into one share of common
stock.
Our
board
of directors carefully considered the proposed sale of our embedded business
and
recommends that you vote in favor of this transaction. Our management team
is
excited about the sale of our embedded business and believes it is an essential
step in maximizing value for our stockholders.
Whether
or not you plan to attend the special meeting in person, it is important that
your shares be represented and voted at the meeting.
Please
date, sign, and return your proxy card promptly in the enclosed envelope to
ensure that your shares will be represented and voted at the special meeting,
even if you cannot attend. If you attend the special meeting, you may vote
your
shares in person even though you have previously signed and returned your
proxy.
On
behalf
of your board of directors, thank you for your investment in and continued
support of SBE, Inc.
You
are
cordially invited to attend a Special Meeting of Stockholders of SBE, Inc.,
a
Delaware corporation (the “Company”). The meeting will be held on March 29, 2007
at 9:00 a.m., local time, at SBE’s offices located at 4000 Executive
Parkway, Suite 200, San Ramon, California94583, for the following
purposes:
(1) To
approve the sale of our embedded business pursuant to an asset purchase
agreement between us and One Stop Systems, Inc. pursuant to which
One Stop
would acquire our embedded business for $2,200,000 in cash and assume
our
obligations under the lease of our corporate headquarters building
and
certain equipment leases;
(2) To
approve an amendment to the Company’s Certificate of Incorporation to
effect a stock combination (reverse stock split) pursuant to which
every
five shares of outstanding common stock would be reclassified into
one
share of common stock; and
(3) To
transact such other business as may properly come before the meeting
or
any adjournment thereof.
These
items of business are more fully described in the Proxy Statement accompanying
this Notice.
The
record date for the Annual Meeting is March 6, 2007. Only stockholders of record
at the close of business on that date may vote at the meeting or any adjournment
thereof.
YOU
ARE CORDIALLY INVITED TO ATTEND THE SPECIAL MEETING IN PERSON.
WHETHER
OR NOT YOU EXPECT TO ATTEND THE SPECIAL MEETING, PLEASE COMPLETE, SIGN AND
DATE
THE ENCLOSED PROXY AND RETURN IT PROMPTLY IN THE ENCLOSED ENVELOPE, WHICH DOES
NOT REQUIRE ANY POSTAGE IF MAILED IN THE UNITED STATES,
IN ORDER TO ENSURE YOUR REPRESENTATION AT THE SPECIAL MEETING. EVEN IF YOU
HAVE
VOTED BY PROXY, YOU MAY STILL VOTE IN PERSON IF YOU ATTEND THE MEETING. PLEASE
NOTE, HOWEVER, THAT IF YOUR SHARES ARE HELD OF RECORD BY A BROKER, BANK OR
OTHER
NOMINEE AND YOU WISH TO VOTE AT THE MEETING, YOU MUST OBTAIN A PROXY ISSUED
IN
YOUR NAME FROM THAT RECORD HOLDER IN ORDER TO VOTE IN
PERSON.
Unaudited
Pro Forma Condensed Consolidated Financial Statements—Without Embedded
Hardware Business
Annex
G
Unaudited
Pro Forma Condensed Consolidated Financial Statements—Embedded Business on
Stand-Alone Basis
Annex
H
Unaudited
Pro Forma Condensed Consolidated Financial Statements—Without Embedded
Hardware Business and with Neonode
Transaction
SUMMARY
TERM SHEET
FOR
THE SALE OF EMBEDDED BUSINESS
The
following summary provides an overview of the proposed sale of our embedded
business discussed in this proxy statement. The summary also contains
cross-references to the more detailed discussions elsewhere in the proxy
statement. This summary may not contain all of the information that is important
to you. To understand the proposed asset sale fully, and for a more complete
description of the terms of the proposed asset sale, you should carefully read
this entire proxy statement and the attached annexes in their
entirety.
The
Companies (see page 14)
SBE
SBE,
Inc., headquartered in San Ramon, California, designs and provides iSCSI-based
storage networking solutions for an extensive range of business critical
applications, including Disk-to-Disk Back-up and Disaster Recovery. We deliver
an affordable, expandable, easy-to-use portfolio of software solutions designed
to enable optimal performance and rapid deployment across a wide range of next
generation storage systems. We
also
manufacture and sell hardware products, including wide area network and local
area network interface cards and central processor units to original equipment
manufacturers that
embed
our hardware products into their products for the telecommunications
markets.
Our
hardware products perform critical computing and input/output, or I/O, tasks
in
diverse markets such as high-end enterprise level computing servers, Linux
super-computing clusters, workstations, media gateways, routers and Internet
access devices. We refer to this hardware business in this proxy statement
as
our embedded business. Our products are distributed worldwide through a direct
sales force, distributors, independent manufacturers’ representatives and
value-added resellers.
One
Stop
One
Stop Systems,
Inc. is
a manufacturer of industrial-grade computing systems and components, including
a
line of Peripheral Component Interconnect, or PCI, Express-based products.
One
Stop’s PCI Express-based products increase network bus speed up to 16 times
faster than 64-bit PCI and 80 times faster than Gigabit Ethernet. One Stop
offers over 400 standard products, including its MAX Express product line,
passive backplane, Virtual Machine Environment and custom and proprietary bus
structures. One Stop’s principal executive office is located at 2235 Enterprise
Street, Suite 110, Escondido, California92029.
Neonode
(see page 14)
On
January 19, 2007, we entered into an Agreement and Plan of Merger and
Reorganization with Neonode, Inc., a Delaware corporation. Neonode is a
Sweden-based developer and manufacturer of multimedia mobile handsets. For
a
description of the proposed Neonode transaction, please see “Overview of the
Neonode Transaction” on page 33. The sale of our embedded business to One Stop
is a condition to closing the transaction with Neonode. We intend to file a
proxy statement in connection with the merger with Neonode. The proxy statement,
when it becomes available, will contain important information about the merger
transaction and about Neonode. Free copies of the proxy statement will be
available at the SEC’s website at www.sec.gov.
Overview
of the Transaction (see page 33)
We
have
entered into an asset purchase agreement with One Stop. Under the asset purchase
agreement, One Stop would acquire our embedded business for $2,200,000 in cash
and assume our obligations under the lease of our corporate headquarters
building and certain equipment leases. The asset purchase agreement is attached
to this proxy statement as Annex A.1
3
Recommendation
of the Board of Directors (see page 17)
Our
board
of directors has determined that the asset sale is fair to, and in the best
interests of, us and our stockholders and recommends that our stockholders
vote
FOR the proposal to approve the sale of our embedded business to One
Stop.
To
review
the background and reasons for the asset sale in detail, see “Asset Sale —
Reasons for the Asset Sale” beginning on page 17.
Opinion
of Our Financial Advisor (see page 18)
In
connection with the proposed asset sale, our board of directors received a
written opinion from our financial advisor, Seidman & Co., Inc. as to
the fairness of the consideration to be received by us, from a financial point
of view and as of the date of the opinion. The full text of Seidman &
Co., Inc.’s written opinion is attached to this proxy statement as Annex B. You
are encouraged to read this opinion carefully in its entirety for a description
of the assumptions made, matters considered and limitations on the review
undertaken.
The
Asset Sale (see page 16)
General
On
January 11, 2007, we entered into an Agreement for Purchase and Sale of Assets
with One Stop, the asset purchase agreement, pursuant to which we agreed to
sell
our embedded business to One Stop for $2,200,000 in cash plus One Stop’s
assumption of the lease of our corporate headquarters building and certain
equipment leases.
Terms
of the Asset Purchase Agreement
The
asset
purchase agreement is attached to this proxy statement as Annex A. We
encourage you to read the asset purchase agreement carefully. Our board of
directors has approved the asset purchase agreement, and it is the binding
legal
agreement that governs the terms of the asset sale.
Conditions
Precedent
One
Stop’s obligation to complete the asset sale depends on the satisfaction or
waiver of a number of conditions, including conditions relating to:
•
accuracy
of our representations on and as of the
closing;
•
our
performance, satisfaction and compliance with all covenants, agreements
and closing conditions;
•
no
material adverse change will have occurred with respect to the embedded
business;
•
receipt
of an officer’s certificate executed by our chief executive officer
certifying that all closing conditions have been
fulfilled;
•
absence
of litigation pertaining to the sale of the embedded
business;
•
our
receipt of stockholder approval of the transaction;
and
•
payment
of certain outstanding accounts payable attributable to our embedded
business.
In
addition, our obligation to complete the asset sale is subject to satisfaction
or waiver of certain additional conditions, including conditions relating
to:
4
•
accuracy
of One Stop’s representations on and as of the
closing;
•
One
Stop’s performance, satisfaction and compliance with all covenants,
agreements and closing conditions;
and
•
absence
of litigation pertaining to the
transaction.
Termination
The
asset
purchase agreement may be terminated under the following
circumstances:
•
by
mutual written consent of the parties, duly authorized by their respective
boards;
•
the
closing has not occurred on or before April 30, 2007, unless the
party
terminating in this circumstance is at fault for the delay in
closing;
•
any
proceeding is pending against either party that could prevent performance
of the asset sale; or
•
any
governmental entity has issued an order, the effect of which is to
prohibit the asset sale.
Restriction
on Competition
We
have
agreed that for four years following the closing of the asset sale, we will
not
directly or indirectly engage in the embedded business or have any interest
in
(whether as an employee, officer, director, agent, security holder, creditor,
consultant, or otherwise), any entity engaged in the embedded
business.
Indemnification
Each
party has agreed to indemnify the other party for damages arising for any breach
of any of the representations or warranties or covenants or obligations in
the
asset purchase agreement. In addition, we have agreed to indemnify One Stop
for
any liabilities attributable to operation of the embedded business prior to
the
closing. All representations, warranties and covenants expire on the first
anniversary of the closing. Our liability for indemnification claims made by
One
Stop pursuant to the asset purchase agreement is capped at $2,200,000 in the
aggregate.
Regulatory
Approvals
We
are
not aware of any federal or state regulatory requirements that must be complied
with or approvals that must be obtained to consummate the asset sale other
than
the filing of this proxy statement with the SEC. If any additional approvals
or
filings are required, we will use our commercially reasonable efforts to obtain
those approvals and make any required filings before completing the
transactions.
Dissenters’
Rights
Our
stockholders are not entitled to exercise dissenters’ rights in connection with
the asset sale.
5
Transactions
Following the Asset Sale
The
assets we propose to sell to One Stop comprise all of our embedded business.
After the closing of such sale, we expect our only remaining assets will be
cash, accounts receivable, fixed assets and the storage software business we
acquired in connection with our acquisition of PyX Technologies, Inc. in 2005.
On January 19, 2007, we entered into an Agreement and Plan of Merger and
Reorganization, with Neonode Inc., a Delaware corporation. Neonode is a
Sweden-based developer and manufacturer of multimedia mobile handsets. It is
anticipated that our name will be changed to “Neonode Inc.” in connection with
the completion of the merger. The sale of our embedded business to One Stop
is a
condition to closing the transaction with Neonode. For a description of the
proposed Neonode transaction, please see “Overview of the Neonode Transaction”
on page 33. We intend to file a proxy statement in connection with the
merger with Neonode. The proxy statement, when it becomes available, will
contain important information about the merger transaction. Free copies of
the
proxy statement will be available at the SEC's web site at www.sec.gov. We
are
evaluating strategic alternatives regarding our storage software
business.
6
Except
as
otherwise specifically noted, “SBE,”“we,”“our,”“us” and similar words in this
proxy statement refer to SBE, Inc. and its subsidiaries. References to “One
Stop” shall mean One Stop Systems, Inc.
FORWARD-LOOKING
STATEMENTS
The
information in this proxy statement contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Statements
that are not historical in nature, including statements about beliefs and
expectations, are forward-looking statements. Words such as “may,”“will,”“should,”“estimates,”“predicts,”“believes,”“anticipates,”“plans,”“expects,”“intends” and similar expressions are intended to identify these
forward-looking statements, but are not the exclusive means of identifying
such
statements. Such statements are based on currently available operating,
financial and competitive information and are subject to various risks and
uncertainties. You are cautioned that these forward-looking statements reflect
management's estimates only as of the date hereof, and we assume no obligation
to update these statements, even if new information becomes available or other
events occur in the future. Actual future results, events and trends may differ
materially from those expressed in or implied by such statements depending
on a
variety of factors, including, but not limited to those set forth under “Risk
Factors” and elsewhere in this proxy statement. Important factors that might
cause or contribute to such a discrepancy include, but are not limited
to:
•
the
timing and success of the proposed sale of our embedded business
and our
proposed transaction with Neonode;
•
the
effect of the transaction on our market
price;
•
the
factors discussed under “Risk Factors,” beginning on page 12;
and
•
other
risks referenced from time to time in our filings with the Securities
and
Exchange Commission, or SEC.
WHERE
YOU CAN FIND MORE INFORMATION
We
are a
reporting company and file annual, quarterly and special reports, proxy
statements and other information with the SEC. You may read and copy any
reports, proxy statements or other information that we file at the SEC’s public
reference room at 100 F Street N.E., Room 1580, Washington, D.C., 20549. You
can
also request copies of these documents by writing to the SEC and paying a fee
for the copying costs. Please call the SEC at 1-800-SEC-0330 for more
information about the operation of the public reference room. Our public filings
with the SEC are also available on the web site maintained by the SEC
athttp://www.sec.gov.
We
have
supplied all information in this proxy statement relating to SBE. One Stop
has
supplied all information in this proxy statement relating to One Stop. Neonode
has supplied all information in this proxy statement relating to Neonode.
Seidman & Co., Inc. has supplied the information regarding its fairness
opinion.
The
Special Meeting of Stockholders of SBE, Inc. will be held on March 29, 2007,
at
4000 Executive Parkway, Suite 200, San Ramon, California94583, beginning
promptly at 9:00 a.m., local time. The enclosed proxy is solicited by our board
of directors. It is anticipated that this proxy statement and the accompanying
proxy card will be first mailed to holders of our common stock on or about
March9, 2007.
INFORMATION
ABOUT THE MEETING
Why
am I receiving this proxy statement and proxy card?
You
are
receiving a proxy statement and proxy card because you own shares of our common
stock. This proxy statement describes the issues on which we would like you,
as
a stockholder, to vote. It also gives you information on these issues so that
you can make an informed decision.
Who
can vote at the special meeting?
Only
stockholders of record at the close of business on March 6, 2007 will be
entitled to vote at the special meeting. On this record date, there were
11,142,831
shares
of common stock outstanding and entitled to vote.
Stockholder
of Record: Shares Registered in Your Name
If
on
March 6, 2007 your shares were registered directly in your name with our
transfer agent, American Stock Transfer & Trust, then you are a stockholder
of record. As a stockholder of record, you may vote in person at the meeting
or
vote by proxy. Whether or not you plan to attend the meeting, we urge you to
fill out and return the enclosed proxy card to ensure your vote is counted.
Beneficial
Owner: Shares Registered in the Name of a Broker or Bank
If
on
March 6, 2007 your
shares were held, not in your name, but rather in an account at a brokerage
firm, bank, dealer, or other similar organization, then you are the beneficial
owner of shares held in “street name” and these proxy materials are being
forwarded to you by that organization. The organization holding your account
is
considered to be the stockholder of record for purposes of voting at the special
meeting. As a beneficial owner, you have the right to direct your broker or
other agent on how to vote the shares in your account. You are also invited
to
attend the special meeting. However, since you are not the stockholder of
record, you may not vote your shares in person at the meeting unless you request
and obtain a valid proxy from your broker or other agent.
8
What
am I voting on?
You
are
being asked to approve the sale of our embedded business pursuant to an asset
purchase agreement between us and One Stop Systems, Inc. pursuant to which
One
Stop would acquire our embedded business for $2,200,000 in cash and assume
our
obligations under the lease of our corporate headquarters building and certain
equipment leases. In addition, you are being asked to approve an amendment
to
our certificate of incorporation to effect a stock combination (reverse stock
split) pursuant to which every five shares of outstanding common stock would
be
reclassified into one share of common stock.
How
do I vote?
For
the
matter to be voted on, you may vote “For” or “Against” or abstain from voting.
The procedures for voting are fairly simple:
Stockholder
of Record: Shares Registered in Your Name
If
you
are a stockholder of record, you may vote in person at the special meeting
or
vote by proxy using the enclosed proxy card. Whether or not you plan to attend
the meeting, we urge you to vote by proxy to ensure your vote is counted. You
may still attend the meeting and vote in person if you have already voted by
proxy.
•
To
vote in person, come to the special meeting and we will give you
a ballot
when you arrive.
•
To
vote using the proxy card, simply complete, sign and date the enclosed
proxy card and return it promptly in the envelope provided. If you
return
your signed proxy card to us before the special meeting, we will
vote your
shares as you direct.
Beneficial
Owner: Shares Registered in the Name of Broker or Bank
If
you
are a beneficial owner of shares registered in the name of your broker, bank,
or
other agent, you should have received a proxy card and voting instructions
with
these proxy materials from that organization rather than from us. Simply
complete and mail the proxy card to ensure that your vote is counted. To vote
in
person at the special meeting, you must obtain a valid proxy from your broker,
bank, or other agent. Follow the instructions from your broker or bank included
with these proxy materials, or contact your broker or bank to request a proxy
form.
How
many votes do I have?
On
each
matter to be voted upon, you have one vote for each share of common stock you
own as of March 6, 2007.
How
are votes counted?
Votes
will be counted by the inspector of election appointed for the meeting, who
will
separately count “For” and “Against” votes, abstentions and broker non-votes.
Abstentions will be counted towards the vote total for each proposal and will
have the same effect as “Against” votes. Broker non-votes have no effect and
will not be counted towards the vote for proposal 1. For Proposal 2, broker
non-votes will have the same effect as “Against” votes.
If
your
shares are held by your broker as your nominee (that is, in “street name”), you
will need to obtain a proxy form from the institution that holds your shares
and
follow the instructions included on that form regarding how to instruct your
broker to vote your shares. If you do not give instructions to your broker,
the
shares will be treated as broker non-votes.
9
What
if I return a proxy card but do not make specific
choices?
If
you
return a signed and dated proxy card without marking any voting selections,
your
shares will be treated as broker non-votes and will have no effect on Proposal
1
and will have the same effect as an “Against” vote for Proposal 2.
Who
is paying for this proxy solicitation?
We
will
pay for the entire cost of soliciting proxies. In addition to these mailed
proxy
materials, our directors and employees may also solicit proxies in person,
by
telephone or by other means of communication. Directors and employees will
not
be paid any additional compensation for soliciting proxies. We may also
reimburse brokerage firms, banks and other agents for the cost of forwarding
proxy materials to beneficial owners.
What
does it mean if I receive more than one proxy card?
If
you
receive more than one proxy card, your shares are registered in more than one
name or are registered in different accounts. Please complete, sign and return
each
proxy
card to ensure that all of your shares are voted.
Can
I change my vote after submitting my proxy?
Yes.
You
can revoke your proxy at any time before the final vote at the meeting. If
you
are the record holder of your shares, you may revoke your proxy in any one
of
three ways:
•
You
may submit another properly completed proxy card with a later
date;
•
You
may send a written notice that you are revoking your proxy to our
Secretary at 4000 Executive Parkway, Suite 200, San Ramon, California94583; or
•
You
may attend the special meeting and vote in person. However, simply
attending the special meeting will not, by itself, revoke your
proxy.
If
your
shares are held by your broker or bank as a nominee or agent, you should follow
the instructions provided by your broker or bank.
When
do you expect the asset sale and reverse split to be
completed?
We
plan
to complete the asset sale as soon as possible after the special meeting,
subject to the satisfaction or waiver of certain conditions to the asset sale,
which are described in this proxy statement. We cannot predict when, or if,
these conditions will be satisfied or waived.
We
will
complete the reverse split as soon as possible after the special
meeting.
What
risks should I consider in evaluating the asset sale?
You
should consider the risks described under the heading “Risk Factors” beginning
on page 12.
How
many votes are needed to approve each proposal?
To
be
approved, Proposal 1 (to consider and vote on the proposed sale of assets)
and
Proposal 2 (to approve a reverse stock split) must each receive a “For” vote
from the majority of our outstanding shares. For Proposal 2, broker non-votes
will have the same effect as “Against” votes.
10
What
is the quorum requirement?
A
quorum
is necessary to hold a valid meeting. A quorum will be present if a majority
of
the outstanding shares are represented either by stockholderspresent
at the meeting or by proxy. On the record date, there were 11,142,831 shares
of
SBE common stock outstanding and entitled to vote. Thus, at least 5,571,417
shares must be represented either by stockholders present at the meeting or
by
proxy in order to have a quorum.
Your
shares will be counted towards the quorum only if you submit a valid proxy
(or
one is submitted on your behalf by your broker, bank or other nominee) or if
you
vote in person at the meeting. Abstentions and broker non-votes will be counted
towards the quorum requirement. If there is no quorum, a majority of the votes
present at the meeting may adjourn the meeting to another date.
Does
the board of directors recommend approval of each of the proposals at the
special meeting?
Yes.
After careful consideration, our board of directors recommends that our
stockholders vote FOR Proposal 1 and Proposal 2.
Who
can help answer my questions about the proposal?
If
you
have additional questions about the proposal, you should contact David Brunton,
our Secretary, at (925) 355-2000.
How
can I find out the results of the voting at the special
meeting?
Preliminary
voting results may be announced at the special meeting. Final voting results
will be published in our quarterly report on Form 10-Q for the quarter in which
the special meeting occurs.
11
RISK
FACTORS
You
should consider carefully the following risk factors as well as other
information in this proxy statement and the documents incorporated by reference
herein or therein, including our annual report on Form 10-K for the year ended
October 31, 2006 in voting on the proposal relating to the asset sale. If any
of
the following risks actually occur, our business, operating results and
financial condition could be adversely affected. This could cause the market
price of our common stock to decline, and you may lose all or part of your
investment.
Risks
Relating to the Transaction with One Stop
If
we are unable to complete the asset sale, our business will be adversely
affected.
If
the
asset sale is not completed, our business and the market price of our stock
will
be adversely affected. We currently anticipate that our available cash balances,
available borrowings and cash generated from operations will be sufficient
to
fund our operations only through May 2007. If we are unable to complete the
asset sale, we may be unable to find another buyer for our embedded business
or
another way to grow our business. Costs related to the transaction, such as
legal, accounting and financial advisor fees, must be paid even if the
transaction is not completed. In addition, even if we have sufficient funds
to
continue to operate our business but the transaction are not completed, the
current market price of our common stock may decline.
We
may be unable to complete our proposed Neonode transaction or other strategic
transactions following the asset sale.
After
the
closing of the proposed asset sale, we expect our only remaining assets will
be
cash, accounts receivable, fixed assets and the storage software business we
acquired in connection with our acquisition of PyX Technologies, Inc. in 2005.
On January 19, 2007, we entered into an Agreement and Plan of Merger and
Reorganization, with Neonode Inc., a Delaware corporation. Neonode is a Swedish
based developer and manufacturer of multimedia mobile handsets. With over five
years of research and development Neonode is today a leader and trendsetter
in
buttonless touch screen mobile phones and gesture-based user interfaces. Neonode
mobile phones are based on patented technologies. With Neonode's open Microsoft
based platform consumers can themselves upgrade and customize their handsets
similar to a PC. It is anticipated that our name will be changed to “Neonode
Inc.” in connection with the completion of the merger. We intend to file a proxy
statement in connection with the merger with Neonode. The proxy statement,
when
it becomes available, will contain important information about the merger
transaction. Free copies of the proxy statement will be available at the SEC's
web site at www.sec.gov. We are evaluating strategic alternatives regarding
our
storage software business. We do not currently have any signed agreement for
any
sale of our software business or acquisition transaction, nor do we believe
that
we can continue to operate our software business without additional financing.
We may be unable to reach agreement on any such transactions on commercially
acceptable terms or at all. The failure to effect any such transactions would
likely result in SBE’s liquidation.
If
One Stop defaults on the assumed building and equipment leases, we will be
obligated, as guarantor of such leases, to make the lease
payments.
One
Stop
is assuming our headquarters building lease and engineering equipment lease
and
is obligated to make regularly scheduled lease payments through September 2010.
If One Stop defaults on the leases at any time prior to the lease termination
dates, we, as the guarantor of such leases, will be obligated to make the lease
payments. We may have insufficient funds and be unable to meet the lease
obligations.
12
We
may be obligated to indemnify One Stop pursuant to the asset purchase
agreement.
We
have
agreed to indemnify One Stop for any damages suffered by One Stop arising for
any breach of any of the representations or warranties or covenants or
obligations we have made in the asset purchase agreement. In addition, we have
agreed to indemnify One Stop for any liabilities attributable to operation
of
the embedded business prior to the closing. The terms of our indemnification
obligations are described elsewhere in this proxy statement. In the event we
are
required to indemnify One Stop, SBE’s financial condition may be materially
adversely affected and any value obtainable for SBE’s stockholders in connection
with an acquisition of another business, a sale of our software business or
liquidation may decrease.
13
THE
COMPANIES
SBE
We
design, manufacture
and sell hardware products, including wide area network and local area network
interface cards and central processor units, to original equipment manufacturers
that
embed
our hardware products into their products for the telecommunications
markets.
Embedded
networking technology is hardware or software that serves as a component within
a larger networking or storage device or system, such as a Gigabit Ethernet
or a
T-1/T-3 input/output network interface card, that plugs into an expansion slot
in a high-end computer or storage system. Our
embedded hardware products perform critical computing and I/O tasks in diverse
markets such as high-end enterprise level computing servers, Linux
super-computing clusters, workstations, media gateways, routers and Internet
access devices. We
also
design and sell iSCSI-based storage networking solutions for an extensive range
of business critical applications, including Disk-to-Disk Back-up and Disaster
Recovery. We deliver an affordable, expandable, and easy-to-use portfolio of
software solutions designed to enable optimal performance and rapid deployment
across a wide range of next generation storage systems. We are evaluating
strategic alternatives regarding our storage software business, including
selling the business.
We
were
incorporated in 1961 as Linear Systems, Inc. In 1976, we completed our initial
public offering. In July 2000, we acquired LAN Media Corporation, a privately
held company, to complement and grow our WAN adapter product line from both
a
hardware and software perspective. In August 2003, we acquired the products
and
technologies of Antares Microsystems to increase the functionality of our
hardware product line. In 2005, we acquired PyX Technologies, Inc., a company
engaged in the development implementation and sale of software.
The
assets we propose to sell to One Stop comprise all of our embedded hardware
business. After the closing of such sale, we expect our only remaining assets
will be cash, accounts receivable, fixed assets and the storage software
business we acquired in connection with our acquisition of PyX Technologies,
Inc. in 2005. Substantially
all our revenue for the past year has been generated by our embedded hardware
business. After
the
sale of the embedded hardware business is completed, we will no longer be active
in the embedded hardware business and
future cash will have to be derived from our storage software operations or
from
the operations from Neonode after the proposed merger is completed.
On
January 19, 2007, we entered into an Agreement and Plan of Merger and
Reorganization, with Neonode Inc., a Delaware corporation. Neonode is a Swedish
based developer and manufacturer of multimedia mobile handsets. With over five
years of research and development, Neonode is today a leader and trendsetter
in
buttonless touch screen mobile phones and gesture-based user interfaces. Neonode
mobile phones are based on patented technologies. With Neonode's open Microsoft
based platform, consumers can themselves upgrade and customize their handsets
similar to a PC. It is anticipated that our name will be changed to “Neonode
Inc.” in connection with the completion of the merger. The sale of our embedded
business to One Stop is a condition to closing the transaction with Neonode.
We
intend to file a proxy statement in connection with the merger with Neonode.
The
proxy statement, when it becomes available, will contain important information
about the merger transaction. Free copies of the proxy statement will be
available at the SEC's web site at www.sec.gov.
One
Stop
One
Stop
Systems,
Inc. is
a manufacturer of industrial-grade computing systems and components, including
a
line of PCI Express-based products. One Stop’s PCI Express-based products
increase network bus speed up to 16 times faster than 64-bit PCI and 80 times
faster than Gigabit Ethernet. One Stop offers over 400 standard products,
including its MAX Express product line, passive backplane, Virtual Machine
Environment and custom and proprietary bus structures. One Stop’s principal
executive office is located at 2235 Enterprise Street, Suite 110, Escondido,
California92029.
14
Neonode
On
January 19, 2007, we entered into an Agreement and Plan of Merger and
Reorganization with Neonode, Inc., a Delaware corporation. Neonode is a
Sweden-based developer and manufacturer of multimedia mobile handsets.
The
sale
of our embedded business to One Stop is a condition to closing the transaction
with Neonode. For
a
description of the proposed Neonode transaction, please see “Overview of the
Neonode Transaction” on page 33. We intend to file a proxy statement in
connection with the merger with Neonode. The proxy statement, when it becomes
available, will contain important information about the merger transaction
and
about Neonode. Free copies of the proxy statement will be available at the
SEC’s
website at www.sec.gov.
15
THE
ASSET SALE
Background
of the Asset Sale
On
August21, 2006, our board of directors held a regular meeting and discussed the
strategic direction of SBE. The board authorized our management to retain
investment banking advisors to seek alternative measures to increase stockholder
value.
On
September 8, 2006, we engaged Stratpoint Consulting LLC to assist us with the
sale of our embedded business.
On
September 21, 2006, our board of directors held a special meeting to discuss
the
strategic future of SBE, including the possible disposition of all of our
assets.
At that
meeting, our board of directors authorized
management to enter into discussions and negotiate term sheets for the
disposition of all or a portion of our assets, subject to final approval of
the
term sheet by the board of directors.
On
September 28, 2006, we met with Stratpoint Consulting LLC and finalized a list
of 22 prospective companies to contact regarding the potential purchase of
our
embedded business.
During
the week of October 2, 2006, Stratpoint Consulting LLC mailed inquiry letters
to
the list of prospective companies.
From
October 4, 2006 through October 24, 2006, we entered into nondisclosure
agreements with six companies that expressed an interest in purchasing our
embedded business and sent informational sales packages to each of the
companies.
On
October 10, 2006, John Reardon, a member of our board of directors and a member
of One Stop’s board of directors, introduced our Chief Financial Officer, David
Brunton, to One Stop’s Chief Executive Officer, Steve Cooper, to discuss the
potential acquisition of our embedded business by One Stop.
On
October 12, 2006, our board of directors formed a Strategic Transaction
Committee comprised of our independent board members to review and approve
all
strategic alternatives presented to the board for approval. Mr. Reardon recused
himself from all One Stop and SBE board discussions relating to the potential
acquisition of our embedded business by One Stop.
We
entered into a nondisclosure agreement with One Stop on October 24, 2006.
From
October 24, 2006 through November 10, 2006, we continued to have discussions
with two of the companies that received the informational sales packages related
to the sale of our embedded business. The other four potential bidders declined
to continue discussions.
During
the period from August 2006 through the execution of the asset purchase
agreement with One Stop, our Chief Executive Officer provided our board of
directors with frequent status updates on the potential divestiture of the
embedded business.
On
November 10, 2006, we had discussions with the two final purchaser candidates
and considered purchase offers submitted by both entities before accepting
the
superior offer from One Stop.
On
November 10, 2006, we signed a non-binding term sheet with One Stop pertaining
to the proposed sale of our embedded business.
On
November 13, 2006, our board of directors met to approve the term sheet and
instructed our management to move forward with the asset sale.
On
December 6, 2006, we received the initial draft of the asset purchase agreement
from One Stop and its counsel.
During
December 2006 through January 8, 2007, negotiations continued on the asset
purchase agreement.
On
December 13, 2006, we retained Seidman & Co., Inc. to analyze the sale of
our embedded business to One Stop and to determine the fairness of the proposed
transaction, from a financial point of view, to our stockholders.
On
January 9, 2007, at a meeting of our board of directors, Seidman & Co., Inc.
delivered its oral opinion to our board of directors that the consideration
to
be received by SBE in the proposed asset sale is fair, from a financial point
of
view, to SBE’s stockholders. Thereafter, the board of directors, together with
management and SBE’s outside counsel, engaged in a full discussion of the
proposed transaction. After such discussion, the board of directors determined
that the transaction was advisable and in the best interests of SBE and its
stockholders, determined to recommend to SBE’s stockholders that they approve
the proposed transaction, and authorized SBE management to execute the asset
purchase agreement in the form in which it was presented to the board of
directors.
On
January 11, 2007, we and One Stop signed the asset purchase agreement. On the
same day, we announced via press release the execution of the agreement and
filed a corresponding Form 8-K with the Securities and Exchange
Commission.
Reasons
for the Asset Sale
In
reaching its decision to approve the asset sale and to recommend approval of
the
asset purchase agreement by our stockholders, our board of directors consulted
with our management team and advisors.
Prior
to
approving the asset sale, our board of directors considered various alternative
ways to maximize stockholder value. After such consideration, our board of
directors concluded that the asset sale presented the best course of action
for
us at this time.
The
material factors considered by our board of directors in making its
determination to pursue the asset sale included the following:
1.
the
amount and form of the consideration to be paid in the
transaction;
2.
the
belief that, after conducting an extensive review of our financial
condition, results of operations and business and earning prospects,
the
sale of the embedded business was likely to create greater value
for our
stockholders as compared to pursuing our existing course of business
or an
alternative business strategy; and
3.
the
extensive process conducted by our management in seeking potential
buyers
and the belief that the alternatives to the proposed transaction
were not
reasonably likely to provide equal or greater value to us and our
stockholders.
Recommendation
of Our Board of Directors
At
its
meeting held on January 9, 2007, our board of directors (1) determined that
the asset sale and the asset purchase agreement are fair to and in the best
interests of SBE and our stockholders and (2) determined to recommend that
our stockholders approve the proposal related to the transaction. Accordingly,
our board of directors recommends that our stockholders vote FOR the asset
sale
and the asset purchase agreement.
17
In
connection with the foregoing actions, our board of directors consulted with
our
management team, as well as our financial advisor and legal counsel, and
considered the following material factors:
1.
all
the reasons described above under “Reasons for the Asset
Sale”;
2.
the
judgment, advice and analyses of our senior management, including
their
favorable recommendation of the asset
sale;
3.
alternatives
to the asset sale;
4.
the
presentations by and discussions with our senior management and
representatives of our counsel and financial advisor regarding the
terms
and conditions of the asset
purchase;
5.
the
presentations by and discussions with our senior management and
representatives of our counsel regarding the terms and conditions
of the
asset purchase agreement and the asset sale;
and
6.
that
while the asset sale is likely to be completed, there are risks associated
with completing the transactions and, as a result of conditions to
the
completion of the transactions, it is possible that the transactions
may
not be completed even if approved by our
stockholders.
Our
board
of directors did not find it useful to, and did not attempt to, quantify, rank
or otherwise assign relative weights to these factors. Our board of directors
relied on the analysis, experience, expertise and recommendation of our
management team with respect to each of the transactions and relied on Seidman
& Co., Inc., our financial advisor, for analyses of the financial terms of
the asset sale. See “Opinion of Our Financial Advisor” on page 18.
In
addition, our board of directors did not undertake to make any specific
determination as to whether any particular factor, or any aspect of any
particular factor, was favorable or unfavorable to its ultimate determination,
but rather our board of directors conducted an overall analysis of the factors
described above, including discussions with our management team and legal,
financial and accounting advisors. In considering the factors described above,
individual members of our board of directors may have given different weight
to
different factors.
Opinion
of Our Financial Advisor
In
connection with the proposed asset sale, our board of directors received a
written opinion from Seidman & Co., Inc. as to the fairness of the
consideration to be received by us, from a financial point of view and as of
the
date of the opinion. The full text of Seidman & Co., Inc.’s written opinion
is attached to this proxy statement as Annex B. You are encouraged to read
this
opinion carefully in its entirety for a description of the assumptions made,
matters considered and limitations on the review undertaken.
18
PROPOSAL
1
APPROVAL
OF THE SALE OF SBE’S EMBEDDED BUSINESS
General
On
January 11, 2007, we entered into an asset purchase agreement with One Stop,
pursuant to which we agreed to sell our embedded business to One Stop for
$2,200,000 in cash plus One Stop’s assumption of the lease of our corporate
headquarters building and certain equipment leases.
The
asset
purchase agreement is attached to this proxy statement as Annex A. You
should read the asset purchase agreement carefully. It is the agreement that
governs the terms of the asset sale. The following information summarizes the
terms of the asset purchase agreement.
Effective
Time of the Asset Sale
The
asset
purchase agreement provides that the closing of the asset sale will take place
as soon as practicable after the conditions to closing set forth in the asset
purchase agreement are fulfilled. Completion of the asset sale could be delayed
if there is a delay in satisfying the closing conditions to the asset sale.
There can be no assurances as to whether, and on what date, the conditions
will
be satisfied or that the asset sale will be completed at all. If the asset
sale
is not completed on or before April 30, 2007, either we or One Stop may
terminate the asset purchase agreement, except that a party cannot terminate
the
agreement if that party’s failure to fulfill any of its obligations under the
asset purchase agreement was the cause of the asset sale not being completed
by
that date.
Representations
and Warranties
The
asset
purchase agreement contains representations and warranties made by us to One
Stop and by One Stop to us for purposes of allocating the risks associated
with
the asset sale. Our representations and warranties to One Stop in the asset
purchase agreement include, among other things:
•
our
organization, qualification and good
standing;
•
the
accuracy of our financial
statements;
•
the
absence of certain changes since July 31,2006;
•
our
debts, obligations and liabilities;
•
the
assets of our business, including our real property, inventory, tangible
personal property, accounts receivable, intellectual property and
other
intangible property;
conflicts
of interest with our customers, suppliers or competitors;
and
•
personnel.
One
Stop’s representations and warranties to us include, among other
things:
•
organization,
qualification and good standing;
•
necessary
authority and consents; and
•
ability
to pay the purchase price.
Certain
Covenants
The
asset
purchase agreement provides that we must meet certain obligations with respect
to our embedded business prior to the closing of the asset sale:
•
provide
One Stop with access to all of our records and
documents;
•
conduct
our embedded business in the ordinary course and in substantially
the same
manner as conducted prior to the asset purchase
agreement;
•
preserve
our business and relationships;
•
maintain
our existing insurance;
•
not
make changes in compensation or benefits of our employees, sales
agents or
representatives;
•
not
enter into new contracts (i) not in the ordinary course or consistent
with
past practices, (ii) in the ordinary course for an amount in excess
of
$50,000, (iii) for the lease of capital equipment or property with
annual
lease charges in excess of $10,000 or (iv) for the sale of any capital
assets with a net book value in excess of
$10,000;
•
not
modify or terminate any of our existing contracts or agreements;
•
obtain
the written consent of certain third
parties;
•
upon
request, deliver to One Stop a description of our trade secrets,
processes
or business procedures;
•
obtain
written approval of our board of directors for the asset sale;
and
•
comply
with our confidentiality
obligations.
The
asset
purchase agreement provides that One Stop must meet certain obligations prior
to
the closing of the asset sale:
•
comply
with its confidentiality
obligations;
•
cooperate
in our efforts to obtain the consents of certain third
parties;
•
furnish
a resale certificate to comply with California sales and use tax
laws;
and
•
obtain
written approval of its board of directors for the purchase of
assets.
20
Conditions
Precedent
One
Stop’s obligation to complete the asset sale depends on the satisfaction or
waiver of a number of conditions, including conditions relating to:
•
accuracy
of our representations on and as of the
closing;
•
our
performance, satisfaction and compliance with all covenants, agreements
and closing conditions;
•
no
material adverse change will have occurred with respect to the embedded
business;
•
receipt
of an officer’s certificate executed by our chief executive officer
certifying that all closing conditions have been
fulfilled;
•
absence
of litigation pertaining to the sale of the embedded
business;
•
our
receipt of stockholder approval of the transaction;
and
•
payment
of certain outstanding accounts payable attributable to the embedded
business.
In
addition, our obligation to complete the asset sale is subject to satisfaction
or waiver of certain additional conditions, including conditions relating
to:
•
accuracy
of One Stop’s representations on and as of the
closing;
•
One
Stop’s performance, satisfaction and compliance with all covenants,
agreements and closing conditions;
and
•
absence
of litigation pertaining to the
transaction.
Termination
The
asset
purchase agreement may be terminated under the following
circumstances:
•
by
mutual written consent of the parties, duly authorized by their respective
boards;
•
the
closing has not occurred on or before April 30, 2007, unless the
party
terminating in this circumstance is at fault for the delay in
closing;
•
any
proceeding is pending against either party that could prevent performance
of the asset sale; or
•
any
governmental entity has issued an order, the effect of which is to
prohibit the asset sale.
Restriction
on Competition
We
have
agreed that for four years following the closing of the asset sale, we will
not
directly or indirectly engage in the embedded business or have any interest
in
(whether as an employee, officer, director, agent, security holder, creditor,
consultant, or otherwise), any entity engaged in the embedded
business.
Indemnification
Each
party has agreed to indemnify the other party for damages arising for any breach
of any of the representations or warranties or covenants or obligations in
the
asset purchase agreement. In addition, we have agreed to indemnify One Stop
for
any liabilities attributable to operation of the embedded business prior to
the
closing. All representations, warranties and covenants expire on the first
anniversary of the closing. Our liability for indemnification claims made by
One
Stop pursuant to the asset purchase agreement is capped at $2,200,000 in the
aggregate.
21
Waivers
Any
provision of the asset
purchase agreement
may be waived if the waiver is duly executed and delivered by the party against
whom the waiver is to be effective and will only be applicable in the specific
instance in which it is given.
Amendments
Any
provision of the asset purchase agreement may be amended if the amendment is
duly executed and delivered by us and One Stop.
Fees
and Expenses
We
and
One Stop will each pay our own respective fees, costs and expenses incurred
in
connection with the asset purchase agreement.
22
PROPOSAL
2
APPROVAL
OF REVERSE STOCK SPLIT
Background
Our
common stock is quoted on The Nasdaq Capital Market under the symbol SBEI.
In
order for our common stock to continue to be quoted on the Nasdaq Capital
Market, we must satisfy various listing maintenance standards established by
Nasdaq. Among other things, as such requirements pertain to us, we are required
to have stockholders’ equity of at least $2.5 million and public float value of
at least $1 million and our common stock must have a minimum closing bid price
of $1.00 per share. Our
stockholders’ equity as of October 31, 2006 was approximately $3.3 million and
our closing bid price on October 31, 2006 was $0.37.
On
July14, 2006, we received a notice from The Nasdaq Stock Market, or Nasdaq,
indicating that for the preceding 30 consecutive business days, the bid price
of
our common stock closed below the $1.00 minimum bid price required for continued
listing by Nasdaq Marketplace Rule 4310(c)(4), referred to as the Rule. The
notice stated that we would be provided 180 calendar days, or until January10,2007, to regain compliance with the Rule. The notice further stated that if
we
were not in compliance with the Rule by January 10, 2007, the Nasdaq staff
would
determine whether we meet the Nasdaq initial listing criteria as set forth
in
Nasdaq Marketplace Rule 4310(c), except for the bid price requirement. If we
met
the initial listing criteria, the Nasdaq staff would notify us that we had
been
granted an additional 180 calendar day compliance period. If we were not
eligible for an additional compliance period, the Nasdaq staff would provide
us
written notification that our securities would be delisted from Nasdaq, and
at
that time we would be able to appeal the staff’s determination to a Listings
Qualifications Panel.
On
January 11, 2007, we received a notice from Nasdaq that our stock is subject
to
delisting and that we would not be given the additional 180 day compliance
period and that we did not meet the Nasdaq initial listing criteria as set
forth
in Nasdaq Marketplace Rule 4310(c). We filed an appeal of the staff’s
determination to a Listings Qualifications Panel. Delisting of our stock from
Nasdaq is stayed pending the determination of the Listings Qualifications Panel.
The appeals hearing was held on February 22, 2007 and we are awaiting the
Panel’s determination. We expect the Panel will grant us an extension such that
if we complete a stock split sufficient to increase our bid price to $1.00
or
more prior to the extension date, our shares may remain listed on the Nasdaq
Capital Market. We anticipate seeking stockholder approval of such reverse
split
at the same time as we seek stockholder approval of the One Stop Systems
transaction. We will need to comply with the Nasdaq initial listing criteria,
which requires a $4.00 minimum bid price, in connection with the Neonode
transaction so we may effect a subsequent reverse split in connection with
that
transaction.
In
response to the notice from Nasdaq, we propose that a 1-for-5 reverse stock
split be implemented for the purpose of increasing the market price of our
common stock above the Nasdaq minimum bid requirement. There is no assurance
that we will meet the continued listing requirements following the split or
that, even if the continued listing requirements are met, that our common stock
will continue to be traded on the Nasdaq Capital Market.
If
we
fail to regain compliance with the standards necessary to be quoted on The
Nasdaq Capital Market or we are unsuccessful in our appeal of the delisting
determination and our common stock is delisted, trading in our common stock
would be conducted on the OTC Bulletin Board as long as we continue to file
reports required by the Securities and Exchange Commission. The OTC Bulletin
Board is generally considered to be a less efficient market than The Nasdaq
Capital Market, and our stock price, as well as the liquidity of our
common
stock,
may be
adversely impacted as a result.
Purpose
and Material Effects of Proposed Reverse Split
One
of
the key requirements for continued listing on The Nasdaq Capital Market is
that
our common stock must maintain a minimum bid price above $1.00 per share. We
believe that the reverse split will improve the price level of our common stock
so that we are able to maintain compliance with the Nasdaq minimum bid price
listing standard. Furthermore, we believe that maintaining our Nasdaq Capital
Market listing, if possible, may provide us with a broader market for our common
stock.
23
However,
the effect of the reverse split upon the market price for our common stock
cannot be predicted, and the history of similar stock split combinations for
companies in like circumstances is varied. There can be no assurance that the
market price per share of our common stock after the reverse split will rise
in
proportion to the reduction in the number of shares of our common stock
outstanding resulting from the reverse split. The market price of our common
stock may also be based on our performance and other factors, some of which
may
be unrelated to the number of shares outstanding. Furthermore, the possibility
exists that liquidity in the market price of our common stock could be adversely
affected by the reduced number of shares that would be outstanding after the
reverse split. There can be no assurance that the market price per post-reverse
split share will either exceed or remain in excess of the $1.00 minimum bid
price as required by Nasdaq, or that we will otherwise meet the requirements
of
Nasdaq for continued listing on The Nasdaq Capital Market, including the minimum
public float or stockholders’ equity requirements.
The
reverse split will affect all of our stockholders uniformly and will not affect
any stockholder’s percentage ownership interests in us or proportionate voting
power, except to the extent that the reverse split results in any of our
stockholders owning a fractional share. In lieu of issuing fractional shares,
we
will pay cash to each stockholder owning fractional shares as described below.
Although the reverse split will not affect any stockholder’s percentage
ownership or proportionate voting power (subject to the treatment of fractional
shares), the number of authorized shares of common stock will not be reduced
and
will increase the ability of the Board to issue such authorized and unissued
shares without further stockholder action. This issuance of such additional
shares, if such shares were issued, may have the effect of diluting the earnings
per share and book value per share, as well as the stock ownership and voting
rights, of outstanding common stock. The effective increase in the number of
authorized but unissued shares of common stock may be construed as having an
anti-takeover effect by permitting the issuance of shares to purchasers who
might oppose a hostile takeover bid or oppose any efforts to amend or repeal
certain provisions of our certificate of incorporation or bylaws.
The
principal effect of the reverse split will be that (i) the number of shares
of common stock issued and outstanding will be reduced from approximately
11,130,831 million shares as of January 29, 2007 to approximately 2,226,166
million shares, (ii) all outstanding options entitling the holders thereof
to purchase shares of common stock will enable such holders to purchase, upon
exercise of their options, one-fifth of the number of shares of common stock
which such holders would have been able to purchase upon exercise of their
options immediately preceding the reverse split at an exercise price equal
to
five times the exercise price specified before the reverse split, resulting
in
the same aggregate price being required to be paid therefor upon exercise
thereof immediately preceding the reverse split, and (iii) the number of
shares reserved for issuance in our equity incentive plans will be reduced
to
one-fifth of the number of shares currently included in each such
plan.
The
reverse split will not affect the par value of our common stock. As a result,
on
the effective date of the reverse split, the stated capital on our balance
sheet
attributable to the common stock will be reduced to one-fifth of its present
amount, and the additional paid-in capital account shall be credited with the
amount by which the stated capital is reduced. The per share net income or
loss
and net book value of our common stock will be increased because there will
be
fewer shares of our common stock outstanding.
The
reverse split is not intended as, and will not have the effect of, a “going
private transaction” covered by Rule 13e-3 under the Securities Exchange Act of
1934. We will continue to be subject to the periodic reporting requirements
of
the Securities Exchange Act of 1934.
Procedure
for Effecting Reverse Split and Exchange of Stock
Certificates
If
the
reverse split is approved by our stockholders and the Board of Directors has
determined to effect the reverse split, we will promptly file a certificate
of
amendment with the Secretary of State of the State of Delaware. The reverse
split will become effective on the date of filing the certificate of amendment,
which we will refer to as the effective date. Beginning on the effective date,
each certificate representing pre-reverse split shares will be deemed for all
corporate purposes to evidence ownership of post-reverse split
shares.
24
As
soon
as practicable after the effective date, stockholders will be notified that
the
reverse split has been effected. Our transfer agent will act as exchange agent
for purposes of implementing the exchange of stock certificates. We refer to
such person as the exchange agent. Holders of pre-reverse split shares may
be
asked to surrender to the exchange agent certificates representing pre-reverse
split shares in exchange for certificates representing post-reverse split shares
in accordance with the procedures to be set forth in a letter of transmittal
to
be sent by us. Stockholders
should not destroy any stock certificate and should not submit any certificates
until requested to do so.
Fractional
Shares
We
will
not issue fractional certificates for post-reverse split shares in connection
with the reverse split. In lieu of any such fractional share interest, each
holder of pre-reverse split shares who as a result of the reverse split would
otherwise receive a fractional share of post-reverse split common stock will
be
entitled to receive cash in an amount equal to the product obtained by
multiplying (i) the closing sales price of our common stock on the effective
date as reported on The Nasdaq Capital Market by (ii) the number of shares
of
pre-reverse split common stock held by such holder that would otherwise have
been exchanged for such fractional share interest. Such amount will be issued
to
such holder in the form of a check in accordance with the exchange procedures
outlined above.
No
Dissenter’s Rights
Under
the
Delaware General Corporation Law, our stockholders are not entitled to
dissenter’s rights with respect to our proposed amendment to our charter to
effect the reverse split and we will not independently provide our stockholders
with any such right.
Federal
Income Tax Consequences of the Reverse Split
The
following is a summary of important U.S. federal income tax considerations
of
the reverse split. It addresses only stockholders who hold the pre-reverse
split
shares and post-reverse split shares as capital assets. It does not purport
to
be complete and does not address stockholders subject to special rules, such
as
financial institutions, tax-exempt organizations, insurance companies, dealers
in securities, mutual funds, foreign stockholders, stockholders who hold the
pre-reverse split shares as part of a straddle, hedge, or conversion
transaction, stockholders who hold the pre-reverse split shares as qualified
small business stock within the meaning of Section 1202 of the Internal Revenue
Code of 1986, as amended (the “Code”), stockholders who are subject to the
alternative minimum tax provisions of the Code, and stockholders who acquired
their pre-reverse split shares pursuant to the exercise of employee stock
options or otherwise as compensation. This summary is based upon current law,
which may change, possibly even retroactively. It does not address tax
considerations under state, local, foreign, and other laws. Furthermore, we
have
not obtained a ruling from the Internal Revenue Service or an opinion of legal
or tax counsel with respect to the consequences of the reverse stock split.
Each
stockholder is advised to consult his or her tax advisor as to his or her own
situation.
The
reverse stock split is intended to constitute a reorganization within the
meaning of Section 368 of the Internal Revenue Code of 1968. Assuming the
reverse split qualifies as a reorganization, a stockholder generally will not
recognize gain or loss on the reverse stock split, except to the extent of
cash,
if any, received in lieu of a fractional share interest in the post-reverse
split shares. The aggregate tax basis of the post-reverse split shares received
will be equal to the aggregate tax basis of the pre-reverse split shares
exchanged therefor (excluding any portion of the holder’s basis allocated to
fractional shares), and the holding period of the post-reverse split shares
received will include the holding period of the pre-reverse split shares
exchanged.
A
holder
of the pre-reverse split shares who receives cash will generally recognize
gain
or loss equal to the difference between the portion of the tax basis of the
pre-reverse split shares allocated to the fractional share interest and the
cash
received. Such gain or loss will be a capital gain or loss and will be short
term if the pre-reverse split shares were held for one year or less and long
term if held more than one year.
No
gain
or loss will be recognized by SBE as a result of the reverse stock
split.
25
Vote
Required
The
affirmative vote of the holders of a majority of the shares of our common stock
will be required to approve the amendment to our Certificate of Incorporation
to
effect the reverse split. As a result, abstentions and broker non-votes will
have the same effect as negative votes.
THE
BOARD OF DIRECTORS RECOMMENDS A VOTE
IN
FAVOR OF PROPOSAL 2
26
BUSINESS
Overview
SBE
designs, manufactures and sells embedded hardware products including wide area
network (WAN) and local area network (LAN) network interface cards (NICs) and
central processing units (CPUs) to OEMs who embed our hardware products into
their products for the communications markets. Our embedded hardware products
perform critical, computing and Input/Output (I/O) tasks in diverse markets
such
as high-end enterprise level computing servers, Linux super-computing clusters,
workstations, media gateways, routers and Internet access devices.
We
also
design and provide software based storage networking solutions for an extensive
range of business critical applications, including Disk-to-Disk Back-up and
Disaster Recovery. We deliver an affordable, expandable, and easy-to-use
portfolio of software solutions designed to enable optimal performance and
rapid
deployment across a wide range of next generation storage systems We sell
standards-based storage software solutions to original equipment manufacturers
(OEMs), system integrators and value added resellers (VARs) who embed our
software into their IP storage area network (IP SAN) and network attached
storage (NAS) systems to provide data storage solutions for the small and medium
business (SMB) enterprise storage markets. We are evaluating strategic
alternatives regarding our storage software business, including selling the
business.
We
experienced a decline in our sales volume of our embedded hardware products
and
a lack of market acceptance for our storage software that dramatically affected
our operating cash flow for fiscal 2006. Because of the continuing decline
of
our cash balance, we have been evaluating strategic alternatives to return
the
company to cash flow positive and unlock value for our shareholders. In
September 2006, our Board of Directors and management believed that the best
course of action was to consider selling our embedded hardware and storage
software businesses and to consider seeking a viable merger candidate.
On
January 11, 2007, we signed an asset purchase agreement with One Stop Systems,
Inc., a private California corporation, to purchase our embedded hardware
business for $2.2 million cash plus the assumption of our corporate headquarters
office lease and a lease for certain engineering equipment. When the divesture
of our embedded hardware business is completed we will no longer participate
in
the embedded hardware markets. We will transfer our entire inventor and the
engineering and test equipment associated with the embedded hardware business
to
One Stop.
On
January 19, 2007, we entered into an Agreement and Plan of Merger and
Reorganization with Neonode Inc., a Delaware corporation. Neonode is a
Sweden-based developer and manufacturer of multimedia mobile handsets. With
over
five years of research and development, Neonode is today a leader and
trendsetter in buttonless touch screen mobile phones and gesture-based user
interfaces. Neonode mobile phones are based on patented technologies. With
Neonode's open Microsoft based platform consumers can themselves upgrade and
customize their handsets similar to a PC. It is anticipated that our name will
be changed to “Neonode Inc.” in connection with the completion of the merger.
The sale of our embedded business to One Stop is a condition to closing the
transaction with Neonode. We intend to file a proxy statement in connection
with
the merger with Neonode. The proxy statement, when it becomes available, will
contain important information about the merger transaction. Free copies of
the
proxy statement will be available at the SEC's web site at www.sec.gov.
Products
and Technologies
Storage
Products
Managing,
growing, and protecting storage is regarded as one of the most burdensome and
expensive responsibilities of a company’s data center management. In the
direct-attached storage (DAS) environments that most small to mid-sized
companies deploy, the process of managing storage is made more difficult by
the
number of physical connection points and the number of storage systems in the
organization. Imagine an environment with ten computers, each with its own
storage system. That creates ten storage systems that need to be managed and
maintained, which then equates to ten times the effort normally required in
order to handle storage expansion, reallocation and repairs. One of the main
driving forces behind a transition from DAS to a SAN is often high data growth
and the need for operations efficiency. In these circumstances the legacy DAS
environment becomes increasingly complex, backup/restore operations become
increasingly unreliable, and the storage environment is unable to support the
demands of the business.
27
Developed
to extend the reach of SANs by enabling SAN functionality over the IP network,
Internet Small Computer System Interface (iSCSI) technology uses the SCSI
command set over Transmission Control Protocol/ Internet Protocol (TCP/IP),
enabling any requesting node on the IP network (the initiator) to contact any
remote storage server (the target) and perform block I/O on the target as if
it
was a local hard drive. Because of the ubiquity of IP networks, iSCSI can be
used to transmit data over LANs, WANs, or the Internet and can enable location
independent data storage and retrieval. iSCSI has no distance limitations,
can
utilize existing network infrastructure, does not require specialized training,
and takes advantage of Ethernet’s economies of scale. With the immediate
availability of 10G adapters and switches, we believe that iSCSI SANs can more
than double the performance levels of leading-edge Fibre Channel
implementations, while mass adoption continues to drive costs down.
On
top of
all that, regulatory compliance pressures, the need to integrate geographically
dispersed data assets, and the availability of effective information life-cycle
management solutions create further issues and serve as drivers behind the
move
to IP SANs. Another significant driver behind IP SANs is the availability of
data center staff. Most smaller, regional, and departmental data centers have
to
operate with limited staff. Often, the decision to move to a SAN environment
hinges on whether the existing staff can handle it. In these cases an IP SAN
solution becomes a viable alternative, since it can almost always be more easily
managed by existing staff and skill sets.
Our
IP
SAN Director Suite addresses the need for easy-to-manage, inexpensive storage
and data protection through our iSCSI transport stack, storage management
features, and data protection modules.
The
iSCSI
transport stack is the foundation of our IP SAN Director Suite and is scalable
from Wi-Fi to 10 Gigabit Ethernet. It delivers the same level of reliability,
quality of service and system robustness as alternative solutions, such as
Fibre
Channel, but at a fraction of the cost. We believe that the advanced features
designed into the architecture of our iSCSI protocol stack enables highly
efficient and cost-effective storage transport by optimizing bandwidth usage,
enabling unlimited storage to be attached to each target device, and leveraging
existing network technologies.
Our
iSCSI
protocol stack provides multipathing I/O functionality for maximum redundancy
and reliability, aggregation of bandwidth to reduce service costs, as well
as
multiple connections per session to increase bandwidth efficiency and data
integrity. Enterprise-level quality of service functionality enables traffic
to
be consistently classified, prioritized, and queued at line rate. We believe
that the Error Recovery Level 2 (ERL2) featured in our iSCSI protocol stack
increases system reliability, availability and adaptability. ERL2 supports
active/active task migration, which prevents session and data loss. Our iSCSI
stack is fully tested and compliant with IETF RFC-3720 iSCSI standards,
including all mandatory and optional feature sets. Our SBE iSCSI target supports
most Linux distributions and is compatible with any compliant iSCSI initiator
under any OS distribution, including Linux, Windows and Solaris. An additional
benefit of using iSCSI transport is its interoperability with any storage
protocol disk drive interfaces (SCSI, Serial Attached SCSI (SAS), Serial ATA
(SATA), Fiber Channel drives).
On
top of
our foundation iSCSI protocol stack, we have developed and manufactured a wide
variety of storage management features and data protection modules. While the
iSCSI protocol stack provides for a robust, inexpensive, and highly scalable
transport infrastructure, modules included in our IP SAN Director Suite such
as
iSNS (Internet Storage Name Service), SNMP (Simple Network Management Protocol),
Snapshot, High Availability, and Replication seamlessly address the needs and
requirements of today’s IT storage managers.
The
iSNS
feature set provides similar functionality as a DHCP (Dynamic Host Configuration
Protocol) server. As new storage subsystems are brought online, iSNS allows
automatically names and adds them to the storage pool. Consistent with our
integrated approach to system design, both an iSNS client and iSNS server are
provided. To further ease the burdens of large-scan storage administration,
the
SNMP module allows the user to monitor the status of a large SAN from a single
console.
28
As
a
component of our IP SAN Director Suite, the Snapshot add-in module provides
critical data protection by creating point-in-time images of iSCSI data volumes.
As a standalone application the snapshot module provides maximum protection;
users may access data at discrete times in history when a combination of
application error and user error overwrites, or corrupts critical data. In
the
event of a catastrophic event such as virus infection, the rollback feature
allows the IT administrator to recover the entire data volume to a previously
known healthy state. The Snapshot module conjoined with backup software running
on an application server allows mainline, primary data access to continue,
while
the backup process copies the snapshot image to a secondary and offline
storage.
Replication
across storage subsystems is a critical part of any IP SAN data protection
solution. Multiple versions of replication exist and are required for different
purposes and application environments. To effectively address the wide spectrum
of needs, we are developing 3 distinct Replication add-in modules that are
seamlessly integrated into our IP SAN Director Suite. The first two add-in
modules in our Replication portfolio address the need for data mirrors for
primary storage within a SAN. With the Synchronous Online Replication module,
both the local target and remote target must complete any writes from iSCSI
initiators before an acknowledgment is sent. This guarantees data integrity
and
works well in low-latency SAN environments for primary storage.
There
are
some instances where performance is the top priority. In these cases, the
Asynchronous Online Replication module is appropriate. Writes completed on
the
primary target are immediately acknowledged in parallel with writes that are
sent to the mirror target, thus the latency associated with waiting for the
mirror target to acknowledge a write are avoided. This is also beneficial in
higher latency environments for backup when the mirror target may be on a WAN
connection.
In
a
disaster recovery scenario, the mirror target is often located several hundred
miles from the primary target and accessible only through a bandwidth-limited
WAN connection. In this situation, the Offline Replication module is most
appropriate. This module allows the system administrator to schedule replication
events during discrete periods of time.
A
complete IP SAN solution requires data availability and access features as
well
as data protection features. While SBE’s Snapshot and Replication add-in modules
support data protection, SBE is proud to offer High Availability as an
additional module to directly address the need for uninterruptible access to
missing critical data. In the event of failure at the primary storage director,
the mirror storage director automatically takes over with no disruption and
interruption of service to the initiators accessing the underlying storage.
The
high availability functionality is transparent to the initiators requiring
zero
additional configurations.
Hardware
Products
Upon
closing the sale of our embedded hardware business to One Stop Systems,
estimated to take place in the second quarter of fiscal 2007, we will no longer
have a hardware product line and the terms and conditions of the asset sale
agreement prohibit us from competing in the embedded hardware markets for at
least four year after the transaction is completed.
Network
Interface Cards
Wide
Area Networking Adapters.
A WAN is
a computer or communications network that spans a relatively large geographical
area. Computers attached to a WAN are often connected through dedicated
networks, such as the telephone system, leased lines or satellites. Our series
of WAN adapter products is designed to address the need for WAN interfaces
in
data communication products, such as those used in Internet and other
communications routers, security firewalls, Virtual Private Network (VPN)
servers and Voice over Internet Protocol (VoIP) gateways. We provide a broad
range of standards-based interfaces that can be easily integrated into our
OEM
customers’ products.
Local
Area Networking Adapters.
A LAN is
a computer network spanning a relatively small geographical area. Often confined
to a single building or group of buildings, most LANs connect workstations
and
personal computers in an office environment. Each computer in the LAN is able
to
access data and devices, such as printers, located anywhere on the LAN. There
are many different types of LANs but Ethernet is the one that is most commonly
deployed. Ethernet LAN connectivity is utilized by virtually every market
segment in both the embedded and enterprise space.
29
Our
LAN
adapter products are focused on LAN connectivity using high speed Ethernet
technology. We offer single, dual or quad port LAN adapters that feature
connectivity speeds of up to 10 Megabits (Mb)/second, 100 Mb/second or 1000
Mb/second. Our Gigabit Ethernet NICs include trunking and failover features.
These features allow our customers’ systems to take advantage of static load
balancing and failure recovery within a user-defined communications trunk.
Our
Gigabit Ethernet NICs are designed to distribute traffic across the aggregated
links, detect port failures, and increase throughput. In the event of a system
failure, the software will automatically redistribute outgoing loads across
the
remaining links.
Storage
Network Interface Cards.
Our
storage NICs are comprised of SCSI products. SCSI is a parallel interface
standard used by personal computers and many UNIX systems for attaching
peripheral devices, such as printers and disk drives, to computers. SCSI
interfaces are designed to allow for faster transmission rates than standard
serial ports, which transfer data one bit at a time, and parallel ports, which
simultaneously transfer data more than one bit at a time. Our series of SCSI
host bus adapters are specifically designed for the enterprise Sun UNIX market.
With transfer rates ranging from 40 Megabytes (MB)/sec to 320 MB/sec, our SCSI
adapters have been utilized in data centers and enterprise environments within
the financial, government, manufacturing, and healthcare sectors. These SCSI
boards are also utilized in UNIX-based SCSI tape backup systems.
Encryption
Adapters.
Our
secure PMC series of high-performance security offload solutions is designed
for
integration into Linux-based systems. Advanced encryption processors accelerate
SSL and IPsec cryptographic operations, significantly improving security,
performance, and availability of networking applications. Designed to enable
quick integration by OEMs, VARs and end users, our secure PMC adapters can
be
used in a wide variety of networking equipment, including routers, switches,
web
servers, server load balancers, firewalls, SANs and VPN gateways.
TCP/IP
Offload Engine (TOE).
A TOE is
a highly specialized TCP/IP protocol accelerator. Typically, in the form of
a
NIC, it is designed to reduce the amount of host CPU cycles required for TCP/IP
processing and maximize Ethernet throughput. This is accomplished by offloading
TCP/IP protocol processing from the host processor to the hardware on the TOE.
It is designed to provide fast, reliable, and secure access to networked storage
devices via the Internet without seriously impacting the host CPU.
Intelligent
Communications Controllers
Our
HighWire products are "intelligent," containing their own microprocessors and
memory. This architecture allows our communications controllers to offload
many
of the lower-level communications tasks that would typically be performed by
the
host platform.
In
the
telecommunications market, the HighWire series of communications controller
products provide high bandwidth intelligent connectivity to servers designed
to
act as gateways and signaling points within communication networks and network
devices. The HighWire co-processing controllers enable operators of wireline
and
wireless networks to deliver Intelligent Network and Advanced Intelligent
Network services such as Caller ID, voice messaging, personal number calling,
Service Provider Local Number Portability, and customized routing and billing,
as well as digital wireless services such as Personal Communications Systems
(PCS) and Global System for Mobile Telecommunications (GSM). The HighWire
products are designed for integration with standard server platforms that enable
traditional carriers and new telecommunications entrants to pursue cost-reduced
and performance-enhanced network architectures based on IP, broadband or other
"packet" technologies.
Other
Although
we continue to sell and manufacture legacy products such as Multibus, Versa
Module Europa (VME) bus, and ISA, we emphasize three principal lines of
products: storage software solutions, WAN/LAN adapter products, and carrier
platforms (also known as our “HighWire” line). Our legacy, WAN/LAN, adapter and
carrier platforms products comprise our embedded hardware products that we
are
selling to One Stop Systems.
30
The
following table shows sales by major product type as a percentage of net sales
for fiscal 2006, 2005 and 2004:
We
sell
and license our products, both domestically and internationally, using a direct
sales force as well as independent manufacturers' representatives, resellers,
and distributors. We have a network of 8 manufacturers’ representatives covering
the United States and Canada. In addition, we have 12 distributors and resellers
covering the United States, Canada, Western and Eastern Europe and Asia. We
believe that our direct sales force is well suited to communicate how our
products differ from those of our competitors. Since our products represent
a
complex and technical sale, our sales force is supported by field application
engineers who provide customers with pre-sale technical assistance. After the
sale of our embedded hardware business to One Stop, we will continue to have
our
network of 8 manufacturers’ representatives and a direct sales force. Our
distributor channel supports our embedded hardware business.
Our
internal sales and marketing organization supports our channel marketing
partners by providing sales collateral, such as product data sheets,
presentations, and other sales/marketing resource tools. Our sales staff
solicits prospective customers, provides technical advice with respect to our
products, and works closely with marketing partners to train and educate their
staffs on how to sell, install, and support our product lines.
We
have
focused our sales and marketing efforts in North America, Europe and Asia.
All
of our international sales are negotiated and executed in U.S. dollars.
International sales constituted 43%, 37% and 12% of net sales in fiscal 2006,
2005 and 2004, respectively. . International sales are primarily executed in
Europe with 31% to customers in the United Kingdom. After the sale of our
embedded hardware business we will continue to focus the sales of our storage
software in North America. Substantially all our historical sales have been
of
our embedded hardware products that we are selling to One Stop.
Our
direct sales force is based in three locations in the United States and we
conduct our marketing activities from our corporate headquarters in San Ramon,
California. After the sale of our embedded hardware business to One Stop we
will
have a direct sales force based in two locations.
Research
and Development
We
continue to invest in research and development of current and emerging
technologies that we deem critical to maintaining our competitive position
in
the storage software market. Many factors are involved in determining the
strategic direction of our product development focus, including trends and
developments in the marketplace, competitive analyses, market demands, business
conditions, and feedback from our customers and strategic partners. Our product
development efforts are focused principally on our storage software products,
providing advanced storage software features.
We
entered into an Agreement for the Purchase and Sale of Assets with One Stop
Systems, Inc., a manufacturer of industrial-grade computing systems and
components, pursuant to which we agreed to sell all of the assets associated
with our embedded hardware business. In addition, we entered into an Agreement
and Plan of Merger and Reorganization with Neonode Inc., a designer and
manufacturer of mobile multi-media telephones in which we agreed to merge the
two companies.
31
Although
we are evaluating strategic alternatives for our storage software business
including selling the business, we continued development of our storage software
products to bring a broader spectrum of IP storage solutions to market. In
fiscal 2006, we completed the development of some key storage networking
solutions that enable an extensive range of business critical applications,
including Disk-to-Disk Back-up and Disaster Recovery to complement our iSCSI
based transport software.
During
fiscal 2006, 2005 and 2004, we incurred $3.9 million, $2.7 million and $2.4
million, respectively, in product research and development
expenses.
Manufacturing
We
do not
engage in any manufacturing operations. Instead, we utilize third-party
manufacturers to build our embedded hardware products. We currently have
non-exclusive manufacturing agreements with ProWorks, Inc., United
Manufacturing, Inc. and Sonic Manufacturing Technology. We believe that
ProWorks, United and Sonic are equipped to provide cost-efficient and timely
product delivery, thus allowing us to focus on our core competencies of product
development and technology innovation. The use of external manufacturing
partners allows us to respond more quickly and effectively to fluctuations
in
customer demand. All our third party manufacturing partners support our embedded
hardware business that we are selling to One Stop. After the sale is complete
we
will no longer engage in any manufacturing operations, except as required by
the
proposed merger with Neonode.
Competition
The
market for both storage and communications interface products is highly
competitive. Many of our competitors have greater financial resources and are
well established in the space. Competition within the communications market
varies principally by application segment. Our intelligent communications
products compete with offerings from Radisys Corp, Performance Technologies,
Interphase Corp, Artesyn Technologies, and Adax, along with various other
platform and controller product providers. Our WAN/LAN products compete
primarily with products from Performance Technologies, Motorola, Interphase
Corp., Themis Computers, GE Fanuc and various other companies on a
product-by-product basis. Our SCSI products compete with LSI, Adaptec, Qlogic
and Sun Microsystems, Inc. Our TOE products compete with Qlogic and Adaptec.
To
compete and differentiate ourselves in our markets, we emphasize the
functionality, engineering support, quality and price of our products in
relation to the products of our competitors, as well as our ability to customize
our products to meet the customers’ specific application needs. After the sale
of our embedded hardware business to One Stop we will no longer compete with
any
companies within the embedded hardware markets. Our storage software product
compete with products designed and/or manufactured by Lefthand Networks, Wasabi
Systems, OpenE Software, FalconStor Software and UNH.
Additionally,
we compete with the internal engineering resources of our customers. Typically,
as our customers become successful with their products, they seek to reduce
costs and integrate functions. To compete with the internal engineering
resources of our customers, we position ourselves as an extension of our
customers’ engineering teams, focusing on satisfying their price/performance and
time-to-market challenges through product innovation, technological expertise,
and comprehensive support. By doing so, we emphasize the advantages and
efficiencies of outsourcing embedded hardware and software, and keeping internal
engineering resources focused on their core competencies and value-added
services.
Intellectual
Property
We
believe that innovation in product engineering, sales, marketing, support,
and
customer relations, and protection of this proprietary technology and knowledge
impacts our future success. We entered into separate agreements to sell our
embedded hardware business and to merge with a designer of mobile telephones.
We
rely on a combination of copyright, trademark, trade secret laws and contractual
provisions to establish and protect our proprietary rights in our products.
We
typically enter into confidentiality agreements with our employees, strategic
partners, channel partners and suppliers, and enforce strict limitations and
access to our proprietary information.
32
Backlog
On
October 31, 2006, we had a sales backlog of product orders of approximately
$1.1
million, compared to a sales backlog of product orders of approximately $1.2
million as of October 31, 2005. Our entire backlog at October 31, 2006 is for
our embedded hardware products and substantially all will be shipped to
customers in our first quarter of fiscal 2007. Because customer purchase orders
are subject to changes in customer delivery schedules, cancellation, or price
changes, our backlog as of any particular date may not be representative of
actual sales for any succeeding fiscal period. We do not anticipate any problems
in fulfilling our current backlog.
Employees
Our
employees represent one of our most valuable assets. We believe that our future
success will depend, in part, on our ability to attract and retain qualified
technical (particularly engineering), marketing and management personnel. We
promote employee-focused programs designed to foster a positive and productive
work environment, including specialized training/development, in-house seminars,
and team-building activities.
On
December 31, 2006, we had 34 employees of which 11 support the embedded hardware
business and will transfer to One Stop upon completing the sale of our embedded
hardware business. None of our employees are represented by a labor union.
We
have experienced no work stoppages. We believe our employee relations are
positive.
Properties
We
lease
22,000 square feet of office space to house our engineering and administrative
headquarters located in San Ramon, California. The lease expires in 2010. .
In
connection with the sale of our embedded hardware business, on January 10,2007,
we signed a definitive agreement providing for the assumption of the lease
of
our San Ramon office space effective with the closing of the transaction. We
will continue to be secondary guarantor on the lease for the term of the lease.
OVERVIEW
OF THE NEONODE TRANSACTION
Overview
On
January 19, 2007, we entered into an Agreement and Plan of Merger and
Reorganization with Cold Winter Acquisition Corporation, a Delaware corporation
and wholly-owned subsidiary of SBE, referred to in this report as Merger Sub,
and Neonode. The merger agreement contemplates that, subject to the terms
and conditions of the merger agreement, Merger Sub will be merged with and
into
Neonode, with Neonode continuing after the merger as the surviving corporation
and a wholly-owned subsidiary of SBE. It is anticipated that SBE’s name will be
changed to “Neonode Inc.” in connection with the completion of the merger. The
securities offered in the merger will not be registered under the Securities
Act
of 1933 and may not be offered or sold in the United States absent registration
or an applicable exemption from registration requirements.
Although
the exact number of shares to be issued in the merger will be determined at
closing according to a formula contained in the merger agreement, it is
currently estimated that SBE will issue approximately 57 million shares of
its
common stock in exchange for outstanding shares of Neonode common stock and
will
assume options and warrants exercisable for approximately 17 million additional
shares of SBE common stock. The number of shares estimated to be issued pursuant
to the merger transaction have not reflected to proposed 1 for 5 reverse stock
split.
SBE
expects to complete the transaction in the second fiscal quarter of 2007,
subject to satisfaction of closing conditions set forth in the merger agreement.
In addition to customary closing conditions, the transaction is subject to
the
approval of the SBE and Neonode stockholders and a reverse split of SBE’s
outstanding common stock. The number of shares referenced above is presented
on
a pre-split basis. After the merger is completed, the combined company's
headquarters will be in Stockholm, Sweden, where Neonode’s corporate
headquarters and research and development activities are located. The combined
company’s stock is expected to continue to trade on The Nasdaq Capital
Market.
33
The
Board
of Directors of SBE has unanimously approved the merger agreement. Neonode
and SBE have made customary representations, warranties and covenants in the
merger agreement. Neonode’s and SBE’s covenants include, among others,
that (i) each company will conduct its business in the ordinary course
consistent with past practice during the interim period between the execution
of
the merger agreement and the effective time of the merger, except that SBE
may
complete its proposed sale of its embedded business to One Stop Systems, Inc.,
(ii) each company will not engage in certain types of transactions during such
interim period, (iii) each company will call, hold and convene a meeting of
its
stockholders to consider adoption of the merger agreement, (iv) subject to
certain exceptions, the Board of Directors of each company will recommend to
its
stockholders that they adopt the merger agreement, (v) neither company will
solicit proposals relating to alternative business combination transactions,
and
(vi) subject to certain exceptions, neither company will enter into discussions
concerning or provide confidential information in connection with any proposals
for alternative business combination transactions.
SBE
intends to file a proxy statement in connection with the meeting of SBE
stockholders to be held with respect to the proposed merger. Completion of
the merger is subject to customary closing conditions, including, among other
things, (i) adoption of the merger agreement by Neonode’s and SBE’s
stockholders; (ii) the absence of any order or injunction prohibiting the
consummation of the merger; (iii) the accuracy of the representations and
warranties of each party and (iv) compliance of each party with its covenants.
In addition, the completion of SBE’s proposed sale of its embedded business and
the execution of six-month lockup agreements by all holders of Neonode
securities are conditions to closing.
The
merger agreement contains certain termination rights for both SBE and Neonode,
and further provides that, upon a party’s termination of the merger agreement
under specified circumstances, such party may be required to pay the other
party
a termination fee. This description of the merger agreement is qualified in
its
entirety by the terms and conditions of the merger agreement, which is filed
as
Exhibit 2.1 hereto, and is incorporated herein by reference.
In
connection with the execution of the merger agreement, the holders of
approximately 67% of Neonode’s outstanding capital stock entered into a voting
agreement with SBE and Merger Sub pursuant to which, among other things, such
holders agreed with SBE and Merger Sub to vote in favor of the merger and,
subject to certain exceptions, agreed not to dispose of any shares of Neonode
common stock held by such parties prior to the consummation of the
merger.
The
merger agreement provides investors with information regarding the terms of
the
proposed merger. It is not intended to provide any other factual
information about SBE or Neonode. In addition, the merger agreement
contains representations and warranties of each of the parties to the merger
agreement and the assertions embodied in those representations and warranties
are qualified by information in confidential disclosure schedules that the
parties delivered in connection with the execution of the merger
agreement. The parties reserve the right to, but are not obligated to,
amend or revise the merger agreement. In addition, certain representations
and warranties may not be accurate or complete as of any specified date because
they are subject to a contractual standard of materiality different from those
generally applicable to stockholders or were used for the purpose of allocating
risk between the parties rather than establishing matters as facts.
Accordingly, investors should not rely on the representations and warranties
as
characterizations of the actual state of facts, or for any other purpose, at
the
time they were made or otherwise.
34
Additional
Information and Where to Find It
We
are
not asking for your approval of the Neonode merger at this time, only the
proposed asset sale to One Stop and the proposed five-for-one reverse split.
In
connection with the proposed merger and required stockholder approval, we intend
to file with the SEC a proxy statement on Schedule 14A that will be mailed
to
the stockholders of SBE. INVESTORS AND SECURITY HOLDERS OF SBE ARE URGED TO
READ
THE PROXY STATEMENT AND ANY OTHER RELEVANT MATERIALS WHEN THEY BECOME AVAILABLE
BECAUSE THEY WILL CONTAIN IMPORTANT INFORMATION ABOUT THE PROPOSED MERGER.
The
definitive proxy statement will be mailed to the stockholders as of a record
date to be established for voting on the proposed merger. Investors and security
holders will be able to obtain free copies of the proxy statement, as well
as
other filed materials containing information about SBE, at www.sec.gov, the
SEC’s website. Investors may also access the proxy statement and the other
materials at www.sbei.com, or obtain copies of such material by request to
SBE’s
Corporate Secretary at: SBE, Inc., 4000 Executive Parkway, Suite 200, San Ramon,
CA94583.
35
SELECTED
UNAUDITED CONDENSED FINANCIAL DATA
The
following selected condensed financial data of SBE should be read in conjunction
with “Management’s Discussion and Analysis of Financial Condition and Results of
Operations” and the audited and pro forma Financial Statements and the notes
thereto included elsewhere in this proxy statement.
For
years ended October 31,
and
at October 31
2006
2005
2004
2003
2002
(in
thousands, except for per share amounts and number of
employees)
Net
sales
$
6,127
$
8,056
$
11,066
$
7,456
$
6,898
Net
income (loss)
$
(16,183
)
$
(4,230
)
$
(1,679
)
$
563
$
(1,731
)
Net
income (loss) per share - basic
$
(1.57
)
$
(0.66
)
$
(0.33
)
$
0.13
$
(0.46
)
Net
income (loss) per share - diluted
$
(1.57
)
$
(0.66
)
$
(0.33
)
$
0.12
$
(0.46
)
Product
research and development
$
3,979
$
2,694
$
2,411
$
1,330
$
3,027
Expenses
Working
capital
$
1,701
$
5,520
$
3,939
$
3,945
$
2,985
Total
assets
$
4,868
$
18,832
$
6,173
$
6,975
$
5,321
Long-term
liabilities
$
255
$
241
$
139
$
217
$
10
Stockholders’
equity
$
3,321
$
17,348
$
4,303
$
5,387
$
3,696
Number
of employees
34
37
36
32
24
36
SELECTED
UNAUDITED PRO FORMA CONDENSED FINANCIAL DATA
(Without
Embedded Hardware Business)
The
following selected unaudited pro forma condensed financial data present the
results of operations for SBE for the year ended October 31, 2006 on a pro
forma basis as if the proposed sale of our embedded business had occurred on
November 1, 2005.
(in
thousands, except for per share amounts and number of
employees)
Net
sales
$
53
Net
loss
$
(15,487
)
Net
loss per share - basic
$
(1.50
)
Net
loss per share - diluted
$
(1.50
)
Product
research and development
$
2,348
Expenses
Working
capital
$
3,412
Total
assets
$
5,414
Long-term
liabilities
$
66
Stockholders’
equity
$
4,898
Number
of employees
23
37
AUDITED
FINANCIAL STATEMENTS - SBE, INC.
The
audited balance sheets for SBE as of October 31, 2006 and 2005 and the
related audited statements of operations, stockholders’ equity and cash flows
for each of the three years ended October 31, 2006, 2005 and 2004, together
with the report of our independent registered public accounting firm, BDO
Seidman LLP, are attached to this proxy statement as Annex C. You are
encouraged to review such financial statements in their entirety.
FINANCIAL
STATEMENTS - NEONODE INC.
The
audited balance sheets for Neonode, Inc. as of December 31, 2005 and 2004
and the related audited statements of operations, stockholders’ equity and cash
flows for each of the two years ended December 31, 2005 and 2004, together
with the report of their independent registered public accounting firm,
PriceWaterhouseCoopers LLP, are attached to this proxy statement as
Annex D. The unaudited balance sheets for Neonode, Inc. as of September 30,2006 and the related unaudited statements of operations, stockholders’ equity
and cash flows for the nine months ended September 30, 2006 are attached to
this
proxy statement as Annex E. You are encouraged to review such financial
statements in their entirety.
UNAUDITED
PRO FORMA FINANCIAL STATEMENTS
The
unaudited balance sheets as of October 31, 2006 and 2005 and statements of
operations for each of the three years ended October 31, 2006, 2005 and 2004
are
presented on a pro forma basis: first, to present the balance sheet and results
of operations of SBE as if the proposed sale of our embedded business had
occurred on October 31, 2006 and November 1, 2005, respectively, attached
to this proxy statement as Annex F; and second, to present the balance sheet
and
results of operations for our embedded business on a stand-alone basis, attached
to this proxy statement as Annex G.
Also
attached to this proxy statement as Annex H are the unaudited condensed
consolidated balance sheet as of October 31, 2006 and statement of
operations for the year ended October 31, 2006, presented on a pro forma basis,
as if both the proposed sale of our embedded business and our proposed Neonode
transaction had occurred on November 1, 2005 and October 31, 2006, respectively.
After the merger transaction with Neonode is completed, Neonode will be the
acquirer for accounting purposes.
SBE Pro Forma Combined (without
embedded hardware business):
Basic and diluted net loss per common
share
$1.50
Book value per share
$0.45
MARKET
PRICE OF AND DIVIDENDS ON SBE’S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Our
common stock is quoted on the Nasdaq Capital Market under the symbol SBEI.
The
following table presents quarterly information on the price range of our common
stock, indicating the high and low bid prices reported by the Nasdaq Capital
Market. These prices do not include retail markups, markdowns or commissions.
As
of December 31, 2006, there were approximately 427 holders of record of our
common stock.
38
Fiscal
quarter ended
January
31
April
30
July
31
October
31
Fiscal
2006
High
$
1.44
$
1.08
$
0.40
$
0.38
Low
1.33
1.05
0.36
0.35
Fiscal
2005
High
$
4.59
$
3.55
$
3.65
$
3.50
Low
3.03
2.30
2.09
2.17
There
are
no restrictions on our ability to pay dividends; however, it is currently the
intention of our Board of Directors to retain all earnings, if any, for use
in
our business and we do not anticipate paying cash dividends in the foreseeable
future. Any future determination as to the payment of dividends will depend,
among other factors, upon our earnings, capital requirements, operating results
and financial condition.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
Overview
We
experienced a decline in our sales volume of our embedded hardware products
and
a lack of market acceptance for our storage software that dramatically affected
our operating cash flow for fiscal 2006. Because of the continuing decline
of
our cash balance, we have been evaluating strategic alternatives to return
the
company to cash flow positive and unlock value for our shareholders. In
September 2006, our Board of Directors and management believed that the best
course of action was to consider selling our embedded hardware and storage
software businesses and to consider seeking a viable merger candidate.
We
design, manufacture and sell embedded hardware products including WAN and LAN
NICs and CPUs to OEMs who embed our hardware products into their products for
the communications markets. Our hardware products perform critical, computing
and, I/O tasks in diverse markets such as high-end enterprise level computing
servers, Linux super-computing clusters, workstations, media gateways, routers
and Internet access devices.
We
also
design and provide software based storage networking solutions for an extensive
range of business critical applications, including Disk-to-Disk Back-up and
Disaster Recovery. We deliver an affordable, expandable and easy-to-use
portfolio of software solutions designed to enable optimal performance and
rapid
deployment across a wide range of next generation storage systems. We sell
standards-based storage software solutions to OEMs, system integrators and
value
added resellers (VARs) who embed our software into their IP storage area network
(IP SAN) and NAS systems to provide data storage solutions for the small and
medium business (SMB) enterprise storage markets. We are evaluating strategic
alternatives regarding our storage software business, including selling the
business.
Our
products are distributed worldwide through a direct sales force, distributors,
independent manufacturers' representatives and value-added resellers.
Our
business is characterized by a concentration of sales to a small number of
OEMs
and distributors who provide products and services to the communications and
data storage markets. Consequently, the timing of significant orders from major
customers and their product cycles cause fluctuation in our operating results.
Data Connection Limited (DCL) was the largest of our customers representing
31%
of our sales in fiscal 2006. The Hewlett Packard Company (HP) has historically
been one of our largest customer and represented 13% and 45% of net sales in
fiscal 2005 and 2004 respectively. We shipped the last $1.0 million of VME
products to HP in the first quarter of fiscal 2005. We do not expect to receive
any future purchase orders from HP.
39
During
the year ended October 31, 2006, $257,000 or 4% of our sales were sold to
distributors compared to $640,000 or 8% and $874,000 or 8% in fiscal 2005 and
2004, respectively. Our reserves for distributor programs total approximately
$13,000 and $22,000 as of October 31, 2006 and 2005, respectively. All of our
distributors are related to our embedded hardware business.
On
January 11, 2007, we entered into an asset purchase Agreement for the Purchase
and Sale of Assets (the Purchase Agreement) with One Stop Systems, Inc., a
manufacturer of industrial-grade computing systems and components (One Stop),
pursuant to which we agreed to sell all of the assets associated with our
embedded hardware business (excluding cash, accounts receivable and other
excluded assets specified in the asset purchase agreement) to One Stop for
approximately $2.2 million in cash plus One Stop’s assumption of the lease of
our corporate headquarters building and certain equipment leases. Substantially
all our revenue has been generated from our embedded hardware business. Upon
closing the sale of our embedded hardware business to One Stop Systems we will
no longer have a hardware product line and the terms and conditions of the
asset
sale agreement prohibit us from competing in the embedded hardware markets
for
at least four year after the transaction is completed.
On
January 19, 2007, we entered into an Agreement and Plan of Merger and
Reorganization with Neonode Inc., a Delaware corporation. Neonode is a
Sweden-based developer and manufacturer of multimedia mobile handsets. With
over
five years of research and development, Neonode is today a leader and
trendsetter in buttonless touch screen mobile phones and gesture based user
interfaces. Neonode mobile phones are based on patented technologies. With
Neonode's open Microsoft based platform, consumers can themselves upgrade and
customize their handsets similar to a PC. It is anticipated that our name will
be changed to “Neonode Inc.” in connection with the completion of the merger. We
intend to file a proxy statement in connection with the merger with Neonode.
The
proxy statement, when it becomes available, will contain important information
about the merger transaction. Free copies of the proxy statement will be
available at the SEC's web site at www.sec.gov. In the future, if any of our
major customers reduces orders for our products, we could lose revenues and
suffer damage to our business reputation. Orders by our OEM customers are
affected by factors such as new product introductions, product life cycles,
inventory levels, manufacturing strategy, contract awards, competitive
conditions and general economic conditions.
On
October 31, 2006, we had a sales backlog of product orders of approximately
$1.1
million compared to a sales backlog of product orders of approximately $1.2
million as of October 31, 2005. Our entire backlog is for embedded hardware
products and substantially all our backlog will be shipped to customers in
our
first quarter of fiscal 2007.
Critical
Accounting Policies and Estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Such estimates include levels of reserves for
doubtful accounts, obsolete inventory, warranty costs and deferred tax assets.
Actual results could differ from those estimates.
Our
critical accounting policies and estimates include the following:
Revenue
Recognition
Hardware
Products
Our
policy is to recognize revenue for hardware product sales when title transfers
and risk of loss has passed to the customer, which is generally upon shipment
of
our hardware products to our customers. We defer and recognize service revenue
over the contractual period or as services are rendered. We estimate expected
sales returns and record the amount as a reduction of revenue and cost of
hardware and other revenue at the time of shipment. Our policy complies with
the
guidance provided by the Securities and Exchange Commission (SEC) Staff
Accounting Bulletin (SAB) No. 104, Revenue Recognition in Financial Statements.
Judgments are required in evaluating the credit worthiness of our customers.
Credit is not extended to customers and revenue is not recognized until we
have
determined that collectibility is reasonably assured. Our sales transactions
are
denominated in U.S. dollars. The software component of our hardware products
is
considered incidental. Therefore, we do not recognize software revenue related
to our hardware products separately from the hardware product sale.
40
When
selling hardware, our agreements with OEMs, such as DCL and Nortel Networks
Corp. (Nortel), typically incorporate clauses reflecting the following
understandings:
-
all
prices are fixed and determinable at the time of
sale;
-
title
and risk of loss pass at the time of shipment (FOB shipping
point);
-
collectibility
of the sales price is probable (the OEM is creditworthy, the OEM
is
obligated to pay and such obligation is not contingent on the ultimate
sale of the OEM’s integrated
solution);
-
the
OEM’s obligation to us will not be changed in the event of theft or
physical destruction or damage of the
product;
-
we
do not have significant obligations for future performance to directly
assist in the resale of the product by the OEMs;
and
-
there
is no contractual right of return other than for defective
products.
Our
agreements with our distributors include certain product rotation and price
protection rights. All distributors have the right to rotate slow moving
products once each fiscal quarter. The maximum dollar value of inventory
eligible for rotation is equal to 25% of our products purchased by the
distributor during the previous quarter. In order to take advantage of their
product rotation rights, the distributors must order and take delivery of
additional products of ours equal to at least the dollar value of the products
that they want to rotate.
Each
distributor is also allowed certain price protection rights. If and when we
reduce or plan to reduce the price of any of our products and the distributor
is
holding any of the affected products in inventory, we will credit the
distributor the difference in price when they place their next order with us.
We
record an allowance for price protection at the time of the price reduction,
thereby reducing our net sales and accounts receivable. The allowance is based
on the price difference of the inventory held by our stocking distributors
at
the time we expect to reduce selling prices. We believe we are able to fully
evaluate potential returns and adjustments and continue to recognize the sale
based on shipment to our distributors. Reserves for the right of return and
restocking are established based on the requirements of Statement of Financial
Accounting Standards (SFAS) SFAS 48, Revenue
Recognition when Right of Return Exists.
During
the year ended October 31, 2006, $257,000 or 4% of our sales were sold to
distributors compared to $640,000 or 8% and $874,000 or 8% in fiscal 2005 and
2004, respectively. Our reserves for distributor programs total approximately
$13,000 and $22,000 as of October 31, 2006 and 2005, respectively.
Software
Products
We
derive
revenues from the following sources: (1) software, which includes new iSCSI
software licenses and (2) services, which include consulting. We account for
the
licensing of software in accordance with of American Institute of Certified
Public Accountants (AICPA) Statement of Position (SOP) 97-2, Software
Revenue Recognition.
SOP
97-2 requires judgment, including whether a software arrangement includes
multiple elements, and if so, whether vendor-specific objective evidence (VSOE)
of fair value exists for those elements. These documents include post delivery
support, upgrades and similar services. We typically charge software maintenance
equal to 20% of the software license fees.
For
software license arrangements that do not require significant modification
or
customization of the underlying software, we recognize new software license
revenues when: (1) we enter into a legally binding arrangement with a customer
for the license of software; (2) we deliver the products; (3) customer payment
is deemed fixed or determinable and free of contingencies or significant
uncertainties; and (4) collection is reasonably assured. We initially defer
all
revenue related to the software license and maintenance fees until such time
that we are able to establish VSOE for these elements of our software products.
Revenue deferred under these arrangements is recognized to revenue over the
expected contract term. We will also continue to defer revenues that represent
undelivered post-delivery engineering support until the engineering support
has
been completed and the software product is accepted.
41
For
one
customer we began recognizing software license fee revenue and related
engineering support revenue by amortizing previously deferred revenue related
to
engineering services over 36-months beginning in March 2006, which was the
month
the first software license for this customer was activated. The 36-month
amortization period is the estimated life of the related software product for
this customer. We also amortize all fees related to the licensing of our
software to this customer over 36-months beginning with the month the software
license is activated. In the fiscal year ended October 31, 2006, we recognized
$16,800 of software license fees for this customer and $26,000 of deferred
revenue related to engineering services to this customer.
Certain
software arrangements include consulting implementation services sold separately
under consulting engagement contracts. For the fiscal year ended October 31,2006, we recognized $10,000 of software consulting revenue.
Allowance
for Doubtful Accounts
Our
policy is to maintain allowances for estimated losses resulting from the
inability of our customers to make required payments. Credit limits are
established through a process of reviewing the financial history and stability
of each customer. Where appropriate, we obtain credit rating reports and
financial statements of the customer when determining or modifying their credit
limits. We regularly evaluate the collectibility of our trade receivable
balances based on a combination of factors. When a customer’s account balance
becomes past due, we initiate dialogue with the customer to determine the cause.
If it is determined that the customer will be unable to meet its financial
obligation to us, such as in the case of a bankruptcy filing, deterioration
in
the customer’s operating results or financial position or other material events
impacting their business, we record a specific allowance to reduce the related
receivable to the amount we expect to recover. Should all efforts fail to
recover the related receivable, we will write-off the account.
We
also
record an allowance for all customers based on certain other factors including
the length of time the receivables are past due and historical collection
experience with customers. We believe our reported allowances are adequate.
If
the financial conditions of those customers were to deteriorate, however,
resulting in their inability to make payments, we may need to record additional
allowances which would result in additional general and administrative expenses
being recorded for the period in which such determination was made.
Warranty
Reserves
We
accrue
the estimated costs to be incurred in performing warranty services at the time
of revenue recognition and shipment of the products to the OEMs. Because there
is no contractual right of return other than for defective products, we can
reasonably estimate such returns and record a warranty reserve at the point
of
shipment. Our estimate of costs to service our warranty obligations is based
on
historical experience and expectation of future conditions. To the extent we
experience increased warranty claim activity or increased costs associated
with
servicing those claims, the warranty accrual will increase, resulting in
decreased gross margin.
Inventories
Inventories
are stated at the lower of cost, using the first-in, first-out method, or market
value. We utilize standard cost, which approximates actual costs for certain
indirect costs.
We
are
exposed to a number of economic and industry factors that could result in
portions of our inventory becoming either obsolete or in excess of anticipated
usage, or subject to lower of cost or market issues. These factors include,
but
are not limited to, technological changes in our markets, our ability to meet
changing customer requirements, competitive pressures in products and prices,
and the availability of key components from our suppliers. Our policy is to
establish inventory reserves when conditions exist that suggest that our
inventory may be in excess of anticipated demand or is obsolete based upon
our
assumptions about future demand for our products and market conditions. We
regularly evaluate our ability to realize the value of our inventory based
on a
combination of factors including the following: historical usage rates,
forecasted sales or usage, product end-of-life dates, estimated current and
future market values and new product introductions. Purchasing practices and
alternative usage avenues are explored within these processes to mitigate
inventory exposure. When recorded, our reserves are intended to reduce the
carrying value of our inventory to its net realizable value. If actual demand
for our products deteriorates, or market conditions are less favorable than
those that we project, additional inventory reserves may be required.
42
Income
Taxes
We
account for income taxes in accordance with SFAS No. 109, Accounting
for Income Taxes.
SFAS
109 requires recognition of deferred tax liabilities and assets for the expected
future tax consequences of items that have been included in the financial
statements or tax returns. Deferred income taxes represent the future net tax
effects resulting from temporary differences between the financial statement
and
tax bases of assets and liabilities, using enacted tax rates in effect for
the
year in which the differences are expected to reverse. Valuation allowances
are
recorded against net deferred tax assets where, in our opinion, realization
is
uncertain. Based on the uncertainty of future pre-tax income, we fully reserved
our deferred tax assets as of October 31, 2006 and 2005. In the event we were
to
determine that we would be able to realize our deferred tax assets in the
future, an adjustment to the deferred tax asset would increase income in the
period such determination was made. The provision for income taxes represents
the net change in deferred tax amounts, plus income taxes payable for the
current period.
Long-lived
Assets
We
assess
any impairment by estimating the future cash flow from the associated asset
in
accordance with SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets.
If the
estimated undiscounted cash flow related to these assets decreases in the future
or the useful life is shorter than originally estimated, we may incur charges
for impairment of these assets. The impairment is based on the estimated
discounted cash flow associated with the asset. Capitalized software costs
consist of costs to purchase software and costs to internally develop software.
Capitalization of software costs begins upon the establishment of technological
feasibility. All capitalized software costs are amortized as related sales
are
recorded on a per-unit basis with a minimum amortization to cost of goods sold
based on a straight-line method over the estimated useful life, generally two
to
three years. We evaluate the estimated net realizable value of each software
product and record provisions to the asset value of each product for which
the
net book value is in excess of the net realizable value.
During
fiscal 2006, we evaluated the current expected cash flow from the sale of
storage software and determined that the net book value was in excess of the
net
realizable value. In the year ended October 31, 2006, we recorded asset
impairment charges of $6.5 million against our earnings for the period, reducing
our capitalized storage software asset to $1.3 million, which represents the
present value of the expected future sales of our storage software products
less
costs. This asset impairment charge is included in amortization of purchased
software in the Statements of Operations for the fiscal year ended October31,2006. Prior to the write-down, we amortized our storage software over 36 months
at the rate of $339,000 per month. We will amortize the remaining $1.3 million
software asset over the remaining 21-month amortization period at the rate
of
$63,000 per month. We are evaluating strategic alternatives regarding our
storage software business, including selling the business. If we sell the
storage software business we will no longer have a software asset.
New
Accounting Pronouncements
In
June
2006, the FASB issued Interpretation No. 48, Accounting
for Uncertainty in Income Taxes.
FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with SFAS 109. This
interpretation prescribes a recognition threshold and measurement attribute
for
the financial statement recognition and measurement of a tax position taken
or
expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. FIN 48 will be effective for us beginning
November 1, 2007. We are currently evaluating this interpretation to determine
if it will have a material impact on our financial statements.
In
September 2006, the SEC issued SAB 108, Considering
the Effects of Prior Year Misstatements in Current Year Financial
Statements.
SAB 108
expresses the SEC Staff’s views regarding the process of quantifying financial
statement misstatements. SAB 108 addresses the diversity in practice in
quantifying financial statement misstatements and the potential under current
practice for the build up of improper amounts on the balance sheet. SAB 108
will
be effective for the year beginning November 1, 2006. The cumulative effect
of
the initial application of SAB 108 will be reported in the carrying amounts
of
assets and liabilities as of the beginning of the fiscal year, with the
offsetting balance to retained earnings. We do not expect the adoption of SAB
108 to have a material impact on our financial statements.
43
In
September 2006, the FASB issued SFAS No. 157, Fair
Value Measurements.
SFAS
157 defines fair value, establishes a framework for measuring fair value as
required by other accounting pronouncements and expands fair value measurement
disclosures. SFAS 157 is effective for fiscal years beginning after November15,2007. We are currently evaluating the impact of SFAS 157 on our financial
statements.
Results
of Operations
The
following table sets forth, as a percentage of net sales, certain statements
of
operations data for the fiscal years ended October 31, 2006, 2005 and 2004.
These operating results are not necessarily indicative of our operating results
for any future period.
Amortization
and impairment of acquired software and intellectual
property
161
13
11
Cost
of hardware and other revenue
66
54
66
Product
research and development
65
33
22
Sales
and marketing
36
28
19
General
and administrative
37
24
16
Loan
loss recovery
---
---
(2)
Total
operating expenses
365
85
55
Operating
loss before income taxes
(265)
(52)
(15)
Income
tax (provision) benefit
---
---
---
Net
loss
(265)%
(52)%
(15)%
Net
Sales
Net
sales
for fiscal 2006 were $6.1 million, a 25% decrease from $8.1 million in fiscal
2005. Our net sales for fiscal 2005 represents a 27% decrease from $11.1 million
in fiscal 2004. The decrease in fiscal 2006 sales as compared to fiscal 2005
were primarily attributable to a decrease in sales to what was our largest
customer, HP. We did not have any sales to HP in fiscal 2006 compared to $1.0
million in fiscal 2005. In addition, sales to other customers also decreased
in
fiscal 2006 as compared to 2005, most notably a $400,000 reduction in the sales
of our Antares products to our distributors, a $300,000 year over year reduction
in sales to DCL and a $100,000 reduction in sales to Nortel The decrease in
fiscal 2005 net sales as compared to fiscal 2004 was primarily attributable
to a
decrease in sales to HP. Sales to HP were $1.0 million in fiscal 2005 compared
to $4.9 million in fiscal 2004. We shipped our final order for $1.0 million
of
VME products to HP in the first quarter of fiscal 2005. Sales to HP, primarily
of VME products, represented 0% of net sales in fiscal 2006 compared to 13%
of
net sales for fiscal 2005 and 45% during fiscal 2004. Sales to individual
customers in excess of 10% of net sales for the year ended October 31, 2006
included sales to DCL located in the United Kingdom of $1.9 million, or 31%
of
net sales, Nortel of $1.3 million, or 21% of net sales and Raytheon of $750,000,
or 12% of net sales. In fiscal 2005, sales to DCL were $2.2 million, or 28%
of
net sales and to were Nortel of $1.4 million, or 18% of net sales. Sales to
Nortel were $1.5 million, or 13% of net sales in fiscal 2004.
44
Sales
of
our adapter products were $4.0 million for fiscal 2006, as compared to $4.0
million in fiscal 2005 and $4.9 million in fiscal 2004. Sales of our HighWire
products were $2.0 million in fiscal 2006, as compared to $2.5 million in fiscal
2005 and $1.3 million in fiscal 2004. Our adapter products are used primarily
in
edge-of-the-network applications such as VPN and other routers, VoIP gateways
and security devices, whereas our HighWire products are primarily targeted
at
core-of-the-network applications used primarily by telecommunications central
offices.
Revenue
from software license fees was $16,700 and from software consulting services
$36,100 in fiscal 2006 compared to none in prior years.
Our
sales
backlog at October 31, 2006 was $1.1 million compared to $1.2 million at October31, 2005. Most of our backlog at October 31, 2006 will be shipped to customers
in the first quarter of fiscal 2007.
While
we
anticipated an increase in the sales volume of our storage software, adapter
and
HighWire products over the course of fiscal 2006 as certain of our prior design
wins went into production and our software products gained market acceptance,
the expected sales growth did not occur. Because of the decline in our sales
volume and the lack of market acceptance for our storage software, we evaluated
strategic alternatives to enhance shareholder value. As a result of our
evaluation, we entered into an agreement to sell our embedded hardware business
to One Stop Systems, Inc., a manufacturer of industrial-grade computing systems
and components and an agreement to merge the company with Neonode, Inc., a
designer and manufacturer of mobile multi-media telephones. After the sale
of
the embedded business and merger transactions are completed, we will no longer
be active in the embedded hardware business and will change our name to
“Neonode, Inc” and be active in the design and manufacturing of mobile
multi-media telephones with patented buttonless touch screen mobile phones
and
gesture-based user interfaces.
We
are
evaluating strategic alternatives regarding our storage software business.
International
sales constituted 43%, 37% and 12% of net sales in fiscal 2006, 2005 and 2004,
respectively. International sales are primarily executed in Europe with 31%
to
customers in the United Kingdom. All international sales are executed in U.S.
dollars.
Amortization
and Impairment of Purchased Software and Intellectual
Property
We
recorded a software asset totaling $12.4 million when we acquired PyX and
capitalized $256,000 related to the development of the now discontinued VoIP
products. We also continually upgrade our software by enhancing the existing
features of our products and by adding new features and products. We often
evaluate whether to develop these new offerings in-house or whether we can
achieve a greater return on investment by purchasing or licensing software
from
third parties. Based on our evaluations we have purchased or licensed various
software for resale since 1996.
Recurring
amortization of capitalized software and intellectual property costs totaled
$3.4 million for the fiscal year ended October 31, 2006 compared to $1.0 million
for the fiscal year ended October 31, 2005 and $408,000 for the fiscal year
ended October 31, 2004 and is included in amortization of purchased software
and
intellectual property in our Statements of Operations. The increase in 2006
over
205 and 2004 was due to the amortization of the software asset acquired in
the
PyX acquisition.
In
the
fiscal year ended October 31, 2006 we discontinued our VoIP product development
and as a result wrote-off $256,000 of capitalized software development costs
related to the VoIP products. This write-off is included in our product research
and development expense in our Statements of Operations.
45
In
the
fiscal year ended October 31, 2006, we recorded an asset impairment charge
of
$6.5 million against our earnings for the year, reducing our storage software
asset to $1.3 million. This asset impairment charge is included in amortization
and impairment of purchased software and intellectual property in our Statements
of Operations. Prior to the write-down, we amortized our storage software over
36 months at the rate of $339,000 per month. We will amortize the remaining
$1.3
million software asset over the remaining 21 month amortization period at the
rate of $63,000 per month.
In
the
fiscal ended October 31, 2004 we recorded an asset impairment charge of $713,000
against our earnings for the year. We wrote off the remaining balance of the
intellectual property asset related to our acquisition of Antares Microsystems,
Inc. This asset impairment charge is included in amortization and impairment
of
purchased software and intellectual property in our Statements of
Operations.
Cost
of Hardware Products and Other Revenue
Cost
of
hardware products and other revenues consists of the direct and indirect costs
of our manufactured hardware products and the cost of personnel in our
operations and production departments including share-based payment compensation
expense associated with the implementation of SFAS No. 123(R) Share Based
Payment. Cost of hardware products and other revenues for the year ended October31, 2006 decreased by 7% to $4.0 million compared with $4.4 million for the
fiscal year ended October 31, 2005. Cost of hardware products and other revenues
for the fiscal year ended October 31, 2005 decreased by 19.8% compared with
$5.4
million the fiscal year ended October 31, 2004. The decrease in cost of hardware
products and other revenue in absolute dollars for both the comparative fiscal
periods were principally due to a lower volume of hardware sales that decreased
the total direct and indirect cost of our manufactured products.
Included
in cost of hardware products and other revenue expense for
the
fiscal year ended October 31, 2006 is $80,000 of non-cash stock-based
compensation expense related to the stock-for-pay program, stock option expense
under SFAS 123R and the issuance of restricted stock to employees compared
to
none in 2005 and 2004.
Gross
profit is calculated as net sales less the cost of hardware and other revenue.
Gross profit as a percentage of net sales was 34%, 46% and 51% in fiscal 2006,
2005 and 2004, respectively. The decrease in our gross profit margin in fiscal
2006 as compared to 2005 is related to the reduction in sales of higher gross
margin products to HP combined with a change to the product mix of our sales
and
a lower sales volume not efficiently absorbing our second line production costs.
The decrease in our gross profit margin in fiscal 2005 as compared to 2004
is
related to the reduction in sales of higher gross margin products to HP. In
fiscal 2004 we sold $4.9 million of product to HP and in fiscal 2005 we sold
$1.0 million. The direct cost gross profit on the HP sales was approximately
70%
as compared to the average gross profit on HighWire products, which was
approximately 60%, and adapter products, which was approximately 55%. The direct
cost gross margin is reduced by allocations of costs related to our production
and operations departments and because of lower sales volume we are not
efficiently absorbing these second line production costs which results in
decreasing overall gross margins
Product
Research and Development
Product
research and development (R&D) expenses were $3.9 million, a 48% increase
over $2.7 million in fiscal 2006. R&D expense for fiscal 2005 increased by
11% over $2.4 million in fiscal 2004.
The
increase in R&D in fiscal 2006 as compared to fiscal 2005 is primarily the
result of three factors:
·
the
inclusion of $543,300 of non-cash compensation expense related to
stock
option expense under SFAS 123(R) compared to none in 2005 and
2004;
·
an
increase in engineering design projects related expenditures related
to
the development of our storage software;
and
·
a
$256,000 asset impairment write-off of previously capitalized VoIP
development expense that was written-off to expense in fiscal 2006
due to
the cancellation of the VoIP development
project.
The
increase in R&D in fiscal 2005 as compared to fiscal 2004 is primarily the
result of two factors:
46
·
the
inclusion of increases related to our Storage business segment when
we
hired seven employees in conjunction with the PyX acquisition; and
·
an
increase in engineering design project related expenditures related
to the
development of our storage software and VoIP/DSP gateway
products.
In
fiscal
2006, we continued development of our PyX storage software. During fiscal 2006
we developed a wide variety of storage software management features and data
protection modules. While the iSCSI protocol stack provides for a robust,
inexpensive, and highly scalable transport infrastructure, modules included
in
our IP SAN Director Suite such as iSNS (Internet Storage Name Service), SNMP
(Simple Network Management Protocol), Snapshot, High Availability, and
Replication seamlessly address the needs and requirements of today’s IT storage
managers.
Included
in R&D expense for the fiscal year ended October 31, 2006, in addition to
the $543,300 stock option expense previously mentioned, is $282,000 of non-cash
stock-based compensation expense related to the stock-for-pay program and the
issuance of restricted stock to employees compared to none in 2005 and
2004.
With
the
planned sale of our embedded hardware business and lack of market acceptance
for
our storage software products, we reduced our R&D budget significantly and
have focused our R&D efforts on key storage management features to enhance
the value of our storage software business. We expect to continue modest levels
of R&D expenditures associated with the development of management and other
feature for our storage software.
We
did
not capitalize any internal software development costs in fiscal 2006, 2005
or
2004 and do not expect to capitalize internal software development costs in
the
future. We do not expect to capitalize any internal software development costs
in the future.
Sales
and Marketing
Sales
and
marketing expenses for fiscal 2006 were $2.3 million, a 5% decrease from fiscal
2005. This decrease is primarily related to a decrease in headcount and
decreased travel and product marketing activities. We decreased our marketing
expenditures by 30% in fiscal 2006 as we reduce cash expenditures across the
company.
Fiscal
2005 sales and marketing expense was $2.2 million, a 5% increase over fiscal
2004. This increase is primarily related to an increase in headcount due to
the
acquisition of PyX and an increase travel and product marketing activities.
We
increased our marketing expenditures by 58% in fiscal 2005 as we attended more
industry trade shows and increased our advertising and public relations efforts
to reach our target prospects more effectively.
Included
in sales and marketing expense for the fiscal year ended October 31, 2006 is
$234,000 of non-cash stock-based compensation expense related to the
stock-for-pay program, stock option expense under SFAS 123(R) and the issuance
of restricted stock to employees compared to none in 2005 and 2004.
We
are
not currently planning to attend trade shows or engage in product marketing
activities other than via our Web site and word of mouth.
General
and Administrative
General
and administrative expenses for fiscal 2006 increased approximately $340,000
to
$2.2 million in fiscal 2005. General and administrative expenses for fiscal
2006
include $592,000 of non-cash compensation expense related to stock option
expense under SFAS 123(R) compared to none in 2005 and 2004. General and
administrative expenses for fiscal 2005 increased approximately $150,000 to
$1.9
million as compared to fiscal 2004. We assumed the PyX employee stock option
plan as part of our acquisition of PyX and recorded $2,484,000 of deferred
compensation. Included in general and administrative expense for fiscal 2005
is
$173,000 amortization expense related to the deferred compensation.
Included
in general and administrative expense for the fiscal year ended October 31,2006, in addition to the $592,000 stock option expense previously mentioned,
is
$357,000 of non-cash stock-based compensation expense related to the
stock-for-pay program and the issuance of restricted stock to employees compared
to none in 2005 and 2004.
47
Loan
Reserve Benefit
On
November 6, 1998, we made a loan to our former president and chief executive
offer, who retired as of December 31, 2004. The loan was used by him to exercise
an option to purchase 139,400 shares of our common stock and pay related taxes.
The loan, as amended, was collateralized by shares of our common stock, bore
interest at a rate of 2.48% per annum and was due on December 14,2003.
On
October 31, 2002, we determined that it was probable that we would be unable
to
fully recover the balance of the loan on its due date of December 14, 2003.
Accordingly, a valuation allowance of $474,000 was recorded against the loan
at
October 31, 2002.
During
the fourth quarter of fiscal 2003, the officer repaid $362,800 of the loan
and,
as a result, we recognized a benefit of $235,000 related to the reversal of
the
loan impairment charge taken by us in fiscal 2002. During the first quarter
of
fiscal 2004, the officer repaid the remaining loan balance in full and, as
a
result, we recorded a benefit of $239,000 relating to the reversal of the
remaining loan impairment charge.
Income
Taxes
Our
effective tax rate was 0% in fiscal 2006, 2005 and 2004, respectively. We
recorded valuation allowances in fiscal 2006 and 2005 for deferred tax assets
due to the uncertainty of realization. In the event of future taxable income,
our effective income tax rate in future periods could be lower than the
statutory rate as such tax assets are realized.
Net
Loss
As
a
result of the factors discussed above, we recorded a net loss
of $16.2
million in fiscal 2006 compared to a net loss of $4.2 million in fiscal 2005
and
$1.7 in fiscal 2004.
Contractual
Obligations and Commercial Commitments
The
following table sets forth a summary of our material contractual obligations
and
commercial commitments as of October 31, 2006:
Payments
due by period (in thousands)
Contractual
Obligations
Total
Less
than 1 year
1-2
Years
3-5
Years
More
than 5 Years
Building
leases
$
2,223
$
580
$
1,160
$
483
$
—
Capital
leases
255
74
149
32
---
Total
net lease payments
$
2,478
$
654
$
1,309
$
515
$
—
One
Stop
Systems, Inc. agreed to the assumption of our corporate headquarters office
lease and a lease for certain engineering equipment as part of the consideration
related to the purchase of our embedded hardware business. One Stop will assume
approximately $2.2 million of future lease payments. The sale transaction to
One
Stop is expected to be completed in our second quarter of fiscal
2007.
In
addition to salary, each of our directors and executive officers is eligible
to
receive a bonus pursuant to our Director and Officer Bonus Plan adopted
September 21, 2006 and each of our executive officers have severance agreements
that provide for 6 months salary and accelerated vesting of all unvested stock
options upon certain events triggered by a change in control. The total
estimated amounts due under the Bonus and severance agreements is approximately
$530,000. The amounts due will be paid to the directors and executive officers
upon completion of the asset sale and merger.
48
Substantially
all our sales backlog at October 31, 2007 of $1.1 million is scheduled for
shipment to customers prior to the projected closing of the sale of our embedded
hardware business to One Stop Systems, Inc.
Off-Balance
Sheet Arrangements
We
do not
have any transactions, arrangements, or other relationships with unconsolidated
entities that are reasonably likely to affect our liquidity or capital resources
other than the operating leases noted above. We have no special purpose or
limited purpose entities that provide off-balance sheet financing, liquidity,
or
market or credit risk support; or engage in leasing, hedging, research and
development services, or other relationships that expose us to liability that
is
not reflected on the face of the financial statements.
Liquidity
and Capital Resources
We
experienced a decline in our sales volume of our embedded hardware products
and
a lack of market acceptance for our storage software that dramatically effected
our operating cash flow for fiscal 2006. Because of the continuing decline
of
our cash balance, we have been evaluating strategic alternatives to return
the
company to cash flow positive. We determined the best way to enhance shareholder
value and preserve the remaining cash balance was to sell our embedded hardware
business to One Stop Systems, Inc. and to merge with Neonode, Inc. The sale
of
the embedded hardware business will provide cash of $2.2 million plus relieve
us
of a $2.2 million real estate lease burden. After the sale of the embedded
business and merger transactions are completed, we will no longer be active
in
the embedded hardware business and future cash will have to be derived from
the
operations of Neonode.
Our
liquidity is dependent on many factors, including sales volume, operating profit
and the efficiency of asset use and turnover. Our future liquidity after the
merger with Neonode is completed will be affected by, among other
things:
-
actual
versus anticipated sales of Neonode’s
products;
-
our
actual versus anticipated operating
expenses;
-
the
timing of Neonode’s product
shipments;
-
our
actual versus anticipated Neonode’s gross profit
margin;
-
our
ability to raise additional capital, if necessary;
and
-
our
ability to secure credit facilities, if
necessary.
We
had
cash and cash equivalents of $1.2 million and $3.6 million on October 31, 2006
and October 31, 2005, respectively. In fiscal 2006, $2.3 million of cash was
used by operating activities, primarily as a result of net losses. Our cash
used
was reduced by the inclusion of $6.5 million impairment write-down of the PyX
software plus $3.9 million of amortization and depreciation expense related
to
property and equipment and capitalized software and $2.1 million of stock based
compensation expense that are included in the $16.2 million net loss but did
not
require cash. Cash was generated by a $625,000 decrease in our accounts
receivable and a $544,000 decrease in our inventory. The decrease in trade
accounts receivable is due to a general decrease in overall sales activity
in
fiscal 2006 as compared to the end of fiscal 2005. The decrease in inventory
is
due to reducing our inventory from $1.3 million at the beginning of the year
to
$740,000 at year-end. The current inventory level better matches our current
sales levels. Our working capital (current assets less current liabilities)
at
October 31, 2006 was $1.7 million, as compared to $5.2 million at October 31,2005.
In
fiscal
2006, we purchased $176,000 of fixed assets, consisting primarily of computers
and engineering equipment. Purchased software amounted to $40,000, primarily
for
engineering and product design activities and payments related to our cancelled
VoIP products.
We
received $37,000 in fiscal 2006 from proceeds associated with the exercise
of
employee stock options.
49
In
mid-January 2006, we took steps to reduce our cash flow break-even point. We
changed the formula for paying all officers and employees and our Board of
Directors (Board) for their services. For the January 31, 2006 through March31,2006 payrolls, officer and employees were paid 70% in cash and 30% in shares
of
our common stock. Beginning with our April 15, 2006 payroll, the formula was
changed to a range of 62% to 90% in cash and 10% to 38% in shares of our common
stock. Our Board’s monthly fees were paid entirely in our common stock. On
August 21, 2006, the Board suspended the stock-for-pay program for all members
of the Board and officers. The suspension was effective August 1, 2006 for
members of the board and effective August 16, 2006 for officers. Despite the
suspension of the stock-for-pay program, the previously-announced salary
reductions for officers and cessation of cash Board compensation will remain
in
effect until such time as the Board shall determine. The stock-for-pay program
has continued for our non-officer employees.
As
of
October 31, 2006, we had $1.2 million in cash and we are not operating at cash
breakeven. Unless we are able to increase our sales to get to cash breakeven,
we
will not have sufficient cash generated from our business activities to support
our operations for the next twelve months. We have embarked on a strategy to
sell all or a portion of our business and signed a definitive agreement to
sell
our embedded hardware business. The overwhelming majority of our cash flow
from
operations has been generated from the embedded hardware business that we are
selling. We expect to close the sale of our embedded hardware business in our
second quarter of fiscal 2007. We also signed a definitive agreement to merge
with Neonode and have been reducing our staffing levels and other cash
expenditures to sustainable levels. We expect the $2.2 million cash proceeds
from the sale of our embedded hardware business to be sufficient to support
our
remaining operations until the merger transaction closes, or for at least the
next twelve months if the merger is delayed. We are also seeking other strategic
alternatives including selling our storage software business.
If
our
projected sales of our storage software products do not materialize or we are
unable to consummate the sale of our embedded hardware business and the merger
transaction, we will need to reduce expenses further and raise additional
capital through customer prepayments or the issuance of debt or equity
securities. If we raise additional funds through the issuance of preferred
stock
or debt, these securities could have rights, privileges or preferences senior
to
those of common stock, and debt covenants could impose restrictions on our
operations. The sale of equity or debt could result in additional dilution
to
current stockholders, and such financing may not be available to us on
acceptable terms, if at all.
Quantitative
and Qualitative Disclosures About Market Risk
Our
cash
and cash equivalents are subject to interest rate risk. We invest
primarily on a short-term basis. Our financial instrument holdings at October31, 2006 were analyzed to determine their sensitivity to interest rate changes.
The fair values of these instruments were determined by net present values.
In
our sensitivity analysis, the same change in interest rate was used for all
maturities and all other factors were held constant. If interest rates increased
by 10%, the expected effect on net loss related to our financial instruments
would be immaterial. We hold no assets or liabilities denominated in a foreign
currency and all sales are denominated in U.S. dollars.
50
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The
following table sets forth certain information regarding the ownership of our
common stock as of January 10, 2007 by: (i) each director and nominee for
director; (ii) each of our “named executive officers,” as defined in Item 402
under Regulation S-K promulgated by the Securities and Exchange Commission;
(iii) all executive officers and directors of SBE as a group; and (iv) all
those
known by us to be beneficial owners of more than five percent of our common
stock. The address for each of the persons and entities set forth below is
c/o
SBE, Inc., 4000 Executive Parkway, Suite 200, San Ramon, California94583.
All
executive officers and directors as a group (10 persons) (3)
2,355,697
21.2
%
(1) This
table is based upon information supplied by officers, directors and principal
stockholders and Schedules 13D and 13G, if any, filed with the SEC. Unless
otherwise indicated in the footnotes to this table and subject to community
property laws where applicable, we believe that each of the stockholders named
in this table has sole voting and investment power with respect to the shares
indicated as beneficially owned.
(2) Applicable
percentages are based on 11,101,554 shares outstanding on January 10, 2007,
adjusted as required by rules promulgated by the SEC.
(3) Includes,
445,000, 45,000, 35,000, 45,000, 50,000, 320,000, 202,000, 110,000 and 255,000
shares that Messrs. Yamamoto, Reardon, Ritchie, Stuckey, D’Errico, Brunton,
Anderson, Abal and Fang, respectively, have the right to acquire within 60
days
after the date of this table under outstanding stock options.
51
(4) Includes
60,000 shares
held by
UTMA as Custodian for Melanie Yamamoto and 60,000 shares held by UTMA as
Custodian for Nicholas Yamamoto, the children of Mr. Yamamoto.
52
OTHER
MATTERS
Accountants
Representatives
of BDO Seidman, LLP are not expected to be present at the Special Meeting and
as
a result will not be available to respond to questions at the Special
Meeting.
This
document is not intended to create, and will not be deemed to create, a legally
binding or enforceable offer or agreement of any type or nature, unless and
until it is executed and delivered by each party hereto. Until so executed
and
delivered, this document is intended solely to facilitate discussions among
the
parties. The provisions contained herein are subject to change based on the
results of the Buyer’s ongoing due diligence review of the
Company.
-
1
-
TABLE
OF CONTENTS
RECITALS
1
ARTICLE
1. DEFINITIONS
1
ARTICLE
2. PURCHASE AND SALE OF ASSETS
2
2.1
Sale
and Transfer of Assets
2
2.2
Excluded
Assets
3
2.3
Consideration
from Buyer at Closing
4
2.4
Assumption
of Liabilities
4
2.5
Purchase
Price and Allocation
4
2.6
Excise
and Property Taxes
4
2.7
Possible
Purchase Price Adjustment for Inventory
4
2.8
Escrow
Reserve and Payment
5
ARTICLE
3. WARRANTIES OF CORPORATION
5
3.1
Organization,
Standing, and Qualification of Corporation
ARTICLE
5. CORPORATION’S OBLIGATIONS BEFORE CLOSING
13
5.1
Buyer’s
Access to Premises and Information
13
5.2
Conduct
of Business in Normal Course
13
5.3
Preservation
of Business and Relationships
13
5.4
Maintenance
of Insurance
13
5.5
Employees
and Compensation
13
5.6
New
Transactions
13
5.7
Existing
Agreements
14
5.8
Consents
of Others
14
5.9
Corporate
Approval
14
5.10
Information
to Be Held in
Confidence
14
ARTICLE
6. BUYER’S OBLIGATIONS BEFORE CLOSING
14
6.1
Information
to Be Held in Confidence
15
i
6.2
Cooperation
in Securing Consents of Third Parties
15
6.3
Resale
Certificate
15
6.4
Bulk
Sales Law
15
6.5
Corporate
Approval
15
ARTICLE
7. CONDITIONS PRECEDENT TO BUYER’S PERFORMANCE
15
7.1
Accuracy
of Corporation’s Representations and Warranties
15
7.2
Performance
by Corporation
16
7.3
No
Material Adverse Change
16
7.4
Certification
by Corporation
16
7.5
Absence
of Litigation
16
7.6
Shareholder
Approval
16
7.7
Approval
of Documentation and Delivery
16
7.8
Payment
of Accounts
Payable
16
ARTICLE
8. CONDITIONS PRECEDENT TO CORPORATION’S
PERFORMANCE
16
8.1
Accuracy
of Buyer’s Representations and Warranties
17
8.2
Buyer’s
Performance
17
8.3
Absence
of Litigation
17
8.4
Approval
of Documentation and Delivery
17
8.5
Shareholder
Approval
17
ARTICLE
9. THE CLOSING
17
9.1
Time
and Place
17
9.2
Corporation’s
Obligations at Closing
17
9.3
Buyer’s
Obligation at Closing
18
ARTICLE
10. OBLIGATIONS AFTER CLOSING
18
10.1
Shareholder’s
Competition
18
10.2
Further
Assurances
19
10.3
Corporate
Liabilities
19
10.4
Accounts
Payable and Accounts Receivable
19
ARTICLE
11. NATURE AND SURVIVAL OF REPRESENTATIONS AND
OBLIGATIONS
20
11.1
Representations
and Warranties
20
11.2
Survival
20
11.3
Indemnification
and Reimbursement by Corporation
20
11.4
Indemnification
and Reimbursement by Corporation--Environmental
Matters
20
11.5
Indemnification
and Reimbursement by Buyer
21
11.6
Time
Limitations
21
11.7
Limitations
onCorporation’s
Indemnity
21
11.8
Knowledge
of Breach.
21
11.9
Indemnification
Claims.
22
11.10
Defense
of Third Party Actions.
22
11.11
Subrogation.
23
11.12
Exclusivity.
23
ARTICLE
12. PUBLICITY
23
ARTICLE
13. COSTS
23
13.1
Finder’s
or Broker’s Fees
23
13.2
Expenses
23
ARTICLE
14. FORM OF AGREEMENT
24
14.1
Effect
of Headings
24
14.2
Word
Usage
24
ii
14.3
Entire
Agreement; Modification; Waiver
24
14.4
Counterparts;
Facsimile Delivery
24
ARTICLE
15. PARTIES
25
15.1
Parties
in Interest
25
15.2
Assignment
25
ARTICLE
16. REMEDIES
25
16.1
Arbitration
25
16.2
Specific
Performance and Waiver of Rescission Rights
25
16.3
Recovery
of Litigation Costs
25
16.4
Termination
25
ARTICLE
17. NOTICES
26
ARTICLE
18. GOVERNING LAW
27
ARTICLE
19. SEVERABILITY
27
iii
AGREEMENT
FOR PURCHASE AND SALE OF ASSETS
This
Agreement for Purchase and Sale of Assets (“Agreement”) is made as of January11, 2007, at Escondido, California, between One
Stop
Systems, Inc. (“Buyer”),
a California corporation, having its principal office at 2235 Enterprise Street,
Suite 110, Escondido, California92029; and SBE,
Inc.
(“Corporation”), a Delaware corporation, having its principal office at 4000
Executive Parkway, Suite 200, San Ramon, California94583.
RECITALS
WHEREAS,
Buyer desires to purchase from Corporation and Corporation desires to sell
to
Buyer, on the terms and subject to the conditions of this Agreement, all the
assets, business, and properties of the Embedded Business in exchange for the
cash and other consideration of Buyer described in this Agreement; Shareholder
desires this transaction to be consummated. In consideration of the mutual
covenants, agreements, representations, and warranties contained in this
Agreement, the parties agree as follows:
AGREEMENT
ARTICLE
1. DEFINITIONS
As
used
in this Agreement, the following defined terms have the following
meanings:
1.1“Embedded
Business”
meansthe
WAN,
LAN, Carrier, Storage Hardware, Encryption, DSP and legacy product lines of
Corporation.
1.2“Encumbrance”
means
any lien, pledge, hypothecation, charge, mortgage, deed of trust, security
interest, encumbrance, claim, infringement, option, right of first refusal,
preemptive right, community property interest, or restriction of any nature
on
any asset;
1.3“Entity”
means a
Person other than an individual;
1.4“Governmental
Authority”
means
any federal, state, local, or foreign court, administrative agency or
commission, or other governmental authority or instrumentality;
1.5“Intellectual
Property Rights”
means,
collectively, all of the following worldwide intangible legal rights, acquired
by ownership, license, or other legal operation: (i) all patents, patent
applications, and patent rights, including all continuations,
continuations-in-part, divisions, reissues, reexaminations, and extensions
of
them, (ii) all trademarks, trade names, logos, and service marks,
registered or not; (iii) all rights associated with works of authorship,
including copyrights (registered or not), copyright applications, copyright
registrations, moral rights, mask work rights, mask work applications, and
mask
work registrations; (iv) all inventions (patentable or not), know-how,
show-how, formulas, processes, techniques, confidential business information,
trade secrets, and other proprietary information, technology, and intellectual
property rights, and (v) all rights to sue or make any claims for any past,
present, or future misappropriation or unauthorized use of any of the foregoing
rights and the right to receive income, royalties, damages, or payments that
are
now or will later become due with regard to the foregoing rights.
1
1.6“Person”
means
any individual, corporation, partnership, estate, trust, company (including
any
limited liability company), firm, or other enterprise, association,
organization, or Governmental Authority;
1.7“Proceeding”
means
any claim, action, suit, investigation, or administrative or other proceeding
before any Governmental Authority or any arbitration or mediation;
1.8“Taxes”
means
any and all federal, state, local, or foreign taxes, assessments, and other
governmental charges, duties, impositions, and liabilities relating to taxes
of
any kind, together with all interest, penalties, and additions imposed with
respect to such amounts.
ARTICLE
2. PURCHASE AND SALE OF ASSETS
2.1Sale
and Transfer of Assets.
Subject
to the terms and conditions set forth in this Agreement, at the Closing,
Corporation will sell, convey, transfer, assign, and deliver to Buyer, and
Buyer
will purchase from Corporation, all rights and title to, and interest in, the
assets, properties, and business of Corporation used in the Embedded Business
of
every kind, character, and description, whether tangible, intangible, real,
personal, or mixed, and wherever located (all of which are sometimes
collectively referred to as the Assets), free and clear of all Encumbrances,
including the following (provided however, notwithstanding the foregoing, the
Assets will not include the items set forth at Paragraph 2.2).
(a) All
inventory, finished goods, supplies, materials, and works in process for the
Embedded Business;
(b) All
equipment, machinery, furniture, and motor vehicles used by the Corporation
for
the Embedded Business;
(c) All
real
property, and all buildings, fixtures and improvement thereon;
(d) All
claims and rights under leases, contracts, insurance policies, notes, evidences
of indebtedness, and purchase and sales orders for the Embedded
Business;
(e) All
software programs and software code for the Embedded Business;
(f) All
copies and tangible embodiments of the software programs and software code
(in
source and object code form), together with all documentation related to such
programs and code for the Embedded Business;
(g) All
Intellectual Property Rights exercisable or available in any jurisdiction of
the
world, and the exclusive right for Buyer to hold itself out to be the successor
to the business of Corporation for the Embedded Business (provided, however,
that Corporation will retain the SBE name, logo and associated Intellectual
Property Rights and Buyer will be able to use such name and logo as may be
reasonably agreed in writing by Corporation);
2
(h) All
licenses to assets and properties of third parties (including licenses with
respect to Intellectual Property Rights owned by third parties) for the Embedded
Business;
(i) Claims,
causes of actions, royalty rights, deposits, and rights and claims to refunds
(excluding Tax refunds) and adjustments of any kind (including rights to set-off
and recoupment), and insurance proceeds for the Embedded Business;
(j) All
Internet domain names and registrations that are held or owned by Corporation
for the Embedded Business other than www.sbei.com;
(k) All
franchises, permits, licenses, agreements, waivers, and authorizations from,
issued, or granted by any Governmental Authority for the Embedded
Business;
(l) True
and
complete copies of all Corporation’s business records, including general and
financial records, marketing and sale information, and plans, pricing, and
customer lists for the Embedded Business; and
(m) All
goodwill associated with Corporation’s business and the Assets for the Embedded
Business.
2.2Excluded
Assets.
The
following assets of the Embedded Business will not be purchased by Buyer from
Corporation, nor will Corporation sell to Buyer will any of the
following:
(a) Cash
and
cash equivalents;
(b) Accounts
receivable;
(c) Assets
including software and hardware associated with the Corporation’s Oracle
financial accounting system and stock option tracking programs;
(d) Assets
including software, hardware, and any form of Intellectual Property associated
with the Corporation’s Storage Software Business including but not limited to
Source Code, Test Equipment and Test Software;
(e) all
minute books, stock records and corporate seals of Corporation;
(f) the
shares of capital stock of Corporation held in treasury;
(g) all
insurance policies and rights thereunder;
(h) all
of
the contracts of Corporation other than those listed in Schedule
2.4;
(i) all
personnel records and other records that Corporation is required by law to
retain in its possession;
(j) all
claims for refund of Taxes and other governmental charges of whatever nature;
(k) all
rights in connection with and assets of Corporation’s employee benefit plans;
and
3
(l) all
rights of Corporation under this Agreement.
2.3Consideration
from Buyer at Closing.
As
full
payment for the transfer of the Assets to Buyer, Buyer will deliver to
Corporation at the Closing, in accordance with the provisions of this Agreement
and subject to Paragraph 2.7, the following (collectively, the “Purchase
Price”):
(a) a
bank
cashier’s check or wire transfer, payable to the order of Corporation, in the
amount of One Million Seven Hundred Thousand Dollars ($1,700,000);
and
(b) a
bank
cashier’s check or wire transfer, payable to the order of the Escrow Holder per
Paragraph 2.8 in the amount of Five Hundred Thousand Dollars
($500,000).
2.4Assumption
of Liabilities.
From
and
after the Closing, Buyer will assume all of Corporation’s rights and obligations
arising after the Closing under those contracts (and only those contracts)
listed and marked with an asterisk in Exhibit 2.4; provided, Buyer will not
be
obligated to assume any such contract for which assignment to Buyer requires
the
consent of the other party to such contract unless such consent has been
obtained in writing and delivered to Buyer on or before the Closing. Corporation
will remain liable for all obligations arising under such contracts before
the
Closing. Corporation will have the right to require Buyer to complete any sales
order not assumed by Buyer in that exhibit for Corporation’s account at a price
to Corporation equal to Buyer’s cost. It is expressly understood and agreed that
Buyer will not be liable for any of the debts, obligations, or liabilities
of
Corporation of any kind other than those specifically assumed by Buyer under
this paragraph and that Corporation will remain liable and responsible for
any
and all of its debts, obligations, and liabilities not expressly assumed by
Buyer under this Agreement.
2.5Purchase
Price and Allocation.
The
Purchase Price will be as allocated among the Assets as set forth at Exhibit
2.5. Each of the parties agrees to report the transactions contemplated by
this
Agreement for all Tax purposes (including in Tax returns) in a manner that
is
consistent with the foregoing allocation of the purchase price and not to take
any position inconsistent with such allocation in any Tax return, refund claim,
or any litigation relating to Taxes.
2.6Excise
and Property Taxes.
Corporation
will pay all sales, use, and similar Taxes arising from the transfer of the
Assets (other than Taxes on a party’s income). Buyer will reimburse Corporation
for all such Taxes paid by Corporation within thirty (30) days after receiving
an invoice. Buyer will not be responsible for any other business, occupation,
withholding, property or similar Tax, or any Taxes of any kind incurred by
Corporation related to any period before the Closing.
2.7Possible
Purchase Price Adjustment for Inventory.
2.7.1Possible
Adjustment.
Corporation agrees the book value of the Inventory per Paragraph 3.5.2 at
Closing will be at least Six Hundred Eighty Thousand Dollars ($680,000). If
the
Inventory at Closing is less than Six Hundred Eighty Thousand Dollars
($680,000), the Purchase Price will be reduced by the amount of the deficiency.
If the Inventory at Closing is greater than Eight Hundred Thousand Dollars
($800,000), the Purchase Price will be increased by the amount of the
excess.
2.7.2Procedure
to Determine Amount.
Within
two (2) days prior to Closing, Corporation will provide Buyer with an estimate
of the amount of the Inventory. Within five (5) days after Closing, Corporation
will prepare and deliver to Buyer the calculations of the Inventory as of the
Closing Date based on a physical inventory conducted within ten (10) days prior
to the Closing. The Inventory amount will be prepared by Corporation in good
faith and in accordance with generally accepted accounting principles applied
on
a basis consistent with Corporation’s prior calculations of inventory value
except as otherwise provided in this Agreement. Buyer and its representatives
will be provided with reasonable access to the books, records, work papers
and
other information of the Corporation’s Embedded Business necessary to review the
Inventory amount. The Inventory amount, when delivered by Corporation to Buyer,
will be deemed conclusive and binding on the parties unless Buyer notifies
Corporation in writing within five (5) days after receipt of the Inventory
amount from Corporation, of Buyer’s disagreement therewith (which notice will
state with reasonable specificity the reasons for any disagreement and the
amounts in dispute). If there is disagreement, and such disagreement cannot
be
resolved by Buyer and Corporation within fifteen (15) days following receipt
of
the Inventory amount by Buyer, the items in dispute will be submitted to a
firm
of independent auditors acceptable to both Buyer and Corporation, and the
determination by such independent auditing firm will be binding and conclusive
upon the parties. Buyer and Shareholders will each pay one-half of the cost
of
the fees and expenses of such independent auditing firm.
4
2.7.3Payment.
Payment
of the deficiency, if any, will be made by Escrow Holder to Buyer upon receipt
by Escrow Holder of the written determination by the independent auditing
firm.
2.8Escrow
Reserve and Payment.
From
the
Purchase Price, Buyer will withhold and deposit into an interest bearing escrow
account at First
American Title Insurance Company
(“Escrow
Holder”), the sum of Five Hundred Thousand Dollars ($500,000) as a reserve
(“Reserve”) for amounts, if any, owed by the Corporation to Buyer regarding (i)
Inventory per Paragraph 2.6, (ii) Suppliers, vendors, personnel, sales
representatives and distributors per Paragraph 10.3 and (iii) Indemnification
obligations in this Agreement. The amount of the Reserve does not limit the
Corporation’s obligations herein. The provisions of the Reserve are set forth in
Exhibit ___ entitled “Escrow”. The term of the Escrow will be no more than sixty
(60) days.
ARTICLE
3. WARRANTIES OF CORPORATION
Except
as
set forth in the Disclosure Schedules attached, Corporation
warrants:
3.1Organization,
Standing, and Qualification of Corporation.
Corporation
is a corporation duly organized, validly existing, and in good standing under
the laws of Delaware and has all necessary corporate powers to own its
properties and operate its business as now owned and operated by it. Neither
the
ownership of its properties nor the nature of its business requires the Embedded
Business to be qualified to do business as a foreign corporation in any other
jurisdiction.
3.2Financial
Statements.
Corporation
has filed with the Securities and Exchange Commission consolidated balance
sheets of the Corporation as of October 31, 2004, and October 31, 2005, and
the
related statements of income, for the two years ending on those dates, audited
by Corporation’s independent public accountants, whose opinions with respect to
those financial statements are included in such filings. Corporation has filed
with the Securities and Exchange Commission the unaudited consolidated balance
sheet of the Corporation as of July 31, 2006, and together with related
unaudited statement of income, for the nine (9) month period ending on that
date, certified by the chief financial officer of Corporation as accurately
reflecting the financial condition of the Corporation for the period. The
financial statements in Schedule 3.2 are referred to as the financial
statements. The financial statements (i) have been prepared in accordance
with the books and records of Corporation, (ii) have been prepared in
accordance with generally accepted accounting principles consistently applied
by
Corporation throughout the periods indicated (except that unaudited financial
statements are subject to normal year-end audit adjustments and do not contain
all footnotes required by generally accepted accounting principles), and
(iii) fairly present the financial position of Corporation as of the
respective dates of the balance sheets included and the results of its
operations for the respective periods indicated.
5
3.3Absence
of Changes in Corporation.
Since
July 31, 2006 regarding the Embedded Business, except as may have been described
in Corporation’s filings with the Securities and Exchange Commission since
January 1, 2006 (the “SEC Filings”), there has not been any:
(a) Transaction
by Corporation except in the ordinary course of business as conducted on that
date;
(b) Material
adverse change in the financial condition, liabilities, assets, business,
results of operations, or prospects of the Embedded Business;
(c) Destruction,
damage, or loss of any asset of the Embedded Business (insured or uninsured)
that materially and adversely affects the financial condition, business, results
of operations, or prospects of Corporation;
(d) Change
in
accounting methods or practices (including any change in depreciation,
amortization policies, or rates) by Corporation;
(e) Revaluation
or write-down by Corporation of any assets of Embedded Business;
(f) Increase
or decrease in the salary or other compensation payable or to become payable
by
Corporation to any of the Embedded Business employees or declaration, payment,
or obligation of any kind for payment, by Corporation, of a bonus or other
additional salary or compensation to any such employee;
(g) Sale
or
transfer of any asset of Embedded Business, except in the ordinary course of
business;
(h) Amendment
or termination of, or any release or waiver granted with respect to, any
contract, agreement, or license of Embedded Business to which Corporation is
a
party, except in the ordinary course of business;
(i)
Encumbrance
of any asset or property of Embedded Business;
(j)
Waiver
or
release of any material right or claim of Embedded Business, except in the
ordinary course of business;
(k) Commencement
of, or notice or threat of commencement of, any Proceeding against Embedded
Business or its business, assets, or affairs;
(l)
Agreement
by Corporation to do any of the things described in the preceding clauses (a)
through (i); or
(m) Other
event or condition of any character that has or might reasonably be expected
have a material adverse effect on the financial condition, business, results
of
operation, assets, liabilities, or prospects of the Embedded
Business.
6
3.4Claims
and Liabilities.
3.4.1Debts,
Obligations, and Liabilities.
Schedule
3.4 to this Agreement contains a complete and accurate list, description, and
schedule of all of the outstanding debts, liabilities, and pecuniary obligations
of the Embedded Business. The Embedded Business has no other debts, liabilities,
or obligations of any nature, whether accrued, absolute, contingent, or
otherwise, and whether due or to become due, that are not set forth in Schedule
3.4.
3.5Assets
of Business.
3.5.1Real
Property.
(a)List.
Schedule 3.5.1 to this Agreement is a complete list of all real property owned
by, leased to, or occupied and used by the Embedded Business (“Current
Premises”).
(b)Hazardous
Materials.
Corporation is not in violation of any Environmental Law (as defined below),
with regard to disposal of Hazardous Materials (as defined below) or the
environmental conditions on or under such properties or facilities, including
soil and groundwater conditions. During the time Corporation or its
predecessors-in-interest have leased or occupied the Current Premises,
Corporation has not used, generated, manufactured, or stored on or under, or
transported to or from, any part of the Current Premises, any Hazardous
Materials (as defined below) in violation of any Environmental Law, nor has
there been any storage, use, processing, treatment, manufacture, disposal,
spillage, discharge, release, or threatened release of any Hazardous Material
on, from, or under any part of the Premises. There is no reasonable basis to
believe the Corporation’s business has been conducted or is being conducted in
violation of any Environmental Law. There is not pending against the Corporation
any Proceeding that asserts liability against any of such Persons, or seeks
an
injunction or decree against any of such Persons, under any Environmental Law.
Corporation is not presently obligated under any judgment, order, or decree
of
any Governmental Authority that relates to Environmental Laws.
“Environmental
Law” means all federal, state, local, and foreign laws and regulations, relating
to pollution, the protection of human health, or the environment, including
ambient air, surface water, ground water, land surface, or subsurface strata,
including those regulations relating to the emission, discharge, release or
threatened release, manufacture, processing, distribution, use, treatment,
storage, disposal, transport, or handling of Hazardous Materials.
“Hazardous
Material” means any pollutant, contaminant, toxic, hazardous, or noxious
substance or waste that is, or becomes before Closing, regulated by any
Governmental Authority under any Environmental Law, including (i) oil or
petroleum compounds, flammable substances, explosives, radioactive materials,
or
other materials that pose a hazard to human beings or cause any real property
to
be in violation of any Environmental Law; (ii) to the extent regulated, asbestos
and asbestos-containing materials; (iii) any materials regulated under the
Toxic Substance Act (15 USC §2601), (iv) any materials designated as
“hazardous substances” under the Clean Water Act (33 USC §1251), or under the
Comprehensive Environmental Response, Compensation and Liability Act of 1980
(42
USC §9601), and (v) any “hazardous waste” under Resource Conservation and
Recovery Act (42 USC §6901).
To
Corporation’s knowledge, there are no underground storage tanks located on the
real property described in Schedule 3.5.1 in which any Hazardous Material,
as
defined below, is being or has been in the past five (5) years stored, nor
has
there been any spill, disposal, discharge, or release of any Hazardous Material
into, on, from, or over that real property or into or on ground or surface
water
on that real property and currently there are no Hazardous Materials on or
in
the land occupied by or groundwater under, the Current Premises. There are
no
asbestos-containing materials incorporated into the buildings or interior
improvements that are part of that real property, or into other assets of
Corporation, and there is no electrical transformer, fluorescent light fixture
with ballasts, or other equipment containing PCBs on that real
property.
7
3.5.2Inventory.
The
Embedded Business’s inventories of raw materials, work in process, and finished
goods (collectively called inventories) shown on the Corporation’s balance sheet
as of July 31, 2006, included in the financial statements, consist of items
of a
quality and quantity usable and salable in the ordinary course of business
by
Corporation, except for obsolete and slow-moving items and items below standard
quality, all of which have been written down on the books of Corporation to
net
realizable market value or have been provided for by adequate reserves. All
items included in the inventories are the property of Corporation, except for
sales made in the ordinary course of business since the date of the balance
sheet. For each of these sales, either the purchaser has made full payment
or
the purchaser’s liability to make payment is reflected in the books of
Corporation as a receivable. No item included in the inventories is subject
to
any Encumbrance or is held by Corporation on consignment from others. The
inventories shown on all the consolidated balance sheets included in the
financial statements are based on quantities determined by physical count or
measurement, taken within the preceding twelve (12) months, and are valued
at
the lower of cost (determined on a first-in, first-out basis) or market value
and on a basis consistent with that of prior years.
3.5.3Other
Tangible Personal Property.
Schedule
3.5.3 to this Agreement is a complete and accurate schedule describing and
specifying the location of all trucks, automobiles, vehicles, machinery,
equipment, furniture, fixtures, supplies, tools, dies, rigs, molds, patterns,
drawings, and all other tangible personal property owned by, in the possession
of, or used by the Embedded Business in connection with itsbusiness,
except inventories of raw materials, work in process, and finished goods. The
property listed in Schedule 3.5.3 constitutes all such tangible personal
property necessary for the conduct by the Embedded Business of its
businessas
now
conducted.
Except
as
stated in Schedule 3.5.3, no personal property used by the Embedded Business
in
connection with its business is held under any lease or subject to any
Encumbrance, is held by Corporation on consignment from others, or is located
at
any location other than one in the direct and actual possession of
Corporation.
3.5.4Accounts
Receivable.
All
accounts receivable of the Embedded Business shown on the balance sheet of
Corporation as of July 31, 2006, and all accounts receivable of Corporation
created after that date, arose from valid sales in the ordinary course of
business.
3.5.5Intellectual
Property.
(a) Corporation
owns, or has the right to use under license, all Intellectual Property Rights
necessary for the operation of the Embedded Business as presently conducted
and
as currently proposed to be conducted. Each Intellectual Property Right owned,
licensed to, or used by the Embedded Business immediately before the Closing
will be owned, licensed to, or available for use by Buyer on identical terms
and
conditions immediately after the Closing.
8
(b) The
past
conduct by the Embedded Business of its business and the use of the Assets
by
Corporation in the conduct of the business do not infringe on, misappropriate,
or otherwise conflict with any Intellectual Property Right of any third party
and no third party has asserted or threatened to assert against Corporation
any
claim of infringement or misappropriation of any Intellectual Property Rights.
The transfer of the Assets to Buyer will not infringe on any Intellectual
Property Right of any third party. To the best knowledge of Corporation, no
third party has interfered with, infringed on, or misappropriated any
Intellectual Property Rights of the Embedded Business.
(c) Regarding
the Embedded Business of the Corporation, Schedule 3.5.5 identifies: (i) each
patent, copyright, mask work, trademark, or service mark (or registration of
such) that has been granted or registered and issued to Corporation in any
jurisdiction, (ii) each pending patent application and each application for
registration of a copyright, mask work, trademark, service mark, or similar
right that Corporation has made in any jurisdiction together with all associated
filing or serial numbers, (iii) all unregistered copyrights, (iv) all
unregistered trademarks, trade names, or service marks used by Corporation
in
connection with the business or the Assets, and (v) each license, Agreement,
or
other permission that Corporation has granted to any third party with respect
to
any of its Intellectual Property Rights or any of the Assets, none of which
grants any third party any exclusive rights with respect to any of such
Intellectual Property Rights or any of the Assets. Corporation has delivered
to
Buyer true, correct, and complete copies of all such registrations and all
such
applications and licenses, agreements, and permissions. For each Intellectual
Property Rights, license agreement, or other permission required to be
identified on Schedule 3.5.5: (i) Corporation possesses all right and title
to,
and interest in, such Intellectual Property Right, license, agreement, or
permission free and clear of any Encumbrance; (ii) such Intellectual Property
Right, license, agreement, or permission is not subject to any outstanding
judgment, order, or charge; and (iii) no proceeding is pending or, to
Corporation’s knowledge, threatened that challenges the legality, validity,
enforceability, use, or ownership of such Intellectual Property Rights, license,
agreement, or permission.
(d) Schedule
3.5.5 sets forth and summarizes each Intellectual Property Right that a third
party owns and that the Embedded Business uses under a license, agreement,
or
other permission, and Corporation has delivered to Buyer, true, correct, and
complete copies of all such licenses, agreements, and permissions from third
parties. For each Intellectual Property Right required to be identified in
Schedule 3.5.5: (i) the license, agreement, or permission covering the item
is
legal, valid, binding, enforceable, and in full force and effect and will
continue to be legal, valid, binding, enforceable, and in full force and effect
on identical terms to Buyer’s benefit immediately following the Closing; (ii)
all consents to the assignment of each such license, agreement, or permission
required to assign it to Buyer under this Agreement without breach or violation
of any agreement binding on Corporation and without infringing any Intellectual
Property Rights of any third party have been obtained; (iii) the license,
agreement, or permission does not restrict Corporation’s ability to do business
in any geographic territory or with respect to any market or industry; (iv)
Corporation is not in breach or default of, and to Corporation’s knowledge, no
other party to any such license, agreement, or permission is in breach or
default of, and no event has occurred that, with notice or lapse of time or
both, would constitute a breach or default of, or permit termination,
modification, or acceleration of, any such license, agreement, or permission;
and (v) no proceeding is pending or, to Corporation’s knowledge, threatened that
challenges the legality, validity, or enforceability of any such license,
agreement, or permission or any Intellectual Property Right governed by
it.
9
(e) All
employees, contractors, and consultants of Corporation or any other third
parties who have been involved in the development of any Intellectual Property
Rights owned by the Embedded Business, have executed invention assignment and
confidentiality agreements in the form delivered to Buyer’s counsel, and all
employees and consultants of Corporation who have access to confidential
information or trade secrets related to or comprising the Intellectual Property
Rights owned by the Embedded Business or the Assets have executed appropriate
nondisclosure agreements in the form delivered to Buyer’s counsel. Corporation
has taken reasonable steps, consistent with industry standards, to protect
the
secrecy and confidentiality of all and Intellectual Property Rights owned by
the
Embedded Business. To Corporation’s knowledge, no third party is in possession
of any confidential information pertaining to any of the Assets, except under
a
written confidentiality agreement in a form disclosed in writing to
Buyer.
3.5.6Other
Intangible Property.
Schedule
3.5.6 to this Agreement is a complete and accurate list of all intangible
assets, other than those specifically referred to elsewhere in this Agreement,
relating to the Embedded Business.
3.6Title
to Assets; Sufficiency of Assets.
Corporation
has good and marketable title to all of the Assets, whether real, personal,
mixed, tangible, or intangible, that constitute all the assets and interests
in
assets that are used in the Embedded Business. All of the Assets are free and
clear of any Encumbrances except for (i) those disclosed in Corporation’s
balance sheet as of October 31, 2006, or in Schedules attached hereto; and
(ii)
possible minor matters that, in the aggregate, are not substantial in amount
and
do not materially detract from or interfere with the present or intended use
of
any of these Assets or materially impair business operations. Corporation is
notin
default or in arrears in any material respect under any lease or license. All
real property and tangible personal property of the Embedded Business
isin
good
operating condition and repair, ordinary wear and tear excepted. Corporation
is
in possession of all premises leased to them from others. The Embedded Business
does not occupy any real property in violation of any law, regulation, or
decree. The Assets constitute all assets, properties, rights, and Intellectual
Property Rights that are necessary or required to enable Buyer, following the
Closing, to own, conduct, operate, and maintain the Embedded Business’s business
as historically conducted or as proposed to be conducted without (i) the need
for Buyer to acquire or license any other asset, property, or Intellectual
Property Right, (ii) the breach or violation of any contract or commitment
to
which the Corporation is bound or to which any of the Assets is subject, or
(iii) infringement of any Intellectual Property Right of any other
person.
3.7Customers
and Sales.
Schedule
3.7 to this Agreement is a correct and current list of all customers of the
Embedded Business with which Corporation has consummated sales of at least
Ten
Thousand Dollars ($10,000) in the aggregate in the one year before the date
of
this Agreement together with summaries of the sales made to each customer during
the Corporation’s most recent fiscal year. Except as indicated in Schedule 3.7,
Corporation has no information, nor is aware of any facts, indicating any of
these customers intends to cease doing business with the Embedded Business
or
materially alter the amount of the business such customer is presently doing
with the Embedded Business.
10
3.8Employment
Contracts and Benefits.
Schedule
3.8 to this Agreement is a list of all the Embedded Business’s employment
contracts, collective bargaining agreements, and pension, bonus, profit-sharing,
stock option plans, or other agreements providing for employee remuneration
or
benefits. To the best of Corporation’s knowledge, Corporation is not in default
under any of these agreements, nor has any event occurred that with notice,
lapse of time, or both, would constitute a default by Corporation under any
of
these agreements.
3.9Insurance
Policies.
Corporation
has maintained and now maintains (i) insurance on all its assets and Embedded
Business of a type customarily insured, covering property damage and loss of
income by fire or other casualty, and (ii) adequate insurance protection against
all liabilities, claims, and risks against which it is customary to insure.
Corporation is not in default with respect to payment of premiums on any such
policy. Except as set forth in Schedule 3.9, no claim is pending under any
such
policy.
3.10Other
Contracts.
The
Embedded Business is nota
party
to, nor is its propertybound
by,
any distributor’s or manufacturer’s representative or agency agreement; any
output or requirements agreement; any agreement not entered into in the ordinary
course of business; any indenture, Encumbrance, or lease; or any agreement
that
is unusual in nature, duration, or amount (including any agreement requiring
the
performance by Corporation of any obligation for a period of time extending
beyond one year from Closing or calling for consideration of more than Ten
Thousand Dollars ($10,000)); except the agreements listed in Schedule 3.10,
copies of which have been furnished or made available to Buyer. There is no
default or event that, with notice or lapse of time or both, would constitute
a
default by the Corporation to any of these agreements. Corporation has not
received notice that any party to any of these agreements intends to cancel
or
terminate any of these agreements or to exercise or not exercise any options
under any of these agreements. Corporation is not a party to, or the property
bound by, any agreement that is materially adverse to the business, properties,
or financial condition of the Embedded Business.
3.11Compliance
with Laws.
To
the
knowledge of Corporation, the Embedded Business has complied in all material
respects with all federal, state, and local statutes, laws, and regulations.
Corporation has not received any notice asserting any violation of any statute,
law, or regulation that has not been remedied before the date of this
Agreement.
3.12Litigation.
There
is
no pending, or,
to
the best knowledge of Corporation, threatened Proceeding
against
or affecting the Embedded Business or any of its assets or financial condition.
There is not pending against the Embedded Business, any judgment, order, writ,
injunction, or decree of any federal, state, local, or foreign Governmental
Authority. The Embedded Business is notin
default with respect to, nor has an event occurred that, with notice, lapse
of
time, or both, would be a default under, any judgment, order, writ, injunction,
or decree of any federal, state, local, or foreign court, or Governmental
Authority. Except as set forth in Schedule 3.12, Corporation is not presently
a
party to any Proceeding instituted by it, nor does it have any plans to
institute any Proceeding against any other Person.
3.13Agreement
Will not Cause Breach or Violation.
The
execution, delivery, and performance of this Agreement by Corporation and the
consummation of the transactions contemplated by this Agreement will not result
in or constitute any of the following: (i) a breach of any term or provision
of
this Agreement; (ii) a default or an event that, with notice, lapse of time,
or
both, would be a default, breach, or violation of the articles of incorporation
or bylaws of Corporation or any lease, license, promissory note, conditional
sales contract, commitment, indenture, or other agreement, instrument, or
arrangement to which Shareholder, Corporation, is a party or by which any of
them or any assets or properties of any of them is bound; (iii) an event that
would permit any party to terminate any agreement to which Corporation is a
party or is bound or to which any of itsassets
is
subject or to accelerate the maturity of any indebtedness or other obligation
of
Corporation; or (iv) the creation or imposition of any Encumbrance on any of
the
properties of Corporation.
11
3.14Authority
and Consents.
Corporation has the right, power, legal capacity, and authority to enter into
and perform its respective obligations under this Agreement (including the
sale
of the Assets to Buyer), and no approvals or consents of any governmental
authority are necessary in connection with the sale of the Assets to Buyer
and
the performance by Corporation of its obligations under this Agreement. The
execution, delivery, and performance of this Agreement by Corporation and the
consummation of the transactions contemplated have been duly authorized by
all
necessary corporate action on the part of Corporation.
3.15Interest
in Customers, Suppliers, and Competitors.
Except
as
set forth in Schedule 3.15, neither Corporation, nor, to the knowledge of
Corporation, any officer, director, or employee of Corporation, nor any spouse
or child of any of them, has any direct or indirect interest in any competitor,
supplier, or customer of the Embedded Business or in any entity from whom or
to
whom Corporation leases any real or personal property, or in any other entity
with whom Corporation is doing business.
3.16Personnel.
Schedule
3.16 is a list of the names and addresses of all officers, directors, employees,
agents, and manufacturer’s representatives of the Embedded Business, stating the
rates of compensation payable to each.
3.17Full
Disclosure.
None
of
the representations and warranties made by Corporation in this Agreement
(including the Schedules to this Agreement and the certificate delivered
pursuant to Paragraph 7.4) contains or will contain any untrue statement of
a
material fact, or omits to state a material fact necessary to prevent the
statements from being misleading.
ARTICLE
4. BUYER’S WARRANTIES
Buyer
warrants the following:
4.1Organization,
Standing and Qualification.
Buyer is
a corporation duly organized, existing, and in good standing under the laws
of
California. The execution and delivery of this Agreement and the consummation
of
this transaction by Buyer have been duly authorized, and no further corporate
authorization is necessary on the part of Buyer.
4.2Authority
and Consents.
Buyer
has the right, power, legal capacity, and authority to enter into and perform
its obligations under this Agreement (including the purchase of the Assets
from
Corporation), and no approvals or consents of any governmental authority are
necessary in connection with the purchase of the Assets by Buyer and the
performance by Buyer of its obligations under this Agreement. The execution,
delivery, and performance of this Agreement by Buyer and the consummation of
the
transactions contemplated have been duly authorized by all necessary corporate
action on the part of Buyer.
12
4.3Full
Disclosure.
None
of
the representations and warranties made by Buyer in this Agreement contains
or
will contain any untrue statement of a material fact, or omits to state a
material fact necessary to prevent the statements from being
misleading.
4.4Financial
Wherewithal. Buyer
will not render itself insolvent.
ARTICLE
5. CORPORATION’S OBLIGATIONS BEFORE CLOSING
Corporation
agrees from the date of this Agreement until the earlier to occur of the Closing
or the termination of this Agreement in accordance with its terms:
5.1Buyer’s
Access to Premises and Information.
Buyer
and
its counsel, accountants, and other representatives will have reasonable access
during normal business hours to all properties, books, accounts, records,
contracts, and documents of or relating to the Embedded Business. Corporation
will furnish or cause to be furnished to Buyer and its representatives all
data
and information concerning the business, finances, and properties of the
Embedded Business that may reasonably be requested. No information or knowledge
obtained by Buyer in any investigation under this paragraph will affect or
be
deemed to modify any representation or warranty of Corporation or the conditions
to the obligations of the Corporation to effect the Closing.
5.2Conduct
of Business in Normal Course.
Corporation
will carry on itsEmbedded
Business and activities diligently, in the ordinary course, and in substantially
the same manner as they previously have been carried out and will not make
or
institute any unusual or novel methods of manufacture, purchase, sale, lease,
management, accounting, collections, payments, or operation that vary materially
from those methods used by Corporation on the date of this Agreement.
Corporation will not ship nor bill customers in an accelerated manner which
exceeds its practices for the period January 1, 2006 through October 31,2006.
5.3Preservation
of Business and Relationships.
Corporation
will use its best efforts to preserve its Embedded Business intact, to keep
available Embedded Business’s present employees, and to preserve its Embedded
Business’s present relationships with suppliers, customers, and others having
business relationships with it.
5.4Maintenance
of Insurance.
Corporation
will continue to carry its Embedded Business’s existing insurance.
5.5Employees
and Compensation.
Regarding
the Embedded Business,Corporation
willnot
do,
or agree to do, any of the following acts: (i) increase any compensation
payable, or to become payable, to any employee, sales agent, or representative;
(ii) increase any benefits payable to any officer, employee, sales agent, or
representative under any bonus or pension plan or other contract or commitment;
or (iii) modify any collective bargaining agreement to which it is a party
or by
which it may be bound.
5.6New
Transactions.
Corporation
will not, without Buyer’s written consent, do or agree to do any of the
following acts regarding the Embedded Business:
(a) Enter
into any contract, commitment, or transaction not in the usual and ordinary
course of its business or not consistent with its past practices;
13
(b) Enter
into any contract, commitment, or transaction in the usual course of business
involving an amount exceeding Fifty Thousand Dollars ($50,000)
individually;
(c) Enter
into any leases of capital equipment or property under which the annual lease
charge is in excess of Ten Thousand Dollars ($10,000);
(d) Sell
or
dispose of any capital assets with a net book value exceeding Ten Thousand
Dollars ($10,000) individually, or place or allow to be imposed any Encumbrance
on any of the Assets;
(e) Sell
or
dispose of any inventory with a value exceeding Ten Thousand Dollars
($10,000);
(f) Ship
any
orders with a value exceeding Ten Thousand Dollars ($10,000) except as set
forth
on Schedule 5.6; or
(g) Hire
any
personnel.
5.7Existing
Agreements.
Regarding
the Embedded Business,Corporation
will not modify, amend, cancel, or terminate any of its existing contracts
or
agreements, or agree to do any of those acts.
5.8Consents
of Others. As
soon
as reasonably practicable after the execution and delivery of this Agreement,
and in any event on or before the Closing, Corporation will obtain the written
consent of the Persons described in Schedule 5.8 to this Agreement and will
furnish to Buyer executed copies of those consents. Buyer will exercise its
best
efforts and promptly execute and deliver any documents and instruments that
may
be reasonably required to assist Corporation in obtaining such consents;
provided, however, Buyer will not be obligated under this paragraph to execute
any guaranty, assumption of liability, or other document or instrument requiring
it to assume obligations not contemplated in this Agreement.
5.9Corporate
Approval.
Corporation
will deliver to Buyer, on or before the Closing, a written consent or minutes
of
a meeting of its Board of Directors authorizing and approving the Corporation’s
execution, delivery, and performance of its obligations under this Agreement
(including the sale of all of Embedded Business’s assets to Buyer under this
Agreement).
5.10Information
to Be Held in Confidence.
From
and
after the Closing, Corporation and itsrespective
officers, directors, and other representatives will each hold in strict
confidence all information of a confidential nature and not generally known
to
the public with respect to the Embedded Business or the Assets except when
that
disclosure of such information may be required by law by any Governmental
Authority or in any proceeding. If the Corporation believes that such disclosure
is required (other than with respect to Corporation’s reporting requirements
under the Securities Exchange Act of 1934,), it will give Buyer advance notice
of the disclosure and the basis for it, and permit Buyer a reasonable
opportunity to eliminate the need for or to narrow such disclosure.
14
ARTICLE
6. BUYER’S OBLIGATIONS BEFORE CLOSING
6.1Information
to Be Held in Confidence.
Unless
and until the Closing has been consummated, Buyer and its officers, directors,
and other representatives will hold in strict confidence, and will not use
to
the detriment of Corporation, all data and information with respect to the
business of Corporation obtained in connection with this transaction or
agreement, except when that data and information may be required by law to
be
included in Buyer’s proxy statement in connection with a meeting of its
stockholders, required by the Securities Exchange Act of 1934 and the general
rules and regulations issued under that act, or unless disclosure of such
information is otherwise compelled by law by any Governmental Authority or
in
any Proceeding. If Buyer believes that such disclosure is required, either
under
the Securities Exchange Act of 1934 or otherwise, it will give Corporation
advance notice of its disclosure and the basis for it, and permit Corporation
a
reasonable opportunity to eliminate the need for or narrow such disclosure.
If
the transactions contemplated by this Agreement are not consummated, Buyer
will
return to Corporation all that data and information that Corporation may
reasonably request, including worksheets, test reports, manuals, lists,
memoranda, and other documents prepared by or made available to Buyer in
connection with this Agreement and the transaction contemplated.
6.2Cooperation
in Securing Consents of Third Parties.
Buyer
will use its reasonable efforts to assist Corporation in obtaining the consent
of all necessary Persons to the assignment and transfer to Buyer of properties,
assets, and agreements to be assigned and transferred under the terms of this
Agreement, provided, however, this provision will not impose on Buyer any
obligation to pay for any default or perform any obligation of Corporation
under
any such agreements or relieve Corporation from any failure to obtain such
consent.
6.3Resale
Certificate.
Buyer
will furnish any resale certificate or other documents reasonably requested
by
Corporation to comply with the provisions of the sales and use Tax laws of
the
State of California.
6.4Bulk
Sales Law.
Buyer
waives compliance with the provisions of Division 6 of the California Uniform
Commercial Code relating to bulk sale in connection with this sale of assets,
subject to the indemnities of Corporation contained in this Agreement. Nothing
in this paragraph will stop or prevent either Buyer or Corporation from
asserting as a bar or defense to any proceeding brought under the bulk sale
law
that such law does not apply to the sale contemplated under this
Agreement.
6.5Corporate
Approval.
Buyer
will deliver to Corporation, on or before the Closing, a written consent of
its
board of directors authorizing and approving the Buyer’s execution, delivery,
and performance of its obligations under this Agreement.
ARTICLE
7. CONDITIONS PRECEDENT TO BUYER’S PERFORMANCE
The
obligations of Buyer to purchase the Assets under this Agreement are subject
to
the satisfaction, at or before the Closing, of all the conditions set out below
in this Article 7. Buyer may waive any or all of these conditions in whole
or in
part in writing.
7.1Accuracy
of Corporation’s Representations and Warranties.
All
representations and warranties bythe
Corporation in this Agreement (including the Schedules to this Agreement and
the
certificate delivered pursuant to Paragraph 7.4) must be true and correct in
all
material respects on and as of the Closing, as though such representations
and
warranties were made on and as of that date.
15
7.2Performance
by Corporation.
On
or
before the Closing, the Corporation will have performed, satisfied, and complied
with in all material respects all covenants, agreements, and conditions that
it
is required by this Agreement to perform, comply with, or satisfy, before or
at
the Closing.
7.3No
Material Adverse Change.
During
the period from the execution of the Agreement to the Closing, there will not
have been any material adverse change in the financial condition or the results
of operations of the Embedded Business, and Corporation will not have sustained
any material loss or damage to the Assets that materially affects its ability
to
conduct its Embedded Business or the value of the assets to be purchased by
Buyer under this Agreement at the Closing.
7.4Certification
by Corporation.
Buyer
will have received a certificate, dated the Closing, signed and verified by
Corporation’s Chief Executive Officer, stating that the conditions specified in
this Agreement have been fulfilled.
7.5Absence
of Litigation.
No
litigation pertaining to the transaction contemplated by this Agreement or
to
its consummation, or that could reasonably be expected to have a material
adverse effect on Buyer, its businesses, assets, or financial conditions, or
the
Assets will have been instituted or threatened before the Closing.
7.6Shareholder
Approval.
The
execution, delivery, and performance of this Agreement by Corporation and the
consummation of the transactions contemplated will have been duly authorized
by
all necessary corporate action by the stockholders of Corporation.
7.7Approval
of Documentation and Delivery.
Corporationwill
have
delivered to Buyer all documents and taken all actions required to be taken
by
such parties under Article 9 of this Agreement. The form and substance of all
certificates, instruments, opinions, and other documents delivered to Buyer
under this Agreement must be satisfactory in all reasonable respects to Buyer
and its counsel.
7.8Payment
of Accounts Payable.
On the
Closing, all Embedded Business accounts payable which are outstanding more
than
thirty (30) days will be paid.
ARTICLE
8. CONDITIONS PRECEDENT TO CORPORATION’S PERFORMANCE
The
obligations of Corporation to sell and transfer the Assets under this Agreement
are subject to the satisfaction, at or before Closing, of all the following
conditions. Corporation may waive any or all of these conditions in whole or
in
part in writing; provided, however, that no such waiver of a condition will
constitute a waiver by Corporation of any of its other rights or remedies,
at
law or in equity, if Buyer should be in default of any of its representations,
warranties, or covenants under this Agreement.
16
8.1Accuracy
of Buyer’s Representations and Warranties.
All
representations and warranties by Buyer in this Agreement must be true in all
material respects on and as of the Closing as though such warranties were made
on and as of that date.
8.2Buyer’s
Performance.
On
or
before the Closing, Buyer will have performed, satisfied, and complied with
in
all material respects all covenants, agreements, and conditions that it is
required by this Agreement to perform, comply with, or satisfy, before or at
the
Closing.
8.3Absence
of Litigation.
No
Proceeding, pertaining to the transaction contemplated by this Agreement or
to
its consummation, will have been instituted or threatened on or before the
Closing.
8.4Approval
of Documentation and Delivery.
Buyer
will have delivered to Corporation all documents and taken all actions required
to be taken by such parties under Article 9 of this Agreement. The form and
substance of all certificates, instruments, opinions, and other documents
delivered to Corporation under this Agreement must be satisfactory in all
reasonable respects to itand
its
counsel.
8.5Shareholder
Approval.
The
execution, delivery, and performance of this Agreement by Corporation and the
consummation of the transactions contemplated will have been duly authorized
by
all necessary corporate action by the stockholders of Corporation.
ARTICLE
9. THE CLOSING
9.1Time
and Place.
The
sale
and transfer of the Assets by Corporation to Buyer (the Closing) will take
place
at the offices of Alan
Rich
& Associates,
APLC,
5857
Owens Avenue, Carlsbad, California, 92084 at 10:00 a.m. local time, on the
date
that is the later of (i) February 28, 2007 or (ii) two (2) business days after
approval by Corporation’s shareholders per Paragraph 8.5, or at such other time
and place, as the parties may agree to in writing (the date on which the Closing
actually occurs, the Closing).
9.2Corporation’s
Obligations at Closing.
At
the
Closing, Corporation must deliver or cause to be delivered to
Buyer:
(a) Assignment
and Assumption of the real property facility lease of the Embedded Business,
properly executed and acknowledged by Corporation, and accompanied by consent
of
lessor;
(b) Instruments
of assignment and transfer of all other property of the Embedded Business of
every kind and description and wherever situated, including all its interest
in
claims enforceable by legal or equitable actions, rights under agreements,
trademarks, trade names, patents, patent applications, patent licenses,
copyrights, shop rights, and other tangible or intangible property including
the
assumption of the personal property lease associated with the oscilloscope
per
the lease agreement dated July 27, 2005 with Alexander
Properties Company
as
lessor, except as expressly excluded in an exhibit to this
Agreement;
17
(c) Resolutions
of Corporation’s board of directors, in form reasonably satisfactory to counsel
for Buyer, authorizing the execution and performance of this Agreement and
all
actions to be taken by Corporation under this Agreement;
(d) A
certificate executed by the president, certifying all Corporation’s
representations and warranties under this Agreement are true in all material
respects as of the Closing, as though each of those warranties had been made
on
that date; and
Simultaneously
with the consummation of the transfer, Corporation, through its officers,
agents, and employees, will put Buyer into full possession and enjoyment of
all
properties and assets to be conveyed and transferred by this
Agreement.
9.3Buyer’s
Obligation at Closing.
At
the
Closing, Buyer must deliver to Corporation the following instruments and
documents against delivery of the items specified in this
Agreement:
(a) A
bank
cashier’s check or wire transfer in the amount of One Million Seven Hundred
Thousand Dollars ($1,700,000);
(b) A
bank
cashier’s check or wire transfer, payable to the order of the Escrow Holder per
Paragraph 2.7 in the amount of Five Hundred Thousand Dollars
($500,000).
(c) Assignment
and Assumption of the real property facility lease of the Embedded Business,
properly executed and acknowledged by Buyer and accompanied by consent of
lessor;
(d) Resolutions
of Buyer’s board of directors, in form reasonably satisfactory to counsel for
Corporation, authorizing the execution and performance of this Agreement and
all
actions to be taken by Buyer under this Agreement; and
(e) A
certificate executed by the president of Buyer certifying all Buyer’s
representations and warranties under this Agreement are true in all material
respects as of the Closing, as though each of those warranties had been made
on
that date.
ARTICLE
10. OBLIGATIONS AFTER CLOSING
10.1Shareholder’s
Competition.
In
consideration for the payment by Buyer of the Purchase Price, to be made on
the
Closing, Corporation will not, at any time within the four (4) year period
immediately following the Closing, directly or indirectly engage in, or have
any
interest in any Entity (whether as an employee, officer, director, agent,
security holder, creditor, consultant, or otherwise) that engages in any
activity in California, or in any other state or any country that is the same
as, similar to, or competitive with any activity now (or since January 1, 2004)
engaged in by the Embedded Business in any of these states or
countries.
The
parties intend the covenant contained in the preceding portion of this section
be construed as a series of separate covenants, one for California and each
state and country referred to in the preceding paragraph. Except for geographic
coverage, each such separate covenant will be considered identical in terms
to
the covenant contained in the preceding paragraph. If, in any Proceeding, a
court refuses to enforce any of the separate covenants included in this
paragraph, the unenforceable covenant will be considered eliminated from these
provisions for the purpose of those Proceedings to the extent necessary to
permit the remaining separate covenants to be enforced.
18
Corporation
will not to divulge, communicate, use to the detriment of Buyer or for the
benefit of any other Person (except as may be required by law or legal process),
or misuse in any way, any confidential information or trade secrets of the
Embedded Business, including personnel information, secret processes, know-how,
customer lists, recipes, formulas, or other technical data.
10.2Further
Assurances.
Corporation,
at any time on or after the Closing, will execute, acknowledge, and deliver
any
further deeds, assignments, conveyances, and other assurances, documents, and
instruments of transfer, reasonably requested by Buyer, and will take any other
action consistent with the terms of this Agreement that may reasonably be
requested by Buyer for the purpose of assigning, transferring, granting,
conveying, and confirming to Buyer, or reducing to possession, any or all
property to be conveyed and transferred under this Agreement. If requested
by
Buyer, corporation will prosecute or otherwise enforce in its own name for
the
benefit and under the direction of Buyer, any claims, rights, or benefits that
are transferred to Buyer under this Agreement and that require prosecution
or
enforcement in Corporation’s name. Any prosecution or enforcement of claims,
right, or benefits under this paragraph will be solely at Buyer’s expense,
unless the prosecution or enforcement is made necessary by a breach of this
Agreement by the Corporation.
10.3Corporate
Liabilities.
10.3.1Payment.
Corporation, within thirty (30) days after the Closing, will have paid in full
all the following obligations of the Embedded Business (“Liabilities”): (i)
Supplier and vendor payables, (ii) employee obligations including, but not
limited to wages, bonuses, fringe benefits, accrued vacation and sick leave,
payroll related taxes, etc. and (iii) sales representative and distributor
obligations including, but not limited to, commissions, bonuses and
royalties.
10.3.2Procedure
to Determine Payment of Obligations.
Within
forty-five (45) days after the Closing, Corporation will prepare and deliver
to
the Buyer, a schedule of the Liabilities outstanding as of the Closing and
a
schedule of the Liabilities outstanding thirty (30) days after the Closing
(“Liabilities Schedules”). The Liabilities Schedules will be prepared by
Corporation in good faith and in accordance with generally accepted accounting
principles applied on a consistent basis except as otherwise provided in this
Agreement. Buyer and its representatives will be provided with complete access
to the books, records, work papers and other information of the Corporation
necessary to review, audit and confirm the Liabilities Schedules. The
Liabilities Schedules, when delivered by the Corporation to the Buyer, will
be
deemed conclusive and binding on the parties unless the Buyer notifies
Corporation in writing within thirty (30) days after receipt of the Liabilities
Schedules from Corporation, of Buyer’s disagreement therewith (which notice will
state with reasonable specificity the reasons for any disagreement and the
amounts in dispute). If there is disagreement, and such disagreement cannot
be
resolved by Buyer and Corporation within thirty (30) days following receipt
of
the Obligations Schedules by Buyer, the items in dispute will be submitted
to a
firm of independent auditors acceptable to both Buyer and Corporation, and
the
determination by such independent auditing firm will be binding and conclusive
upon the parties. If the auditor’s determine there are outstanding Obligations,
Escrow will pay those outstanding Obligations within three (3) days of the
auditor’s determination. Buyer and Shareholders will each pay one-half of the
cost of the fees and expenses of such independent auditing firm.
10.4Accounts
Payable and Accounts Receivable.
Corporation
and Buyer, on or immediately following the Closing, will establish a protocol
and procedures to redirect incorrect payables billed to Corporation or Buyer
(“Protocol”). The Protocol will also address redirecting accounts receivable
incorrectly received by Corporation or Buyer. Corporation and Buyer will in
good
faith follow in a timely manner the Protocol.
19
ARTICLE
11. NATURE AND SURVIVAL OF REPRESENTATIONS
AND
OBLIGATIONS
11.1Representations
and Warranties.
No
representations or warranties whatever are made by any party except as
specifically set forth in this Agreement or in an instrument or certificate,
provided for in this Agreement. All statements contained in any of these
instruments, certificates, or other writings will be considered to be warranties
under this Agreement.
11.2Survival.
All
representations, warranties, covenants, and agreements of the parties will
survive the Closing until 5:00 p.m. California time on the first anniversary
of
the Closing (the “Expiration Time”).
11.3Indemnification
and Reimbursement by Corporation.
Corporation will indemnify and hold harmless Buyer and its subsidiaries
(collectively, the “Buyer Indemnified Persons”), and will reimburse the Buyer
Indemnified Persons for any loss, Liability, claim, damage, expense (including
costs of investigation and defense and reasonable attorneys’ fees and expenses)
or diminution of value, whether or not involving a Third-Party Claim (as defined
below) (collectively, “Damages”), arising from or in connection
with:
(a) any
breach of any representation or warranty made by Corporation in this Agreement
(including the Schedules to this Agreement and the certificate delivered
pursuant to Paragraph 7.4);
and
(b) any
breach of any covenant or obligation of Corporation in this Agreement (including
the Schedules to this Agreement and the certificate delivered pursuant to
Paragraph 7.4);
(c) any
liability arising out of the ownership or operation of the Assets prior to
the
Closing;
(d) any
product or component thereof manufactured by or shipped, or any services
provided by, Corporation, in whole or in part, prior to the
Closing.
11.4Indemnification
and Reimbursement by Corporation - Environmental
Matters.
In
addition to the other indemnification provisions in this Article 11, Corporation
will indemnify and hold harmless Buyer and the other Buyer Indemnified Persons,
and will reimburse Buyer and the other Buyer Indemnified Persons, for any
Damages (including costs of cleanup, containment or other remediation) arising
from or in connection with:
(a) any
Environmental, Health and Safety Liabilities arising out of or relating to:
(i)
Corporation's ownership or operation at any time on or prior to the Closing
of
any of the Facilities, Assets or the business of Corporation, or (ii) any
Hazardous Materials or other contaminants that were present on the Facilities
or
Assets at any time on or prior to the Closing as a result of Corporation’s
activities; or
20
(b) any
bodily injury (including illness, disability and death, regardless of when
any
such bodily injury occurred, was incurred or manifested itself), personal
injury, property damage (including trespass, nuisance, wrongful eviction and
deprivation of the use of real property) or other damage of or to any Person
or
any Assets in any way arising from or allegedly arising from any Hazardous
Activity conducted by Corporation with respect to the business of Corporation
or
the Assets prior to the Closing or from any Hazardous Material resulting from
Corporation's activities that was (i) present or suspected to be present on
or
before the Closing on or at the Facilities (or present or suspected to be
present on any other property, if such Hazardous Material emanated or allegedly
emanated from any Facility and was present or suspected to be present on any
Facility, on or prior to the Closing) or (ii) Released or allegedly Released
by
Corporation on or at any Facilities or Assets at any time on or prior to the
Closing. Buyer will be entitled to control any Remedial Action, any Proceeding
relating to an Environmental Claim and, except as provided in the following
sentence, any other Proceeding with respect to which indemnity may be sought
under this Paragraph 11.4.
11.5Indemnification
and Reimbursement by Buyer.
Buyer
will indemnify and hold harmless Corporation, and will reimburse Corporation,
for any Damages arising from or in connection with:
(a) any
Breach of any representation or warranty made by Buyer in this Agreement
;
and
(b) any
Breach of any covenant or obligation of Buyer in this Agreement.
11.6Time
Limitations.
(a) If
the
Closing occurs, Corporation will have liability for indemnification hereunder
only if on or before the Expiration Time, Buyer delivers a Claim Notice (as
defined below) to Corporation.
(b) If
the
Closing occurs, Buyer will have liability for indemnification hereunder only
if
on or before the Expiration Time, Corporation delivers a Claim Notice to
Buyer.
11.7Limitations
on Corporation’s Indemnity.
Corporation’s
liability under this Agreement will not, however, exceed the aggregate amount
of
Two Million Two Hundred Thousand Dollars ($2,200,000) absent fraud. Despite
any
other provision of this Agreement, Corporation will not be liable for
indemnification hereunder until such time as all claims of Damages cumulatively
exceed Twenty-Five Thousand Dollars ($25,000); if and when the aggregate amount
of all such claims of Damages cumulatively exceed such amount, Corporation
will,
subject, to the above limitation on itsmaximum
aggregate liability, thereafter be liable in full for all claims of Damages
including the first Twenty-Five Thousand Dollars ($25,000).
11.8Knowledge
of Breach.
For
purposes of this Paragraph 11, Corporation will not be deemed to have breached
any representation or warranty if Buyer had, on or prior to the Closing, any
actual knowledge of the breach of, or of any facts or circumstances constituting
or resulting in a breach of, such representation or warranty.
21
11.9Indemnification
Claims.
If
either party hereto (the “Claimant”) wishes to assert an indemnification claim
against the other party hereto, the Claimant will deliver to the other party
a
written notice (a “Claim Notice”) setting forth:
(a) the
specific representation and warranty alleged to have been breached by such
other
party;
(b) a
detailed description of the facts and circumstances giving rise to the alleged
breach of such representation and warranty; and
(c) a
detailed description of, and a reasonable estimate of the total amount of,
the
Damages actually incurred or expected to be incurred by the Claimant as a direct
result of such alleged breach.
11.10Defense
of Third Party Actions.
If
either party hereto (the “Indemnitee”) receives notice or otherwise obtains
knowledge of any claim, demand, dispute, action, suit, examination, audit,
proceeding, investigation, inquiry or other similar matter (a “Matter”) or any
threatened Matter that may give rise to an indemnification claim against the
other party hereto (the “Indemnifying Party”), then the Indemnitee will promptly
deliver to the Indemnifying Party a written notice describing such Matter in
reasonable detail; provided,
however,
that for
the sole purpose of determining whether a Matter or threatened Matter may give
rise to an indemnification claim against Seller within the meaning of this
sentence, the limitation set forth in Paragraph 11.9 will not be taken into
account. The timely delivery of such written notice by the Indemnitee to the
Indemnifying Party will be a condition precedent to any liability on the part
of
the Indemnifying Party under this Paragraph 11.10 with respect to such
Matter. The Indemnifying Party will have the right, at its option, to assume
the
defense of any such Matter with its own counsel satisfactory to the Indemnitee.
If the Indemnifying Party elects to assume the defense of any such Matter,
then:
(a) notwithstanding
anything to the contrary contained in this Agreement, the Indemnifying Party
will be required to pay or otherwise indemnify the Indemnitee against any
attorneys’ fees or other expenses incurred on behalf of the Indemnitee in
connection with such Matter following the Indemnifying Party’s election to
assume the defense of such Matter;
(b) the
Indemnitee will make available to the Indemnifying Party all books, records
and
other documents and materials that are under the direct or indirect control
of
the Indemnitee or any of the Indemnitee’s Associates and that the Indemnifying
Party considers necessary or desirable for the defense of such
Matter;
(c) the
Indemnitee will execute such documents and take such other actions as the
Indemnifying Party may reasonably request for the purpose of facilitating the
defense of, or any settlement, compromise or adjustment relating to, such
Matter;
(d) the
Indemnitee will otherwise fully cooperate as reasonably requested by the
Indemnifying Party in the defense of such Matter;
(e) the
Indemnitee will not admit any liability with respect to such Matter;
and
22
(f) the
Indemnifying Party will have the exclusive right to settle, adjust or compromise
such Matter, on such terms as it may deem appropriate, with the consent and
approval of the Indemnitee or any other Person.
If
the
Indemnifying Party elects not to assume the defense of such Matter, then the
Indemnitee will proceed diligently to defend such Matter with the assistance
of
counsel satisfactory to the Indemnifying Party; provided,
however,
that the
Indemnitee will not settle, adjust or compromise such Matter, or admit any
liability with respect to such Matter, without the prior written consent of
the
Indemnifying Party.
11.11Subrogation.
To the
extent that either party hereto (the “Indemnitor”) makes or is required to make
any indemnification payment to the other party hereto (the “Indemnified Party”),
the Indemnitor will be entitled to exercise, and will be subrogated to, any
rights and remedies (including rights of indemnity, rights of contribution
and
other rights of recovery) that the Indemnified Party or any of the Indemnified
Party’s Associates may have against any other Person with respect to any
Damages, circumstances or Matter to which such indemnification payment is
directly or indirectly related. The Indemnified Party will permit the Indemnitor
to use the name of the Indemnified Party and the names of the Indemnified
Party’s Associates in any transaction or in any proceeding or other Matter
involving any of such rights or remedies; and the Indemnified Party will take
such actions as the Indemnitor may reasonably request for the purpose of
enabling the Indemnitor to perfect or exercise the Indemnitor’s right of
subrogation hereunder.
11.12Exclusivity.
Other
than with respect to claims of fraud or as specified in Paragraph 16.2, the
right of each party hereto to assert indemnification claims and receive
indemnification payments pursuant to this Paragraph 11 will be the sole and
exclusive right and remedy exercisable by such party with respect to any breach
by the other party hereto of any representation or warranty.
ARTICLE
12. PUBLICITY
With
the
exception of Corporation’s reports filed with the Securities and Exchange
Commission, all notices to third parties and all other publicity concerning
the
transactions contemplated in this Agreement will be jointly planned and
coordinated by and between Buyer and Corporation.No
party
will act unilaterally in this regard without the prior written approval of
the
others; however, this approval will not be unreasonably withheld.
ARTICLE
13. COSTS
13.1Finder’s
or Broker’s Fees.
Each
party represents and warrants to the other that, except as set forth in the
last
sentence of this Paragraph 13.1, it has dealt with no broker or finder in
connection with any transaction contemplated by this Agreement, and, as far
as
it knows, no broker or other Person is entitled to any commission or finder’s
fee in connection with any of these transactions. Corporation and Buyer each
indemnify and hold harmless one another against any Losses incurred by reason
of
any brokerage or other commission or finder’s fee alleged to be payable because
of any act, omission, or statement of the indemnifying party. Corporation has
retained Stratapoint Consulting LLC to act as its broker in this transaction
and
will be responsible for payment of any fees or expenses payable to such
broker.
13.2Expenses.
Each
party will pay all costs and expenses, including its attorney fees and expenses,
incurred or to be incurred by it in negotiating and preparing this Agreement
and
in Closing and carrying out the transactions contemplated in this
Agreement.
23
ARTICLE
14. FORM OF AGREEMENT
14.1Effect
of Headings.
The
subject headings of the paragraphs and subparagraphs of this Agreement are
included for convenience only and will not affect the construction or
interpretation of any of its provisions.
14.2Word
Usage.
Unless
the context clearly requires otherwise:
(a) Plural
and singular numbers will each be considered to include the other;
(b) The
masculine, feminine, and neuter genders will each be considered to include
the
others;
(c)“Will,”“must,”“agree,” and “covenants” are each mandatory;
(d)“May”
is
permissive;
(e)“Or”
is
not exclusive; and
(f)“Includes”
and “including” are not limiting.
(g) Reference
to any statute is a reference to that statute as amended to the date of this
Agreement.
(h) Reference
to any document is to that document, as amended to the date of this Agreement,
including all exhibits and schedules, if any.
(i)“Known
to” or “knowledge of” a party means, with respect to any fact, circumstance,
event, or other matter in question, the actual knowledge of it with respect
to
an individual, if knowledge refers to the knowledge of an individual, and of
an
officer or director of a party if knowledge refers to a party that is not an
individual.
14.3Entire
Agreement; Modification; Waiver.
This
Agreement constitutes the entire agreement between the parties pertaining to
the
subject matter contained in it and supersedes all prior and contemporaneous
agreements, representations, and understandings of the parties. No supplement,
modification, or amendment of this Agreement will be binding unless executed
in
writing by all the parties. No waiver of any of the provisions of this Agreement
will be considered, or will constitute, a waiver of any other provision, and
no
waiver will constitute a continuing waiver. No waiver will be binding unless
executed in writing by the party making the waiver.
14.4Counterparts;
Facsimile Delivery.
This
Agreement may be executed in one or more counterparts, each of which will be
considered an original, but all of which together will constitute one and the
same instrument. This Agreement may be executed and delivered by facsimile
and
on such delivery, the facsimile signature will be deemed to have the same effect
as if the original signature had been delivered to the other party. The original
signature copy must be delivered to the other party by express overnight
delivery. The failure to deliver the original signature copy or the nonreceipt
of the original signature copy will have no effect on the binding and
enforceable nature of this Agreement.
24
ARTICLE
15. PARTIES
15.1Parties
in Interest.
Nothing
in this Agreement, whether express or implied, is intended to confer any rights
or remedies under, or by reason of, this Agreement on any Persons other than
the
parties to it and their respective successors and assigns; nothing in this
Agreement is intended to relieve or discharge the obligation or liability of
any
third party to any party to this Agreement; and no provision will give any
third
party any right of subrogation or claim against any party to this
Agreement.
15.2Assignment.
This
Agreement will be binding on, and will inure to the benefit of, the parties
to
it and their respective heirs, legal representatives, successors, and assigns,
provided that the Corporation may not assign itsobligations
under this Agreement, and before the Closing, Buyer may not assign any of its
rights under this Agreement except to a wholly owned subsidiary corporation
of
Buyer. No such assignment by Buyer to its wholly owned subsidiary will relieve
Buyer of any of its obligations or duties under this Agreement.
ARTICLE
16. REMEDIES
16.1Arbitration.
Any
controversy or claim arising from or relating to this Agreement, or its making,
performance, or interpretation, will be settled by arbitration in San Diego,
California under the commercial arbitration rules of the American Arbitration
Association then existing. Judgment on the arbitration award may be entered
in
any court having jurisdiction over the subject matter of the controversy.
Arbitrators will be individuals experienced in negotiating, making, and
consummating acquisition agreements.
16.2Specific
Performance and Waiver of Rescission Rights.
Each
party’s obligation under this Agreement is unique. If any party should default
in its obligations under this Agreement, the parties each acknowledge that
it
would be extremely impracticable to measure the resulting damages; accordingly,
the nondefaulting party or parties, in addition to any other available rights
or
remedies, may sue in equity for specific performance, and the parties each
expressly waive the defense that a remedy in damages will be adequate. Despite
any breach or default by any of the parties of any of their respective
representations, warranties, covenants, or agreements under this Agreement,
if
the purchase and sale contemplated by this Agreement will be consummated at
the
Closing, each of the parties waives any rights that they may have to rescind
this Agreement or the transaction consummated by it provided that this waiver
will not affect any other rights or remedies available to the parties under
this
Agreement or under the law.
16.3Recovery
of Litigation Costs.
If
any
legal Proceeding is brought for the enforcement of this Agreement, or because
of
an alleged dispute, breach, default, or misrepresentation in connection with
any
of the provisions of this Agreement, the successful or prevailing party or
parties will be entitled to recover reasonable attorney fees and other costs
incurred in that Proceeding, in addition to any other relief to which they
may
be entitled.
16.4Termination.
25
16.4.1Conditions
Permitting Termination.
This
Agreement may be terminated at any time before completion of the
Closing:
(a) by
mutual
written consent of the parties, duly authorized by the boards of directors
of
Buyer and Corporation; or
(b) by
either
party if the Closing has not occurred on or before April 30, 2007 (which date
may be extended in accordance with Paragraph 2.7.2), for any reason, provided,
however, that the right to terminate this Agreement under this paragraph, will
not be available to any party whose action or failure to act has been a
principal cause of or resulted in the failure of the Closing to occur on or
before such date and such action or failure to act constitutes a breach of
this
Agreement.
16.4.2Termination
for Governmental Prohibition.
This
Agreement may be terminated at any time before completion of
Closing:
(a) by
either
party if any bona fide Proceeding is pending against any party on the Closing
that could result in an unfavorable judgment, decree, or order that would
prevent or make unlawful the performance of this Agreement.
(b) by
either
party, if any Governmental Entity has issued an order, decree or ruling or
taken
any other action, in each case, having the effect of permanently restraining,
enjoining, or otherwise prohibiting the transactions contemplated by this
Agreement, and such order, decree, ruling, or other action is final and
nonappealable.
16.4.3Defaults
Permitting Termination.
If,
before the Closing, either Buyer or Corporation materially defaults in the
due
and timely performance of any of their covenants, or agreements under this
Agreement, or if any representation or warranty becomes materially untrue,
the
nondefaulting party or parties may terminate this Agreement, provided that,
if
the default or breach of the covenant or agreement, or untruth in the
representation, can be cured, termination will not be effective for thirty
(30)
days after delivery of written notice of intent to terminate, and if the breach
is cured within that time, the nondefaulting party will have no right to
terminate this Agreement on account of that breach. In addition, no party may
exercise any right to terminate under this paragraph if it is in material breach
of this Agreement.
16.4.4Effect
of Termination.
Any
proper termination of this Agreement in accordance with its terms will be
effective immediately on delivery of written notice by the terminating party
to
the other parties (unless a provision of this Agreement permits a party a cure
period, and then on the expiration of that cure period without cure). In the
event of termination of this Agreement as provided in Paragraph 16.4.1, then
this Agreement will be of no further force or effect, except Article 13;
and
nothing in this Agreement will relieve any party from liability for any willful
breach of any covenant of this Agreement or for any intentional or willful
act
or omission by a party that renders any representation or warranties of such
party untrue.
26
ARTICLE
17. NOTICES
All
notices, requests, demands, and other communications under this Agreement must
be in writing and will be considered to have been duly given on the date of
service if served personally on the party to whom notice is to be given, or
on
the second (2nd)
day
after mailing if mailed to the party to whom notice is to be given, by first
class mail, registered or certified, postage prepaid, and properly addressed
as
follows:
Any
party
may change its address for purposes of this paragraph by giving the other
parties written notice of the new address in the manner set forth
above.
ARTICLE
18. GOVERNING LAW
This
Agreement will be construed in accordance with, and governed by, the laws of
the
State of California as applied to contracts that are executed and performed
entirely in California.
ARTICLE
19. SEVERABILITY
If
any
provision of this Agreement is held invalid or unenforceable by any court of
competent jurisdiction, it is the intent of the parties that all other
provisions of this Agreement be construed to remain fully valid, enforceable,
and binding on the parties.
IN
WITNESS WHEREOF, the parties to this Agreement have duly executed it on the
day
and year first above written.
You
have
requested the opinion of Seidman & Co., Inc. as to the fairness, from a
financial point of view, to the shareholders of SBE, Inc. (“SBE” the “Company”),
a Delaware corporation, of the proposed sale (the “Transaction”) of the business
of the SBE Embedded Hardware Division (“Embedded”) to One Stop Systems, Inc.
(“One Stop”), a privately-held company. It is understood that One Stop proposes
to pay $2,200,000 in cash, subject to certain adjustments, for certain of the
assets of Embedded plus the assumption of SBE’s obligations under the lease of
its corporate headquarters building and certain equipment leases.
The
proposed acquisition by One Stop Systems, Inc., as provided for in the Agreement
of Purchase and Sale of Assets (the “Agreement”), dated January 11, 2007, by and
between One Stop Systems, Inc. and SBE, Inc., provides for One Stop to purchase
certain assets of SBE primarily used in the business of Embedded for $2,200,000
in cash, excluding accounts receivable in the amount $649,379 subject to
liabilities of approximating $547,397. In addition, One Stop will assume SBE’s
obligations under the lease of its corporate headquarters building and certain
equipment leases, with an aggregate estimated capitalized present value of
$1,500,000. Thus, the total transaction value for the sale of the business
of
the SBE Embedded Hardware Division approximates $3,800,000.
In
reaching our fairness opinion, we have examined and considered all available
information and data which we deemed relevant to determining the fairness of
the
subject Transaction from a financial point of view, including:
1.
The
proposed asset acquisition and assumption of SBE’s lease obligations as
delineated in the Agreement for Purchase and Sale of Assets dated
January11, 2007;
Limited
internal, unaudited historic and current operating data for the SBE
Embedded Hardware Division;
4.
Statistical
analyses of selected comparable companies with publicly-traded common
shares, and derivation of financial ratios typical of embedded hardware
companies;
5.
Analysis
of comparable company merger/acquisition transactions over the past
year
and one-half;
B
-
1
6.
Conditions
in, and the outlook for the embedded hardware
industry;
7.
Conditions
in, and the outlook for the United States economy, interest rates
and
financial markets;
8.
Other
studies, analyses, and investigations as we deemed
appropriate.
The
preparation of a fairness opinion is a complex process and is not necessarily
susceptible to partial analysis or summary description. Selecting portions
of
the analyses or of the summary set forth herein without considering the analysis
as a whole could create an incomplete view of the processes underlying Seidman
& Co. Inc.’s fairness opinion. This letter is prepared solely for the
purpose of Seidman & Co., Inc. providing an outline of the opinion as to the
fairness of the subject disposition, and does not purport to be an appraisal
or
necessarily reflect the prices at which businesses or securities actually may
be
sold. This letter only has application as it is employed with reference to
the
full written analysis and supporting research and tables.
During
the course of our investigation, we conducted interviews with persons who,
in
our judgment, were capable of providing us with information necessary to
complete the assignment, including members of management. We have assumed that
the information and accounting supplied by management and others are accurate,
and reflect good faith efforts to describe the current and prospective status
of
the SBE Embedded Hardware Division from an operational and financial point
of
view. We have relied, without independent verification, upon the accuracy of
the
information provided by these sources.
Fairness
is determined by comparison of the proposed transaction value with the fair
market value of the business being purchased / sold. In the instance of the
sale
of the SBE Embedded Hardware Division to One Stop Systems, Inc., the relevant
analysis is the comparison of the proposed transaction value of approximately
$3,800,000 with the fair market value of the SBE Embedded Hardware Division.
If
the transaction consideration is equal to or in excess of the subject fair
market value, then the proposed transaction is deemed to be fair to the
shareholders of SBE, Inc.
The
valuation of the operating business of the Embedded Hardware Division of SBE,
Inc. is based on the generally accepted and recommended procedures for valuing
an on-going operating business designated the market comparable, or “guideline
company” approach." In this valuation technique, the market value of a company
is established on the basis of market prices and indicated market values of
comparable companies with minority shares freely- and publicly-traded on various
securities exchanges. Value is expressed in the relationship of these market
prices to selective balance sheet and operating data of these market comparable
companies, and derivation of market capitalization factors.
In
employing the market comparable method of valuation, it is necessary to compare
over an historical period, typically one, three, and five years, the financial
performance of the subject company with an appropriate universe of "market
comparable" companies which have common stock that is publicly-traded. In-depth
financial data for the market comparable companies are then presented for easy
comparison, and selective financial measurements and ratios are computed and
studied.
These
measurements and ratios for analysis of a company include the
following:
•
Annual
growth increments and annual average compounded growth in revenues
and
earnings;
•
Gross,
operating, and pre-tax profits as a percentage of
revenues;
•
Dividend
payout and dividend yield;
•
Return
on equity;
•
Debt/equity
ratio;
B
-
2
•
Price
to book value ratio;
•
Price
to operating cash flow (that is, “EBITDA,” or earnings before interest,
taxes, depreciation, and amortization)
ratio;
•
Price
to operating income (that is, “EBIT,” or earnings before interest and
taxes) ratio; and,
•
Price
to pre-tax income ratio
For
securities which enjoy an active public market, market prices are determinative
of fair market value on any given date, unless the market for the particular
security is affected by some abnormal influence or condition.
In
contrast, the determination of the fair market value of securities with no
marketability or liquidity, as is the case with Embedded, when considered as
a
standalone entity separate and apart from SBE, presents a more complex problem.
Principal weight must be given to evidence of (i) earnings, cash flow and
dividend paying power, (ii) book value, (iii) the financial and competitive
position of the subject company, and, (iv) the prices and derived capitalization
factors at which the common stock of generally similar companies, that is,
the
market comparables, are traded.
Among
the
ratios typically most directly employed in establishing the valuation profile
of
a company are price/revenues, price/book value, price/operating cash flow,
price/operating income, and price/pre-tax income, each of which is developed
by
dividing the per share market price by book value per share and the appropriate
per share profit and loss, or operating reference, respectively, for each
comparable company. These derived ratios are then applied to the book value
and
operating references of the subject closely-held company to establish a matrix
of aggregate value. Ultimately it is the relationship of price to the results
of
operations (viz., operating cash flow, operating income and pre-tax income)
which most significantly summarizes and defines the value of a
business.
Where
the
companies chosen for market comparative purposes differ significantly from
the
company being valued with respect to operating performance, size, balance sheet
liquidity and strength and management dependence, discounts or premiums may
have
to be applied to the derived aggregate value to compensate for such differences.
Likewise, adjustments to value may be necessary to account for the absence
of a
market for the underlying ownership securities -- common stock -- and for other
qualities such as control or lack of control.
For
purposes of valuing Embedded, a review was made of the operating and financial
data of a number of comparable companies with shares freely- and
publicly-traded. While it is not possible to delineate a universe of market
comparable, publicly-traded companies engaged exclusively in the embedded
hardware industry, there are a number of companies with principal activities
in
such products or markets and which share key financial and/or non-financial
characteristics with Embedded. These companies were selected from a much larger
universe of public companies as the focus for analytic comparison.
The
six
most comparable companies selected for market comparable analyses
are:
1.
Digi
International, Inc.
2.
Dynatem
Inc.
3.
Interphase
Corp.
4.
Performance
Technologies, Inc.
5.
Radisys
Corp.
6.
Ciprico
Inc.
B
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3
Notwithstanding
that the market comparable methodology involves deriving appropriate
capitalizing factors of multiples from a universe of publicly-traded market
comparable companies and applying the applicable multiple to Embedded’s
operating data so as to derive capitalized freely traded minority share value
(“CFTM”), given the absence of earnings and the history of losses over the last
three years, those measures most indicative of Embedded’s performance are
price/book value and price/revenues, respectively.
Table
I
following provides the latest year and average of latest three years price/book
value and price/revenue ratios, respectively, for each of the six market
comparable companies.
In
examining each of the market comparable companies, it is observed that all
of
the companies, excepting Dynatem, Inc., are larger than Embedded in terms of
annual revenue. The market comparable companies range in revenue from a low
of
$3.4 million for Dynatem to a high of $294 million for Radisys, with a median
approximating $41 million for the latest year. Embedded had approximately $6.1
million of revenue for the year ended October 31, 2006.
All
of
the companies that are larger than Embedded have price/revenue ratios in excess
of 1.18x. Dynatem, the one company with lower revenues than Embedded, has a
price/revenues ratio of 0.54x for the latest year and 0.57x for the latest
three
years. The inference from examining price/revenue data is that larger companies
have higher price/revenue multiples than smaller companies that have fewer
resources, are more vulnerable due to a lack of diversification, and lack the
economies of scale of the larger companies. Consequently, Embedded is most
appropriately compared with Dynatem. Assuming an effective transaction value
for
Embedded of approximately $3.8 million, Embedded shows a price/latest years
revenues multiple of 0.62x, and a price/average three years revenue multiple
of
0.45x. With declining revenues of Embedded over the past three years, and the
unlikely prospect of a near-term recovery, latest year revenues is arguably
the
more relevant standard for comparison for Embedded. In this regard, latest
year
price/revenues of Embedded at 0.62x is higher than the price/revenues ratio
of
Dynatem at 0.54x. Notwithstanding its smaller size, Dynatem appears to be
somewhat stronger than Embedded with a more technologically advanced product
line and should enjoy a higher price/revenue multiple than Embedded. Given
that
Embedded has a higher price/latest year revenue multiple than that of Dynatem,
this is indicative of fairness, from a financial point-of-view, to the
shareholders of SBE of the consideration being paid for the SBE Embedded
Hardware Division.
In
terms
of price/book value, Table I shows the median price/book of all the market
comparable companies at 2.20x. With an estimated standalone book value of
approximately $1.2 million, this would indicate a capitalized value for Embedded
of approximately $2.6 million. Since the indicated purchase price for Embedded
of approximately $3.8 million is higher than the capitalized price/book value
of
Embedded of $2.6 million, fairness of the transaction to the shareholders of
SBE, Inc. is indicated, from a financial point of view, employing this
standard.
In
addition to the market comparable methodology, Seidman & Co., Inc. reviewed
acquisition transactions from the Mergerstat database from June 2005 through
September 2006 of all target companies in SIC Codes 3571, 3572, and 3577,
respectively, of which the SBE Embedded Hardware Division is a part. The
transaction results returned by this search did not produce any transactions
with meaningful relevance to the subject transaction.
Based,
therefore, on our analysis and consideration of the foregoing respective
information and data, with particular weight accorded to the market comparable,
or “guideline company” analysis methodology, it is our considered professional
judgment that the approximately $3,800,000 transaction value of the proposed
sale of the SBE Embedded Hardware business to One Stop Systems, Inc. is fair
to
the shareholders of SBE, Inc. from a financial point of view.
Yours
truly,
Seidman
& Co., Inc.
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6
ANNEX
C
Report
of Independent Registered Public Accounting Firm
Board
of
Directors
SBE,
Inc.
San
Ramon, California
We
have
audited the accompanying balance sheets of SBE, Inc. as of October 31, 2006
and
2005 and the related statements of operations, stockholders’ equity, and cash
flows for each of the three years in the period October 31, 2006. We have also
audited Schedule II - Valuation and Qualifying Accounts (the Schedule). These
financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements and the
Schedule based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control
over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures
in
the financial statements, assessing the accounting principles used and
significant estimates made by management, 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 financial statements referred to above present fairly, in all
material respects, the financial position of SBE, Inc. at October 31, 2006
and
2005, and the results of its operations and its cash flows for each of the
years
in the period ended October 31, 2006, in conformity with accounting principles
generally accepted in the United States of America.
Also,
in
our opinion, the Schedule presents fairly, in all material effects, the
information set forth therein.
The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. As discussed in Note 1 to the financial
statements, the Company has suffered recurring losses and negative cash flows
from operations that raise substantial doubt about its ability to continue
as a
going concern. Management’s plans in regard to these matters are described in
Note 1. The financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
Adjustments
to reconcile loss to net cash used in operating
activities:
Depreciation
and amortization
3,880
1,241
829
Impairment
of intellectual property and software
6,500
---
713
Stock-based
compensation expense
2,119
259
--
Non-cash
valuation allowance (recovery) on loan from officer
---
---
(240
)
Loss
on sale of assets
---
6
---
Changes
in operating assets and liabilities:
Trade
accounts receivable
625
113
150
Inventories
544
643
(46
)
Other
assets
146
(121
)
13
Trade
accounts payable
(186
)
(113
)
160
Other
current liabilities
235
(319
)
(40
)
Non-current
liabilities
14
102
---
Net
cash used in operating activities
(2,306
)
(2,419
)
(140
)
Cash
flows from investing activities:
Purchases
of property and equipment
(176
)
(337
)
(87
)
Cash
payments related to purchase of PyX, net of cash received
---
(359
)
---
Purchased
software
(40
)
(207
)
(136
)
Net
cash used in investing activities
(216
)
(903
)
(223
)
Cash
flows from financing activities:
Proceeds
from stock plans
37
130
251
Proceeds
from issuance of common stock and warrants, net
---
4,975
202
Proceeds
from repayment of shareholder note
---
---
382
Net
cash provided by financing activities
37
5,105
834
Net
increase (decrease) in cash and cash equivalents
(2,485
)
1,783
471
Cash
and cash equivalents at beginning of year
3,632
1,849
1,378
Cash
and cash equivalents at end of year
$
1,147
$
3,632
$
1,849
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION
Cash
paid during the year for:
Income
taxes
$
7
$
5
$
1
SUPPLEMENTAL
SCHEDULE OF NON CASH INVESTING AND FINANCING ACTIVITIES
Assets
acquired under capital leases
$
---
$
---
$
164
Non-cash
stock portion of PyX purchase price
$
---
$
11,714
$
---
Non-cash
stock portion of Antares purchase price
$
---
$
197
$
86
The
accompanying notes are an integral part of these financial
statements.
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NOTES
TO FINANCIAL STATEMENTS
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a)Liquidity:
The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the settlement of liabilities
and commitments in the normal course of business. As reflected in the
accompanying financial statements, as of October 31, 2006, we had cash and
cash
equivalents on hand of $1.2 million with cash used in operations of
approximately $2.3 million in the twelve months ended October 31, 2006 and
an
accumulated deficit of approximately $31.9 million. Our ability to continue
as a
going concern is dependent on our ability to raise additional funds and
implement our business plan. Our independent registered public accountants
stated in their opinion that there is substantial doubt about our ability to
continue as a going concern.
We
are
not operating at cash breakeven. Unless we are able to increase our sales to
get
to cash breakeven, we will not have sufficient cash generated from our business
activities to support our operations for the next twelve months. We have
embarked on a strategy to sell all or a portion of our business and signed
a
definitive agreement to sell our hardware business to One Stop Systems, Inc.
The
overwhelming majority of our cash flow from operations has been generated from
the embedded hardware business that we are selling. We expect to close the
sale
of our embedded hardware business in our second quarter of fiscal 2007 and
all
cash flow generated by the embedded hardware business will cease after that
date. We also signed a definitive agreement to merge with Neonode, Inc. and
have
been reducing our staffing levels and other cash expenditures to sustainable
levels. We expect the $2.2 million cash proceeds from the sale of our embedded
hardware business to be sufficient to support our remaining operations until
the
merger transaction closes, or for at least the next twelve months if the merger
is delayed. We are also seeking other strategic alternatives including selling
our storage software business.
If
our
projected sales of our storage software do not materialize or we are unable
to
consummate the sale of our embedded hardware business and the merger
transaction, we will need to reduce expenses further and raise additional
capital through customer prepayments or the issuance of debt or equity
securities. If we raise additional funds through the issuance of preferred
stock
or debt, these securities could have rights, privileges or preferences senior
to
those of common stock, and debt covenants could impose restrictions on our
operations. The sale of equity or debt could result in additional dilution
to
current stockholders, and such financing may not be available to us on
acceptable terms, if at all.
The
Company and Basis of Presentation:
SBE,
Inc., headquartered in San Ramon, California, designs, manufactures and sells
hardware products including wide area network (WAN) and local area network
(LAN)
network interface cards (NICs) and central processor units (CPUs) to original
equipment manufacturers (OEMs) who embed our hardware products into their
products for the telecommunications markets. Our hardware products perform
critical, computing and Input/Output (I/O) tasks in diverse markets such as
high-end enterprise level computing servers, Linux super-computing clusters,
workstations, media gateways, routers and Internet access devices. Our products
are distributed worldwide through a direct sales force, distributors,
independent manufacturers' representatives and value-added resellers. We also
provide Internet Small Computer System Interface (iSCSI)-based storage
networking solutions for an extensive range of business critical applications,
including Disk-to-Disk Back-up and Disaster Recovery. We deliver an affordable,
expandable, and easy-to-use portfolio of software solutions designed to enable
optimal performance and rapid deployment across a wide range of next generation
storage systems
Use
of Estimates:
The
preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Such estimates include levels of reserves for
doubtful accounts, obsolete inventory, warranty costs and deferred tax assets.
Actual results could differ from those estimates.
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Fair
Value of Financial Instruments:
The
fair
value of our cash and cash equivalents, accounts receivable, accounts payable
and accrued liabilities approximate their carrying value due to the short-term
maturity rate structure of those instruments.
Cash
and Cash Equivalents:
We
consider all highly liquid investments readily convertible into cash with an
original maturity of three months or less to be cash equivalents. Substantially
all of our cash and cash equivalents are held with one large financial
institution and may at times be above insured limits.
Inventories:
Inventories
are stated at the lower of cost, using the first-in, first-out method, or market
value. We utilize standard costs, which approximates actual cost, for certain
indirect costs.
We
are
exposed to a number of economic and industry factors that could result in
portions of our inventory becoming either obsolete or in excess of anticipated
usage, or subject to lower of cost or market issues. These factors include,
but
are not limited to, technological changes in our markets, our ability to meet
changing customer requirements, competitive pressures in products and prices,
and the availability of key components from our suppliers. Our policy is to
establish inventory reserves when conditions exist that suggest that our
inventory may be in excess of anticipated demand or is obsolete based upon
our
assumptions about future demand for our products and market conditions. We
regularly evaluate our ability to realize the value of our inventory based
on a
combination of factors including the following: historical usage rates,
forecasted sales or usage, product end-of-life dates, estimated current and
future market values and new product introductions. Purchasing practices and
alternative usage avenues are explored within these processes to mitigate
inventory exposure. When recorded, our reserves are intended to reduce the
carrying value of our inventory to its net realizable value. If actual demand
for our products deteriorates, or market conditions are less favorable than
those that we project, additional inventory reserves may be
required.
Property
and Equipment:
Property
and equipment are carried at cost. We record depreciation charges on a
straight-line basis over the assets' estimated useful lives of three years
for
computers and related equipment to eight years for manufacturing equipment.
Leasehold improvements are amortized over the lesser of their useful lives
or
the remaining term of the related leases.
When
assets are sold or otherwise disposed of, the cost and accumulated depreciation
are removed from the accounts and any gain or loss on sale or disposal is
recognized in operations. Maintenance, repairs and minor renewals are charged
to
expense as incurred. Expenditures which substantially increase an asset's useful
life are capitalized.
We
review
property and equipment for impairment whenever events or changes in
circumstances indicate the carrying value of an asset may not be recoverable.
In
performing the review for recoverability, we would estimate the future gross
cash flows expected to result from the use of the asset and its eventual
disposition. If such gross cash flows are less than the carrying amount of
the
asset, the asset is considered impaired. The amount of the impairment loss,
if
any, would then be calculated based on the excess of the carrying amount of
the
asset over its fair value.
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Long-lived
Assets:
We
assess
any impairment by estimating the future cash flow from the associated asset
in
accordance with Statement of Financial Accounting Standards (SFAS) No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. If the estimated
undiscounted cash flow related to these assets decreases in the future or the
useful life is shorter than originally estimated, we may incur charges for
impairment of these assets. The impairment is based on the estimated discounted
cash flow associated with the asset.
Capitalized
software costs consist of costs to purchase software and costs to internally
develop software. Capitalization of software costs begins upon the establishment
of technological feasibility. All capitalized software costs are amortized
as
related sales are recorded on a per-unit basis with a minimum amortization
to
cost of goods sold based on a straight-line method over a two to three year
estimated useful life. We evaluate the estimated net realizable value of each
software product and record provisions to the asset value of each product for
which the net book value is in excess of the net realizable value.
Revenue
Recognition:
Hardware
Products
Our
policy is to recognize revenue for hardware product sales when title transfers
and risk of loss has passed to the customer, which is generally upon shipment
of
our hardware products to our customers. We defer and recognize service revenue
over the contractual period or as services are rendered. We estimate expected
sales returns and record the amount as a reduction of revenue and cost of
hardware and other revenue at the time of shipment. Our policy complies with
the
guidance provided by the Securities and Exchange Commission (SEC) Staff
Accounting Bulletin (SAB) No. 104,
Revenue Recognition in Financial Statements.
Judgments are required in evaluating the credit worthiness of our customers.
Credit is not extended to customers and revenue is not recognized until we
have
determined that collectibility is reasonably assured. Our sales transactions
are
denominated in U.S. dollars. The software component of our hardware products
is
considered incidental. Therefore, we do not recognize software revenue related
to our hardware products separately from the hardware product sale.
When
selling hardware, our agreements with OEMs, such as Data Connection Limited
(DCL) and Nortel Networks Corp. (Nortel), typically incorporate clauses
reflecting the following understandings:
-
all
prices are fixed and determinable at the time of
sale;
-
title
and risk of loss pass at the time of shipment (FOB shipping
point);
-
collectibility
of the sales price is probable (the OEM is creditworthy, the OEM
is
obligated to pay and such obligation is not contingent on the ultimate
sale of the OEM’s integrated
solution);
-
the
OEM’s obligation to us will not be changed in the event of theft or
physical destruction or damage of the
product;
-
we
do not have significant obligations for future performance to directly
assist in the resale of the product by the OEMs;
and
-
there
is no contractual right of return other than for defective
products.
Our
agreements with our distributors include certain product rotation and price
protection rights. All distributors have the right to rotate slow moving
products once each fiscal quarter. The maximum dollar value of inventory
eligible for rotation is equal to 25% of our products purchased by the
distributor during the previous quarter. In order to take advantage of their
product rotation rights, the distributors must order and take delivery of
additional products of ours equal to at least the dollar value of the products
that they want to rotate.
Each
distributor is also allowed certain price protection rights. If and when we
reduce or plan to reduce the price of any of our products and the distributor
is
holding any of the affected products in inventory, we will credit the
distributor the difference in price when they place their next order with us.
We
record an allowance for price protection at the time of the price reduction,
thereby reducing our net sales and accounts receivable. The allowance is based
on the price difference of the inventory held by our stocking distributors
at
the time we expect to reduce selling prices. We believe we are able to fully
evaluate potential returns and adjustments and continue to recognize the sale
based on shipment to our distributors. Reserves for the right of return and
restocking are established based on the requirements of SFAS 48, Revenue
Recognition when Right of Return Exists.
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During
the year ended October 31, 2006, $257,000 or 4% of our sales were sold to
distributors compared to $640,000 or 8% and $874,000 or 8% in fiscal 2005 and
2004, respectively. Our reserves for distributor programs total approximately
$13,000 and $22,000 as of October 31, 2006 and 2005, respectively.
Software
Products
We
derive
revenues from the following sources: (1) software, which includes new iSCSI
software licenses and (2) services, which include consulting. We account for
the
licensing of software in accordance with of American Institute of Certified
Public Accountants (AICPA) Statement of Position (SOP) 97-2, Software Revenue
Recognition. SOP 97-2 requires judgment, including whether a software
arrangement includes multiple elements, and if so, whether vendor-specific
objective evidence (VSOE) of fair value exists for those elements. These
documents include post delivery support, upgrades and similar services. We
typically charge software maintenance equal to 20% of the software license
fees.
For
software license arrangements that do not require significant modification
or
customization of the underlying software, we recognize new software license
revenues when: (1) we enter into a legally binding arrangement with a customer
for the license of software; (2) we deliver the products; (3) customer payment
is deemed fixed or determinable and free of contingencies or significant
uncertainties; and (4) collection is reasonably assured. We initially defer
all
revenue related to the software license and maintenance fees until such time
that we are able to establish VSOE for these elements of our software products.
Revenue deferred under these arrangements is recognized to revenue over the
expected contract term. We will also continue to defer revenues that represent
undelivered post-delivery engineering support until the engineering support
has
been completed and the software product is accepted.
For
one
customer we began recognizing software license fee revenue and related
engineering support revenue by amortizing previously deferred revenue related
to
engineering services over 36-months beginning in March 2006 which was the month
the first software license for this customer was activated. The 36-month
amortization period is the estimated life of the related software product for
this customer. We also amortize all fees related to the licensing of our
software to this customer over 36-months beginning with the month the software
license is activated. In the fiscal year ended October 31, 2006, we recognized
$16,800 of software license fees to this customer and $26,000 of deferred
revenue related to engineering services to this customer.
Certain
software arrangements include consulting implementation services sold separately
under consulting engagement contracts. For the fiscal year ended October 31,2006, we recognized $10,000 of software consulting revenue.
Product
Warranty:
Our
embedded products are sold with warranty provisions that require us to remedy
deficiencies in quality or performance of our products over a specified period
of time, generally 12 months, at no cost to our customers. Our policy is to
establish warranty reserves at levels that represent our estimate of the costs
that will be incurred to fulfill those warranty requirements related to our
embedded products at the time that revenue is recognized. We believe that our
recorded liabilities are adequate to cover our future cost of materials, labor
and overhead for the servicing of our embedded products sold through that date.
If actual product failures, or material or service delivery costs differ from
our estimates, our warranty liability would need to be revised
accordingly.
Allowance
for Doubtful Accounts:
Our
policy is to maintain allowances for estimated losses resulting from the
inability of our customers to make required payments. Credit limits are
established through a process of reviewing the financial history and stability
of each customer. Where appropriate, we obtain credit rating reports and
financial statements of the customer when determining or modifying their credit
limits. We regularly evaluate the collectibility of our trade receivable
balances based on a combination of factors. When a customer’s account balance
becomes past due, we initiate dialogue with the customer to determine the cause.
If it is determined that the customer will be unable to meet its financial
obligation to us, such as in the case of a bankruptcy filing, significant
deterioration in the customer’s operating results or financial position or other
material events impacting its business, we record a specific allowance to reduce
the related receivable to the amount we expect to recover and should all
collection efforts fail, will write-off the account.
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We
also
record an allowance for all customers based on certain other factors including
the length of time the receivables are past due and historical collection
experience with customers. We believe our reported allowances are adequate.
If
the financial conditions of those customers were to deteriorate, however,
resulting in their inability to make payments, we may need to record additional
allowances which would result in additional general and administrative expenses
being recorded for the period in which such determination is made.
Product
Research and Development Expenditures:
Product
research and development (R&D) expenditures, other than certain software
development costs, are charged to expense as incurred. Contractual
reimbursements for R&D expenditures under joint R&D contracts with
customers are accounted for as revenue when received.
Capitalized
software costs consist of costs to purchase software and costs to internally
develop software. Capitalization of software costs begins upon the establishment
of technological feasibility. All capitalized software costs are amortized
as
related sales are recorded on a per-unit basis with a minimum amortization
to
cost of goods sold based on a straight-line method over a two to three year
estimated useful life. We evaluate the estimated net realizable value of each
software product and record provisions to the asset value of each product for
which the net book value is in excess of the net realizable value. No internal
software development costs were capitalized in the years ended October 31,2006,
2005 and 2004. All remaining capitalized software assets result from our costs
in the acquisition of PyX Technologies, Inc. (PyX) (see note 15).
Stock-Based
Compensation:
Effective
November 1, 2005, we adopted the provisions of SFAS 123(R), Share-Based
Payment,
using
the modified prospective method, which requires measurement of compensation
cost
for all stock-based awards at fair value on the grant date and recognition
of
compensation expense over the requisite service period for awards expected
to
vest.
The
fair
value method under SFAS 123(R) is similar to the fair value method under SFAS
123, Accounting
for Stock Based Compensation
(SFAS
123), as amended, with respect to measurement and recognition of stock-based
compensation. However, SFAS 123 permitted us to recognize forfeitures as they
occur, while SFAS 123(R) requires us to estimate future forfeitures and adjust
our estimate on a periodic basis. SFAS 123(R) also requires a classification
change in the statement of cash flows whereby the income tax benefit from stock
option exercises is reported as a financing cash flow rather than an operating
cash flow as previously reported.
We
have
several approved stock option plans for which stock options and restricted
stock
awards are available to grant to employees and directors. All employee and
director stock options granted under our stock option plans have an exercise
price equal to the market value of the underlying common stock on the grant
date. There are no vesting provisions tied to performance conditions for any
option as vesting for all outstanding option grants was based only on continued
service as an employee of SBE. All of our outstanding stock options and
restricted stock awards are classified as equity instruments.
Stock
For Pay Awards
On
January 12, 2006, our Board of Directors (Board) approved a Company-wide 30%
reduction in employee cash base salaries, effective January 16, 2006. In order
to continue to motivate and retain our employees despite such salary reductions,
the Board also approved stock grants to all of our employees pursuant to the
1996 Stock Option Plan and 2006 Equity Incentive Plan. Effective April 1, 2006,
the Board modified the 30% reduction in employee base salaries to a cash salary
reduction ranging from 10% to 38% of the employee’s base salaries. The level of
reduction of the cash portion of the salary for each employee is dependent
on
their respective position and base salary. Employees with lower salaries
generally have lower reductions. The stock issued to employees in-lieu of a
portion of their cash compensation is valued at a 15% reduction from the market
price on the date of issuance and is included in compensation expense.
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10
In
addition, the Board approved the suspension of all cash payments of Board and
Board committee fees until further notice. The stock issued to Board members
in-lieu of their cash compensation is calculated at a 15% reduction from the
market price on the date of issuance and is included in general and
administrative expense.
On
August21, 2006, the Board suspended the stock-for-pay program for all members of
the
Board and officers. The suspension is effective as of August 1, 2006 for all
members of the Board and August 16, 2006 for all officers. Despite suspension
of
the stock-for-pay program, the previously-announced salary reductions for the
affected officers and cessation of cash compensation for the Board will remain
in effect until such time as the Board shall determine. The Board adopted a
bonus plan for the affected individuals that will pay a prescribed amount of
cash or stock upon our completion of one of a number of specified milestones
set
forth in a written bonus plan, provided that the affected individual remains
employed by us or a member of the Board at the time such milestone is achieved.
All non-officer employees remain on the stock-for-pay plan until such time
as
the Board shall determine.
Restricted
Stock Awards
On
March21, 2006, our Board approved restricted stock grants to all employees in order
to continue to motivate and retain our employees. The shares of restricted
stock
granted under the plan vest 25% on the first anniversary of the initial grant
date with the remainder vesting monthly thereafter for the following six months.
The total fair value of the restricted stock grants is calculated on the date
of
issuance and is amortized on a straight-line basis to expense over the 18-month
vesting period.
Advertising
Costs:
Advertising
and marketing expenditures are expensed as incurred. Advertising and marketing
costs were $225,000, $324,000 and $204,000 in fiscal 2006, 2005 and 2004,
respectively.
Income
Taxes:
We
account for income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes.
SFAS
No. 109 requires recognition of deferred tax liabilities and assets for the
expected future tax consequences of items that have been included in the
financial statements or tax returns. Deferred income taxes represent the future
net tax effects resulting from temporary differences between the financial
statement and tax bases of assets and liabilities, using enacted tax rates
in
effect for the year in which the differences are expected to reverse. Valuation
allowances are recorded against net deferred tax assets where, in our opinion,
realization is uncertain. The provision for income taxes represents the net
change in deferred tax amounts, plus income taxes payable for the current
period.
Comprehensive
Income:
Comprehensive
income is defined as the change in equity of a business enterprise during a
period from transactions and other events and circumstances from non-owner
sources. Through October 31, 2006, we have not had any transactions that were
required to be reported in other comprehensive income and, accordingly,
comprehensive income (loss) is the same as net income (loss).
New
Accounting Pronouncements:
In
June
2006, the FASB issued Interpretation No. 48, Accounting
for Uncertainty in Income Taxes.
FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with SFAS 109. This
interpretation prescribes a recognition threshold and measurement attribute
for
the financial statement recognition and measurement of a tax position taken
or
expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. FIN 48 will be effective for the Company
beginning November 1, 2007. We are currently evaluating this interpretation
to
determine if it will have a material impact on our financial
statements.
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In
September 2006, the SEC issued SAB 108, Considering
the Effects of Prior Year Misstatements in Current Year Financial
Statements.
SAB 108
expresses the SEC Staff’s views regarding the process of quantifying financial
statement misstatements. SAB 108 addresses the diversity in practice in
quantifying financial statement misstatements and the potential under current
practice for the build up of improper amounts on the balance sheet. SAB 108
will
be effective for the year beginning November 1, 2006. The cumulative effect
of
the initial application of SAB 108 will be reported in the carrying amounts
of
assets and liabilities as of the beginning of the fiscal year, with the
offsetting balance to retained earnings. We do not expect the adoption of SAB
108 to have a material impact on our financial statements.
In
September 2006, the FASB issued SFAS No.157, Fair
Value Measurements.
SFAS
157 defines fair value, establishes a framework for measuring fair value as
required by other accounting pronouncements and expands fair value measurement
disclosures. SFAS 157 is effective for fiscal years beginning after November15,2007. We are currently evaluating the impact of SFAS 157 on our financial
statements.
2.
INVENTORIES
Inventories
at October 31, are comprised of the following (in thousands):
2006
2005
Finished
goods
$
273
$
815
Parts
and materials
466
468
Total
inventory
$
739
$
1,283
The
total
reserve for slow moving and obsolete inventory is $2,567,000 and $2,313,000
at
October 31, 2006 and 2005, respectively. All the inventory relates to the
embedded hardware business and will be transferred to One Stop Systems upon
the
close of the sale transaction. (See note 17)
3.
PROPERTY AND EQUIPMENT
Property
and equipment at October 31, are comprised of the following (in
thousands):
2006
2005
Machinery
and equipment
$
3,792
$
3,476
Furniture
and fixtures
64
226
Leasehold
improvements
153
145
4,009
3,847
Less
accumulated depreciation and amortization
(3,502
)
(3,284
)
$
508
$
563
Depreciation
and amortization expense totaled $230,000, $194,000 and $213,000 for the years
ended October 31, 2006, 2005 and 2004, respectively. Depreciation expense on
capital leases in fiscal 2006, 2005 and 2004 was $12,600, $25,000 and $25,000,
respectively. Approximately $320,000 of our fixed assets will be sold to One
Stop Systems upon the close of sale of the embedded hardware
business.
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4.
CAPITALIZED SOFTWARE COSTS
Capitalized
software costs at October 31, 2006 and 2005 comprise the following (in
thousands):
2006
2005
Purchased
software
$
14,217
$
14,177
Less
accumulated amortization
(12,903
)
(2,753
)
$
1,314
$
11,424
Capitalized
software costs consist of software relating to current products and the design
of future storage software products acquired with our acquisition of PyX in
July
2005. We capitalized $40,000, $12,424,000 and $136,000 of purchased software
costs in 2006, 2005, and 2004 respectively. We amortized capitalized software
related to the acquisition of PyX on a straight line basis over 36 months at
the
rate of $339,000 per month, beginning August 1, 2005. Recurring amortization
of
capitalized software costs totaled $3,394,000, $1,048,000, and $208,000 for
the
years ended October 31, 2006, 2005 and 2004, respectively.
In
the
fiscal year ended October 31, 2006 we discontinued our Voice over IP (VoIP)
product development and, as a result, wrote-off $256,000 of capitalized software
development costs related to the VoIP products. This write-off is included
in
our Product Research and Development expense in our Statements of Operations for
the fiscal year ended October 31, 2006.
In
the
fiscal year ended October 31, 2006, we recorded an asset impairment charge
of
$6.5 million against our earnings for the period, reducing our storage software
asset to $1.3 million, which represents the present value of the expected future
sales of our storage software products less costs. This asset impairment charge
is included in amortization and impairment of acquired software and intellectual
property in the Statements of Operations for the fiscal year ended October31,2006. Prior to the write-down, we amortized our storage software over 36 months
at the rate of $339,000 per month. We will amortize the remaining $1.3 million
software asset over the remaining 21-month amortization period at the rate
of
$63,000 per month.
5.
INTANGIBLE ASSETS
Antares
At
the
end of fiscal 2004 we completed our asset impairment review and determined
that
the estimated fair market value of the balance of the intellectual property
acquired when we purchased certain assets of Antares Microsystems, Inc.
(Antares), a California corporation, was nominal. As a result, we recorded
an
impairment charge of $713,000, thus writing off the remaining value, at October31, 2004, of the intellectual property asset recorded when we acquired Antares
in August 2003.
The
non-cash amortization expense related to the Antares intellectual property
in
fiscal 2004 was $1.1 million and consisted of $408,000 of regularly scheduled
annual amortization expense plus $713,000 write down related to the Antares
impairment valuation analysis. This write-down plus the regularly scheduled
amortization is included as an expense item in amortization and impairment
of
acquired software and intellectual property for fiscal 2004.
6.
STOCKHOLDERS' EQUITY
On
June27, 2003, we completed a private placement of 500,000 shares of common stock
plus a warrant to purchase 50,000 shares of common stock, resulting in gross
cash proceeds of $550,000 and net cash proceeds of approximately $464,000.
The
warrant has a term of five years with an exercise price of $1.50 per share
subject to certain adjustment provisions.
In
connection with the private placement we paid Puglisi & Co. and its
associates (together, Puglisi) a placement fee of $33,000 and warrants to
purchase 150,000 shares of common stock. The warrants have a five-year term
with
exercise prices between $1.50 and $2.00 per share, subject to certain adjustment
provisions. The warrants to purchase a total of 200,000 shares of common stock
have a calculated fair value of approximately $225,000. This value was derived
using the “Black-Scholes” pricing model based on the following
assumptions:
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1)
expected life: 5 years,
2)
risk
free interest rate: 3%,
3)
volatility: 121.71%.
We
registered for resale all of the shares of common stock sold in this offering
and the shares subject to sale pursuant to the exercise of the warrants with
the
Securities and Exchange Commission. During fiscal 2004, Puglisi exercised a
portion of their warrants and purchased 70,000 shares of common stock for a
total purchase price of $116,000.
During
fiscal 2005 and 2004, we issued 68,945 and 30,000 shares of our common stock,
respectively, to an employee who was one of the owners of Antares pursuant
to
the original purchase agreement. The value of the common stock was
$282,982.
In
fiscal
year 2004, we issued 9,903 shares of common stock under the Employee Stock
Purchase Plan.
On
July26, 2005, we closed a private placement with AIGH Investment Partners, LLC
and
other accredited investors providing for the sale and issuance of shares of
our
common stock and warrants to purchase shares of our common stock, with gross
proceeds to us of $5,150,000. The investors purchased units consisting of one
share of our common stock and a warrant to purchase 0.5 of a share of our common
stock at a price per unit of $2.50. We issued 2,060,000 shares of our common
stock and warrants to purchase an additional 1,030,000 shares of our common
stock in the future in connection with the private placement. The warrants
issued in connection with the private placement have a term of five years and
are exercisable at $3.33 per share, subject to proportional adjustments for
stock splits, stock dividends, recapitalizations and the like. The warrants
also
contain a cashless exercise feature. We registered for resale all of the shares
of common stock sold in this offering and the shares subject to sale pursuant
to
the exercise of the warrants with the Securities and Exchange Commission
effective November 14, 2005.
On
July26, 2005, we acquired PyX for a total purchase price of $11,714,000 paid to
the
selling shareholders of PyX in the form of shares of our common stock and the
assumption of PyX’s employee stock option plan plus cash expenses totaling
$359,000 for legal, accounting and valuation services. A total of 2,561,050
shares of our common stock were issued in respect of outstanding PyX common
stock. We registered for resale all of the shares of common stock issued to
the
selling shareholders of PyX with the Securities and Exchange Commission
effective November 14, 2005 (see Note 15).
During
fiscal 2006, we issued 158,295 shares of our common stock to the non-employee
members of our Board of Directors in lieu of 100% of their cash compensation.
The value of the common stock of $126,000 was recorded as a general and
administrative expense.
During
fiscal 2006, we issued 858,040 shares of our common stock to our employees
and
contractors in lieu of a portion of their cash compensation. The value of the
common stock of $637,000 was recorded as compensation expense in the Statements
of Operations.
7.
DEFERRED COMPENSATION
On
January 1, 2005, our retiring President and Chief Executive Officer was awarded
options to purchase 75,000 shares of our common stock at a price of $4.00 per
share (closing price on December 31, 2004). The fair value of this option grant
was estimated on the date of grant using the Black-Scholes option-pricing model
and was included as deferred compensation on the balance sheet. The $120,000
deferred compensation was amortized to general and administrative expense at
the
rate of $8,000 per month over the 15 month vesting period ending March 2006
based on his continued service as a director. For the fiscal year ended ,October31, 2005, $80,000 of the deferred compensation has been amortized to expense
and
is included in general and administrative expense. In connection with the
adoption of SFAS 123R, we reduced deferred compensation and common stock by
$40,000, the value of the unamortized balance of the deferred compensation
as of
November 1, 2005.
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We
awarded stock option grants to certain non-employee strategic business advisors
as a part of their fee structure. The fair value of these option grants is
estimated on the date of grant using the Black-Scholes option-pricing model
and
is included as deferred compensation on the balance sheet. The deferred
compensation balance is recalculated on a quarterly basis based on market price.
The $56,000 deferred compensation is amortized to general and administrative
expense at the rate of $2,000 per month over the vesting period of the grants.
As of October 31, 2005, $6,000 of the deferred compensation has been amortized
to expense and is included in General and Administrative expense. In connection
with the adoption of SFAS 123R, we reduced deferred compensation and common
stock by $48,000, the value of the unamortized balance of the deferred
compensation as of November 1, 2005
We
assumed the PyX employee stock option plan as part of the July 2005 acquisition
of PyX and as a result an additional 2,038,950 shares of our common stock,
with
an exercise price of $2.17, will be issuable upon exercise of assumed stock
options. The intrinsic value of the unvested portion of these options is
included as deferred compensation on the balance sheet as of October 31, 2005.
As of October 31, 2005, $173,000 of the deferred compensation has been amortized
to expense and is included in General and Administrative expense. In connection
with the adoption of SFAS 123(R), we reduced deferred compensation and common
stock by $2.3 million, the value of the unamortized balance of the deferred
compensation as of November 1, 2005.
8.
INCOME TAXES
The
components of the benefit for income taxes for the years ended October 31,2006,
2005 and 2004 are comprised of the following:
2006
2005
2004
Federal:
Current
$
---
$
---
$
---
Deferred
---
---
---
State:
Current
7
5
---
Deferred
---
---
---
Net
income tax (benefit) provision
$
7
$
5
$
---
The
effective income tax rate differs from the statutory federal income tax rate
for
the following reasons:
2006
2005
2004
Statutory
federal income tax rate
(34.0
)%
(34.0
)%
(34.0
)%
Basis
difference in acquisition
---
104.5
---
Change
in valuation allowance
47.6
(95.3
)
34.0
True-up
of prior year and other
(13.6
)
24.8
---
(0
)%
(0
)%
(0
)%
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Significant
components for 2006 and 2005
2006
2005
Deferred
tax assets:
Current
Accrued
employee benefits
$
27
$
32
Inventory
allowances
1,039
926
Allowance
for doubtful accounts
26
21
Warranty
accruals and other assets
8
11
Distributor
reserves
4
8
Stock
compensation
506
103
Deferred
revenue
186
---
Noncurrent
Deferred
rent
52
87
R&D
credit carryforward
3,053
2,859
Net
operating loss carryforwards
7,828
5,437
Depreciation
and amortization, net
446
---
Restructuring
costs
---
10
Total
deferred tax assets
13,175
9,494
Less:
Deferred tax asset valuation allowance
(12,649
)
(4,923
)
Net
deferred tax asset
526
4,571
Deferred
tax liability - acquired software
(526
)
(4,461
)
Deferred
tax liability - capitalized assets
---
(110
)
Net
deferred tax assets
$
---
$
---
Valuation
allowances are recorded to offset certain deferred tax assets due to
management's uncertainty of realizing the benefit of these items. The valuation
allowance increased by $7.7 million in fiscal 2006 primarily as a result of
increases in inventory allowances, stock compensation, deferred revenue, R&D
tax credit carryforwards and operating loss carryforwards. The Company
recognized deferred tax liabilities of approximately $526,000 and $4,461,000
from our acquisition of PyX. At October 31, 2006, we have research and
experimentation tax credit carryforwards of $2.0 million and $1.4 million for
federal and state tax purposes, respectively. These carryforwards expire in
the
periods ending 2013 through 2026. The State of California Research and
Development tax credits do not expire. We have net operating loss carryforwards
for federal and state income tax purposes of approximately $21.0 million and
$11.7 million, respectively, which expire in periods ending 2007 through
2026.
Under
the
Tax Reform Act of 1986, the amounts of benefits from net operating loss
carryforwards are limited as we have incurred a cumulative ownership change
of
more than 50%, as defined, over a three-year period. Usage of net operating
loss
carryforwards is limited based on the Company’s capital at the date of change
times a risk-free interest rate.
9.
WARRANTY OBLIGATIONS AND OTHER GUARANTEES:
The
following is a summary of our agreements that we have determined are within
the
scope of FIN 45 Guarantor's
Accounting and Disclosure Requirements for Guarantees, including Indirect
Guarantees of Indebtedness of Others - an interpretation of FASB Statements
No. 5, 57 and 107 and rescission of FIN 34.
We
accrue
the estimated costs to be incurred in performing warranty services at the time
of revenue recognition and shipment of the products to our customers. Our
estimate of costs to service our warranty obligations is based on historical
experience and expectation of future conditions. To the extent we experience
increased warranty claim activity or increased costs associated with servicing
those claims, the warranty accrual will increase, resulting in decreased gross
margin.
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The
following table sets forth an analysis of our warranty reserve at October 31
(in
thousands):
2006
2005
2004
Warranty
reserve at beginning of period
$
22
$
20
$
53
Less:
Cost to service warranty obligations
(9
)
(12
)
(33
)
Plus:
Increases to reserves
---
14
---
Total
warranty reserve included in other accrued
expenses
$
13
$
22
$
20
We
have
agreed to indemnify each of our executive officers and directors for certain
events or occurrences arising as a result of the officer or director serving
in
such capacity. The term of the indemnification period is for the officer's
or
director's lifetime. The maximum potential amount of future payments we could
be
required to make under these indemnification agreements is unlimited. However,
we have a directors’ and officers’ liability insurance policy that should enable
us to recover a portion of future amounts paid. As a result of our insurance
policy coverage, we believe the estimated fair value of these indemnification
agreements is minimal and have no liabilities recorded for these agreements
as
of October 31, 2006 and 2005, respectively.
We
enter
into indemnification provisions under our agreements with other companies in
the
ordinary course of business, typically with business partners, contractors,
customers and landlords. Under these provisions we generally indemnify and
hold
harmless the indemnified party for losses suffered or incurred by the
indemnified party as a result of our activities or, in some cases, as a result
of the indemnified party's activities under the agreement. These indemnification
provisions often include indemnifications relating to representations made
by us
with regard to software rights. These indemnification provisions generally
survive termination of the underlying agreement. The maximum potential amount
of
future payments we could be required to make under these indemnification
provisions is unlimited. We have not incurred material costs to defend lawsuits
or settle claims related to these indemnification agreements. As a result,
we
believe the estimated fair value of these agreements is minimal. Accordingly,
we
have no liabilities recorded for these agreements as of October 31, 2006 and
2005, respectively.
Other
Our
commitment as the secondary guarantor on the sublease of our previous
headquarters terminated in March 2006.
10.
COMMITMENTS
We
lease
our buildings under noncancelable operating leases which expire at various
dates
through the year 2010. Additionally, we have acquired assets with capital lease
obligations. Future minimum lease payments under noncancelable operating leases
and capital leases, are as follows (in thousands):
Operating
Capital
Year
ending October 31:
2007
$
580
$
74
2008
580
74
2009
580
74
2010
483
32
2011
and thereafter
---
1
Total
minimum lease payments
$
2,223
$
255
Less:
Amount representing interest1
(42
)
Present
value of net minimum lease payments2
$
213
1
Amount
necessary to reduce net minimum lease payments to present value calculated
at
the actual lease interest rate of 12% per annum at the inception of the
leases.
2
Reflected in the balance sheet as other current liabilities and other long-term
liabilities of $54,000 and $159,000, respectively.
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In
October 2005, we entered into a facilities lease for our engineering and
administrative headquarters located in San Ramon, California. The lease expires
in 2010. On January 11, 2007, we signed a definitive agreement to sell our
hardware business to One Stop Systems, Inc. and as part of the sales price
One
Stop will assume the lease of our San Ramon office space. The assumption of
the
lease payments by One Stop will relieve us of approximately $2.2 million of
future lease payments. We are projecting to close the sale to One Stop in our
second quarter of fiscal 2007. We will continue to be the secondary guarantor
on
the lease for the term of the lease.
Our
rent
expense under all operating leases, net of reimbursements for subleases, for
the
years ended October 31, 2006, 2005 and 2004 totaled $546,000, $381,000 and
$384,000, respectively. We had reimbursements of sublease proceeds of $265,000,
$637,000 and $637,000 for the years ended October 31, 2006, 2005 and 2004,
respectively.
In
connection with the retirement of Mr. William Heye, Jr. as our President and
Chief Executive Officer in 2004, we paid Mr. Heye $250,000 at the rate of
$20,833 each month for the period January 1, 2005 through December 31, 2005.
The
commitment to pay $250,000 was accrued as of October 31, 2004 and is included
in
general and administrative expense and accrued payroll and employee benefits
liability as of that date.
11.
STOCK OPTION AND STOCK PURCHASE PLANS
Effective
November 1, 2005, we adopted SFAS 123(R) using the modified prospective method,
which requires measurement of compensation cost for all stock-based awards
at
fair value on the grant date and recognition of compensation expense over the
requisite service period for awards expected to vest. The fair value of stock
option grants is determined using the Black-Scholes valuation model, which
is
consistent with our valuation techniques previously utilized for options in
footnote disclosures required under SFAS No. 123, Accounting
for Stock Based Compensation
as
amended. The fair value of restricted stock awards is determined based on the
number of shares granted and the quoted price of our common stock. Such fair
values will be recognized as compensation expense over the requisite service
period, net of estimated forfeitures, using the straight line method under
SFAS
123R.
The
fair
value method under SFAS 123(R) is similar to the fair value method under SFAS
123 with respect to measurement and recognition of stock-based compensation.
However, SFAS 123 permitted us to recognize forfeitures as they occur, while
SFAS 123(R) requires us to estimate future forfeitures and adjust our estimate
on a quarterly basis. SFAS 123(R) also requires a classification change in
the
statement of cash flows whereby the income tax benefit from stock option
exercises is reported as financing cash flow rather than an operating cash
flow
as previously reported.
We
have
several approved stock option plans for which stock options and restricted
stock
awards are available to grant to employees and directors. All employee and
director stock options granted under our stock option plans have an exercise
price equal to the market value of the underlying common stock on the grant
date. There are no vesting provisions tied to performance conditions for any
options, as vesting for all outstanding option grants was based only on
continued service as an employee of the Company. All of our outstanding stock
options and restricted stock awards are classified as equity instruments.
Stock
Options
We
sponsor four employee stock option plans:
•
The
1996 Stock Option Plan (the 1996 Plan), terminated January 17, 2006;
•
the
1998 Non-Officer Stock Option Plan (the 1998
Plan);
•
the
PyX 2005 Stock Option Plan (the PyX Plan); and
•
the
2006 Equity Incentive Plan (the 2006 Plan).
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We
also
sponsor one non-employee stock option plan:
•
The
2001 Non-Employee Director Stock Option Plan (the Director
Plan).
The
following table details the options to purchase shares pursuant to each plan
at
October 31, 2006:
Plan
Shares
Reserved
Options
Outstanding
Available
for
Issue
Outstanding
Options
Vested
1996
Plan
2,730,000
1,049,887
---
757,149
1998
Plan
650,000
258,785
135,699
220,545
PyX
Plan
2,038,950
1,021,200
---
425,495
2006
Plan
1,500,000
385,000
---
---
Director
Plan
340,000
175,000
108,750
120,000
Total
7,258,950
2,889,872
244,449
1,523,189
The
1996
Plan terminated effective January 17, 2006 and although we can no longer issue
stock options out of the plan, the outstanding options at the date of
termination will remain outstanding and vest in accordance with their terms.
Options granted under the Director Plan vest over a one to four-year period,
expire five to seven years after the date of grant and have exercise prices
reflecting market value of the shares of our common stock on the date of grant.
Stock options granted under the 1996, 1998, 2006 and PyX Plans are exercisable
over a maximum term of ten years from the date of grant, vest in various
installments over a one to four-year period and have exercise prices reflecting
the market value of the shares of common stock on the date of grant.
On
November 1, 2005, the date of adoption of SFAS 123(R), there were options to
purchase 4,213,704 shares of our common stock outstanding, of which 1,400,397
were fully vested. The fair value of the unearned portion of stock-based
compensation related to the unvested employee stock options outstanding on
November 1, 2005 is calculated using the Black-Scholes option pricing model
as
of the grant date of the underlying stock options. We recognized no net deferred
tax impact on the adoption of SFAS 123(R). The remaining unamortized stock-based
compensation expense associated with unvested employee stock options outstanding
on November 1, 2005 is expensed over the remaining service period through
September 2009.
Included
in the outstanding but unvested stock options on November 1, 2005, are options
to purchase 2,038,950 shares of our common stock related to the PyX 2005 Stock
Option Plan that was assumed by us in our acquisition of PyX. The fair value
related to the unvested portion of the PyX stock options totaled $2,484,000
and
was recorded as deferred compensation in the fourth quarter of fiscal 2005.
In
connection with the adoption of SFAS 123(R), we reduced deferred compensation
and common stock by $2,311,000, the value of the unamortized balance of the
deferred PyX compensation as of November 1, 2005.
We
granted options to purchase 797,500 shares of our common stock to employees
and
members of the Board of Directors during the twelve months ended October 31,2006, respectively. The fair value of the unearned portion of stock-based
compensation related to the employee and director stock options is calculated
using the Black-Scholes option pricing model as of the grant date of the
underlying stock options. The stock-based compensation expense associated with
the stock options granted to employees and directors during the twelve months
ended October 31, 2006, will be expensed over the remaining service period
through September 2010.
C
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19
Employee
and Director stock-based compensation expense related to stock options in the
accompanying statements of operations (in thousands):
The
fair
value of stock-based awards to employees is calculated using the Black-Scholes
option pricing model, even though this model was developed to estimate the
fair
value of freely tradable, fully transferable options without vesting
restrictions, which differ significantly from the our stock options. The
Black-Scholes model also requires subjective assumptions, including future
stock
price volatility and expected time to exercise, which greatly affect the
calculated values. The expected term and forfeiture rate of options granted
is
derived from historical data on employee exercises and post-vesting employment
termination behavior, as well as expected behavior on outstanding options.
The
risk-free rate is based on the U.S. Treasury rates in effect during the
corresponding period of grant. The expected volatility is based on the
historical volatility of our stock price. These factors could change in the
future, which would affect the stock-based compensation expense in future
periods.
There
was
no stock-based compensation expense related to employee stock options and
employee stock purchases recognized during the fiscal years ended October 31,2005 and 2004.
We
award
stock option grants to certain non-employee strategic business advisors as
part
of their fee structure. The fair value of these option grants is estimated
on
the date of grant using the Black-Scholes option-pricing model and is
recalculated on a monthly basis based on market price until vested. For the
fiscal year ended October 31, 2006 we recorded $2,900 of compensation expense
related to non-employee stock options.
A
summary
of the combined activity under all of the stock option plans is set forth
below:
The
following table summarizes information with respect to all options to purchase
shares of common stock outstanding under the 1996 Plan, the 1998 Plan, the
2006
Plan, the PyX Plan and the Director Plan at October 31, 2006:
Options
Outstanding
Options
Exercisable
Range
of Exercise Price
Number
Outstanding
at
10/31/06
Weighted
Average Remaining Contractual Life (years)
Weighted
Average
Exercise
Price
Number
Exercisable
at
10/31/06
Weighted
Average
Exercise
Price
$0.00-
$1.00
806,500
4.76
$0.72
430,666
$0.91
$1.01-
$2.00
145,000
3.18
$1.33
63,000
$1.64
$2.01-
$3.00
1,424,076
5.32
$2.34
589,659
$2.35
$3.01-
$4.00
206,000
3.14
$3.55
141,912
$3.71
$4.01-
$5.00
175,796
1.64
$4.51
171,601
$4.51
$5.01-
$6.00
94,000
0.82
$5.28
94,000
$5.29
$6.01-
$7.00
13,000
3.44
$6.87
9,977
$6.85
$7.01-
$8.00
25,000
4.16
$7.09
21,874
$7.10
$8.01-
$20.00
500
0.56
$18.38
500
$18.38
2,889,872
$4.52
$2.10
1,523,189
$2.57
The
weighted average grant-date fair value of options granted during the fiscal
years ended October 31, 2006, 2005 and 2004 was $1.42, $3.48 and $4.99,
respectively. The total intrinsic value of options exercised during the fiscal
years ended October 31, 2006, 2005 and 2004 was $38,400, $128,200 and $221,300,
respectively.
Restricted
Stock Awards
On
March21, 2006, our Board approved restricted stock grants to all employees in order
to continue to motivate and retain our employees. The shares of restricted
stock
granted by the board vest 25% on the first anniversary of the initial grant
date
with the remainder vesting monthly thereafter for the following six months.
A
total of 290,000 restricted shares of our common stock were issued to employees
under the restricted stock grants with initial vesting to commence between
April1, 2007 and June 19, 2007. A total of 48,000 of the restricted shares have
been
cancelled that were issued to employees who have terminated their employment
prior to vesting. The total fair value of the restricted stock grants on the
date of issuance is $301,000 and will be amortized over the 18-month vesting
period. For the fiscal year ended October 31, 2006, we recorded $88,500 of
amortization expense related to the restricted stock grants.
On
January 12, 2006, our Board approved a company-wide 30% reduction in employee
base salaries, effective January 16, 2006. In order to continue to motivate
and
retain our employees despite such salary reductions, the Board approved stock
grants to all of our employees pursuant to the 1996 Plan and 2006 Plan.
Effective April 1, 2006, the Board modified the 30% across the board reduction
in employee and contractor base salaries to a cash salary reduction ranging
from
10% to 38% of the employees base salaries. The level of reduction of the cash
portion of the salary for each employee and contractor is dependent on their
respective position and base salary, and employees with lower salaries generally
have lower reductions. A total of 858,040 shares of our common stock have been
issued since January 1, 2006 pursuant to the stock-for-pay plan. For the fiscal
year ended October 31, 2006, we recorded approximately $637,000 of stock-based
compensation associated with such stock grants.
C
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21
In
addition, the Board approved the suspension of all cash payments of Board and
Board committee fees, until further notice. A total of 158,295 shares of our
common stock has been issued to Board members in lieu of such fees under the
stock-for-pay plan since January 1, 2006. For the fiscal year ended October31,2006, we recorded approximately $126,000 of stock-based compensation and
director expense associated with the stock-for-pay plan.
On
August21, 2006, the Board suspended the stock-for-pay program for all members of
the
Board and executive officers of SBE. The suspension is effective as of August1,2006 for all members of the Board and August 16, 2006 for all affected executive
officers. Despite suspension of the stock-for-pay program, the
previously-announced salary reductions for the affected officers and cessation
of cash compensation for the Board will remain in effect until such time as
the
Board shall determine. The Board adopted a bonus plan for the affected
individuals that will pay a prescribed amount of cash or stock upon our
completion of one of a number of specified milestones set forth in the plan,
provided that the affected individual remains employed by the Company or a
member of the Board at the time such milestone is achieved. All non-officer
employees remain on the stock-for-pay plan until such time as the Board shall
determine.
Prior
Year
Prior
to
November 1, 2005, we accounted for stock-based awards under the intrinsic value
method, which followed the recognition and measurement principles of Accounting
Principles Board (APB) Opinion No. 25, Accounting
for Stock Issued to Employees
(APB
Opinion 25), and related interpretations. Under this method, compensation
expense was recorded on the date of grant only if the current market price
of
the underlying stock exceeded the exercise price. Our practice is to award
employee stock options with an exercise price equal to the market price on
the
date of the award. Accordingly, no stock-based employee compensation cost has
previously been recognized in net income for the stock option plans. Had
compensation cost for our stock option plans been determined based on the fair
value recognition provisions of SFAS 123, our net income and income per share
would have been as follows (in thousands):
Stock
based employee compensation expense included in reported
net
loss, net of related tax effects
168
---
Less
total stock based employee compensation expense determined
under
fair value based method for all awards, net of related tax effects
(1,237
)
(1,177
)
Pro
forma net loss
$
(5,299
)
$
(2,856
)
Loss
per share:
Basic
and diluted - as reported
$
(0.66
)
$
(0.33
)
Basic
and diluted - pro forma
$
(0.82
)
$
(0.57
)
The
fair
value of each option grant was estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions:
Options
granted in years ended October 31
2005
2004
Expected
life (in years)
4.00
4.00
Risk-free
interest rate
4.25%
3.29%
Volatility
99.88%
120.20%
Dividend
yield
0.00%
0.00%
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The
weighted average fair value of options granted during 2005 and 2004 was $2.91
and $2.93 per option, respectively.
12.
NET LOSS PER SHARE:
Basic
net
loss per common share for the years ended October 31, 2006, 2005 and 2004 was
computed by dividing the net loss for the relevant period by the weighted
average number of shares of common stock outstanding. Diluted earnings per
common share is computed by dividing net loss by the weighted average number
of
shares of common stock and common stock equivalents outstanding.
Common
stock equivalents of approximately 149,000, 937,000 and 792,000 options are
excluded from the diluted earnings per share calculation for fiscal 2006, 2005
and 2004, respectively, due to their anti-dilutive effect.
(in
thousands, except per share amounts)
Years
ended October 31
2006
2005
2004
Basic
earnings per share:
Net
loss
$
(16,183
)
$
(4,230
)
$
(1,679
)
Number
of shares for computation of earnings per share
10,304
6,439
5,022
Basic
loss per share
$
(1.57
)
$
(0.66
)
$
(0.33
)
Diluted
earnings per share:
Weighted
average number of common shares outstanding during the
year
10,304
6,439
5,022
Assumed
issuance of stock under warrant plus stock issued the employee and
non-employee stock option plans
(a
)
(a
)
(a
)
Number
of shares for computation of earnings per share
10,304
6,439
5,022
Diluted
loss per share
$
(1.57
)
$
(0.66
)
$
(0.33
)
(a)
In
loss periods, common share equivalents would have an anti-dilutive
effect
on net loss per share and therefore have been
excluded.
13.
EMPLOYEE SAVINGS AND INVESTMENT PLAN
We
contribute a percentage of income before income taxes into an employee savings
and investment plan. The percentage is determined annually by the Board of
Directors. These contributions are payable annually, vest over five years,
and
cover substantially all employees who have been employed by us at least one
year. Additionally, until January 2006 we made matching payments to the employee
savings and investment plan of 50% of each employee's contribution up to three
percent of employees' earnings. We suspended the matching payments program
in
January 2006.
For
the
years ended October 31, 2006, 2005 and 2004, total expense under the employee
savings and investment plan was $18,685, $87,918 and $90,099,
respectively.
14.
CONCENTRATION OF CREDIT AND BUSINESS RISKS
Our
trade
accounts receivable are concentrated among a small number of customers,
principally located in the United States and Europe. Two customers accounted
for
52% of our outstanding accounts receivable at October 31, 2006 compared to
two
customers who accounted for more than 41% of total accounts receivable at
October 31, 2005. Ongoing credit evaluations of customers' financial condition
are performed and, generally, no collateral is required. We maintain an
allowance for doubtful accounts for potential credit losses. Actual bad debt
losses have not been material and have not exceeded our expectations. Trade
accounts receivable are recorded net of an allowance for doubtful accounts
of
$26,000 and $54,000 at October 31, 2006 and 2005, respectively.
C
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Sales
to
individual customers in excess of 10% of net sales for the year ended October31, 2006 included sales to DCL located in the United Kingdom of $1.9 million,
or
31% of net sales, Nortel of $1.3 million, or 21% of net sales and Raytheon
of
$750,000, or 12% of net sales compared to sales to DCL in fiscal 2005 of $2.2
million, or 28% and Nortel of $1.4 million, or 18% of net sales, and sales
to HP
of $1.0 million, or 13% of net sales, in fiscal 2005.
International
sales constituted 43%, 37% and 12% of net sales in fiscal 2006, 2005 and 2004,
respectively. International sales are primarily executed in Europe with 31%
to
customers in the United Kingdom. All international sales are executed in U.S.
dollars.
We
depend
on a limited number of customers for substantially all revenue to date. Failure
to anticipate or respond adequately to technological developments in our
industry, changes in customer or supplier requirements or changes in regulatory
requirements or industry standards, or any significant delays in the development
or introduction of products or services, could have a material adverse effect
on
our business, operating results and cash flows.
Substantially
all of our manufacturing process is subcontracted to three independent
companies. The chipsets used in some of our hardware products are currently
available from single source suppliers. The inability to obtain sufficient
key
components as required, or to develop alternative sources if and as required
in
the future, could result in delays or reductions in product shipments or margins
that, in turn, could have a material adverse effect on our business, operating
results, financial condition and cash flows.
15.
ACQUISITION OF PYX TECHNOLOGIES, INC. (PYX)
In
July
2005, we acquired PyX for a total purchase price of $11,714,000 paid to the
selling shareholders of PyX in the form of shares of our common stock and the
assumption of PyX’s employee stock option plan, plus cash expenses totaling
$359,000 for legal, accounting and valuation services. A total of 2,561,050
shares of our common stock were issued in respect of outstanding PyX common
stock. We registered these shares for resale with the Securities and Exchange
Commission. An additional 1,021,200 shares of our common stock will be issuable
upon exercise of assumed stock options for services of selling shareholders
who
became our employees. The option shares are issuable upon exercise of options,
subject to vesting restrictions, except that if an optionee’s employment is
terminated without cause or the optionee resigns for certain specified reasons,
the vesting on the option will accelerate and become fully vested.
The
acquisition enabled us to obtain storage software which we consider to be
complementary to our business. While this product has reached technological
feasibility and is being capitalized, we will continue to customize it to meet
our specific customer needs.
A
summary
of the assets acquired and consideration paid is as follows:
Tangible
assets acquired
$
31,000
Software
12,217,000
Total
assets acquired
12,248,000
Liabilities
assumed
534,000
Net
assets acquired
$
11,714,000
Fair
value of common stock provided
$
9,040,000
Fair
value of stock options assumed
5,158,000
Less:
value of deferred compensation related to stock options
(2,484,000
)
Total
consideration
$
11,714,000
We
used
the purchase method of accounting for the acquisition and combined PyX results
of operations with our own beginning July 26, 2005. The fair value of the common
stock provided to the PyX shareholders was calculated as the value of the
2,561,050 shares of common stock multiplied by the closing price of our common
stock on July 26, 2005 ($3.53 per share). The fair value of the vested portion
of the 2,038,950 PyX stock options assumed by us was calculated using the
Black-Scholes valuation model and included in the purchase price. The intrinsic
value of the unvested portion of the 2,038,950 PyX stock options assumed by
us
was recorded as deferred compensation (see Note 7) and was amortized to
compensation expense over the remaining 43-month vesting period. In connection
with the adoption of SFAS 123(R), we reduced deferred compensation and common
stock by $2,401,000, the value of the unamortized balance of the deferred
compensation as of November 1, 2005. We allocated the purchase price to the
tangible assets and liabilities based on fair market value at the time of the
acquisition and to software based on future expected cash flows to be derived
from the acquired iSCSI software product line.
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16.
NASDAQ NOTICE OF NON-COMPLIANCE
On
July14, 2006, we received a notice from The Nasdaq Stock Market (Nasdaq) indicating
that for the preceding 30 consecutive business days, the bid price of our common
stock closed below the $1.00 minimum bid price required for continued listing
by
Nasdaq Marketplace Rule 4310(c)(4) (the Rule). The notice stated that we would
be provided 180 calendar days, or until January 10, 2007, to regain compliance
with the Rule. The notice further states that if we were not in compliance
with
the Rule by January 10, 2007, the Nasdaq staff would determine whether we meet
the Nasdaq initial listing criteria as set forth in Nasdaq Marketplace Rule
4310(c), except for the bid price requirement. If we met the initial listing
criteria, the Nasdaq staff would notify us that we had been granted an
additional 180 calendar day compliance period. If we were not eligible for
an
additional compliance period, the Nasdaq staff would provide us written
notification that our securities would be delisted from Nasdaq, and at that
time
we would be able to appeal the staff’s determination to a Listings
Qualifications Panel.
On
January 11, 2007, we received a notice from Nasdaq that our stock is subject
to
delisting and that we would not be given the additional 180 day compliance
period and that we did not meet the Nasdaq initial listing criteria as set
forth
in Nasdaq Marketplace Rule 4310(c). Our shareholders’ equity and the market
value of our public float are each less than the required $5.0 million. We
filed
an appeal of the staff’s determination to a Listings Qualifications Panel.
Delisting of our stock from Nasdaq is stayed pending the determination of the
Listings Qualifications Panel. The appeals hearing is scheduled for February22,2007.
17.
SUBSEQUENT EVENTS
Sale
of Embedded Hardware Business
On
January 11, 2007, we entered into an Agreement for the Purchase and Sale of
Assets (the “Purchase Agreement”) with One Stop Systems, Inc., a manufacturer of
industrial-grade computing systems and components (One Stop), pursuant to which
we agreed to sell all of the assets associated with our hardware business
(excluding cash, accounts receivable and other excluded assets specified in
the
asset purchase agreement) to One Stop for approximately $2,200,000 in cash
plus
One Stop’s assumption of the lease of our corporate headquarters building and
certain equipment leases. The purchase price will be reduced dollar-for-dollar
to the extent our hardware business inventory has a net book value of less
than
$680,000 as of the closing date. The purchase price will be increased
dollar-for-dollar to the extent our hardware business inventory has a net book
value of more than $800,000 as of the closing date. A total of $500,000 will
be
held back from the purchase price for a period of 60 days and will be used
to
pay certain liabilities of the embedded business and satisfy any indemnification
obligations to One Stop that arise under the asset purchase agreement during
such period. Any funds not used will be released to us after 60
days.
The
Purchase Agreement contains customary representations and warranties, covenants
and closing conditions. In addition, we have agreed that for four years
following the closing of the asset sale, we will not directly or indirectly
engage in the hardware business or have any interest in any entity engaged
in
the hardware business. Each party has agreed to indemnify the other party for
damages arising for any breach of any of the representations or warranties
or
covenants or obligations in the Purchase Agreement. In addition, we have agreed
to indemnify One Stop for any liabilities arising out of the ownership or
operation of the hardware business prior to the closing of the transaction.
All
representations, warranties and covenants will expire on the first anniversary
of the closing. Our liability for indemnification claims made by One Stop
pursuant to the asset purchase agreement is capped at $2,200,000 in the
aggregate.
Merger
and Reorganization
On
January 19, 2007, we entered into an Agreement and Plan of Merger and
Reorganization with Neonode Inc., a Delaware corporation. It is anticipated
that
our name will be changed to “Neonode Inc.” upon completion of the merger. The
securities offered in the merger will not be registered under the Securities
Act
of 1933 and may not be offered or sold in the United States absent registration
or an applicable exemption from registration requirements.
Although
the exact number of shares to be issued in the merger will be determined at
closing according to a formula contained in the merger agreement, it is
currently estimated that we will issue approximately 57 million shares of its
common stock in exchange for outstanding shares of Neonode common stock and
will
assume Neonode’s options and warrants exercisable for approximately 17 million
additional shares of SBE common stock.
We
expect
to complete the transaction in our second quarter of fiscal 2007, subject to
satisfaction of closing conditions set forth in the merger agreement. In
addition to customary closing conditions, the transaction is subject to the
approval of both our and Neonode’s shareholders and a reverse split of our
outstanding common stock. The number of shares referenced above is presented
on
a pre-split basis. After the merger is completed, the combined company's
headquarters will be in Stockholm, Sweden, where Neonode’s corporate
headquarters and research and development activities are located. The combined
company’s stock is expected to continue to trade on the Nasdaq Capital
Market.
QUARTERLY
FINANCIAL INFORMATION (UNAUDITED)
(in
thousands except
per
share amounts)
First
Quarter
Second
Quarter
Third
Quarter
Fourth
Quarter
2006:
Net
sales
$
1,400
$
1,816
$
1,552
$
1,359
Gross
loss
(425
)
(487
)
(6,010
)
(895
)
Net
loss
(2,727
)
(3,029
)
(7,842
)
(2,585
)
Basic
and diluted loss per common share
$
(0.28
)
$
(0.30
)
$
(0.76
)
$
(0.23
)
2005:
Net
sales
$
2,815
$
1,706
$
1,720
$
1,815
Gross
profit (loss)
1,585
630
648
(212
)
Net
income (loss)
177
(936
)
(945
)
(2,526
)
Basic
income (loss) per common share
$
0.03
$
(0.18
)
$
(0.17
)
$
(0.26
)
Diluted
income (loss) per common share
$
0.03
$
(0.18
)
$
(0.17
)
$
(0.26
)
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25
ANNEX
D
Report
of Independent Auditors
To
the
shareholders of Neonode Inc
In
our
opinion, the accompanying consolidated balance sheets and the related
consolidated income statements and statements of cash flow present fairly,
in
all material respects, the financial position of Neonode Inc and its subsidiary
at December 31, 2005 and December 31, 2004 , and the results of their operations
and their cash flows for the years then ended in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based
on
our audits. We
conducted our audits of these statements in accordance with the standards
of the
Public Company Accounting Oversight Board (United States). 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, assessing the
accounting principles used and significant estimates made by management,
and
evaluating the overall financial statement presentation. We believe that
our
audits provide a reasonable basis for our opinion.
As
discussed in Note 1 to the financial statements, the Company has recurring
losses and limited capital resources.
All
amounts in (000) except for share and per share data
1.
Nature of the business and operations
Neonode,
Inc. (the Company) was incorporated in the State of Delaware in 2006 as the
parent of Neonode AB, a company founded in February 2004 and incorporated
in
Sweden. In February 2004, Neonode AB acquired the assets, including intangible
assets, relating to the current business, in exchange for cash of SEK 1,200
($168) and the assumption of a loan of SEK 1,000 ($140). The Company allocated
the consideration to intangible assets in the amount of SEK 2,024 ($284)
and to
equipment in the amount of 176 ($25) based on relative fair values. In February,
2006, a corporate reorganization was effected by issuing all of the shares
of
Neonode Inc. to the stockholders of Neonode AB based upon the number and
class
of shares owned by each in exchange for all of the outstanding stock of Neonode
AB. Following the reorganization, Neonode AB became a wholly-owned subsidiary
of
the Company. The reorganization was accounted for with no change in accounting
basis for Neonode AB, since there was no change in control of the Group.
The
consolidated accounts comprise the accounts of the Companies as if they had
been
owned by the Company throughout the entire reporting period. In connection
with
the reorganization, the Company commenced borrowing from a group of new
investors (AIGH).
The
Company develops and sells multimedia mobile phones, technologies and software
with a focus on design, uniqueness and user experience. The first model of
the
multimedia mobile phone, the N1, was released in November 2004. Approximately
7,000 units of the N1 have been sold and the Company is currently developing
the
next generation model of its multimedia mobile phone.
The
Company was a development stage company in 2004 since the planned principle
operations had commenced but not generated any significant revenues. Beginning
with 2005, the company was no longer in the development stage as the release
of
the N1 began generating significant revenues.
The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the ordinary course of business. The Company has incurred net operating
losses and negative operating cash flows since inception. As of December31,2005 and December 31, 2004the Company had accumulated deficits of $5,109
and
$1,427, respectively. Management has been able to provide financing in the
past
and believes that it has secured financing that is adequate for the next
12
months. The financial statements do not include any adjustments related to
the
recovery of assets and classification of liabilities that might be necessary
should the Company be unable to continue as going concern.
2.
Summary of significant accounting policies
Principles
of Consolidation
The
consolidated financial statements include the accounts of Neonode Inc and
its
subsidiary based in Sweden, Neonode AB. All inter-company accounts and
transactions have been eliminated in consolidation.
Estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles requires the Company to make estimates and assumptions
that affect at the date of the financial statements the reported amounts
of
assets and liabilities, disclosure of contingent assets and liabilities and
the
reported amounts of revenue and expenses. Actual results could differ from
these
estimates. Significant estimates include but are not limited to collectibility
of accounts receivable, carrying value of inventory, valuation of intangible
assets, and valuation of deferred tax assets.
D
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6
Cash
The
Company has not had any liquid investments other than normal cash deposits
with
bank institutions to date.
Accounts
receivable
The
Company states its net accounts receivable at net realizable value. We regularly
evaluate the collectibility of our trade receivable balances based on a
combination of factors. Our policy is to maintain allowances for specifically
identified estimated losses resulting from the inability of our customers
to
make required payments.
Inventories
Inventories
are stated at the lower of cost, using the first-in, first-out method, or
market. Our policy is to establish inventory reserves when conditions exist
that
suggest that our inventory may be in excess of anticipated demand or is obsolete
based upon our assumptions about future demand for our products and market
conditions.
Machinery
and equipment
Machinery
and equipment are stated at cost, net of accumulated depreciation and
amortization. Depreciation and amortization are computed using the straight-line
method based upon estimated useful lives of the assets ranging from one to
five
years as follows:
Estimated
useful lives
Computer
equipment
3
years
Furniture
and fixtures
1
to 5 years
Equipment
purchased under capital leases are amortized on a straight-line basis over
the
estimated useful life of the asset.
Upon
retirement or sale of property and equipment, cost and accumulated depreciation
on such assets are removed from the accounts and any gains or losses are
reflected in the statement of operations. Maintenance and repairs are charged
to
expense as incurred.
Intangible
assets
The
Company has intangible assets with finite life that are recorded at cost,
less
accumulated amortization. Amortization is computed over the estimated useful
life of the assets, which is five years.
Long-lived
assets
We
assess
any impairment by estimating the future cash flow from the associated asset
in
accordance with SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets.
If the
estimated undiscounted cash flow related to these assets decreases in the
future
or the useful life is shorter than originally estimated, we may incur charges
for impairment of these assets. The impairment is based on the estimated
discounted cash flow associated with the asset.
Foreign
currency translation
The
functional currency of Neonode Inc.'s foreign subsidiary is the applicable
local
currency. The translation from the respective foreign currency to U.S. dollars
is performed for balance sheet accounts using current exchange rates in effect
at the balance sheet date and for income statement accounts using a weighted
average exchange rate during the period. Gains or losses resulting from such
translation are included as a separate component of accumulated other
comprehensive loss. Gains or losses resulting from foreign currency transactions
are included in other income (expense). Foreign currency transaction gains
and
losses which are included in other income and (expense) were (2) and (1)
during
the twelve month period that ended December 31, 2005 and for the 10 month
period
ending December 31 2004, respectively.
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Revenue
recognition
Our
policy complies with the guidance provided by the Securities and Exchange
Commission’s Staff Accounting Bulletin (SAB) No. 104, Revenue
Recognition in Financial Statements,
issued
by the Securities and Exchange Commission. The Company recognizes revenue
from
the sale of its mobile phones when all of the following conditions have been
met: (1) evidence exists of an arrangement with the customer, typically
consisting of a purchase order or contract; (2) the Company’s products have been
delivered and risk of loss has passed to the customer; (3) the Company has
completed all of the necessary terms of the contract; (4) the amount of revenue
to which the Company is entitled is fixed or determinable; and (5) the Company
believes it is reasonably assured that it will be able to collect the amount
due
from the customer. To the extent that one or more of these conditions has
not
been satisfied, the Company defers recognition of revenue. Judgments are
required in evaluating the credit worthiness of our customers. Credit is
not
extended to customers and revenue is not recognized until we have determined
that collectibility is reasonably assured.
Revenue
for the twelve months ended December 31, 2005 includes revenue from the sales
of
the N1 multimedia mobile phone and revenue from a licensing agreement with
a
major Asian manufacturer. In July 2005, we entered into a licensing agreement
with a major Asian manufacturer whereby we licensed our touch screen technology
for use in a mobile phone to be included in their product assortment. In
this
agreement, we received €1,500 in return for granting an exclusive right to use
our software over a two year period. The exclusive rights do not limit Neonode’s
right to use the Neonode licensed technology for its own use, nor to grant
to
third parties to use the Neonode licensed technology in other devices than
mobile phones. The net revenue related to this agreement has been allocated
over
the term of the agreement, amounting to $400 in 2005. The contract also included
consulting services to be provided by Neonode on an “as needed basis”. The fees
for these consultancy services vary from hourly rates to monthly rates and
are
based on reasonable market rates for such services. Another component of
the
agreement provides that should the Asian manufacture begin selling a mobile
based on Neonode's technology, a fee of €2 per telephone would be due to
Neonode. As of December 31, 2005, the Asian Manufacturer had not sold any
mobile
telephones using Neonode’s technology.
Warranty
Reserve
The
Company’s products are generally warranted against defects for twelve months
following the sale. The Company has a twelve month warranty from the
manufacturer of the mobile phones. Reserves for potential warranty claims
not
covered by the manufacturer are provided at the time of revenue recognition
and
are based on several factors, including current sales levels and the Company’s
estimate of repair costs.
Advertising
Advertising
costs are expensed as incurred. To date, such costs have not been
significant.
Research
and Development
Research
and Development costs are expensed as incurred. Software development costs
are
accounted for in accordance with Statement of Financial Accounting Standards
("SFAS") No. 86, "Accounting for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed." Costs incurred in the product development
of new
software products are expensed as incurred until technological feasibility
has
been established. To date, the establishment of technological feasibility
of the
Company's products and general release substantially coincide. As a result,
the
Company has not capitalized any software development costs since such costs
have
been immaterial.
Research
and development costs consists mainly of personnel related costs in addition
to
some external consultancy costs such as testing, certifying, measurements,
etc.
Concentration
of Risk
Financial
instruments which potentially subject the Company to concentrations of credit
risk consist principally of accounts receivable with customers. Since the
Company is in the process of getting its product to market, the first customers
will comprise over 10 percent of revenue and the Company will need to rely
on a
smaller customer base as it grows. In addition, the Company usually sells
to
customers with either prepayment, letter of credit or bank guarantees. The
Company's customers are generally distributors of telecommunications equipment.
The Company will maintain allowances for potential credit losses, if necessary.
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Risk
and uncertainties
The
Company’s long-term success is dependent on obtaining sufficient capital to fund
its operations and development of its products, bringing such products to
the
worldwide market, and obtaining sufficient sales volume to be profitable.
To
achieve these objectives, the Company will be required to raise additional
capital through public or private financings or other arrangements. It can
not
be assured that such financings will be available on terms attractive to
the
Company, if at all. Such financings may be dilutive to stockholders and may
contain restrictive covenants.
The
Company is subject to certain risks common to technology-based companies
in
similar stages of development. Principal risks to the Company include
uncertainty of growth in market acceptance for the Company’s products; history
of losses since inception, ability to remain competitive in response to new
technologies, costs to defend, as well as risks of losing patent and
intellectual property rights, reliance on limited number of suppliers, reliance
on outsourced manufacture of the Company’s products for quality control and
product availability, ability to increase production capacity to meet demand
for
the Company’s products, concentration of the Company’s operations in a limited
number of facilities, uncertainty of demand for the Company’s products in
certain markets, ability to manage growth effectively, dependence on key
members
of the Company’s management and development team, limited experience in
conducting operations internationally, and ability to obtain adequate capital
to
fund future operations.
Since
the
Company is in the process of launching a new generation of its product, the
first customers will comprise over 10 percent of revenue and the Company
will
need to rely on a smaller customer base as it grows. In addition the company
will produce telephones through an agreement with a production partner exposing
it to the risk that the supplier cannot fulfil contracted volumes or deliveries.
Even the sources of components could cause delays in production and deliveries.
We
areexposed
to a number of economic and industry factors that could result in portions
of
our inventory becoming either obsolete or in excess of anticipated usage,
or
subject to lower of cost or market issues. These factors include, but are
not
limited to, technological changes in our markets, our ability to meet changing
customer requirements, competitive pressures in products and prices, and
the
availability of key components from our suppliers.
A
significant portion of the Company's business is conducted in currencies
other
than the U.S. dollar (the currency in which its financial statements are
stated), primarily the Swedish krona and, to a lesser extent, the Euro. The
Company incurs a significant portion of its expenses in Swedish krona, including
a significant portion of its product development expenses and a substantial
portion of its general and administrative expenses. As a result, appreciation
of
the value of the Swedish krona relative to the other currencies in which
the
Company generates revenues, particularly the U.S. dollar, could adversely
affect
operating results. The Company does not currently undertake hedging transactions
to cover its currency exposure, but the Company may choose to hedge a portion
of
its currency exposure in the future as it deems appropriate.
The
Company's future success depends on market acceptance of its products as
well as
the Company's ability to introduce new versions of its products to meet the
evolving needs of its customers.
Stock
based compensation expense
We
account for stock-based employee compensation arrangements in accordance
with
Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting
for
Stock-Based Compensation and SFAS No. 148, Accounting for Stock Based
Compensation - Transition and Disclosure. We account for equity instruments
issued to non-employees in accordance with SFAS No. 123, which require that
such
equity instruments be recorded at their fair value. When determining stock
based
compensation expense involving options and warrants, we determine the estimated
fair value of options and warrants using the Black-Scholes option pricing
model.
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Income
taxes
We
account for income taxes in accordance with SFAS No. 109, Accounting for
Income
Taxes (SFAS 109). SFAS 109 requires recognition of deferred tax liabilities
and
assets for the expected future tax consequences of items that have been included
in the financial statements or tax returns. The Company estimates income
taxes
based on rates in effect in each of the jurisdictions in which it operates.
Deferred income tax assets and liabilities are determined based upon differences
between the financial statement and income tax bases of assets and liabilities
using enacted tax rates in effect for the year in which the differences are
expected to reverse. The realization of deferred tax assets is based on
historical tax positions and expectations about future taxable income. Valuation
allowances are recorded against net deferred tax assets where, in our opinion,
realization is uncertain based on the “not more likely than not” criteria of
SFAS No. 109, Accounting for Income Taxes.
Based
on
the uncertainty of future pre-tax income, we fully reserved our deferred
tax
assets as of December 31, 2005 and 2004. In the event we were to determine
that
we would be able to realize our deferred tax assets in the future, an adjustment
to the deferred tax asset would increase income in the period such determination
was made. The provision for income taxes represents the net change in deferred
tax amounts, plus income taxes payable for the current period.
Net
income (loss) per share
Net
income (loss) per share amounts have been computed in accordance with SFAS
No.
128, "Earnings per Share". For each of the periods presented, basic earnings
per
share amounts were computed based on the weighted average number of shares
of
common stock outstanding during the period. Net income (loss) per share -
assuming dilution amounts are computed based on the weighted average number
of
shares of common stock and potential common stock outstanding during the
period.
The Company had no dilutive potential common stock during the twelve month
period that ended December 31, 2005 and during the 10 month period ending
December 31 2004, since they would be antidilutive.
Comprehensive
loss
The
Company applies Statement of Financial Standard ("SFAS") No. 130, "Reporting
Comprehensive Income". SFAS No. 130 which establishes standards for reporting
and displaying all changes in equity other than transaction with owners in
their
capacity as owners. The Company’s comprehensive loss includes foreign currency
translation gains and losses reflected in equity. The Company has reported
the
components of comprehensive loss on its consolidated statements of stockholders'
equity.
Cash
flow information
Cash
flows in foreign currencies have been converted to U.S. dollars at an
approximate weighted average exchange rate for the respective reporting
periods.
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Fair
value of financial instruments
The
Company discloses the estimated fair values for all financial instruments
for
which it is practicable to estimate fair value. Financial instruments including
cash and cash equivalents, receivables and payables, deferred revenue, and
current portions of long-term debt are deemed to approximate fair value due
to
their short maturities. The carrying amount of long-term debt with banks
and
capitalized lease obligations are also deemed to approximate their fair
values.
Effects
of recent accounting pronouncements
The
following are expected effects of new US GAAP accounting pronouncements.
In
December 2004 the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard No. 123 (revised 2004), Share-Based Payment
(“SFAS No. 123(R)”). SFAS No. 123(R) requires compensation cost relating to
unvested share-based payment transactions that are outstanding as of the
effective date and newly issued transactions to be recognized in the financial
statements. That cost will be measured based on the fair value of the equity
or
liability instruments issued. SFAS No. 123(R) covers a wide range of share-based
compensation arrangements including share options, restricted share plans,
performance-based awards, share appreciation rights and employee share purchase
plans. SFAS No. 123(R) supersedes SFAS No. 123, Accounting for Stock-Based
Compensation (“SFAS No. 123”), and supersedes Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees (“Opinion 25”). Public
entities will be required to apply SFAS No. 123(R) as of the first annual
reporting period that begins after June 15, 2005, which is effective with
the
Company’s first quarter of fiscal 2006. Since the company already applies SFAS
No. 123, we do believe that new standard SFAS no. 123R will have any significant
impact on the Company’s Consolidated Financial Statements.
In
February 2006, the FASB issued SFAS No. 155 Accounting for Certain Hybrid
Financial Instruments—an amendment of FASB Statements No. 133 and 140. This
Statement is effective for all financial instruments acquired or issued after
the beginning of an entity’s first fiscal year that begins after September 15,2006. We do not believe that SFAS No. 155 will have any impact on our
Consolidated Financial Statements.
In
March
2006, FASB issued SFAS No. 156 Accounting for Servicing of Financial Assets—an
amendment of FASB Statement No. 140. An entity should adopt this Statement
as of the beginning of its first fiscal year that begins after September15,2006. We do not believe that SFAS No. 156 will have any impact on our
Consolidated Financial Statements
In
May
2005, the FASB issued SFAS No 154, Accounting Changes and Error Corrections—A
replacement of APB Opinion No 20 and FASB Statement No. 30 (SFAS 154). SFAS
154
changes the requirement for the accounting for and reporting of a change
in
accounting principle. This statement applies to all voluntary changes in
accounting principles and changes required by an accounting pronouncement
in the
unusual instance that the pronouncement does not include specific transition
provisions. The provisions in SFAS 154 are effective for accounting changes
and
correction of errors made in fiscal years beginning after December 15, 2005,
which is effective with the Company’s first quarter of fiscal 2006. We do not
believe that the adoption of SFAS No. 154 will have a material impact on
our
Consolidated Financial Statements, however, after adoption, if a change in
accounting principle is made, SFAS no. 154 could have a material on our
consolidated financial statements.
On
July13, 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty
in
Income Taxes—an interpretation of FASB Statement No. 109. Interpretation 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with Statement 109, Accounting
for Income Taxes. This Interpretation prescribes a recognition threshold
and
measurement attribute for financial statement recognition, measurement and
disclosure of tax positions that a company has taken or expects to be take
on a
tax return. Additionally, Interpretation 48 provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods and
transition. Interpretation 48 is effective for fiscal years beginning after
December 15, 2006, with early adoption permitted. We do not believe that
the
adoption of FASB issued interpretation No. 48 will have any significant effect
on our consolidated financial statements.
In
September 2006, FASB issued SFAS No. 157 Fair Value Measurements. This Statement
is effective for financial statements issued for fiscal years beginning after
November 15, 2007. We do not believe the adoption of SFAS No. 157 will
have a material effect on our consolidated financial statements.
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In
September 2006, FASB issued SFAS No. 158 Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements
No. 87, 88, 106, and 132(R). An employer with publicly traded equity
securities is required to initially recognize the funded status of a defined
benefit postretirement plan and to provide the required disclosures as of
the
end of the fiscal year ending after December 15, 2006. The Company does
not currently have a defined benefit plan. The Company will evaluate the
provisions of the standard, but do not anticipate that it will have any effect
on our consolidated financial statements.
In
September 2006, the SEC issued Staff Accounting Bulletin No. 108 (SAB 108).
SAB
108 addresses how the effects of prior year uncorrected misstatements should
be
considered when quantifying misstatements in current year financial statements.
SAB 108 requires companies to quantify misstatements using a balance sheet
and
income statement approach and to evaluate whether either approach results
in
quantifying an error that is material in light of relevant quantitative and
qualitative factors. The guidance is applicable for fiscal years ending after
November 15, 2006. The adoption of SAB 108 has not had a material impact
on the
Company’s financial position or results of operations.
3.
Inventories
At
December 31, 2004 and 2005, inventories consisted of parts, materials and
finished products as follows:
4.
Prepaid
expenses and accrued
income
Prepaid
expenses and accrued income consist of the following:
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5.
Other
current assets
Other
current assets consist of the following:
6.
Machinery
and equipment
Machinery
and equipment consists of the following:
January1, 2005, the company entered into a capital lease for office furniture that
extends over a 36 month period with an annualized interest rate of 9%. The
amount of the lease at inception was $12. The present value of the lease
payments is recorded as notes payable. Lease payments are recorded as interest
and principle payments. The assets are depreciated over a five year period.
The
future lease payments related to the capital lease are as follows:
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7.
Intangible
assets
Intangible
assets consists of the following:
The
amortization of patents for future years for 2006, 2007, 2008 and 2009 is
estimated at approximately $60, $60, $60 and $11, respectively.
8.
Accrued
expenses
9.
Other
liabilities
Other
liabilities consist of the following:
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10.
Long-term
debt
The
Company’s debt consists of the following:
Debt
maturities per year for the above loans are as follows:
The
Petrus Holding SA and ALMI Företagspartner Stockholm AB loans described below
were issued to Neonode, Inc.’s Swedish subsidiary company Neonode AB and are
denominated in Swedish Kronor.
Loan
agreement - Petrus Holding SA (Petrus)
On
December 22, 2004 Neonode AB entered into a Loan agreement with Petrus Holding
SA, a company incorporated under the laws of Luxemburg. The funds under this
loan agreement were received in January 2005. In this loan arrangement, Petrus
Holding SA granted a loan of SEK 5,000 to Neonode AB at an interest rate
of 5%
per annum. The loan shall be repaid no later than 22 December 2009. The Petrus
loan is subordinated in right of payment to all indebtedness of Neonode to
Almi
Företagspartner Stockholm AB.
Loan
agreements - ALMI Företagspartner Stockholm AB (Almi)
Almi
1
On
April29, 2004, Neonode AB entered into a loan agreement with ALMI Företagspartner
Stockholm AB (Almi) in the initial amount of SEK 1,000 with the following
principle conditions. The credit period for the loan is 36 months starting
April29, 2004 with an annualized interest rate of 9.25%. The loan should be repaid
with quarterly principle payments of SEK 91 plus accrued interest. The debtor
has a mutual right to redeem the loan at any time prior to expiration. A
floating charge (chattel mortgage) of SEK 1,000 is pledged as security.
Individual guarantees by related parties were provided as security for the
loan
and amount to SEK 150.
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Almi
2
On
March21, 2005 Neonode AB entered into a loan agreement with Almi for in the amount
of
SEK 2,000 with 40,000 detachable warrants in Neonode AB (corresponding to
72,000
warrants when converted into Neonode Inc. shares). The loan has a credit
period
of 48 months beginning on March 21, 2005 and ending March 21, 2009 with an
annualized interest rate of 2%. The company was not required to make any
repayments of principle for the first nine months. Quarterly repayments of
principle thereafter amounted to SEK 154. The debtor has a mutual right to
redeem the loan at any time prior to expiration. A floating charge (chattel
mortgage) of SEK 2,000 is pledged as security.
A
fair
market value allocation was made in accordance with APB opinion 14 Accounting
for Convertible Debts and Debts issued with stock purchase
warrants.
The
company allocated the proceeds of the debt between the debt and the detachable
warrants based on the relative fair values of the debt security without the
warrants and the warrants themselves. To calculate the debt discount related
to
the warrants the fair market value of the warrants was calculated using the
Black-Scholes options pricing model using a share price of $3.93, an exercise
price of $5.11, volatility of 30, interest rate of 4.5% and term of the loan
3
years. The fair value of the debt was discounted using an interest rate of
6.0
percent. The aggregate debt discount amounting to $42 is amortized over the
expected term of the loan agreement.
11.
Stockholders’
equity
All
share
amounts below related to Neonode AB have been converted at a rate of 1 Neonode
AB share to 1.8 Neonode Inc shares.
The
company was founded in February 2004 with SEK 100 ($14) corresponding to
1,800,000 shares of common stock. Immediately thereafter, 18 shares of common
stock were issued to Serwello AB for an aggregate amount of SEK 1,900 ($250).
Serwello AB is a company registered in Sweden.
In
May
2004, a private placement consisting of 317,652 shares of common stock was
carried out to Iwo Jima SARL, amounting to SEK 5,000 ($642). Iwo Jima SARL
is a
company registered in Luxembourg.
In
August
2004 105,883 shares of common stock were issued for SEK 2,000 ($260) with
50%
going to Iwo Jima SARL and 50% going to Spray AB. Spray AB is a company
registered in Sweden.
In
October 2004 127,060 shares of common stock were issued for SEK 2,000 ($273)
whereby Iwo Jima SARL subscribed 50,825 (40%) Serwello AB subscribed 25,412
(20%) and the remaining 40% were subscribed by six other private investors.
In
April
2005, 263,619 common shares were issued for SEK 6,618 ($935) with the majority
going to Jourbemanning AB (128,619 shares) and the rest to 7 smaller investors.
Of the shares that went to Jourbemanning, 74,619 shares were paid for by
converting an existing receivable from Neonode AB. The receivable, which
was
originally a deposit made to Neonode AB as a prepayment for telephones, was
converted to Neonode AB common stock using a share price at the time the
transaction was agreed upon. When the new share issue was later carried out
and
subscribed, the share value had increased, resulting in the agreed upon price
for Jourbemanning being lower than the fair market value of the shares at
the
time of issuance. The difference between the fair market value of the shares
at
issuance and the share value at the time of agreement with Jourbemanning
was
recorded as a finance expense, as a stock based compensation charge of
$100.
Also
in
April 2005 together with loan financing as described above, 427,135 warrants
were issued in Neonode AB. Of these warrants, 355,135 warrants were issued
to
Iwo Jima SARL for a total warrant premium of SEK 131 ($17). The fair value
of
the warrants amounted to $166 and the difference of $149 was recorded as
a stock
compensation charge. The assumptions used in the Black-Scholes options pricing
model when calculating fair market value of the warrants issued to Iwo Jima
SARL
included a share price of $3.93, an exercise price of $4.80, volatility of
30,
interest rate of 4.5% and term of the loan 2 years. The remaining warrants
were
issued with the Almi 2 SEK 2,000 loan, where 72,000 warrants were issued
to ALMI
Företagspartner Stockholm AB (Almi). The Black-Scholes calculated fair market
value of the warrants attached to the Almi 2 loan were recorded as a debt
discount amounting to SEK 294 ($42). The assumptions used in the Black-Scholes
options pricing model when calculating fair market value of the warrants
issued
to Almi included a share price of $3.93, an exercise price of $5.11, volatility
of 30, interest rate of 4.5% and expected term of the loan 3 years.
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In
May
2005 46,800 warrants to buy Neonode AB shares were sold for cash to employees
with an aggregate option premium, based on fair market value calculated using
the Black-Scholes option pricing model, amounting to SEK 50 ($6). The
assumptions used in the Black-Scholes options pricing model included a share
price of $3,93, exercise share prices of $6.30 and $7.87, volatility of 30,
interest rate of 4.5% and a term of 2 years.
The
exercise prices per share are translated from Swedish kronor at 7.06 kronor
per
dollar and adjusted for the conversion of Neonode AB shares to Neonode Inc
shares at 1.8 shares of Neonode Inc for 1 share of Neonode AB. All options
and
warrants issued were fully exercisable and vested on date of grant.
12.
Warranty
obligations and other
guarantees
The
following is a summary of our agreements that we
have
determined are within the scope of FASB Interpretation (FIN) No. 45 Guarantor's
Accounting and Disclosure Requirements for Guarantees, including Indirect
Guarantees of Indebtedness of Others
--
an
interpretation of FASB Statements No. 5, 57 and 107 and rescission of FIN
34.
The
Company’s products are generally warranted against defects for twelve months
following the sale. The Company has a twelve month warranty from the
manufacturer of the mobile phones. Our estimate of costs to service our warranty
obligations is based on expectation of future conditions. To the extent we
estimate warranty claim activity or increased costs associated with servicing
those claims, a warranty accrual will be created and may increase or decrease
from time to time, resulting in increases or decreases in gross margin.
We
enter
into indemnification provisions under our agreements with other companies
in the
ordinary course of business, typically with business partners, contractors,
customers
and
landlords. Under these provisions we generally indemnify and hold harmless
the
indemnified party for losses suffered or incurred by the indemnified party
as a
result of our activities or, in some cases, as a result of the indemnified
party's activities under the agreement.
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13.
Income
taxes
Loss
before income taxes was distributed geographically as follows:
The
Company had no provision (benefit) for income taxes at December 31, 2005
and
2004.
The
effective income tax rate differs from the statutory federal income tax rate
for
the following reasons:
Significant
components of the deferred tax balances are as follows:
Valuation
allowances are recorded to offset certain deferred tax assets due to
management’s uncertainty of realizing the benefits of these items. Neonode Inc,
and its subsidiary company Neonode AB have only been existence since 2004.
Management applies a full valuation allowance for the accumulated losses
of
Neonode Inc, and its subsidiary Neonode AB since it is not determinable using
the “more likely than not” criteria that there will be any future benefit of the
Company’s deferred tax assets. This is mainly due to the lack of historical
information, the fact that the company has not had any significant revenues
from
the sale of its products, and due to the competitive character of the hand-held
media device/mobile telephone market. The main components of the Company’s
deferred tax benefits are the accumulated net operating loss carry-forwards,
which are almost entirely related to the operations of Neonode AB in Sweden.
Currently, under Swedish tax law these benefits do not expire and may be
carried
forward and utilized indefinitely.
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14.
Employee
benefit plans
The
Company participates in a number of individual defined contribution pension
plans for employees in Sweden. Contributions by the Company relating to its
defined contribution plans for the years ended December 31, 2004 and 2005
were
$1, and $7, respectively.
15.
Commitments
and contingencies
Operating
leases
The
Company leases office facilities and certain office equipment under various
non-cancellable operating lease agreements. Aggregate future minimum lease
payments under non-cancellable operating leases are as follows as of December31, 2005:
Total
rent expense under the leases was $211 and $27 for the years ended December31,2005 and 2004.
Legal
proceedings
There
were no significant legal proceedings at December 31, 2005 or 2004. See note
20
“Subsequent Events” for a description of any legal proceedings occurring
thereafter.
16.
Net
income (loss) per share
Basic
net
income (loss) per common share for the year ended December 31, 2005 and for
the
ten month period ending December 31, 2004 was computed by dividing the net
income (loss) for the relevant period by the weighted average number of shares
of common stock outstanding. The Diluted earnings per common share is computed
by dividing net income (loss) by the weighted average number of shares of
common
stock and common stock equivalents outstanding.
Weighted
average common stock equivalents of approximately 327,531 are excluded from
the
diluted earnings per share calculation for the twelve month period ending
December 31, 2005 due to their anti-dilutive effect. There were no common
stock
equivalents at December 31, 2004.
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17.
Segment
information
We
have
one reportable segment. The segment is evaluated based on consolidated operating
results. The Company operates in one industry segment, the development and
selling of multimedia mobile phones. To date, the company has carried out
substantially all of its operations through its subsidiary in Sweden, although
the Company carries out some development activities together with its production
partner in Malaysia. The Company intends to manage its future growth on a
geographic basis and the Company's management will evaluate the performance
of
its segments and allocate resources to them based upon income (loss) from
operations.
Geographic
data for revenues based upon customer location as follows:
The
Company had two significant customers in the 12 month period ending December31,2005 with one customer accounting for 32% of revenues and the other accounting
for 30% of revenue. There were no significant customers in the 10 period
ending
December 31, 2004.
18.
Related
party transactions
Upon
formation of the Company in February 2004, of the shares acquired by Serwello
AB, 407,880 and 611,820 were further sold to Wirelesstoys Sweden AB and Rector
AB, respectively. Wirelesstoys Sweden AB is beneficially owned by Thomas
Eriksson and Rector AB is beneficially owned by Magnus Goertz, both founders
and
employees of Neonode AB. Magnus Goertz is also the Secretary of Neonode
Inc.
During
2004 and 2005, the Company had a consultancy agreement with Rector AB for
services performed by Magnus Goertz. The amount invoiced to the company during
these periods under the agreement amounted to $7 thousand during 2004, $107
thousand during 2005. The consultancy agreement with Magnus Goertz was
terminated in 2005.
During
2004 and 2005, the Company had a consultancy agreement with Wireless Toys
AB for
services performed by Thomas Eriksson. The amount invoiced to the company
during
these periods under the agreement amounted to $7 thousand during 2004, $107
thousand during 2005. The consultancy agreement with Thomas Eriksson was
terminated in 2005.
Iwo
Jima
SARL and Spray AB as described in Note 11 Stockholders Equity are companies
where the Chairman of Neonode Inc, Per Bystedt owns or has significant
influence. Consequently, all the transactions described in Notes 10 and 11
relating to Iwo Jima SARL and Spray AB should be regarded as related party
transactions.
Relating
to the Almi 1 loan in Note 10, Thomas Ericsson, Magnus Goertz have issued
personal guaranties for the repayment of the loan amounting to approximately
$5
each. In addition, a Board Member at the time of the issuance of the loan,
Philip Edner, has issued a personal guaranty of approximately $10.
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19.
Subsequent
events
In
February 2006, 36,000 common stock shares were issued for SEK 1,533 ($199)
to
Neomagic Corporation.
In
February, 2006, a corporate reorganization was effected by issuing all of
the
shares of Neonode Inc. to the stockholders of Neonode AB based upon the number
and class of shares owned by each in exchange for all of the outstanding
stock
of Neonode AB. Following the reorganization, Neonode AB became a wholly-owned
subsidiary of the Company. The reorganization was accounted for with no change
in accounting basis for Neonode AB, since there was no change in control
of the
Group. In connection with the reorganization, the Company commenced borrowing
from a group of new investors (AIGH).
At
the
time of the Company’s reorganization on February 28, 2006, Iwo Jima SARL
received 216,993 shares of Neonode Inc common shares corresponding to a fair
market value of $1,085 and 110,929 warrants with a fair market value of $25
in a
stock/warrant based compensation agreement to retire previously issued warrants
in Neonode AB. The transaction resulted in a non-cash charge to “General and
administrative expense” amounting to $743. In addition, Almi received 43,993
shares of common stock with a fair market value of $220 and 22,490 warrants
with
a fair market value of $3 in a stock/warrant based agreement to retire
previously issued warrants in Neonode AB, which resulted in a non-cash charge
to
“Other interest and other expenses” amounting to $142. The stock based
compensation charges related to this transaction were calculated as the
difference between the fair value of the Neonode AB warrants surrendered
in
return for Neonode Inc. common stock and warrants
Of
the
warrants issued to employees in May 2005, 5000 warrants expired prior the
corporate reorganization on February 28, 2006 and 21,000 warrants were converted
into 37,800 Neonode Inc. warrants with the same exercise dates and relative
strike prices as the Neonode AB warrants.
As
a
result of the corporate reorganization on February 28, 2006 the original
warrants connected to the loan arrangement were traded for common stock and
warrants in Neonode Inc. See note 11.
On
February 28, 2006, the Company commenced borrowing from a group of new investors
(AIGH) in the amount of $4,000. The senior secured notes (bridge notes) issued
under the note purchase agreement bear interest at 4% and have a maturity
date
of August 31, 2007. The bridge notes are collateralized by the common stock
shares of Neonode Inc.’s wholly owned subsidiary, Neonode AB and are
subordinated in right of payment to all indebtedness of Neonode to Almi
Företagspartner Stockholm AB. The bridge notes provide that the amounts borrowed
there under, will be converted at the same terms and conditions included
in the
Company’s next significant sale of equity securities. The bridge notes may be
prepaid without premium or penalty, in whole or in part, on 20 days notice;
provided that the Lender shall have the opportunity, prior to such prepayment,
to convert the bridge note into common stock of the Company as describe below.
In the event that the Company fails to complete a registered public offering
with gross proceeds in excess of $5,500 by August 28, 2007 the notes shall
be
converted into common stock of the company at a price per share equal to
the
fair market value of such shares as determined by negotiation.
Debt
conversion terms (Petrus , Almi 1, and Bridge Notes)
In
April
2006 the SEK 1,000 Almi loan with an outstanding balance of SEK 646 was amended
to provide for conversion rights. On October 26, 2006 the Petrus loan agreement
was amended to include accrued interest to February 28, 2006 in the loan
amount,
which increased the loan amount to SEK 5,353 and instated the same conversion
rights as the Almi1 loan and Bridge Notes. After the amendments, the Almi1
loan,
Petrus loan and Bridge Notes all had the following conversion rights whereby:
In
the event the Company completes a registered public offering or merges with
an
existing public company on or before August 28, 2007, the above loans, Petrus,
Almi 1 and bridge notes, including without limitation all accrued interest
and
other obligations under the notes, shall automatically convert without any
action of the holder into units in the Company at a price of $5 per unit,
each
unit consisting of one share of Company common stock and 0.5 five-year warrants,
each exercisable to purchase one share at $10 per share.
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In
June
2006 Neonode terminated the contract with a supplier to for the production
of
mobile telephones. Neonode AB contracted with the supplier for the production
and delivery of telephones during 2005. Neonode AB believes that the supplier
did not deliver the telephones in accordance with its obligations under the
contract, which entitled Neonode AB to terminate the contract. Neonode AB
terminated the contract in June 2006. Since the contract was terminated due
to
the supplier’s breach of contract, Neonode believed that the supplier had no
right to payment in excess of what had already been paid for telephones
delivered. The invoices for the produced but not delivered telephones amounted
to 860 thousand USD. Neonode and the supplier came to an agreement in a
settlement in December 2006 were Neonode AB will pay the supplier 410 thousands
USD for the final shipment, after which none of the parties will have any
claims
on the other party except for warranty claims. Since the company is not certain
that any telephones received in this settlement will be sellable in the future,
due to the next generation model currently being introduced, the cost for
the
settlement has been included in the September 30, 2006 results in
full.
In
November 2006, additional senior secured notes (bridge notes) were issued
for
$1, 000 bringing the balance of outstanding bridge notes to $5,000.
On
January 19, 2007, Neondode signed a definitive merger agreement with SBE
Inc,
(Nasdaq symbol SBEI) an American public company listed on the Nasdaq stock
exchange.
In
February 2007, the company completed a $ 5,000 additional convertible secured
note financing package that was offered proportionally to the Shareholders
of
Neonode inc, and guarantied by AIGH. In return for the guarantee, AIGH had
first
right to any subscription amounts not taken by other existing
shareholders.
D
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ANNEX
E
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1
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2
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3
NEONODE
INC
Notes
to the Consolidated Financial Statements
Unaudited
All
amounts in (000) except share data and per share data
1.
Background
and summary of significant accounting
policies
Background
and operations
In
February, 2006, a corporate reorganization was effected by issuing all of
the
shares of Neonode Inc. to the stockholders of Neonode AB based upon the number
and class of shares owned by each in exchange for all of the outstanding
stock
of Neonode AB. Following the reorganization, Neonode AB became a wholly-owned
subsidiary of the Company. The reorganization was accounted for with no change
in accounting basis for Neonode AB, since there was no change in control
of the
Group. The consolidated accounts comprise the accounts of the Companies as
if
they had been owned by the Company throughout the entire reporting period.
In
connection with the reorganization, the Company commenced borrowing from
a group
of new investors (AIGH).
The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the ordinary course of business. The Company has incurred net operating
losses and negative operating cash flows since inception. As of September30,2006 and December 31, 2005the Company had accumulated deficits of $8,688
and
$5,109, respectively. Management has been able to provide financing in the
past
and believes that it has secured financing that is adequate for the next
12
months. The financial statements do not include any adjustments related to
the
recovery of assets and classification of liabilities that might be necessary
should the Company be unable to continue as going concern.
Principles
of Consolidation
The
Consolidated Statement of Financial Position as of September 30, 2006, the
Consolidated Statements of Operations and Consolidated Statements of Cash
Flows
for the nine months ended September 30, 2005 and 2006 are unaudited. These
unaudited interim financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America.
In the
opinion of management, adjustments necessary for a fair presentation of such
information have been included. The results of operations for the interim
periods are not necessarily indicative of the results that can be expected
for
any other interim period or any fiscal year.
The
consolidated financial statements include the accounts of Neonode Inc and
its
subsidiary based in Sweden, Neonode AB. All intercompany accounts and
transactions have been eliminated in consolidation.
Estimates
The
preparation of financial statements in conformity with generally accepted
accounting principles requires the Company to make estimates and assumptions
that affect at the date of the financial statements the reported amounts
of
assets and liabilities, disclosure of contingent assets and liabilities and
the
reported amounts of revenue and expenses. Actual results could differ from
these
estimates. Significant estimates include but are not limited to collectibility
of accounts receivable, carrying value of inventory, valuation of intangible
assets, and valuation of deferred tax assets.
Warranty
Reserve
The
Company’s products are generally warranted against defects for twelve months
following the sale. The Company has a twelve month warranty from the
manufacturer of the mobile phones. Reserves for potential warranty claims
not
covered by the manufacturer are provided at the time of revenue recognition
and
are based on several factors, including current sales levels and the Company’s
estimate of repair costs.
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4
Net
income (loss) per share
Net
income (loss) per share amounts have been computed in accordance with SFAS No.
128, "Earnings per Share". For each of the periods presented, basic earnings
per
share amounts were computed based on the weighted average number of shares
of
common stock outstanding during the period. Net income (loss) per share -
assuming dilution amounts are computed based on the weighted average number
of
shares of common stock and potential common stock outstanding during the
period.
The Company had no dilutive potential common stock during the nine month
periods
that ended September 30, 2006 and 2005, since they would be antidilutive.
Comprehensive
loss
The
Company applies Statement of Financial Standard ("SFAS") No. 130, "Reporting
Comprehensive Income". SFAS No. 130 which establishes standards for reporting
and displaying all changes in equity other than transaction with owners in
their
capacity as owners. The Company’s comprehensive loss includes foreign currency
translation gains and losses reflected in equity. The Comprehensive loss
for the
nine month periods ending September 30, 2006 and 2005 amounted to $3,795
and
$2,614, respectively.
Cash
flow information
Cash
flows in foreign currencies have been converted to U.S. dollars at an
approximate weighted average exchange rate for the respective reporting
periods.
Effects
of recent accounting pronouncements
The
following are expected effects of new US GAAP accounting pronouncements.
In
December 2004 the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard No. 123 (revised 2004), Share-Based Payment
(“SFAS No. 123(R)”). SFAS No. 123(R) requires compensation cost relating to
unvested share-based payment transactions that are outstanding as of the
effective date and newly issued transactions to be recognized in the financial
statements. That cost will be measured based on the fair value of the equity
or
liability instruments issued. SFAS No. 123(R) covers a wide range of share-based
compensation arrangements including share options, restricted share plans,
performance-based awards, share appreciation rights and employee share purchase
plans. SFAS No. 123(R) supersedes SFAS No. 123, Accounting for Stock-Based
Compensation (“SFAS No. 123”), and supersedes Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees (“Opinion 25”). Public
entities will be required to apply SFAS No. 123(R) as of the first annual
reporting period that begins after June 15, 2005, which is effective with
the
Company’s first quarter of fiscal 2006. SFAS no. 123R did not have any
significant impact on the Company’s Consolidated Financial
Statements.
In
February 2006, the FASB issued SFAS No. 155 Accounting for Certain Hybrid
Financial Instruments—an amendment of FASB Statements No. 133 and 140. This
Statement is effective for all financial instruments acquired or issued after
the beginning of an entity’s first fiscal year that begins after September 15,2006. We do not believe that SFAS No. 155 will not have any impact on our
Consolidated Financial Statements.
In
March
2006, FASB issued SFAS No. 156 Accounting for Servicing of Financial Assets—an
amendment of FASB Statement No. 140. An entity should adopt this Statement
as of the beginning of its first fiscal year that begins after September15,2006. We do not believe that SFAS No. 156 will have any impact on our
Consolidated Financial Statements
In
May
2005, the FASB issued SFAS No 154, Accounting Changes and Error Corrections—A
replacement of APB Opinion No 20 and FASB Statement No. 30 (SFAS 154). SFAS
154
changes the requirement for the accounting for and reporting of a change
in
accounting principle. This statement applies to all voluntary changes in
accounting principles and changes required by an accounting pronouncement
in the
unusual instance that the pronouncement does not include specific transition
provisions. The provisions in SFAS 154 are effective for accounting changes
and
correction of errors made in fiscal years beginning after December 15, 2005,
which is effective with the Company’s first quarter of fiscal 2006. The adoption
of SFAS No. 154 had no material impact on our Consolidated Financial Statements.
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5
On
July13, 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty
in
Income Taxes—an interpretation of FASB Statement No. 109. Interpretation 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with Statement 109, Accounting
for Income Taxes. This Interpretation prescribes a recognition threshold
and
measurement attribute for financial statement recognition, measurement and
disclosure of tax positions that a company has taken or expects to be take
on a
tax return. Additionally, Interpretation 48 provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods and
transition. Interpretation 48 is effective for fiscal years beginning after
December 15, 2006, with early adoption permitted. We do not believe that
the
adoption of FASB issued interpretation No. 48 will have any significant effect
on our consolidated financial statements.
In
September 2006, FASB issued SFAS No. 157 Fair Value Measurements. This Statement
is effective for financial statements issued for fiscal years beginning after
November 15, 2007. We do not believe the adoption of SFAS No. 157 will
have a material effect on our consolidated financial statements.
In
September 2006, FASB issued SFAS No. 158 Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements
No. 87, 88, 106, and 132(R). An employer with publicly traded equity
securities is required to initially recognize the funded status of a defined
benefit postretirement plan and to provide the required disclosures as of
the
end of the fiscal year ending after December 15, 2006. The Company does
not currently have a defined benefit plan. The Company will evaluate the
provisions of the standard, but do not anticipate that it will have any effect
on our consolidated financial statements.
In
September 2006, the SEC issued Staff Accounting Bulletin No. 108 (SAB 108).
SAB
108 addresses how the effects of prior year uncorrected misstatements should
be
considered when quantifying misstatements in current year financial statements.
SAB 108 requires companies to quantify misstatements using a balance sheet
and
income statement approach and to evaluate whether either approach results
in
quantifying an error that is material in light of relevant quantitative and
qualitative factors. The guidance is applicable for fiscal years ending after
November 15, 2006. The adoption of SAB 108 has not had a material impact
on the
Company’s financial position or results of operations
Prepaid
expenses and accrued income consist of the following:
4.
Other
current assets
Other
current assets consist of the following:
5.
Accrued
expenses
Accrued
expenses consist of the following:
For
a
description of the legal settlement see note 11.
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6.
Other
liabilities
Other
liabilities consist of the following:
7.
Long-term
debt
Long-term
debt consists of the following:
Senior
secured notes (bridge notes)
On
February 28, 2006, the Company commenced borrowing from a group of new investors
(AIGH). The senior secured notes (bridge notes) issued under the note purchase
agreement bear interest at 4% and have a maturity date of August 31, 2007.
At
September 30, 2006, the Company had drawn down $4,000 out of the total amount
of
$5,500 available. The bridge notes are collateralized by the common stock
shares
of Neonode Inc.’s wholly owned subsidiary, Neonode AB and are subordinated in
right of payment to all indebtedness of Neonode to Almi Företagspartner
Stockholm AB. The bridge notes provide that the amounts borrowed there under,
will be converted at the same terms and conditions included in the Company’s
next significant sale of equity securities. The bridge notes may be prepaid
without premium or penalty, in whole or in part, on 20 days notice; provided
that the Lender shall have the opportunity, prior to such prepayment, to
convert
the bridge note into common stock of the Company as described below. In the
event that the Company fails to complete a registered public offering with
gross
proceeds in excess of $5,500 by August 28, 2007 the notes shall be converted
into common stock of the company at a price per share equal to the fair market
value of such shares as determined by negotiation.
Debt
conversion terms (Petrus , Almi 1, and Bridge Notes)
In
April
2006 the SEK 1,000 Almi loan with an outstanding balance of SEK 646 was amended
to provide for conversion rights. On October 26, 2006 the Petrus loan agreement
was amended to include accrued interest to February 28, 2006 in the loan
amount,
which increased the loan amount to SEK 5,353 and instated the same conversion
rights as the Almi1 loan and Bridge Notes. After the amendments, the Almi1
loan,
Petrus loan and Bridge Notes all had the following conversion rights whereby:
In
the event the Company completes a registered public offering or merges with
an
existing public company on or before August 28, 2007, the above loans, Petrus,
Almi 1 and bridge notes, including without limitation all accrued interest
and
other obligations under the notes, shall automatically convert without any
action of the holder into units in the Company at a price of $5 per unit,
each
unit consisting of one share of Company common stock and 0.5 five-year warrant,
each exercisable to purchase one share at $10 per share.
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8.
Stockholders’
equity
All
share
amounts below related to Neonode AB have been converted at a rate of 1 Neonode
AB share to 1.8 Neonode Inc shares.
In
February 2006, 36,000 common stock shares were issued for SEK 1,533 ($199)
to
Neomagic Corporation.
In
February, 2006, a corporate reorganization was effected by issuing all of
the
shares of Neonode Inc. to the stockholders of Neonode AB based upon the number
and class of shares owned by each in exchange for all of the outstanding
stock
of Neonode AB. Following the reorganization, Neonode AB became a wholly-owned
subsidiary of the Company. The reorganization was accounted for with no change
in accounting basis for Neonode AB, since there was no change in control
of the
Group. In connection with the reorganization, the Company commenced borrowing
from a group of new investors (AIGH).
At
the
time of the Company’s reorganization on February 28, 2006, Iwo Jima SARL
received 216,993 shares of Neonode Inc common shares corresponding to a fair
market value of $1,085 and 110,929 warrants with a fair market value of $25
in a
stock/warrant based compensation agreement to retire previously issued warrants
in Neonode AB. The transaction resulted in a non-cash charge to “General and
administrative expense” amounting to $743. In addition, Almi received 43,993
shares of common stock with a fair market value of $220 and 22,490 warrants
with
a fair market value of $3 in a stock/warrant based agreement to retire
previously issued warrants in Neonode AB, which resulted in a non-cash charge
to
“Other interest and other expenses” amounting to $142. The stock based
compensation charges related to this transaction were calculated as the
difference between the fair value of the Neonode AB warrants surrendered
in
return for Neonode Inc. common stock and warrants.
The
warrants issued to IWO Jima Sarl and to Almi in 2006 in connection with the
company reorganization have the following terms and conditions:
-
Exercisable
on the date of grant of February 28th, 2006 through February 28th,
2011.
-
Exercise
price of USD 10.00/share.
-
May
be called by The Company for USD 0.10 per Warrant if the common
stock
closes on any exchange market for 20 consecutive business days
at a price
of USD 12.50 or more.
-
Holders
have pre-emptive rights to participate in any issuances of equity
by
Neonode Inc while the Warrants are outstanding, subject to exceptions
of
the following issuances: (i) options under employee incentive plans
approved by the stockholders, (ii) reasonable warrants granted
to bona
fide leasing companies, strategic partners, or major lenders or
(iii) in
connection with bona fide
acquisitions
-
The
holders will be protected against stock splits, stock dividends,
reverse
splits, combination of shares, reclassifications and similar
transactions.
Of
the
warrants issued to employees in May 2005, 9000 warrants expired prior the
corporate reorganization on February 28, 2006. The remaining warrants were
converted into 37,800 Neonode Inc. warrants with the same exercise dates
and
relative strike prices as the Neonode AB warrants.
Other
than as disclosed in the above reorganization, the Company did not grant
any new
options or warrants and no options or warrants were exercised during the
nine
month period ending September 30, 2006.
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9.
Other
guarantees
We
enter
into indemnification provisions under our agreements with other companies
in the
ordinary course of business, typically with business partners, contractors,
customers and landlords. Under these provisions we generally indemnify and
hold
harmless the indemnified party for losses suffered or incurred by the
indemnified party as a result of our activities or, in some cases, as a result
of the indemnified party's activities under the agreement.
10.
Income
taxes
Valuation
allowances are recorded to offset certain deferred tax assets due to
management’s uncertainty of realizing the benefits of these items. Neonode Inc,
and its subsidiary company Neonode AB have only been existence since 2004.
Management applies a full valuation allowance for the accumulated losses
of
Neonode Inc, and its subsidiary Neonode AB since it is not determinable using
the “more likely than not” criteria that there will be any future benefit of the
Company’s deferred tax assets. This is mainly due to the lack of historical
information, the fact that the company has not had any significant revenues
from
the sale of its products, and due to the competitive character of the hand-held
media device/mobile telephone market. The main components of the Company’s
deferred tax benefits are the accumulated net operating loss carry-forwards,
which are almost entirely related to the operations of Neonode AB in Sweden.
Currently, under Swedish tax law these benefits do not expire and may be
carried
forward and utilized indefinitely.
11.
Commitments
and contingencies
Legal
proceedings
In
September 2006, a reserve was recorded for a dispute that developed between
Neonode and a supplier. Neonode AB contracted with a supplier for the production
and delivery of telephones during 2005. Neonode AB believes that the supplier
did not deliver the telephones in accordance with its obligations under the
contract, which entitled Neonode AB to terminate the contract. Neonode AB
terminated the contract in June 2006. Since the contract was terminated due
to
the supplier’s breach of contract, Neonode believed that the supplier had no
right to payment in excess of what had already been paid for telephones
delivered. The invoices for the produced but not delivered telephones amounted
to 860 thousand USD. Neonode and the supplier came to agreement in a settlement
in December 2006 were Neonode AB will pay the supplier 410 thousands USD
for the
final shipment, after which none of the parties will have any claims on the
other party except for warranty claims. Since the company is not certain
that
any telephones received in this settlement will be sellable in the future,
due
to newer models currently being introduced, the cost for the settlement has
been
included in the September 30, 2006 results in full.
12.
Segment
information
We
have
one reportable segment. The segment is evaluated based on consolidated operating
results. The Company operates in one industry segment, the development,
manufacturing and selling of multimedia mobile phones. To date, the company
has
carried out substantially all of its operations through its subsidiary in
Sweden, although the Company carries out some development activities together
with its production partner in Malaysia. The Company intends to manage its
future growth on a geographic basis and the Company's management will evaluate
the performance of its segments and allocate resources to them based upon
income
(loss) from operations.
The
Company had two significant customers in the nine month period ending September30, 2006 with one customer accounting for 51% of revenues and the other
accounting for 47% of revenue. The Company had three significant customers
in
the nine month period ending September 30, 2005 amounting to 40%, 19% and
10% of
revenue.
13.
Subsequent
events
In
November 2006 the senior secured notes (bridge notes) were amended and an
additional $1, 000 of financing was received by the Company bringing the
balance
of outstanding bridge notes to $5,000.
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On
January 19, 2007, Neonode signed a definitive merger agreement with SBE Inc,
an
American public company listed on the Nasdaq stock exchange (Nasdaq symbol
SBEI).
In
February 2007 the company completed a $5,000 additional convertible secured
note
financing package that was offered in proportion to the holdings of the
shareholders, warrant holders and convertible note holders of Neonode inc.
The
offering was guarantied by AIGH. In return for the guaranty, AIGH had first
right to any subscription amounts not taken by other existing
shareholders.
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ANNEX
F
SBE,
INC.
WITHOUT
EMBEDDED HARDWARE BUSINESS
The
Unaudited Pro Forma Balance Sheet set forth below is presented as if the
sale of
our embedded hardware business to One Stop System had occurred on October31,2006.
F
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SBE,
INC.
WITHOUT
EMBEDDED HARDWARE BUSINESS
The
Unaudited Pro Forma Balance Sheet set forth below is presented as if the
sale of
our embedded hardware business to One Stop System had occurred on October31,2006.
F
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2
SBE,
INC.
WITHOUT
EMBEDDED HARDWARE BUSINESS
The
Unaudited Pro Forma Statement of Operations set forth below is presented
as if
the sale of our embedded hardware business to One Stop Systems had occurred
at
the beginning of our fiscal year, November 1, 2005.
UNAUDITED
PRO FORMA STATEMENT OF OPERATIONS
(in
thousands, except share and per share amounts)
F
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3
SBE,
INC.
WITHOUT
EMBEDDED HARDWARE BUSINESS
The
Unaudited Pro Forma Statement of Operations set forth below is presented
as if
the sale of our embedded hardware business to One Stop Systems had occurred
at
the beginning of our fiscal year, November 1, 2005.
UNAUDITED
PRO FORMA STATEMENT OF OPERATIONS
(in
thousands, except share and per share amounts)
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-
4
SBE,
INC.
WITHOUT
EMBEDDED HARDWARE BUSINESS
The
Unaudited Pro Forma Statement of Operations set forth below is presented
as if
the sale of our embedded hardware business to One Stop Systems had occurred
at
the beginning of our fiscal year, November 1, 2005.
UNAUDITED
PRO FORMA STATEMENT OF OPERATIONS
(in
thousands, except share and per share amounts)
F
-
5
ANNEX
G
SBE,
INC.
EMBEDDED
BUSINESS ON STAND-ALONE BASIS
UNAUDITED
PRO FORMA BALANCE SHEET
(in
thousands, except share and per share amounts)
October
31
2006
2005
ASSETS
Current
assets:
Cash
and cash equivalents
$
--
$
--
Trade
accounts receivable, net of allowance for doubtful accounts of
$26 and
$54
Amortization
and impairment of acquired software and intellectual
property
10
17
1,213
Cost
of hardware and other revenue
4,039
4,356
5,433
Product
research and development
1,631
2,488
2,411
Sales
and marketing
1,090
2,087
2,177
General
and administrative
400
1,906
1,516
Total
operating expenses
7,170
10,854
12,750
Net
loss
$
(1,096
)
$
(2,798
)
$
(1,679
)
Basic
and diluted loss per common share
$
(0.11
)
$
(0.43
)
$
(0.33
)
Basic
and diluted - Shares used in per share computations
10,304
6,439
(5,022
)
G
-
2
ANNEX
H
SBE,
INC.
WITHOUT
EMBEDDED HARDWARE BUSINESS AND WITH NEONODE TRANSACTION
The
Unaudited Pro Forma Balance Sheet set forth below is presented as if the
sale of
our embedded hardware business to One Stop System and the proposed merger
with
Neonode, Inc. had occurred on October 31, 2006. The Unaudited Pro Forma
Balance
Sheet is presented for informational purposes only. We intend to file a
proxy
statement in connection with the merger with Neonode. The proxy statement,
when
it becomes available, will contain important information about the merger
transaction and about Neonode.
UNAUDITED
PRO FORMA BALANCE SHEET
(in
thousands, except share and per share amounts)
H
-
1
SBE,
INC.
WITHOUT
EMBEDDED HARDWARE BUSINESS AND WITH NEONODE TRANSACTION
The
Unaudited Pro Forma Statement of Operations set forth below is presented
as if
the sale of our embedded hardware business to One Stop System and the proposed
merger with Neonode, Inc. had occurred at the beginning of our fiscal year,
November 1, 2005. The Unaudited Pro Forma Statement of Operations is presented
for informational purposes only. We intend to file a proxy statement in
connection with the merger with Neonode. The proxy statement, when it becomes
available, will contain important information about the merger transaction
and
about Neonode.
UNAUDITED
PRO FORMA STATEMENT OF OPERATIONS
(in
thousands, except share and per share amounts)
H-2
Dates Referenced Herein and Documents Incorporated by Reference
