Overview

We design, develop and market devices that make it possible to access, manage, control and configure electronic products over the Internet or other networks. We are a leader in providing innovative networking solutions. We were initially formed as “Lantronix,” a California corporation, in June 1989. We reincorporated as “Lantronix, Inc.,” a Delaware corporation, in May 2000.

We have a history of providing devices that enable information technology (“IT”) equipment to network using standard protocols for connectivity, including Ethernet and wireless. Our first device was a terminal server that allowed “dumb” terminals to connect to a network. Building on the success of our terminal servers, in 1991 we introduced a complete line of print servers that enabled users to inexpensively share printers over a network. Since then, we have continually refined our core technology and have developed additional innovative networking solutions that expand upon the business of providing our customers network connectivity. With the expansion of networking and the Internet, our technology focus has been increasingly expanded beyond IT equipment, so that our device solutions provide a product manufacturer with the ability to network its products within the industrial, service and commercial markets referred to as machine-to-machine (“M2M”) networking.

The following describes our M2M device networking product lines:

·

Device Enablement (DeviceLinx) – We offer an array of embedded and external device enablement solutions that enable integrators and manufacturers of electronic and electro-mechanical products to add network connectivity, manageability and control. Our customers’ products emanate from a wide variety of applications within the M2M market, from blood analyzers that relay critical patient information directly to a hospital’s information system, to simple devices such as time clocks, allowing the user to obtain information from these devices and to improve how they are managed and controlled. We also offer products such as multi-port device servers that enable devices outside the data center to effectively share the costs of the network connection and convert various protocols to industry standard interfaces such as Ethernet and the Internet.

 

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·

Device Management (SecureLinx and ManageLinx) – We offer off-the-shelf appliances such as console servers, digital remote keyboard, video, mouse extenders, and power control products that enable IT professionals to remotely connect, monitor and control network infrastructure equipment, distributed branch office equipment and large groups of servers using highly secure out-of-band management technology. In addition, our ManageLinx solution provides secure remote Internet access to virtually any piece of IP-enabled equipment, including our DeviceLinx products – even behind remote firewalls or virtual private networks.

The following describes our non-core product line:

·

Non-core – Over the years, we have innovated or acquired various product lines that are no longer part of our primary, core markets described above. In general, these non-core businesses represent decreasing markets and we minimize research and development in these product lines. Included in this category are terminal servers, visualization solutions, legacy print servers, software and other miscellaneous products. We have announced the end-of-life for almost all of our non-core products and expect a steep decline in non-core revenues in fiscal 2009 while we complete the exit of this product category.

 

Financial Highlights and Other Information for the Fiscal Quarter Ended December 31, 2008

The following is a summary of the key factors and significant events that impacted our financial performance during the fiscal quarter ended December 31, 2008:

·

Net revenue was $12.9 million for the fiscal quarter ended December 31, 2008, a decrease of $2.4 million or 15.7%, compared to $15.3 million for the fiscal quarter ended December 31, 2007. The decrease was primarily the result of a $1.8 million, or 12.7%, decrease in our device networking product lines and a $588,000, or 52.6%, decrease in our non-core product lines.

·

Gross profit margin was 53.9% for the fiscal quarter ended December 31, 2008 compared to 51.5% for the fiscal quarter ended December 31, 2007. The increase in gross profit margin percent was primarily attributable to lower inventory reserve costs and lower personnel costs as a result of our restructuring activities.

·

Loss from operations was $67,000 for the fiscal quarter ended December 31, 2008 compared to income from operations of $756,000 for the fiscal quarter ended December 31, 2007. Loss from operations for the fiscal quarter ended December 31, 2008 included a restructuring charge of $128,000.

·

Net loss was $148,000, or $0.00 per basic and diluted share, for the fiscal quarter ended December 31, 2008 compared to net income of $983,000, or $0.02 per basic and diluted share, for the fiscal quarter ended December 31, 2007.

·

Cash and cash equivalents were $9.2 million as of December 31, 2008, an increase of $1.7 million, compared to $7.4 million as of June 30, 2008.

·

Net accounts receivable were $2.1 million as of December 31, 2008, a decrease of $2.0 million, compared to $4.2 million as of June 30, 2008. Annualized days sales outstanding (“DSO”) in receivables were 22 days for the fiscal quarter ended December 31, 2008 compared to 24 days for the fiscal quarter ended June 30, 2008. Our accounts receivable and DSO are primarily affected by the timing of shipments within a quarter, our collections performance and the fact that a significant portion of our revenues are recognized on a sell-through basis (upon shipment from distributor inventories rather than as goods are shipped to distributors).

·

Net inventories were $8.1 million as of December 31, 2008 compared to $8.0 million as of June 30, 2008. Annualized inventory turns were 2.9 turns for the fiscal quarter ended December 31, 2008 compared to 3.0 turns for the fiscal quarter ended June 30, 2008.

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, warranty reserves, allowance for doubtful accounts, inventory valuation, valuation of deferred income taxes, goodwill and purchased intangible assets, restructuring reserves and legal settlement costs. These policies are described in further detail in our Annual Report on Form 10-K for the fiscal year ended June 30, 2008. There have been no significant changes in our critical accounting policies and estimates during the fiscal quarter ended December 31, 2008 as compared to what was previously disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2008.

 

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Recent Accounting Pronouncements

Recent accounting pronouncements issued by the Financial Accounting Standards Board (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants, and the SEC did not or are not believed by management to have a material impact on the Company’s present or future consolidated financial statements.

Consolidated Results of Operations

The following table presents the percentage of net revenues represented by each item in our condensed consolidated statement of operations:

		Three Months Ended				Six Months Ended
		December 31,				December 31,
		2008		2007		2008		2007
Net revenues		100.0%		100.0%		100.0%		100.0%
Cost of revenues		46.1%		48.5%		46.6%		49.5%
Gross profit		53.9%		51.5%		53.4%		50.5%
Operating expenses:
Selling, general and administrative		41.2%		34.9%		38.8%		41.0%
Research and development		12.0%		11.5%		11.3%		12.4%
Restructuring charge		1.0%		0.0%		2.7%		0.0%
Amortization of purchased intangible assets		0.1%		0.1%		0.1%		0.1%
Total operating expenses		54.4%		46.5%		52.9%		53.6%
Income (loss) from operations		(0.5%)		4.9%		0.5%		(3.1%)
Interest expense, net		(0.4%)		(0.4%)		(0.3%)		(0.3%)
Other income (expense), net		(0.1%)		0.8%		0.0%		0.5%
Income (loss) before income taxes		(1.1%)		5.3%		0.2%		(2.9%)
Provision (benefit) for income taxes		0.1%		(1.1%)		0.1%		(0.5%)
Net income (loss)		(1.1%)		6.4%		0.1%		(2.4%)

 

Comparison of the Fiscal Quarters Ended December 31, 2008 and 2007

Net Revenue by Product Line

The following table presents fiscal quarter net revenue by product line:

		Three Months Ended December 31,
						% of Net								% of Net				Change
		2008				Revenue				2007				Revenue				$				%
		(In thousands, except percentages)
Device enablement		$	10,115				78.5	%		$	11,285				73.9	%		$	(1,170	)			(10.4	%)
Device management			2,241				17.4	%			2,875				18.8	%			(634	)			(22.1	%)
Device networking			12,356				95.9	%			14,160				92.7	%			(1,804	)			(12.7	%)
Non-core			529				4.1	%			1,117				7.3	%			(588	)			(52.6	%)
Net revenue		$	12,885				100.0	%		$	15,277				100.0	%		$	(2,392	)			(15.7	%)

 

The decrease in net revenue for the three months ended December 31, 2008 compared to the fiscal quarter ended December 31, 2007 was the result of a decrease in net revenue across all major product lines and regions.  The decrease in our device enablement product line was due to a decrease in our embedded device enablement products, and more specifically, our WiPort, XPort and MatchPort product families and our external device enablement products, more specifically, our MSS and UDS product families. The decrease in our device management product line was the result of a decrease in our SLC, SLS, SCS product families offset by an increase in our SLB product family. We are no longer investing in the development of our non-core product lines and expect net revenue related to these products to continue to decline in the future as we focus our investment on our device networking product lines.

 

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The following table presents fiscal year-to-date net revenue by product line:

		Six Months Ended December 31,
						% of Net								% of Net				Change
		2008				Revenue				2007				Revenue				$					%
		(In thousands, except percentages)
Device enablement		$	21,668				80.0	%		$	21,114				74.5	%		$	554				2.6	%
Device management			4,219				15.6	%			4,826				17.0	%			(607	)			(12.6	%)
Device networking			25,887				95.5	%			25,940				91.5	%			(53	)			(0.2	%)
Non-core			1,210				4.4	%			2,391				8.5	%			(1,181	)			(49.4	%)
Net revenue		$	27,097				100.0	%		$	28,331				100.0	%		$	(1,234	)			(4.4	%)

 

The decrease in net revenue for the six months ended December 31, 2008 compared to the six months ended December 31, 2007 was primarily the result of a decrease in our non-core and device management product lines, offset by an increase in our device enablement product line. The increase in our device enablement product line was primarily due to an increase in our embedded device enablement products, and more specifically, our XPort and MatchPort product families, offset by a decrease in our external device enablement products, more specifically, our MSS and UDS product families.

Net Revenue by Geographic Region

The following table presents fiscal quarter net revenue by geographic region:

		Three Months Ended December 31,
						% of Net								% of Net				Change
		2008				Revenue				2007				Revenue				$					%
		(In thousands, except percentages)
Americas		$	7,544				58.5	%		$	8,908				58.3	%		$	(1,364	)			(15.3	%)
EMEA			3,668				28.5	%			4,125				27.0	%			(457	)			(11.1	%)
Asia Pacific			1,673				13.0	%			2,244				14.7	%			(571	)			(25.4	%)
Net revenue		$	12,885				100.0	%		$	15,277				100.0	%		$	(2,392	)			(15.7	%)

 

All major geographic regions contributed to the decrease in net revenue for the three months ended December 31, 2008 compared to the fiscal quarter ended December 31, 2007.  The decrease in the Americas region was primarily due to the decrease in our non-core product lines in addition to a decrease in our device enablement product lines, and more specifically, the MatchPort, UDS and MSS product families as well as our device management product lines, and more specifically, the SLC, SLS, SCS product families offset by an increase in our SLB product family. The decrease in our EMEA (“Europe, Middle East and Africa”) region was primarily due to a decrease in our device management product lines, and more specifically, the SLC product family as well as our non-core product lines. The decrease in our Asia Pacific region was due to a decrease in our device enablement product lines, and more specifically, the XPort product family and our device management product lines, and more specifically, the SLC product family.

The following table presents fiscal year-to-date net revenue by geographic region:

		Six Months Ended December 31,
						% of Net								% of Net				Change
		2008				Revenue				2007				Revenue				$					%
		(In thousands, except percentages)
Americas		$	15,972				58.9	%		$	16,843				59.5	%		$	(871	)			(5.2	%)
EMEA			7,480				27.6	%			7,510				26.5	%			(30	)			(0.4	%)
Asia Pacific			3,645				13.5	%			3,978				14.0	%			(333	)			(8.4	%)
Net revenue		$	27,097				100.0	%		$	28,331				100.0	%		$	(1,234	)			(4.4	%)

 

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The decrease in net revenue for the six months ended December 31, 2008 compared to six months ended December 31, 2007 was due to a decrease in our Americas and Asia Pacific regions. The decrease in the Americas region was primarily due to the decrease in our non-core product lines and our device management product lines, and more specifically, the SLS and SCS product families offset by an increase in our SLB product family. The decrease in the Asia Pacific region was primarily due to a decrease in our non-core product lines and our device management product lines, and more specifically, the SLC product family.

Gross Profit

The following table presents fiscal quarter gross profit:

		Three Months Ended December 31,
						% of Net								% of Net				Change
		2008				Revenue				2007				Revenue				$					%
		(In thousands, except percentages)
Gross profit		$	6,943				53.9	%		$	7,863				51.5	%		$	(920	)			(11.7	%)

 

Gross profit represents net revenue less cost of revenue. Cost of revenue consisted primarily of the cost of raw material components, subcontract labor assembly from contract manufacturers, manufacturing overhead, amortization of purchased intangible assets, establishing or relieving inventory reserves for excess and obsolete products or raw materials, warranty costs, royalties and share-based compensation.

The increase in gross profit margin for the three months ended December 31, 2008 compared to the three months ended December 31, 2007 was primarily attributable to lower inventory reserve costs and lower personnel-related expenses as a result of the restructuring activities.

The following table presents fiscal year-to-date gross profit:

		Six Months Ended December 31,
						% of Net								% of Net				Change
		2008				Revenue				2007				Revenue				$					%
		(In thousands, except percentages)
Gross profit		$	14,467				53.4	%		$	14,304				50.5	%		$	163				1.1	%

 

The increase in gross profit margin for the six months ended December 31, 2008 compared to the six months ended December 31, 2007 was primarily attributable to lower inventory reserve costs, lower unfavorable inventory variances and lower personnel-related expenses as a result of the restructuring activities.

Selling, General and Administrative

Selling, general and administrative expenses consisted of personnel-related expenses including salaries and commissions, share-based compensation, facility expenses, information technology, trade show expenses, advertising, and legal and accounting fees offset by reimbursement of legal fees from insurance proceeds.

 

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The following table presents fiscal quarter selling, general and administrative expenses:

		Three Months Ended December 31,
					% of Net					% of Net		Change
		2008			Revenue		2007			Revenue		$					%
		(In thousands, except percentages)
Personnel-related expenses		$	2,734				$	2,922				$	(188	)			(6.4	%)
Professional fees & outside services			534					768					(234	)			(30.5	%)
Advertising and marketing			712					663					49				7.4	%
Facilities			321					389					(68	)			(17.5	%)
Share-based compensation			485					132					353				267.4	%
Depreciation			139					93					46				49.5	%
Other			390					364					26				7.1	%
Selling, general and administrative		$	5,315		41.2%		$	5,331		34.9%		$	(16	)			(0.3	%)

 

In order of significance, the decrease in selling, general and administrative expenses for the three months ended December 31, 2008 compared to the three months ended December 31, 2007 was primarily due to: (i) decreased professional fees and outside services as a result of cost cutting measures and (ii) decreased personnel-related expenses as a result of the restructuring activities; offset by (iii) increased share-based compensation as a result of the new restricted stock grants related to LTIP and Performance Plan.

     The following table presents fiscal year-to-date selling, general and administrative expenses:

		Six Months Ended December 31,
					% of Net					% of Net		Change
		2008			Revenue		2007			Revenue		$					%
		(In thousands, except percentages)
Personnel-related expenses		$	5,540				$	6,585				$	(1,045	)			(15.9	%)
Professional fees & outside services			1,333					1,476					(143	)			(9.7	%)
Advertising and marketing			1,268					1,321					(53	)			(4.0	%)
Facilities			700					772					(72	)			(9.3	%)
Share-based compensation			714					402					312				77.6	%
Depreciation			269					176					93				52.8	%
Other			699					878					(179	)			(20.4	%)
Selling, general and administrative		$	10,523		38.8%		$	11,610		41.0%		$	(1,087	)			(9.4	%)

 

In order of significance, the decrease in selling, general and administrative expenses for the six months ended December 31, 2008 compared to the six months ended December 31, 2007 was primarily due to: (i) decreased personnel-related expenses as a result of the restructuring activities and (ii) decreased professional fees and outside services as a result of cost cutting measures; offset by (iii) increased share-based compensation as a result of the new restricted stock grants related to LTIP and Performance Plans.

Research and Development

Research and development expenses consisted of personnel-related expenses including share-based compensation, as well as expenditures to third-party vendors for research and development activities.

 

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The following table presents fiscal quarter research and development expenses:

		Three Months Ended December 31,
					% of Net					% of Net		Change
		2008			Revenue		2007			Revenue		$					%
		(In thousands, except percentages)
Personnel-related expenses		$	989				$	1,333				$	(344	)			(25.8	%)
Facilities			236					216					20				9.3	%
Professional fees & outside services			40					53					(13	)			(24.5	%)
Share-based compensation			221					74					147				198.6	%
Depreciation			19					14					5				35.7	%
Other			44					68					(24	)			(35.3	%)
Research and development		$	1,549		12.0%		$	1,758		11.5%		$	(209	)			(11.9	%)

 

Research and development expenses for the three months ended December 31, 2008 decreased compared to the three months ended December 31, 2007 mainly due to decreased personnel-related expenses as a result of the restructuring activities; offset by increased share-based compensation as a result of the new restricted stock grants related to LTIP and Performance Plans.

The following table presents fiscal year-to-date research and development expenses:

		Six Months Ended December 31,
					% of Net					% of Net		Change
		2008			Revenue		2007			Revenue		$					%
		(In thousands, except percentages)
Personnel-related expenses		$	2,044				$	2,588				$	(544	)			(21.0	%)
Facilities			484					428					56				13.1	%
Professional fees & outside services			88					134					(46	)			(34.3	%)
Share-based compensation			303					186					117				62.9	%
Depreciation			37					26					11				42.3	%
Other			96					164					(68	)			(41.5	%)
Research and development		$	3,052		11.3%		$	3,526		12.4%		$	(474	)			(13.4	%)

 

Research and development expenses for the six months ended December 31, 2008 decreased compared to the six months ended December 31, 2007 primarily due to decreased personnel-related expenses as a result of the restructuring activities; offset by increased share-based compensation as a result of the new restricted stock grants related to LTIP and Performance Plans.

Restructuring Charges

During the fourth fiscal quarter ended June 30, 2008, we implemented a restructuring plan to optimize our organization to better leverage existing customer and partner relationships to drive revenue growth and profitability. As part of the restructuring plan, 10 employees from the senior-level ranks of the sales, marketing, operations and engineering groups were terminated. During the first fiscal quarter ended September 30, 2008, we implemented a second restructuring plan. As part of the second restructuring plan, an additional 29 employees from all ranks and across all functional groups of the Company were terminated. During the second fiscal quarter ended December 31, 2008, we incurred additional restructuring expenses related to settling with a senior-level employee in France and closing the France sales office.

The following table presents fiscal quarter restructuring charges:

		Three Months Ended December 31,
						% of Net								% of Net				Change
		2008				Revenue				2007				Revenue				$					%
		(In thousands, except percentages)
Restructuring charge		$	128				1.0	%		$	-				0.0	%		$	128				0.0	%

 

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The following table presents fiscal year-to-date restructuring charges:

		Six Months Ended December 31,
																		Change
						% of Net								% of Net
		2008				Revenue				2007				Revenue				$				%
		(In thousands, except percentages)
Restructuring charge		$	721				2.7	%		$	-				0.0	%		$	721				0.0	%

 

Provision for Income Taxes

 

At July 1, 2008, our fiscal 2001 through fiscal 2008 tax years remain open to examination by the Federal and state taxing authorities.  We have net operating losses (“NOLs”) beginning in fiscal 2001 which cause the statute of limitations to remain open for the year in which the NOL was incurred.

 

The following table presents our effective tax rate based upon our income tax provision:

 

		Three Months Ended								Six Months Ended
		December 31,								December 31,
		2008				2007				2008				2007
Effective tax rate			6%				21%				38%				18%

 

We utilize the liability method of accounting for income taxes as set forth in Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes.” The federal statutory rate was 34% for all periods. The difference between our effective tax rate and the federal statutory rate resulted primarily from the effect of our domestic losses recorded with a fully reserved tax benefit, as well as the effect of foreign earnings taxed at rates differing from the federal statutory rate. We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. As a result of our cumulative losses, we provided a full valuation allowance against our domestic net deferred tax assets for the fiscal quarters ended December 31, 2008 and 2007.

Liquidity and Capital Resources

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

		December 31,				June 30,				Increase
		2008				2008				(Decrease)
		(In thousands)
Working capital		$	7,859			$	5,686			$	2,173
Cash and cash equivalents		$	9,151			$	7,434			$	1,717

 

In order of significance, our working capital as of December 31, 2008 increased compared to June 30, 2008 primarily due to: (i) an increase in cash and decrease in accounts payable as a result of the proceeds from the term loan and (ii) a decrease in accrued payroll as a result of the timing of pay periods compared to the prior year, offset by (iii) a decrease in accounts receivable as a result of lower shipments compared to the quarter ended June 30, 2008 and (iv) an increase in short term debt as a result of the new term loan. Our cash balance increased compared to the quarter ended June 30, 2008 as a result of our cash management activities, which included the timing of cash payments to our vendors and the timing of cash receipts from our customers.

We believe that our existing cash and cash equivalents and funds available from our line of credit will be adequate to meet our anticipated cash needs through at least the next 12 months. Our future capital requirements will depend on many factors, including the timing and amount of our net revenues, research and development, expenses associated with any strategic partnerships or acquisitions and infrastructure investments, and expenses related to government investigations and litigation, which could affect our ability to generate additional cash. If cash generated from operations and financing activities is insufficient to satisfy our working capital requirements, we may need to raise capital by borrowing additional funds through bank loans, the selling of securities or other means. There can be no assurance that we will be able to raise any such capital on terms acceptable to us, if at all. If we are unable to secure additional financing, we may not be able to develop or enhance our products, take advantage of future opportunities, respond to competition or continue to operate our business.

In August 2008, we entered into an amendment to our Line of Credit, which provides for a three-year $2.0 million Term Loan and a two-year $3.0 million Revolving Credit Facility. The Term Loan was funded on August 26, 2008 and is payable in 36 equal installments of principal and monthly accrued interest. There are no borrowings outstanding on the Revolving Credit Facility as of the fiscal quarter end.

 

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Borrowings under the Term Loan and Revolving Credit Facility bear interest at the greater of 6.25% or prime rate plus 1.25% per annum. If we achieve two consecutive quarters of positive EBITDAS (as defined in the Loan Agreement) greater than $1.00, and only for so long as we maintain EBITDAS greater than $1.00 at the end of each subsequent fiscal quarter, then the borrowings under the Term Loan and Revolving Credit Facility will bear interest at the greater of 5.75% or prime rate plus 0.75% per annum. We paid a fully earned, non-refundable commitment fee of $35,000 and are required to pay an additional $35,000 on the first anniversary of the effective date.

The following table presents our available borrowing capacity and outstanding letters of credit, which were used to secure equipment leases, deposits for a building lease and security deposits:

		December 31,				June 30,
		2008				2008
		(In thousands)
Available borrowing capacity		$	902			$	3,163
Outstanding letters of credit		$	732			$	732

 

As of December 31, 2008 and June 30, 2008, approximately $727,000 and $801,000, respectively, of our cash was held in foreign subsidiary bank accounts.  Such cash is unrestricted with regard to foreign liquidity needs; however, our ability to utilize a portion of this cash to satisfy liquidity needs outside of such foreign locations is subject to approval by the foreign subsidiary’s board of directors.

Cash Flows for the Three and Six Months Ended

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

		Three Months Ended								Six Months Ended
		December 31,								December 31,
		2008				2007				2008				2007
		(In thousands)
Net cash provided by (used in):
Net income (loss)		$	(148	)		$	983			$	36			$	(670	)
Non-cash operating expenses, net			1,185				468				2,273				1,200
Changes in operating assets and liabilities:			-				-
Accounts receivable			784				(1,286	)			2,057