LANTRONIX INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and the related notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q for the three months ended September 30, 2022 (the “Report”). This discussion and analysis contains forward-looking statements that are based on our current expectations and reflect our plans, estimates and anticipated future financial performance. See the section of this Report entitled “Cautionary Note Regarding Forward-Looking Statements” for additional information. These statements involve numerous risks and uncertainties. Our actual results may differ materially from those expressed or implied by these forward-looking statements as a result of many factors, including those set forth in “Risk Factors” in Part II, Item 1A of this Report. Unless otherwise indicated by the context, all references to the “Company”, “Lantronix”, "we", "us", and "our" in this Quarterly Report on Form 10-Q include Lantronix, Inc. and its consolidated subsidiaries. Overview Lantronix, Inc. is a global Industrial and Enterprise IoT provider of solutions that target diversified verticals ranging from Smart Cities, Utilities and Healthcare to Enterprise, Intelligent Transportation, and Industrial Automation. Building on a long history of connectivity and video processing competence, target applications include Video Surveillance, Traffic management, Infotainment systems, Robotics, Edge Computing and Remote Environment Management (“REM”). We 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 portfolio services and products into the following product lines: Embedded IoT Modules, IoT Systems Solutions, and Software and Engineering Services. Embedded IoT Modules This portfolio of embedded products provides a variety of solutions including Compute System-on-Module (SOM) or System-in-Package (SIP) solutions supplemented with wired and wireless network Connectivity options. As the level of silicon integration continues to grow, the compute modules also provide the ability to Collect digital information (Video, Audio or Sensors) and analyze/comprehend the data streams based on specific AI/ML algorithms. The new implementations of SIP devices can process multiple media streams with CV (Computer Vision) technology and the modules can be Controlled remotely via ConsoleFlow™, Lantronix’s Cloud SaaS platform. Our IoT compute products typically are embedded into a customer product, enabling advanced application functionality at the edge. Our compute products are normally embedded into new designs. These products include application processing that delivers compute to meet customer needs for data transformation, computer vision, machine learning, augmented / virtual reality, audio / video aggregation and distribution, and custom applications at the edge. Many of the products are offered with software tools intended to further accelerate our customers’ time-to-market and increase their value add. Most of our IoT embedded products are pre-certified in a number of countries thereby significantly reducing our OEM customers’ regulatory certification costs and accelerating their time to market IoT System Solutions The IoT Systems Solutions portfolio consists of fully functional standalone systems that provider routing, switching or gateway functionalities as well as Telematics and media conversion. These products include wired and wireless connections that enhance the value and utility of modern electronic systems and equipment by providing secure network connectivity, power for IoT end devices through Power over Ethernet (PoE), application hosting, protocol conversion, media conversion, secure access for distributed IoT deployments and many other functions. Most of our IoT System products are pre-certified in a number of countries thereby significantly reducing our original equipment manufacturer (“OEM”) customers’ regulatory certification costs and accelerating their time to market. 23 Software and Engineering Services Our SaaS platform provides single pane of glass management for REM and IoT deployments. Our platform enables customers to easily deploy, monitor, manage, and automate across their global deployments, all from a single platform login, virtually connected as though directly on each device. Our platform eliminates the need to have 24/7 personnel on site, and makes it easy to see and drill into an issue quickly, even in large scale deployments. We leverage our engineering expertise and product development best practices to deliver high quality, innovative products, cost-effectively and on time. Our engineering services flexible business model allows for choosing turnkey product development or team augmentation for accelerating complex areas of product development such as; camera development and tuning, voice control, machine learning, artificial intelligence, computer vision, augmented / virtual reality, mechanical and radio-frequency design, thermal and power optimization, or in any specific area a customer needs assistance. Recent Developments Acquisition On September 12, 2022 we acquired Uplogix, Inc. (“Uplogix”) for an aggregate purchase price of $8,000,000, subject to certain adjustments, plus an earnout up to an additional $4,000,000 depending on the achievement of certain revenue targets of the business of Uplogix through September 30, 2023. Uplogix brings immediate scale to our out-of-band OOB remote management solutions, adding a complementary high-end product offering that includes high-margin maintenance and licensing revenues. Refer to Note 3 of Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Report, which are incorporated herein by reference, for additional discussions regarding the acquisition of Uplogix. COVID-19 Update Since the outbreak of the COVID-19 pandemic, we have taken measures to protect the health and safety of our employees and comply with applicable local directives. Most of our employees transitioned to remote working arrangements commencing in March 2020, and many continue to primarily work remotely as of the date hereof. We continue to monitor the implications of the COVID-19 pandemic on our business, as well as our customers’ and suppliers’ businesses, including the emergence of new strains of the virus, current or future government-imposed shutdowns, and the impact of ongoing vaccination efforts. Our supply chain 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, our ability to predict the impact of the COVID-19 pandemic on our business in future periods remains limited. The full effects of the pandemic on our business are unlikely to be fully realized, or reflected in our financial results, until future periods. Recent Accounting Pronouncements Refer to Note 1 of 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. 24 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, restructuring charges, valuation of deferred income taxes, business combinations, goodwill and intangible assets and stock-based compensation. These policies are described in further detail in our Annual Report on Form 10-K for the year ended June 30, 2022 and filed with the Securities and Exchange Commission (the “SEC”) on August 29, 2022 (the “Form 10-K”) and have not changed significantly during the three months ended September 30, 2022 as compared to what was previously disclosed in the Form 10-K. Results of Operations – Three Months Ended September 30, 2022 Compared to the Three Months Ended September 30, 2021 Summary In the three months ended September 30, 2022, our net revenue increased by $4,090,000 or 14.8%, compared to the three months ended September 30, 2021. The increase in net revenue was driven by a 22.0% increase in net revenue in our Embedded IoT Solutions product line, as well as an 11.1% increase in net revenue in our IoT System Solutions product line. We had a net loss of $1,653,000 for the three months ended September 30, 2022 compared to a net loss of $2,241,000 for the three months ended September 30, 2021. The decrease in net loss was primarily driven by the increase in revenues partially offset by an increase in operating expenses of 1,184,000 or 8% during the three months ended September 30, 2022 compared to the three months ended September 30, 2021. Net Revenue The following tables present our net revenue by product line and by geographic region: Three Months Ended September 30, % of Net % of Net Change 2022 Revenue 2021 Revenue $ % (In thousands, except percentages) Embedded IoT Solutions $ 15,095 47.5% $ 12,376 44.7% $ 2,719 22.0% IoT System Solutions 14,621 46.0% 13,158 47.5% 1,463 11.1% Software & Services 2,079 6.5% 2,171 7.8% (92 ) (4.2% ) $ 31,795 100.0% $ 27,705 100.0% $ 4,090 14.8% Three Months Ended September 30, % of Net % of Net Change 2022 Revenue 2021 Revenue $ % (In thousands, except percentages) Americas $ 20,930 65.8% $ 18,227 65.8% $ 2,703 14.8% EMEA 5,201 16.4% 4,659 16.8% 542 11.6% APJ 5,664 17.8% 4,819 17.4% 845 17.5% $ 31,795 100.0% $ 27,705 100.0% $ 4,090 14.8% Embedded IoT Solutions Net revenue from our Embedded IoT Solutions product line increased in the three months ended September 30, 2022 compared to the three months ended September 30, 2021 primarily due to organic growth in our compute modules and embedded ethernet connectivity products in the Americas and EMEA regions. This increase was partially offset by a decrease in revenues of our WiFi gateway products in the Americas region. 25 IoT System Solutions Net revenue from our IoT System Solutions product line increased in the three months ended September 30, 2022 compared to the three months ended September 30, 2021 primarily due to sales of our network switches and media converter products, mostly in the Americas region. These increases were partially offset by a decrease in sales of our out of band products, primarily in the Americas region. Software & Services Net revenue from our Software & Services product line decreased in the three months ended September 30, 2022 compared to the three months ended September 30, 2021 primarily due to a decrease in our engineering services revenue in the EMEA region. This decrease was partially offset by a modest contribution in services revenue from the Uplogix acquisition. Gross Profit Gross profit represents net revenue less cost of revenue. Cost of revenue consists primarily of the cost of raw material components, subcontract labor assembly from contract manufacturers, direct and indirect personnel expenses related to professional services, manufacturing overhead, inventory reserves for excess and obsolete products or raw materials, warranty costs, royalties and share-based compensation. The following table presents our gross profit: Three Months Ended September 30, % of Net % of Net Change 2022 Revenue 2021 Revenue $ % (In thousands, except percentages) Gross profit $ 14,036 44.1% $ 12,463 45.0% $ 1,573 12.6% Gross profit as a percent of revenue (referred to as “gross margin”) for the three months ended September 30, 2022 decreased slightly compared to the three months ended September 30, 2021 due primarily to our sales mix. As compared to the prior year period, in the current quarter we experienced (i) higher unit sales of our compute modules which typically carry lower gross margins than some of our other legacy product families and (ii) lower unit sales of some of our higher-margin out of band products. Additionally, our gross margin in the current quarter was favorably impacted by lower freight and duties costs. Selling, General and Administrative Selling, general and administrative expenses consist of personnel-related expenses, including salaries and commissions, share-based compensation, facility expenses, information technology, trade show expenses, advertising, and legal and accounting fees. The following table presents our selling, general and administrative expenses: Three Months Ended September 30, % of Net % of Net Change 2022 Revenue 2021 Revenue $ % (In thousands, except percentages) Personnel-related expenses $ 4,680 $ 4,430 $ 250 5.6% Professional fees and outside services 1,682 1,318 364 27.6% Advertising and marketing 582 501 81 16.2% Facilities and insurance 483 278 205 73.7% Share-based compensation 1,405 1,126 279 24.8% Other 325 253 72 28.5% Selling, general and administrative $ 9,157 28.8% $ 7,906 28.5% $ 1,251 15.8% 26 Selling, general and administrative expenses for the three months ended September 30, 2022 increased when compared to the three months ended September 30, 2021 primarily due to (i) increased professional fees and outside services costs for certain legal, financial and other services, (ii) increased share-based compensation expenses due to additional grants of performance stock units, and (iii) increased personnel expenses resulting from our acquisitions. Research and Development Research and development expenses consist of personnel-related expenses, including share-based compensation, as well as expenditures to third-party vendors for research and development activities and product certification costs. Our quarterly costs related to outside services and product certifications vary from period to period depending on our level of development activities. The following table presents our research and development expenses: Three Months Ended September 30, % of Net % of Net Change 2022 Revenue 2021 Revenue $ % (In thousands, except percentages) Personnel-related expenses $ 2,961 $ 2,520 $ 441 17.5% Facilities 642 508 134 26.4% Outside services 164 321 (157 ) (48.9% ) Product certifications 213 235 (22 ) (9.4% ) Share-based compensation 332 255 77 30.2% Other 214 202 12 5.9% Research and development $ 4,526 14.2% $ 4,041 14.6% $ 485 12.0% Research and development expenses for the three months ended September 30, 2022 increased when compared to the three months ended September 30, 2021 primarily due to an increase in personnel-related costs driven by our acquisitions and internal growth of our engineering teams worldwide. Restructuring, Severance and Related Charges During the three months ended September 30, 2022, we incurred charges of approximately $92,000 related to headcount reductions and restructuring of certain non-essential operations. We may incur additional restructuring, severance and related charges in future periods as we continue to identify cost savings and synergies related to our acquisitions and general business operations. Acquisition-Related Costs During the three months ended September 30, 2022, we incurred approximately $213,000 of costs primarily in connection with the acquisition of Uplogix. These costs were mainly comprised of banking, legal and other professional fees. Interest Income (Expense), Net For the three months ended September 30, 2022, we incurred net interest expense due to borrowings on our credit facilities. We also earn interest income on our domestic cash balance. 27 Other Income (Expense), Net Our other income (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 8 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: September 30, June 30, 2022 2022 Change (In thousands) Working capital $ 50,316 $ 54,512 $ (4,196 ) Cash, cash equivalents, and restricted cash $ 13,125 $ 17,221 $ (4,096 ) In September 2022 we entered into an amendment to our Senior Credit Facilities (as defined in Note 6 of Notes to Unaudited Condensed Consolidated Financial Statements, included in Part I, Item 1 of this Report) which provide for an additional term loan in the original principal amount of $5,000,000 that matures on August 2, 2025. We also borrowed $2,000,000 on our revolving credit facility. Our principal sources of cash and liquidity include our existing cash and cash equivalents, borrowings and amounts available under our loan agreement with our bank, and cash generated from operations. We believe that these sources will be sufficient to fund our current requirements for working capital, capital expenditures and other financial commitments for at least the next 12 months. We anticipate that the primary factors affecting our cash and liquidity are net revenue, working capital requirements and capital expenditures. We define cash and cash equivalents as highly liquid deposits with original maturities of 90 days or less when purchased. We maintain cash and cash equivalents balances at certain financial institutions in excess of amounts insured by federal agencies. Management does not believe this concentration subjects us to any unusual financial risk beyond the normal risk associated with commercial banking relationships. We frequently monitor the third-party depository institutions that hold our cash and cash equivalents. Our emphasis is primarily on safety of principal and secondarily on maximizing yield on those funds. Our future working capital requirements will depend on many factors, including the following: timing and amount of our net revenue; our product mix and the resulting gross margins; research and development expenses; selling, general and administrative expenses; and expenses associated with any strategic partnerships, acquisitions or infrastructure investments. From time to time, we may seek additional capital from public or private offerings of our capital stock, borrowings under our existing or future credit lines or other sources in order to (i) develop or enhance our products, (ii) take advantage of strategic opportunities, (iii) respond to competition or (iv) continue to operate our business. We currently have a Form S-3 shelf registration statement on file with the SEC. If we issue equity securities to raise additional funds, our existing stockholders may experience dilution, and the new equity securities may have rights, preferences and privileges senior to those of our existing stockholders. If we issue debt securities to raise additional funds, we may incur debt service obligations, become subject to additional restrictions that limit or restrict our ability to operate our business, or be required to further encumber our assets. There can be no assurance that we will be able to raise any such capital on terms acceptable to us, if at all. 28 Bank Loan Agreements Refer to Note 6 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 agreements. Cash Flows The following table presents the major components of the unaudited condensed consolidated statements of cash flows: Three Months Ended September 30, 2022 2021 Change (In thousands) Net cash used in operating activities $ (4,666 ) $ (516 ) $ (4,150 ) Net cash used in investing activities (5,606 ) (24,092 ) 18,486 Net cash provided by financing activities 6,176 25,139 (18,963 ) Operating Activities Cash used in operating activities during the three months ended September 30, 2022 increased compared to the prior year period. For the three months ended September 30, 2022, our net loss included $3,592,000 of non-cash charges, while the changes in operating assets and liabilities used net cash of $6,605,000. Our net inventories increased by $7,581,000, or 20.1%, from June 30, 2022 to September 30, 2022. Of this increase, $3,590,000 of net inventories were acquired in the Uplogix acquisition. The remainder of the increase resulted primarily from a build-up of critical long-lead time components as we continue to experience lead time and supply constraints. Accounts payable decreased by $5,266,000, or 25.5%, from June 30, 2022 to September 30, 2022, which was slightly offset by the acquisition of $278,000 of accounts payable from the Uplogix acquisition. The reduction is primarily due to the timing of our inventory purchases and related payments to our vendors. Investing Activities Net cash used in investing activities during the three months ended September 30, 2022 was driven by the acquisition of Uplogix, which used net cash of $4,650,000. We also used cash for the purchase of property and equipment, primarily related to building out and furnishing our new lease facilities in California and Minnesota. Financing Activities Net cash provided by financing activities during the three months ended September 30, 2022 resulted primarily from (i) $7,000,000 in gross proceeds received from our credit facilities with SVB. The increase in cash was partially offset by payments on the senior credit facility as well as tax withholdings paid on behalf of employees for restricted shares. 29 Item 3. Quantitative and Qualitative Disclosures about Market Risk As a smaller reporting company, we are not required to provide the information required by this Item 3.