LANTRONIX INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read together with our unaudited condensed consolidated financial statements and the related notes included in Part I, Item 1 of this Quarterly Report on Form 10-Q for the three months ended March 31, 2024 (this “Report”). This discussion and analysis contains forward-looking statements that are based on our current expectations and reflect our plans, estimates and anticipated future financial performance. See the section of this Report entitled “Cautionary Note Regarding Forward-Looking Statements” for additional information. These statements involve numerous risks and uncertainties. Our actual results may differ materially from those expressed or implied by these forward-looking statements as a result of many factors, including those set forth in “Risk Factors” in Part II, Item 1A of this Report. Unless otherwise indicated by the context, all references to the “Company”, “Lantronix”, "we", "us", and "our" in this Quarterly Report on Form 10-Q include Lantronix, Inc. and its consolidated subsidiaries. Overview Lantronix, Inc. is a global industrial and enterprise internet of things (“IoT”) provider of solutions that target diversified verticals ranging from smart cities, utilities and healthcare to enterprise, intelligent transportation, and industrial automation. Building on a long history of connectivity and video processing competence, target applications include video surveillance, traffic management, infotainment systems, robotics, edge computing and remote environment management. We conduct our business globally and manage our sales teams by three geographic regions: the Americas; Europe, Middle East, and Africa (“EMEA”); and Asia Pacific Japan (“APJ”). Products and Solutions Overview We organize our portfolio services and products into the following product lines: Embedded IoT Modules, IoT Systems Solutions, and Software and Engineering Services. Embedded IoT Modules This portfolio of embedded products provides a variety of options including Compute System-on-Module (“SOM”) or System-in-Package (“SIP”) solutions supplemented with wired and wireless network connectivity products. As the level of silicon integration continues to grow, the compute modules also provide the ability to collect digital information (Video, Audio or Sensors) and analyze/comprehend the data streams based on specific AI/ML algorithms. The new implementations of SIP devices can process multiple media streams with CV (Computer Vision) technology and the modules can be controlled remotely via ConsoleFlow™, Lantronix’s Cloud software-as-a-service (“SaaS”) platform. Our IoT compute products typically are embedded into a customer new product design, enabling advanced application functionality at the edge. These products include application processing that delivers compute to meet customer needs for data transformation, computer vision, machine learning, augmented / virtual reality, audio / video aggregation and distribution, and custom applications at the edge. Many of the products are offered with software tools intended to further accelerate our customers’ time-to-market and increase their value add. Most of our IoT embedded products are pre-certified in a number of countries thereby significantly reducing our original equipment manufacturer (“OEM”) customers’ regulatory certification costs and accelerating their time-to-market. 22 IoT System Solutions The IoT Systems Solutions portfolio consists of fully functional standalone systems that provide routing, switching or gateway functionalities as well as Telematics and media conversion. These products include wired and wireless connections that enhance the value and utility of modern electronic systems and equipment by providing secure network connectivity, power for IoT end devices through Power over Ethernet (“PoE”), application hosting, protocol conversion, media conversion, secure access for distributed IoT deployments and many other functions. Most of our IoT System products are pre-certified in a number of countries thereby significantly reducing our OEM customers’ regulatory certification costs and accelerating their time-to-market. Software and Services Our SaaS platform provides single pane of glass management for remote environment management and IoT deployments. Our platform enables customers to easily deploy, monitor, manage, and automate across their global deployments, all from a single platform login, virtually connected as though directly on each device. Our platform eliminates the need to have 24/7 personnel on site, and makes it easy to see and drill into an issue quickly, even in large scale deployments. We leverage our engineering expertise and product development best practices to deliver high quality, innovative products, cost-effectively and on time. Our engineering services flexible business model allows for choosing turnkey product development or team augmentation for accelerating complex areas of product development such as camera development and tuning, voice control, machine learning, artificial intelligence, computer vision, augmented / virtual reality, mechanical and radio-frequency design, thermal and power optimization, or in any specific area a customer needs assistance. We also provide extended warranty, support and maintenance services related to our out-of-band (“OOB”) and certain other product families. Recent Accounting Pronouncements Refer to Note 1 of Notes to Unaudited Condensed Consolidated Financial Statements, included in Part I, Item 1 of this Report, which is incorporated herein by reference, for a discussion of recent accounting pronouncements. Critical Accounting Policies and Estimates The accounting policies that have the greatest impact on our financial condition and results of operations and that require the most judgment are those relating to revenue recognition, sales returns and allowances, inventory valuation, restructuring charges, valuation of deferred income taxes, business combinations, valuation of goodwill and long-lived and intangible assets, stock-based compensation, litigation and other contingencies. These policies are described in further detail in our Annual Report on Form 10-K for the year ended June 30, 2023 and filed with the Securities and Exchange Commission (the “SEC”) on September 12, 2023 (the “Form 10-K”) and have not changed significantly during the nine months ended March 31, 2024 as compared to what was previously disclosed in the Form 10-K. Results of Operations – Three Months Ended March 31, 2024 Compared to the Three Months Ended March 31, 2023 Summary In the three months ended March 31, 2024, our net revenue increased by $8,219,000 or 24.9%, compared to the three months ended March 31, 2023. The increase in net revenue was driven by a 90.9% increase in net revenue in our IoT System Solutions product line, partially offset by a 22.4% decrease in net revenue in our Embedded IoT Solutions product line and a 32.5% decrease in our Software & Services product line. We had a net loss of $423,000 for the three months ended March 31, 2024 compared to a net loss of $3,065,000 for the three months ended March 31, 2023. The decrease in net loss was primarily driven by the increase in revenues for the three months ended March 31, 2024 compared to the three months ended March 31, 2023, combined with a decrease in operating expenses of $468,000 related to a decreases in (i) restructuring and severance charges, (ii) amortization, and (iii) charges related to earnout fair value remeasurement. These changes were partially offset by a reduction in gross margin percentage. 23 Net Revenue The following tables present our net revenue by product line and by geographic region: Three Months Ended March 31, % of Net % of Net Change 2024 Revenue 2023 Revenue $ % (In thousands, except percentages) Embedded IoT Solutions $ 12,452 30.2% $ 16,055 48.7% $ (3,603 ) (22.4% ) IoT System Solutions 26,789 65.0% 14,034 42.6% 12,755 90.9% Software & Services 1,942 4.8% 2,875 8.7% (933 ) (32.5% ) $ 41,183 100.0% $ 32,964 100.0% $ 8,219 24.9% Three Months Ended March 31, % of Net % of Net Change 2024 Revenue 2023 Revenue $ % (In thousands, except percentages) Americas $ 17,543 42.6% $ 19,095 57.9% $ (1,552 ) (8.1% ) EMEA 18,354 44.6% 6,380 19.4% 11,974 187.7% APJ 5,286 12.8% 7,489 22.7% (2,203 ) (29.4% ) $ 41,183 100.0% $ 32,964 100.0% $ 8,219 24.9% Embedded IoT Solutions Net revenue decreased primarily due to (i) lower unit sales of our embedded compute product line in the Americas and APJ regions and (ii) lower unit sales of our network interface cards and our wireless communication products across all regions. IoT System Solutions Net revenue increased primarily due to increased unit sales related to our custom solutions in our EMEA region, as we continued to ramp volume production for a European smart energy grid provider, as well as an increase in unit sales of our out-of-band products across all regions. These increases were partially offset by decreases in sales of certain network switches products across all regions. Software & Services Net revenue decreased primarily due to a decrease in our engineering services revenue in the EMEA region as two of our large design services projects recently transitioned from the design phase to full production. Gross Profit Gross profit represents net revenue less cost of revenue. Cost of revenue consists primarily of the cost of raw material components, subcontract labor assembly from contract manufacturers, direct and indirect personnel expenses related to professional services, manufacturing overhead, inventory reserves for excess and obsolete products or raw materials, warranty costs, royalties and share-based compensation. 24 The following table presents our gross profit: Three Months Ended March 31, % of Net % of Net Change 2024 Revenue 2023 Revenue $ % (In thousands, except percentages) Gross profit $ 16,504 40.1% $ 14,636 44.4% $ 1,868 12.8% Gross profit as a percent of revenue (referred to as “gross margin”) decreased due primarily to (i) our product sales mix, (ii) higher various overhead charges, and (iii) higher freight and logistics costs in the current quarter. Selling, General and Administrative Selling, general and administrative expenses consist of personnel-related expenses, including salaries and commissions, share-based compensation, facility expenses, information technology, trade show expenses, advertising, and legal and accounting fees. The following table presents our selling, general and administrative expenses: Three Months Ended March 31, % of Net % of Net Change 2024 Revenue 2023 Revenue $ % (In thousands, except percentages) Personnel-related expenses $ 5,763 $ 5,299 $ 464 8.8% Professional fees and outside services 736 1,378 (642 ) (46.6% ) Advertising and marketing 543 570 (27 ) (4.7% ) Facilities and insurance 651 605 46 7.6% Share-based compensation 1,337 1,293 44 3.4% Depreciation 352 280 72 25.7% Other 371 521 (150 ) (28.8% ) Selling, general and administrative $ 9,753 23.7% $ 9,946 30.2% $ (193 ) (1.9% ) Selling, general and administrative expenses decreased primarily due to a lower professional and outside services expenses related to (i) audit and accounting compliance costs that were higher in the prior year as we implemented Section 404(b) of the Sarbanes-Oxley Act, (ii) new facility costs for our California and Minnesota facilities incurred in the prior year period, and (iii) reduced current year costs for outsourced sales and marketing resources. The decrease in professional and outside services expenses was partially offset by an increase in personnel-related expenses for certain variable compensation costs. Research and Development Research and development expenses consist of personnel-related expenses, including share-based compensation, as well as expenditures to third-party vendors for research and development activities and product certification costs. Our quarterly costs related to outside services and product certifications vary from period to period depending on our level of development activities. 25 The following table presents our research and development expenses: Three Months Ended March 31, % of Net % of Net Change 2024 Revenue 2023 Revenue $ % (In thousands, except percentages) Personnel-related expenses $ 3,608 $ 3,154 $ 454 14.4% Facilities 640 713 (73 ) (10.2% ) Outside services 76 196 (120 ) (61.2% ) Product certifications 180 296 (116 ) (39.2% ) Share-based compensation 469 388 81 20.9% Other 213 320 (107 ) (33.4% ) Research and development $ 5,186 12.6% $ 5,067 15.4% $ 119 2.3% Research and development expenses increased primarily due to an increase in personnel-related expenses for certain variable compensation costs, partially offset by (i) lower costs for outsourced resources and (ii) lower product certification expenses resulting from the timing of costs incurred on various ongoing development projects. Results of Operations – Nine Months Ended March 31, 2024 Compared to the Nine Months Ended March 31, 2023 Summary In the nine months ended March 31, 2024, our net revenue increased by $14,987,000 or 15.6%, compared to the nine months ended March 31, 2023. The increase in net revenue was driven by a 58.0% increase in net revenue in our IoT System Solutions product line, partially offset by a 20.6% decrease in net revenue in our Embedded IoT Solutions product line as well as a 13.5% decrease in revenue in our Software & Services product line. We had a net loss of $4,902,000 for the nine months ended March 31, 2024 compared to a net loss of $7,327,000 for the nine months ended March 31, 2023. The decrease in net loss was primarily driven by the increase in revenues, partially offset by an increase in operating expenses of $680,000 coupled with a reduction in gross margin percentage for the nine months ended March 31, 2024 compared to the nine months ended March 31, 2023. Net Revenue The following tables present our net revenue by product line and by geographic region: Nine Months Ended March 31, % of Net % of Net Change 2024 Revenue 2023 Revenue $ % (In thousands, except percentages) Embedded IoT Solutions $ 35,589 32.0% $ 44,818 46.6% $ (9,229 ) (20.6% ) IoT System Solutions 68,847 61.9% 43,568 45.3% 25,279 58.0% Software & Services 6,816 6.1% 7,879 8.1% (1,063 ) (13.5% ) $ 111,252 100.0% $ 96,265 100.0% $ 14,987 15.6% 26 Nine Months Ended March 31, % of Net % of Net Change 2024 Revenue 2023 Revenue $ % (In thousands, except percentages) Americas $ 61,077 54.9% $ 59,713 62.0% $ 1,364 2.3% EMEA 37,831 34.0% 16,486 17.1% 21,345 129.5% APJ 12,344 11.1% 20,066 20.9% (7,722 ) (38.5% ) $ 111,252 100.0% $ 96,265 100.0% $ 14,987 15.6% Embedded IoT Solutions Net revenue decreased primarily due to lower units sales of (i) our embedded compute product line in the Americas and APJ regions, (ii) our network interface cards across all regions, and (iii) our embedded ethernet connectivity products in the Americas and EMEA regions. IoT System Solutions Net revenue increased primarily due to increases in units sales of (i) our custom solutions, as we continued to ramp volume production for a European smart energy grid provider in the current period, (ii) our out-of-band products in the Americas and EMEA regions, and (iii) our converters and radio nodes products in the Americas region. These increases were partially offset by decreases in sales of our network switches in the Americas region. Software & Services Net revenue decreased primarily due to a year over year decline in our engineering services in the EMEA region as two of our large design services projects recently transitioned from the design phase to full production, partially offset by growth in our extended warranty services across all regions. Gross Profit The following table presents our gross profit: Nine Months Ended March 31, % of Net % of Net Change 2024 Revenue 2023 Revenue $ % (In thousands, except percentages) Gross profit $ 45,632 41.0% $ 42,466 44.1% $ 3,166 7.5% Gross profit as a percent of revenue (referred to as “gross margin”) decreased due primarily to our (i) product sales mix and (ii) higher freight and logistics costs in the current year period. 27 Selling, General and Administrative The following table presents our selling, general and administrative expenses: Nine Months Ended March 31, % of Net % of Net Change 2024 Revenue 2023 Revenue $ % (In thousands, except percentages) Personnel-related expenses $ 15,882 $ 15,312 $ 570 3.7% Professional fees and outside services 3,439 4,219 (780 ) (18.5% ) Advertising and marketing 1,578 1,618 (40 ) (2.5% ) Facilities and insurance 2,165 1,960 205 10.5% Share-based compensation 4,238 4,132 106 2.6% Depreciation 1,024 694 330 47.6% Other 821 981 (160 ) (16.3% ) Selling, general and administrative $ 29,147 26.2% $ 28,916 30.0% $ 231 0.8% Selling, general and administrative expenses increased primarily due to (i) an increase in personnel-related expenses arising from certain variable compensation costs, (ii) an increase in depreciation expense related to new equipment and certain business analysis tools that we added in the current year, and (iii) increases in insurance premiums and various facility-related costs. These increases were partially offset by reductions in professional fees and outside services related to (i) audit and accounting compliance costs that were higher in the prior year as we implemented Section 404(b) of the Sarbanes-Oxley Act, (ii) new facility costs for our California and Minnesota facilities incurred in the prior year period, and (iii) reduced current year costs for outsourced sales and marketing resources. Research and Development The following table presents our research and development expenses: Nine Months Ended March 31, % of Net % of Net Change 2024 Revenue 2023 Revenue $ % (In thousands, except percentages) Personnel-related expenses $ 10,186 $ 9,382 $ 804 8.6% Facilities 1,852 1,985 (133 ) (6.7% ) Outside services 368 570 (202 ) (35.4% ) Product certifications 532 828 (296 ) (35.7% ) Share-based compensation 1,381 1,090 291 26.7% Other 698 822 (124 ) (15.1% ) Research and development $ 15,017 13.5% $ 14,677 15.2% $ 340 2.3% 28 Research and development expenses increased primarily due to an increase in personnel-related costs related to variable compensation expenses and increased share-based compensation costs for various equity award grants made in the current fiscal year. These increases were partially offset by a reduction in product certification expenses resulting from the timing of costs incurred on various ongoing development projects and lower costs for outsourced resources. Restructuring, Severance and Related Charges During the three and nine months ended March 31, 2024, we incurred charges of approximately $350,000 and $900,000, respectively, related to headcount reductions and restructuring of certain non-essential operations. During the three and nine months ended March 31, 2023, we incurred $490,000 and $664,000, respectively, of restructuring, severance and related charges. We may incur additional restructuring, severance and related charges in future periods as we continue to identify cost savings and synergies related to our acquisitions and general business operations. Acquisition-Related Costs During the three and nine months ended March 31, 2024 and during the three months ended March 31, 2023, we did not incur any acquisition-related costs. During the nine months ended March 31, 2023, we incurred approximately $315,000 of costs related to the acquisition of Uplogix. These costs were mainly comprised of banking, legal and other professional fees. Interest Income (Expense), Net For the three and nine months ended March 31, 2024 and March 31, 2023, we incurred net interest expense due to borrowings on our credit facilities. We also earn interest income on our domestic cash balance. Other Income (Expense), Net Our other income (expense), net, is comprised primarily of foreign currency remeasurement and transaction adjustments related to our foreign subsidiaries whose functional currency is the U.S. dollar. Provision for Income Taxes Refer to Note 8 of Notes to Unaudited Condensed Consolidated Financial Statements, included in Part I, Item 1 of this Report, which is incorporated herein by reference, for a discussion regarding our provision for income taxes. Liquidity and Capital Resources Liquidity The following table presents details of our working capital and cash and cash equivalents: March 31, June 30, 2024 2023 Change (In thousands) Working capital $ 54,310 $ 50,163 $ 4,147 Cash and cash equivalents $ 24,642 $ 13,452 $ 11,190 29 Our principal sources of cash and liquidity include our existing cash and cash equivalents, borrowings and amounts available under our existing term loan and revolving credit facility (together, the “Senior Credit Facilities”), and cash generated from operations. We are subject to a variable amount of interest on the principal balance of our Senior Credit Facilities and could be adversely impacted by rising interest rates in the future. We believe that our current cash holdings and net cash flows from operations are sufficient to satisfy our current obligations for the foreseeable future, and, assuming continued access to the undrawn amounts available under our Senior Credit Facilities, these combined sources will be sufficient to fund our material requirements for working capital, capital expenditures and other financial commitments for at least the next 12 months and beyond. We continue to monitor our existing banking relationships and the availability of potential alternate sources of credit based on market conditions and our ongoing capital requirements. There can be no guarantee that we would be able to obtain any needed alternate financing on acceptable terms, or at all, or that such a financing would not result in a default under the Loan Agreement (as defined in Note 6 of Notes to Unaudited Condensed Consolidated Financial Statements, included in Part I, Item 1 of this Report). We anticipate that the primary factors affecting our cash and liquidity are net revenue, working capital requirements and capital expenditures. We define cash and cash equivalents as highly liquid deposits with original maturities of 90 days or less when purchased. We maintain cash and cash equivalents balances at certain financial institutions in excess of amounts insured by the Federal Deposit Insurance Corporation (“FDIC”). There can be no assurance that our deposits in excess of the FDIC limits will be backstopped by the U.S., or that any bank or financial institution with which we do business will be able to obtain needed liquidity from other banks, government institutions or by acquisition in the event of a failure or liquidity crisis. As of the date of this Report, we have full access to and control of our cash and cash equivalents balance at Silicon Valley Bank (“SVB”) and our other banking institutions. Our emphasis is primarily on safety of principal and secondarily on maximizing yield on those funds. In April 2023, we entered into the Letter Agreement (as defined in Note 6 of Notes to Unaudited Condensed Consolidated Financial Statements, included in Part I, Item 1 of this Report) 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. As of the date of this Report, we are in compliance with all covenants of the Loan Agreement. Our future working capital requirements will depend on many factors, including the following: timing and amount of our net revenue; our product mix and the resulting gross margins; research and development expenses; selling, general and administrative expenses; and expenses associated with any strategic partnerships, acquisitions or infrastructure investments. From time to time, we may seek additional capital from public or private offerings of our capital stock, borrowings under our existing or future credit lines or other sources in order to (i) develop or enhance our products, (ii) take advantage of strategic opportunities, (iii) respond to competition or (iv) continue to operate our business. We currently have a Form S-3 shelf registration statement on file with the SEC. If we issue equity securities to raise additional funds, our existing stockholders may experience dilution, and the new equity securities may have rights, preferences and privileges senior to those of our existing stockholders. If we issue debt securities to raise additional funds, we may incur debt service obligations, become subject to additional restrictions that limit or restrict our ability to operate our business, or be required to further encumber our assets. There can be no assurance that we will be able to raise any such capital on terms acceptable to us, if at all. Bank Loan Agreements Refer to Note 6 of Notes to Unaudited Condensed Consolidated Financial Statements, included in Part I, Item 1 of this Report, which is incorporated herein by reference, for a discussion of our loan agreements. 30 Cash Flows The following table presents the major components of the unaudited condensed consolidated statements of cash flows: Nine Months Ended March 31, 2024 2023 Change (In thousands) Net cash provided by (used in) operating activities $ 16,348 $ (956 ) $ 17,304 Net cash used in investing activities (1,325 ) (6,975 ) 5,650 Net cash (used in) provided by financing activities (3,833 ) 3,505 (7,338 ) Operating Activities Cash provided by operating activities during the nine months ended March 31, 2024 increased compared to the prior year period. We used cash from operations in the prior year due to the build-up of our inventories and decreases in our accounts payable and accrued liabilities. For the nine months ended March 31, 2024, our net loss included $12,163,000 of non-cash charges, while the changes in operating assets and liabilities provided net cash of $9,087,000. Our net inventories decreased by $9,184,000, or 18.5%, from June 30, 2023 to March 31, 2024. The decrease resulted primarily from increased shipments on certain existing large customer contracts for which we had been building up our stock levels in recent periods. Accounts payable decreased by $1,444,000, or 11.6%, from June 30, 2023 to March 31, 2024. The reduction is primarily due to the decrease in our inventories and the timing of payments to our vendors. Accounts receivable increased by $860,000, or 3.1%, from June 30, 2023 to March 31, 2024. The increase is primarily due to the increased sales during the current quarter coupled with timing of payments received from our customers. Accrued payroll and related expenses increased by $2,108,000 or 86.7% from June 30, 2023 to March 31, 2024. The increase is primarily due to variable compensation costs incurred during the current year. Other current liabilities decreased by $6,625,000, or 23.0%, from June 30, 2023 to March 31, 2024. This was mostly driven by a reduction in deposits previously received related to shipments under a customer contract. Investing Activities Net cash used in investing activities for the nine months ended March 31, 2024 consisted of purchases of equipment amounting to $1,325,000, primarily for research and development and certain business analysis tools. Cash used during the nine months ended March 31, 2023 included the acquisition of Uplogix, which used net cash of $4,650,000, as well as purchases of plant and equipment of $2,325,000 primarily related to building out and furnishing our new lease facilities in California and Minnesota. Financing Activities Net cash used in financing activities during the nine months ended March 31, 2024 resulted primarily from principal payments on the Senior Credit Facilities as well as tax withholdings paid on behalf of employees for restricted shares. Additionally, we used cash of $1,262,000 to pay the contingent consideration earned related to the Uplogix acquisition. Net cash provided by financing activities during the nine months ended March 31, 2023 resulted primarily from $7,000,000 in gross proceeds received from our Senior Credit Facilities with SVB partially offset by payments on the term loan as well as tax withholdings paid on behalf of employees for restricted shares. 31 Item 3. Quantitative and Qualitative Disclosures about Market Risk As a smaller reporting company, we are not required to provide the information required by this Item 3.