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LANTRONIX INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion and analysis in conjunction with our consolidated financial statements and related notes included in Item 1 of this Report, the "Risk Factors" included in Item 1A of this Report and in our Annual Report on Form 10-K for the year ended June 30, 2014, or the Form 10-K, as well as the Cautionary Note Regarding Forward Looking Statements described elsewhere in this Report, before deciding to purchase, hold or sell our common stock. Overview Lantronix, Inc. (the "Company," "Lantronix," "we," "our," or "us") designs, develops, markets and sells networking and communications products to make it easier and more cost effective for our customers to participate in the Internet of Things ("IoT") market. We provide solutions and services that enable machines, devices and sensors to be securely accessed, managed and controlled with a focus on the convergence of mobility with machine-to-machine ("M2M") systems. We provide a broad portfolio of products intended to enhance the value of electronic devices or machines. Our products are typically used by enterprise and commercial businesses, government institutions, telecommunication and utility companies, financial institutions, and individual consumers. We organize our solutions into two product lines based on how they are marketed, sold and deployed: OEM Modules and Enterprise Solutions. We conduct our business globally and manage our sales teams by geography, according to four regions: the Americas; Europe, Middle East, and Africa ("EMEA"); Asia Pacific; and Japan. Products and Solutions Overview OEM Modules OEM Modules are electronic products that serve as building blocks embedded inside modern electronic systems and equipment. Our OEM Modules product line includes wired and wireless products that are designed to enhance the value and utility of modern electronic systems and equipment by providing secure network connectivity, application hosting, protocol conversion and other functions.The products are offered with a software suite intended to decrease our customer's time-to-market and increase their value add. Among others, the following product families are included in our OEM Module product line: MatchPort®, PremiereWave® EN, WiPort®, xPico®, xPico® Wi-Fi, and xPort®. OEM Modules are typically sold to OEMs, original design manufacturers ("ODMs"), contract manufacturers and distributors. OEMs design and sell products under their own brand that are either manufactured by the OEM in-house or by third-party contract manufacturers. ODMs design and manufacture products for third parties, which then sell those products under their own brand. The design cycles using our OEM modules typically range from 12 to 24 months and can generate revenue for the entire life-cycle of an end-user's product. Enterprise Solutions Our Enterprise Solutions are electronic products that are typically connected to one or more existing pieces of electronic equipment to provide additional connectivity or functionality. Our Enterprise Solutions are designed to enhance the value and utility of machines and other devices through network connectivity, routing, switching, application hosting, remote management, telemetry, telematics, printing, protocol conversion and other functions. Our Enterprise Solutions include products such as wired and wireless device servers, I/O servers, terminal servers, console servers, print servers, remote keyboard video mouse (KVM), management, power management and software management platforms. Among others, the following product families are included in our Enterprise Solutions product line: EDS, PremierWave® XC, PremierWave®XN, SLB™, SLC™, SLP™, Spider™, UDS, xDirect®, xPress™, xPrintServer®, and xSenso®. Enterprise Solutions are typically sold through value added resellers ("VARs"), systems integrators, distributors, e-tailers and to a lesser extent to OEMs. Sales are often project based and may result in significant quarterly fluctuations. Recent Accounting Pronouncements Please refer to Note 1 of Notes to Unaudited Condensed Consolidated Financial Statements, included in Item 1 of this Report for a discussion of recent accounting pronouncements. 13 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, and goodwill. These policies are described in further detail in the Form 10-K. There have been no significant changes in our critical accounting policies and estimates during the three months ended September 30, 2014 as compared to what was previously disclosed in the Form 10-K. Results of Operations - Summary In the three months ended September 30, 2014 our net revenues increased by $653,000, or 6%, compared to the three months ended September 30, 2013. Our net loss was $262,000 for the three months ended September 30, 2014 compared to a net loss of $267,000 in the three months ended September 30, 2013. Our net loss for the current quarter improved as a result of our increased revenues, which was partially offset by (i) a decrease in gross margin from 49.5% to 48.5% and (ii) an increase in operating expenses of $190,000, or 3.4%, which primarily resulted from higher personnel-related expenses. Results of Operations - Three Months Ended September 30, 2014 Compared to the Three Months Ended September 30, 2013 Net Revenue by Product Line and Geographic Region The following tables present our fiscal quarter net revenue by product line and geographic region: Three Months Ended September 30, % of Net % of Net Change 2014 Revenue 2013 Revenue $ % (In thousands, except percentages) OEM Modules $ 5,628 48.8% $ 5,218 47.9% $ 410 7.9%Enterprise Solutions 5,908 51.2% 5,665 52.1% 243 4.3% Net revenue $ 11,536 100.0% $ 10,883 100.0% $ 653 6.0% Three Months Ended September 30, 2014 2013 (In thousands) OEM Enterprise OEM Enterprise Modules Solutions Total Modules Solutions Total Americas $ 2,409 $ 4,150 $ 6,559 $ 1,864 $ 3,686 $ 5,550 EMEA 2,169 1,125 3,294 2,124 1,206 3,330 Asia Pacific 617 312 929 626 392 1,018 Japan 433 321 754 604 381 985 $ 5,628 $ 5,908 $ 11,536 $ 5,218 $ 5,665 $ 10,883 OEM Modules To date, the revenue contribution from our newer OEM Modules products has been modest. Revenue from our OEM Modules product line grew due to increases in unit sales across substantially all of our product families. Enterprise Solutions Net revenue from our Enterprise Solutions product line increased primarily as a result of increased sales of new products in the Americas region. In particular, the SLB2, PremierWaveXN, EDS-MD, and xPort Direct product families contributed to the increased sales. The revenue increase generated by new product sales was partially offset by decreased unit sales in our mature EDS, Xpress and UDSproduct families. 14 Gross Profit Gross profit represents net revenue less cost of revenue. Cost of revenue consists primarily of the cost of raw material components, subcontract labor assembly from contract manufacturers, manufacturing overhead, establishing or relieving inventory reserves for excess and obsolete products or raw materials, warranty costs, royalties and share-based compensation. The following table presents our fiscal quarter gross profit: Three Months Ended September 30, % of Net % of Net Change 2014 Revenue 2013 Revenue $ % (In thousands, except percentages) Gross profit $ 5,599 48.5% $ 5,390 49.5% $ 209 3.9% Gross profit as a percent of revenue (referred to as "gross margin") for the three months ended September 30, 2014 was lower than the prior year period due to higher costs related to manufacturing overhead and freight. As newer products typically have lower margins until they reach production volumes, we may experience downward pressure on gross margins as new product sales grow as a percentage of total net revenue. Selling, General and Administrative Selling, general and administrative expenses consist of personnel-related expenses, including salaries and commissions, share-based compensation, facility expenses, information technology, trade show expenses, advertising, and legal and accounting fees. The following table presents our fiscal quarter selling, general and administrative expenses: Three Months Ended September 30, % of Net % of Net Change 2014 Revenue 2013 Revenue $ % (In thousands, except percentages) Personnel-related expenses $ 2,522 $ 2,331 $ 191 8.2% Professional fees and outside services 364 437 (73 ) (16.7%) Advertising and marketing 419 437 (18 ) (4.1%) Travel 149 157 (8 ) (5.1%) Facilities 300 275 25 9.1%Share-based compensation 174 158 16 10.1% Depreciation 65 110 (45 ) (40.9%) Other 82 43 39 90.7% Selling, general and administrative $ 4,075 35.3% $ 3,948 36.3% $ 127 3.2% The increase in selling, general and administrative expenses was primarily due to an increase in personnel-related expenses, largely merit increases and sales commissions. 15 Research and Development Research and development expenses consist of personnel-related expenses, including share-based compensation, as well as expenditures to third-party vendors for research and development activities and product certification costs. The following table presents our fiscal quarter research and development expenses: Three Months Ended September 30, % of Net % of Net Change 2014 Revenue 2013 Revenue $ % (In thousands, except percentages)Personnel-related expenses $ 1,154 $ 1,109 $ 45 4.1% Facilities 189 193 (4 ) (2.1%) Outside services 184 223 (39 ) (17.5%) Product certifications 81 43 38 88.4% Share-based compensation 64 60 4 6.7% Other 72 53 19 35.8% Research and development $ 1,744 15.1% $ 1,681 15.4% $ 63 3.7% Research and development expenses increased slightly due to merit increases. Outside services and product certifications were impacted by the timing of development projects. Provision for Income Taxes The following table presents our effective tax rate based upon our income tax provision: Three Months Ended September 30, 2014 2013 Effective tax rate 7% 5% We utilize the liability method of accounting for income taxes. The difference between our effective tax rates and the federal statutory rate resulted primarily from a tax benefit from our domestic losses being recorded with a full valuation allowance, 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 that we believe these assets will more likely than not be realized. As a result of our cumulative losses and uncertainty of generating future taxable income, we have provided a full valuation allowance against our net deferred tax assets as of September 30,2014 and June 30, 2014. Liquidity and Capital Resources The following table presents details of our working capital and cash and cash equivalents: September 30, June 30, Increase 2014 2014 (Decrease) (In thousands) Working capital $ 8,775 $ 8,804 $ (29 ) Cash and cash equivalents $ 6,283 $ 6,264 $ 19 Our principal sources of cash and liquidity include our existing cash and cash equivalents, amounts available under our credit facilities and cash generated from operations. We believe that these sources will be sufficient to fund our current requirements for working capital, capital expenditures and other financial commitments for at least the next 12 months. We anticipate that the primary factors affecting our cash and liquidity are net revenue, working capital requirements, and capital expenditures. Management defines cash and cash equivalents as highly liquid deposits with original maturities of 90 days or less when purchased. We maintain cash and cash equivalents balances at certain financial institutions in excess of amounts insured by federal agencies. Management does not believe this concentration subjects us to any unusual financial risk beyond the normal risk associated with commercial banking relationships. We frequently monitor the third-party depository institutions that hold our cash and cash equivalents. Our emphasis is primarily on safety of principal and secondarily on maximizing yield on those funds. 16 Our future working capital requirements will depend on many factors, including the timing and amount of our net revenue, research and development expenses, and expenses associated with any strategic partnerships or acquisitions and infrastructure investments. From time to time, we may seek additional capital from public or private offerings of our capital stock, borrowings under our existing or future credit lines or other sources in order to (i) develop or enhance our products, (ii) take advantage of future opportunities, (iii) respond to competition or (iv) continue to operate our business. If we issue equity or debt securities to raise additional funds, our existing stockholders may experience dilution, and the new equity or debt securities may have rights, preferences and privileges senior to those of our existing stockholders. There can be no assurance that we will be able to raise any such capital on termsacceptable to us, if at all. Loan Agreement On September 30, 2014, we entered into an amendment (the "Amendment") to our existing Loan and Security Agreement dated May 23, 2006 (the "Loan Agreement") with Silicon Valley Bank ("SVB"). The Amendment provides, among other things, for (i) a renewal of our $4.0 million revolving line of credit with an extended maturity date of September 30, 2016 and (ii) a modification of the revolving credit line borrowing base formula in the Loan Agreement to include a portion of our foreign accounts receivable to the borrowing base and increase the borrowing limit related to domestic accounts receivable. The Loan Agreement provides for an interest rate per annum equal to the greater of the prime rate plus 0.75% or 4.0%, provided that we maintain a monthly quick ratio of 1.0 to 1.0 or greater. The quick ratio measures our ability to use our cash and cash equivalents maintained at SVB to extinguish or retire our current liabilities immediately. If this ratio is not met, the interest rate will become the greater of the prime rate plus 1.25% or 4.0%. We maintained a monthly quick ratio greater than 1.0 to 1.0 as of and during the three months ended September 30, 2014. The Loan Agreement includes a covenant requiring us to maintain a certain Minimum Tangible Net Worth ("Minimum TNW"), which is currently required to be $6.0 million. This amount is subject to adjustment upward to the extent we raise additional equity or debt financing or achieve net income in future quarters. Our Actual Tangible Net Worth ("Actual TNW") is calculated as total stockholders' equity, less goodwill. If we continue to incur net losses, we may have difficulty satisfying the Minimum TNW financial covenant in the future, in which case we may be unable to borrow funds under the Loan Agreement and any amounts outstanding may need to be repaid immediately. The following table sets forth the Minimum TNW compared to our Actual TNW: September 30, 2014 (In thousands) Minimum TNW $ 6,000 Actual TNW $ 10,671 As of September 30, 2014, there were no borrowings outstanding on the revolving line of credit. The following table presents the available borrowing capacity on the revolving line of credit and outstanding letters of credit, which were used as security deposits. To date, we have not used any of the borrowing capacity under the revolving line of credit. September 30, June 30, 2014 2014 (In thousands)Available borrowing capacity $ 3,232 $ 1,721 Outstanding letters of credit $ 113 $ 113 Cash Flows The following table presents the major components of the unaudited condensed consolidated statements of cash flows: Three Months Ended September 30, Increase 2014 2013 (Decrease) (In thousands)Net cash provided by operating activities $ 212 $ 885 $ (673 ) Net cash used in investing activities (181 ) (118 ) 63 Net cash used in financing activities (12 ) (179 ) (167 ) 17 Operating Activities Net cash provided by operating activities during the three months ended September 30, 2014 decreased as compared to the prior year period due primarily to (i) increases in inventory and contract manufacturer receivables during the current quarter and (ii) the payment during the current quarter of variable compensation that was accrued as of June 30, 2014. Investing Activities Cash used in investing activities was related to capital expenditures for the purchase of property and equipment, primarily related to tooling and test equipment for new product deployment. Financing Activities The decrease in net cash used in financing activities was primarily due to the payoff of our term loan in September 2013. Off-Balance Sheet Arrangements As part of our ongoing business, we have not participated in transactions that generate material relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities ("SPEs"), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of September 30, 2014, we were not involved in any material unconsolidated SPEs. |