LANTRONIX INC 10-K

ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that this information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2023. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of June 30, 2023 due to the material weaknesses identified and described below. In light of the material weaknesses described below, management performed additional analysis and other procedures to ensure that our interim and annual Consolidated Financial Statements were prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). Accordingly, management believes that the Consolidated Financial Statements included in this Report fairly present, in all material respects, our financial position, results of operations, and cash flows as of and for the periods presented, in accordance with U.S. GAAP. Management’s Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Internal control over financial reporting includes policies and procedures that provide reasonable assurance regarding the reliability of financial reporting and the preparation of Consolidated Financial Statements for external reporting purposes in accordance with U.S. GAAP. Our internal control over financial reporting includes those policies and procedures that: · pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; · provide reasonable assurance that transactions are recorded properly to allow for the preparation of financial statements in accordance with U.S. GAAP and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and · provide reasonable assurance regarding prevention or timely detection of unauthorized acquisitions, use, or disposition of our assets that could have a material effect on the Consolidated Financial Statements. Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable assurance and may not prevent or detect misstatements. Further, because of changing conditions, effectiveness of internal control over financial reporting may vary over time. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of June 30, 2023 based on the guidelines established in the Internal Control—Integrated Framework (2013 framework) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). We excluded Uplogix, Inc. from our assessment of internal control over financial reporting as of June 30, 2023 because it was acquired in a business purchase acquisition during the fiscal year ended June 30, 2023. The total revenue excluded represented approximately 4% of our consolidated fiscal 2023 net revenue. Based on its assessment, management concluded that the Company’s internal control over financial reporting was not effective as of June 30, 2023 due to material weakness in our control environment whereby the Company did not maintain adequate information technology (“IT”) general controls related to user access to the Company’s information systems that are relevant to the preparation of financial statements to ensure appropriate segregation of duties and to adequately restrict access to financial applications and data. Notwithstanding that we did not identify any material misstatements to the consolidated financial statements and there were no changes to previously released financial results as a result of the material weakness, the control deficiencies created a reasonable possibility that a material misstatement to the consolidated financial statements would not be prevented or detected on a timely basis. As a result, management believes that, as of June 30, 2023, our internal control over financial reporting was not effective. 36 Baker Tilly US, LLP, the independent registered public accounting firm that audited the financial statements included in this Annual Report on Form 10-K, has provided an attestation report on Lantronix’s internal control over financial reporting. As a result of the material weaknesses described below, such report includes an adverse audit report on the effectiveness of internal control over financial reporting as of June 30, 2023. Material Weakness in Internal Control Over Financial Reporting In connection with the evaluation of the Company’s internal control over financial reporting as described above, management has identified a deficiency constituting a material weakness related to the design and implementation of information technology general controls related to the Company’s information systems that are relevant to the preparation of consolidated financial statements. Specifically, we did not design and maintain user access controls to adequately restrict user access to the financial application and data to appropriate Company personnel. Notwithstanding we did not identify any material misstatements to the consolidated financial statements and there were no changes to previously released financial results as a result of this material weakness, the control deficiencies created a reasonable possibility that a material misstatement to the consolidated financial statements would not be prevented or detected on a timely basis. Remediation Efforts to Address the Material Weaknesses Existing in the Current Period Management has initiated a remediation plan to enhance the design of information technology general controls related to user access by implementing controls over user access including monitoring controls and enforcing proper segregation of duties within IT environments based on roles and responsibilities. The material weakness will not be considered remediated until the controls have operated effectively, as evidenced through testing, for a sufficient number of instances. 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(d) and 15d-15(d) of the Exchange Act that occurred during the quarter ended June 30, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. ITEM 9B. OTHER INFORMATION On September 11, 2023, Heidi Nguyen and Paul Folino notified the Company of their decision not to stand for re-election at the Company’s 2023 annual meeting of stockholders (the “Annual Meeting”). Their decision was not as a result of any disagreement with the Company on any matter relating to the Company’s operations, policies or practices. The Company has selected Bernhard Bruscha as a nominee for election by stockholders at the Annual Meeting, and the size of the board of directors has been reduced to five members, effective as of the Annual Meeting. ITEM 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections None. 37 PART III Portions of our definitive Proxy Statement on Schedule 14A relating to our 2023 annual meeting of stockholders (“Proxy Statement”), which will be filed with the SEC within 120 days after the end of the fiscal year covered by this Report, are incorporated by reference into Part III of this Report, as indicated below. ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE The names of our executive officers and their ages, titles and biographies as of the date hereof are set forth in Item 1 in the section entitled “Information About Our Executive Officers” in Part I, Item 1 of this Report, which is incorporated herein by reference. We have adopted a code of business conduct and ethics that applies to all employees, including employees of our subsidiaries, as well as each member of our board of directors. The code of business conduct and ethics is available at our website at www.lantronix.com under the Investor Relations-Corporate Governance section. We intend to satisfy any disclosure requirement under applicable rules of the SEC or Nasdaq Stock Market regarding an amendment to, or waiver from, a provision of this code of business conduct and ethics by posting such information on our website, at the web address specified above. The other information required by this Item is incorporated by reference to our Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference to our Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information required by this Item is incorporated by reference to our Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE The information required by this Item is incorporated by reference to our Proxy Statement. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by this Item is incorporated by reference to our Proxy Statement. 38 PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES 1. Consolidated Financial Statements The following consolidated financial statements and related Report of Independent Registered Public Accounting Firm are filed as part of this Report. Page Report of Independent Registered Public Accounting Firm (PCAOB ID 23) F-1 Consolidated Balance Sheets as of June 30, 2023 and 2022 F-4 Consolidated Statements of Operations for the fiscal years ended June 30, 2023 and 2022 F-5 Consolidated Statements of Stockholders’ Equity for the fiscal years ended June 30, 2023 and 2022 F-6 Consolidated Statements of Cash Flows for the fiscal years ended June 30, 2023 and 2022 F-7 Notes to Consolidated Financial Statements F-8 – F-37 2. Exhibits Incorporated by Reference Exhibit Number Exhibit Description Provided Herewith Form Exhibit Filing Date 3.1 Amended and Restated Certificate of Incorporation of Lantronix, Inc., as amended 10-K 3.1 8/29/2013 3.2 Amended and Restated Bylaws of Lantronix, Inc. 8–K 3.2 11/15/2012 4.1 Description of Lantronix Common Stock 10-K 4.1 9/11/2019 10.1* Lantronix, Inc. 2010 Inducement Equity Incentive Plan 10–Q 10.2 11/08/2010 10.2* Form of Stock Option Agreement under the Lantronix, Inc. 2010 Inducement Equity Incentive Plan 10–Q 10.3 11/08/2010 10.3* Lantronix, Inc. Amended and Restated 2010 Stock Incentive Plan, as Amended on November 14, 2017 8-K 99.1 11/15/2017 10.4* Form of Stock Option Agreement under the Lantronix, Inc. Amended and Restated 2010 Stock Incentive Plan S-8 4.3 5/09/2013 10.5* Form of Restricted Stock Award Agreement under the Lantronix, Inc. Amended and Restated 2010 Stock Incentive Plan S-8 4.4 5/09/2013 39 10.6* Lantronix, Inc. 2020 Performance Incentive Plan, as amended and restated 8-K 10.1 11/09/2022 10.7* Form of Director Stock Option Agreement under the Lantronix, Inc. 2020 Performance Incentive Plan 10-K 10.7 8/27/2021 10.8* Form of Restricted Stock Unit Award Agreement under the Lantronix, Inc. 2020 Performance Incentive Plan 10-K 10.8 8/27/2021 10.9* Form of Director Restricted Stock Unit Award Agreement under the Lantronix, Inc. 2020 Performance Incentive Plan 10-K 10.9 8/27/2021 10.10* Form of Nonqualified Stock Option Agreement under the Lantronix, Inc. 2020 Performance Incentive Plan 10-K 10.10 8/27/2021 10.11* Form of Incentive Stock Option Agreement under the Lantronix, Inc. 2020 Performance Incentive Plan 10-K 10.11 8/27/2021 10.12* Form of Performance Stock Unit Award Agreement under the Lantronix, Inc. 2020 Performance Incentive Plan 10-K 10.12 8/27/2021 10.13*+ Form of Performance Stock Unit Award Agreement under the Lantronix, Inc. 2020 Performance Incentive Plan (2022 Grants) 10-K 10.13 8/29/2022 10.14* Letter Agreement dated September 8, 2011 between Lantronix, Inc. and Jeremy Whitaker 8–K 10.1 9/26/2011 10.15* Amendment to Offer Letter between Lantronix, Inc. and Jeremy Whitaker, dated as of November 13, 2012 8-K 99.2 11/15/2012 10.16* Form of Indemnification Agreement entered into between Lantronix, Inc. with its directors and certain of its executive officers 8-K 10.2 6/20/2016 10.17* Summary of Lantronix, Inc. Annual Bonus Program 8-K 99.1 9/08/2015 10.18* Form of Executive Officer Retention Letter Agreement 8-K 10.1 7/05/2023 10.19*+ Change in Control Agreement between Lantronix, Inc. and Jeremy Whitaker, dated December 2, 2021 10-K 10.19 8/29/2022 10.20* Lantronix, Inc. 2013 Employee Stock Purchase Plan, as amended and restated 8-K 10.2 11/9/2022 10.21* Offer Letter dated March 23, 2019 between Lantronix, Inc. and Paul H. Pickle 8-K 99.1 3/27/2019 10.22* Inducement Stock Option Agreement, dated April 22, 2019, between Lantronix, Inc. and Paul H. Pickle S–8 4.1 4/26/2019 40 10.23* Inducement Restricted Stock Unit Agreement, effective as of May 1, 2019, between Lantronix, Inc. and Paul H. Pickle S–8 4.2 4/26/2019 10.24* Offer Letter dated January 4, 2020, between Lantronix, Inc. and Roger Holliday 10-K 10.22 9/11/2020 10.25* Form of Inducement Stock Option Agreement S-8 4.1 9/04/2020 10.26* Form of Inducement Restricted Stock Unit Agreement S-8 4.2 9/04/2020 10.27* Intrinsyc Technologies Corporation Amended and Restated Incentive Stock Option Plan 10-Q 10.1 5/15/2020 10.28* Intrinsyc Technologies Corporation Restricted Share Unit Plan 10-Q 10.2 5/15/2020 10.29 Third Amended and Restated Loan and Security Agreement with Silicon Valley Bank, dated August 2, 2021, by and between Lantronix, Inc., Lantronix Holding Company, Lantronix Canada ULC and Lantronix Technologies Canada (Taiwan) Ltd. and Transition Networks, Inc. 8-K 10.1 8/02/2021 10.30 Mezzanine Loan and Security Agreement, dated August 2, 2021, by and between Lantronix, Inc. and SVB Innovation Credit Fund VIII, L.P. 8-K 10.2 8/02/2021 10.31 2020 Non-Employee Director Compensation Policy 10-Q 10.1 11/12/2021 10.32*+ Non-Employee Director Compensation Policy, as revised August 8, 2022 to be effective November 8, 2022 10-K 10.32 8/29/2022 10.33 Warrant to Purchase Common Stock issued to SVB Innovation Credit Fund VIII, L.P. 10-Q 10.2 11/12/2021 10.34+ Warrant to Purchase Common Stock issued to Innovation Credit Fund VIII-A, L.P. 10-K 10.34 8/29/2022 10.35 Lease dated November 5, 2021 between Lantronix, Inc. and Discovery Business Center LLC 8-K 10.1 11/8/2021 10.36 Lease dated January 20, 2022 between Lantronix, Inc. and Jet 55 Property Owner LLC 8-K 10.1 1/26/2022 10.37 First Amendment to Third and Restated Loan Security Agreement dated February 15, 2022, among Lantronix, Inc., Lantronix Holding Company, Lantronix Canada, ULC and Lantronix Technologies Canada (Taiwan) Ltd. and Transition Networks, Inc. 10-Q 10.3 2/11/2022 10.38 Second Amendment to Third and Restated Loan Security Agreement dated February 15, 2022, among Lantronix, Inc., Lantronix Holding Company, Lantronix Canada, ULC and Lantronix Technologies Canada (Taiwan) Ltd. and Transition Networks, Inc. 8-K 10.1 2/16/2022 10.39 Third Amendment to Third Amended and Restated Loan and Security Agreement dated September 7, 2022 among Lantronix, Inc., Lantronix Holding Company, Lantronix Canada ULC and Lantronix Canada (Taiwan) Ltd., Transition Networks, Inc. and Silicon Valley Bank 8-K 10.1 9/12/2022 41 10.40* Offer Letter dated July 30, 2018 between Lantronix, Inc. and Fathi Hakam 10-Q 10.2 11/9/2022 10.41* Change in Control Agreement between Lantronix, Inc. and Fathi Hakam dated April 25, 2021 10-Q 10.3 11/9/2022 10.42* Offer Letter dated December 12, 2022 and countersigned January 24, 2023 between Lantronix, Inc. and Eric Bass X 10.43 Letter Agreement dated April 3, 2023, by and between Silicon Valley Bank, a Division of First-Citizens Bank & Trust Company (successor by purchase to the Federal Deposit Insurance Corporation as receiver for Silicon Valley Bank, N.A. (as successor to Silicon Valley Bank), Lantronix, Inc., Lantronix Holding Company, Lantronix Technologies Canada (Taiwan) Ltd., Lantronix Canada ULC, Transition Networks, Inc. and Uplogix, Inc. 8-K 10.1 4/6/2023 21.1+ Subsidiaries of Lantronix, Inc. X 23.1+ Consent of Independent Registered Public Accounting Firm, Baker Tilly US, LLP X 24.1+ Power of Attorney (included on the signature page) X 31.1+ Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 X 31.2+ Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 X 32.1++ Certification of Chief Executive Officer and Chief Financial Officer furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 X 101.INS Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document 101.SCH XBRL Taxonomy Extension Schema Document 101.CAL XBRL Taxonomy Extension Calculation Linkbase Document 101.DEF XBRL Taxonomy Extension Definition Linkbase Document 101.LAB XBRL Taxonomy Extension Label Linkbase Document 101.PRE XBRL Taxonomy Extension Presentation Linkbase Document 104 Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101) __________ * Indicates management contract or compensatory plan, contract or arrangement. + Filed herewith ++ Furnished herewith. ITEM 16. FORM 10-K SUMMARY None. 42 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. LANTRONIX, INC. By: /s/ JEREMY WHITAKER Jeremy Whitaker Interim Chief Executive Officer and Chief Financial Officer Date: September 12, 2023 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each individual whose signature appears below hereby constitutes and appoints Jeremy Whitaker, acting individually, as his or her true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Report, and to file the same, with all exhibits thereto and other documents in connection therewith, with the SEC, granting unto said attorney-in-fact and agent, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully for all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent, or their or his or her substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated: Signature Title Date /s/ JEREMY WHITAKER Interim Chief Executive Officer and Chief Financial Officer September 12, 2023 Jeremy Whitaker (Principal Executive, Financial and Accounting Officer) /s/ PAUL FOLINO Chairman of the Board September 12, 2023 Paul Folino /s/ PHILIP BRACE Director September 12, 2023 Philip Brace /s/ JASON COHENOUR Director September 12, 2023 Jason Cohenour /s/ PHU HOANG Director September 12, 2023 Phu Hoang /s/ HEIDI NGUYEN Director September 12, 2023 Heidi Nguyen /s/ HOSHI PRINTER Director September 12, 2023 Hoshi Printer 43 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and the Board of Directors of Lantronix, Inc.: Irvine, California Opinions on the Financial Statements and Internal Control over Financial Reporting We have audited the accompanying consolidated balance sheets of Lantronix, Inc. and its subsidiaries (the Company) as of June 30, 2023 and 2022, the related consolidated statements of operations, stockholders' equity and cash flows for the years then ended, and the related notes (collectively referred to as the consolidated financial statements). We also have audited the Company’s internal control over financial reporting as of June 30, 2023, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2023 and 2022, and the results of its operations and its cash flows for each of the years in the two-year period ended June 30, 2023 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, because of the effect of the material weakness described below on the achievement of the objective of the control criteria, the Company has not maintained effective internal control over financial reporting as of June 30, 2023, based on the COSO criteria. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weakness has been identified and included in management’s assessment. Management has identified a material weakness associated with ineffective information technology general controls (ITGCs) in the areas of user access controls over the information technology (IT) systems that supports the Company’s financial reporting processes. Automated and manual business process controls that are dependent on the affected ITGCs were also deemed ineffective because they could have been adversely impacted to the extent that they rely upon information from the affected IT systems. The material weakness referred to above is described in Management’s Annual Report on Internal Control Over Financial Reporting included in Item 9A of this Annual Report on Form 10-K. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2023 consolidated financial statements, and our opinion regarding the effectiveness of the Company’s internal control over financial reporting does not affect our opinion on those consolidated financial statements. Basis for Opinions The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Item 9A of this Annual Report on Form 10-K. Our responsibility is to express an opinion on the Company's consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. F- 1 Definition and Limitations of Internal Control Over Financial Reporting A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. INVENTORIES – EXCESS AND OBSOLETE RESERVE Critical Audit Matter Description As described in Note 1 and 4 to the consolidated financial statements, inventories are stated at the lower of cost or net realizable value and the Company’s consolidated inventories balance was approximately $49.7 million at June 30, 2023, net of reserves. The Company provides for reserves for excess and obsolete inventories primarily based upon estimates of future demand of products, the age of the inventory, and considering contractual supplier protection provisions and distributor stock rotation privileges. We identified the auditing of management’s lower of cost or net realizable value determination for excess or obsolete inventories as a critical audit matter. The procedures to audit management’s lower of cost or net realizable value determination for excess or obsolete inventories was especially challenging and highly judgmental because of (i) Inherent estimation uncertainty relating to assumptions used by management in the inventory reserve model which involved a high degree of subjectivity. (ii) the uncertainties in determining demand for aging inventory and (iii) future market conditions . How We Addressed the Matter in Our Audit The primary procedures we performed to address this critical audit matter included: § Obtaining an understanding and evaluating the design of the controls over the determination of the lower of cost or net realizable value for excess and obsolete inventories . § Reviewing manufacturer contracts for contractual supplier protection provisions . § Testing the completeness and accuracy of the underlying data used in management’s reserve calculation . § Evaluating the reasonableness of management’s assumptions relating to future demand of products by performing a retrospective review of the prior year assumptions to actual activity. § Evaluating the appropriateness and consistency of management’s methods and assumptions used in developing estimates around forecasted sales and expected stock rotation privileges . F- 2 VALUATION OF INTANGIBLE ASSETS IN ACQUISITION OF UPLOGIX, INC. Critical Audit Matter Description As described in Note 3 to the consolidated financial statements, on September 12, 2022, the Company acquired Uplogix, Inc. The transaction was accounted for as business combination and the assets acquired and liabilities assumed have been recorded based on the final assessment of fair value. The acquired intangible assets included approximately $1.0 million in customer relationships and approximately $0.6 million in acquired technology. The significant assumptions used to estimate the fair value of these intangible assets included revenue growth rates, customer attrition rates and discount rates. These significant assumptions are forward-looking and could be affected by future economic and market conditions . We identified auditing of management’s valuation of intangible assets in the acquisition of Uplogix, Inc. as a critical audit matter. The procedures used to audit the valuation of the acquired technology and customer relationship assets acquired include (i) a high degree of auditor judgment and subjectivity in applying procedures relating to the fair value measurement of intangible assets acquired due to the significant amount of judgment by management when developing the estimate; (ii) significant audit effort in evaluating the significant assumptions relating to the estimate, such as revenue growth rates, the customer attrition rate, and discount rates; and (iii) the use of professionals with specialized skill and knowledge to assist in performing these procedures and evaluating the audit evidence . How We Addressed the Matter in Our Audit The primary procedures we performed to address this critical audit matter included: § Obtaining an understanding and evaluating the design and implementation of the Company's controls over its estimation process supporting the recognition and measurement of the customer and technology intangible assets, including controls over management’s evaluation of the methodology and underlying assumptions used in determining the fair value . § Evaluating the Company's selection of the valuation methodology and testing significant assumptions and inputs used by the Company in the valuation of the intangible assets by evaluating the sensitivity of changes in assumptions to the fair value of the intangible assets and comparing the significant assumptions to current industry and market and economic trends . § Evaluating the competency and objectivity of third-party specialists engaged by the Company to assist in developing management’s assumptions . § Involving firm employed valuation specialists to assist with our evaluation of the methodology and significant underlying assumptions used by management in determining the fair value estimates . § Testing the mathematical accuracy of the models used to determine the fair values of assets acquired. /s/ Baker Tilly US, LLP We have served as the Company’s auditors since 2011. Irvine, California 23 September 12, 2023 F- 3 LANTRONIX, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except share and par value data) June 30, June 30, 2023 2022 Assets Current Assets: Cash and cash equivalents $ 13,452 $ 17,221 Accounts receivable, net 27,682 26,262 Inventories, net 49,736 37,679 Contract manufacturers' receivable 3,019 3,454 Prepaid expenses and other current assets 2,662 5,417 Total current assets 96,551 90,033 Property and equipment, net 4,629 3,652 Goodwill 27,824 20,768 Purchased intangible assets, net 10,565 14,559 Lease right-of-use assets 11,583 8,037 Other assets 472 325 Total assets $ 151,624 $ 137,374 Liabilities and stockholders' equity Current Liabilities: Accounts payable $ 12,401 $ 20,644 Accrued payroll and related expenses 2,431 4,729 Current portion of long-term debt, net 2,743 1,671 Other current liabilities 28,813 8,477 Total current liabilities 46,388 35,521 Long-term debt, net 16,221 14,274 Other non-current liabilities 11,459 7,683 Total liabilities 74,068 57,478 Commitments and contingencies (Note 10) – – Stockholders' equity: Preferred stock, $ 0.0001 par value; 5,000,000 shares authorized; none issued and outstanding – – Common stock, $ 0.0001 par value; 100,000,000 shares authorized; 36,875,586 and 35,129,301 shares issued and outstanding at June 30, 2023 and 2022, respectively 4 4 Additional paid-in capital 295,686 289,046 Accumulated deficit ( 218,505 ) ( 209,525 ) Accumulated other comprehensive income 371 371 Total stockholders' equity 77,556 79,896 Total liabilities and stockholders' equity $ 151,624 $ 137,374 See accompanying notes to consolidated financial statements. F- 4 LANTRONIX, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) Years Ended June 30, 2023 2022 Net revenue $ 131,189 $ 129,655 Cost of revenue 74,925 74,069 Gross profit 56,264 55,586 Operating expenses: Selling, general and administrative 36,948 34,529 Research and development 19,625 17,687 Restructuring, severance and related charges 693 795 Acquisition-related costs 315 889 Fair value remeasurement of earnout consideration ( 447 ) 1,107 Amortization of purchased intangible assets 5,804 5,590 Total operating expenses 62,938 60,597 Loss from operations ( 6,674 ) ( 5,011 ) Interest expense, net ( 1,485 ) ( 1,472 ) Loss on extinguishment of debt – ( 764 ) Other income (expense), net ( 73 ) 53 Loss before income taxes ( 8,232 ) ( 7,194 ) Provision (benefit) for income taxes 748 ( 1,832 ) Net loss and comprehensive loss $ ( 8,980 ) $ ( 5,362 ) Net loss per share - basic and diluted $ ( 0.25 ) $ ( 0.16 ) Weighted-average common shares - basic and diluted 36,257 32,671 See accompanying notes to consolidated financial statements. F- 5 LANTRONIX, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (In thousands) Additional Accumulated Other Total Common Stock Paid-In Accumulated Comprehensive Stockholders' Shares Amount Capital Deficit Income Equity Balance at June 30, 2021 29,088 $ 3 $ 249,885 $ ( 204,163 ) $ 371 $ 46,096 Shares issued pursuant to equity offering, net 4,700 1 32,593 – – 32,594 Shares issued pursuant to stock awards, net 1,341 – 1,633 – – 1,633 Tax withholding paid on behalf of employees for restricted shares – – ( 1,811 ) – – ( 1,811 ) Fair value of warrants to purchase common stock issued with bank credit facility – – 500 – – 500 Share-based compensation – – 6,246 – – 6,246 Net loss – – – ( 5,362 ) – ( 5,362 ) Balance at June 30, 2022 35,129 $ 4 $ 289,046 $ ( 209,525 ) $ 371 $ 79,896 Shares issued pursuant to stock awards, net 1,746 – 1,253 – – 1,253 Tax withholding paid on behalf of employees for restricted shares – – ( 821 ) – – ( 821 ) Share-based compensation – – 6,208 – – 6,208 Net loss – – – ( 8,980 ) – ( 8,980 ) Balance at June 30, 2023 36,875 $ 4 $ 295,686 $ ( 218,505 ) $ 371 $ 77,556 See accompanying notes to consolidated financial statements. F- 6 LANTRONIX, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) Years Ended June 30, 2023 2022 Operating activities Net loss $ ( 8,980 ) $ ( 5,362 ) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Share-based compensation 6,208 6,246 Amortization of purchased intangible assets 5,804 5,590 Depreciation and amortization 1,735 1,028 Amortization of manufacturing profit in acquired inventory associated with acquisitions 225 380 Loss on disposal of property and equipment 15 4 Amortization of deferred debt issuance costs 104 261 Fair value remeasurement of earnout consideration ( 447 ) 1,107 Loss on extinguishment of debt – 764 Changes in operating assets and liabilities, net of assets and liabilities acquired: Accounts receivable 480 ( 7,470 ) Inventories ( 8,692 ) ( 15,266 ) Contract manufacturers' receivable 435 ( 1,494 ) Prepaid expenses and other current assets 3,043 ( 2,183 ) Lease right-of-use assets 2,088 1,564 Other assets ( 18 ) ( 85 ) Accounts payable ( 8,575 ) 8,782 Accrued payroll and related expenses ( 2,560 ) ( 222 ) Other liabilities 9,372 ( 3,060 ) Net cash provided by (used in) operating activities 237 ( 9,416 ) Investing activities Purchases of property and equipment ( 2,673 ) ( 2,118 ) Cash payment for acquisitions, net of cash and cash equivalents acquired ( 4,650 ) ( 23,629 ) Net cash used in investing activities ( 7,323 ) ( 25,747 ) Financing activities Net proceeds from issuances of common stock 1,253 34,227 Tax withholding paid on behalf of employees for restricted shares ( 821 ) ( 1,811 ) Earnout consideration paid – ( 1,500 ) Net proceeds from issuance of debt 4,909 28,800 Payment of borrowings on term loan ( 1,994 ) ( 17,062 ) Net proceeds from borrowing on line of credit 2,000 2,500 Payment of borrowings on line of credit ( 2,000 ) ( 2,500 ) Payment of lease liabilities ( 30 ) ( 9 ) Net cash provided by financing activities 3,317 42,645 Increase (decrease) in cash and cash equivalents ( 3,769 ) 7,482 Cash and cash equivalents at beginning of year 17,221 9,739 Cash and cash equivalents at end of year $ 13,452 $ 17,221 Supplemental disclosure of cash flow information Interest paid $ 1,563 $ 1,494 Income taxes paid $ 539 $ 215 See accompanying notes to consolidated financial statements. F- 7 LANTRONIX, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2023 1. Company and Significant Accounting Policies Company Lantronix, Inc., which we refer to herein as the Company, Lantronix, we, our, or us, 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, our target applications include Smart Cities infrastructure, Infotainment systems and Video Surveillance all supplemented with a comprehensive Out of Band Management products offering for Cloud and Edge Computing. We were incorporated in California in 1989 and re-incorporated in Delaware in 2000. Basis of Presentation The consolidated financial statements include the accounts of Lantronix and our wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The industry in which we operate is characterized by rapid technological change. As a result, estimates made in preparing the consolidated financial statements include revenue recognition, the allowance for doubtful accounts, business combinations, inventory valuation, goodwill valuation, deferred income tax asset valuation allowances, share-based compensation, restructuring charges and warranty reserves. In the macroeconomic environment affected by COVID-19, our estimates could require increased judgement and carry a higher degree of variability volatility. To the extent there are material differences between our estimates and actual results, future results of operations will be affected. Revenue Recognition Refer to Note 2 below for a discussion of our significant accounting policy over revenue recognition. Accounts Receivable and Allowance for Doubtful Accounts Accounts receivable are stated at the amount we expect to collect, which is net of 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 various considerations, including the length of time the receivables are past due and our historical bad debt collection experience. We also consider our understanding of current economic and industry conditions that may affect the collectability of customer receivables. Accounts that are deemed uncollectible are written off against the allowance for doubtful accounts. F- 8 Concentration of Credit Risk Our accounts receivable are primarily derived from revenue earned from customers located throughout North America, Europe and Asia. We perform periodic credit evaluations of our customers’ financial condition and maintain allowances for potential credit losses. Credit losses have historically been within our expectations. We generally do not require collateral or other security from our customers. Fair Value of Financial Instruments Our financial instruments consist primarily of cash and cash equivalents, accounts receivable, contract manufacturers’ receivable, accounts payable, and accrued liabilities. The fair value of a financial instrument is the amount that would be received in an asset sale or paid to transfer a liability in an orderly transaction between unaffiliated market participants. Assets and liabilities measured at fair value are categorized based on whether or not the inputs are observable in the market and the degree to which the inputs are observable. The categorization of financial instruments within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The hierarchy is prioritized into three levels (with Level 3 being the lowest) defined as follows: Level 1: Inputs are based on quoted market prices for identical assets and liabilities in active markets at the measurement date. Level 2: Inputs include quoted prices for similar assets or liabilities in active markets and/or quoted prices for identical or similar assets or liabilities in markets that are not active near the measurement date. Level 3: Inputs include management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. The inputs are unobservable in the market and significant to the instrument’s valuation. The hierarchy noted above requires us to minimize the use of unobservable inputs and to use observable market data, if available, when determining fair value. Other than earnout consideration liabilities (see Note 3 ), during the fiscal years ended June 30, 2023 and 2022 we did not have any assets or liabilities that were measured at fair value on a recurring basis. As of June 30, 2023 we do not have any assets or liabilities that were measured at fair value on a non-recurring basis, We believe all of our financial instruments’ recorded values approximate their current fair values because of the nature and short duration of these instruments. Foreign Currency Remeasurement The functional currency for all our foreign subsidiaries is currently the U.S. dollar. Non-monetary and monetary foreign currency assets and liabilities are valued in U.S. dollars at historical and end-of-period exchange rates, respectively. Exchange gains and losses from foreign currency transactions and remeasurements are recognized in the consolidated statements of operations. Translation adjustments for foreign subsidiaries whose functional currencies were previously their respective local currencies are suspended in accumulated other comprehensive income. Accumulated Other Comprehensive Income Accumulated other comprehensive income is composed of accumulated translation adjustments as of June 30, 2023 and 2022. We did not have any other comprehensive income or losses during the fiscal years ended June 30, 2023 or 2022. F- 9 Cash and Cash Equivalents Cash and cash equivalents consist of cash and short-term investments, with original maturities of 90 days or less. Inventories Inventories are stated at the lower of cost (on a first-in, first-out basis) or net realizable value. We provide reserves for excess and obsolete inventories determined primarily based upon estimates of future demand for our products. Shipping and handling costs are classified as a component of cost of revenue in the consolidated statements of operations. Inventory Sale and Purchase Transactions with Contract Manufacturers Under certain circumstances, we sell raw materials to our contract manufacturers and subsequently repurchase finished goods from the contract manufacturers which contain such raw materials. Net sales of raw materials to the contract manufacturers are recorded on the consolidated balance sheets as contract manufacturers’ receivables and are eliminated from net revenue as we intend to repurchase the raw materials from the contract manufacturers in the form of finished goods. We have contractual arrangements with certain of our contract manufacturers that require us to purchase unused inventory that the contract manufacturer has purchased to fulfill our forecasted manufacturing demand. To the extent that inventory on-hand at one or more of these contract manufacturers exceeds our contractually reported forecasts, we record the amount we may be required to purchase as part of other current liabilities and inventories on the consolidated balance sheets. Property and Equipment Property and equipment are carried at cost. Depreciation is provided using the straight-line method over the assets’ estimated useful lives, generally ranging from three to five years. Depreciation and amortization of leasehold improvements are computed using the shorter of the remaining lease term or five years. Major renewals and betterments are capitalized, while replacements, maintenance and repairs, which do not improve or extend the estimated useful lives of the respective assets, are expensed as incurred. 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”), 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. Acquisition-related expenses and related restructuring costs are recognized separately from the business combination and are expensed as incurred. F- 10 Goodwill Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the acquired net tangible and intangible assets acquired. We evaluate goodwill for impairment on an annual basis in our fiscal fourth 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. We begin 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. Based on that 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. During the fourth quarter of the fiscal year ended June 30, 2023, we performed a qualitative assessment of whether goodwill impairment existed and did not determine that it was more likely than not that the fair value of our single reporting unit was less than its carrying amount. Purchased Intangible Assets Included within "purchased intangible assets, net" at June 30, 2023 are customer lists, developed technology, tradenames, and other intangible assets acquired in connection with various business combinations. Such capitalized costs and intangible assets are being amortized over a period of one to five years. 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 amount of long-lived assets may not be recoverable. We estimate the future cash flows, undiscounted and without interest charges, expected to be generated by the assets from its use or eventual disposition. If the sum of the expected undiscounted 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. Income Taxes Income taxes are computed under the liability method. This method requires the recognition of deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities. The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled and are reflected in the consolidated financial statements in the period of enactment. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized. Financial statement effects of a tax position are initially recognized when it is more likely than not, based on the technical merits, that the position will be sustained upon examination by a taxing authority. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that meets the more-likely-than-not threshold of being realized upon ultimate settlement with a taxing authority. We recognize potential accrued interest and penalties related to unrecognized tax benefits as income tax expense. Share-Based Compensation We account for share-based compensation by expensing the estimated grant date fair value of our shared-based awards ratably over the requisite service period. We recognize the impact of forfeitures on our share-based compensation expense as such forfeitures occur. Previously recognized expense is reversed for the portion of awards forfeited prior to vesting. F- 11 Net Income (Loss) Per Share Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted-average number of common shares outstanding during the fiscal year. Diluted net income (loss) per share is calculated by adjusting the weighted-average number of common shares outstanding, assuming any dilutive effects of outstanding share-based awards using the treasury stock method. Research and Development Costs Costs incurred in the research and development of new products and enhancements to existing products are expensed as incurred. Development costs of computer software to be sold, leased or otherwise marketed are subject to capitalization beginning when a product’s technological feasibility has been established and ending when a product is available for general release to customers. In most instances, we believe our current process for developing products is essentially completed concurrently with the establishment of technological feasibility and thus, software development costs have been expensed as incurred. Warranty 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. 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. Leases We determine if an arrangement is a lease, or contains a lease, at the inception of the arrangement and evaluate whether the lease is an operating lease or a finance lease at the commencement date. We recognize right-of-use (“ROU”) assets and lease liabilities for operating and finance leases with terms greater than 12 months. ROU assets represent our right to use an asset for the lease term, while lease liabilities represent our obligation to make lease payments. To the extent a lease includes a renewal option, we include such options in the calculation of the ROU asset and lease liability if it is reasonably assured that we will exercise the option. Operating and finance lease ROU assets and liabilities are recognized based on the present value of lease payments over the lease term at the lease commencement date. To determine the present value of lease payments, we use the implicit interest rate, if it is readily determinable or estimable. To the extent that we are unable to utilize an interest rate implicit in the lease, we generally use our 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. Operating and finance lease ROU assets are recognized net of any lease prepayments and incentives. Operating lease expense is recognized on a straight-line basis over the lease term. Finance lease expense is recognized based on the effective-interest method over the lease term. For leases that we acquire in acquisition transactions, we generally elect not to recognize assets or liabilities at the acquisition date for leases that, at the acquisition date, have a remaining lease term of 12 months or less. This includes not recognizing an intangible asset if the terms of an operating lease are favorable relative to the market terms or a liability if the terms are unfavorable relative to the market terms. Refer to Note 9 below for additional information regarding our leases. F- 12 Advertising Expenses Advertising expenses are recorded in the period incurred and totaled $ 262,000 and $ 253,000 for the fiscal years ended June 30, 2023 and 2022, respectively. The costs are included in selling, general and administrative expenses in the consolidated statements of operations. Segment Information We have one operating and reportable business segment. Recent Accounting Pronouncements Revenue Contracts In October 2021, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update (“ASU”) to improve the accounting for acquired revenue contracts with customers in a business combination by addressing diversity and inconsistency related to (i) recognition of an acquired contract liability and (ii) payment terms and their effect on subsequent revenue recognized by the acquirer. The amendments in this ASU require that an entity (acquirer) recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with existing revenue recognition guidance under Accounting Standard Codification Topic (“ASC”) 606. At the acquisition date, an acquirer would assess how the acquiree applied ASC 606 to determine what to record for the acquired revenue contracts. Generally, this would result in an acquirer recognizing and measuring the acquired contract assets and contract liabilities consistent with how they were recognized and measured in the acquiree’s financial statements. Lantronix adopted this ASU in the first quarter of our fiscal year ended June 30, 2023, and as such, we recorded applicable contract assets and liabilities acquired in the Uplogix acquisition (see Note 3 ) in accordance with this ASU. Current Expected Credit Losses In June 2016, the FASB issued a new ASU requiring financial assets measured at amortized cost be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The ASU eliminates the threshold for initial recognition in current U.S. GAAP and reflects an entity’s current estimate of all expected credit losses. The measurement of expected credit losses is based on historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the financial assets. The ASU is effective for Lantronix beginning in the first quarter of fiscal year 2024. The adoption of this guidance is not expected to have a material effect on our consolidated financial statements. 2. Revenue 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. On occasion we enter into contracts that can include various combinations of products and services, which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of (i) any taxes collected from customers, which are subsequently remitted to governmental authorities and (ii) shipping and handling costs collected from customers. F- 13 Products Most of our product revenue is recognized as a distinct single performance obligation when products are tendered to a carrier for delivery, which represents the point in time that our customer obtains control of the promised products. A smaller portion of our product revenue is recognized when our customer receives delivery of the promised products. 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. We base our estimates for returns and price adjustments primarily on historical experience; however, we also consider contractual allowances, approved pricing adjustments and other known or anticipated returns and price adjustments in a given period. Such estimates are generally made at the time of shipment to the customer and updated at the end of each reporting period as additional information becomes available and only to the extent that it is probable that a significant reversal of any incremental revenue will not occur. Our estimates of accrued variable consideration are included in other current liabilities in the accompanying consolidated balance sheets. Services Revenues from our extended warranty and services are generally recognized ratably over the applicable service period. Revenues from sales of our software-as-a-service (“SaaS”) products are recognized ratably over the applicable service period as well. We prepay sales commissions related to certain of these contracts, which are incremental costs of obtaining the contract. We capitalize these costs and expense them ratably on a straight-line basis over the life of the contract. At June 30, 2023, prepaid sales commissions included in prepaid expenses and other current assets totaled $ 150,000 and included in other assets totaled $ 58,000 . Engineering Services We derive a portion of our revenues from engineering and related consulting service contracts with customers. Revenues from professional engineering services are generally recognized as services are performed. 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. 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. F- 14 Multiple Performance Obligations From time to time, we may enter into contracts with customers that include promises to transfer multiple deliverables that may include sales of products, professional engineering services and other product qualification or certification services. Determining whether the deliverables in such 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 such 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. Net Revenue by Product Line and Geographic Region We organize our products and solutions into three product lines: Embedded IoT Solutions, IoT System Solutions, and Software & Services. Our Embedded IoT 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. Our IoT System 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. Our Software & Services products can be classified as either (i) our SaaS platform, which 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, (ii) engineering services, which is a flexible business model that allows customers to select from turnkey product development or team augmentation for accelerating complex areas of product development or (iii) extended warranty, support and maintenance. 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”). The following tables present our net revenue by product line and by geographic region. Net revenues by geographic region are generally based on the “bill-to” location of our customers: Schedule of net revenue by product lines Years Ended June 30, 2023 2022 (In thousands) Embedded IoT Solutions $ 63,636 $ 61,773 IoT System Solutions 57,496 59,019 Software & Services 10,057 8,863 $ 131,189 $ 129,655 Schedule of net revenue by geographic region Years Ended June 30, 2023 2022 (In thousands) Americas $ 78,557 $ 77,799 EMEA 23,286 22,542 APJ 29,346 29,314 $ 131,189 $ 129,655 F- 15 The following table presents product revenues and service revenues as a percentage of our total net revenue: Schedule of percentage total net revenues Year Ended June 30, 2022 2021 Product revenues 93 % 94 % Service revenues 7 % 6 % Service revenue is comprised primarily of professional services, software license subscriptions, and extended warranties. 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 primarily comprised of unearned revenue related to our extended warranty services and certain software 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 consolidated balance sheets. The following table presents the changes in our deferred revenue balance for the year ended June 30, 2023 (in thousands): Schedule of changes in deferred revenue Balance, July 1, 2022 $ 1,342 New performance obligations 3,183 Performance obligations acquired from acquisitions 4,096 Recognition of revenue as a result of satisfying performance obligations ( 5,240 ) Balance, June 30, 2023 $ 3,381 Less: non-current portion of deferred revenue ( 888 ) Current portion, June 30, 2023 $ 2,493 We expect to recognize substantially all of the non-current portion of deferred revenue over the next 2 to 5 years. F- 16 3. Acquisitions Acquisition of Uplogix On September 12, 2022 (the “Closing Date”), we entered into a Merger Agreement with Uplogix, Inc. (“Uplogix”) pursuant to which Uplogix became a wholly-owned subsidiary of Lantronix. Pursuant to the Merger Agreement, all of the issued and outstanding shares of Uplogix were cancelled and converted into the right to receive an applicable portion of the Consideration Pool Amount (as defined in the Merger Agreement). In addition, the holders of promissory notes issued by Uplogix entered into note termination agreements with Uplogix, which provided, among other things, that the issued and outstanding promissory notes were cancelled and terminated upon the closing of the Merger. Holders of Company Junior-Only Notes (as defined in the Merger Agreement) received, in connection with their cancellation and termination of such notes, the full payment of principal and interest. Holders of Company Senior Notes (as defined in the Merger Agreement), including those holders of Company Senior Notes and Company Junior Notes (as defined in the Merger Agreement) (the “Company Senior Noteholders”), received the applicable portions of the Estimated Merger Consideration (as defined in the Merger Agreement). The aggregate consideration payable by Lantronix under the Merger Agreement was equal to $8,000,000 (inclusive of payments to satisfy the Company Junior-Only Notes), subject to certain adjustments, including, without limitation, for cash, debt, transaction expenses (including the Bonus Amount (as defined below)) and net working capital. Prior to the Closing Date, Uplogix entered into an amended and restated bonus plan, which provided that certain of its employees would be entitled to receive, in the aggregate, 15% of the consideration otherwise payable to the holders of Company Senior Notes (the “Bonus Amount”) under the Merger Agreement, with the terms of such bonus payments (including the amounts per employee and the timing of such payments) as specified in such bonus plan. In addition, the Company Senior Noteholders and former Uplogix employees have the right to receive up to an additional $4,000,000 in the aggregate (the “Earnout Amount”), payable after the closing of the Merger based on revenue targets for the business of Uplogix as specified in the Merger Agreement. The Earnout Amount will be based on Uplogix achieving revenue (subject to certain adjustments as specified in the Merger Agreement) of $7,000,000 to $14,000,000 for the period beginning at the Closing Date and ending on September 30, 2023. The Company Senior Noteholders are entitled to an advance of the Earnout Amount if the revenue of the Uplogix business for the period beginning at the closing of the Merger and ending on March 31, 2023 is between $7,000,000 to $14,000,000, but in no event will the Earnout Amount, together with any such advance of the Earnout Amount, exceed $4,000,000. The acquisition of Uplogix brings immediate scale to our out-of-band remote management solutions, adding a complementary high-end product offering that includes high-margin maintenance and licensing revenues. A summary of the purchase consideration for the Uplogix acquisition is as follows (in thousands): Schedule of purchase consideration Cash paid, including initial working capital adjustments $ 8,754 Preliminary estimated fair value of earnout consideration 1,718 Total purchase consideration $ 10,472 We recorded Uplogix’s tangible and intangible assets and liabilities based on their estimated fair values as of the Closing Date and allocated the remaining purchase consideration to goodwill. Our valuation assumptions of acquired assets and assumed liabilities require significant estimates, especially with respect to intangible assets. Updates to the valuation of certain assets acquired and liabilities assumed may result in changes to the recorded amounts of assets and liabilities, with corresponding adjustments to goodwill in subsequent periods. As of June 30, 2023, the measurement period is complete. F- 17 During the fiscal year ended June 30, 2023, based on additional analysis and refinements to our estimates, we adjusted the preliminary purchase price allocation as of the Closing Date to (i) decrease the estimated fair value of intangible assets acquired by $ 660,000 , (ii) increase the fair value of other current liabilities by a net amount of $ 12,000 . These adjustments resulted in an increase to goodwill of $ 672,000 . The final purchase price allocation is as follows (in thousands): Schedule of purchase price allocation Cash and cash equivalents $ 4,104 Accounts receivable, net 1,900 Inventories, net 3,590 Prepaid expense and other current assets 288 Lease right-of-use asset 778 Other non-current assets 129 Amortizable intangible assets 1,810 Goodwill 7,056 Accounts payable ( 278 ) Accrued payroll ( 262 ) Deferred revenue ( 4,096 ) Other current liabilities ( 3,067 ) Notes payable ( 900 ) Other noncurrent liabilities ( 580 ) Total consideration $ 10,472 As discussed above, the purchase consideration and resulting purchase price allocation for this acquisition included various adjustments for transaction expenses, the Bonus Amount, payment of Company Junior-Only Notes and certain other accrued expenses paid shortly after the Closing Date. Pursuant to the Merger Agreement, substantially all of the $ 4,104,000 cash acquired was to be utilized for these items. The purchase price allocation above reflects both this cash acquired and the applicable accrued liabilities and notes payable that were substantially all disbursed on or shortly after the Closing Date. The factors that contributed to a purchase price resulting in the recognition of goodwill include our belief that this 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. Depending on the structure of a particular acquisition, goodwill and identifiable intangible assets may not be deductible for tax purposes. We have determined that goodwill and identifiable intangible assets related to this acquisition are deductible. Acquisition-related costs were expensed in the periods in which the costs were incurred. The valuation of identifiable intangible assets and their estimated useful lives are as follows: Schedule of intangible assets of useful lives Asset Fair Value Weighted Average Useful Life (In thousands) (In years) Customer relationships $ 1,030 5.0 Developed technology 600 5.0 Trademarks and trade names 180 1.0 F- 18 The intangible assets are amortized on a straight-line basis over the estimated weighted-average useful lives. Valuation Methodology The customer relationships were valued using the multi-period excess earnings method, which estimates revenues and cash flows derived from this asset and also considers portions of the cash flows that can be attributed to the use of other supporting assets. The useful lives of customer relationships are estimated based primarily upon customer turnover data. Order backlog was estimated to be substantially fulfilled within a year of the Closing Date. Developed technology and trades names were valued using the relief-from-royalty method. This method is an income approach that estimates the portion of a company’s earnings attributable to an asset based on the royalty rate the company would have paid for the use of the asset if it did not own it. Royalty payments are estimated by applying a royalty rate to the prospective revenue attributable to the intangible asset. The resulting annual royalty payments are tax-affected and then discounted to present value. Assumptions used in forecasting cash flows for each of the identified intangible assets included consideration of the following: · Historical performance including sales and profitability · Business prospects and industry expectations · Estimated economic life of the asset · Development of new technologies · Acquisition of new customers · Attrition of existing customers · Obsolescence of technology over time The fair value of earnout consideration was estimated based on applying a Monte Carlo simulation method to forecast achievement of the revenue targets. This method involves many possible value outcomes which are evaluated to establish an estimated value. Key inputs in the valuation include forecasted revenue, revenue volatility and discount rate. Remeasurement of Earnout Consideration During the year ended June 30, 2023, we remeasured the estimated fair value of the earnout consideration based on our updated expectations of achieving the revenue targets for the business of Uplogix. F- 19 The following table presents the change in the earnout consideration liability (in thousands): Schedule of change in the earnout consideration liability Preliminary estimated fair value of earnout consideration $ 1,718 Remeasurement estimates ( 447 ) Payments – Balance at June 30, 2023 $ 1,271 The remeasurement of the earnout consideration liability was recorded within our operating expenses in the accompanying consolidated statement of operations for the fiscal year ended June 30, 2023. The balance of this liability is recorded in other current liabilities on the accompanying consolidated balance sheet at June 30, 2023. Supplemental Pro Forma Information (Unaudited) The following supplemental pro forma data summarizes our results of operations for the periods presented, as if we completed the acquisition of Uplogix as of the first day of our fiscal year ended June 30, 2022. The supplemental pro forma data reports actual operating results adjusted to include the pro forma effect and timing of the impact of 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 year ended June 30, 2022 supplemental pro forma data (i) cost of goods sold from manufacturing profit in acquired inventory of $ 225,000 , (ii) acquisition related restructuring costs of $ 315,000 and (iii) acquisition-related costs of $ 315,000 , with a corresponding reduction in the year ended June 30, 2023 supplemental pro forma data. Additionally, we recorded $ 506,000 of amortization expense in the year ended June 30, 2022 supplemental pro forma data, and a reduction of amortization expense of $ 79,000 in the year ended June 30, 2023 supplemental pro forma data to represent amortization for the full fiscal year period. Net revenue related to products and services from the acquisition of Uplogix contributed just under 4% of our total net revenue for the year ended June 30, 2023. As of the Closing Date, we began to immediately integrate the acquisition into existing operations, engineering groups, sales distribution networks and management structure, making it generally impracticable to determine the post-acquisition earnings on a standalone basis. Supplemental pro forma data is as follows: Schedule of supplemental pro forma data Years ended June 30, 2023 2022 (In thousands, except per share amounts) Pro forma net revenue $ 133,224 $ 138,835 Pro forma net loss $ ( 7,545 ) $ ( 5,813 ) Pro forma net loss per share: Basic and Diluted $ ( 0.21 ) $ ( 0.18 ) Acquisition of Transition Networks On April 28, 2021, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with Communications Systems, Inc., a Minnesota corporation (“CSI”), pursuant to which we agreed to purchase from CSI the Transition Networks (“TNI”) and Net2Edge businesses of CSI (the “Transaction”). The Transaction closed on August 2, 2021 (the “Closing Date”), with Lantronix acquiring all outstanding shares of the common stock of TNI and all of the outstanding ordinary shares of Transition Networks Europe Limited (such entity, together with TNI, the “TN Companies”) for an aggregate purchase price of up to approximately $ 32,028 ,000 consisting of (i) $ 25,028,000 in cash paid on the Closing Date, plus (ii) earnout payments of up to $ 7,000,000 , payable following two successive 180-day intervals after the Closing Date based on revenue targets for the business of the TN Companies as specified in the Purchase Agreement, subject to certain adjustments and allocations as further described in the Purchase Agreement. Based on preliminary working capital estimates of the TN Companies at the Closing Date, we paid $24,160,000 in cash consideration on the Closing Date. In September 2021, pursuant to working capital adjustments as outlined in the Purchase Agreement, the net cash consideration paid as of the Closing Date was adjusted to approximately $23,651,000. F- 20 The acquisition of the TN Companies provided Lantronix with complementary IoT connectivity products and capabilities, including switching, power over ethernet and media conversion and adapter products. A summary of the purchase consideration for the TN Companies is as follows (in thousands): Schedule of purchase consideration Cash consideration paid to CSI $ 23,651 Estimated fair value of earnout consideration 393 Total purchase consideration $ 24,044 We recorded the TN Companies’ tangible and intangible assets and liabilities based on their estimated fair values as of the Closing Date and allocated the remaining purchase consideration to goodwill. Our valuation assumptions of acquired assets and assumed liabilities require significant estimates, especially with respect to intangible assets. The final purchase price allocation is as follows (in thousands): Schedule of purchase price allocation Cash and cash equivalents $ 22 Accounts receivable, net 5,277 Inventories, net 7,734 Prepaid expense and other current assets 355 Property and equipment, net 121 Goodwill 4,958 Amortizable intangible assets 10,794 Accounts payable ( 1,872 ) Accrued payroll ( 9 ) Deferred tax liability ( 2,036 ) Other current liabilities ( 1,300 ) Total consideration $ 24,044 The factors that contributed to a purchase price resulting in the recognition of goodwill include our belief that the Transaction 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. Depending on the structure of a particular acquisition, goodwill and identifiable intangible assets may not be deductible for tax purposes. We determined that goodwill and identifiable intangible assets related to the Transaction are not deductible. Acquisition-related costs were expensed in the periods in which the costs were incurred. F- 21 The valuation of identifiable intangible assets and their estimated useful lives are as follows: Schedule of intangible assets of useful lives Asset Fair Value Weighted Average Useful Life (In thousands) (In years) Customer relationships $ 7,467 3.5 Developed technology 1,890 3.5 Order backlog 567 1.0 Trademarks and trade names 870 2.0 The intangible assets are amortized on a straight-line basis over the estimated weighted-average useful lives. 4. Supplemental Financial Information Accounts Receivable The following table presents details of our accounts receivable: Schedule of accounts receivable June 30, 2023 2022 (In thousands) Accounts receivable $ 28,204 $ 26,602 Allowance for doubtful accounts ( 522 ) ( 340 ) Accounts receivable, net $ 27,682 $ 26,262 Inventories The following table presents details of our inventories: Schedule of Inventory June 30, 2023 2022 (In thousands) Finished goods $ 25,670 $ 16,094 Raw materials 24,066 21,585 Inventories, net $ 49,736 $ 37,679 F- 22 Property and Equipment The following table presents details of property and equipment: Schedule of property and equipment June 30, 2023 2022 (In thousands) Computer, software and office equipment $ 7,167 $ 5,370 Furniture and fixtures 3,119 760 Production, development and warehouse equipment 5,443 5,147 Construction-in-progress 52 1,612 Property and equipment, gross 15,781 12,889 Less accumulated depreciation ( 11,152 ) ( 9,237 ) Property and equipment, net $ 4,629 $ 3,652 Purchased Intangible Assets The following table presents details of purchased intangible assets: Schedule of purchased intangible assets June 30, 2023 June 30, 2022 Gross Carrying Amount Accumulated Amortization Net Book Value Gross Carrying Amount Accumulated Amortization Net Book Value (In thousands) Developed technology $ 6,331 $ ( 3,881 ) $ 2,450 $ 5,731 $ ( 2,493 ) $ 3,238 Customer relationships 17,528 ( 9,487 ) 8,041 16,498 ( 5,700 ) 10,798 Order backlog 1,406 ( 1,406 ) – 1,406 ( 1,356 ) 50 Non-compete agreements 400 ( 400 ) – 400 ( 400 ) – Trademark and trade name 1,425 ( 1,351 ) 74 1,245 ( 772 ) 473 $ 27,090 $ ( 16,525 ) $ 10,565 $ 25,280 $ ( 10,721 ) $ 14,559 We do not currently have any purchased intangible assets with indefinite useful lives. As of June 30, 2023, future estimated amortization expense is as follows: Schedule of future estimated amortization expense Years Ending June 30, (In thousands) 2024 $ 5,314 2025 3,684 2026 1,177 2027 326 2028 64 Total amortization expense $ 10,565 F- 23 Goodwill The following table presents details of our goodwill balance: Schedule of goodwill Year Ended June 30, 2023 (In thousands) Balance at June 30, 2022 $ 20,768 Acquisition of Uplogix 7,056 Balance at June 30, 2023 $ 27,824 Warranty Reserve The following table presents details of our warranty reserve: Schedule of Warranty Reserve Years Ended June 30, 2023 2022 (In thousands) Beginning balance $ 594 $ 197 Warranty reserve assumed from acquisition of the TN Companies – 483 Charged to cost of revenues 352 202 Usage ( 158 ) ( 288 ) Ending balance $ 788 $ 594 Other Liabilities The following table presents details of our other liabilities: Schedule of Other Liabilities June 30, 2023 2022 (In thousands) Current Accrued variable consideration $ 2,167 $ 1,905 Customer deposits and refunds 16,344 922 Accrued raw materials purchases 267 132 Deferred revenue 2,493 969 Lease liability 1,859 978 Taxes payable 647 371 Warranty reserve 788 594 Accrued operating expenses 4,248 2,606 Total other current liabilities $ 28,813 $ 8,477 Non-current Lease liability $ 10,425 $ 7,310 Deferred tax liability 146 – Deferred revenue 888 373 Total other non-current liabilities $ 11,459 $ 7,683 F- 24 Computation of Net Loss per Share The following table presents the computation of net loss per share: Schedule of computation of net loss per Share Years Ended June 30, 2023 2022 (In thousands, except per share data) Numerator: Net loss $ ( 8,980 ) $ ( 5,362 ) Denominator: Weighted-average shares outstanding - basic and diluted 36,257 32,671 Net loss per share - basic and diluted $ ( 0.25 ) $ ( 0.16 ) 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. Schedule of antidilutive securities Years Ended June 30, 2023 2022 (In thousands) Common stock equivalents 637 1,069 Severance and Related Charges The following table presents details of the liability we recorded related to restructuring, severance and related activities during the current fiscal year: Schedule of severance and related charges Year Ended June 30, 2023 (In thousands) Beginning balance $ 34 Charges 693 Payments ( 630 ) Ending balance $ 97 The ending balance is recorded in accrued payroll and related expenses on the accompanying consolidated balance sheet at June 30, 2023. F- 25 Supplemental Cash Flow Information The following table presents non-cash investing and financing transactions excluded from the consolidated statements of cash flows: Schedule of non-cash transactions Years Ended June 30, 2023 2022 (In thousands) Acquisition of property through operating leases $ 4,320 $ 7,170 Acquisition of property through financing leases $ 536 $ – Accrued property and equipment paid for in the subsequent period $ 54 $ 868 Warrants to purchase common stock issued with bank credit facility $ – $ 500 Fair value adjustment of earnout consideration for TN companies at acquisition date $ – $ 393 5. Bank Loan Agreements On September 7, 2022 we entered into a Third Amendment to the Third Amended and Restated Loan and Security Agreement (the “Amendment”) with Silicon Valley Bank (“SVB”), pertaining to our existing term loan and revolving credit facility (together, the “Senior Credit Facilities”), which amends that certain Third Amended and Restated Loan and Security Agreement, dated as of August 2, 2021, as amended by the First Amendment to Third Amended and Restated Loan and Security Agreement, dated as of October 21, 2021, as amended by the Second Amendment to Third Amended and Restated Loan and Security Agreement, dated as of February 15, 2022 by and among Lantronix and SVB (collectively with the Amendment, the “Loan Agreement”). The Amendment, among other things, provided for an additional term loan in the original principal amount of $ 5,000,000 that matures on August 2, 2025 . The Senior Credit Facilities bears interest at Term Secured Overnight Financing Rate (“ 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 1.50% and a Prime Rate floor of 3.25%. The Amendment reduces the minimum liquidity requirement from $ 5,000,000 to $ 4,000,000 . As a condition to entering into the Amendment, we were obligated to pay a nonrefundable facility increase fee in the amount of $ 25,000 . The Senior Credit Facilities mature on August 2, 2025 . The Senior Credit Facilities are secured by substantially all of our assets. On September 7, 2022, we borrowed $ 2,000,000 on our revolving credit facility. We subsequently paid this amount back to the bank in full in February 2023. On April 3, 2023, we entered into a Letter Agreement (the “Letter Agreement”) with SVB, which, among other matters, amended the Loan Agreement to reduce the former requirement to hold 85% of our company-wide cash balances at SVB to 50%, and provided a waiver of any event of default under the Loan Agreement for any failure to comply with this covenant prior to the date of the Letter Agreement. The following table summarizes our outstanding debt: Schedule of outstanding debt June 30, 2023 2022 (In thousands) Outstanding borrowings on Senior Credit Facilities $ 19,194 $ 16,188 Less: Unamortized debt issuance costs ( 230 ) ( 243 ) Net Carrying amount of debt 18,964 15,945 Less: Current portion ( 2,743 ) ( 1,671 ) Non-current portion $ 16,221 $ 14,274 F- 26 During the year ended June 30, 2023, we recognized $ 1,610,000 of interest expense in the accompanying consolidated statement of operations related to interest and amortization of debt issuance associated with the borrowings under the Senior Credit Facilities. On March 10, 2023, SVB was closed by the California Department of Financial Protection and Innovation, which appointed the Federal Deposit Insurance Corporation (“FDIC”) as receiver. On March 13, 2023, the FDIC announced that it had transferred all insured and uninsured deposits and substantially all assets of SVB to a newly created, full-service FDIC-operated “bridge bank” called Silicon Valley Bridge Bank, N.A., where depositors would have full access to their money immediately. On March 27, 2023, First Citizens Bank announced that it entered into an agreement with the FDIC to purchase all of the assets and liabilities of Silicon Valley Bridge Bank. We currently have full control of our cash and cash equivalents balance at SVB and our other banking institutions. 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. Financial Covenants The Senior Credit Facilities require Lantronix to comply with a minimum liquidity test, a maximum leverage ratio and a minimum fixed charge coverage ratio. We were in compliance with all financial covenants as of June 30, 2023. Liquidity The Senior Credit Facilities require that we maintain a minimum liquidity of $4,000,000 at SVB, as measured at the end of each month. Maximum leverage ratio The Senior Credit Facilities require that we maintain a maximum leverage ratio, calculated as the ratio of funded debt to the consolidated trailing 12 month earnings before interest, taxes, depreciation and amortization, and certain other allowable exclusions of (i) 2.50 to 1.00 for each calendar quarter ending June 30, 2021 through and including September 30, 2022, (ii) 2.25 to 1.00 for each calendar quarter ending December 31, 2022 through and including September 30, 2023, and (iii) 2.00 to 1.00 for the calendar quarter December 31, 2023 and each calendar quarter thereafter. Minimum fixed charge coverage ratio The Senior Credit Facilities require that we maintain a minimum fixed charge coverage ratio, calculated as the ratio of consolidated trailing 12 month earnings before interest, taxes, depreciation and amortization, and certain other allowable exclusions, less capital expenditures and taxes paid, to the trailing twelve month principal and interest payments on all funded debt of 1.25 to 1.00 as measured at the end of each calendar quarter. In addition, the Senior Credit Facilities contain customary representations and warranties, affirmative and negative covenants, including covenants that limit or restrict Lantronix and its subsidiaries’ ability to incur liens, incur indebtedness, dispose of assets, make investments, make certain restricted payments, merge or consolidate and enter into certain speculative hedging arrangements. The Senior Credit Facilities include a number of events of default, including, among other things, non-payment defaults, covenant defaults, cross-defaults to other materials indebtedness, bankruptcy and insolvency defaults and material judgment defaults. If any event of default occurs (subject, in certain instances, to specified grace periods), the principal, premium, if any, interest and any other monetary obligations on all the then outstanding amounts under the Senior Credit Facilities may become due and payable immediately. F- 27 6. Stockholders’ Equity Stock Incentive Plans We have stock incentive plans in effect under which non-qualified and incentive stock options to purchase shares of Lantronix common stock (“stock options”) have been granted to employees, non-employees and board members. In addition, we have previously granted restricted common stock awards (“non-vested shares”) to employees and board members under these plans. In November 2020, our stockholders voted to approve the 2020 Performance Incentive Plan (the “2020 Plan”), replacing our Amended and Restated 2010 Stock Incentive Plan (the “2010 Plan”), which expired in September 2020. At the 2010 Plan’s expiration date, approximately 1,097,000 shares of our common stock that remained available for award grants under the 2010 Plan became available for award grants under the 2020 Plan. An additional 2,500,000 shares our common stock are also available for award grants under the 2020 Plan. In addition, any shares of common stock subject to outstanding awards under the 2010 Plan that expire, are cancelled, or otherwise terminate after the expiration date of the 2010 Plan will be available for award grant purposes under the 2020 Plan. The 2020 Plan authorizes awards of stock options (both non-qualified and incentive), stock appreciation rights, non-vested shares, restricted stock units (“RSUs”) and performance shares (“PSUs”). New shares are issued to satisfy stock option exercises and share issuances. At June 30, 2023, approximately 2,465,000 shares remain available for issuance under the 2020 Plan. We have also granted stock options and RSUs under individual inducement award agreements. The Compensation Committee of our board of directors determines eligibility, vesting schedules and exercise prices for stock options and shares granted under the plans. Stock options are generally granted with an exercise price equal to the market price of our common stock on the grant date. Stock options generally have a contractual term of seven to ten years. Share-based awards generally vest and become exercisable over a one to four-year service period. As of June 30, 2023, no stock appreciation rights or non-vested stock was outstanding. No income tax benefit was realized from activity in the share-based plans during the fiscal years ended June 30, 2023 and 2022. Stock Option Awards The fair value of each stock option grant is estimated on the grant date using the Black-Scholes-Merton option-pricing formula. The expected term of stock options granted is based on our recent historical exercise data. Expected volatilities are 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. The following weighted-average assumptions were used to estimate the fair value of all of our stock option grants: Schedule of Valuation Assumptions Years Ended June 30, 2023 2022 Expected term (in years) 3.9 4.7 Expected volatility 62 % 63 % Risk-free interest rate 3.79 % 0.82 % Dividend yield 0.00 % 0.00 % F- 28 The following table presents a summary of activity for all of our stock options: Schedule of option activity Weighted-Average Exercise Remaining Aggregate Number of Price Contractual Intrinsic Shares Per Share Term Value (In thousands) (In years) (In thousands) Balance of options outstanding at June 30, 2022 1,383 $ 3.40 Granted 115 4.96 Expired ( 9 ) 2.04 Exercised ( 164 ) 2.55 Balance of options outstanding at June 30, 2023 1,325 $ 3.65 2.1 $ 987 Options exercisable at June 30, 2023 1,147 $ 3.45 1.5 $ 979 The following table presents a summary of grant date fair value and intrinsic value information for all of our stock options: Summary of option grant-date fair value and intrinsic value information Years Ended June 30, 2023 2022 (In thousands, except per share data) Weighted-average grant date fair value per share $ 2.44 $ 2.94 Intrinsic value of options exercised $ 454 $ 1,506 Restricted Stock Units The fair value of our RSUs is based on the closing market price of our common stock on the grant date. The following table presents a summary of activity with respect to our RSUs: Summary of other than option activity Number of Shares Weighted-Average Grant Date Fair Value per Share (In thousands) Balance of RSUs outstanding at June 30, 2022 1,115 $ 5.50 Granted 763 5.59 Forfeited ( 96 ) 5.51 Vested ( 593 ) 5.22 Balance of RSUs outstanding at June 30, 2023 1,189 $ 5.70 F- 29 Performance Shares The following table presents a summary of activity with respect to our PSUs: Summary of other than option activity Number of Shares (In thousands) Balance of PSUs outstanding at June 30, 2022 1,030 Granted 1,147 Forfeited ( 299 ) Vested ( 947 ) Balance of PSUs outstanding at June 30, 2023 931 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 ESPP currently operates with six month offering periods commencing on the first trading day on or after May 16 and November 16 of each year (an “Offering Period”). Common stock may be purchased under the ESPP at the end of each six-month Offering Period unless the participant withdraws or terminates employment earlier. Shares of the Company’s common stock may be purchased under the ESPP at a price not less than 85% of the lesser of the fair market value of our common stock on the first or last trading day of each Offering Period. The per share fair value of stock purchase rights granted under the ESPP was estimated using the following weighted-average assumptions: Schedule of Valuation Assumptions Years Ended June 30, 2023 2022 Expected term (in years) 0.5 0.5 Expected volatility 66 % 59 % Risk-free interest rate 4.88 % 0.92 % Dividend yield 0.00 % 0.00 % The following table presents a summary of activity under our ESPP: Summary of other than option activity Year Ended June 30, 2023 (In thousands, except per share data) Shares available for issuance at June 30, 2022 85 Shares reserved for issuance 500 Shares issued ( 204 ) Shares available for issuance at June 30, 2023 381 Weighted-average purchase price per share $ 4.26 Intrinsic value of ESPP shares on purchase date $ 153 F- 30 Share-Based Compensation Expense The following table presents a summary of share-based compensation expense included in each applicable functional line item on our consolidated statements of operations: Schedule of share-based compensation expense by functional line item Years Ended June 30, 2023 2022 (In thousands) Cost of revenues $ 158 $ 369 Selling, general and administrative 4,546 4,862 Research and development 1,504 1,015 Total share-based compensation expense $ 6,208 $ 6,246 The following table presents a summary of the remaining unrecognized share-based compensation expense related to our outstanding share-based awards as of June 30, 2023: Schedule of unrecognized share-based compensation expense Remaining Unrecognized Compensation Expense Remaining Weighted-Average Years to Recognize (In thousands) Stock options $ 402 2.6 RSUs 5,666 2.2 PSUs 1,650 1.9 Common stock purchase rights under ESPP 128 0.4 $ 7,846 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 expense will increase to the extent that we grant additional share-based awards. 7. Retirement Plan We have a retirement savings plan (the “Plan”) to which eligible employees may elect to make contributions through salary deferrals up to 100% of their base pay, subject to limitations. We made approximately $ 411,000 and $ 373,000 in matching contributions to participants in the Plan during the fiscal years ended June 30, 2023 and 2022, respectively. In addition, we may make discretionary profit-sharing contributions, subject to limitations. During the fiscal years ended June 30, 2023 and 2022, we made no such contributions to the Plan. F- 31 8. Income Taxes The provision (benefit) for income taxes consists of the following components: Schedule of Components of Income Tax Expense Years Ended June 30, 2023 2022 (In thousands) Current: Federal $ – $ – State 294 11 Foreign 308 254 Total Current taxes $ 602 $ 265 Deferred: Federal 146 ( 1,805 ) State – ( 292 ) Foreign – – Provision (benefit) for income taxes $ 748 $ ( 1,832 ) The following table presents U.S. and foreign income (loss) before income taxes: Schedule of Income before Income Tax, Domestic and Foreign Years Ended June 30, 2023 2022 (In thousands) United States $ ( 9,168 ) $ ( 7,829 ) Foreign 936 635 Loss before income taxes $ ( 8,232 ) $ ( 7,194 ) F- 32 The tax effects of temporary differences that give rise to deferred tax assets and liabilities are as follows: Schedule of Deferred Tax Assets and Liabilities Years Ended June 30, 2023 2022 (In thousands) Deferred tax assets: Tax losses and credits $ 9,882 $ 15,310 Reserves not currently deductible 2,054 1,881 Capitalized research and development expenses* 6,975 – Deferred compensation 1,301 1,858 Inventory capitalization 2,390 1,508 Lease liabilities 2,848 2,260 Depreciation and amortization – 130 Identified intangibles 446 – Other 263 333 Gross deferred tax assets 26,159 23,280 Valuation allowance ( 22,532 ) ( 20,173 ) Deferred tax assets, net 3,627 3,107 Deferred tax liabilities: State taxes ( 518 ) ( 404 ) Right-of-use assets ( 2,676 ) ( 2,240 ) Identified intangibles – ( 463 ) Depreciation and amortization ( 579 ) – Deferred tax liabilities ( 3,773 ) ( 3,107 ) Net deferred tax assets (liabilities) $ ( 146 ) $ – * As required by the 2017 Tax Cuts and Jobs Act (the “2017 Act”), research and experimental (“R&E”) expenses under Internal Revenue Code Section 174 are required to be capitalized beginning in our fiscal year ended June 30, 2023. R&E expenses are required to be amortized over five years for domestic expenses and 15 years for foreign expenses. Our net deferred tax liability of $ 146,000 at June 30, 2023 represents the excess of our indefinite-lived deferred tax liabilities over our indefinite-lived deferred tax assets, and is recorded in other non-current liabilities on the accompanying consolidated balance sheet at June 30, 2023. Realization of deferred tax assets is dependent upon the generation of future taxable income. As required by ASC 740, we have evaluated the positive and negative evidence bearing upon our ability to realize the deferred tax assets as of June 30, 2023. We have determined that it was more likely than not that Lantronix would not realize the deferred tax assets due to our cumulative losses and uncertainty of generating future taxable income. As a result of the acquisition of the TN Companies during the fiscal year ended June 30, 2022, we recorded U.S. deferred tax liabilities in the 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. Pursuant to ASC 805, the impact on our existing deferred tax assets and liabilities caused by an acquisition should be recorded in the consolidated financial statements outside of acquisition accounting. Accordingly, we recorded an income tax benefit during the fiscal year ended June 30, 2022 of $ 2,036,000 for the partial release of the valuation allowance as a result of such purchase accounting considerations. F- 33 The following table presents a reconciliation of the provision (benefit) for income taxes to taxes computed at the U.S. federal statutory rate: Schedule of Effective Income Tax Reconciliation Years Ended June 30, 2023 2022 (In thousands) Statutory federal provision (benefit) for income taxes $ ( 1,729 ) $ ( 1,510 ) Increase (decrease) resulting from: Stock options ( 283 ) ( 588 ) Other permanent differences 30 ( 54 ) Change in valuation allowance 2,222 ( 1,829 ) Global intangible low-tax income inclusion 2 4 Foreign tax rate variances 112 120 Acquisition costs – 395 Other 394 1,630 Provision (benefit) for income taxes $ 748 $ ( 1,832 ) Due to the “change of ownership” provision of the Tax Reform Act of 1986, utilization of our net operating loss (“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 NOL carryforwards: Summary of Operating Income (Loss) Carryforwards June 30, 2023 (In thousands) Federal $ 43,320 State $ 22,589 Our federal NOL carryforwards generated for tax years beginning before July 1, 2018 began to expire in the fiscal year ended June 30, 2021. Pursuant to the 2017 Act, we also have federal NOL carryforwards of $ 6,788,000 that will not expire but can only be used to offset 80 % of future taxable income. For state income tax purposes, our NOL carryforwards began to expire in the fiscal year ended June 30, 2013. We continue to assert that our foreign earnings are indefinitely reinvested in our overseas operations and as such, deferred income taxes were not provided on undistributed earnings of certain foreign subsidiaries. The 2017 Act created a requirement that certain income earned by foreign subsidiaries, known as global intangible low-tax income (“GILTI”), must be included in the gross income of their U.S. shareholder. The FASB allows an accounting policy election of either recognizing deferred taxes for temporary differences expected to reverse as GILTI in future years or recognizing such taxes as a current-period expense when incurred. During the fiscal years ended June 30, 2023 and 2022, we elected to treat the tax effect of GILTI as a current-period expense when incurred. F- 34 Unrecognized Tax Benefits The following table summarizes our liability for uncertain tax positions for the fiscal year ended June 30, 2023: Summary of uncertain tax position Year Ended June 30, 2023 (In thousands) Balance as of June 30, 2022 $ 5,652 Change in balances related to uncertain tax positions ( 839 ) Balance as of June 30, 2023 $ 4,813 At June 30, 2023, we had $ 4,813,000 of gross unrecognized tax benefits which was recorded as a reduction to deferred tax assets, and a corresponding reduction in our valuation allowance of $ 4,813,000 . The balance decreased from the prior year due to the expiration of certain federal research and development tax credit carryforwards. To the extent such portion of unrecognized tax benefits is recognized at a time such valuation allowance no longer exists, the recognition would reduce the effective tax rate. Our continuing practice is to recognize interest and penalties related to income tax matters in income tax expense. During the fiscal years ended June 30, 2023 and 2022, we recorded an immaterial expense for interest and penalties related to income tax matters in the provision for income taxes. At June 30, 2023, we had approximately $ 303,000 of accrued interest and penalties related to uncertain tax positions. At June 30, 2023, our fiscal years ended June 30, 2020 through 2023 remain open to examination by the federal taxing jurisdiction and our fiscal years ended June 30, 2019 through 2023 remain open to examination by the state taxing jurisdictions. However, we have NOLs beginning in the fiscal year ended June 30, 2001 which would cause the statute of limitations to remain open for the year in which the NOL was incurred. Our fiscal years ended June 30, 2015 through 2023 remain open to examination by foreign taxing authorities. We currently do not anticipate that the amount of unrecognized tax benefits as of June 30, 2023 will significantly increase or decrease within the next 12 months. 9. Leases In general, our leases include office buildings for various facilities worldwide which are all classified as operating leases. We also have financing leases related to some office equipment in the United States. Components of lease expense and supplemental cash flow information: Components of lease expense June 30, 2023 (In thousands) Components of lease expense Operating lease cost $ 2,583 Financing lease cost 30 Financing lease interest expense 10 Supplemental cash flow information Cash paid for amounts included in the measurement of operating lease liabilities $ 1,701 Cash paid for amounts included in the measurement of financing lease liabilities $ 30 Right-of-use assets obtained in exchange for lease obligation $ 4,856 F- 35 The weighted-average remaining lease term is 3.76 years. The weighted-average discount rate is 4.6 percent. Maturities of lease liabilities as of June 30, 2023 were as follows: Maturities of lease liabilities Years ending June 30, Operating Financing (In thousands) 2024 $ 2,272 $ 222 2025 2,059 213 2026 1,695 117 2027 1,648 22 2028 1,698 19 Thereafter 4,479 – Total remaining lease payments 13,851 593 less: imputed interest ( 2,076 ) ( 84 ) Lease liability $ 11,775 $ 509 Reported as: Current liabilities $ 1,677 $ 182 Non-current liabilities $ 10,098 $ 327 California Corporate Headquarters Lease In July 2022, we commenced the lease of approximately 14,000 square feet of office space for our corporate headquarters in Irvine, California. The term of the lease is 84 months from the commencement date, with an option to extend the lease for one 60-month extension period at a basic rent to be agreed upon by the parties or determined pursuant to the lease. The initial basic rent payable is $28,900 per month and is subject to customary annual rent increases. The aggregate basic rent payable under the lease during the 84-month term is approximately $2,700,000. We are also obligated to pay as additional rent our proportionate share of operating expenses, including property taxes. Additionally, the lease required us to deliver to the landlord an irrevocable stand-by letter of credit in the amount of $50,000 as security in the case of default. We accounted for this lease as an operating lease in accordance with ASC 842. Upon commencement of the lease, we recorded a right-of-use asset of $2,852,000 and lease liability of $2,852,000 at the inception of the lease based upon a discount rate of 4.6% over a term of 7 years. 10. Commitments and Contingencies From time to time, we are subject to legal proceedings and claims in the ordinary course of business. We are currently not aware of any such legal proceedings or claims that we believe will have, individually or in the aggregate, a material adverse effect on our business, prospects, financial position, operating results or cash flows. 11. Significant Geographic, Customer and Supplier Information The following table presents our sales within geographic regions as a percentage of net revenue, which is generally based on the “bill-to” location of our customers: Schedule of revenue by geographic area Years Ended June 30, 2023 2022 Americas 60 % 60 % Europe, Middle East, and Africa 18 % 17 % Asia Pacific Japan 22 % 23 % Total 100 % 100 % F- 36 Long-lived assets, which consists of property and equipment, net, lease right-of-use assets, purchased intangible assets, net, and goodwill by geographic area are as follows: Long-lived Assets by Geographic Areas June 30, 2023 2022 (In thousands) U.S. $ 44,757 $ 36,037 Canada 9,169 10,158 Rest of world 675 821 $ 54,601 $ 47,016 Customers The following table presents sales to our significant customers as a percentage of net revenue: Schedule of Revenue by Major Customers Years Ended June 30, 2023 2022 Top five customers (1) 35 % 44 % Ingram Micro 10 % 14 % Amtran * 10 % (1) Includes Ingram Micro and Amtran in the fiscal years ended June 30, 2023 and 2022. * Less than 10% No other customer represented more than 10% of our annual net revenue during these fiscal years. Related Party Transactions We had no net revenue from related parties for the fiscal years ended June 30, 2023 and 2022. Suppliers We do not own or operate a manufacturing facility. All of our products are manufactured by third-party contract manufacturers and foundries primarily located in Thailand, Taiwan and China. We have several single-sourced supplier relationships, either because alternative sources are not available or because the relationship is advantageous to us. If these suppliers are unable to provide a timely and reliable supply of components, we could experience manufacturing delays that could adversely affect our consolidated results of operations. F- 37