LANTRONIX INC - Quarter Report: 2019 September (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2019

OR

o      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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)

Securities registered pursuant to Section 12(b) of the Act:

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 every Interactive Data File required to be submitted 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 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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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 November 8, 2019, there were 23,063,077 shares of the registrant’s common stock outstanding.

LANTRONIX, INC.

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED

SEPTEMBER 30, 2019

INDEX

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q for the three months ended September 30, 2019, 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. These forward-looking statements relate 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 I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended June 30, 2019, filed with the Securities and Exchange Commission (the “SEC”), on September 11, 2019, or the Form 10-K, 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 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 Capital Market. 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)

See accompanying notes.

LANTRONIX, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands)

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

SEPTEMBER 30, 2019

The Company

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 (“IoT”) assets. Our mission is to be the leading supplier of IoT and related Information Technology (“IT”) management solutions 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 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, 2019, included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2019, which was filed with the SEC on September 11, 2019. 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 September 30, 2019, and the consolidated results of our operations and cash flows for the three months ended September 30, 2019. All intercompany accounts and transactions have been eliminated. Accounting measurements at interim dates inherently involve greater reliance on estimates than at year-end. The results of operations for the three months ended September 30, 2019 are not necessarily indicative of the results to be expected for the full year or any future interim periods.

Reclassifications

Certain reclassifications have been made to the prior fiscal year financial information to conform with the current fiscal year presentation.

Recent Accounting Pronouncements

Shared-Based Compensation

On July 1, 2019 Lantronix adopted Accounting Standard Update No. 2018-07 that expands the scope of existing share-based compensation guidance for employees. The standard includes share-based payment transactions for acquiring goods and services from nonemployees, whereby share-based payments to nonemployees will be measured and recorded at the fair value of the equity instruments that an entity is obligated to issue on the grant date. The adoption of the standard did not have a material impact on our financial statements.

Leases

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2016-02 (“ASU 2016-02” or “Topic 842”) that revises lease accounting guidance. Most prominent among the changes in the standard is the recognition of right-of-use (“ROU”) assets and lease liabilities based on the present value of lease payments over the lease term by lessees for those leases classified as operating leases under the existing guidance.

The Company adopted Topic 842 on July 1, 2019 using the modified retrospective approach by applying the new standard to leases existing at the date of adoption and not restating comparative prior periods. The adoption did not have a material impact on the Company’s results of operations or cash flows. Refer to Note 3 below for additional information.

The following tables present our net revenue by product line and by geographic region. Net revenues by geographic region are based on the “bill-to” location of our customers:

Contract Balances

In certain instances, the timing of revenue recognition may differ from the timing of invoicing to our customers. We record a contract asset receivable when revenue is recognized prior to invoicing, and a contract or deferred revenue liability when revenue is recognized subsequent to invoicing. With respect to product shipments, we expect to fulfill contract obligations within one year and so we have elected not to separately disclose the amount nor the timing of recognition of these remaining performance obligations. For contract balances related to contracts that include services and multiple performance obligations, refer to the deferred revenue discussion below.

Deferred Revenue

Deferred revenue is currently comprised primarily of unearned revenue related to our extended warranty services. These services are generally invoiced at the beginning of the contract period and revenue is recognized ratably over the service period. Current and non-current deferred revenue balances represent revenue allocated to the remaining unsatisfied performance obligations at the end of a reporting period and are respectively included in other current liabilities and other non-current liabilities in the accompanying condensed consolidated balance sheets.

The following table presents the changes in our deferred revenue balance for the three months ended September 30, 2019 (in thousands):

We expect to recognize substantially all of the non-current portion of deferred revenue over the next two to four years.

On July 5, 2019 (the "Acquisition Date"), Lantronix acquired all outstanding shares of Maestro Wireless Solutions Limited, a Hong Kong private company limited by shares (“MWS”), Fargo Telecom Asia Limited, a Hong Kong private company limited by shares (“FTA” and together with MWS and their respective subsidiaries, the “Acquired Companies” or “Maestro”) for $5,355,000 in cash. The acquisition provides various additional and complementary cellular connectivity technologies to our portfolio of IoT solutions.

We recorded Maestro’s tangible and intangible assets and liabilities based on their estimated fair values as of the Acquisition Date and allocated the remaining purchase consideration to goodwill. The Company’s valuation assumptions of acquired assets and assumed liabilities require significant estimates, especially with respect to intangible assets. The consideration allocation set forth herein is preliminary and may be revised as additional information becomes available during the measurement period which could be up to 12 months from the Acquisition Date. Any such revisions or changes may be material. The preliminary purchase price allocation is as follows (in thousands):

The factors that contributed to a purchase price resulting in the recognition of goodwill include our belief that the acquisition will create a more diverse IoT company with respect to product offerings and our belief that we are committed to improving cost structures in accordance with our operational and restructuring plans which should result in a realization of cost savings and an improvement of overall efficiencies.

Acquisition-related costs are expensed in the periods in which the costs are incurred.

The valuation of identifiable intangible assets and their estimated useful lives are as follows:

The intangible assets are amortized on a straight-line basis over the estimated weighted average useful lives.

Supplemental Pro Forma Information

The following supplemental pro forma data summarizes the Company’s results of operations for the periods presented, as if we completed the acquisition of Maestro as of the first day of fiscal 2019. The supplemental pro forma data reports actual operating results adjusted to include the pro forma effect and timing of the impact in amortization expense of identified intangible assets, restructuring costs, the purchase accounting effect on inventories acquired, and transaction costs. In accordance with the pro forma acquisition date, we recorded in the fiscal 2019, supplemental pro forma data (i) cost of goods sold from manufacturing profit in acquired inventory of $171,000, (ii) Maestro related restructuring costs of $469,000 and (iii) acquisition-related costs of $581,000, with a corresponding reduction in the fiscal 2020 supplemental proforma data. Additionally, we recorded $144,000 of amortization expense in the fiscal 2019 supplemental pro-forma data, and reversed amortization expense of $51,000 in the fiscal 2020 supplemental pro forma data to represent the amount related to assets that would have been fully amortized.

Net sales related to products from the acquisition of Maestro contributed approximately 25% to 29% of net sales for the three months ended September 30, 2019. Post-acquisition net sales and earnings on a standalone basis are generally impracticable to determine, as on the Acquisition Date, we implemented a plan developed prior to the completion of the acquisition and began to immediately integrate the acquisition into existing operations, engineering groups, sales distribution networks and management structure. 

Supplemental pro forma data is as follows:

On July 1, 2019, the Company adopted Topic 842 and elected the available practical expedient to recognize the cumulative effect of initially adopting the standard as an adjustment to the opening balance sheet of the period of adoption (i.e., July 1, 2019). The Company also elected the other available practical expedients and will not separate lease components from non-lease components for office leases, or reassess historical lease classification, whether existing or expired contracts are or contain leases, or the initial direct costs for existing leases as of July 1, 2019. The condensed consolidated balance sheets and results from operations for reporting periods beginning after July 1, 2019 are presented under Topic 842, while prior period amounts are not adjusted and continue to be reported in accordance with the historic accounting under Topic 840.

Adoption of the standard resulted in the recording of net operating and financing lease ROU assets and corresponding operating and financing lease liabilities of $984,000 and $1,114,000, respectively on July 1, 2019. The adoption of the standard did not materially affect the condensed consolidated statements of operations and had no impact on cash flows.

The Company's leases include office buildings for its facilities worldwide and car leases in Germany, which are all classified as operating leases. The Company also has a financing lease related to R&D equipment in the United States.

The Company determines if an arrangement is a lease at inception. Certain leases include renewal options that are under the Company's sole discretion. The renewal options were included in the ROU asset and lease liability calculation if it is reasonably assured that the Company will exercise the option. As the Company's leases generally do not provide an implicit rate, the Company uses its collateralized incremental borrowing rate based on the information available at the lease commencement date, including lease term, in determining the present value of lease payments. Lease expense for these leases is recognized on a straight-line basis over the lease term.

Components of lease expense and supplemental cash flow information:

The weighted average remaining lease term is 1.7 years. The weighted average discount rate is 6.39 percent.

Maturities of lease liabilities as of September 30, 2019 were as follows:

The lease liabilities and ROU assets as of September 30, 2019 include leases assumed in the acquisition of Maestro if the remaining lease term at the acquisition date was determined to exceed one year. Refer to Note 4 below for further information on the acquisition of Maestro. As of September 30, 2019, the ROU assets totaled $957,000 and were recorded in other assets in the unaudited condensed consolidated balance sheet.

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 Loss per Share

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

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

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

Severance and Related Charges

Current Fiscal Year

During the three months ended September 30, 2019, we continued a plan to realign certain personnel resources to better fit our current business needs, particularly as it relates to identifying cost savings and synergies to be gained from the acquisition of Maestro. These activities resulted in a total charge of approximately $749,000.

The following table presents details of the liability we recorded related to these activities:

The ending balance is recorded in accrued payroll and related expenses on the accompanying unaudited condensed consolidated balance sheet at September 30, 2019.

Prior Fiscal Year

During the three months ended September 30, 2018, we executed a plan to realign certain personnel resources to better fit our current business needs. These activities were substantially completed by September 30, 2018 and resulted in a total charge of approximately $323,000 of severance costs.

Supplemental Cash Flow Information

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

The standard warranty periods we provide 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 for any known or anticipated product warranty issues.

The following table presents details of our warranty reserve:

In October 2018, we entered into a Loan and Security Agreement (the “Loan Agreement”) with Silicon Valley Bank (“SVB”). The Loan Agreement provided us with a $4.0 million revolving line of credit based on qualified accounts receivable and had a maturity date of September 30, 2020. There were no outstanding borrowings as of September 30, 2019 or June 30, 2019.

The Loan Agreement provides for an interest rate per annum equal to the greater of (i) the prime rate plus 0.50% or (ii) 5.00%, 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 (i) the prime rate plus 1.00% or (ii) 5.00%. At September 30, 2019, we met the quick ratio requirement.

The Loan Agreement also includes a covenant requiring us to maintain a certain Minimum Tangible Net Worth (“Minimum TNW”), currently required to be $7,750,000. The Minimum TNW is subject to adjustment upward to the extent we raise additional equity or debt financing or achieve net income in future periods. Our Actual Tangible Net Worth (“Actual TNW”) is calculated as total stockholders’ equity, less goodwill and other intangible assets. At September 30, 2019, our Actual TNW was $21,166,000.

On November 12, 2019, we entered into a Second Amended and Restated Loan and Security Agreement (“Amended Agreement”) with Silicon Valley Bank, which amended, restated and superseded the Loan Agreement in its entirety.

Pursuant to the Amended Agreement, SVB has agreed to make available to us a senior secured revolving line of credit of up to $6 million (“Revolving Facility”) and a senior secured term loan of up to $6 million (“Term Loan Facility”). Advances under the Revolving Facility may be borrowed from time to time prior to November 12, 2021, subject to the satisfaction of certain conditions, and may be used to fund our working capital and general business requirements. The proceeds of the Term Loan Facility were drawn in full at closing and may be used solely to fund our acquisition of Intrinsyc, refer to Note 11 below for further information on the acquisition of Intrinsyc. In the event the Intrinsyc acquisition is not consummated prior to January 31, 2020, we must immediately repay the obligations under the Term Loan Facility. The Revolving Facility matures on November 12, 2021. The Term Loan Facility is repayable over a 48 month period commencing January 1, 2020 after an initial interest-only period following closing.

The interest rate on the Revolving Facility floats at a rate per annum equal to the greater of the prime rate and 5.00 percent. The interest rate on the Term Loan Facility floats at a rate per annum equal to the greater of 1.00 percent above the prime rate and 6.00 percent. We may elect to repay and reborrow the amounts outstanding under the Revolving Facility at any time prior to the maturity date of the Revolving Facility without premium or penalty. We may elect to repay the Term Loan Facility at any time without premium or penalty in minimum amounts equal to at least $1,000,000. A commitment fee in the amount of $60,000 was paid to the Lender on the closing date and a $10,000 anniversary fee is payable to the Lender on the earliest to occur of the one year anniversary of the effective date, the termination of the Amended Agreement or the Revolving Facility, or the occurrence of an event of default.

The Amended Agreement includes a financial covenant that requires that we maintain a minimum cash balance of $3,000,000 at SVB, as measured at the end of each month. The Amended agreement also requires that we do not exceed a maximum leverage ratio, calculated as the ratio of funded debt to the consolidated trailing 12 month earnings before interest, taxes, depreciation and amortization, of (i) 3.0 to 1.0 for each calendar quarter ending December 31, 2019 through and including December 31, 2020, (ii) 2.5 to 1.0 for each calendar quarter ending March 31, 2021 through and including December 31, 2021, and (iii) 2.0 to 1.0 for each calendar quarter ending after January 1, 2022. We are in compliance with all covenants.

Public Offering

On September 18, 2018, we entered into an underwriting agreement with Needham & Company, LLC and Lake Street Capital Markets, LLC (the “Underwriters”) relating to the offer and sale of 2,500,000 shares of our common stock, par value $0.0001 per share, to the public at a price of $4.00 per share. We also granted the Underwriters a 30-day option to purchase up to 375,000 additional shares of our common stock to cover over-allotments, if any (the “Option Shares”). Pursuant to the underwriting agreement, we sold an aggregate of 2,700,000 shares, including 200,000 Option Shares, to the Underwriters and received proceeds net of underwriting discounts and expenses of approximately $9,774,000.

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 September 30, 2019, no stock appreciation rights, non-vested stock, or performance shares were outstanding.

Stock Options

The following table presents a summary of activity during the three months ended September 30, 2019 with respect to our stock options:

Restricted Stock Units

The following table presents a summary of activity during the three months ended September 30, 2019 with respect to our RSUs:

Employee Stock Purchase Plan

Our 2013 Employee Stock Purchase Plan (“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 our ESPP, subject to certain limitations as set forth in our ESPP.

The following table presents a summary of activity under our ESPP during the three months ended September 30, 2019:

Share-Based Compensation Expense

The following table presents a summary of share-based compensation expense included in each functional line item on our accompanying 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 September 30, 2019:

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 we believe it is more likely than not that these assets will be realized. Due to 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 September 30, 2019 and June 30, 2019.

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.

Acquisition of Intrinsyc

On October 30, 2019, Lantronix entered into an Arrangement Agreement (the “Agreement”) with Intrinsyc Technologies Corporation (“Intrinsyc”), a leading provider of solutions for the development of embedded and IoT products, pursuant to which all of the outstanding common shares of Intrinsyc (the “Intrinsyc Shares”) will be acquired by Lantronix (the “Transaction”). The transaction, which is subject to approval by the shareholders of Intrinsyc along with other specified closing conditions, is expected to be completed by December 31, 2019 or shortly thereafter.

Under the Agreement, the terms of which were unanimously approved by the boards of directors of Lantronix and Intrinsyc, Lantronix will pay $0.55 and 0.2135 of a share of common stock, par value $0.0001, of Lantronix (the “Lantronix Common Stock”), for each issued and outstanding Intrinsyc Share. Pursuant to the Agreement, Lantronix will, in the aggregate, pay approximately $11,500,000 in cash and issue approximately 4,300,000 shares of Lantronix Common Stock to Intrinsyc shareholders. Following the Transaction, Intrinsyc shareholders are expected to own approximately 16% of the outstanding shares of Lantronix Common Stock. Certain shareholders of Intrinsyc that collectively own approximately 14.5% of the outstanding Intrinsyc Shares have entered into voting agreements to vote in favor of the transaction.

Performance Stock Units

On October 18, 2019 the Company granted 975,000 RSUs with performance-based vesting requirements (“performance stock units” or “PSUs”) to certain executive employees. One third of the PSUs will be eligible to vest in each of the three years beginning in fiscal 2020 if certain earnings per share and revenue targets are met.

Lease Agreement

On October 1, 2019 we entered into a lease agreement for an office in Hyderabad, India. The initial term of the lease is five years, with the option to renew the lease under the terms of a new agreement after the initial term has expired. Initially, monthly rent is $19,000 for the first year, after which time the monthly rent will increase 5 percent per year. We took possession of the property on October 1, 2019.

Debt Agreement

On November 12, 2019, we entered into a Second Amended and Restated Loan and Security Agreement (“Amended Agreement”) with Silicon Valley Bank. Refer to Note 7 above for further information regarding the Amended Agreement.

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, 2019, or this 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.

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, assets. Our mission is to be the leading supplier of IoT and related Information Technology (“IT”) management solutions 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 (“EMEA”); and Asia Pacific Japan (“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 or are built into new industrial devices to provide network connectivity. Our products 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 the network.

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.

Our IoT products may be embedded into new designs or attached to existing machines. Our IoT products include wired and wireless connections that enhance the value and utility of modern electronic systems and equipment by providing secure network connectivity, application hosting, protocol conversion, secure access for distributed IoT deployments and many other functions. Many of the products are offered with software tools intended to further accelerate our customer’s time-to-market and increase their value add.

Most of our IoT products are pre-certified in a number of countries thereby significantly reducing our original equipment manufacturer customers’ regulatory certification costs and accelerating their time to market.

The following product families are included in our IoT product line: EDS, EDS-MD, PremierWave^® EN, PremierWave^® XC, SGX^™, UDS, WiPort^®, xDirect^®, xPico^®, xPico^® Wi-Fi, xPico^® 200, xPress^™, XPort^®, XPort^® Pro, XPort^® Edge, Micro, and MACH10^® Global Device Manager.

On July 5, 2019 we acquired Maestro Wireless Solutions Limited and its subsidiaries. The acquisition provides additional and complementary cellular connectivity, LPWAN, and telematic technologies and devices to our portfolio of IoT solutions. The following product families are now included in our IoT product line as a result of the acquisition: M110, E210, E220, Bolero45, FOX3-2G, FOX3-3G, FOX3-4G, S40, and D2Sphere.

IT Management

Today, organizations are managing an ever-increasing number of devices and data on enterprise networks where 24/7 reliability is mission critical. Out-of-band management is a technique that uses a dedicated management network to access critical network devices to ensure management connectivity (including the ability to determine the status of any network component) independent of the status of other in-band network components. Remote out-of-band access allows organizations to effectively manage their enterprise IT resources and at the same time, optimize their IT support resources. Our vSLM™, a virtualized central management software solution, simplifies secure administration of our IT Management products and the equipment attached to them through a standard web browser.

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

The following product families are included in our IT Management product line: SLB^™, SLC^™8000, Spider^™, ConsoleFlow and vSLM™.

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^®. In addition, this product line includes end-of-life versions of our MatchPort^®, SLC^™, SLP^™, xPress Pro, xSenso^®, PremierWave^® XN, and WiBox product families.

Recent Developments

Refer to Note 11 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 entering into an agreement to acquire all of the outstanding shares of Intrinsyc Technologies Corporation (“Intrinsyc”). The transaction will bring immediate scale to Lantronix, adding complementary IoT computing and embedded product development capabilities and expanding the company’s IoT market opportunity.

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 acquisition of Maestro, which occurred on July 5, 2019.

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, allowance for doubtful accounts, inventory valuation, warranty reserves, 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 September 30, 2019 as compared to what was previously disclosed in the Form 10-K.

Results of Operations – Three Months Ended September 30, 2019 Compared to the Three Months Ended September 30, 2018

Summary

In the three months ended September 30, 2019 our net revenue increased by $462,000, or 3.8%, compared to the three months ended September 30, 2018. The increase in net revenue was driven by a 14% increase in net revenue in our IoT product line partially offset by a decline in revenue of 25.8% in our IT Management product line. We had a net loss of $2,470,000 for the three months ended September 30, 2019 compared to a net loss of $83,000 for the three months ended September 30, 2018. The increase in net loss was driven by an 8.6% decrease in gross profit and a 26.7% increase in operating expenses.

Net Revenue

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

Revenue outside of the Americas increased as a percent of total revenue as a result of our recent acquisition of Maestro.  We expect revenue outside of the Americas to continue to represent a majority of our sales as a result of the acquisition.

IoT

Net revenue from our IoT product line for the three months ended September 30, 2019 increased in all regions when compared to the three months ended September 30, 2018 due to the addition of sales from products obtained through the acquisition of Maestro. The overall increase was partially offset by decreases in unit sales of our XPort and Xport Pro product families in the Americas region and the EMEA region.

IT Management

Net revenue from our IT Management product line for the three months ended September 30, 2019 decreased compared to the three months ended September 30, 2018 due to decreased unit sales of (i) our SLC 8000 product family across all three of our regions and (ii) our SLB product family, mostly in the Americas region. In the prior year quarter, we saw stronger demand for both product families partially driven by the timing of sales to certain large customers.

Other

Net revenue from our Other products, which are comprised of non-focus and end-of-life product families was flat over the period.

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, 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 September 30, 2019 decreased compared to the three months ended September 30, 2018 due primarily to sales of products obtained through the acquisition of Maestro, which typically have lower margins than legacy Lantronix products. We expect this product mix to continue going forward. Gross margin was further reduced due to the amortization of unrealized profit in acquired inventory in the amount of $171,000, all of which was recognized during the period.

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:

Selling, general and administrative expenses increased slightly primarily due to (i) higher professional fees and outside services and (ii) increased share-based compensation. These increases were partially offset by a decrease in personnel-related expenses due to reduced bonus expense in the three months ended September 30, 2019, slightly offset by an increase in salary and wages resulting from an increase in workforce from the acquisition of Maestro.

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 (i) headcount-related expenses, as we have added engineering personnel through the acquisition of Maestro, and (ii) outside service costs and product certification costs related to new product development projects.

Restructuring, Severance and Related Charges  

Current Fiscal Year

During the three months ended September 30, 2019, we continued a plan to realign certain personnel resources to better fit our current business needs, particularly as it relates to identifying cost savings and synergies to be gained from the acquisition of Maestro. These activities resulted in a total charge of approximately $749,000.  

Prior Fiscal Year

During the three months ended September 30, 2018, we executed a plan to realign certain personnel resources to better fit our business needs. These activities were substantially completed by September 30, 2018 and resulted in a total charge of approximately $323,000.

Acquisition-Related Costs  

During the three months ended September 30, 2019, in connection with the acquisitions of Maestro and Intrinsyc, we incurred approximately $643,000 of acquisition related costs. These costs are mainly comprised of legal and other professional fees.

Amortization of Purchased Intangible Assets

As a result of the acquisition of Maestro, we acquired certain intangible assets which we recorded at fair-value as of the acquisition date. These assets are amortized on a straight-line basis over their estimated useful lives, which resulted in a charge of $144,000 during the three months ended September 30, 2019.

Interest Income (Expense), Net

We earn interest on our domestic cash balance. Our interest income was partially offset by interest expense related to our unused line of credit.

Other Expense, Net

Other expense, net, is comprised primarily of foreign currency remeasurement and transaction adjustments related to our foreign subsidiaries whose functional currency is the U.S. dollar.

Provision for Income Taxes

Refer to Note 9 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 regarding our provision for income taxes.

Liquidity and Capital Resources

Liquidity

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

In September and October 2018, we sold an aggregate of 2,700,000 shares of our common stock in a public underwritten offering, which included 200,000 shares sold pursuant to the underwriters’ exercise of an option to purchase additional shares of our common stock. We received net cash proceeds from the offering of approximately $9,774,000. We maintained an increased cash balance as a result of these net proceeds until we acquired Maestro, which reduced our net cash balance by $5,073,000. Additionally, the net loss incurred during the three months ended September 30, 2019 resulted in the Company using cash in operating activities of $1,079,000.

Subsequent to September 30, 2019, we entered into an Arrangement Agreement to acquire Intrinsyc, which is expected to use approximately $11,500,000 in cash.

Our principal sources of cash and liquidity include our existing cash and cash equivalents, borrowings and amounts 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, working capital requirements and capital expenditures.

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 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.

Bank Line of Credit

Refer to Note 7 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. There were no amounts outstanding under our Loan Agreement as of September 30, 2019.

Cash Flows

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

Operating Activities

We used an additional $605,000 of net cash from operating activities during the three months ended September 30, 2019 as compared to the prior year period. This was largely due to an increase in net loss incurred during the three months ended September 30, 2019 as a result of an increase in operating expenses and acquisition costs related to our recent acquisition of Maestro. The impact of the increased net loss was partially offset by an increase in non-cash expenses such as depreciation and amortization and share-based compensation as well as a decrease in the contract manufacturers’ receivables balance.

Investing Activities

Net cash used in investing activities was related to the acquisition of Maestro for net cash of $5,073,000 as well as capital expenditures for the purchase of property and equipment, primarily related to tooling and test equipment.

Financing Activities

Net cash provided by financing activities during the three months ended September 30, 2018 resulted primarily from the public offering of common stock described above. Additionally, for the period ended September 30, 2019 financing activities provided cash from stock option exercises by employees. This was partially offset by payments for (i) withholding taxes related to the vesting of restricted stock units and (ii) capital leases.

Off-Balance Sheet Arrangements

As of September 30, 2019, we did not have any relationships with unconsolidated organizations or financial partnerships, including structured finance or special purpose entities, that have been established to facilitate off-balance sheet arrangements or for other purposes.

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 September 30, 2019 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 September 30, 2019, 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 Part I, Item 1 of this Report. 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.

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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.