LANTRONIX INC Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)

The following discussion and analysis of our financial condition and results of
operations should be read together with our unaudited condensed consolidated
financial statements and the related notes included in Part I, Item 1 of this
Quarterly Report on Form 10-Q for the three months ended September 30, 2022 (the
"Report"). This discussion and analysis contains forward-looking statements that
are based on our current expectations and reflect our plans, estimates and
anticipated future financial performance. See the section of this Report
entitled "Cautionary Note Regarding Forward-Looking Statements" for additional
information. These statements involve numerous risks and uncertainties. Our
actual results may differ materially from those expressed or implied by these
forward-looking statements as a result of many factors, including those set
forth in "Risk Factors" in Part II, Item 1A of this Report.



Unless the context otherwise requires, all references to the “Company”, “Lantronix”, “we”, “us” and “our” in this Quarterly Report on Form 10-Q include
Lantronix, Inc. and its consolidated subsidiaries.


Overview



Lantronix, Inc. is a global Industrial and Enterprise IoT provider of solutions
that target diversified verticals ranging from Smart Cities, Utilities and
Healthcare to Enterprise, Intelligent Transportation, and Industrial Automation.
Building on a long history of connectivity and video processing competence,
target applications include Video Surveillance, Traffic management, Infotainment
systems, Robotics, Edge Computing and Remote Environment Management ("REM").



We operate globally and manage our sales teams across three geographic regions: Americas; Europe, Middle Eastand Africa (“EMEA”); and Asia-Pacific Japan (“APJ”).

Presentation of products and solutions

We organize our service and product portfolio into the following product lines: Embedded IoT Modules, IoT System Solutions, and Software and Engineering Services.



Embedded IoT Modules



This portfolio of embedded products provides a variety of solutions including
Compute System-on-Module (SOM) or System-in-Package (SIP) solutions supplemented
with wired and wireless network Connectivity options. As the level of silicon
integration continues to grow, the compute modules also provide the ability to
Collect digital information (Video, Audio or Sensors) and analyze/comprehend the
data streams based on specific AI/ML algorithms. The new implementations of SIP
devices can process multiple media streams with CV (Computer Vision) technology
and the modules can be Controlled remotely via ConsoleFlow™, Lantronix's Cloud
SaaS platform. Our IoT compute products typically are embedded into a customer
product, enabling advanced application functionality at the edge. Our compute
products are normally embedded into new designs. These products include
application processing that delivers compute to meet customer needs for data
transformation, computer vision, machine learning, augmented / virtual reality,
audio / video aggregation and distribution, and custom applications at the edge.
Many of the products are offered with software tools intended to further
accelerate our customers' time-to-market and increase their value add. Most of
our IoT embedded products are pre-certified in a number of countries thereby
significantly reducing our OEM customers' regulatory certification costs and
accelerating their time to market



IoT System Solutions


The IoT Systems Solutions portfolio consists of fully functional standalone
systems that provider routing, switching or gateway functionalities as well as
Telematics and media conversion. These products include wired and wireless
connections that enhance the value and utility of modern electronic systems and
equipment by providing secure network connectivity, power for IoT end devices
through Power over Ethernet (PoE), application hosting, protocol conversion,
media conversion, secure access for distributed IoT deployments and many other
functions. Most of our IoT System products are pre-certified in a number of
countries thereby significantly reducing our original equipment manufacturer
("OEM") customers' regulatory certification costs and accelerating their time to
market.







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Engineering software and services

Our SaaS platform provides single pane of glass management for REM and IoT
deployments. Our platform enables customers to easily deploy, monitor, manage,
and automate across their global deployments, all from a single platform login,
virtually connected as though directly on each device. Our platform eliminates
the need to have 24/7 personnel on site, and makes it easy to see and drill into
an issue quickly, even in large scale deployments.



We leverage our engineering expertise and product development best practices to
deliver high quality, innovative products, cost-effectively and on time. Our
engineering services flexible business model allows for choosing turnkey product
development or team augmentation for accelerating complex areas of product
development such as; camera development and tuning, voice control, machine
learning, artificial intelligence, computer vision, augmented / virtual reality,
mechanical and radio-frequency design, thermal and power optimization, or in any
specific area a customer needs assistance.



Recent Developments



Acquisition



On September 12, 2022 we acquired Uplogix, Inc. ("Uplogix") for an aggregate
purchase price of $8,000,000, subject to certain adjustments, plus an earnout up
to an additional $4,000,000 depending on the achievement of certain revenue
targets of the business of Uplogix through September 30, 2023. Uplogix brings
immediate scale to our out-of-band OOB remote management solutions, adding a
complementary high-end product offering that includes high-margin maintenance
and licensing revenues.



Refer to Note 3 of Notes to Unaudited Condensed Consolidated Financial
Statements included in Part I, Item 1 of this Report, which are incorporated
herein by reference, for additional discussions regarding the acquisition of
Uplogix.



COVID-19 Update



Since the outbreak of the COVID-19 pandemic, we have taken measures to protect
the health and safety of our employees and comply with applicable local
directives. Most of our employees transitioned to remote working arrangements
commencing in March 2020, and many continue to primarily work remotely as of the
date hereof. We continue to monitor the implications of the COVID-19 pandemic on
our business, as well as our customers' and suppliers' businesses, including the
emergence of new strains of the virus, current or future government-imposed
shutdowns, and the impact of ongoing vaccination efforts.



Our supply chain continues to face challenges as most of our manufacturing is done in Thailand, Taiwan and China. We have experienced increased component costs for certain products as well as increased transportation and logistics costs and expect these cost increases to continue. These and other factors have contributed to recent delays in deliveries to some customers.

Overall, in light of the changing nature and continuing uncertainty around the
COVID-19 pandemic, our ability to predict the impact of the COVID-19 pandemic on
our business in future periods remains limited. The full effects of the pandemic
on our business are unlikely to be fully realized, or reflected in our financial
results, until future periods.



Recent accounting pronouncements

Refer to Note 1 of the Notes to the Unaudited Condensed Consolidated Financial Statements, included in Part I, Item 1 of this report, which is incorporated herein by reference, for a discussion of recent accounting pronouncements.






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Significant Accounting Policies and Estimates



The accounting policies that have the greatest impact on our financial condition
and results of operations and that require the most judgment are those relating
to revenue recognition, allowance for doubtful accounts, inventory valuation,
warranty reserves, restructuring charges, valuation of deferred income taxes,
business combinations, goodwill and intangible assets and stock-based
compensation. These policies are described in further detail in our Annual
Report on Form 10-K for the year ended June 30, 2022 and filed with the
Securities and Exchange Commission (the "SEC") on August 29, 2022 (the "Form
10-K") and have not changed significantly during the three months ended
September 30, 2022 as compared to what was previously disclosed in the Form
10-K.



Results of operations – Quarters ended September 30, 2022 Compared to the three months ended September 30, 2021


Summary


In the three months ended September 30, 2022, our net revenue increased by
$4,090,000 or 14.8%, compared to the three months ended September 30, 2021. The
increase in net revenue was driven by a 22.0% increase in net revenue in our
Embedded IoT Solutions product line, as well as an 11.1% increase in net revenue
in our IoT System Solutions product line. We had a net loss of $1,653,000 for
the three months ended September 30, 2022 compared to a net loss of $2,241,000
for the three months ended September 30, 2021. The decrease in net loss was
primarily driven by the increase in revenues partially offset by an increase in
operating expenses of 1,184,000 or 8% during the three months ended September
30, 2022 compared to the three months ended September 30, 2021.



Net Revenue



The following tables present our net revenue by product line and by geographic
region:



                                 Three Months Ended September 30,
                                      % of Net                   % of Net            Change
                           2022        Revenue        2021        Revenue         $           %
                                            (In thousands, except percentages)

Embedded IoT solutions $15,095 47.5% $12,376 44.7%

    $ 2,719       22.0%
IoT System Solutions       14,621         46.0%       13,158         47.5%       1,463       11.1%
Software & Services         2,079          6.5%        2,171          7.8%         (92 )     (4.2% )
                         $ 31,795        100.0%     $ 27,705        100.0%     $ 4,090       14.8%




                   Three Months Ended September 30,
                        % of Net                   % of Net            Change
             2022        Revenue        2021        Revenue         $           %
                              (In thousands, except percentages)
Americas   $ 20,930         65.8%     $ 18,227         65.8%     $ 2,703       14.8%
EMEA          5,201         16.4%        4,659         16.8%         542       11.6%
APJ           5,664         17.8%        4,819         17.4%         845       17.5%
           $ 31,795        100.0%     $ 27,705        100.0%     $ 4,090       14.8%




Embedded IoT Solutions



Net revenue from our Embedded IoT Solutions product line increased in the three
months ended September 30, 2022 compared to the three months ended September 30,
2021 primarily due to organic growth in our compute modules and embedded
ethernet connectivity products in the Americas and EMEA regions. This increase
was partially offset by a decrease in revenues of our WiFi gateway products
in
the Americas region.







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IoT System Solutions



Net revenue from our IoT System Solutions product line increased in the three
months ended September 30, 2022 compared to the three months ended September 30,
2021 primarily due to sales of our network switches and media converter
products, mostly in the Americas region. These increases were partially offset
by a decrease in sales of our out of band products, primarily in the Americas
region.



Software & Services



Net revenue from our Software & Services product line decreased in the three
months ended September 30, 2022 compared to the three months ended September 30,
2021 primarily due to a decrease in our engineering services revenue in the EMEA
region. This decrease was partially offset by a modest contribution in services
revenue from the Uplogix acquisition.



Gross Profit



Gross profit represents net revenue less cost of revenue. Cost of revenue
consists primarily of the cost of raw material components, subcontract labor
assembly from contract manufacturers, direct and indirect personnel expenses
related to professional services, manufacturing overhead, inventory reserves for
excess and obsolete products or raw materials, warranty costs, royalties and
share-based compensation.


The following table presents our gross margin:



                        Three Months Ended September 30,
                             % of Net                    % of Net            Change
                 2022        Revenue         2021        Revenue          $           %
                                   (In thousands, except percentages)
Gross profit   $ 14,036          44.1%     $ 12,463          45.0%     $ 1,573       12.6%




Gross profit as a percent of revenue (referred to as "gross margin") for the
three months ended September 30, 2022 decreased slightly compared to the three
months ended September 30, 2021 due primarily to our sales mix. As compared to
the prior year period, in the current quarter we experienced (i) higher unit
sales of our compute modules which typically carry lower gross margins than some
of our other legacy product families and (ii) lower unit sales of some of our
higher-margin out of band products. Additionally, our gross margin in the
current quarter was favorably impacted by lower freight and duties costs.



Selling, general and administrative expenses



Selling, general and administrative expenses consist of personnel-related
expenses, including salaries and commissions, share-based compensation, facility
expenses, information technology, trade show expenses, advertising, and legal
and accounting fees.



The following table presents our selling, general and administrative expenses:



                                   Three Months Ended September 30,
                                        % of Net                     % of Net              Change
                           2022         Revenue         2021         Revenue           $             %
                                                (In thousands, except percentages)
Personnel-related
expenses                $    4,680                    $   4,430                    $     250          5.6%
Professional fees and
outside services             1,682                        1,318                          364         27.6%
Advertising and
marketing                      582                          501                           81         16.2%
Facilities and
insurance                      483                          278                          205         73.7%
Share-based
compensation                 1,405                        1,126                          279         24.8%
Other                          325                          253                           72         28.5%
Selling, general and
administrative          $    9,157          28.8%     $   7,906          28.5%     $   1,251         15.8%








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Selling, general and administrative expenses for the three months ended
September 30, 2022 increased when compared to the three months ended September
30, 2021 primarily due to (i) increased professional fees and outside services
costs for certain legal, financial and other services, (ii) increased
share-based compensation expenses due to additional grants of performance stock
units, and (iii) increased personnel expenses resulting from our acquisitions.



Research and Development



Research and development expenses consist of personnel-related expenses,
including share-based compensation, as well as expenditures to third-party
vendors for research and development activities and product certification costs.
Our quarterly costs related to outside services and product certifications vary
from period to period depending on our level of development activities.



The following table presents our research and development expenses:


                                        Three Months Ended September 30,
                                             % of Net                     % of Net              Change
                                2022         Revenue         2021         Revenue           $             %
                                                     (In thousands, except percentages)
Personnel-related expenses   $    2,961                    $   2,520                    $     441         17.5%
Facilities                          642                          508                          134         26.4%
Outside services                    164                          321                         (157 )      (48.9% )
Product certifications              213                          235                          (22 )       (9.4% )
Share-based compensation            332                          255                           77         30.2%
Other                               214                          202                           12          5.9%
Research and development     $    4,526          14.2%     $   4,041          14.6%     $     485         12.0%



Research and development expenses for the three months ended September 30, 2022
increased when compared to the three months ended September 30, 2021 primarily
due to an increase in personnel-related costs driven by our acquisitions and
internal growth of our engineering teams worldwide.



Restructuring, severance and related charges

In the three months ended September 30, 2022we incurred costs of approximately $92,000 linked to workforce reductions and the restructuring of certain non-essential activities.



We may incur additional restructuring, severance and related charges in future
periods as we continue to identify cost savings and synergies related to our
acquisitions and general business operations.



Acquisition-Related Costs


In the three months ended September 30, 2022we hired about
$213,000 costs mainly related to the acquisition of Uplogix. These costs consisted mainly of bank, legal and other professional fees.

Interest income (expense), net



For the three months ended September 30, 2022, we incurred net interest expense
due to borrowings on our credit facilities. We also earn interest income on
our
domestic cash balance.







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Other Income (Expense), Net


Our other income (expense), net, mainly includes foreign currency revaluation and transaction adjustments related to our foreign subsidiaries whose functional currency is WE dollar.


Provision for Income Taxes


Refer to Note 8 of the Notes to the Unaudited Condensed Consolidated Financial Statements, included in Part I, Item 1 of this report, which is incorporated herein by reference, for a discussion of our provision for income taxes.

Cash and capital resources


Liquidity



The following table presents details of our working capital and cash and cash
equivalents:



                                               September 30,      June 30,
                                                   2022             2022         Change
                                                            (In thousands)
Working capital                               $        50,316     $  54,512     $ (4,196 )
Cash, cash equivalents, and restricted cash   $        13,125     $  17,221
    $ (4,096 )




In September 2022 we entered into an amendment to our Senior Credit Facilities
(as defined in Note 6 of Notes to Unaudited Condensed Consolidated Financial
Statements, included in Part I, Item 1 of this Report) which provide for an
additional term loan in the original principal amount of $5,000,000 that matures
on August 2, 2025. We also borrowed $2,000,000 on our revolving credit facility.



Our principal sources of cash and liquidity include our existing cash and cash
equivalents, borrowings and amounts available under our loan agreement with our
bank, and cash generated from operations. We believe that these sources will be
sufficient to fund our current requirements for working capital, capital
expenditures and other financial commitments for at least the next 12 months. We
anticipate that the primary factors affecting our cash and liquidity are net
revenue, working capital requirements and capital expenditures.



We define cash and cash equivalents as highly liquid deposits with original
maturities of 90 days or less when purchased. We maintain cash and cash
equivalents balances at certain financial institutions in excess of amounts
insured by federal agencies. Management does not believe this concentration
subjects us to any unusual financial risk beyond the normal risk associated with
commercial banking relationships. We frequently monitor the third-party
depository institutions that hold our cash and cash equivalents. Our emphasis is
primarily on safety of principal and secondarily on maximizing yield on those
funds.



Our future working capital requirements will depend on many factors, including
the following: timing and amount of our net revenue; our product mix and the
resulting gross margins; research and development expenses; selling, general and
administrative expenses; and expenses associated with any strategic
partnerships, acquisitions or infrastructure investments.



From time to time, we may seek additional capital from public or private
offerings of our capital stock, borrowings under our existing or future credit
lines or other sources in order to (i) develop or enhance our products, (ii)
take advantage of strategic opportunities, (iii) respond to competition or (iv)
continue to operate our business. We currently have a Form S-3 shelf
registration statement on file with the SEC. If we issue equity securities to
raise additional funds, our existing stockholders may experience dilution, and
the new equity securities may have rights, preferences and privileges senior to
those of our existing stockholders. If we issue debt securities to raise
additional funds, we may incur debt service obligations, become subject to
additional restrictions that limit or restrict our ability to operate our
business, or be required to further encumber our assets. There can be no
assurance that we will be able to raise any such capital on terms acceptable to
us, if at all.







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Bank Loan Agreements


Refer to Note 6 of the Notes to the Unaudited Condensed Consolidated Financial Statements, included in Part I, Item 1 of this report, which is incorporated herein by reference, for a discussion of our loan agreements.


Cash Flows


The following table presents the main components of the unaudited condensed consolidated statements of cash flows:


                                              Three Months Ended
                                                 September 30,
                                              2022          2021         Change
                                                (In thousands)
Net cash used in operating activities       $  (4,666 )   $    (516 )   $  (4,150 )
Net cash used in investing activities          (5,606 )     (24,092 )      18,486
Net cash provided by financing activities       6,176        25,139       (18,963 )




Operating Activities



Cash used in operating activities during the three months ended September 30,
2022 increased compared to the prior year period. For the three months ended
September 30, 2022, our net loss included $3,592,000 of non-cash charges, while
the changes in operating assets and liabilities used net cash of $6,605,000.



Our net inventories increased by $7,581,000, or 20.1%, from June 30, 2022 to
September 30, 2022. Of this increase, $3,590,000 of net inventories were
acquired in the Uplogix acquisition. The remainder of the increase resulted
primarily from a build-up of critical long-lead time components as we continue
to experience lead time and supply constraints.



Accounts payable decreased by $5,266,000, or 25.5%, from June 30, 2022 to
September 30, 2022, which was slightly offset by the acquisition of $278,000 of
accounts payable from the Uplogix acquisition. The reduction is primarily due to
the timing of our inventory purchases and related payments to our vendors.

Investing Activities



Net cash used in investing activities during the three months ended September
30, 2022 was driven by the acquisition of Uplogix, which used net cash of
$4,650,000. We also used cash for the purchase of property and equipment,
primarily related to building out and furnishing our new lease facilities in
California and Minnesota.



Financing Activities



Net cash provided by financing activities during the three months ended
September 30, 2022 resulted primarily from (i) $7,000,000 in gross proceeds
received from our credit facilities with SVB. The increase in cash was partially
offset by payments on the senior credit facility as well as tax withholdings
paid on behalf of employees for restricted shares.







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