UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
x QUARTERLY
REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934
For
the quarterly period ended September 30, 2006
OR
o TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
1934
For
the transition period from _________ to ___________.
Commission
file number: 1-16027
LANTRONIX,
INC.
(Exact
name of registrant as specified in its charter)
Delaware
|
33-0362767
|
(State
or other jurisdiction
|
(I.R.S.
Employer
|
of
incorporation or organization)
|
Identification
No.)
|
15353
Barranca Parkway, Irvine, California
(Address
of principal executive offices)
92618
(Zip
Code)
(949)
453-3990
(Registrant’s
telephone number, including area code)
Former
name, former address and former fiscal year, if changed since last report:
N/A
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days. Yes x
No
o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer o
|
Accelerated
filer o
|
Non-accelerated
filer x.
|
Indicate
by check mark whether the registrant is a shell company (as defined by Rule
12b-2 of the Exchange Act). Yes o
No
x.
As
of
November 10, 2006, 59,596,957 shares of the Registrant’s common stock were
outstanding.
LANTRONIX,
INC.
FORM
10-Q
FOR
THE FISCAL QUARTER ENDED
September
30, 2006
INDEX
|
|
|
Page
|
|
|
|
|
PART
I.
|
FINANCIAL
INFORMATION
|
|
1
|
|
|
|
|
Item
1.
|
Financial
Statements.
|
|
1
|
|
|
|
|
|
Unaudited
Condensed Consolidated Balance Sheets at September 30, 2006 and
June 30,
2006
|
|
1
|
|
|
|
|
|
Unaudited
Condensed Consolidated Statements of Operations for the Three Months
Ended
|
|
|
|
September
30, 2006 and 2005
|
|
2
|
|
|
|
|
|
Unaudited
Condensed Consolidated Statements of Cash Flows for the Three Months
Ended
|
|
|
|
September
30, 2006 and 2005
|
|
3
|
|
|
|
|
|
Notes
to Unaudited Condensed Consolidated Financial Statements.
|
|
4
|
|
|
|
|
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
|
9
|
|
|
|
|
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risk.
|
|
16
|
|
|
|
|
Item
4.
|
Controls
and Procedures.
|
|
17
|
|
|
|
|
PART
II.
|
OTHER
INFORMATION
|
|
17
|
|
|
|
|
Item
1.
|
Legal
Proceedings
|
|
17
|
|
|
|
|
Item
1A.
|
Risk
Factors
|
|
17
|
|
|
|
|
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds.
|
|
26
|
|
|
|
|
Item
3.
|
Defaults
Upon Senior Securities
|
|
26
|
|
|
|
|
Item
4.
|
Submission
of Matters to a Vote of Security Holders
|
|
26
|
|
|
|
|
Item
5.
|
Other
Information
|
|
26
|
|
|
|
|
Item
6.
|
Exhibits
|
|
26
|
PART
I. FINANCIAL INFORMATION
Item
1. Financial Statements
LANTRONIX,
INC.
UNAUDITED
CONDENSED CONSOLIDATED BALANCE SHEETS
|
|
September
30,
|
|
June
30,
|
|
|
|
2006
|
|
2006
|
|
|
|
(In
thousands)
|
ASSETS
|
|
|
|
|
|
|
|
Current
Assets:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
7,687
|
|
$
|
7,729
|
|
Marketable
securities
|
|
|
94
|
|
|
88
|
|
Accounts
receivable, net
|
|
|
2,734
|
|
|
3,087
|
|
Inventories,
net
|
|
|
9,234
|
|
|
8,113
|
|
Contract
manufacturers' receivable
|
|
|
681
|
|
|
1,049
|
|
Settlements
recovery
|
|
|
14,096
|
|
|
15,325
|
|
Prepaid
expenses and other current assets
|
|
|
553
|
|
|
577
|
|
Total
current assets
|
|
|
35,079
|
|
|
35,968
|
|
|
|
|
|
|
|
|
|
Property
and equipment, net
|
|
|
1,651
|
|
|
1,589
|
|
Goodwill
|
|
|
9,488
|
|
|
9,488
|
|
Purchased
intangible assets, net
|
|
|
590
|
|
|
610
|
|
Officer
loans
|
|
|
124
|
|
|
122
|
|
Other
assets
|
|
|
38
|
|
|
38
|
|
Total
assets
|
|
$
|
46,970
|
|
$
|
47,815
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
Current
Liabilities:
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
9,821
|
|
$
|
7,865
|
|
Accrued
payroll and related expenses
|
|
|
1,386
|
|
|
1,596
|
|
Warranty
reserve
|
|
|
495
|
|
|
693
|
|
Accrued
settlements
|
|
|
15,153
|
|
|
16,767
|
|
Other
current liabilities
|
|
|
3,055
|
|
|
3,675
|
|
Total
current liabilities
|
|
|
29,910
|
|
|
30,596
|
|
Long-term
liabilities
|
|
|
269
|
|
|
230
|
|
Long-term
capital lease obligations
|
|
|
174
|
|
|
211
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders'
equity:
|
|
|
|
|
|
|
|
Common
stock
|
|
|
6
|
|
|
6
|
|
Additional
paid-in capital
|
|
|
183,355
|
|
|
182,857
|
|
Accumulated
deficit
|
|
|
(167,101
|
)
|
|
(166,450
|
)
|
Accumulated
other comprehensive income
|
|
|
357
|
|
|
365
|
|
Total
stockholders' equity
|
|
|
16,617
|
|
|
16,778
|
|
Total
liabilities and stockholders' equity
|
|
$
|
46,970
|
|
$
|
47,815
|
|
|
|
|
|
|
|
|
|
See
accompanying notes.
|
|
LANTRONIX,
INC.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
|
|
Three
Months Ended
|
|
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
|
|
(In
thousands, except per share data)
|
|
|
|
|
|
|
Net
revenues (1)
|
|
$
|
12,514
|
|
$
|
12,240
|
|
Cost
of revenues (2)
|
|
|
5,907
|
|
|
6,120
|
|
Gross
profit
|
|
|
6,607
|
|
|
6,120
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
|
5,498
|
|
|
6,072
|
|
Research
and development
|
|
|
1,718
|
|
|
1,403
|
|
Litigation
settlement costs
|
|
|
15
|
|
|
-
|
|
Amortization
of purchased intangible assets
|
|
|
18
|
|
|
2
|
|
Restructuring
recovery
|
|
|
-
|
|
|
(29
|
)
|
Total
operating expenses
|
|
|
7,249
|
|
|
7,448
|
|
Loss
from operations
|
|
|
(642
|
)
|
|
(1,328
|
)
|
Interest
income, net
|
|
|
6
|
|
|
3
|
|
Other
expense, net
|
|
|
(3
|
)
|
|
(10
|
)
|
Loss
before income taxes
|
|
|
(639
|
)
|
|
(1,335
|
)
|
Provision
for income taxes
|
|
|
12
|
|
|
6
|
|
Net
loss
|
|
$
|
(651
|
)
|
$
|
(1,341
|
)
|
|
|
|
|
|
|
|
|
Net
loss per share (basic and diluted)
|
|
$
|
(0.01
|
)
|
$
|
(0.02
|
)
|
|
|
|
|
|
|
|
|
Weighted-average
shares (basic and diluted)
|
|
|
59,262
|
|
|
58,499
|
|
|
|
|
|
|
|
|
|
(1)
Includes net revenues from related party
|
|
$
|
279
|
|
$
|
295
|
|
|
|
|
|
|
|
|
|
(2)
Includes amortization of purchased intangible assets
|
|
$
|
2
|
|
$
|
297
|
|
|
LANTRONIX,
INC.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
|
|
Three
Months Ended
|
|
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
|
|
(In
thousands)
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(651
|
)
|
$
|
(1,341
|
)
|
|
|
|
|
|
|
|
|
Adjustments
to reconcile net loss to net cash (used in) provided by operating
activities:
|
|
|
|
|
|
|
|
Share-based
compensation
|
|
|
314
|
|
|
239
|
|
Depreciation
|
|
|
100
|
|
|
116
|
|
Amortization
of purchased intangible assets
|
|
|
20
|
|
|
297
|
|
Provision
for doubtful accounts
|
|
|
18
|
|
|
6
|
|
Litigation
settlement costs
|
|
|
15
|
|
|
-
|
|
Provision
for inventories
|
|
|
1
|
|
|
(213
|
)
|
Restructuring
recovery
|
|
|
-
|
|
|
(29
|
)
|
Gain
on disposal of fixed assets
|
|
|
-
|
|
|
4
|
|
Foreign
currency transaction gain
|
|
|
-
|
|
|
14
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
334
|
|
|
(155
|
)
|
Inventories
|
|
|
(1,122
|
)
|
|
852
|
|
Contract
manufacturers' receivable
|
|
|
368
|
|
|
21
|
|
Prepaid
expenses and other current assets
|
|
|
25
|
|
|
(480
|
)
|
Other
assets
|
|
|
(3
|
)
|
|
4
|
|
Accounts
payable
|
|
|
1,957
|
|
|
650
|
|
Accrued
payroll and related expenses
|
|
|
(213
|
)
|
|
(285
|
)
|
Accrued
settlements
|
|
|
(400
|
)
|
|
-
|
|
Warranty
reserve
|
|
|
(198
|
)
|
|
(54
|
)
|
Other
liabilities
|
|
|
(741
|
)
|
|
464
|
|
Net
cash (used in) provided by operating activities
|
|
|
(176
|
)
|
|
110
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
Purchases
of property and equipment, net
|
|
|
(4
|
)
|
|
(38
|
)
|
Net
cash used in investing activities
|
|
|
(4
|
)
|
|
(38
|
)
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
Net
proceeds from issuances of common stock
|
|
|
184
|
|
|
150
|
|
Payment
of capital lease obligations
|
|
|
(33
|
)
|
|
(39
|
)
|
Net
cash provided by financing activities
|
|
|
151
|
|
|
111
|
|
Effect
of foreign exchange rate changes on cash
|
|
|
(13
|
)
|
|
(20
|
)
|
(Decrease)
increase in cash and cash equivalents
|
|
|
(42
|
)
|
|
163
|
|
Cash
and cash equivalents at beginning of period
|
|
|
7,729
|
|
|
6,690
|
|
Cash
and cash equivalents at end of period
|
|
$
|
7,687
|
|
$
|
6,853
|
|
See
accompanying notes.
|
LANTRONIX,
INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2006
1.
Basis
of Presentation
The
condensed consolidated financial statements included herein are unaudited.
They
contain all normal recurring accruals and adjustments which, in the opinion
of
management, are necessary to present fairly the consolidated financial position
of Lantronix, Inc. and its subsidiaries (collectively, the “Company”) at
September 30, 2006, and the consolidated results of its operations and cash
flows for the three months ended September 30, 2006 and 2005. All intercompany
accounts and transactions have been eliminated. It should be understood that
accounting measurements at interim dates inherently involve greater reliance
on
estimates than at year-end. The results of operations for the three months
ended
September 30, 2006 are not necessarily indicative of the results to be expected
for the full year or any future interim periods.
These
financial statements do not include certain footnotes and financial
presentations normally required under generally accepted accounting principles.
Therefore, they should be read in conjunction with the audited consolidated
financial statements and notes thereto for the fiscal year ended June 30,
2006,
included in the Company’s Annual Report on Form 10-K filed with the Securities
and Exchange Commission (“SEC”) on September 12, 2006.
2. Computation
of Net Loss per Share
Basic
and
diluted net loss per share is calculated by dividing net loss by the
weighted-average number of common shares outstanding during the
year.
The
following table presents the computation of net loss per share:
|
|
Three
Months Ended
|
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
|
|
(In
thousands, except
per share data)
|
|
Numerator:
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(651
|
)
|
$
|
(1,341
|
)
|
Denominator:
|
|
|
|
|
|
|
|
Weighted-average
shares outstanding
|
|
|
59,262
|
|
|
58,831
|
|
Less:
Unvested common shares outstanding
|
|
|
-
|
|
|
(332
|
)
|
Weighted-average
shares (basic and diluted)
|
|
|
59,262
|
|
|
58,499
|
|
|
|
|
|
|
|
|
|
Net
loss per share (basic and diluted)
|
|
$
|
(0.01
|
)
|
$
|
(0.02
|
)
|
The
following table presents the common stock equivalents excluded from the diluted
net loss per share calculation, because they were anti-dilutive as of such
dates. These excluded common stock equivalents could be dilutive in the
future.
|
|
Three
Months Ended
|
|
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
Common
stock equivalents
|
|
|
2,587,780
|
|
|
1,173,926
|
|
3.
Inventories
Inventories
are stated at the lower of cost (first-in, first-out) or market and consist
of
the following:
|
|
September
30,
|
|
June
30,
|
|
|
|
2006
|
|
2006
|
|
|
|
(In
thousands)
|
|
Raw
materials
|
|
$
|
4,336
|
|
$
|
3,863
|
|
Finished
goods
|
|
|
6,628
|
|
|
6,518
|
|
Inventory
at distributors
|
|
|
1,476
|
|
|
1,690
|
|
Large
scale integration chips *
|
|
|
1,256
|
|
|
731
|
|
|
|
|
13,696
|
|
|
12,802
|
|
Reserve
for excess and obsolete inventories
|
|
|
(4,462
|
)
|
|
(4,689
|
)
|
|
|
$
|
9,234
|
|
$
|
8,113
|
|
|
|
|
|
|
|
|
|
*
This item is both sold individually and embedded into the Company's
products.
|
4.
Warranty
Upon
shipment to its customers, the Company provides for the estimated cost to
repair
or replace products to be returned under warranty. The Company’s products
typically carry a one- to two-year warranty. In addition, certain products
that
were sold prior to August 2003 carry a five-year warranty. Although the Company
engages in extensive product quality programs and processes, its warranty
obligation is affected by product failure rates, use of materials or service
delivery costs that differ from our estimates. As a result, additional warranty
reserves could be required, which could reduce gross margins. Additionally,
the
Company sells extended warranty services, which extend the warranty period
for
an additional one to three years depending upon the product.
The
following table is a reconciliation of the changes to the product warranty
liability for the periods presented:
|
|
Three
Months Ended
|
|
Year
Ended
|
|
|
|
September
30,
|
|
June
30,
|
|
|
|
2006
|
|
2006
|
|
|
|
(In
thousands)
|
|
Beginning
balance
|
|
$
|
693
|
|
$
|
1,248
|
|
Recovered
to cost of revenues
|
|
|
(94
|
)
|
|
(35
|
)
|
Usage
|
|
|
(104
|
)
|
|
(520
|
)
|
Ending
balance
|
|
$
|
495
|
|
$
|
693
|
|
5.
Bank Line of Credit and Debt
In
May
2006, the Company entered into a two-year secured revolving Loan and Security
Agreement (“Line of Credit”) with a bank, which provides for borrowings up to
$5.0 million. The borrowing capacity is limited to eligible accounts receivable
as defined under the Line of Credit. Borrowings under the Line of Credit
bear
interest at the prime rate plus 1.75% per annum. The Company is required
to pay
an unused line fee of 0.50% on the unused portion of the Line of Credit.
In
addition, the Company paid a fully earned, non-refundable commitment fee
of
$54,000 and is required to pay an additional $54,000 on the first anniversary
of
the Effective Date.
The
Company's obligations under the Line of Credit are secured by substantially
all
of the Company’s assets, including its intellectual property.
The
Company is subject to a number of covenants under the Line of Credit, pursuant
to which, among other things, the Company has agreed that it will not, without
the Bank's prior written consent: (a) sell, lease, transfer or otherwise
dispose, any of the Company's business or property, provided, however, that
the
Company may sell inventory in the ordinary course of business consistent
with
the provisions of the Line of Credit; (b) change the Company's business
structure, liquidate or dissolve, or permit a change in beneficial ownership
of
more than 20% of the outstanding shares; (c) acquire, merge or consolidate
with
or into any other business organization; (d) incur any debts outside the
ordinary course of the Company's business, except for permitted indebtedness,
or
grant any security interests in or permit a lien, claim or encumbrance upon
all
or any portion of the Company's assets, except in favor of or agreed to by
the
bank; (f) make any investments other than permitted investments; (g) make
or
permit any payments on any subordinated debt, except under the terms of existing
subordinated debt or on terms acceptable to the bank, or amend any provision
in
any document related to the subordinated debt that would increase the amount
thereof, or (h) become an "investment company" as such term is defined under
the
Investment Company Act of 1940. The Line of Credit also contains a number
of
affirmative covenants, including, among other things, covenants regarding
the
delivery of financial statements and notice requirements, accounts receivable,
payment of taxes, access to collateral and books and records, maintenance
of
properties and insurance policies, and litigation by third parties.
The
Line
of Credit includes events of default that include, among other things,
non-payment of principal, interest or fees, violation of affirmative and
negative covenants, cross default to certain other indebtedness, material
adverse change, material judgments, bankruptcy and insolvency events.
As
of
September 30, 2006, the Company had no borrowings against the Line of
Credit.
6. Share-Based
Compensation
The
following table presents a summary of option activity under the Company’s stock
option plans:
|
|
Number
of
|
|
|
|
Shares
|
|
Balance
at June 30, 2006
|
|
|
5,467,753
|
|
Options
granted
|
|
|
411,000
|
|
Options
forfeited
|
|
|
(196,958
|
)
|
Options
expired
|
|
|
(498
|
)
|
Options
exercised
|
|
|
(2,200
|
)
|
Balance
at September 30, 2006
|
|
|
5,679,097
|
|
The
following table presents stock option grant date information:
|
|
Three
Months Ended
|
|
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
Weighted-average
grant date fair value
|
|
$
|
1.24
|
|
$
|
1.09
|
|
Weighted-average
grant date exercise price
|
|
$
|
1.60
|
|
$
|
1.37
|
|
The
following table presents a summary of share-based compensation by functional
line item:
|
|
Three
Months Ended
|
|
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
|
|
(In
thousands)
|
|
Cost
of revenues
|
|
$
|
12
|
|
$
|
20
|
|
Selling,
general and administrative
|
|
|
209
|
|
|
167
|
|
Research
and development
|
|
|
93
|
|
|
52
|
|
|
|
$
|
314
|
|
$
|
239
|
|
7.
Income
Taxes
The
Company utilizes the liability method of accounting for income taxes. The
following table presents the Company’s effective tax rates based upon the income
tax provision for the periods shown:
|
|
Three
Months Ended
|
|
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
Effective
tax rate
|
|
|
2%
|
|
|
0%
|
|
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 without a tax benefit, as well as
the
effect of foreign earnings taxed at rates differing from the federal statutory
rate.
8. Comprehensive
Loss
The
components of comprehensive loss are as follows:
|
|
Three
Months Ended
|
|
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
|
|
(In
thousands)
|
Net
loss
|
|
$
|
(651
|
)
|
$
|
(1,341
|
)
|
Other
comprehensive income (loss):
|
|
|
|
|
|
|
|
Change
in net unrealized gain on investment, net of taxes of $0
|
|
|
6
|
|
|
7
|
|
Change
in translation adjustments, net of taxes of $0
|
|
|
(14
|
)
|
|
(5
|
)
|
Total
comprehensive loss
|
|
$
|
(659
|
)
|
$
|
(1,339
|
)
|
9. Litigation
Settlements
Securities
Litigation Settlements
Securities
Class Action Lawsuits (“Class Action”)
Beginning
on May 15, 2002, a number of securities class actions were filed against
the
Company and certain of its current and former directors and former officers
alleging violations of the federal securities laws. These actions were
consolidated into a single action pending in the United States District Court
for the Central District of California and entitled: In re
Lantronix, Inc.
Securities Litigation, Case No. CV 02-3899 GPS (JTLx). After the Court
appointed a lead plaintiff, amended complaints were filed by the plaintiff,
and
the defendants filed various motions to dismiss directed at particular
allegations. Through that process, certain of the allegations were
dismissed by the Court.
On
October 18, 2004, the plaintiff filed the third amended complaint, which
is now
the operative complaint in the action. The complaint alleges violations of
Sections 11 and 15 of the Securities Act of 1933, as amended (the “Securities
Act”) and violations of Sections 10(b) and 20(a) and Rule 10b-5 of the
Securities Exchange Act of 1934, as amended (the “Exchange Act”). The Securities
Act claims are brought on behalf of all persons who purchased common stock
of
Lantronix pursuant or traceable to the Company’s August 4, 2000 initial public
offering (“IPO”). The Exchange Act claims are based on alleged misstatements
related to the Company’s financial results that were contained in the
Registration Statement and Prospectus for the IPO. The claims brought under
the
Exchange Act are brought on behalf of all persons and entities that purchased
or
acquired Lantronix securities from November 1, 2000 through May 30, 2002
(the
“Class Period”). The complaint alleges that defendants issued false and
misleading statements concerning the business and financial condition in
order
to allegedly inflate the value of the Company’s securities during the Class
Period. The complaint alleges that during the Class Period, Lantronix overstated
financial results through improper revenue recognition and failure to comply
with Generally Accepted Accounting Principles (“GAAP”). Defendants have filed an
answer to the complaint and the case is now in discovery. While the
complaint does not specify the damages plaintiff may seek on behalf of the
purported classes of stockholders, a recovery by the plaintiff and the plaintiff
classes could have a material adverse impact on the Company. The proceeds
from
certain insurance policies have funded and continue to fund much of the
Company’s defense to the Class Action lawsuit.
The
Company has reached an agreement with plaintiffs to settle the Class Action
lawsuit. The Company has also reached agreements with its relevant insurance
carriers with respect to the funding of the cash portions of the settlement
with
plaintiffs. Under the terms of the agreement with the Class Action plaintiffs,
the Company will not be required to contribute any cash to the Class Action
settlement, as all cash contributed would be from the Company’s insurance
carriers. However, as part of the agreement with the plaintiffs in the Class
Action lawsuit, the Company has agreed to issue certain Lantronix securities
to
the plaintiffs. As
a
result of the anticipated issuance of such securities, and in connection
with
the issuance of securities for the settlement of the Synergetic action described
below, the Company recorded a charge of $1.2 million in the consolidated
statement of operations for the fiscal year ended June 30, 2006. As
of
September 30, 2006, the
Company has recorded an accrued settlement of $15.2 million of which the
Company’s insurance carriers have agreed to fund $14.1 million. After
a
hearing on August 29, 2006, the Court gave its preliminary approval to the
settlement on September 8, 2006. The settlement is subject to final approval
of
the Court, and a hearing for final Court approval of the settlement is scheduled
for November 22, 2006.
Securities
Claims Brought by Former Stockholders of Synergetic Micro Systems, Inc.
(“Synergetic”)
On
October 17, 2002, Richard Goldstein and several other former stockholders
of
Synergetic filed a complaint entitled Goldstein,
et al. v. Lantronix, Inc., et al.
in the
Superior Court of the State of California, County of Orange, against the
Company
and certain of its former officers and directors. Plaintiffs filed an amended
complaint on January 7, 2003. The amended complaint alleges fraud, negligent
misrepresentation, breach of warranties and covenants, breach of contract
and
negligence, all stemming from its acquisition of Synergetic. The complaint
seeks
an unspecified amount of damages, interest, attorneys’ fees, costs, expenses,
and an unspecified amount of punitive damages. On May 5, 2003, the Company
answered the complaint and generally denied the allegations in the complaint.
In
May
2006, the Company entered into a definitive settlement agreement with the
plaintiffs in the Synergetic action. Pursuant to the settlement agreement,
in
June 2006, the Company issued 84,053 common shares with a fair value of $175,000
as partial consideration for its settlement of the Synergetic claims, and
the
Company’s insurance carriers paid $750,000 to the plaintiffs. In connection with
the settlement, the plaintiffs filed a request for dismissal with prejudice
of
all claims against all parties with the Court on July 7, 2006, and this
litigation is now concluded.
Government
Investigation
During
June 2006, the Company reached an agreement in principle with the regional
staff
of the SEC regarding the terms of a settlement that the regional staff has
agreed to recommend to the SEC. On September 27, 2006, the Commission formally
approved of the proposed settlement. The settlement, under which the Company
has
not admitted or denied any wrongdoing, fully resolves all claims against
the
Company relating to the formal investigation that the SEC commenced in
July 2002 relating to the Company’s restatement of its financial results
announced in May and June 2002. The settlement includes the following principal
terms:
·
|
The
Company will agree to a cease and desist order from future violations
of
securities laws;
|
·
|
The
Company will not be required to pay any monetary penalties;
and
|
·
|
The
Company will agree to cooperate with the Commission on any further
proceedings in connection with its investigation.
|
Accrued
Settlements and Settlements Recovery
The
following table presents details of the Company’s accrued settlements and
settlements recovery:
|
|
September
30,
|
|
June
30,
|
|
|
|
2006
|
|
2006
|
|
|
|
(In
thousands)
|
|
Accrued
settlements:
|
|
|
|
|
|
|
|
Class
Action and Synergetic
|
|
$
|
15,153
|
|
$
|
15,167
|
|
Derivative
|
|
|
-
|
|
|
1,200
|
|
Patent
infringement
|
|
|
-
|
|
|
400
|
|
|
|
|
15,153
|
|
|
16,767
|
|
Settlements
recovery:
|
|
|
|
|
|
|
|
Class
Action and Synergetic
|
|
|
14,096
|
|
|
14,125
|
|
Derivative
|
|
|
-
|
|
|
1,200
|
|
|
|
|
14,096
|
|
|
15,325
|
|
Direct
settlement obligations of the Company
|
|
$
|
1,057
|
|
$
|
1,442
|
|
10.
Litigation
From
time
to time, the Company is subject to other legal proceedings and claims in
the
ordinary course of business. Except as discussed in Note 9, the Company is
currently not aware of any such legal proceedings or claims that it believes
will have, individually or in the aggregate, a material adverse effect on
its
business, prospects, financial position, operating results or cash
flows.
11.
Subsequent
Event
On
October 19, 2006, the Company sold its remaining ownership interest in Xanboo
for cash consideration of $700,000. The Company will record the sale as other
income during the fiscal second quarter ending December 31, 2006.
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations
Cautionary
Statement
You
should read the following discussion and analysis in conjunction with our
Unaudited Condensed Consolidated Financial Statements and the related notes
thereto contained elsewhere in this Quarterly Report on Form 10-Q. The
information contained in this Quarterly Report on Form 10-Q is not a
complete description of our business or the risks associated with an investment
in our common stock. We urge you to carefully review and consider the various
disclosures made by us in this Report and in our other reports filed with
the
Securities and Exchange Commission (“SEC”), including our Annual Report on
Form 10-K for the fiscal year ended June 30, 2006 and subsequent
reports on our Current Reports on Form 8-K, which discuss our business in
greater detail.
The
section entitled “Risk Factors” set forth in Part II, Item 1A, and similar
discussions in our other SEC filings, describe some of the important risk
factors that may affect our business, results of operations and financial
condition. You should carefully consider those risks, in addition to the
other
information in this Quarterly Report on Form 10-Q and in our other filings
with
the SEC, before deciding to purchase, hold or sell our common
stock.
This
report contains forward-looking statements which include, but are not limited
to, statements concerning projected net revenues, expenses, gross profit
and net
income (loss), the need for additional capital, market acceptance of our
products, our ability to achieve further product integration, the status
of
evolving technologies and their growth potential and our production capacity.
Among these forward-looking statements are statements regarding a potential
decline in net revenue from non-core product lines, potential variances in
quarterly operating expenses, the adequacy of existing resources to meet
cash
needs, some reduction in the average selling prices and gross margins of
products, need to incorporate software from third-party vendors and open
source
software in our future products and the potential impact of an increase in
interest rates or fluctuations in foreign exchange rates on our financial
condition or results of operations. These forward-looking statements are
based
on our current expectations, estimates and projections about our industry,
our
beliefs and certain assumptions made by us. Words such as “anticipates,”
“expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “may,” “will”
and variations of these words or similar expressions are intended to identify
forward-looking statements. In addition, any statements that refer to
expectations, projections or other characterizations of future events or
circumstances, including any underlying assumptions, are forward-looking
statements. These statements are not guarantees of future performance and
are
subject to certain risks, uncertainties and assumptions that are difficult
to
predict. Therefore, our actual results could differ materially and adversely
from those expressed in any forward-looking statements as a result of various
factors, including but not limited to those identified under the heading
“Risk
Factors” set forth in Part II, Item 1A. We undertake no obligation to revise or
update publicly any forward-looking statements for any reason.
Overview
Lantronix,
Inc. (“Lantronix” or “the Company”) designs, develops and markets 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 broader and has 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.
During
the fiscal quarter ended September 30, 2006, we renamed our product lines
to
reflect the single focus on device networking and our broadening product
portfolio and entry into new adjacent applications. The Company will report
its
two core product lines as “device enablement” (formerly “device networking”),
and “device management” (formerly “IT management”). The non-core category,
representing older legacy products, will include terminal servers formerly
categorized as a part of “IT management”.
The
following describes our core product lines:
·
|
Device
Enablement
-
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 originate from a wide variety of
applications within the machine-to-machine (“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 products and to improve how
they are
managed and controlled.
|
|
|
·
|
Device
Management -We
offer off-the-shelf appliances such as console servers, remote
KVM
servers, and power control products that enable IT professionals
to
remotely connect, monitor and control network infrastructure equipment
and
large groups of servers using highly secure out-of-band management
technology. We also offer products such as multi-port devices servers
that
enable devices outside the data center to cost effectively share
the
network connection and convert various protocols to industry standard
interfaces such as Ethernet and the Internet. In addition, we offer
off-the-shelf appliances that enable IT professionals to reliably,
remotely and simply monitor, configure and manage multiple devices
from a
single point of control.
|
The
following describes our non-core product line:
·
|
Non-core
Products
-
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.
|
Financial
Highlights and Other Information for the Fiscal Quarter Ended September 30,
2006
The
following is a summary of the key factors and significant events that impacted
our financial performance during the fiscal quarter ended September 30, 2006:
·
|
Net
revenues of $12.5 million for the fiscal quarter ended September 30,
2006 increased by $274,000 or 2.2% as compared to $12.2 million
reported during the fiscal quarter ended September 30, 2005. The
increase
in net revenues is due to an increase of $597,000 in our core product
lines as a result of a $746,000 increase in our device enablement
product
line, which was offset by a $149,000 decrease in our device management
product line. Our non-core product line decreased by $323,000.
|
·
|
Gross
profit as a percentage of net revenues was 52.8% for the fiscal
quarter
ended September 30, 2006, increasing 2.8 percentage points from
the 50.0%
reported in the fiscal quarter ended September 30, 2005. As a percentage
of net revenues, the increase in gross profit is in part due to
a decrease
in the amortization of purchased intangible assets as a result
of a
majority of our purchased intangible assets becoming fully amortized
and a
reduction in manufacturing overhead costs.
|
|
|
·
|
Loss
from operations as a percentage of net revenues was 5.1% for the
fiscal
quarter ended September 30, 2006 compared to a 10.8% loss from
operations
in the fiscal quarter ended September 30, 2005.
|
|
|
·
|
Net
loss of $651,000 or $0.01 per basic and diluted share, in the fiscal
quarter ended September 30, 2006, decreased from a net loss of
$1.3 million, or $0.02 per basic and diluted share, in the
fiscal quarter ended September 30, 2005.
|
|
|
·
|
Cash,
cash equivalents and marketable securities remained consistent
at $7.8
million as of September 30, 2006 and June 30, 2006, respectively.
|
|
|
·
|
Accounts
receivable, net were $2.7 million as of September 30, 2006 as
compared to $3.1 million at June 30, 2006. Annualized days sales
outstanding (“DSO”) in receivables as of September 30, 2006 increased
to 21 days from 16 days as of June 30, 2006. 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).
|
|
|
·
|
Inventories,
net were $9.2 million as of September 30, 2006 as compared to
$8.1 million as of June 30, 2006. Our annualized inventory turns
decreased with 2.7 annualized turns during the fiscal quarter ended
September 30, 2006 compared to 3.4 annualized turns during the fiscal
quarter ended June 30, 2006.
|
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 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, 2006. There have been no significant changes in our critical accounting
policies and estimates during the fiscal quarter ended September 30, 2006
as
compared to what was previously disclosed in our Annual Report on Form 10-K
for
the fiscal year ended June 30, 2006.
Recent
Accounting Pronouncements
In
September 2006, the SEC issued Staff Accounting Bulletin No. 108,
Considering
the Effects of Prior Year Misstatements when Qualifying Misstatements in
Current
Year Financial Statements (“SAB
108”), which provides interpretive guidance on the consideration of the effects
of prior year misstatements in quantifying current year misstatements for
the
purpose of a materiality assessment. SAB 108 was issued to address diversity
in
practice in quantifying financial statement misstatements. SAB 108 requires
that
we quantify misstatements based on their impact on each of our financial
statements and related disclosures. SAB 108 is effective for
fiscal years ending after November 15, 2006.
The
Company is currently assessing the impact, if any, from the adoption of SAB
108.
In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value
Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework
for measuring fair value in accordance with generally accepted accounting
principles and expands disclosures about fair value measurements. SFAS 157
is
effective for financial statements issued for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. The
Company is currently assessing the impact, if any, from the adoption of SFAS
157.
In
June
2006, the Financial Accounting Standards Board (“FASB”) issued FASB
Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income
Taxes, an Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48
clarifies the accounting for uncertainty in income taxes recognized in an
enterprise’s financial statements in accordance with FASB Statement
No. 109, “Accounting for Income Taxes,” by prescribing a recognition
threshold and measurement attribute for the financial statement recognition
and
measurement of a tax position taken or expected to be taken in a tax return.
Under FIN 48, the financial statement effects of a tax position should
initially be recognized when it is more likely than not, based on the technical
merits, that the position will be sustained upon examination. A tax position
that meets the more-likely-than-not recognition threshold should initially
and
subsequently be measured as the largest amount of tax benefit that has a
greater
than fifty percent likelihood of being realized upon ultimate settlement
with a
taxing authority. FIN 48 is effective for fiscal years beginning after
December 15, 2006. The cumulative effect, if any, of applying the
provisions of FIN 48 will be reported as an adjustment to the opening balance
of
retained earnings in the period adopted. The Company is currently evaluating
the
impact that the adoption of FIN 48 will have on the results of operations,
financial position and liquidity.
Other
recent accounting pronouncements issued by the FASB (including its Emerging
Issues Task Force), the American Institute of Certified Public Accountants,
and
the Securities and Exchange Commission 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 sets forth, for the periods indicated, the percentage of
net
revenues represented by each item in our condensed consolidated statement
of
operations:
|
|
Three
Months Ended
|
|
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Net
revenues
|
|
|
100.0%
|
|
|
100.0%
|
|
Cost
of revenues
|
|
|
47.2%
|
|
|
50.0%
|
|
Gross
profit
|
|
|
52.8%
|
|
|
50.0%
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
|
43.9%
|
|
|
49.6%
|
|
Research
and development
|
|
|
13.7%
|
|
|
11.5%
|
|
Litigation
settlement costs
|
|
|
0.1%
|
|
|
0.0%
|
|
Amortization
of purchased intangible assets
|
|
|
0.1%
|
|
|
0.0%
|
|
Restructuring
recovery
|
|
|
0.0%
|
|
|
(0.2%)
|
|
Total
operating expenses
|
|
|
57.9%
|
|
|
60.8%
|
|
Loss
from operations
|
|
|
(5.1%)
|
|
|
(10.8%)
|
|
Interest
income, net
|
|
|
0.0%
|
|
|
0.0%
|
|
Other
expense, net
|
|
|
(0.0%)
|
|
|
(0.1%)
|
|
Loss
before income taxes
|
|
|
(5.1%)
|
|
|
(10.9%)
|
|
Provision
for income taxes
|
|
|
0.1%
|
|
|
0.0%
|
|
Net
loss
|
|
|
(5.2%)
|
|
|
(11.0%)
|
|
Comparison
of the Three Months Ended September 30, 2006 and 2005
Net
Revenues by Product Line
The
following table presents net revenues by product line:
|
|
Three
Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
%
of Net
|
|
|
|
%
of Net
|
|
Change
|
|
|
|
2006
|
|
Revenues
|
|
2005
|
|
Revenues
|
|
$
|
|
%
|
|
|
|
(In
thousands, except
percentages)
|
|
Device
enablement
|
|
$
|
9,003
|
|
|
71.9%
|
|
$
|
8,257
|
|
|
67.5%
|
|
$
|
746
|
|
|
9.0%
|
|
Device
management
|
|
|
1,714
|
|
|
13.7%
|
|
|
1,863
|
|
|
15.2%
|
|
|
(149
|
)
|
|
(8.0%)
|
|
Core
|
|
|
10,717
|
|
|
85.6%
|
|
|
10,120
|
|
|
82.7%
|
|
|
597
|
|
|
5.9%
|
|
Non-core
|
|
|
1,797
|
|
|
14.4%
|
|
|
2,120
|
|
|
17.3%
|
|
|
(323
|
)
|
|
(15.2%)
|
|
|
|
$
|
12,514
|
|
|
100.0%
|
|
$
|
12,240
|
|
|
100.0%
|
|
$
|
274
|
|
|
2.2%
|
|
The
increase in net revenues for the three months ended September 30, 2006 as
compared to the same period one year ago was a result of an increase in net
revenues from our device enablement products, offset by a decrease in our
non-core products, and to a lesser extent, our device management products.
The
increase in our device enablement product line is primarily due to an increase
in volume in our embedded device enablement products, which includes our
XPort
and WiPort product families, offset by a decline in our external device
enablement products. We are no longer investing in the development of our
non-core product lines and expect net revenues related to these products
to
continue to decline in the future as we focus our investment in our core
product
lines.
Net
Revenues by Region
The
following table presents net revenues by geographic region:
|
|
Three
Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
%
of Net
|
|
|
|
%
of Net
|
|
Change
|
|
|
|
2006
|
|
Revenues
|
|
2005
|
|
Revenues
|
|
$
|
|
%
|
|
|
|
(In
thousands, except percentages)
|
|
Americas
|
|
$
|
7,656
|
|
|
61.2%
|
|
$
|
8,179
|
|
|
66.8%
|
|
$
|
(523
|
)
|
|
(6.4%)
|
|
EMEA
|
|
|
2,991
|
|
|
23.9%
|
|
|
2,959
|
|
|
24.2%
|
|
|
32
|
|
|
1.1%
|
|
Asia
Pacific
|
|
|
1,867
|
|
|
14.9%
|
|
|
1,102
|
|
|
9.0%
|
|
|
765
|
|
|
69.4%
|
|
|
|
$
|
12,514
|
|
|
100.0%
|
|
$
|
12,240
|
|
|
100.0%
|
|
$
|
274
|
|
|
2.2%
|
|
The
increase for the three months ended September 30, 2006 as compared to the
same
period one year ago is primarily a result of an increase in net revenues
in the
Asia Pacific region offset by a decrease in the Americas. In order of
significance, the increase in net revenues in the Asia Pacific region is
primarily attributable to an increase in sales of our embedded device enablement
products. The decrease in net revenues in the Americas region is primarily
due
to a decrease in sales of our device management products.
Gross
Profit
The
following table presents gross profit:
|
|
Three
Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
%
of Net
|
|
|
|
%
of Net
|
|
Change
|
|
|
|
2006
|
|
Revenues
|
|
2005
|
|
Revenues
|
|
$
|
|
%
|
|
|
|
(In
thousands, except percentages)
|
|
Gross
profit
|
|
$
|
6,607
|
|
|
52.8%
|
|
$
|
6,120
|
|
|
50.0%
|
|
$
|
487
|
|
|
8.0%
|
|
Gross
profit represents net revenues less cost of revenues. Cost of revenues consists
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.
In
order
of significance, the increase in gross profit as a percentage of net revenues
for the three months ended September 30, 2006 as compared to the same period
one
year ago is in part due to the following factors: (i) a decrease in the
amortization of purchased intangible assets as a result of a majority of
our
purchased intangible assets becoming fully amortized; and (ii) a reduction
in
manufacturing overhead costs.
Selling,
General and Administrative
The
following table presents selling, general and administrative
expenses:
|
|
Three
Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
%
of Net
|
|
|
|
%
of Net
|
|
Change
|
|
|
|
2006
|
|
Revenues
|
|
2005
|
|
Revenues
|
|
$
|
|
%
|
|
|
|
(In
thousands, except percentages)
|
|
Selling,
general and administrative
|
|
$
|
5,498
|
|
|
43.9%
|
|
$
|
6,072
|
|
|
49.6%
|
|
$
|
(574
|
)
|
|
(9.5%)
|
|
Selling,
general and administrative expenses consist of personnel-related expenses
including salaries, commissions and 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.
In
order
of significance, the decrease in selling, general and administrative expense
for
the three months ended September 30, 2006 as compared to the same period
one
year ago is in part due to the following factors: (i) a decrease in legal
and
professional fees primarily as a result of the settlement of our outstanding
litigation and (ii) a decrease in direct advertising and marketing expenses;
offset by an increase in personnel-related and facilities expenses as a result
of an increase in headcount.
Research
and Development
The
following table presents research and development expenses:
|
|
Three
Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
%
of Net
|
|
|
|
%
of Net
|
|
Change
|
|
|
|
2006
|
|
Revenues
|
|
2005
|
|
Revenues
|
|
$
|
|
%
|
|
|
|
(In
thousands, except percentages)
|
|
Research
and development
|
|
$
|
1,718
|
|
|
13.7%
|
|
$
|
1,403
|
|
|
11.5%
|
|
$
|
315
|
|
|
22.5%
|
|
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.
The
increase in research and development expenses for the three months ended
September 30, 2006 as compared to the same period one year ago is in part
due to
an increase in personnel-related expenses as a result of an increase in
headcount.
Provision
for Income Taxes
The
following table presents our effective tax rate based upon our income tax
provision:
|
|
Three
Months Ended
|
|
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
Effective
tax rate
|
|
|
2%
|
|
|
0%
|
|
We
utilize the liability method of accounting for income taxes as set forth
in SFAS
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 without a 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 net deferred tax assets for the three months ended
September 30, 2006 and 2005.
Liquidity
and Capital Resources
Since
inception through fiscal 2007, we have financed our operations through the
issuance of common stock. We refer to the sum of cash and cash equivalents
and
marketable securities as “cash” for the purposes of discussing our cash balance
and liquidity.
The
following table presents details of our working capital and cash:
|
|
September
30,
|
|
June
30,
|
|
Increase
|
|
|
|
2006
|
|
2006
|
|
(Decrease)
|
|
|
|
|
|
(In
thousands)
|
|
|
|
Working
capital
|
|
$
|
5,169
|
|
$
|
5,372
|
|
$
|
(203
|
)
|
Cash
and cash equivalents
|
|
$
|
7,687
|
|
$
|
7,729
|
|
$
|
(42
|
)
|
Marketable
securities
|
|
|
94
|
|
|
88
|
|
|
6
|
|
|
|
$
|
7,781
|
|
$
|
7,817
|
|
$
|
(36
|
)
|
In
order
of significance, our working capital decreased in part due to (i) a net loss
(ii) an increase in accounts payable as a result of the timing of cash payments
to vendors; offset by (iii) a buildup of inventories in anticipation of
increased sales during our second fiscal quarter. Our cash balances remained
consistent with the prior quarter as a result of our cash management activities
which include the timing of cash payments to our vendors and the timing of
cash
receipts from our customers.
We
believe that the cumulative effect of expense reductions initiated in fiscal
2005 and the settlement of our patent litigation during fiscal 2006 will
result
in reduced operating expenses and will lower our cash breakeven point to
approximately $13.0 to $14.0 million per fiscal quarter. This target is based
upon a financial model, and we expect that actual expenses may vary in any
fiscal quarter and therefore financial results impacting cash usage or
profitability will vary. Also, uses of cash to fund inventories, receivables
and
payables will cause results to vary from the financial model.
We
believe that our existing cash, cash equivalents, marketable securities and
funds available from our line of credit will be adequate to meet our anticipated
cash needs through at least the next twelve 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 borrow funds through bank loans, sales 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
May
2006, we entered into a two-year secured revolving Loan and Security Agreement
("Line of Credit”) with a bank, which provides for borrowings up to $5.0
million. The borrowing capacity is limited to eligible accounts receivable
as
defined under the Line of Credit. Borrowings under the Line of Credit bear
interest at the prime rate plus 1.75% per annum. We are required to pay an
unused line fee of 0.50% on the unused portion of the Line of Credit. As
of
September 30, 2006, we had no borrowings against the Line of
Credit.
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, foreign value added tax account deposits and security
deposits:
|
|
September
30,
|
|
June
30,
|
|
|
|
2006
|
|
2006
|
|
|
|
(In
thousands)
|
|
Available
borrowing capacity
|
|
$
|
1,874
|
|
$
|
2,221
|
|
Outstanding
letters of credit
|
|
$
|
1,594
|
|
$
|
1,594
|
|
During
March 2006, we entered into a lease agreement whereby the lessor will advance
an
amount not to exceed $1.0 million for the implementation of a new ERP
information system to manage our business operations. During the ERP
implementation period, we will pay interest of 9.0% on the amounts advanced.
The
lease agreement states that the aggregate amount advanced to us by the lessor
will be repaid over a three-year period following the completion of the ERP
implementation. As of September 30, 2006, we had incurred costs of $463,000
in
connection with the ERP implementation which will be advanced by the
lessor.
As
of
September 30, 2006, approximately $2.2 million of our cash is 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 location board of directors.
Cash
Flows
The
following table presents the major components of the consolidated statements
of
cash flows:
|
|
Three
Months Ended
|
|
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
|
|
(In
thousands)
|
|
Net
cash provided by (used in):
|
|
|
|
|
|
|
|
Net
loss
|
|
$
|
(651
|
)
|
$
|
(1,341
|
)
|
Non-cash
operating expenses, net
|
|
|
468
|
|
|
434
|
|
Changes
in operating assets and liabilities
|
|
|
7
|
|
|
1,017
|
|
Net
cash (used in) provided by operating activities
|
|
|
(176
|
)
|
|
110
|
|
Net
cash used in investing activities
|
|
|
(4
|
)
|
|
(38
|
)
|
Net
cash provided by financing activities
|
|
|
151
|
|
|
111
|
|
Effect
of foreign exchange rate changes on cash
|
|
|
(13
|
)
|
|
(20
|
)
|
(Decrease)
increase in cash and cash equivalents
|
|
$
|
(42
|
)
|
$
|
163
|
|
Operating
activities used cash during the three months ended September 30, 2006. This
was
the result of at net loss, offset by non-cash operating expenses and cash
provided by operating assets and liabilities. The non-cash items that had
a
significant impact on the net loss included share-based compensation and
depreciation. In order of significance, the changes in operating assets and
liabilities which had a significant impact on the cash used in operating
activities included (i) an increase in accounts payable as a result of the
timing of cash payments to vendors and (ii) a decrease in receivable balances
as
a result of our cash collection efforts; offset by (iii) an increase in
inventories, (iv) a decrease in other liabilities as a result of a decrease
in
customer deposits, (v) a decrease in accrued settlements as a result of the
payment of the Digi settlement and (vi) a reduction in the warranty reserve
to
reflect lower expected warranty return rates.
Operating
activities provided cash during the three months ended September 30, 2005.
This
was the result of cash provided by operating assets and liabilities and non-cash
operating expenses offset by a net loss. In order of significance, the changes
in operating assets and liabilities which had a significant impact on the
cash
provided by operating activities included (i) a decrease in inventories,
(ii) an
increase in accounts payable as a result of the timing of cash payments to
vendors; offset by an increase in prepaid expenses and other current assets.
In
order of significance, the non-cash items that had a significant impact on
net
loss included amortization of purchased intangible assets, share-based
compensation and depreciation partially offset by a recovery of inventory
reserves.
Investing
activities used cash during the three months ended September 30, 2006. This
was
due to the purchase of property and equipment.
Investing
activities used cash during the three months ended September 30, 2005. This
was
due to the purchase of property and equipment.
Financing
activities provided cash during the three months ended September 30, 2006.
This
was due to proceeds from the sale of common shares through employee stock
option
exercises and the Employee Stock Purchase Plan offset by repayments on capital
lease obligations.
Financing
activities provided cash during the three months ended September 30, 2005.
This
was due to proceeds from the sale of common shares through employee stock
option
exercises and the Employee Stock Purchase Plan offset by repayments on capital
lease obligations.
Off-Balance
Sheet Arrangements
We
did
not have any off balance sheet arrangements as of September 30, 2006.
Item
3. Quantitative and Qualitative Disclosures About Market Risk
We
do not
use derivative financial instruments for speculative or trading purposes.
We
place our investments in instruments that meet high credit quality standards,
as
specified in our investment policy.
Interest
Rate Risk
Our
exposure to interest rate risk is limited to the exposure related to our
cash
and cash equivalents and marketable securities. Our cash and cash equivalents
are held in cash deposit accounts and, as such, we believe our cash and cash
equivalents are not subject to significant interest rate risk. We believe
our
marketable securities would not decline in value by a significant amount
if
interest rates increase, and therefore would not have a material effect on
our
financial condition or results of operations.
The
following table presents our cash and cash equivalents and marketable
securities:
|
|
September
30,
|
|
June
30,
|
|
|
|
2006
|
|
2006
|
|
|
|
(In
thousands)
|
|
Cash
and cash equivalents
|
|
$
|
7,687
|
|
$
|
7,729
|
|
Marketable
securities
|
|
|
94
|
|
|
88
|
|
|
|
$
|
7,781
|
|
$
|
7,817
|
|
Foreign
Currency Risk
We
hold a
significant portion of our cash balance in foreign currencies (particularly
the
euro) and, as such, we are subject to foreign currency fluctuations. In
addition, we sell products internationally. As a result, our financial results
could be harmed by factors such as changes in foreign currency exchange rates
or
weak economic conditions in foreign markets. We do not currently enter into
forward exchange contracts to hedge exposure denominated in foreign currencies
or any other derivative financial instruments for trading or speculative
purposes. In the future, if we feel our foreign currency exposure has increased,
we may consider entering into hedging transactions to help mitigate that
risk.
The
following table presents our cash balance held in foreign
currencies:
|
|
September
30,
|
|
June
30,
|
|
|
|
2006
|
|
2006
|
|
|
|
(In
thousands)
|
|
Cash
held in foreign currencies
|
|
$
|
2,354
|
|
$
|
2,554
|
|
Item
4. Controls
and Procedures
(a)
Evaluation of disclosure controls and procedures
We
carried out an evaluation, under the supervision and with the participation
of
our management, including our Chief Executive Officer and our Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under
the
Exchange Act) as of the end of our fiscal quarter ended September 30, 2006.
Based upon that evaluation, our Chief Executive Officer and our Chief Financial
Officer concluded that our disclosure controls and procedures are effective
in
ensuring that information required to be disclosed by us in reports that
we file
or submit under the Exchange Act (i) is recorded, processed, summarized and
reported within the time periods specified in the SEC’s rules and forms and (ii)
is accumulated and communicated to our management, including our Chief Executive
Officer and our Chief Financial Officer to allow timely decisions regarding
required disclosure.
(b)
Changes in internal controls over financial reporting
There
have been no changes in our internal controls over financial reporting
identified during the fiscal quarter that ended September 30, 2006 that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
PART
II. OTHER INFORMATION
Item
1. Legal Proceedings
The
information set forth in Note 9 and 10 to our notes to the unaudited condensed
consolidated financial statements of Part I, Item 1 of this Form 10-Q is
hereby
incorporated by reference.
Item
1A. Risk Factors
Before
deciding to purchase, hold or sell our common stock, you should carefully
consider the risks described below, in addition to the other cautionary
statements and risks described elsewhere and the other information contained in
this Quarterly Report on Form 10-Q and in our other filings with the SEC,
including our subsequent reports on Forms 10-Q and 8-K. The risks and
uncertainties described below are not the only ones we face. Additional risks
and uncertainties not presently known to us or that we currently deem immaterial
may also affect our business. This should be read in conjunction with our
unaudited condensed consolidated financial statements and the accompanying
notes
thereto, and other parts of Management’s Discussion and Analysis of Financial
Condition and Results of Operations included in this Quarterly Report on
Form
10-Q. If any of these known or unknown risks or uncertainties actually occurs
with material adverse effects on Lantronix, our business, financial condition
and results of operations could be seriously harmed. In that event, the market
price for our common stock could decline and you may lose all or part of
your
investment.
Our
quarterly operating results may fluctuate, which could cause our stock to
decline.
We
have
experienced, and expect to continue to experience, significant fluctuations
in
revenues, expenses and operating results from quarter to quarter. We, therefore,
believe that quarter-to-quarter comparisons of our operating results are
not a
good indication of our future performance, and you should not rely on them
to
predict our future performance or the future performance of our stock. Our
short-term expense levels for ongoing operations are relatively fixed and
are
based on our expectations of future net revenues. If we were to experience
a
reduction in revenues in a quarter, we would likely be unable to adjust our
short-term expenditures. If this were to occur, our operating results for
that
fiscal quarter would be harmed. If our operating results in future fiscal
quarters fall below the expectations of market analysts and investors, the
price
of our common stock would likely fall. Other factors that might cause our
operating results to fluctuate on a quarterly basis include:
·
|
changes
in the mix of net revenues attributable to higher-margin and lower-margin
products;
|
|
|
·
|
customers’
decisions to defer or accelerate orders;
|
|
|
·
|
variations
in the size or timing of orders for our products;
|
|
|
·
|
changes
in demand for our products;
|
|
|
·
|
defects
and other product quality problems;
|
|
|
·
|
loss
or gain of significant customers;
|
|
|
·
|
short-term
fluctuations in the cost or availability of our critical
components;
|
|
|
·
|
announcements
or introductions of new products by our competitors;
|
|
|
·
|
effects
of terrorist attacks in the U.S. and abroad; and
|
|
|
·
|
changes
in demand for devices that incorporate our
products.
|
Current
or future litigation over intellectual property rights could adversely affect
us.
Substantial
litigation regarding intellectual property rights exists in our industry.
For
example, in May 2006 we settled a patent infringement lawsuit with Digi
International, Inc. (“Digi”) in which we signed an agreement with Digi to
cross-license each other’s patents. In addition, we paid Digi $600,000 as part
of the settlement. The results of litigation are inherently uncertain, and
adverse outcomes are possible. Adverse outcomes may have a material adverse
effect on our business, financial condition or results of operations. For
a more
detailed description of pending litigation, see Note 9 and 10 to the notes
to
our condensed consolidated financial statements of Part I, Item I of this
Form
10-Q.
There
is
a risk that other third parties could claim that our products, or our customers’
products, infringe on their intellectual property rights or that we have
misappropriated their intellectual property. In addition, software, business
processes and other property rights in our industry might be increasingly
subject to third-party infringement claims as the number of competitors grows
and the functionality of products in different industry segments overlaps.
Other
parties might currently have, or might eventually be issued, patents that
pertain to the proprietary rights we use. Any of these third parties might
make
a claim of infringement against us. The results of litigation are inherently
uncertain, and adverse outcomes are possible.
Responding
to any infringement claim, regardless of its validity, could:
·
|
be
time-consuming, costly and/or result in litigation;
|
·
|
divert
management’s time and attention from developing our
business;
|
·
|
require
us to pay monetary damages, including treble damages if we are
held to
have willfully infringed;
|
·
|
require
us to enter into royalty and licensing agreements that we would
not
normally find acceptable;
|
·
|
require
us to stop selling or to redesign certain of our products;
or
|
·
|
require
us to satisfy indemnification obligations to our
customers.
|
If
any of
these occur, our business, financial condition or results of operations could
be
adversely affected.
Our
use of contract manufacturers in China and Taiwan involves risks that could
adversely affect us.
We
use
contract manufacturers based in China and Taiwan. There are significant risks
of
doing business in these locations, including the following:
·
|
These
locations do not afford the same level of protection to intellectual
property as do domestic or many foreign countries. If our products
were
reverse-engineered or our intellectual property were otherwise
pirated
(reproduced and duplicated without our knowledge or approval),
our
revenues would be reduced;
|
|
|
·
|
Delivery
times are extended due to the distances involved, requiring more
lead-time
in ordering and increasing the risk of excess
inventories;
|
|
|
·
|
We
could incur ocean freight delays because of labor problems, weather
delays
or customs problems; and
|
|
|
·
|
U.S.
foreign relations with these locations have, historically, been
subject to
change. Political considerations and actions could interrupt our
expected
supply of products from these
locations.
|
Delays
in deliveries or quality problems with our component suppliers could damage
our
reputation and could cause our net revenues to decline and harm our results
of
operations.
We
and
our contract manufacturers are responsible for procuring raw materials for
our
products. Our products incorporate components or technologies that are only
available from single or limited sources of supply. In particular, some of
our
integrated circuits are only available from a single source and in some cases
are no longer being manufactured. From time to time, integrated circuits
used in
our products will be phased out of production. When this happens, we attempt
to
purchase sufficient inventory to meet our needs until a substitute component
can
be incorporated into our products. Nonetheless, we might be unable to purchase
sufficient components to meet our demands, or we might incorrectly forecast
our
demands, and purchase too many or too few components. In addition, our products
use components that have, in the past, been subject to market shortages and
substantial price fluctuations. From time to time, we have been unable to
meet
our orders because we were unable to purchase necessary components for our
products. We do not have long-term supply arrangements with many of our vendors
to obtain necessary components or technology for our products. If we are
unable
to purchase components from these suppliers, product shipments could be
prevented or delayed, which could result in a loss of sales. If we are unable
to
meet existing orders or to enter into new orders because of a shortage in
components, we will likely lose net revenues and risk losing customers and
harming our reputation in the marketplace, which could adversely affect our
business, financial condition or results of operations. We have recently
redesigned many of our products to comply with the new environmental Reduction
of Hazardous Substances standard. This standard is new for our supply chain and
interruptions in parts supply due to the additional complexities and limited
number of second source supply choices could adversely impact our
business.
If
we lose the services of any of our contract manufacturers or suppliers, we
may
not be able to obtain alternate sources in a timely manner, which could harm
our
customer relations and adversely affect our net revenues and harm our results
of
operations.
We
do not
have long-term agreements with our contract manufacturers or suppliers. If
any
of these subcontractors or suppliers ceased doing business with us, we may
not be able to obtain alternative sources in a timely or cost-effective manner.
Due to the amount of time that it usually takes us to qualify contract
manufacturers and suppliers, we could experience delays in product shipments
if
we are required to find alternative subcontractors and suppliers. Some of
our
suppliers have or provide technology or trade secrets, the loss of which
could
be disruptive to our procurement and supply processes. If a competitor should
acquire one of our contract manufacturers or suppliers, we could be subjected
to
more difficulties in maintaining or developing alternative sources of supply
of
some components or products. Any problems that we may encounter with the
delivery, quality or cost of our products could damage our customer
relationships and materially and adversely affect our business, financial
condition or results of operations.
If
our research and development efforts are not successful, our net revenues
could
decline and our business could be harmed.
If
we are
unable to develop new products as a result of our research and development
efforts, or if the products we develop are not successful, our business could
be
harmed. Even if we do develop new products that are accepted by our target
markets, we do not know whether the net revenue from these products will
be
sufficient to justify our investment in research and development. In addition,
if we do not invest sufficiently in research and development, we may be unable
to maintain our competitive position. Our research and development spending
has
decreased, which may put us at a competitive disadvantage compared to our
competitors and adversely affect our market position.
The
following table presents our research and development expenses:
|
|
Three
Months Ended September 30,
|
|
|
|
|
|
|
|
|
%
of Net
|
|
|
|
%
of Net
|
|
Change
|
|
|
|
2006
|
|
Revenues
|
|
2005
|
|
Revenues
|
|
$
|
|
%
|
|
|
|
(In
thousands, except percentages)
|
Research
and development
|
|
$
|
1,718
|
|
|
13.7%
|
|
$
|
1,403
|
|
|
11.5%
|
|
$
|
315
|
|
|
22.5%
|
|
If
a major customer cancels, reduces or delays purchases, our net revenues might
decline and our business could be adversely affected.
The
number and timing of sales to our distributors have been difficult for us
to
predict. While our distributors are customers in the sense they buy our
products, they are also part of our product distribution system. To some
extent,
any business lost from a distributor would likely be replaced by sales to
other
customer/distributors in a reasonable period, rather than a total loss of
that
business such as from a customer who used our products in their business
or
products. Some of our distributors could be acquired by a competitor and
stop
buying product from us.
The
following table presents sales to our significant customers as a percentage
of
net revenue:
|
|
Three
Months Ended
|
|
|
|
September
30,
|
|
|
|
2006
|
|
2005
|
|
Top
five customers (1)
|
|
|
35.6%
|
|
|
41.7%
|
|
Tech
Data
|
|
|
9.9%
|
|
|
14.0%
|
|
Ingram
Micro
|
|
|
9.2%
|
|
|
12.6%
|
|
|
|
|
|
|
|
|
|
(1)
Includes
Ingram Micro and Tech Data.
|
|
|
|
|
|
|
|
The
loss
or deferral of one or more significant sales in a quarter could harm our
operating results. We have in the past, and might in the future, lose one
or
more major customers. If we fail to continue to sell to our major customers
in
the quantities we anticipate, or if any of these customers terminate our
relationship, our reputation, the perception of our products and technology
in
the marketplace, could be harmed. The demand for our products from our OEM,
VAR
and systems integrator customers depends primarily on their ability to
successfully sell their products that incorporate our device networking
solutions technology. Our sales are usually completed on a purchase order
basis
and we have few long-term purchase commitments from our customers.
Our
future success also depends on our ability to attract new customers, which
often
involves an extended selling process. The sale of our products often involves
a
significant technical evaluation, and we often face delays because of our
customers’ internal procedures for evaluating and deploying new technologies.
For these and other reasons, the sales cycle associated with our products
is
typically lengthy, often lasting six to nine months and sometimes longer.
Therefore, if we were to lose a major customer, we might not be able to replace
the customer in a timely manner, or at all. This would cause our net revenues
to
decrease and could cause our stock price to decline.
If
we fail to develop or enhance our products to respond to changing market
conditions and government and industry standards, our competitive position
will
suffer and our business will be adversely affected.
Our
future success depends in large part on our ability to continue to enhance
existing products, lower product cost and develop new products that maintain
technological competitiveness and meet government and industry standards.
The
demand for network-enabled products is relatively new and can change as a
result
of innovations, changes or new government and industry standards. For example,
a
recent directive in the European Union bans the use of lead and other heavy
metals in electrical and electronic equipment after July 1, 2006. As a
result, in advance of this deadline, some of our customers selling products
in
Europe had begun demanding product from component manufacturers that did
not
contain these banned substances. Any failure by us to develop and introduce
new
products or enhancements in response to new government and industry standards
could harm our business, financial condition or results of operations. These
requirements might or might not be compatible with our current or future
product
offerings. We might not be successful in modifying our products and services
to
address these requirements and standards. For example, our competitors might
develop competing technologies based on Internet Protocols, Ethernet Protocols
or other protocols that might have advantages over our products. If this
were to
happen, our net revenues might not grow at the rate we anticipate, or could
decline.
We
expect the average selling prices of our products to decline, which could
reduce
our net revenues, gross margins and profitability.
In
the
past, we have experienced some reduction in the average selling prices and
gross
margins of products, and we expect that this will continue for our products
as
they mature. We expect competition to continue to increase, and we anticipate
this could result in additional downward pressure on our pricing. Our average
selling prices for our products might decline as a result of other reasons,
including promotional programs and customers who negotiate price reductions
in
exchange for longer-term purchase commitments. We also may not be able to
increase the price of our products if the prices of components or our overhead
costs increase. In addition, we may be unable to adjust our prices in response
to currency exchange rate fluctuations resulting in lower gross margins.
If
these were to occur, our gross margins would decline and we may not be able
to
reduce the cost to manufacture our products to keep up with the decline in
prices.
Current
or future litigation could adversely affect us.
We
are
currently involved in litigation, including a federal securities class action
lawsuit. We recently concluded multiple securities lawsuits and litigation
with
a former executive officer. We may have an obligation to continue to indemnify
the former executive officer and defend any violations that he may be charged
with. There is a risk that our insurance carriers may not reimburse us for
such
costs. Any lawsuit may involve complex questions of fact and law and may
require
the expenditure of significant funds and the diversion of other resources.
Except as described in this Form 10-Q, we do not know what the outcome of
outstanding legal proceedings will be and cannot determine the extent to
which
these resolutions might have a material adverse effect on our business,
financial condition or results of operations. The results of litigation are
inherently uncertain, and adverse outcomes are possible. For a more detailed
description of our current and recent litigation, see Note 9 and 10 to the
notes
to our condensed consolidated financial statements of Part I, Item 1 of this
Form 10-Q.
If
software that we license or acquire from the open source software community
and
incorporate into our products were to become unavailable or no longer available
on commercially reasonable terms, it could adversely affect sales of our
products, which could disrupt our business and harm our financial results.
Certain
of our products contain components developed and maintained by third-party
software vendors or are available through the “open source” software community.
We also expect that we may incorporate software from third-party vendors
and
open source software in our future products. Our business would be disrupted
if
this software, or functional equivalents of this software, were either no
longer
available to us or no longer offered to us on commercially reasonable terms.
In
either case, we would be required to either redesign our products to function
with alternate third-party software or open source software, or develop these
components ourselves, which would result in increased costs and could result
in
delays in our product shipments. Furthermore, we might be forced to limit
the
features available in our current or future product offerings. We are presently
developing products for use on the Linux platform. The SCO Group (“SCO”) has
filed and threatened to file lawsuits against companies that operate Linux
for
commercial purposes, alleging that such use of Linux infringes SCO’s rights.
These allegations may adversely affect the demand for the Linux platform
and,
consequently, the sales of our Linux-based products.
Our
products may contain undetected software or hardware errors or defects that
could lead to an increase in our costs, reduce our net revenues or damage
our
reputation.
We
currently offer warranties ranging from one to two years on each of our
products. Our products could contain undetected errors or defects. If there
is a
product failure, we might have to replace all affected products without being
able to book revenue for replacement units, or we may have to refund the
purchase price for the units. We do not have a long history with which to
assess
the risks of unexpected product failures or defects for our device server
product line. Regardless of the amount of testing we undertake, some errors
might be discovered only after a product has been installed and used by
customers. Any errors discovered after commercial release could result in
loss
of net revenues and claims against us. Significant product warranty claims
against us could harm our business, reputation and financial results and
cause
the price of our stock to decline.
If
our contract manufacturers are unable or unwilling to manufacture our products
at the quality and quantity we request, our business could be harmed.
We
outsource substantially all of our manufacturing to three manufacturers:
Venture
Electronics Services, Uni Precision Industrial Ltd., and Universal Scientific
Industrial Company, LTD. Our reliance on these third-party manufacturers
exposes
us to a number of significant risks, including:
·
|
reduced
control over delivery schedules, quality assurance, manufacturing
yields
and production costs;
|
|
|
·
|
lack
of guaranteed production capacity or product supply;
and
|
|
|
·
|
reliance
on these manufacturers to maintain competitive manufacturing
technologies.
|
Our
agreements with these manufacturers provide for services on a purchase order
basis. If our manufacturers were to become unable or unwilling to continue
to
manufacture our products at requested quality, quantity, yields and costs,
or in
a timely manner, our business would be seriously harmed. As a result, we
would
have to attempt to identify and qualify substitute manufacturers, which could
be
time consuming and difficult, and might result in unforeseen manufacturing
and
operations problems. For example, Jabil Circuit, Inc. acquired Varian, Inc.
in
March 2005 and closed the facility that manufactured our products. We
transferred this production to another contract manufacturer. Moreover, as
we
shift products among third-party manufacturers, we may incur substantial
expenses, risk material delays or encounter other unexpected issues.
In
addition, a natural disaster could disrupt our manufacturers’ facilities and
could inhibit our manufacturers’ ability to provide us with manufacturing
capacity in a timely manner or at all. If this were to occur, we likely would
be
unable to fill customers’ existing orders or accept new orders for our products.
The resulting decline in net revenues would harm our business. We also are
responsible for forecasting the demand for our individual products. These
forecasts are used by our contract manufacturers to procure raw materials
and
manufacture our finished goods. If we forecast demand too high, we may invest
too much cash in inventory, and we may be forced to take a write-down of
our
inventory balance, which would reduce our earnings. If our forecast is too
low
for one or more products, we may be required to pay charges that would increase
our cost of revenues or we may be unable to fulfill customer orders, thus
reducing net revenues and therefore earnings.
Because
we depend on international sales for a substantial amount of our net revenues,
we are subject to international economic, regulatory, political and other
risks
that could harm our business, financial condition or results of
operations.
The
following table presents our sales within geographic regions:
|
|
Three
Months Ended September 30,
|
|
|
|
|
|
|
|
|
|
%
of Net
|
|
|
|
%
of Net
|
|
Change
|
|
|
2006
|
|
Revenues
|
|
2005
|
|
Revenues
|
|
$
|
|
%
|
|
|
|
(In
thousands, except percentages)
|
Americas
|
|
$
|
7,656
|
|
|
61.2%
|
|
$
|
8,179
|
|
|
66.8%
|
|
$
|
(523
|
)
|
|
(6.4%)
|
|
EMEA
|
|
|
2,991
|
|
|
23.9%
|
|
|
2,959
|
|
|
24.2%
|
|
|
32
|
|
|
1.1%
|
|
Asia
Pacific
|
|
|
1,867
|
|
|
14.9%
|
|
|
1,102
|
|
|
9.0%
|
|
|
765
|
|
|
69.4%
|
|
|
|
$
|
12,514
|
|
|
100.0%
|
|
$
|
12,240
|
|
|
100.0%
|
|
$
|
274
|
|
|
2.2%
|
|
We
expect
that international revenues will continue to represent a significant portion
of
our net revenues in the foreseeable future. Doing business internationally
involves greater expense and many risks. For example, because the products
we
sell abroad and the products and services we buy abroad are priced in foreign
currencies, we are affected by fluctuating exchange rates. In the past, we
have
lost money because of these fluctuations. We might not successfully protect
ourselves against currency rate fluctuations, and our financial performance
could be harmed as a result. In addition, we face other risks of doing business
internationally, including:
·
|
unexpected
changes in regulatory requirements, taxes, trade laws and
tariffs;
|
|
|
·
|
reduced
protection for intellectual property rights in some
countries;
|
|
|
·
|
differing
labor regulations;
|
|
|
·
|
compliance
with a wide variety of complex regulatory requirements;
|
|
|
·
|
changes
in a country’s or region’s political or economic
conditions;
|
|
|
·
|
effects
of terrorist attacks in the U.S. and abroad;
|
|
|
·
|
greater
difficulty in staffing and managing foreign operations;
and
|
|
|
·
|
increased
financial accounting and reporting burdens and
complexities.
|
Our
international operations require significant attention from our management
and
substantial financial resources. We do not know whether our investments in
other
countries will produce desired levels of net revenues or
profitability.
If
we are unable to sell our inventory in a timely manner it could become obsolete,
which could require us to increase our reserves and harm our operating
results.
At
any
time, competitive products may be introduced with more attractive features
or at
lower prices than ours. There is a risk that we may be unable to sell our
inventory in a timely manner to avoid it becoming obsolete.
The
following table presents our inventory and reserve for excess and obsolete
inventory reserve:
|
|
September
30,
|
|
June
30,
|
|
|
|
2006
|
|
2006
|
|
|
|
(In
thousands)
|
|
Raw
materials
|
|
$
|
4,336
|
|
$
|
3,863
|
|
Finished
goods
|
|
|
6,628
|
|
|
6,518
|
|
Inventory
at distributors
|
|
|
1,476
|
|
|
1,690
|
|
Large
scale integration chips *
|
|
|
1,256
|
|
|
731
|
|
|
|
|
13,696
|
|
|
12,802
|
|
Reserve
for excess and obsolete inventories
|
|
|
(4,462
|
)
|
|
(4,689
|
)
|
|
|
$
|
9,234
|
|
$
|
8,113
|
|
|
|
|
|
|
|
|
|
*
This item is both sold individually and embedded into the Company's
products.
|
|
|
|
In
the
event we are required to substantially discount our inventory or are unable
to
sell our inventory in a timely manner, we would be required to increase our
reserves and our operating results could be substantially harmed.
If
we are unable to attract, retain or motivate key senior management and technical
personnel, it could seriously harm our business.
Our
financial performance depends substantially on the performance of our executive
officers and key technical employees. We are dependent in particular on Marc
Nussbaum, our President and Chief Executive Officer, with whom we have no
employment contract. We are also dependent upon our technical personnel,
due to
the specialized technical nature of our business. If we were to lose the
services of Mr. Nussbaum or any of our key technical personnel and were not
able
to find replacements in a timely manner, our business could be disrupted,
other
key personnel might decide to leave, and we might incur increased operating
expenses associated with finding and compensating replacements.
If
our OEM customers develop their own expertise in network-enabling products,
it
could result in reduced sales of our products and harm our operating
results.
We
sell
to both resellers and OEMs. Selling products to OEMs involves unique risks,
including the risk that OEMs will develop internal expertise in network-enabling
products or will otherwise incorporate network functionality in their products
without using our device networking solutions. If this were to occur, our
sales
to OEMs would likely decline, which could reduce our net revenue and harm
our
operating results.
New
product introductions and pricing strategies by our competitors could reduce
our
market share or cause us to reduce the prices of our products, which would
reduce our net revenues and gross margins.
The
market for our products is intensely competitive, subject to rapid change
and is
significantly affected by new product introductions and pricing strategies
of
our competitors. We face competition primarily from companies that
network-enable devices, semiconductor companies, companies in the automation
industry and companies with significant networking expertise and research
and
development resources. Our competitors might offer new products with features
or
functionality that are equal to or better than our products. In addition,
since
we work with open standards, our customers could develop products based on
our
technology that compete with our offerings. We might not have sufficient
engineering staff or other required resources to modify our products to match
our competitors. Similarly, competitive pressure could force us to reduce
the
price of our products. In each case, we could lose new and existing customers
to
our competition. If this were to occur, our net revenues could decline and
our
business could be harmed.
We
are exposed to foreign currency exchange risks, which could harm our business
and operating results.
We
hold a
significant portion of our cash balance in foreign currencies (particularly
euros), and as such are exposed to adverse changes in exchange rates associated
with foreign currency fluctuations. However, we do not currently engage in
any
hedging transactions to mitigate these risks. Although from time to time
we
review our foreign currency exposure and evaluate whether we should enter
into
hedging transactions, we may not adequately hedge against any future volatility
in currency exchange rates and, if we engage in hedging transactions, the
transactions will be based on forecasts which later may prove to be inaccurate.
Any failure to hedge successfully or anticipate currency risks properly could
adversely affect our operating results.
We
may not be able to adequately protect or enforce our intellectual property
rights, which could harm our competitive position.
We
have
not historically relied on patents to protect our proprietary rights, although
we are now building a patent portfolio. In May 2006, we entered into a patent
cross-license agreement with Digi in which the parties agreed to cross-license
each other’s patents, which could reduce the value of our existing patent
portfolio. We rely primarily on a combination of laws, such as copyright,
trademark and trade secret laws, and contractual restrictions, such as
confidentiality agreements and licenses, to establish and protect our
proprietary rights. Despite any precautions that we have taken:
·
|
laws
and contractual restrictions might not be sufficient to prevent
misappropriation of our technology or deter others from developing
similar
technologies;
|
|
|
·
|
other
companies might claim common law trademark rights based upon use
that
precedes the registration of our marks;
|
|
|
·
|
other
companies might assert other rights to market products using our
trademarks;
|
|
|
·
|
policing
unauthorized use of our products and trademarks is difficult, expensive
and time-consuming, and we might be unable to determine the extent
of this
unauthorized use;
|
|
|
·
|
courts
may determine that our software programs use open source software
in such
a way that deprives the entire programs of intellectual property
protection; and
|
|
|
·
|
current
federal laws that prohibit software copying provide only limited
protection from software pirates.
|
Also,
the
laws of some of the countries in which we market and manufacture our products
offer little or no effective protection of our proprietary technology. Reverse
engineering, unauthorized copying or other misappropriation of our proprietary
technology could enable third-parties to benefit from our technology without
paying us for it, which could significantly harm our business.
Acquisitions,
strategic partnerships, joint ventures or investments may impair our capital
and
equity resources, divert our management’s attention or otherwise negatively
impact our operating results.
We
may
pursue acquisitions, strategic partnerships and joint ventures that we believe
would allow us to complement our growth strategy, increase market share in
our
current markets and expand into adjacent markets, broaden our technology
and
intellectual property and strengthen our relationships with distributors
and
OEMs. Any future acquisition, partnership, joint venture or investment may
require that we pay significant cash, issue stock or incur substantial debt.
Acquisitions, partnerships or joint ventures may also result in the loss
of key
personnel and the dilution of existing stockholders as a result of issuing
equity securities. In addition, acquisitions, partnerships or joint ventures
require significant managerial attention, which may be diverted from our
other
operations. These capital, equity and managerial commitments may impair the
operation of our business. Furthermore, acquired businesses may not be
effectively integrated, may be unable to maintain key pre-acquisition business
relationships, may contribute to increased fixed costs and may expose us
to
unanticipated liabilities and otherwise harm our operating results.
Business
interruptions could adversely affect our business.
Our
operations and those of our suppliers are vulnerable to interruption by fire,
earthquake, power loss, telecommunications failure, terrorist attacks and
other
events beyond our control. A substantial portion of our facilities, including
our corporate headquarters and other critical business operations, are located
near major earthquake faults and, therefore, may be more susceptible to damage
if an earthquake occurs. We do not carry earthquake insurance for direct
earthquake-related losses. In addition, we do not carry business interruption
insurance for, nor do we carry financial reserves against, business
interruptions arising from earthquakes or certain other events. If a business
interruption occurs, our business could be materially and adversely affected.
If
we fail to maintain an effective system of disclosure controls or internal
controls over financial reporting, our business and stock price could be
adversely affected.
Section 404
of the Sarbanes-Oxley Act of 2002 requires companies to evaluate periodically
the effectiveness of their internal controls over financial reporting, and
to
include a management report assessing the effectiveness of their internal
controls as of the end of each fiscal year. Beginning with our annual report
on
Form 10-K for our fiscal year ending June 30, 2008, we will be required to
comply with the requirement of Section 404 of the Sarbanes-Oxley Act of 2002
to
include in each of our annual reports an assessment by our management of
the
effectiveness of our internal controls over financial reporting and a report
of
our independent registered public accounting firm addressing these
assessments.
Our
management does not expect that our internal controls over financial reporting
will prevent all errors or frauds. A control system, no matter how well designed
and operated, can provide only reasonable, not absolute, assurance that the
control system’s objectives will be met. Further, the design of a control system
must reflect the fact that there are resource constraints, and the benefits
of
controls must be considered relative to their costs. Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
involving us have been, or will be, detected. These inherent limitations
include
the realities that judgments in decision-making can be faulty and that
breakdowns can occur because of simple errors or mistakes. Controls can also
be
circumvented by individual acts of a person, or by collusion among two or
more
people, or by management override of the controls. The design of any system
of
controls is based in part on certain assumptions about the likelihood of
future
events, and we cannot assure you that any design will succeed in achieving
its
stated goals under all potential future conditions. Over time, controls may
become inadequate because of changes in conditions or deterioration in the
degree of compliance with policies and procedures. Because of the inherent
limitations in a cost-effective control system, misstatements due to errors
or
frauds may occur and not be detected.
We
cannot
assure you that we or our independent registered public accounting firm will
not
identify a material weakness in our disclosure controls and internal controls
over financial reporting in the future. If our internal controls over financial
reporting are not considered adequate, we may experience a loss of public
confidence, which could have an adverse effect on our business and our stock
price.
We
may experience difficulties in implementing or enhancing new information
systems.
During
fiscal 2006, we began the implementation of a new enterprise resource planning
(“ERP”) information system to manage our business operations. While we did not
use the new ERP information system to manage our business during the fiscal
quarter ending September 30, 2006, the possibility exists that our migration
to
the new ERP information system could adversely affect our disclosure controls
and procedures or our operations in future periods. The process of implementing
new information systems could adversely impact our ability to do the following
in a timely manner: accept and process customer orders, receive inventory
and
ship products, invoice and collect receivables, place purchase orders and
pay
invoices, and all other business transactions related to the finance, order
entry, purchasing, supply chain and human resource processes within the new
ERP
systems. Any such disruption could adversely affect our financial position,
results of operations, cash flows and the market price of our common
stock.
Item
2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item
3. Defaults Upon Senior Securities
None.
Item
4. Submission of Matters to a Vote of Security Holders
None.
Item
5. Other Information
None.
Item
6. Exhibits
Exhibit
|
|
|
Number
|
|
Description
of Document
|
|
|
|
31.1
|
|
Certification
of Principal Executive Officer pursuant to Securities Exchange
Act Rules
13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of
the
Sarbanes-Oxley Act of 2002.
|
31.2
|
|
Certification
of Principal Financial Officer pursuant to Securities Exchange
Act Rules
13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of
the
Sarbanes-Oxley Act of 2002.
|
32.1
|
|
Certification
of Chief Executive Officer and Chief Financial Officer Pursuant
to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.*
|
*
Furnished, not filed.
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant
has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
Date: November 14, 2006 |
LANTRONIX,
INC. |
|
(Registrant) |
|
By:
|
/s/
Marc H. Nussbaum
|
|
|
Marc
H. Nussbaum
|
|
|
Chief
Executive Officer
|
|
|
(Principal
Executive Officer)
|
|
By:
|
/s/
James W. Kerrigan
|
|
|
James
W. Kerrigan
|
|
|
Chief
Financial Officer and Secretary
|
|
|
(Principal
Financial Officer)
|