LANTRONIX INC - Quarter Report: 2016 December (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended December 31, 2016

OR

For the transition period from _________ to ___________.

Commission file number: 1-16027 

LANTRONIX, INC.

(Exact name of registrant as specified in its charter)

7535 Irvine Center Drive, Suite 100, Irvine, California

(Address of principal executive offices)

92618

(Zip Code)

(949) 453-3990

(Registrant’s telephone number, including area code)

                    Not Applicable                    

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes o No x

As of January 20, 2017, there were 17,469,935 shares of the registrant’s common stock outstanding.

LANTRONIX, INC.

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED

December 31, 2016

INDEX

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q for the three months ended December 31, 2016, or this Report, contains forward-looking statements within the meaning of the federal securities laws, which statements are subject to substantial risks and uncertainties. These forward-looking statements are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact included in this Report, or incorporated by reference into this Report, are forward-looking statements. Throughout this Report, we have attempted to identify forward-looking statements by using words such as “may,” “believe,” “will,” “could,” “project,” “anticipate,” “expect,” “estimate,” “should,” “continue,” “potential,” “plan,” “forecasts,” “goal,” “seek,” “intend,” other forms of these words or similar words or expressions or the negative thereof. In particular, this Report contains forward-looking statements relating to, among other things:

We have based our forward-looking statements on management’s current expectations and projections about trends affecting our business and industry and other future events. Although we do not make forward-looking statements unless we believe we have a reasonable basis for doing so, we cannot guarantee their accuracy. Forward-looking statements are subject to substantial risks and uncertainties that could cause our future business, financial condition, results of operations or performance, to differ materially from our historical results or those expressed or implied in any forward-looking statement contained in this Report. Some of the risks and uncertainties that may cause actual results to differ from those expressed or implied in the forward-looking statements are described in “Risk Factors” included in Part II, Item 1A of this Report, our Annual Report on Form 10-K for the fiscal year ended June 30, 2016, or the Form 10-K, filed with the Securities and Exchange Commission, or the SEC, on August 24, 2016, as well as in our other public filings with the SEC. In addition, actual results may differ as a result of additional risks and uncertainties of which we are currently unaware or which we do not currently view as material to our business.

You should read this Report in its entirety, together with the Form 10-K, the documents that we file as exhibits to this Report and the documents that we incorporate by reference into this Report, with the understanding that our future results may be materially different from what we currently expect. The forward-looking statements we make speak only as of the date on which they are made. We expressly disclaim any intent or obligation to update any forward-looking statements after the date hereof to conform such statements to actual results or to changes in our opinions or expectations, except as required by applicable law or the rules of The Nasdaq Stock Market, LLC. If we do update or correct any forward-looking statements, investors should not conclude that we will make additional updates or corrections.

We qualify all of our forward-looking statements by these cautionary statements.

PART I. FINANCIAL INFORMATION

LANTRONIX, INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

See accompanying notes.

LANTRONIX, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(1) Includes net revenue from related parties

See accompanying notes.

LANTRONIX, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

See accompanying notes.

LANTRONIX, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2016

The Company

Lantronix, Inc. (the “Company,” “Lantronix,” “we,” “our,” or “us”) is a global provider of secure data access and management for Internet of Things (“IoT”) and information technology assets. Our mission is to be the leading provider of IoT gateways that enable companies to dramatically simplify the creation, deployment, and management of IoT projects while providing secure access to data for applications and people.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Lantronix have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 8 of Securities and Exchange Commission (“SEC”) Regulation S-X. Accordingly, they should be read in conjunction with the audited consolidated financial statements and notes thereto for the fiscal year ended June 30, 2016, included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2016, which was filed with the SEC on August 24, 2016. The unaudited condensed consolidated financial statements contain all normal recurring accruals and adjustments that in the opinion of management, are necessary to present fairly the consolidated financial position of Lantronix at December 31, 2016 and the consolidated results of our operations for the three and six months ended December 31, 2016 and our consolidated cash flows for the six months ended December 31, 2016. All intercompany accounts and transactions have been eliminated. It should be understood that accounting measurements at interim dates inherently involve greater reliance on estimates than at year-end. The results of operations for the three and six months ended December 31, 2016 are not necessarily indicative of the results to be expected for the full year or any future interim periods.

Recent Accounting Pronouncements 

In March 2016, the Financial Accounting Standards Board (“FASB”) issued accounting guidance that changes how companies account for certain aspects of share-based payments to employees. Among other things, under the new guidance companies will no longer record excess tax benefits and certain tax deficiencies in additional paid-in-capital (“APIC”), but will instead record such items as income tax expense or benefit in the income statement, and APIC pools will be eliminated. Companies will apply this guidance prospectively. Another component of the new guidance allows companies to make an accounting policy election for the impact of forfeitures on the recognition of expense for share-based payment awards, whereby forfeitures can be estimated, as required historically, or recognized when they occur. If elected, the change to recognize forfeitures when they occur needs to be adopted using a modified retrospective approach. Lantronix adopted this guidance early for the fiscal year beginning July 1, 2016. In connection with the adoption, we have elected to recognize the impact of forfeitures on our share-based compensation expense as such forfeitures occur. Accordingly, as of July 1, 2016, we recorded a cumulative effect adjustment of approximately $6,000 to increase APIC and accumulated deficit. Going forward, we do not expect the adoption of this guidance to have a material effect on our financial statements.

In February 2016, FASB issued an accounting standard that revises lease accounting guidance. The standard requires lessees to put most leases on their balance sheets, but recognize expenses on their income statements in a manner similar to the previous guidance. The standard will be effective for Lantronix in the fiscal year beginning July 1, 2019. Early adoption is permitted. We are currently evaluating the impact of this standard on our financial statements and related disclosures.

In August 2014, FASB issued an accounting standard which requires management of an entity to assess, for each annual and interim period, if there is substantial doubt about the entity’s ability to continue as a going concern within one year of the financial statement issuance date. The definition of substantial doubt within the new standard incorporates a likelihood threshold of “probable” similar to the use of that term under current U.S. GAAP for loss contingencies. Certain disclosures are required if conditions give rise to substantial doubt about the entity’s ability to continue as a going concern. The standard became effective for Lantronix for the fiscal year beginning July 1, 2016. The adoption of this standard did not have a material impact on our financial statements and related disclosures.

Revenue from Contracts with Customers

In May 2014, FASB issued an accounting standard which superseded existing revenue recognition guidance under current U.S. GAAP. The standard is a comprehensive revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. In doing so, among other things, companies will generally need to use more judgment and make more estimates than under the current guidance. Recently, FASB has issued guidance clarifying certain topics such as (i) gross versus net revenue reporting, (ii) identifying performance obligations and licensing and (iii) accounting for shipping and handling fees and costs and accounting for consideration given by a vendor to a customer.

The standard permits two methods of adoption: (i) retrospectively to each prior reporting period presented (the full retrospective method), or (ii) retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application (the cumulative catch-up transition method). We currently anticipate adopting the standard using the full retrospective method to restate each prior reporting period presented.

The standard will be effective for Lantronix in the fiscal year beginning July 1, 2018, with an option to adopt the standard in the fiscal year beginning July 1, 2017. We are currently considering the effective date on which we plan to adopt the standard.

We currently anticipate the standard will have a material impact on our financial statements and disclosures. While we continue to assess all potential impacts of the standard, we currently believe the most significant impact relates to our accounting for sales made to distributors under agreements which contain a limited right to return unsold products and price adjustment provisions. Under the existing revenue guidance, we have historically concluded that the price to these distributors is not fixed and determinable at the time we deliver products to them. Accordingly, revenue from sales to these distributors has not historically been recognized until the distributor resells the product. By contrast, under the new standard, we expect to recognize revenue, including estimates for applicable variable consideration, predominately at the time of shipment to these distributors.

Inventories

Inventories are stated at the lower of cost (first-in, first-out) or net realizable value and consist of the following:

Other Liabilities

The following table presents details of our other liabilities:

Computation of Net Income (Loss) per Share

Basic and diluted net income (loss) per share is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding during the applicable period.

The following table presents the computation of net income (loss) per share:

The following table presents the common stock equivalents excluded from the diluted net income (loss) per share calculation, because they were anti-dilutive for the periods presented. These excluded common stock equivalents could be dilutive in the future.

Supplemental Cash Flow Information

The following table presents non-cash investing and financing transactions excluded from the unaudited condensed consolidated statements of cash flows:

The standard warranty periods for our products typically range from one to five years. We establish reserves for estimated product warranty costs at the time revenue is recognized based upon our historical warranty experience, and additionally, for any known product warranty issues. Our warranty obligation is affected by product failure rates, and the use of materials or service delivery costs, which could differ from our estimates. As a result, increases or decreases to warranty reserves could be required, which could impact our gross margins.

The following table presents details of our warranty reserve:

On September 22, 2016, we entered into an amendment (the “Amendment”) to our existing Loan and Security Agreement dated May 23, 2006 (as amended, the “Loan Agreement”) with Silicon Valley Bank (“SVB”). The Amendment provides, among other things, for a renewal of our $4.0 million revolving line of credit, based on qualified accounts receivable, with an extended maturity date of September 30, 2018.

The Loan Agreement provides for an interest rate per annum equal to the greater of the prime rate plus 0.75% or 4.25%, provided that we maintain a monthly quick ratio of 1.0 to 1.0 or greater. The quick ratio measures our ability to use our cash and cash equivalents maintained at SVB to extinguish or retire our current liabilities immediately. If this ratio is not met, the interest rate will become the greater of the prime rate plus 1.25% or 4.25%. At December 31, 2016, we met the 1.0 to 1.0 or greater quick ratio.

The Loan Agreement includes a covenant requiring us to maintain a certain Minimum Tangible Net Worth (“Minimum TNW”), currently required to be approximately $6.0 million. The Minimum TNW is subject to adjustment upward to the extent we raise additional equity or debt financing or achieve net income in future quarters. Our Actual Tangible Net Worth (“Actual TNW”) is calculated as total stockholders’ equity, less goodwill.

The following table presents the Minimum TNW compared to our Actual TNW:

The following table presents certain information with respect to the Loan Agreement with SVB:

Our outstanding letters of credit were used as security deposits.

Stock Incentive Plans

Our stock incentive plans permit the granting of stock options (both incentive and nonqualified stock options), restricted stock units (“RSUs”), stock appreciation rights, non-vested stock, and performance shares to certain employees, directors and consultants. As of December 31, 2016, no stock appreciation rights, non-vested stock, or performance shares were outstanding.

Stock Options

The following table presents a summary of activity during the six months ended December 31, 2016 with respect to our stock options:

Restricted Stock Units

The following table presents a summary of activity during the six months ended December 31, 2016 with respect to our RSUs:

In December 2016, 150,000 RSUs vested pursuant to a RSU grant made in April 2016 to Jeffrey Benck, our chief executive officer. In connection with the vesting of these RSUs, we issued approximately 94,000 shares of our common stock to Mr. Benck, and withheld the remaining 56,000 shares for purposes of employee payroll taxes.

Employee Stock Purchase Plan 

Our 2013 Employee Stock Purchase Plan (the “ESPP”) is intended to provide employees with an opportunity to purchase our common stock through accumulated payroll deductions at the end of a specified purchase period. Each of our employees (including officers) is eligible to participate in the ESPP, subject to certain limitations as set forth in the ESPP.

The following table presents a summary of activity under our ESPP during the six months ended December 31, 2016:

Share-Based Compensation Expense

The following table presents a summary of share-based compensation expense included in each functional line item on our unaudited condensed consolidated statements of operations:

The following table presents the remaining unrecognized share-based compensation expense related to our outstanding share-based awards as of December 31, 2016:

If there are any modifications or cancellations of the underlying unvested share-based awards, we may be required to accelerate, increase or cancel remaining unearned share-based compensation expense. Future share-based compensation expense and unearned share-based compensation will increase to the extent that we grant additional share-based awards.

We utilize the liability method of accounting for income taxes. The following table presents our effective tax rates based upon our provision for income taxes for the periods shown:

The difference between our effective tax rates in the periods presented above and the federal statutory rate is primarily due to a tax benefit from our domestic losses being recorded with a full valuation allowance, as well as the effect of foreign earnings taxed at rates differing from the federal statutory rate.

We record net deferred tax assets to the extent that we believe these assets will more likely than not be realized. As a result of our cumulative losses and uncertainty of generating future taxable income, we have provided a full valuation allowance against our net deferred tax assets as of December 31, 2016 and June 30, 2016.

From time to time, we are involved in various legal proceedings and claims arising in the ordinary course of our business. Although the results of legal proceedings and claims cannot be predicted with certainty, we currently believe that the final outcome of these ordinary course matters will not, individually or in the aggregate, have a material adverse effect on our business, operating results, financial condition or cash flows. However, regardless of the outcome, litigation can have an adverse impact on us because of legal costs, diversion of management time and resources, and other factors. 

You should read the following discussion and analysis in conjunction with our unaudited condensed consolidated financial statements and related notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q for the three months ended December 31, 2016, or this Report, the “Risk Factors” included in Part II, Item 1A of this Report and in our Annual Report on Form 10-K for the fiscal year ended June 30, 2016, or the Form 10-K, filed with the Securities and Exchange Commission, or the SEC, on August 24, 2016, as well as the Cautionary Note Regarding Forward Looking Statements described elsewhere in this Report, before deciding to purchase, hold or sell our common stock. 

Overview

Lantronix, Inc., which we refer to herein as the Company, Lantronix, we, our, or us, is a global provider of secure data access and management solutions for Internet of Things, or IoT, and information technology, or IT, assets. Our mission is to be the leading supplier of IoT gateways that enable companies to dramatically simplify the creation, deployment, and management of IoT projects while providing secure access to data for applications and people.

We conduct our business globally and manage our sales teams by three geographic regions: the Americas; Europe, Middle East, and Africa, or EMEA; and Asia Pacific Japan, or APJ.

Products and Solutions Overview

We organize our products and solutions into three product lines: IoT, IT Management and Other. 

IoT

Our IoT products typically connect to one or more existing machines, provide network connectivity and are designed to enhance the value and utility of machines by making the data from the machines available to users, systems and processes or by controlling their properties and features over available networks.

Our IoT products currently consist of IoT Gateways and IoT Building Blocks. IoT Gateways are designed to provide secure connectivity and the ability to add integrated device management and advanced data access features. IoT Building Blocks provide basic secure machine connectivity and unmanaged data access.

The following product families are included in our IoT product line: EDS, EDS-MD®, PremiereWave® product families, UDS, WiPort®, xDirect®, xPico®, xPico® Wi-Fi, xPress™  and XPort®,

IT Management

Our IT Management product line includes console management, power management, and keyboard video mouse products that provide remote out-of-band management access to IT and networking infrastructure deployed in test labs, data centers and server rooms.

The following product families are included in our IT Management product line: SLB™, SLC™ 8000 and Spider™. In addition, our IT Management product line includes vSLM™, a virtualized central management solution that simplifies secure administration of enterprise IT out-of-band devices and attached equipment through a standard web browser. vSLM is designed to operate with both our IT Management products and certain other manufacturers’ IT infrastructure equipment.

Other

We categorize products that are non-focus or end-of-life as Other. Our Other product line includes non-focus products such as the xPrintServer®, xSenso®, and WiBox®. In addition, our Other product line includes end-of-life versions of our MatchPort®, SLC™, SLP™, and xPress Pro™ product families.

Recent Accounting Pronouncements

Refer to Note 1 of Notes to 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.

Critical 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, warranty reserves, allowance for doubtful accounts, inventory valuation, valuation of deferred income taxes, and goodwill. These policies are described in further detail in the Form 10-K. There have been no significant changes in our critical accounting policies and estimates during the three months ended December 31, 2016 as compared to what was previously disclosed in the Form 10-K.

Results of Operations – Three Months Ended December 31, 2016 Compared to the Three Months Ended December 31, 2015

Summary

In the three months ended December 31, 2016 our net revenue increased by $1.7 million, or 17.6%, compared to the three months ended December 31, 2015. The increase in net revenue was primarily due to sales growth in both our IoT and IT Management product lines, which was partially offset by a decrease in net revenue in our Other product line. We had net income of $41,000 for the three months ended December 31, 2016 compared to a net loss of $928,000 for the three months ended December 31, 2015. This improvement in profitability was principally driven by the increase in net revenue and a 26.7% increase in gross profit, partially offset by increased operating expenses of approximately 3.9%.

Net Revenue

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

IoT

Net revenue from our IoT product line for the three months ended December 31, 2016 increased compared to the three months ended December 31, 2015 due to growth in unit sales from a variety of our product families including XPort across all three geographic regions, as well as both xPico and xDirect, largely in the Americas region. 

IT Management

Net revenue from our IT Management product line for the three months ended December 31, 2016 increased compared to the three months ended December 31, 2015 primarily due to growth in our SLC 8000 product family, largely in the Americas region, and to a lesser extent, the EMEA and APJ regions. We also experienced growth in our SLB product family, primarily in the Americas region.

Other

As expected, our Other products, which are comprised of non-focus and end-of-life product families, continued to decline.

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, manufacturing overhead, establishing or relieving inventory reserves for excess and obsolete products or raw materials, warranty costs, royalties and share-based compensation.

The following table presents our fiscal quarter gross profit:

Gross profit as a percent of revenue (referred to as “gross margin”) for the three months ended December 31, 2016 improved compared to the three months ended December 31, 2015 primarily due to lower overhead costs. Additionally, we benefited from improved product mix as some of our higher margin products, such as the SLC 8000, contributed to a larger portion of our net revenue.

Selling, General and Administrative

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 fiscal quarter selling, general and administrative expenses:

Overall, selling, general and administrative expenses increased slightly due to higher headcount-related expenses, primarily related to variable compensation. The overall increase was largely offset by (i) severance expenses from the prior year quarter that did not recur in the current quarter and (ii) lower spending on outside marketing programs and trade shows in connection with our efforts over the last several quarters to reevaluate and focus our marketing activities.

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 fiscal quarter research and development expenses:

Research and development expenses increased primarily due to higher personnel-related expenses, driven by (i) higher variable compensation and (ii) additional headcount attributable to the growth of our engineering team in India. The overall increase in research and development expenses was partially offset by a decrease in spending for outside services for engineering resources, as we have redirected a large portion of this spending toward funding the expansion of our new team in India. We also saw a decrease in product certifications costs as a result of the timing of certain development projects.

Results of Operations – Six Months Ended December 31, 2016 Compared to the Six Months Ended December 31, 2015

Summary

In the six months ended December 31, 2016 our net revenue increased by $2.0 million, or 10.2%, compared to the six months ended December 31, 2015. The increase in net revenue was primarily due to sales growth in both our IoT and IT Management product lines, which was partially offset by a decrease in net revenue in our Other product line. We had a net loss of $63,000 for the six months ended December 31, 2016 compared to a net loss of $1.3 million for the six months ended December 31, 2015. The decrease in net loss was principally driven by the increase in net revenue and a 19.2% increase in gross profit. The overall decrease in our net loss was partially offset by a 5.6% increase in operating expenses.

Net Revenue

The following tables present our fiscal year-to-date net revenue by product line and by geographic region:

IoT

Net revenue from our IoT product line for the six months ended December 31, 2016 increased compared to the six months ended December 31, 2015 due to growth in unit sales from a variety of our product families including the xPico in the Americas and EMEA regions, as well as the XPort, xDirect and Premierwave XN product families, largely in the Americas region. The overall increase was partially offset by (i) a decrease in unit sales of our XPort and xPico WiFi product families in EMEA and (ii) a decline in unit sales of some of our other legacy product families.

IT Management

Net revenue from our IT Management product line for the six months ended December 31, 2016 increased compared to the six months ended December 31, 2015 primarily due to growth in our SLC 8000 product family, largely in the Americas region, and to a lesser extent, the EMEA and APJ regions. We also experienced growth in our SLB product family, primarily in the Americas region.

Other

As expected, our Other products, which are comprised of non-focus and end-of-life product families, continued to decline.

Gross Profit

The following table presents our fiscal year-to-date gross profit:

Gross margin for the six months ended December 31, 2016 improved compared to the six months ended December 31, 2015 primarily due to improved product mix as some of our higher margin products, such as the SLC 8000, contributed to a larger portion of our net revenue.

Selling, General and Administrative

The following table presents our fiscal year-to-date selling, general and administrative expense:

Overall, selling, general and administrative expenses increased slightly due primarily to higher headcount-related expenses, primarily related to variable compensation. The overall increase was largely offset by (i) lower spending on outside marketing programs and trade shows in connection with our efforts over the last several quarters to reevaluate and focus our marketing activities, (ii) severance expenses during the during the six months ended December 31, 2015 that did not recur during the six months ended December 31, 2016 and (iii) lower legal and patent-related fees.

Research and Development

The following table presents our fiscal year-to-date research and development expenses:

Research and development expenses increased primarily due to higher personnel-related expenses, driven by (i) higher variable compensation and (ii) additional headcount attributable to the growth of our engineering team in India. The overall increase in research and development expenses was partially offset by a decrease in spending for outside services for engineering resources, as we have redirected a large portion of this spending toward funding the expansion of our new team in India. We also saw a decrease in product certifications costs as a result of the timing of certain development projects.

Provision for Income Taxes

The following table presents our effective tax rate based upon our provision for income taxes:

We utilize the liability method of accounting for income taxes. The difference between our effective tax rates and the federal statutory rate resulted primarily from a tax benefit from our domestic losses being recorded with a full valuation allowance, as well as the effect of foreign earnings taxed at rates differing from the federal statutory rate.

We record net deferred tax assets to the extent that we believe these assets will more likely than not be realized. As a result of our cumulative losses and uncertainty of generating future taxable income, we have provided a full valuation allowance against our net deferred tax assets as of December 31, 2016 and June 30, 2016.

Liquidity and Capital Resources

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

Our principal sources of cash and liquidity include our existing cash and cash equivalents, borrowings available under our loan agreement, 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 and working capital requirements.

Management defines 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 investment policy primarily emphasizes safety of principal and secondarily emphasizes maximizing yield.

Our future working capital requirements will depend on many factors, including the timing and amount of our net revenue, any future restructuring or cost-cutting measures that we may implement from time to time, research and development expenses, expenses associated with any strategic partnerships or acquisitions, infrastructure investments and fundraising activities.

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 restrictions limiting or restricting our ability to operate our business or be required to encumber all or a portion of 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.

Loan Agreement

Refer to Note 4 of Notes to 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 agreement.

Cash Flows

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

Operating Activities

Net cash provided by operating activities during the six months ended December 31, 2016 increased as compared to cash used by operating activities during the six months ended December 31, 2015 primarily due to a decrease in our net loss to $63,000 in the six months ended December 31, 2016 as compared to our $1.3 million net loss in the six months ended December 31, 2015.

Inventories increased approximately $1.0 million, or 15.6%, as compared to June 30, 2016 as we have (i) made efforts to increase stock in certain products and (ii) experienced an increase in inventory held by certain distributors. The impact of the increase in inventories on operating cash flows was largely offset by increases in (i) accrued payroll and expenses related to accruals for variable compensation and (ii) other current liabilities. Cash provided by operating activities during the six months ended December 31, 2016 increased due to a decrease in accounts receivable of approximately 9.4% from June 30, 2016 to December 31, 2016, which was driven by differences in the timing of our sales during the quarter ended December 31, 2016 as compared to the quarter ended June 30, 2016.

Investing Activities

Net cash used in investing activities was related to capital expenditures for the purchase of property and equipment, primarily related to tooling and test equipment, as well as acquisitions of hardware and equipment related to our new software lab in India.

Financing Activities

Net cash used in financing activities during the six months ended December 31, 2016 related to payments for (i) withholding taxes in connection with the vesting of restricted stock units which had been granted to our chief executive officer and (ii) capital leases. This was substantially offset by cash received from the issuance of common stock to employees in connection with purchases made under our Employee Stock Purchase Plan.

Off-Balance Sheet Arrangements

As part of our ongoing business, we have not participated in transactions that generate material relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, or SPEs, which may be established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of December 31, 2016, we were not involved in any material relationships with unconsolidated SPEs. 

As a smaller reporting company, we are not required to provide the information required by this Item 3.

(a) Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and (ii) is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. 

We carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Report. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of December 31, 2016 at the reasonable assurance level.

(b) Changes in Internal Controls over Financial Reporting

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(f) and 15d-15(f) of the Exchange Act that occurred during the quarter ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

(c) Inherent Limitation on Effectiveness of Controls

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are 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, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance 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 the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART II. OTHER INFORMATION

From time to time, we are involved in various legal proceedings and claims arising in the ordinary course of our business. Although the results of legal proceedings and claims cannot be predicted with certainty, we currently believe that the final outcome of these ordinary course matters will not, individually or in the aggregate, have a material adverse effect on our business, operating results, financial condition or cash flows. However, regardless of the outcome, litigation can have an adverse impact on us because of legal costs, diversion of management time and resources, and other factors.  

An investment in our common stock involves risks. Before making an investment decision, you should carefully consider all of the information in this Report, including in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I, Item 2 of this Report, and the unaudited condensed consolidated financial statements and related notes thereto. In addition, you should carefully consider the risks and uncertainties described in the section entitled “Risk Factors” in the Form 10-K, as well as in our other public filings with the SEC. If any of the identified risks are realized, our business, financial condition, operating results and prospects could be materially and adversely affected. In that case, the trading price of our common stock may decline, and you could lose all or part of your investment. In addition, other risks of which we are currently unaware, or which we do not currently view as material, could have a material adverse effect on our business, financial condition, operating results and prospects.

None.

None.

Not applicable.

None.

See the Exhibit Index immediately following the signature page of this Report, which is incorporated herein by reference.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Exhibit Index

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