Item 7. Management’s Discussion and Analysis
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction
with our consolidated financial statements and the accompanying notes thereto included in Part II, Item 8 of this Report. This discussion
and analysis contains forward-looking statements that are based on our management’s current beliefs and assumptions, which statements
are subject to substantial 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 discussed in “Risk Factors” included in Part I, Item
1A of this Report. Please also see “Cautionary Note Regarding Forward Looking Statements” at the beginning of this Report.
Overview
Lantronix, Inc. is a global Industrial and Enterprise internet of things
(“IoT”) provider of solutions that target diversified verticals ranging from Smart Cities, Utilities and Healthcare to Enterprise,
Intelligent Transportation, and Industrial Automation. Building on a long history of connectivity and video processing competence, target
applications include Video Surveillance, Traffic management, Infotainment systems, Robotics, Edge Computing and Remote Environment Management
(“REM”).
We 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”).
References to “fiscal 2022” refer to the fiscal year ended
June 30, 2022 and references to “fiscal 2021” refer to the fiscal year ended June 30, 2021.
Products and Solutions
To more closely align the categorization of our product lines with
how we position them in the marketplace, we have re-organized our products and solutions. We now organize our products and solutions into
three product lines: Embedded IoT Solutions, IoT System Solutions, and Software & Services. Until this recent change, we had
organized our products and solutions into three different product lines: IoT, REM and Other. Going forward, we do not plan to disclose
our net revenue by the old categorizations. Refer to “Products and Solutions” included in Part I, Item 1 of this Report, which
is incorporated herein by reference, for further discussion.
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Recent Developments
Acquisition
On August 2, 2021 we acquired the Transition Networks and Net2Edge
businesses (the “TN Companies”) from Communication Systems, Inc. (“CSI”) for an aggregate purchase price of approximately
$30,651,000, which includes earnout payments of up to $7,000,000 depending on the achievement of certain revenue targets for the TN Companies.
The TN Companies provide us with complementary IoT connectivity products and capabilities, including switching, Power over Ethernet (“PoE”)
and media conversion and adapter products. In connection with the closing of the acquisition, we entered into new loan agreements with
Silicon Valley Bank (“SVB”) which included (i) a new term loan of $17,500,000 with an available revolving credit facility
of up to $2,500,000 and (ii) a second term loan of $12,000,000. In January 2022, we repaid the $12,000,000 second term loan.
Refer to Notes 3 and 5 of Notes to Consolidated Financial
Statements included in Part II, Item 8 of this Report, which are incorporated herein by reference, for additional discussions regarding
the August 2021 acquisition of the TN Companies and related financing arrangements, respectively.
Underwritten Offering
On November 18, 2021, we entered into an underwriting agreement (the
“Underwriting Agreement”) with TL Investment GmbH (“TL Investment”) and Canaccord Genuity LLC, as representative
of the several underwriters named therein (together, the “Underwriters”), relating to the Company’s offer and sale of
4,700,000 shares (the “Firm Shares”) of our common stock at an initial price to the public of $7.50 per share. In addition,
TL Investment granted the Underwriters a 30-day option to purchase up to an additional 705,000 shares (the “Option Shares”)
of our common stock held by TL Investment at the public offering price, less the underwriting discounts. On November 18, 2021, the Underwriters
exercised their option to purchase the Option Shares from TL Investment in full. On November 22, 2021, we issued and delivered the Firm
Shares and TL Investment delivered the Option Shares.
Net proceeds to Lantronix from the offering of the Firm Shares, after
deducting the underwriting discount and offering expenses, were approximately $32,600,000.
COVID-19 Update
Since the outbreak of the COVID-19 pandemic, we have taken measures
to protect the health and safety of our employees and comply with applicable local directives. Most of our employees transitioned to remote
working arrangements commencing in March 2020, and many continue to primarily work remotely as of the date hereof. We continue to monitor
the implications of the COVID-19 pandemic on our business, as well as our customers’ and suppliers’ businesses, including
the emergence of new strains of the virus, current or future government-imposed shutdowns, and the impact of ongoing vaccination efforts.
Our efforts to support customer engagement through industry events,
trade shows and business travel also continue to be adversely affected. Prolonged shutdowns, or additional future shutdowns and other
restrictions instituted by federal, state and local governments, may lead to a reduction in revenue during the coming quarters. To mitigate
potential revenue declines, we continue to adjust our go-to-market approach by adding more distributors and value-added resellers, who
are closer to the customers and end-customers.
Our supply chain still faces challenges, as most of our manufacturing
is performed in Thailand, Taiwan and China. We have experienced an increase in costs of components for certain products as well as increased
freight and logistics costs and we expect these cost increases to continue. These and other factors have contributed to recent delays
in shipments to some customers.
Overall, in light of the changing nature and continuing uncertainty
around the COVID-19 pandemic, including the emergence of new, highly-contagious variants, our ability to predict the impact of the COVID-19
pandemic on our business in future periods remains limited. The full effects of the pandemic on our business are unlikely to be fully
realized, or reflected in our financial results, until future periods.
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Recent Accounting Pronouncements
Refer to Note 1 of Notes to Consolidated Financial Statements
included in Part II, Item 8 of this Report, which is incorporated herein by reference, for a discussion of recent accounting pronouncements.
Critical Accounting Policies and Estimates
The preparation of financial statements and related disclosures in
accordance with U.S. generally accepted accounting principles requires us to make judgments, estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses
during the reporting period. We regularly evaluate our estimates and assumptions related to revenue recognition, sales returns and allowances,
allowance for doubtful accounts, inventory valuation, warranty reserves, restructuring charges, valuation of deferred income taxes, valuation
of goodwill and long-lived and intangible assets, share-based compensation, litigation and other contingencies. We base our estimates
and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other
sources. To the extent there are material differences between our estimates and the actual results, our future results of operations will
be affected.
We believe the following critical accounting policies require us to
make significant judgments and estimates in the preparation of our consolidated financial statements:
Revenue Recognition
Revenue is recognized upon the transfer of control of promised products
or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services.
We apply the following five-step approach in determining the amount and timing of revenue to be recognized: (i) identifying the contract
with a customer, (ii) identifying the performance obligations in the contract, (iii) determining the transaction price, (iv) allocating
the transaction price to the performance obligations in the contract and (v) recognizing revenue when the performance obligation
is satisfied.
A significant portion of our products are sold to distributors
under agreements which contain (i) limited rights to return unsold products and (ii) price adjustment provisions, both of which are accounted
for as variable consideration when estimating the amount of revenue to recognize. Establishing accruals for product returns and pricing
adjustments requires the use of judgment and estimates that impact the amount and timing of revenue recognition. When product revenue
is recognized, we establish an estimated allowance for future product returns based primarily on historical returns experience and other
known or anticipated returns. We also record reductions of revenue for pricing adjustments, such as competitive pricing programs and rebates,
in the same period that the related revenue is recognized, based primarily on approved pricing adjustments and our historical experience.
Actual product returns or pricing adjustments that differ from our estimates could result in increases or decreases to our net revenue.
A portion of our revenues are derived from engineering and related
consulting service contracts with customers. These contracts generally include performance obligations in which control is transferred
over time because the customer either simultaneously receives and consumes the benefits provided or our performance on the contract creates
or enhances an asset that the customer controls. These contracts typically provide services on the following basis:
·
Time & Materials (“T&M”) – services consist of revenues from software modification, consulting implementation, training and integration services. These services are set forth separately in the contractual arrangements such that the total price of the customer arrangement is expected to vary depending on the actual time and materials incurred based on the customer’s needs.
·
Fixed Price – arrangements to render specific consulting and software modification services which tend to be more complex.
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Performance obligations for T&M contracts qualify for the "Right
to Invoice" practical expedient within the revenue guidance. Under this practical expedient, we may recognize revenue, over time,
in the amount to which we have a right to invoice. In addition, we are not required to estimate variable consideration upon inception
of the contract and reassess the estimate each reporting period. We determined that this method best represents the transfer of services
as, upon billing, we have a right to consideration from a customer in an amount that directly corresponds with the value to the customer
of our performance completed to date.
We recognize revenue on fixed price contracts, over time, using an
input method based on the proportion of our actual costs incurred (generally labor hours expended) to the total costs expected to complete
the contract performance obligation. We determined that this method best represents the transfer of services as the proportion closely
depicts the efforts or inputs completed towards the satisfaction of a fixed price contract performance obligation.
From time to time, we may enter into contracts with customers that
include promises to transfer multiple performance obligations that may include sales of products, professional engineering services and
other product qualification or certification services. Determining whether the promises in these arrangements are considered distinct
performance obligations, that should be accounted for separately versus together, often requires judgment. We consider performance obligations
to be distinct when the customer can benefit from the promised good or service on its own or by combining it with other resources readily
available and when the promised good or service is separately identifiable from other promised goods or services in the contract. In these
arrangements, we allocate revenue on a relative standalone selling price basis by maximizing the use of observable inputs to determine
the standalone selling price for each performance obligation. Additionally, estimating standalone selling prices for separate performance
obligations within a contract may require significant judgment and consideration of various factors including market conditions, items
contemplated during negotiation of customer arrangements and internally-developed pricing models. Changes to performance obligations that
we identify, or the estimated selling prices pertaining to a contract, could materially impact the amounts of earned and unearned revenue
that we record.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability of our customers to make required payments. Our evaluation of the collectability of customer accounts receivable
is based on various factors. In cases where we are aware of circumstances that may impair a specific customer’s ability to meet
its financial obligations subsequent to the original sale, we record an allowance against amounts due based on those particular circumstances.
For all other customers, we estimate an allowance for doubtful accounts based on (i) the length of time the receivables are past due,
(ii) our bad debt collection experience, and (iii) our understanding of general industry conditions. If a major customer’s credit-worthiness
deteriorates, or our customers’ actual defaults exceed our estimates, our financial results could be impacted.
Inventory Valuation
We value inventories at the lower of cost (on a first-in, first-out
basis) or net realizable value, whereby we make estimates regarding the market value of our inventories, including an assessment of excess
and obsolete inventories. We determine excess and obsolete inventories based on an estimate of the future sales demand for our products
within a specified time horizon, which is generally 12 months. In addition, specific reserve estimates are recorded to cover risks for
end-of-life products, inventory located at our contract manufacturers and warranty replacement stock. The estimates we use for demand
are also used for near-term capacity planning and inventory purchasing. Demand for our products can fluctuate significantly from period
to period. A significant decrease in demand could result in an increase in the amount of excess inventory on hand. In addition, our industry
is characterized by rapid technological change, frequent new product development and product obsolescence that could result in an increase
in the amount of obsolete inventory quantities on hand. Additionally, our estimates of future product demand and judgement to determine
excess inventory may prove to be inaccurate, in which case we may have understated or overstated the reduction to the total carrying value
of our inventory for excess and obsolete inventory. In the future, if our inventory is determined to be overvalued, we would be required
to recognize such costs in our cost of goods sold, resulting in a reduction in our gross margins, at the time of such determination. Although
we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand
or technological developments could have a significant impact on the value of our inventory and our results of operations.
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Warranty Reserve
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. Our warranty obligations are impacted by
a number of factors, including historical warranty costs, actual product failure rates, service delivery costs, and the use of materials.
If our actual results are different from our assumptions, increases or decreases to warranty reserves could be required, which could impact
our cost of revenue and gross margins.
Restructuring Charges
We recognize costs and related liabilities for restructuring activities
when they are incurred. Our restructuring charges are primarily comprised of employee separation costs, asset impairments and contract
exit costs. Employee separation costs include one-time termination benefits that are recognized as a liability at estimated fair value,
at the time of communication to employees, unless future service is required, in which case the costs are recognized ratably over the
future service period. Ongoing termination benefits are recognized as a liability at estimated fair value when the amount of such
benefits are probable and reasonably estimable. Contract exit costs include contract termination fees and right-of-use asset impairments
recognized on the date that we have vacated the premises or ceased use of the leased facilities. A liability for contract termination
fees is recognized in the period in which we terminate the contract. Restructuring accruals are based upon management estimates at
the time they are recorded and can change depending upon changes in facts and circumstances subsequent to the date the original liability
is recorded. If actuals results differ, or if management determines revised estimates are necessary, we may record additional liabilities
or reverse a portion or existing liabilities.
Valuation of Deferred Income Taxes
We have recorded a valuation allowance to reduce our net deferred tax
assets to zero, primarily due to historical net operating losses (“NOLs”) and uncertainty of generating future taxable income.
We consider estimated future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation
allowance. If we determine that it is more likely than not that we will realize a deferred tax asset that currently has a valuation allowance,
we would be required to reverse the valuation allowance, which would be reflected as an income tax benefit in our consolidated statements
of operations at that time.
Business Combinations
We allocate the fair value of the purchase consideration of a business
acquisition to the tangible assets, liabilities, and intangible assets acquired, including in-process research and development (“IPR&D”),
if applicable, based on their estimated fair values. The excess of the fair value of purchase consideration over the fair values of these
identifiable assets and liabilities is recorded as goodwill. IPR&D is initially capitalized at fair value as an intangible asset with
an indefinite life and assessed for impairment thereafter. When an IPR&D project is completed, the IPR&D is reclassified as an
amortizable purchased intangible asset and amortized over the asset’s estimated useful life. The valuation of acquired assets and
assumed liabilities requires significant judgment and estimates, especially with respect to intangible assets. The valuation of intangible
assets, in particular, requires that we use valuation techniques such as the income approach. The income approach includes the use of
a discounted cash flow model, which includes discounted cash flow scenarios and requires significant estimates such as future expected
revenue, expenses, capital expenditures and other costs, and discount rates. We estimate the fair value based upon assumptions we believe
to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from our estimates.
Estimates associated with the accounting for acquisitions may change as additional information becomes available regarding the assets
acquired and liabilities assumed. Acquisition-related expenses and related restructuring costs are recognized separately from the business
combination and are expensed as incurred.
Goodwill Impairment Testing
We evaluate goodwill for impairment on an annual basis in our fourth
fiscal quarter or more frequently if we believe indicators of impairment exist that would more likely than not reduce the fair value of
our single reporting unit below its carrying amount.
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We begin our evaluation of goodwill for impairment by assessing qualitative
factors to determine whether it is more likely than not that the fair value of our single reporting unit is less than its carrying value.
Some factors that we consider important in the qualitative assessment which could trigger a goodwill impairment review include:
· significant underperformance relative to historical or projected future operating
results;
· significant changes in the manner of our use of the acquired assets or the
strategy for our overall business;
· significant negative industry or economic trends;
· a significant decline in our stock price for a sustained period; and
· a significant change in our market capitalization relative to our book value.
Based on our qualitative assessment, if we conclude that it is more
likely than not that the fair value of our single reporting unit is less than its carrying value, we conduct a quantitative goodwill impairment
test, which involves comparing the estimated fair value of our single reporting unit with its carrying value, including goodwill. We estimate
the fair value of our single reporting unit using a combination of the income and market approach. If the carrying value of the reporting
unit exceeds its estimated fair value, we recognize an impairment loss for the difference.
Significant management judgment is required in estimating the reporting
unit’s fair value and in the creation of the forecasts of future operating results that are used in the discounted cash flow method
of valuation. These include (i) estimation of future cash flows, which is dependent on internal forecasts, (ii) estimation of the long-term
rate of growth of our business, (iii) estimation of the period during which cash flows will be generated and (iv) the determination of
our weighted-average cost of capital, which is a factor in determining the discount rate. Our estimate of the reporting unit’s fair
value would also generally include the consideration of a control premium, which is the amount that a buyer is willing to pay over the
current market price of a company as indicated by the traded price per share (i.e., market capitalization) to acquire a controlling interest.
If our actual financial results are not consistent with our assumptions and judgments used in estimating the fair value of our reporting
unit, we may be exposed to goodwill impairment losses.
During the fourth quarter of fiscal 2022, we made a qualitative assessment
of whether goodwill impairment existed. Since our assessment of the qualitative factors did not result in a determination that it was
more likely than not that the fair value of our single reporting unit is less than its carrying value, we were not required to perform
the quantitative goodwill impairment test. As of June 30, 2022, the carrying value of our single reporting unit was $79,900,000, while
our market capitalization was $189,000,000. We concluded that no goodwill impairment existed as of June 30, 2022.
Long-Lived Assets and Intangible Assets
We assess the impairment of long-lived assets and intangible assets
whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Circumstances which
could trigger a review include, but are not limited to the following:
·
significant decreases in the market price of the asset;
·
significant adverse changes in the business climate or legal factors;
·
accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset;
·
current period cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with the use of the asset; or
·
current expectation that the asset will more likely than not be sold or disposed of significantly before the end of its estimated useful life.
Whenever events or changes in circumstances suggest that the carrying
amount of long-lived assets and intangible assets may not be recoverable, we estimate the future cash flows expected to be generated by
the asset from its use or eventual disposition. If the sum of the expected future cash flows is less than the carrying amount of those
assets, we recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets. Significant management
judgment is required in the forecasts of future operating results that are used in the discounted cash flow method of valuation. These
significant judgments may include future expected revenue, expenses, capital expenditures and other costs, discount rates and whether
or not alternative uses are available for impacted long-lived assets.
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Share-Based Compensation
We record share-based compensation in our consolidated statements of
operations as an expense, based on the estimated grant date fair value of our share-based awards, with the fair values amortized to expense
over the requisite service period. Our share-based awards are currently comprised of restricted stock units, performance stock units,
common stock options, and common stock purchase rights granted under our 2013 Employee Stock Purchase Plan (“ESPP”).
The fair value of our restricted stock units is based on the closing
market price of our common stock on the date of grant.
The fair value of our performance stock units is estimated as of the
grant date based upon the expected achievement of the performance metrics specified in the grant and the closing market price of our common
stock on the date of grant. To the extent a grant of performance share units contains a market condition, the grant date fair value is
estimated using a Monte Carlo simulation, which incorporates estimates of the potential outcomes of the market condition on the grant
date fair value of each award.
The fair value of our common stock options and ESPP common stock purchase
rights is generally estimated on the grant date using the Black-Scholes-Merton (“BSM”) valuation model. The determination
of the fair value of share-based awards utilizing the BSM model is affected by our stock price and various assumptions, including the
expected term, expected volatility, risk-free interest rate and expected dividend yields. The expected term of stock options granted has
historically been estimated using the simplified method, as permitted by guidance issued by the Securities and Exchange Commission (“SEC”).
We have used the simplified method because we were generally unable to rely on our limited historical exercise data or alternative information
as a reasonable basis upon which to estimate the expected term of such options. For new stock options granted beginning in the fiscal
year ended June 30, 2022, we estimated the expected term based on our recent historical exercise data. The expected volatility is based
on the historical volatility of our stock price. The risk-free interest rate assumption is based on the U.S. Treasury interest rates appropriate
for the expected term of our stock options and common stock purchase rights.
If factors change and we employ different assumptions, share-based
compensation expense may differ significantly from what we have recorded in the past. If there are any modifications or cancellations
of the underlying unvested share-based awards, we may be required to accelerate, increase or cancel any remaining unearned share-based
compensation expense. If these events were to occur, it could increase or decrease our share-based compensation expense, which would impact
our operating expenses and gross margins.
Results of Operations - Fiscal Years Ended June 30, 2022 and 2021
Summary
For fiscal 2022, our net revenue increased by $58,178,000, or 81.4%,
compared to fiscal 2021. The increase in net revenue was driven by a 144.0% increase in net revenue in our IoT System Solutions product
line, as well as an increase of 60.0% in net revenues in our Embedded IoT Solutions product line. We had a net loss of $5,362,000 for
fiscal 2022 compared to a net loss of $4,044,000 for fiscal 2021. The increase in net loss was driven primarily by costs related to the
TN acquisition as both SG&A and R&D expenses as a percent of net revenue were lower in fiscal 2022 than fiscal 2021, largely because
of our business integration efforts and capture of significant cost synergies during fiscal 2022.
26
Net Revenue
The following tables present our net revenue by
product lines and by geographic region:
Years Ended June 30,
% of Net
% of Net
Change
2022
Revenue
2021
Revenue
$
%
(In thousands, except percentages)
Embedded IoT Solutions
$ 61,773
47.6%
$ 38,611
54.0%
$ 23,162
60.0%
IoT System Solutions
59,019
45.5%
24,189
33.8%
34,830
144.0%
Software & Services
8,863
6.9%
8,677
12.2%
186
2.1%
$ 129,655
100.0%
$ 71,477
100.0%
$ 58,178
81.4%
Years Ended June 30,
% of Net
% of Net
Change
2022
Revenue
2021
Revenue
$
%
(In thousands, except percentages)
Americas
$ 77,799
60.0%
$ 38,638
54.1%
$ 39,161
101.4%
EMEA
22,542
17.4%
17,186
24.0%
5,356
31.2%
APJ
29,314
22.6%
15,653
21.9%
13,661
87.3%
$ 129,655
100.0%
$ 71,477
100.0%
$ 58,178
81.4%
Embedded IoT Solutions
Net revenue from our Embedded IoT Solutions product line increased
in fiscal 2022 compared to fiscal 2021 primarily due to organic growth in our compute modules and embedded ethernet connectivity products.
In addition, the acquisition of the TN Companies contributed approximately $7,200,000 in fiscal 2022 primarily in the Americas region.
IoT System Solutions
Net revenue from our IoT System Solutions product line increased in
fiscal 2022 compared to fiscal 2021 primarily due to product sales of our network switches and media converter products from the TN Companies
acquisition, mostly in the Americas region. We also experienced organic growth in our pre-acquisition business driven by (i) our out of
band (“OOB”) products in the Americas, and to a lesser extent, EMEA and APJ, and (ii) our device server products in the Americas
and APJ regions. The overall increase in net revenues was partially offset by a decrease in unit sales in our WiFi gateway products in
the Americas and EMEA regions.
Software & Services
Net revenue from our Software & Services product line in fiscal
2022 was flat when compared to fiscal 2021. In fiscal 2022, we experienced an increase in engineering consulting services revenue when
compared to fiscal 2021. This increase was largely offset by lower revenues from some of our software offerings compared to fiscal 2021
during which we had a large software license sale.
27
For comparative purposes, the following tables present our product
line categorizations prior to our decision to reorganize how we present this information during the fourth quarter of fiscal 2022. As
discussed at Part I, Item 1 of this Report, going forward we do not plan to disclose our net revenue by these categorizations.
Years Ended June 30,
% of Net
% of Net
Change
2022
Revenue
2021
Revenue
$
%
(In thousands, except percentages)
IoT
$ 112,492
86.8%
$ 59,167
82.8%
$ 53,325
90.1%
REM
16,585
12.8%
11,843
16.6%
4,742
40.0%
Other
578
0.4%
467
0.6%
111
23.8%
$ 129,655
100.0%
$ 71,477
100.0%
$ 58,178
81.4%
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 by contract manufacturers, freight costs, personnel-related
expenses, manufacturing overhead, inventory reserves for excess and obsolete products or raw materials, warranty costs, royalties and
share-based compensation.
The following table presents our gross profit:
Years Ended June 30,
% of Net
% of Net
Change
2022
Revenue
2021
Revenue
$
%
(In thousands, except percentages)
Gross profit
$ 55,586
42.9%
$ 33,025
46.2%
$ 22,561
68.3%
Gross profit as a percent of revenue (referred to as “gross margin”)
for fiscal 2022 decreased compared to fiscal 2021 due primarily to our revenue mix. We saw significant growth in unit sales of our compute
modules and growth in our engineering services revenues, which typically carry lower gross margins than many of our products. Gross margin
for fiscal 2022 was also negatively impacted by (i) higher supply chain and logistics costs and (ii) the amortization of unrealized profit
in acquired inventory from the TN Companies in the amount of approximately $380,000. The overall decrease in our gross margins in the
current year period was partially offset by growth in unit sales of our higher-margin OOB products, along with the margin contribution
from the products acquired from the TN Companies.
Selling, General and Administrative
Selling, general and administrative expenses consisted of personnel-related
expenses including salaries and commissions, share-based compensation, facility expenses, information technology, advertising and marketing
expenses and professional legal and accounting fees.
The following table presents our selling, general and administrative
expenses:
Years Ended June 30,
% of Net
% of Net
Change
2022
Revenue
2021
Revenue
$
%
(In thousands, except percentages)
Personnel-related expenses
$ 19,368
$ 12,927
$ 6,441
49.8%
Professional fees and outside services
5,833
2,464
3,369
136.7%
Advertising and marketing
1,893
712
1,181
165.9%
Facilities and insurance
1,476
1,415
61
4.3%
Share-based compensation
4,862
2,719
2,143
78.8%
Other
1,097
571
526
92.1%
Selling, general and administrative
$ 34,529
26.6%
$ 20,808
29.1%
$ 13,721
65.9%
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Selling, general and administrative expenses increased in fiscal 2022
when compared to fiscal 2021 primarily (i) higher personnel-related expenses as we added headcount from the acquisition of the TN Companies
and also recorded higher variable compensation expenses, (ii) increased professional fees and outside services costs for legal and other
services, as well as transition services fees paid to the seller for the acquisition of the TN Companies, (iii) increased share-based
compensation expense due to additional grants of performance stock units and other stock awards with higher fair values compared to the
prior year and (iv) higher marketing spending, including on various events and trade shows that were largely halted in the prior year
due to the COVID-19 pandemic.
Research and Development
Research and development expenses consisted of personnel-related expenses,
share-based compensation, and expenditures to third-party vendors for research and development activities and product certification costs.
Our costs from period-to-period related to outside services and product certifications vary depending on our level and timing of development
activities.
The following table presents our research and development expenses:
Years Ended June 30,
% of Net
% of Net
Change
2022
Revenue
2021
Revenue
$
%
(In thousands, except percentages)
Personnel-related expenses
$ 11,408
$ 7,954
$ 3,454
43.4%
Facilities
2,351
1,335
1,016
76.1%
Outside services
1,158
209
949
454.1%
Product certifications
817
531
286
53.9%
Share-based compensation
1,015
584
431
73.8%
Other
938
500
438
87.6%
Research and development
$ 17,687
13.6%
$ 11,113
15.5%
$ 6,574
59.2%
Research and development expenses increased in fiscal 2022 when compared
to fiscal 2021 primarily due to (i) an increase in personnel-related costs driven by additions to headcount from both the TN Companies
acquisition and internal growth, (ii) higher facility-related costs as we opened our new facility in Germany and expanded our engineering
teams, (iii) increased outside services costs primarily related to the timing of product development projects requiring outsourced engineering
resources, and (iv) increased share-based compensation expense due to additional grants of performance stock units and other stock awards
with higher fair values compared to the prior year.
Restructuring, Severance and Related Charges
Fiscal 2022
During fiscal 2022, we incurred charges of approximately $795,000 related
to headcount reductions and restructuring of non-essential operations, including certain functions determined redundant related to the
acquisition of the TN Companies. We may incur additional restructuring, severance and related charges in future periods as we continue
to identify cost savings and synergies resulting from our acquisitions.
Fiscal 2021
During fiscal 2021, we incurred charges of approximately $506,000 related
to headcount reductions and restructuring of non-essential operations, including certain acquisition-related functions we determined were
redundant.
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Acquisition-Related Costs
During fiscal 2022 and fiscal 2021, we incurred approximately $889,000
and $841,000 of acquisition-related costs, respectively, mostly comprised of banking and legal fees related to the acquisition of the
TN Companies and our exploration of other acquisition targets.
Amortization of Purchased Intangible Assets
We acquired certain intangible assets through our recent acquisitions,
which we recorded at fair-value as of the acquisition dates. These assets are generally amortized on a straight-line basis over their
estimated useful lives and resulted in charges of $5,590,000 and $3,094,000 during fiscal 2022 and 2021, respectively.
Interest Income (Expense), Net
For fiscal 2022 and 2021, we incurred net interest expense from interest
incurred on borrowings on our Credit Facilities. We also earn interest on our domestic cash balances.
Loss on Extinguishment of Debt
For fiscal 2022, we recognized a non-cash loss on the extinguishment
of our mezzanine term loan facility of $764,000, representing the write-off of unamortized deferred financing costs.
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. During fiscal 2021, we also
incurred a loss of approximately $197,000 on disposal of certain property and equipment.
Provision for Income Taxes
The following table presents our provision for income taxes:
Years Ended June 30,
% of Net
% of Net
Change
2022
Revenue
2021
Revenue
$
%
(In thousands, except percentages)
Provision (benefit) for income taxes
$ (1,832 )
(1.4% )
$ 195
0.3%
$ (2,027 )
(1039.5% )
The following table presents our effective tax rate based upon our
provision for income taxes:
Years Ended June 30,
2022
2021
Effective tax rate
25.5%
(5.1% )
We utilize the liability method of accounting for income taxes. In
fiscal 2022 the tax benefit was the result of us recording a U.S. deferred tax liability in the TN Companies acquisition purchase accounting
related to non-tax-deductible intangible assets recognized in our consolidated financial statements. The acquired deferred tax liabilities
are a source of income to support recognition of our existing deferred tax assets. The differences between our effective tax rate and
the federal statutory rate in fiscal 2022 and fiscal 2021 were also impacted by the effect of our domestic losses recorded without a tax
benefit, as well as the effect of foreign earnings taxed at rates differing from the federal statutory rate.
30
We record net deferred tax assets to the extent we believe these assets
are more likely than not to be realized. As a result of our cumulative losses and uncertainty of generating future taxable income, we
provided a full valuation allowance against our net deferred tax assets for fiscal 2022 and fiscal 2021.
Due to the “change of ownership” provision of the Tax Reform
Act of 1986, utilization of our NOL carryforwards and tax credit carryforwards may be subject to an annual limitation against taxable
income in future periods. Due to the annual limitation, a portion of these carryforwards may expire before ultimately becoming available
to reduce future income tax liabilities. The following table presents our NOLs:
June 30, 2022
(In thousands)
Federal
$ 70,456
State
$ 14,861
For federal income tax purposes, our NOL carryovers generated for tax
years beginning before July 1, 2018 began to expire in fiscal 2021. Of our federal NOLs as of June 30, 2022 in the table above, approximately
$26,500,000 will expire by June 30, 2023. For state income tax purposes, our NOLs began to expire in the fiscal year ended June 30, 2013.
Pursuant to the Tax Cuts and Jobs Act enacted by the U.S. federal government in December 2017, for federal income tax purposes, NOL carryovers
generated for our tax years beginning after June 30, 2018 can be carried forward indefinitely, but will be subject to a taxable income
limitation.
Liquidity and Capital Resources
Liquidity
The following table presents our working capital and cash and cash
equivalents:
June 30,
2022
2021
Change
(In thousands)
Working capital
$ 54,512
$ 20,289
$ 34,223
Cash and cash equivalents
$ 17,221
$ 9,739
$ 7,482
In November 2021, we sold 4,700,000 shares of our common stock in an
underwritten public offering. We received net cash proceeds from the offering of approximately $32,600,000. Refer to Note
6 of Notes to Unaudited Condensed Consolidated Financial Statements, included in Part I, Item 1 of this Report for additional
information.
In January 2022, we terminated our $12,000,000 mezzanine term loan
facility that was originated in August 2021. In connection with this termination, we paid a total of $12,152,500 to pay off the facility
in full.
In February 2022, we entered into an amendment to our Senior
Credit Facilities (as defined in Note 5 of Notes to Unaudited Condensed Consolidated Financial Statements, included in Part
I, Item 1 of this Report) which (i) increased the amount available under the revolving credit facility from $2,500,000 to
$7,500,000, (ii) removed and replaced LIBOR benchmark provisions with Term SOFR benchmark provisions and (iii) provided that
advances under the Senior Credit Facilities bear interest at Term SOFR or the Prime Rate, at the option of Lantronix, plus a margin
that ranges from 3.10% to 4.10% in the case of Term SOFR and 1.50% to 2.50% in the case of the Prime Rate, depending on our total
leverage with a Term SOFR floor of 0.00% and a Prime Rate floor of 3.25%. We paid a nonrefundable fee of $25,000 in connection with
this amendment to our Senior Credit Facilities. As of June 30, 2022, we had $16,188,000 million in borrowings outstanding under our
term loan facility.
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Our principal sources of cash and liquidity include our existing cash
and cash equivalents, borrowings and amounts available under our loan agreement with our bank, and cash generated from operations. We
believe that these sources will be sufficient to fund our current requirements for working capital, capital expenditures and other financial
commitments for at least the next 12 months and beyond. 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 Loan Agreements
Refer to Note 5 of Notes to Consolidated Financial Statements,
included in Part II, Item 8 of this Report, which is incorporated herein by reference, for a discussion of our loan agreements.
Cash Flows
The following table presents the major components of the consolidated
statements of cash flows:
Years Ended June 30,
(Decrease)
2022
2021
Increase
(In thousands)
Net cash (used in) provided by operating activities
$ (9,416 )
$ 4,304
$ (13,720 )
Net cash used in investing activities
(25,747 )
(783 )
24,964
Net cash provided by (used in) financing activities
42,645
(1,473 )
44,118
Operating Activities
We used cash in operating activities during fiscal 2022 compared to
operations providing cash in fiscal 2021 mainly due to the increase in our net loss, which was driven by an increase in operating expenses.
For fiscal 2022, our net loss included $15,380,000 of non-cash charges, and the changes in operating assets and liabilities used cash
of $19,434,000.
Our net inventories increased by $22,620,000, or 150.2%, from June
30, 2021 to June 30, 2022. Of this increase, $7,734,000 of net inventories were acquired in the TN Companies acquisition. The remainder
of the increase was a combination of increases in revenue, increased lead times required for certain customers, and supply chain constraints
issues.
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Accounts receivable increased by $12,747,000, or 94.3%, from June 30,
2021 to June 30, 2022, of which $5,277,000 was acquired in the TN Companies acquisition. The remainder of the increase is primarily due
to the increase and timing of our sales and related payments from customers.
Accounts payable increased by $11,522,000, or 126.3%, from June 30,
2021 to June 30, 2022, of which $1,872,000 was acquired in the TN Companies acquisition. The remainder of the increase is primarily due
to the increase and timing of our inventory purchases and related payments to our vendors.
Investing Activities
Net cash used in investing activities during fiscal 2022 was driven
by the acquisition of the TN Companies, which used net cash of $23,629,000. We also used cash for the purchase of property and equipment,
primarily related to various tooling, test and office equipment.
Financing Activities
Net cash provided by financing activities during fiscal 2022 resulted
primarily from (i) net proceeds from our public offering of $32,600,000 and (ii) $29,500,000 in gross proceeds received from our credit
facilities with SVB, partially offset by the repayment of our previous term loan in the amount of $3,750,000 and the mezzanine credit
facility in the amount of $12,000,000. We also used cash of $1,811,000 for tax withholdings paid on behalf of employees for restricted
shares and paid earnout consideration of $1,500,000 for the TN Companies.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not required for a “smaller reporting company.”