| LANTRONIX INC Item 1A Risk Factors Before deciding to purchase, hold or sell our common stock, you should carefully consider the risks described below, in addition to the other cautionary statements and risks described elsewhere and the other information contained in this Report and in our other filings with the SEC, including our subsequent reports on Forms 10-Q and 8-K The risks and uncertainties described below are not the only ones we face |
| Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business |
| If any of these known or unknown risks or uncertainties actually occurs with material adverse effects on Lantronix, our business, financial condition and results of operations could be seriously harmed |
| In that event, the market price for our common stock could decline and you may lose all or part of your investment |
| Our quarterly operating results may fluctuate, which could cause our stock to decline |
| We have experienced, and expect to continue to experience, significant fluctuations in revenues, expenses and operating results from quarter-to-quarter |
| We believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance, and you should not rely on them to predict our future performance or the future performance of our stock |
| Our short-term expense levels for ongoing operations are relatively fixed and are based on our expectations of future net revenues |
| If we were to experience a reduction in revenues in a fiscal quarter, we would likely be unable to adjust our short-term expenditures |
| If this were to occur, our operating results for that fiscal quarter would be harmed |
| If our operating results in future fiscal quarters fall below the expectations of market analysts and investors, the price of our common stock would likely fall |
| Other factors that might cause our operating results to fluctuate on a quarterly basis include: 11 _________________________________________________________________ · changes in the mix of net revenues attributable to higher-margin and lower-margin products; · customers’ decisions to defer or accelerate orders; · variations in the size or timing of orders for our products; · changes in demand for our products; · defects and other product quality problems; · loss or gain of significant customers; · short-term fluctuations in the cost or availability of our critical components; · announcements or introductions of new products by our competitors; · effects of terrorist attacks in the US and abroad; and · changes in demand for devices that incorporate our products |
| Current or future litigation over intellectual property rights could adversely affect us |
| Substantial litigation regarding intellectual property rights exists in our industry |
| For example, in May 2006 we settled a patent infringement lawsuit with Digi International, Inc |
| (“Digi”) in which we signed an agreement with Digi to cross-license each other’s patents |
| In addition, we agreed to pay Digi dlra600cmam000 as part of the settlement of which dlra200cmam000 was paid in May 2006 with the remaining balance to be paid in July 2006 |
| The results of litigation are inherently uncertain, and adverse outcomes are possible |
| Adverse outcomes may have a material adverse effect on our business, financial condition or results of operations |
| For a more detailed description of pending litigation, see Note 10 to the notes to our consolidated financial statements of Part IV, Item 15 of this Form 10-K There is a risk that other third parties could claim that our products, or our customers’ products, infringe on their intellectual property rights or that we have misappropriated their intellectual property |
| In addition, software, business processes and other property rights in our industry might be increasingly subject to third-party infringement claims as the number of competitors grows and the functionality of products in different industry segments overlaps |
| Other parties might currently have, or might eventually be issued, patents that pertain to the proprietary rights we use |
| Any of these third parties might make a claim of infringement against us |
| The results of litigation are inherently uncertain, and adverse outcomes are possible |
| Responding to any infringement claim, regardless of its validity, could: · be time-consuming, costly and/or result in litigation; · divert management’s time and attention from developing our business; · require us to pay monetary damages, including treble damages if we are held to have willfully infringed; · require us to enter into royalty and licensing agreements that we would not normally find acceptable; · require us to stop selling or to redesign certain of our products; or · require us to satisfy indemnification obligations to our customers |
| If any of these occur, our business, financial condition or results of operations could be adversely affected |
| Our use of contract manufacturers in China, Malaysia and Taiwan involves risks that could adversely affect us |
| We use contract manufacturers based in China, Malaysia and Taiwan |
| There are significant risks of doing business in these locations, including the following: · These locations do not afford the same level of protection to intellectual property as do domestic or many foreign countries |
| If our products were reverse-engineered or our intellectual property were otherwise pirated (reproduced and duplicated without our knowledge or approval), our revenues would be reduced; · Delivery times are extended due to the distances involved, requiring more lead-time in ordering and increasing the risk of excess inventories; 12 _________________________________________________________________ · We could incur ocean freight delays because of labor problems, weather delays or customs problems; and · US foreign relations with these locations have historically been subject to change |
| Political considerations and actions could interrupt our expected supply of products from these locations |
| Delays in deliveries or quality problems with our component suppliers could damage our reputation and could cause our net revenues to decline and harm our results of operations |
| We and our contract manufacturers are responsible for procuring raw materials for our products |
| Our products incorporate components or technologies that are only available from single or limited sources of supply |
| In particular, some of our integrated circuits are only available from a single source and in some cases are no longer being manufactured |
| From time to time, integrated circuits used in our products will be phased out of production |
| When this happens, we attempt to purchase sufficient inventory to meet our needs until a substitute component can be incorporated into our products |
| Nonetheless, we might be unable to purchase sufficient components to meet our demands, or we might incorrectly forecast our demands, and purchase too many or too few components |
| In addition, our products use components that have, in the past, been subject to market shortages and substantial price fluctuations |
| From time to time, we have been unable to meet our orders because we were unable to purchase necessary components for our products |
| We do not have long-term supply arrangements with many of our vendors to obtain necessary components or technology for our products |
| If we are unable to purchase components from these suppliers, product shipments could be prevented or delayed, which could result in a loss of sales |
| If we are unable to meet existing orders or to enter into new orders because of a shortage in components, we will likely lose net revenues and risk losing customers and harming our reputation in the marketplace, which could adversely effect our business, financial condition or results of operations |
| We have recently redesigned many of our products to comply with the new environmental Reduction of Hazardous Substances standard |
| This standard is new for our supply chain and interruptions in parts supply due to the additional complexities and limited number of second source supply choices could adversely impact our business |
| If we lose the services of any of our contract manufacturers or suppliers, we may not be able to obtain alternate sources in a timely manner, which could harm our customer relations and adversely affect our net revenues and harm our results of operations |
| We do not have long-term agreements with our contract manufacturers or suppliers |
| If any of these subcontractors or suppliers ceased doing business with us, we may not be able to obtain alternative sources in a timely or cost-effective manner |
| Due to the amount of time that it usually takes us to qualify contract manufacturers and suppliers, we could experience delays in product shipments if we are required to find alternative subcontractors and suppliers |
| Some of our suppliers have or provide technology or trade secrets, the loss of which could be disruptive to our procurement and supply processes |
| If a competitor should acquire one of our contract manufacturers or suppliers, we could be subjected to more difficulties in maintaining or developing alternative sources of supply of some components or products |
| Any problems that we may encounter with the delivery, quality or cost of our products could damage our customer relationships and materially and adversely affect our business, financial condition or results of operations |
| If our research and development efforts are not successful, our net revenues could decline and our business could be harmed |
| If we are unable to develop new products as a result of our research and development efforts, or if the products we develop are not successful, our business could be harmed |
| Even if we do develop new products that are accepted by our target markets, we do not know whether the net revenue from these products will be sufficient to justify our investment in research and development |
| In addition, if we do not invest sufficiently in research and development, we may be unable to maintain our competitive position |
| Our research and development spending has decreased, which may put us at a competitive disadvantage compared to our competitors and adversely affect our market position |
| The following table presents our research and development expenses as a percentage of net revenues: Years Ended June 30, % of Net % of Net Change 2006 Revenues 2005 Revenues $ % (In thousands, except percentages) Research and development $ 5cmam999 11dtta5 % $ 6cmam325 13dtta0 % $ (326 ) (5dtta2 %) If a major customer cancels, reduces or delays purchases, our net revenues might decline and our business could be adversely affected |
| The number and timing of sales to our distributors have been difficult for us to predict |
| While our distributors are customers in the sense they buy our products, they are also part of our product distribution system |
| To some extent, any business lost from a distributor would likely be replaced by sales to other customer/distributors in a reasonable period, rather than a total loss of that business such as from a customer who used our products in their business or products |
| Some of our distributors could be acquired by a competitor and stop buying product from us |
| 13 _________________________________________________________________ The following table presents sales to our significant customers and a related party as a percentage of net revenues: Years Ended June 30, 2006 2005 2004 Top five customers (1) 38dtta0 % 42dtta0 % 38dtta0 % Ingram Micro 13dtta0 % 16dtta0 % 14dtta0 % Tech Data 10dtta0 % 11dtta0 % 9dtta0 % Related party 3dtta0 % 2dtta0 % 3dtta0 % (1) Includes Ingram Micro, Tech Data and related party |
| The loss or deferral of one or more significant sales in a fiscal quarter could harm our operating results |
| We have in the past, and might in the future, lose one or more of our major customers |
| If we fail to continue to sell to our major customers in the quantities we anticipate, or if any of these customers terminate their relationship with us, our reputation, the perception of our products and technology in the marketplace, could be harmed |
| The demand for our products from our OEMs, VARs and systems integrator customers depends primarily on their ability to successfully sell their products that incorporate our device networking solutions technology |
| Our sales are usually completed on a purchase order basis and we have few long-term purchase commitments from our customers |
| Our future success also depends on our ability to attract new customers, which often involves an extended selling process |
| The sale of our products often involves a significant technical evaluation, and we often face delays because of our customers’ internal procedures for evaluating and deploying new technologies |
| For these and other reasons, the sales cycle associated with our products is typically lengthy, often lasting six to nine months and sometimes longer |
| Therefore, if we were to lose a major customer, we might not be able to replace the customer in a timely manner, or at all |
| This would cause our net revenues to decrease and could cause our stock price to decline |
| If we fail to develop or enhance our products to respond to changing market conditions and government and industry standards, our competitive position will suffer and our business will be adversely affected |
| Our future success depends in large part on our ability to continue to enhance existing products, lower product cost and develop new products that maintain technological competitiveness and meet government and industry standards |
| The demand for network-enabled products is relatively new and can change as a result of innovations, changes or new government and industry standards |
| For example, a recent directive in the European Union bans the use of lead and other heavy metals in electrical and electronic equipment after July 1, 2006 |
| As a result, in advance of this deadline, some of our customers selling products in Europe had begun demanding product from component manufacturers that did not contain these banned substances |
| Any failure by us to develop and introduce new products or enhancements in response to new government and industry standards could harm our business, financial condition or results of operations |
| These requirements might or might not be compatible with our current or future product offerings |
| We might not be successful in modifying our products and services to address these requirements and standards |
| For example, our competitors might develop competing technologies based on Internet Protocols, Ethernet Protocols or other protocols that might have advantages over our products |
| If this were to happen, our net revenues might not grow at the rate we anticipate, or could decline |
| We expect the average selling prices of our products to decline, which could reduce our net revenues, gross margins and profitability |
| In the past, we have experienced some reduction in the average selling prices and gross margins, and we expect that will continue as these products mature |
| We expect competition to continue to increase, and we anticipate this could result in additional downward pressure on our pricing |
| Our average selling prices for our products might decline as a result of other reasons, including promotional programs and customers who negotiate price reductions in exchange for longer-term purchase commitments |
| We also may not be able to increase the price of our products if the prices of components or our overhead costs increase |
| In addition, we may be unable to adjust our prices in response to currency exchange rate fluctuations resulting in lower gross margins |
| If these were to occur, our gross margins would decline and we may not be able to reduce the cost to manufacture our products to keep up with the decline in prices |
| 14 _________________________________________________________________ Current or future litigation could adversely affect us |
| We are currently involved in litigation, including a federal securities class action lawsuit |
| We recently concluded multiple securities lawsuits and litigation with a former executive officer |
| We may have an obligation to continue to indemnify the former executive officer and defend any violations that he may be charged with |
| There is a risk that our insurance carriers may not reimburse us for such costs |
| Any lawsuit may involve complex questions of fact and law and may require the expenditure of significant funds and the diversion of other resources |
| Except as described in this Form 10-K, we do not know what the outcome of outstanding legal proceedings will be and cannot determine the extent to which these resolutions might have a material adverse effect on our business, financial condition or results of operations |
| The results of litigation are inherently uncertain, and adverse outcomes are possible |
| For a more detailed description of our current and recent litigation, see Note 10 to the notes to our consolidated financial statements of Part IV, Item 15 of this Form 10-K If the SEC should levy fines against us, or if we have violated the rules regarding offering securities to the public, it could damage our reputation with customers and vendors and adversely affect our stock price |
| The SEC is investigating the events surrounding the restatement of our financial statements filed on June 25, 2002 for the fiscal year ended June 30, 2001 and for the six months ended December 31, 2001 |
| During June 2006, we reached an agreement in principle with the regional staff of the SEC regarding the terms of a settlement that the regional staff has agreed to recommend to the SEC The SEC could conclude that we violated the rules of the Securities Act of 1933, as amended (the “Securities Act”), or the Securities Exchange Act of 1934, as amended (the “Exchange Act”) |
| In either event, the SEC might levy civil fines against us, or might conclude that we lack sufficient internal controls to warrant our being allowed to continue offering our shares to the public |
| This investigation involves substantial cost |
| These costs, and the cost of any fines imposed by the SEC, are not covered by insurance |
| In addition to sanctions imposed by the SEC, an adverse determination could significantly damage our reputation with customers and vendors, and harm our employees’ morale |
| If software that we license or acquire from the open source software community and incorporate into our products were to become unavailable or no longer available on commercially reasonable terms, it could adversely affect sales of our products, which could disrupt our business and harm our financial results |
| Certain of our products contain components developed and maintained by third-party software vendors or are available through the “open source” software community |
| We also expect that we may incorporate software from third-party vendors and open source software in our future products |
| Our business would be disrupted if this software, or functional equivalents of this software, were either no longer available to us or no longer offered to us on commercially reasonable terms |
| In either case, we would be required to either redesign our products to function with alternate third-party software or open source software, or develop these components ourselves, which would result in increased costs and could result in delays in our product shipments |
| Furthermore, we might be forced to limit the features available in our current or future product offerings |
| The SCO Group (“SCO”) has filed and threatened to file lawsuits against companies that operate Linux for commercial purposes, alleging that such use of Linux infringes SCO’s rights |
| These allegations may adversely affect the demand for the Linux platform and, consequently, the sales of our Linux-based products |
| Our products may contain undetected software or hardware errors or defects that could lead to an increase in our costs, reduce our net revenues or damage our reputation |
| We currently offer warranties ranging from one to two years on each of our products |
| Our products could contain undetected errors or defects |
| If there is a product failure, we might have to replace all affected products without being able to book revenue for replacement units, or we may have to refund the purchase price for the units |
| We do not have a long history with which to assess the risks of unexpected product failures or defects for our device server product line |
| Regardless of the amount of testing we undertake, some errors might be discovered only after a product has been installed and used by customers |
| Any errors discovered after commercial release could result in loss of net revenues and claims against us |
| Significant product warranty claims against us could harm our business, reputation and financial results and cause the price of our stock to decline |
| If our contract manufacturers are unable or unwilling to manufacture our products at the quality and quantity we request, our business could be harmed |
| We outsource substantially all of our manufacturing to four manufacturers: Venture Electronics Services, Uni Precision Industrial Ltd, Universal Scientific Industrial Company, LTD and eSilicon Corporation |
| Our reliance on these third-party manufacturers exposes us to a number of significant risks, including: · reduced control over delivery schedules, quality assurance, manufacturing yields and production costs; · lack of guaranteed production capacity or product supply; and · reliance on these manufacturers to maintain competitive manufacturing technologies |
| 15 _________________________________________________________________ Our agreements with these manufacturers provide for services on a purchase order basis |
| If our manufacturers were to become unable or unwilling to continue to manufacture our products at requested quality, quantity, yields and costs, or in a timely manner, our business would be seriously harmed |
| As a result, we would have to attempt to identify and qualify substitute manufacturers, which could be time consuming and difficult, and might result in unforeseen manufacturing and operations problems |
| in March 2005 and closed the facility that manufactured our products |
| We transferred this production to another contract manufacturer |
| Moreover, as we shift products among third-party manufacturers, we may incur substantial expenses, risk material delays or encounter other unexpected issues |
| In addition, a natural disaster could disrupt our manufacturers’ facilities and could inhibit our manufacturers’ ability to provide us with manufacturing capacity in a timely manner or at all |
| If this were to occur, we likely would be unable to fill customers’ existing orders or accept new orders for our products |
| The resulting decline in net revenues would harm our business |
| We also are responsible for forecasting the demand for our individual products |
| These forecasts are used by our contract manufacturers to procure raw materials and manufacture our finished goods |
| If we forecast demand too high, we may invest too much cash in inventory, and we may be forced to take a write-down of our inventory balance, which would reduce our earnings |
| If our forecast is too low for one or more products, we may be required to pay charges that would increase our cost of revenues or we may be unable to fulfill customer orders, thus reducing net revenues and therefore earnings |
| Because we depend on international sales for a substantial amount of our net revenues, we are subject to international economic, regulatory, political and other risks that could harm our business, financial condition or results of operations |
| The following table presents our sales within geographic regions as a percentage of net revenues: Years Ended June 30, 2006 2005 2004 Americas 62dtta5 % 64dtta3 % 69dtta3 % EMEA 27dtta1 % 27dtta2 % 23dtta0 % Asia Pacific 10dtta4 % 8dtta5 % 7dtta7 % 100dtta0 % 100dtta0 % 100dtta0 % We expect that international revenues will continue to represent a significant portion of our net revenues in the foreseeable future |
| Doing business internationally involves greater expense and many risks |
| For example, because the products and services we buy abroad are priced in foreign currencies, we are affected by fluctuating exchange rates |
| We might not successfully protect ourselves against currency rate fluctuations, and our financial performance could be harmed as a result |
| In addition, we face other risks of doing business internationally, including: · unexpected changes in regulatory requirements, taxes, trade laws and tariffs; · reduced protection for intellectual property rights in some countries; · differing labor regulations; · compliance with a wide variety of complex regulatory requirements; · changes in a country’s or region’s political or economic conditions; · effects of terrorist attacks in the US and abroad; · greater difficulty in staffing and managing foreign operations; and · increased financial accounting and reporting burdens and complexities |
| Our international operations require significant attention from our management and substantial financial resources |
| We do not know whether our investments in other countries will produce desired levels of net revenues or profitability |
| If we are unable to sell our inventory in a timely manner it could become obsolete, which could require us to increase our reserves and harm our operating results |
| At any time, competitive products may be introduced with more attractive features or at lower prices than ours |
| There is a risk that we may be unable to sell our inventory in a timely manner to avoid it becoming obsolete |
| 16 _________________________________________________________________ The following table presents our inventory and reserve for excess and obsolete inventory reserve: June 30, 2006 2005 (In thousands) Raw materials $ 3cmam863 $ 3cmam973 Finished goods 7cmam249 7cmam330 Inventory at distributors 1cmam690 1cmam181 12cmam802 12cmam484 Reserve for excess and obsolete inventory (4cmam689 ) (5cmam656 ) $ 8cmam113 $ 6cmam828 In the event we are required to substantially discount our inventory or are unable to sell our inventory in a timely manner, we would be required to increase our reserves and our operating results could be substantially harmed |
| If we are unable to attract, retain or motivate key senior management and technical personnel, it could seriously harm our business |
| Our financial performance depends substantially on the performance of our executive officers and key technical employees |
| We are dependent in particular on Marc Nussbaum, our President and Chief Executive Officer, with whom we have no employment contract |
| We are also dependent upon our technical personnel, due to the specialized technical nature of our business |
| James Kerrigan, our Chief Financial Officer, has announced his intention to retire before the end of the calendar year 2006, although he intends to remain in an advisory capacity to assist with the transition to a new Chief Financial Officer |
| We are currently searching for a replacement for Mr |
| If we were unable to locate a suitable replacement candidate in a timely manner, our business could suffer |
| Nussbaum or any of our key technical personnel and were not able to find replacements in a timely manner, our business could be disrupted, other key personnel might decide to leave, and we might incur increased operating expenses associated with finding and compensating replacements |
| If our OEM customers develop their own expertise in network-enabling products, it could result in reduced sales of our products and harm our operating results |
| We sell to both resellers and OEMs |
| Selling products to OEMs involves unique risks, including the risk that OEMs will develop internal expertise in network-enabling products or will otherwise incorporate network functionality in their products without using our device networking solutions |
| If this were to occur, our sales to OEMs would likely decline, which could reduce our net revenue and harm our operating results |
| New product introductions and pricing strategies by our competitors could reduce our market share or cause us to reduce the prices of our products, which would reduce our net revenues and gross margins |
| The market for our products is intensely competitive, subject to rapid change and is significantly affected by new product introductions and pricing strategies of our competitors |
| We face competition primarily from companies that network-enable devices, semiconductor companies, companies in the automation industry and companies with significant networking expertise and research and development resources |
| Our competitors might offer new products with features or functionality that are equal to or better than our products |
| In addition, since we work with open standards, our customers could develop products based on our technology that compete with our offerings |
| We might not have sufficient engineering staff or other required resources to modify our products to match our competitors |
| Similarly, competitive pressure could force us to reduce the price of our products |
| In each case, we could lose new and existing customers to our competition |
| If this were to occur, our net revenues could decline and our business could be harmed |
| We are exposed to foreign currency exchange risks, which could harm our business and operating results |
| We hold a significant portion of our cash balance in foreign currencies (particularly euros), and as such are exposed to adverse changes in exchange rates associated with foreign currency fluctuations |
| However, we do not currently engage in any hedging transactions to mitigate these risks |
| Although from time to time we review our foreign currency exposure and evaluate whether we should enter into hedging transactions, we may not adequately hedge against any future volatility in currency exchange rates and, if we engage in hedging transactions, the transactions will be based on forecasts which later may prove to be inaccurate |
| Any failure to hedge successfully or anticipate currency risks properly could adversely affect our operating results |
| We may not be able to adequately protect or enforce our intellectual property rights, which could harm our competitive position |
| 17 _________________________________________________________________ We have not historically relied on patents to protect our proprietary rights, although we are now building a patent portfolio |
| In May 2006, we entered into a patent cross-license agreement with Digi in which the parties agreed to cross-license each other’s patents, which could reduce the value of our existing patent portfolio |
| We rely primarily on a combination of laws, such as copyright, trademark and trade secret laws, and contractual restrictions, such as confidentiality agreements and licenses, to establish and protect our proprietary rights |
| Despite any precautions that we have taken: · laws and contractual restrictions might not be sufficient to prevent misappropriation of our technology or deter others from developing similar technologies; · other companies might claim common law trademark rights based upon use that precedes the registration of our marks; · other companies might assert other rights to market products using our trademarks; · policing unauthorized use of our products and trademarks is difficult, expensive and time-consuming, and we might be unable to determine the extent of this unauthorized use; · courts may determine that our software programs use open source software in such a way that deprives the entire programs of intellectual property protection; and · current federal laws that prohibit software copying provide only limited protection from software pirates |
| Also, the laws of some of the countries in which we market and manufacture our products offer little or no effective protection of our proprietary technology |
| Reverse engineering, unauthorized copying or other misappropriation of our proprietary technology could enable third-parties to benefit from our technology without paying us for it, which could significantly harm our business |
| Acquisitions, strategic partnerships, joint ventures or investments may impair our capital and equity resources, divert our management’s attention or otherwise negatively impact our operating results |
| We may pursue acquisitions, strategic partnerships and joint ventures that we believe would allow us to complement our growth strategy, increase market share in our current markets and expand into adjacent markets, broaden our technology and intellectual property and strengthen our relationships with carriers and OEMs |
| Any future acquisition, partnership, joint venture or investment may require that we pay significant cash, issue stock or incur substantial debt |
| Acquisitions, partnerships or joint ventures may also result in the loss of key personnel and the dilution of existing stockholders as a result of issuing equity securities |
| In addition, acquisitions, partnerships or joint ventures require significant managerial attention, which may be diverted from our other operations |
| These capital, equity and managerial commitments may impair the operation of our business |
| Furthermore, acquired businesses may not be effectively integrated, may be unable to maintain key pre-acquisition business relationships, may contribute to increased fixed costs and may expose us to unanticipated liabilities and otherwise harm our operating results |
| Business interruptions could adversely affect our business |
| Our operations and those of our suppliers are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure, terrorist attacks and other events beyond our control |
| A substantial portion of our facilities, including our corporate headquarters and other critical business operations, are located near major earthquake faults and, therefore, may be more susceptible to damage if an earthquake occurs |
| We do not carry earthquake insurance for direct earthquake-related losses |
| In addition, we do not carry business interruption insurance for, nor do we carry financial reserves against, business interruptions arising from earthquakes or certain other events |
| If a business interruption occurs, our business could be materially and adversely affected |
| If we fail to implement and maintain an effective system of disclosure controls and internal controls over financial reporting, we may not be able to report our financial results in an accurate or timely manner, prevent fraud or comply with Section 404 of the Sarbanes-Oxley Act of 2002, which may harm our business and adversely affect the trading price of our stock |
| Section 404 of the Sarbanes-Oxley Act of 2002 requires companies to evaluate periodically the effectiveness of their internal controls over financial reporting, and to include a management report assessing the effectiveness of their internal controls as of the end of each fiscal year |
| Beginning with our annual report on Form 10-K for our fiscal year ending June 30, 2008, we will be required to comply with the requirement of Section 404 of the Sarbanes-Oxley Act of 2002 to include in each of our annual reports an assessment by our management of the effectiveness of our internal controls over financial reporting and a report of our independent registered public accounting firm addressing these assessments |
| 18 _________________________________________________________________ Our management does not expect that our internal controls over financial reporting will prevent all errors or frauds |
| A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met |
| Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs |
| Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, involving us have been, or will be, detected |
| These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes |
| Controls can also be circumvented by individual acts of a person, or by collusion among two or more people, or by management override of the controls |
| The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions |
| Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies and procedures |
| Because of the inherent limitations in a cost-effective control system, misstatements due to errors or frauds may occur and not be detected |
| We cannot assure you that we or our independent registered public accounting firm will not identify a material weakness in our disclosure controls and internal controls over financial reporting in the future |
| If our internal controls over financial reporting are not considered adequate, we may experience a loss of public confidence, which could have an adverse effect on our business and our stock price |
| We may experience difficulties in implementing or enhancing new information systems |
| During calendar 2006, we began the implementation of a new enterprise resource planning (“ERP”) information system to manage our business operations |
| While we did not use the new ERP information system to manage our business during the fiscal year ended June 30, 2006, the possibility exists that our migration to the new ERP information system could adversely affect our disclosure controls and procedures or our operations in future periods |
| The process of implementing new information systems could adversely impact our ability to do the following in a timely manner: accept and process customer orders, receive inventory and ship products, invoice and collect receivables, place purchase orders and pay invoices, and all other business transactions related to the finance, order entry, purchasing, supply chain and human resource processes within the new ERP systems |
| Any such disruption could adversely affect our financial position, results of operations, cash flows and the market price of our common stock |