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EX-31.2 - CERTIFICATION - LANTRONIX INClantronix_10q-ex3102.htm
EX-10.1 - 2010 STOCK INCENTIVE PLAN - LANTRONIX INClantronix_10q-ex1001.htm
EX-32.1 - CERTIFICATION - LANTRONIX INClantronix_10q-ex3201.htm
EX-31.1 - CERTIFICATION - LANTRONIX INClantronix_10q-ex3101.htm


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 December 31, 2010

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.)

167 Technology Drive, 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 S No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    
Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
 
Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company x
    (do not check if a smaller reporting company)  

 
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 February 3, 2011, there were 10,437,001 shares of the Registrant’s common stock outstanding.
 



 
 
 

LANTRONIX, INC.

FORM 10-Q
FOR THE FISCAL QUARTER ENDED
December 31, 2010

INDEX

     
Page
       
       
Item 1.
Financial Statements.                                                                                                                            
 
1
       
 
Unaudited Condensed Consolidated Balance Sheets at December 31, 2010 and June 30, 2010
 
1
       
 
Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months Ended December 31, 2010 and 2009
  2
 
                                                                                                                   
 
 
 
Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2010 and 2009
    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 4.
Controls and Procedures.                                                                                                                            
 
19
       
PART II.
OTHER INFORMATION                                                                                                                            
 
20
       
Item 1A.
Risk Factors
 
20
       
Item 6.
Exhibits                                                                                                                            
 
29

 
 

 

PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements
 
LANTRONIX, INC.
 
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
 
 (In thousands)
             
   
December 31,
   
June 30,
 
   
2010
   
2010
 
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 10,645     $ 10,075  
Accounts receivable, net
    1,970       1,342  
Contract manufacturers' receivable
    1,488       1,015  
Inventories, net
    9,586       6,873  
Prepaid expenses and other current assets
    366       515  
Deferred tax assets
    542       542  
Total current assets
    24,597       20,362  
                 
Property and equipment, net
    2,094       2,392  
Goodwill
    9,488       9,488  
Purchased intangible assets, net
    109       155  
Other assets
    167       135  
Total assets
  $ 36,455     $ 32,532  
                 
Liabilities and stockholders' equity
               
Current liabilities:
               
Accounts payable
  $ 9,756     $ 6,545  
Accrued payroll and related expenses
    1,288       1,568  
Warranty reserve
    209       183  
Short-term debt
    667       667  
Other current liabilities
    4,123       3,776  
Total current liabilities
    16,043       12,739  
Non-current liabilities:
               
Long-term liabilities
    591       646  
Long-term capital lease obligations
    91       153  
Long-term debt
    1,167       111  
Deferred tax liabilities
    542       542  
Total non-current liabilities
    2,391       1,452  
Total liabilities
    18,434       14,191  
                 
Commitments and contingencies
               
                 
Stockholders' equity:
               
Common stock
    1       1  
Additional paid-in capital
    192,084       191,147  
Accumulated deficit
    (174,463 )     (173,206 )
Accumulated other comprehensive income
    399       399  
Total stockholders' equity
    18,021       18,341  
Total liabilities and stockholders' equity
  $ 36,455     $ 32,532  
 
See accompanying notes.
 
 
1

 
 
LANTRONIX, INC.
 
                         
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 
(In thousands, except per share data)
 
                         
                         
   
Three Months Ended
December 31,
   
Six Months Ended
December 31,
 
   
2010
   
2009
   
2010
   
2009
 
Net revenue (1)
  $ 12,719     $ 11,478     $ 24,911     $ 22,432  
Cost of revenue
    6,441       5,429       12,406       10,666  
Gross profit
    6,278       6,049       12,505       11,766  
Operating expenses:
                               
Selling, general and administrative
    5,088       4,855       10,141       9,475  
Research and development
    1,697       1,510       3,520       2,995  
Amortization of purchased intangible assets
    18       18       36       36  
Total operating expenses
    6,803       6,383       13,697       12,506  
Loss from operations
    (525 )     (334 )     (1,192 )     (740 )
Interest expense, net
    (36 )     (42 )     (58 )     (89 )
Other income (expense), net
    (5 )     11       24       (25 )
Loss before income taxes
    (566 )     (365 )     (1,226 )     (854 )
Provision for income taxes
    13       10       31       20  
Net loss
  $ (579 )   $ (375 )   $ (1,257 )   $ (874 )
                                 
Net loss per share (basic and diluted)
  $ (0.06 )   $ (0.04 )   $ (0.12 )   $ (0.09 )
                                 
Weighted-average shares (basic and diluted)
    10,429       10,301       10,389       10,234  
                                 
Net revenue from related parties
  $ 212     $ 142     $ 453     $ 267  
 
 
(1)  Includes net revenue from related parties
 
 
See accompanying notes.
 
 
2

 
 
 
LANTRONIX, INC.
 
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
(In thousands)
 
 
    Six Months Ended  
    December 31,  
   
2010
   
2009
 
Operating activities
           
Net loss
  $ (1,257 )   $ (874 )
Adjustments to reconcile net loss to net cash provided by operating activities:
         
Share-based compensation
    1,061       1,143  
Depreciation
    515       404  
Provision (recovery) for inventories
    152       (119 )
Amortization of purchased intangible assets
    46       62  
Provision for doubtful accounts
    1       12  
Changes in operating assets and liabilities:
               
Accounts receivable
    (629 )     77  
Contract manufacturers' receivable
    (473 )     (371 )
Inventories
    (2,865 )     (8 )
Prepaid expenses and other current assets
    87       (352 )
Other assets
    (31 )     (5 )
Accounts payable
    3,210       1,928  
Accrued payroll and related expenses
    (286 )     (478 )
Warranty reserve
    26       -  
Restructuring reserve
    -       (76 )
Other liabilities
    440       59  
 Cash received related to tenant incentives
    32       -  
Net cash provided by operating activities
    29       1,402  
Investing activities
               
Purchases of property and equipment, net
    (220 )     (625 )
Net cash used in investing activities
    (220 )     (625 )
Financing activities
               
Proceeds from term loan
    2,000       -  
Payment of term loan
    (944 )     (333 )
Minimum tax withholding paid on behalf of employees for restricted shares
    (131 )     (263 )
Payment of capital lease obligations
    (238 )     (138 )
Net proceeds from issuances of common stock
    27       150  
Net cash provided by (used in) financing activities
    714       (584 )
Effect of foreign exchange rate changes on cash
    47       49  
Increase in cash and cash equivalents
    570       242  
Cash and cash equivalents at beginning of period
    10,075       9,137  
Cash and cash equivalents at end of period
  $ 10,645     $ 9,379  
 
 
See accompanying notes.

 
3

 

LANTRONIX, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2010

1. 
Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Lantronix, Inc. (the “Company” or “Lantronix”) have been prepared by the Company in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 8 of Regulation S-X.  Accordingly, they should be read in conjunction with the audited consolidated financial statements and notes thereto for the fiscal year ended June 30, 2010, included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on September 13, 2010. The unaudited condensed consolidated financial statements contain all normal recurring accruals and adjustments which, in the opinion of management, are necessary to present fairly the consolidated financial position of the Company at December 31, 2010, and the consolidated results of its operations and cash flows for the three and six months ended December 31, 2010 and 2009. 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 and six months ended December 31, 2010 are not necessarily indicative of the results to be expected for the full year or any future interim periods.

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
December 31,
    Six Months Ended
December 31,
   
2010
   
2009
   
2010
   
2009
 
    (In thousands, except per share data)  
Numerator:
                       
Net loss
  $ (579 )   $ (375 )   $ (1,257 )   $ (874 )
Denominator:
                               
Weighted-average shares outstanding
    10,617       10,620       10,577       10,553  
Less: Unvested common shares outstanding
    (188 )     (319 )     (188 )     (319 )
Weighted-average shares (basic and diluted)
    10,429       10,301       10,389       10,234  
                                 
Net loss per share (basic and diluted)
  $ (0.06 )   $ (0.04 )   $ (0.12 )   $ (0.09 )
 
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
December 31,
    Six Months Ended
December 31,
   
2010
   
2009
   
2010
   
2009
 
    (In thousands)  
Common stock equivalents
    1,222       1,201       1,130       1,351  
 
 
 
4

 
 
3. 
Inventories

Inventories are stated at the lower of cost (first-in, first-out) or market and consist of the following:
 
   
December 31,
   
June 30,
 
   
2010
   
2010
 
    (In thousands)  
Finished goods
  $ 6,947     $ 4,258  
Raw materials
    1,703       1,390  
Inventory at distributors *
    1,621       1,924  
Large scale integration chips **
    672       516  
Inventories, gross
    10,943       8,088  
Reserve for excess and obsolete inventory
    (1,357 )     (1,215 )
Inventories, net
  $ 9,586     $ 6,873  
 
* Balance represents finished goods held by distributors.
** This item is sold individually and is also 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. 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, which may differ from the Company’s 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:
 
   
Six Months
Ended
    Year Ended  
   
December 31,
   
June 30,
 
   
2010
   
2010
 
    (In thousands)  
Beginning balance
  $ 183     $ 224  
Charged to cost of revenues
    127       84  
Usage
    (101 )     (125 )
Ending balance
  $ 209     $ 183  
 
5. 
Bank Line of Credit and Debt

In September 2010, the Company entered into an Amendment to Loan and Security Agreement (the “Loan Agreement”), which provides for a two-year $4.0 million maximum revolving line (the “Revolving Line”) with a three-year $2.0 million term loan (the “Term Loan”). Per the Loan Agreement, the proceeds from the Term Loan were used to pay the balance of $611,000 outstanding on the term loan that was made under the original agreement in 2008. The Term Loan was funded on September 28, 2010 and is payable in 36 equal monthly installments of principal and accrued interest. There are no borrowings outstanding on the Revolving Line as of the fiscal quarter end.

Borrowings under the Loan Agreement bear interest at the greater of 4.75% or prime rate plus 0.75% per annum. Upon entering into the Loan Agreement, the Company paid a fully earned, non-refundable commitment fee of $20,000 and will pay an additional $15,000 on September 28, 2011, the first anniversary of the effective date of the Loan Agreement.

The Company's obligations under the Loan Agreement are secured by substantially all of the Company's assets, including its intellectual property.

The Borrowing Base (as defined in the Loan Agreement) under the Revolving Line is based upon eligible accounts receivable as defined per the Loan Agreement. The “Amount Available under the Revolving Line” is defined as at any time (a) the lesser of (i) the Revolving Line maximum or (ii) the Borrowing Base, minus (b) the amount of all outstanding letters of credit (including drawn but unreimbursed letters of credit) minus (c) an amount equal to the letter of credit reserves, minus (d) the foreign currency reserve, minus (e) the outstanding principal balance of any advances, and minus (f) one-half of the principal balance then outstanding on the Term Loan.
 
 
5

 
 
The following table presents the balance outstanding on the Term Loan, our available borrowing capacity and outstanding letters of credit, which were used to secure equipment leases, deposits for a building lease, and security deposits:
 
   
December 31,
   
June 30,
 
   
2010
   
2010
 
    (In thousands)  
Term Loan
  $ 1,834     $ 778  
Amount Available under the Revolving Line
    1,538       1,031  
 Outstanding letters of credit     343       343  
 
6. 
Stockholders’ Equity

Share-Based Plans

On November 18, 2009, Lantronix stockholders approved a proposal to authorize the Company’s board of directors to implement, at its discretion, a reverse stock split of the Company’s outstanding shares of common stock within a range of one-third to one-sixth of a share for each outstanding share of common stock, and to file an Amendment to the Company’s Certificate of Incorporation (the “Certificate of Amendment”) to effect such a reverse stock split. On November 18, 2009, the board of directors authorized a one-for-six reverse stock split of the Company’s common stock. On December 18, 2009, the Company filed the Certificate of Amendment. All references to common shares and per-share data for all periods presented in this report have been retrospectively adjusted to give effect to this reverse stock split.

On December 15, 2010, Lantronix stockholders approved the 2010 Stock Incentive Plan which replaces the expired 2000 Stock Plan and reserves 1.4 million shares of Lantronix common stock as available for issuance under the 2010 Stock Incentive Plan.  In addition, Lantronix stockholders approved an amendment to the Lantronix Certificate of Incorporation to reduce the number of common shares authorized from 200 million shares to 100 million shares.

The Company has share-based plans under which non-qualified and incentive stock options have been granted to employees, non-employees and board members. In addition, the Company has granted restricted stock awards to employees and board members under these share-based plans.

The board of directors determines eligibility, vesting schedules and exercise prices for options and shares granted under the plans. Share-based awards are generally granted with an exercise price equal to the market price of the Company’s stock at the date of grant. Option awards generally have a term of 7 to10 years. Share-based awards generally vest and become exercisable over a one- to four-year service period. The Company has granted share-based awards with market conditions whereby vesting is accelerated upon achieving certain stock price thresholds. In addition, the board of directors has approved a share-based performance plan whereby employees will be paid in vested common shares if minimum revenue, income and management objectives are met. The Company issues new shares to satisfy stock option exercises, restricted stock grants, and stock purchases under its share-based plans.

The following table presents a summary of share-based compensation by functional line item:
 
    Three Months Ended
December 31,
    Six Months Ended
December 31,
 
   
2010
   
2009
   
2010
   
2009
 
    (In thousands)  
Cost of revenues
  $ 10     $ 10     $ 35     $ 19  
Selling, general and administrative
    382       428       790       851  
Research and development
    86       146       236       273  
Total share-based compensation
  $ 478     $ 584     $ 1,061     $ 1,143  
 
 
 
 
6

 
 
The following table presents a summary of remaining unrecognized share-based compensation by the vesting condition for the Company’s share-based plans as of December 31, 2010:
 
    Unrecognized    
Remaining
 
    Compensation    
Years
 
Vesting Condition
 
Cost
   
To Vest
 
   
(In thousands)
 
Stock Option Awards:
           
Service-based
  $ 1,794        
Market- and service-based
    76        
Stock option awards
  $ 1,870       2.6  
                 
Restricted Stock Awards:
               
Service-based
  $ 459          
Market- and service-based
    4          
Restricted stock awards
  $ 463       1.5  
 
Stock Option Awards

The fair value of each stock option grant was estimated on the grant date using the Black-Scholes-Merton (“BSM”) option-pricing formula. To the extent that the stock option grant included market conditions, the Company used a lattice model to estimate the fair value for each stock option grant. Expected volatilities were based on the historical volatility of the Company’s stock price. The expected term of options granted was estimated using the simplified method. To the extent that stock option grants included market conditions and therefore did not meet the rules for the simplified method, the Company used a lattice model to estimate the expected term of stock options granted. The risk-free rate for periods within the contractual life of the stock option grant was based on the U.S. Treasury interest rates in effect at the time of grant.

The following table presents a summary of option activity under all of the Company’s stock option plans:

   
Number of
 
   
Shares
 
Balance of options outstanding at June 30, 2010
    1,890,339  
Options granted
    392,755  
Options forfeited
    (110,852 )
Options expired
    (23,393 )
Options exercised
    (10,068 )
Balance of options outstanding at December 31, 2010
    2,138,781  
 
The following table presents stock option grant date information:

    Three Months Ended
December 31,
    Six Months Ended
December 31,
 
   
2010
   
2009
   
2010
   
2009
 
Weighted-average grant date fair value per share
  $ 2.19     $ 2.14     $ 2.19     $ 1.88  
Weighted-average grant date exercise price per share
  $ 3.44     $ 3.06     $ 3.44     $ 2.66  
 
 
 
7

 
 
Nonvested Share Awards

The following table presents a summary of nonvested share activity:
 
   
Number of
Shares
Unvested
   
Weighted
Average
Grant - Date
Fair Value
per Share
 
Balance of nonvested shares at June 30, 2010
    291,646     $ 3.16  
Granted
    -       -  
Forfeited
    (13,099 )     3.00  
Vested
    (90,208 )     3.08  
Balance of nonvested shares at December 31, 2010
    188,339     $ 3.21  
 
The following table presents a summary of the total fair value of shares vested for all of the Company’s nonvested share awards:
 
    Three Months Ended
December 31,
    Six Months Ended
December 31,
 
   
2010
   
2009
   
2010
   
2009
 
    (In thousands)  
Fair value of shares vested
  $ 345     $ 77     $ 345     $ 425  
 
Performance-Based Share Awards

The compensation committee of the board of directors approved a performance plan for the six months ended December 31, 2010 (“Performance Plan”), which will be paid in a combination of cash and vested common shares based on the board of directors discretion and if minimum revenue, EBITDA and management objectives are met. On January 26, 2011, the board of directors approved the final Performance Plan payout of $307,000 for the six months ending December 31, 2010.   The Company recorded $153,500 of share-based compensation and $153,500 of compensation expense in connection with this Performance Plan. The cash portion of the award is recorded as a short-term liability on the consolidated balance sheet and the share-based portion of the award is recorded as a long-term liability on the consolidated balance sheet.

Warrants to Purchase Common Stock

During March 2008, the Company issued warrants to purchase an aggregate of 179,935 shares of Lantronix common stock as consideration for settlement of a shareholder lawsuit. The warrants have an exercise price  of $28.08 per share and expire on February 10, 2011.

7. 
Income Taxes
 
At July 1, 2010, the Company’s fiscal 2003 through fiscal 2009 tax years remained open to examination by the federal, state, and foreign taxing authorities. The Company has annual net operating losses (“NOLs”) beginning in fiscal 2001 that would cause the statute of limitations to remain open for the year in which the NOL was incurred.
 
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
December 31,
  Six Months Ended
December 31,
 
   
2010
   
2009
 
2010
   
2009
 
Effective tax rate
    2%       3%     3%       2%  
 
The federal statutory rate was 34% for all periods. The difference between the Company’s effective tax rate and the federal statutory rate is primarily due to its domestic losses being recorded with a fully reserved tax benefit, as well as the effect of foreign earnings taxed at rates differing from the federal statutory rate.
 
 
 
8

 
 
8. 
Comprehensive Income (Loss)

The components of comprehensive income (loss) are as follows:
 
    Three Months Ended
December 31,
  Six Months Ended
December 31,
 
   
2010
   
2009
   
2010
   
2009
 
    (In thousands)  
Net loss
  $ (579 )   $ (375 )   $ (1,257 )   $ (874 )
Other comprehensive income (loss):
                               
Change in translation adjustments, net of taxes of $0
    -       (25 )     -       22  
Total comprehensive loss
  $ (579 )   $ (400 )   $ (1,257 )   $ (852 )
 
9. 
Litigation

From time to time, the Company is subject to legal proceedings and claims in the ordinary course of business. 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.

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 Report is not a complete description of our business. 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, 2010 and subsequent reports on our Current Reports on Form 8-K.

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 hereto. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

Overview

We design, develop, market and sell products that make it possible to access, manage, connect, control and configure electronic products over the Internet or other networks. Our primary products and technology are focused on device enablement solutions that enable individual electronic products to be connected to a wired or wireless network for the primary purpose of remote access. In addition, our device management solutions address applications that manage equipment at data centers and remote branch offices to provide a reliable, single point of control and data flow management for potentially thousands of networked devices.

Our innovative networking solutions include fully-integrated hardware and software devices, as well as software tools, to develop related customer applications. Because we deal with network connectivity, we provide solutions to broad market segments, including industrial, security, energy, information technology (“IT”), data centers, transportation, government, healthcare, and many others. This past year we identified medical device connectivity as a particularly promising direction for investment and growth.
 
 
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Products and Solutions

Device Enablement Solutions

Device networking is the technology that enables connectivity within a multitude of vertical markets such as healthcare, industrial, security, energy, IT, data centers, transportation, government and many others. Our device enablement solutions released after 2009 support our ManageLinx VIP Access, which allows equipment to be remotely, safely and securely managed behind firewalls. We provide manufacturers, integrators and end users with device enablement solutions for products to be connected, securely accessed, managed and controlled over networks. Our device enablement solutions dramatically shorten a manufacturer’s development time to implement network connectivity and provide competitive advantages with new features, greatly reducing engineering and marketing risks.

Our device servers allow a wide range of equipment to be quickly network-enabled without the need for intermediary gateways, workstations or personal computers (“PC”). Our device servers and web servers eliminate the high cost of ownership and added support issues associated with networking, which frequently would otherwise require using PCs or workstations to perform connectivity and remote management functions. Our solutions contain high-performance processors capable of not only controlling the attached device, but in many cases are also capable of accumulating data and status information. The accumulated data can then be formatted by the device server and presented to users via web pages, e-mail, and other network, transport and application level protocols. Our device servers have a built-in HTTP server, making them easy to manage using any standard Web browser. These device servers include the latest security protocols, such as AES, IPsec, SSL, and SSH, which support the stringent security requirements of the medical, banking, and physical security markets.

Device Management Solutions

We offer single and multi-port products (up to 48 ports) that provide IT professionals with the tools they need to remotely connect to the out-of-band management ports on computers and associated equipment. These solutions include console servers, remote keyboard, video, mouse (“KVM”) servers and managed power distribution products.

Our customers use these solutions to monitor and run their systems to ensure the performance and availability of critical business information systems, network infrastructure and telecommunications equipment. The equipment that our solutions manage includes routers, switches, servers, phone switches and public branch exchanges that are often located in remote or inaccessible locations.

Our console servers provide system administrators and network managers an operationally effective way to connect with their remote equipment through an interface called a console port, helping them work more efficiently, without having to leave their desk or office. Console ports are usually found on servers and special purpose data center equipment, such as environmental monitoring/ control systems, communications switches and storage devices. With remote access, system downtime can be reduced, thereby improving business efficiency. Our console servers provide IT professionals with peace of mind through extensive security features and, in some cases, provisions for dial-in access via modem. These solutions are provided in various configurations and can manage up to 48 devices from one console server.

Other Products

Our other products are comprised primarily of legacy products such as print servers, software and other miscellaneous products.
 
 
10

 

Financial Highlights and Other Information for the Fiscal Quarter Ended December 31, 2010

The following is a summary of the key factors and significant events that impacted our financial performance during the fiscal quarter ended December 31, 2010:

Net revenue was $12.7 million for the fiscal quarter ended December 31, 2010, an increase of $1.2 million or 10.8%, compared to $11.5 million for the fiscal quarter ended December 31, 2009. The increase was primarily the result of a $1.2 million, or 13.1%, increase in sales of our device enablement product lines and a $177,000, or 9.3%, increase in sales of our device management product lines, offset by a $150,000 decrease in our non-core product lines.  As part of an ongoing corporate initiative to optimize our sales distribution channel, we renegotiated our agreement with a direct customer that removed stock rotation and price protection terms, which allows us to recognize revenue uopon shipment as opposed to a sell-through basis.  The result was recognition of approximately $342,000 of net revenue that would have potentially been deferred as of December 31, 2010.  As part of this same initiative, we removed stock rotation and price protection terms from certain low volume direct customers and redirected them to master distributors, which allows us to recognize revenue uopon shipment as opposed to a sell-through basis.  The result was the recognition of approximately $297,000 of net revenue that would have potentially been deferred as of December 31, 2010.

Gross profit margin was 49.4% for the fiscal quarter ended December 31, 2010, compared to 52.7% for the fiscal quarter ended December 31, 2009. The decrease in gross profit margin was due to a change in product mix during the quarter primarily related to an increase in unit sales as a percentage of total sales of our embedded device enablement products, which have a lower margin than our other product lines.  Gross profit margin was also negatively impacted by an increase in the reserve for excess and obsolete inventory related to an end of life product and an increase in warranty reserves related to a specific product.  Freight costs also contributed to the decrease in gross profit margin compared to the equivalent period ended December 31, 2009 primarily related to an increase in volume of inventory receipts during the quarter.

Loss from operations was $525,000 for the fiscal quarter ended December 31, 2010, compared to $334,000 for the fiscal quarter ended December 31, 2009. The loss from operations in the current fiscal quarter was negatively impacted by approximately $372,000 in legal and consulting expenses related to the proxy contest initiated by a dissident director and shareholder that was settled in November 2010.

Net loss was $579,000, or $0.06 per basic and diluted share, for the fiscal quarter ended December 31, 2010, compared to $375,000, or $0.04 per basic and diluted share, for the fiscal quarter ended December 31, 2009. The net loss in the current fiscal quarter was negatively impacted by approximately $372,000 in legal and consulting expenses related to the proxy contest that was settled in November 2010.

Cash and cash equivalents were $10.6 million as of December 31, 2010, an increase of $570,000, compared to $10.1 million as of June 30, 2010.

Net accounts receivable were $2.0 million as of December 31, 2010, an increase of $628,000, compared to $1.3 million as of June 30, 2010. Days sales outstanding (“DSO”) in receivables were 13 days for the fiscal quarter ended December 31, 2010 compared to 15 days for the fiscal quarter ended June 30, 2010. Our accounts receivable and DSO are primarily affected by the timing of shipments within a quarter, our collections performance and the fact that a significant portion of our revenues are recognized on a sell-through basis (upon shipment from distributor inventories rather than as goods are shipped to distributors).

Net inventories were $9.6 million as of December 31, 2010, compared to $6.9 million as of June 30, 2010. Inventory turns were 3.0 turns for the fiscal quarter ended December 31, 2010 compared to 3.5 turns for the fiscal quarter ended June 30, 2010.

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 our Annual Report on Form 10-K for the fiscal year ended June 30, 2010. There have been no significant changes in our critical accounting policies and estimates during the fiscal quarter ended December 31, 2010 as compared to what was previously disclosed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2010.

Recent Accounting Pronouncements

In September 2009, the FASB reached a consensus on Accounting Standards Update (“ASU”) 2009-13, Revenue Recognition (Topic 605) – Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”) and ASU 2009-14, Software (Topic 985) – Certain Revenue Arrangements That Include Software Elements (“ASU 2009-14”). ASU 2009-13 modifies the requirements that must be met for an entity to recognize revenue from the sale of a delivered item that is part of a multiple-element arrangement when other items have not yet been delivered. ASU 2009-13 eliminates the requirement that all undelivered elements must have either: (1) vendor-specific objective evidence (“VSOE”) or (2) third-party evidence (“TPE”) before an entity can recognize the portion of an overall arrangement consideration that is attributable to items that already have been delivered. In the absence of VSOE or TPE of the standalone selling price for one or more delivered or undelivered elements in a multiple-element arrangement, entities will be required to estimate the selling prices of those elements. Overall arrangement consideration will be allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on the entity’s estimated selling price. The residual method of allocating arrangement consideration has been eliminated. ASU 2009-14 modifies the software revenue recognition guidance to exclude from its scope tangible products that contain both software and non-software components that function together to deliver a product’s essential functionality. These new updates are effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. We adopted the provisions of this guidance effective July 1, 2010, which did not have a material impact on our financial statements
 

 
 
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Consolidated Results of Operations

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

    Three Months Ended
December 31,
    Six Months Ended
December 31,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Net revenue
    100.0%       100.0%       100.0%       100.0%  
Cost of revenue
    50.6%       47.3%       49.8%       47.5%  
Gross profit
    49.4%       52.7%       50.2%       52.5%  
Operating expenses:
                               
Selling, general and administrative
    40.0%       42.3%       40.7%       42.2%  
Research and development
    13.3%       13.2%       14.1%       13.4%  
Amortization of purchased intangible assets
    0.1%       0.2%       0.1%       0.2%  
Total operating expenses
    53.5%       55.6%       55.0%       55.8%  
Loss from operations
    (4.1%)       (2.9%)       (4.8%)       (3.3%)  
Interest expense, net
    (0.3%)       (0.4%)       (0.2%)       (0.4%)  
Other income (expense), net
    (0.0%)       0.1%       0.1%       (0.1%)  
Loss before income taxes
    (4.5%)       (3.2%)       (4.9%)       (3.8%)  
Provision for income taxes
    0.1%       0.1%       0.1%       0.1%  
Net loss
    (4.6%)       (3.3%)       (5.0%)       (3.9%)  

Comparison of the Fiscal Quarters Ended December 31, 2010 and 2009

Net Revenue by Product Line

The following table presents fiscal quarter net revenue by product line:
 
    Three Months Ended December 31,      
         
% of Net
         
% of Net
  Change  
   
2010
   
Revenue
   
2009
   
Revenue
  $   %  
    (In thousands, except percentages)  
Device enablement
  $ 10,469       82.3%     $ 9,255       80.6 %   $ 1,214     13.1%  
Device management
    2,076       16.3%       1,899       16.5 %     177     9.3%  
Device networking
    12,545       98.6%       11,154       97.2 %     1,391     12.5%  
Non-core
    174       1.4%       324       2.8 %     (150 )   (46.3%)  
Net revenue
  $ 12,719       100.0%     $ 11,478       100.0 %   $ 1,241     10.8%  
 
 
 
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The increase in net revenue for the three months ended December 31, 2010, compared to the three months ended December 31, 2009 was the result of an increase in net revenue from our device enablement and device management product lines, partially offset by a decrease in net revenue from our non-core product lines. The increase in net revenue from our device enablement product line was due to an increase in unit sales of some of our embedded device enablement products, in particular our XPort, XPort Pro and ASIC product families, partially offset by a decrease in unit sales of some of our external device enablement products, in particular our WiBox and UDS product families, offset by an increase in our EDS product family. The increase in net revenue from our device management product line was due to an increase in unit sales of our Spider and SCS product families, partially offset by a decrease in unit sales of our SLC product family. As part of an ongoing corporate initiative to optimize our sales distribution channel, we renegotiated our agreement with a direct customer that removed stock rotation and price protection terms, which allows us to recognize revenue uopon shipment as opposed to a sell-through basis.  The result was recognition of approximately $342,000 of net revenue that would have potentially been deferred as of December 31, 2010.  As part of this same initiative, we removed stock rotation and price protection terms from certain low volume direct customers and redirected them to master distributors, which allows us to recognize revenue uopon shipment as opposed to a sell-through basis.  The result was the recognition of approximately $297,000 of net revenue that would have potentially been deferred as of December 31, 2010.

The following table presents fiscal year-to-date net revenue by product line:
 
    Six Months Ended December 31,      
         
% of Net
         
% of Net
  Change  
   
2010
   
Revenue
   
2009
   
Revenue
  $   %
    (In thousands, except percentages)  
Device enablement
  $ 20,352       81.7%     $ 17,995       80.2 %   $ 2,357     13.1%  
Device management
    4,234       17.0%       3,902       17.4 %     332     8.5%  
Device networking
    24,586       98.7%       21,897       97.6 %     2,689     12.3%  
Non-core
    325       1.3%       535       2.4 %     (210 )   (39.3%)  
Net revenue
  $ 24,911       100.0%     $ 22,432       100.0 %   $ 2,479     11.1%  
 
The increase in net revenue for the six months ended December 31, 2010, compared to the six months ended December 31, 2009 was the result of an increase in net revenue from our device enablement and device management product lines, partially offset by a decrease in net revenue from our non-core product lines. The increase in net revenue from our device enablement product line was due to an increase in unit sales of some of our embedded device enablement products, in particular our XPort, XPort Pro, MatchPort AR and ASIC product families, partially offset by a decrease in unit sales of some of our external device enablement products, in particular our WiBox, UBox and MSS product families, offset by an increase in our EDS product family.  The increase in net revenue from our device management product line was due to an increase in unit sales of our Spider and SCS product families, partially offset by a decrease in sales of our SLC product family. As part of an ongoing corporate initiative to optimize our sales distribution channel, we renegotiated our agreement with a direct customer that removed stock rotation and price protection terms, which allows us to recognize revenue uopon shipment as opposed to a sell-through basis.  The result was recognition of approximately $342,000 of net revenue that would have potentially been deferred as of December 31, 2010.  As part of this same initiative, we removed stock rotation and price protection terms from certain low volume direct customers and redirected them to master distributors, which allows us to recognize revenue uopon shipment as opposed to a sell-through basis.  The result was the recognition of approximately $297,000 of net revenue that would have potentially been deferred as of December 31, 2010.
 
Net Revenue by Geographic Region

The following table presents fiscal quarter net revenue by geographic region:
 
    Three Months Ended December 31,      
          % of Net         % of Net   Change  
   
2010
   
Revenue
 
2009
   
Revenue
  $   %  
    (In thousands, except percentages)  
Americas
  $ 6,106       48.0 %   $ 6,135       53.5 %   $ (29 )   (0.5%)  
EMEA
    4,613       36.3 %     3,548       30.9 %     1,065     30.0%  
Asia Pacific
    2,000       15.7 %     1,795       15.6 %     205     11.4%  
Net revenue
  $ 12,719       100.0 %   $ 11,478       100.0 %   $ 1,241     10.8%  
 
The increase in net revenue for the three months ended December 31, 2010 compared to the three months ended December 31, 2009 reflects increased unit sales from the Europe, Middle East and Africa (the “EMEA”) and Asia Pacific regions.    The increase in net revenue from the EMEA region was mainly due to an increase in unit sales in our device enablement product lines, in particular our XPort, XPort Pro, ASIC and EDS product families. The increase in net revenue in the Asia Pacific region was due to an increase in unit sales of our device management product lines, in particular our Spider product family, as well as our device enablement product lines, in particular our WiPort and MatchPort AR product families, partially offset by a decrease in sales of our UDS product family
 
 
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The following table presents fiscal year-to-date net revenue by geographic region:
 
     Six Months Ended December 31,      
          % of Net         % of Net   Change  
   
2010
   
Revenue
 
2009
   
Revenue
  $   %  
    (In thousands, except percentages)  
Americas
  $ 12,677       50.9 %   $ 12,386       55.2 %   $ 291     2.3%  
EMEA
    8,144       32.7 %     6,457       28.8 %     1,687     26.1%  
Asia Pacific
    4,090       16.4 %     3,589       16.0 %     501     14.0%  
Net revenue
  $ 24,911       100.0 %   $ 22,432       100.0 %   $ 2,479     11.1%  
 
The increase in net revenue for the six months ended December 31, 2010 compared to the six months ended December 31, 2009 reflects increased unit sales across all geographic regions. The increase in net revenue from the Americas region was due to an increase in unit sales of our device enablement product lines, in particular our XPort, XPort Pro, WiPort and EDS product families, partially offset by a decrease in our MSS and WiBox product families and an increase in unit sales of our device management product lines, in particular our Spider and SCS product families, partially offset by a decrease in our SLC product family. The increase in net revenue from the EMEA region was due to an increase in unit sales in our device enablement product lines, in particular our XPort, XPort Pro, ASIC, Xpress and EDS product families, partially offset by a decrease in our WiPort product family.   The increase in net revenue in the Asia Pacific region was due to an increase in unit sales of our device management product lines, in particular our Spider product family and our device enablement product lines, in particular our Micro, MatchPort AR and WiPort product families.

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, freight, amortization of purchased intangible assets, establishing or relieving inventory reserves for excess and obsolete products or raw materials, warranty costs, royalties and manufacturing overhead, which includes personnel related expenses, such as payroll, facilities expenses and share-based compensation.

The following table presents fiscal quarter gross profit:
 
    Three Months Ended December 31,        
         
% of Net
         
% of Net
    Change  
   
2010
   
Revenue
   
2009
   
Revenue
    $   %  
    (In thousands, except percentages)  
Gross profit
  $ 6,278       49.4%     $ 6,049       52.7%     $ 229     3.8%  
 
The decrease in gross profit as a percent of net revenue (referred to as “gross profit margin”) for the three months ended December 31, 2010 was due to a change in product mix during the quarter primarily related to an increase in unit sales as a percentage of total sales of our embedded device enablement products, which have a lower margin than our other product lines.  Gross profit margin was also negatively impacted by an increase in the reserve for excess and obsolete inventory related to the end of life of a product and an increase in warranty reserves related to a specific product.  Freight costs also contributed to the decrease in gross profit margin compared to the equivalent period ended December 31, 2009 primarily related to an increase in volume of inventory receipts during the quarter.

The following table presents fiscal year-to-date gross profit:
 
    Six Months Ended December 31,        
         
% of Net
         
% of Net
    Change  
   
2010
   
Revenue
   
2009
   
Revenue
    $   %  
    (In thousands, except percentages)  
Gross profit
  $ 12,505       50.2%     $ 11,766       52.5%     $ 739     6.3%  
 
The decrease in gross profit margin for the six months ending December 31, 2010 was partly due to a change in product mix primarily related to an increase in unit sales as a percentage of total sales of our embedded device enablement products, which have a lower margin than our other product lines.  Gross profit margin was also negatively impacted by an increase in freight costs due to expediting charges relating to component and product shortages, transitional costs associated with the implementation of third-party logistics providers in Los Angeles and Hong Kong for inventory management and the increase in the volume of inventory receipts.
 
 
 
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Selling, General and Administrative

Selling, general and administrative expenses consist of personnel-related expenses, including salaries and commissions, share-based compensation, facility expenses, and  information technology, as well as trade show expenses, advertising, and legal and accounting fees.

The following table presents fiscal quarter selling, general and administrative expenses:
 
   
Three Months Ended December 31,
     
       
% of Net
     
% of Net
  Change  
   
2010
 
Revenue
 
2009
 
Revenue
  $   %  
    (In thousands, except percentages)  
Personnel-related expenses
  $ 2,612       $ 2,540       $ 72     2.8%  
Professional fees and outside services
    885         491         394     80.2%  
Advertising and marketing
    333         596         (263 )   (44.1%)  
Facilities
    283         306         (23 )   (7.5%)  
Share-based compensation
    382         428         (46 )   (10.7%)  
Depreciation
    166         147         19     12.9%  
Bad debt expense
    -         17         (17 )   (100.0%)  
Other
    427         330         97     29.4%  
Selling, general and administrative
  $ 5,088  
40.0%
  $ 4,855  
42.3%
  $ 233     4.8%  
 
In order of significance, the increase in selling, general and administrative expenses for the three months ended December 31, 2010, compared to the three months ended December 31, 2009 was primarily due to: (i) an increase in professional fees and outside services mainly due to $372,000 of  legal and consulting expenses as a result of the proxy contest which was settled in November 2010 and (ii) an increase in personnel-related expenses due to the suspension of a Company-wide furlough program in the equivalent period one year ago; partially offset by (iii) a decrease in advertising and marketing expense due to cost saving efforts. As noted above, higher payroll costs reflect a return to normal levels following the suspension of the Company-wide furlough program.

The following table presents fiscal year-to-date selling, general and administrative expenses:
 
    Six Months Ended December 31,      
       
 % of Net
     
 % of Net
  Change  
   
2010
 
 Revenue
 
2009
 
 Revenue
  $   %  
    (In thousands, except percentages)
Personnel-related expenses
  $ 5,172       $ 4,938       $ 234     4.7%  
Professional fees & outside services
    1,690         1,107         583     52.7%  
Advertising and marketing
    783         1,054         (271 )   (25.7%)  
Facilities
    571         634         (63 )   (9.9%)  
Share-based compensation
    790         851         (61 )   (7.2%)  
Depreciation
    331         280         51     18.2%  
Bad debt expense (recovery)
    1         12         (11 )   (91.7%)  
Other
    803         599         204     34.1%  
Selling, general and administrative
  $ 10,141  
40.7%
  $ 9,475  
42.2%
  $ 666     7.0%  
 
In order of significance, the increase in selling, general and administrative expenses for the six months ended December 31, 2010, compared to the six months ended December 31, 2009 was primarily due to: (i) an increase in professional fees and outside services mainly due to $561,000 of legal and consulting expenses as a result of the proxy contest which was settled in November of 2010 and (ii) an increase in personnel-related expenses due to the suspension of a Company-wide furlough program in the equivalent period one year ago, partially offset by (iii) a decrease advertising and marketing expense due to cost saving efforts. As noted above, higher payroll costs reflect a return to normal levels following the suspension of the Company-wide furlough program.
 
 
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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.

The following table presents fiscal quarter research and development expenses:

    Three Months Ended December 31,      
       
% of Net
     
% of Net
  Change  
   
2010
 
Revenue
 
2009
 
Revenue
  $   %  
    (In thousands, except percentages)  
Personnel-related expenses
  $ 1,062       $ 946       $ 116     12.3%  
Facilities
    266         278         (12 )   (4.3%)  
Professional fees and outside services
    169         95         74     77.9%  
Share-based compensation
    86         146         (60 )   (41.1%)  
Depreciation
    11         16         (5 )   (31.3%)  
Other
    103         29         74     255.2%  
Research and development
  $ 1,697  
13.3%
  $ 1,510  
13.2%
  $ 187     12.4%  
 
In order of significance, the increase in research and development expenses for the three months ended December 31, 2010, compared to the three months ended December 31, 2009 was primarily due to: (i) an increase in personnel-related expenses due to the suspension of a Company-wide furlough program in the equivalent period one year ago and (ii) an increase in professional fees and outside services related to development projects for upcoming product releases. As noted above, higher payroll costs reflect a return to normal levels following the suspension of the Company-wide furlough program.  Research and development expenses could increase as we continue to invest in new development efforts.

The following table presents fiscal year-to-date research and development expenses:
 
    Six Months Ended December 31,        
       
% of Net
     
% of Net
  Change  
   
2010
 
Revenue
 
2009
 
Revenue
  $   %  
    (In thousands, except percentages)  
Personnel-related expenses
  $ 2,187       $ 1,919       $ 268     14.0%  
Facilities
    532         522         10     1.9%  
Professional fees & outside services
    360         143         217     151.7%  
Share-based compensation
    236         273         (37 )   (13.6%)  
Depreciation
    23         32         (9 )   (28.1%)  
Other
    182         106         76     71.7%  
Research and development
  $ 3,520  
14.1%
  $ 2,995  
13.4%
  $ 525     17.5%  
 
In order of significance, the increase in research and development expenses for the six months ended December 31, 2010, compared to the six months ended December 31, 2009 was primarily due to: (i) an increase in personnel-related expenses due to the suspension of a Company-wide furlough program in the equivalent period one year ago and (ii) an increase in professional fees and outside services related to development projects for upcoming product releases. As noted above, higher payroll costs reflect a return to normal levels following the suspension of the Company-wide furlough program.  Research and development expenses could increase as we continue to invest in new development efforts.

Provision for Income Taxes
 
At July 1, 2010, our fiscal 2003 through fiscal 2009 tax years remained open to examination by the Federal, state, and foreign taxing authorities. We have annual net operating losses (“NOLs”) beginning in fiscal 2001, which causes the statute of limitations to remain open for the year in which the NOL was incurred.
 
 
 
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The following table presents our effective tax rate based upon our income tax provision:
 
    Three Months Ended
December 31,
  Six Months Ended
December 31,
 
   
2010
   
2009
   
2010
   
2009
 
Effective tax rate
    2%       3%       3%       2%  
 
We utilize the liability method of 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 our domestic losses being recorded with a fully reserved tax benefit, as well as the effect of foreign earnings taxed at rates differing from the federal statutory rate. We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. As a result of our cumulative losses, we provided a full valuation allowance against our domestic net deferred tax assets for the fiscal quarters ended December 31, 2010 and 2009.

Liquidity and Capital Resources

The following table presents information about our working capital and cash:
 
   
December 31,
   
June 30,
   
Increase
 
   
2010
   
2010
   
(Decrease)
 
    (In thousands)  
Working capital
  $ 8,554     $ 7,623     $ 931  
Cash and cash equivalents
  $ 10,645     $ 10,075     $ 570  
 
In order of significance, our working capital as of December 31, 2010 increased as compared to June 30, 2010, primarily due to: (i) an increase in inventory due to the timing of shipments and inventory receipts, (ii) an increase in accounts receivable as a result of the timing of shipments, cash collections and an increase in revenue, and (iii) and increase in cash due to the proceeds from the amended term loan. This was partially offset by an increase in accounts payable related to the increase in inventory.

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

In September 2010, we entered into an Amendment to the Loan and Security Agreement (the “Loan Agreement”), which provides for a two-year $4.0 million maximum revolving line (the “Revolving Line”) with a three-year $2.0 million term loan (the “Term Loan”). Per the Loan Agreement, the proceeds from the Term Loan were used to pay the balance of $611,000 outstanding on the term loan that was made under the original agreement in 2008. The Term Loan was funded on September 28, 2010 and is payable in 36 equal monthly installments of principal and accrued interest. There are no borrowings outstanding on the Revolving Line as of the fiscal quarter end.

Borrowings under the Loan Agreement bear interest at the greater of 4.75% or prime rate plus 0.75% per annum. Upon entering into the Loan Agreement, we paid a fully earned, non-refundable commitment fee of $20,000 and will pay an additional $15,000 on September 28, 2011, the first anniversary of the effective date of the Loan Agreement.

The Borrowing Base (as defined in the Loan Agreement) under the Revolving Line is based upon eligible accounts receivable as defined per the Loan Agreement. The “Amount Available under the Revolving Line” is defined as at any time (a) the lesser of (i) the Revolving Line maximum or (ii) the Borrowing Base, minus (b) the amount of all outstanding letters of credit (including drawn but unreimbursed letters of credit), minus (c) an amount equal to the letter of credit reserves, minus (d) the foreign currency reserve, minus (e) the outstanding principal balance of any advances, and minus (f) one-half of the principal balance then outstanding of the Term Loan
 
 
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The following table presents the balance outstanding on the Term Loan, our available borrowing capacity and outstanding letters of credit, which were used to secure equipment leases, deposits for a building lease, and security deposits:
 
   
December 31,
   
June 30,
 
   
2010
   
2010
 
    (In thousands)  
Term Loan
  $ 1,834     $ 778  
Amount Available under the Revolving Line
    1,538       1,031  
 Outstanding letters of credit     343       343  
 
As of December 31, 2010 and June 30, 2010, approximately $366,000 and $400,000, respectively, of our cash was held by our foreign subsidiaries in foreign bank accounts. Such cash may be 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 may be subject to approval by the foreign subsidiaries’ board of directors.

Cash Flows for the Three and Six Months Ended December 31

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

   
Three Months Ended
December 31,
   
Six Months Ended
December 31,
 
   
2010
   
2009
   
2010
   
2009
 
    (In thousands)  
Net cash provided by (used in):
                       
Net loss
  $ (579 )   $ (375 )   $ (1,257 )   $ (874 )
Non-cash operating expenses, net
    907       757       1,775       1,502  
Changes in operating assets and liabilities:
                               
Accounts receivable
    (205 )     (114 )     (629 )     77  
Contract manufacturers' receivable
    (345 )     (343 )     (473 )     (371 )
Inventories
    (2,225 )     (414 )     (2,865 )     (8 )
Prepaid expenses and other current assets
    (38 )     (363 )     87       (352 )
Other assets
    6       9       (31 )     (5 )
Accounts payable
    2,743       1,756       3,210       1,928  
Accrued payroll and related expenses
    (354 )     (165 )     (286 )     (478 )
Warranty reserve
    57       -       26       -  
Restructuring reserve
    -       (31 )     -       (76 )
Other liabilities
    682       211       440       59  
Cash received related to tenant incentives
    -       -       32       -  
Net cash provided by operating activities
    649       928       29       1,402  
Net cash used in investing activities
    (137 )     (420 )     (220 )     (625 )
Net cash (used in) provided by financing activities
    (323 )     (244 )     714       (584 )
Effect of foreign exchange rate changes on cash
    (2 )     (5 )     47       49  
Increase in cash and cash equivalents
  $ 187     $ 259     $ 570     $ 242  
 
Cash Flows for the Three Months Ended December 31

Operating activities provided $649,000 in cash during the three months ended December 31, 2010. This was the result of cash provided by operating assets and liabilities and non-cash operating expenses offset by a net loss. Significant non-cash items included share-based compensation and depreciation. In order of significance, the changes in operating assets and liabilities that had a significant impact on the cash provided operating activities included (i) an increase in accounts payable due to the timing of payments and the increase in inventory and (ii) an increase in other liabilities related to the increase in customer pre-payments, offset by (iii) an increase in inventories mainly due to sourcing components directly to ensure supply, (iv) an increase in accounts and contract manufacturers’ receivables due to the timing of collections and the increase in sales and (v) a decrease in accrued payroll and related expenses as a result of the timing of the payroll cycle.
 
 
 
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Operating activities provided $928,000 in cash during the three months ended December 31, 2009. This was the result of cash provided by operating assets and liabilities and non-cash operating expenses offset by a net loss. Significant non-cash items included share-based compensation and depreciation. In order of significance, the changes in operating assets and liabilities that had a significant impact on the cash provided by operating activities included (i) an increase in accounts payable due to the timing of payments; offset by (ii) an increase in inventory due to the timing of receipts (iii) an increase in prepaid expenses and other current assets due to a large receivable from the Company’s landlord for reimbursements related to improvements on the new corporate headquarters and (iv) an increase in contract manufacturers’ receivables due to the timing of collections and shipments.

Investing activities used cash during the three months ended December 31, 2010 and 2009, due to the purchase of property and equipment.

Financing activities used cash during the three months ended December 31, 2010 and 2009, due to payments on capital lease obligations and the Term Loan.

Cash Flows for the Six Months Ended December 31

Operating activities provided $29,000 in cash during the six months ended December 31, 2010. This was the result of cash provided by non-cash operating expenses offset by a net loss and cash used by operating assets and liabilities. Significant non-cash items included share-based compensation and depreciation. In order of significance, the changes in operating assets and liabilities that had a significant impact on the cash provided operating activities included (i) an increase in accounts payable due to the timing of payments  and (ii) an increase in other liabilities related to timing of payments on legal and consulting fees as a result of the proxy contest, offset by (iii) an increase in inventories mainly due to sourcing components directly to ensure supply and (iv) an increase in accounts and contract manufacturers’ receivables due to the timing of collections and the increase in sales.

Operating activities provided $1.4 million in cash during the six months ended December 31, 2009.  This was the result of cash provided by operating assets and liabilities and non-cash operating expenses, partially offset by a net loss. Significant non-cash items included share-based compensation and depreciation. In order of significance, the changes in operating assets and liabilities that had a significant impact on the cash provided by operating activities included (i) an increase in accounts payable due to the timing of payments; offset by (ii) a decrease in accrued payroll and related expenses due to the timing of payroll periods (iii) an increase in contract manufacturers’ receivables due to the timing of collections and shipments and (iv) an increase in prepaid expenses and other current assets due to a large receivable from the Company’s landlord for reimbursements related to improvements on the new corporate headquarters.

Investing activities used cash during the six months ended December 31, 2010 and 2009, due to the purchase of property and equipment.

Financing activities provided cash during the six months ended December 31, 2010 due to (i) proceeds from the amended term loan and (ii) proceeds from the sale of common shares through employee stock option exercises, partially offset by (iii) payments related to the Term Loan, (iv) minimum tax withholding paid on behalf of employees related to the vesting of restricted shares and (v) payments on capital lease obligations.

Financing activities used cash during the six months ended December 31, 2009 due to (i) payments for the minimum tax withholdings on behalf of employees for vested restricted shares and (ii) payments on capital lease obligations and the Term Loan; offset by (iii) proceeds from the sale of common shares through employee stock option exercises.

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. 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.
 
 
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(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 December 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
PART II. OTHER INFORMATION

Item 1A. Risk Factors
 
We operate in a rapidly changing environment that involves numerous risks and uncertainties. Before deciding to purchase, hold or sell our common stock, you should carefully consider the risks described in this section. This section should be read in conjunction with the consolidated financial statements and accompanying notes thereto, and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Quarterly Report on Form 10-Q and in the risks described in our Annual Report on Form 10-K. If any of these 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.
 
We have a history of losses.
 
We incurred a net loss of approximately $1.2 million for the six months ended December 31, 2010.  There can be no assurance that we will net profits in future periods.  In addition, while we were cash flow positive in the recently completed quarter, there can be no assurance that we will be cash flow positive in future periods.  In the event we fail to achieve profitability in future periods, the value of our common stock my decline.  In addition, if we were unable to maintain positive cash flows, we would be required to seek additional funding, which may not be available on favorable terms, if at all.
 
Our quarterly operating results may fluctuate, which could cause our stock price to decline.
 
We have experienced, and expect to continue to experience, significant fluctuations in net 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. A high percentage of our operating expenses are relatively fixed and are based on our forecast of future net revenue. If we were to experience an unexpected reduction in net revenue in a quarter, we would likely be unable to adjust our short-term expenditures significantly. If this were to occur, our operating results for that fiscal quarter would be harmed. In addition, if our operating results in future fiscal quarters were to 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 business and economic conditions, including the recent global economic recession;

 
changes in the mix of net revenue 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;

 
fluctuations in exchange rates;

 
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;
 
 
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natural disasters in the U.S. and abroad;

 
changes in demand for devices that incorporate our products; and

 
our customers’ decisions to integrate network access and control directly onto their own platforms.

Delays in deliveries or quality problems with our component suppliers could damage our reputation and could cause our net revenue 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 some components and 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 by the manufacturer. 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. Due to the downturn in the economy, we have been experiencing higher component shortages and extended lead-times. 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 most 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.
 
If we are unable to raise additional capital, our business could be adversely affected.

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

If a major distributor or 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 that they buy our products from us, they are also part of our product distribution system. One or more 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:
 
    Six Months Ended  
    December 31,  
   
2010
   
2009
 
Top five customers (1)(2)
    39.3%       37.6%  
Ingram Micro
    13.1%       7.9%  
Tech Data
    7.7%       10.8%  
 
(1) Includes Ingram Micro and Tech Data
(2) All top five customers are distributors
 
 
 
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The loss or deferral of one or more significant customers in a quarter could significantly harm our operating results. We have in the past, and may 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 and 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 revenue to decrease and could cause our stock price to decline.

We may experience difficulties in transitioning to third-party logistics providers.
 
We recently transitioned a majority of our physical inventory management process, as well as the shipping and receiving of our inventory, to third-party logistics providers in Los Angeles and Hong Kong. There is a possibility that these third-party logistics providers will not perform as expected and we could experience delays in our ability to ship, receive, and process the related data in a timely manner. This could adversely affect our financial position, results of operations, cash flows and the market price of our common stock.
 
Relying on third-party logistics providers could increase the risk of the following: failing to receive accurate and timely inventory data, theft or poor physical security of our inventory, inventory damage, ineffective internal controls over inventory processes or other similar business risks out of our immediate control.
 
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 revenue and results of operations.
 
We do not have long-term agreements with our contract manufacturers or suppliers. If any of these subcontractors or suppliers were to cease doing business with us, we might 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 from our contract manufacturers or suppliers could damage our customer relationships and materially and adversely affect our business, financial condition or results of operations.
 
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 evolving government and industry standards. The demand for network-enabled products is relatively new and can change as a result of innovations, new technologies or new government and industry standards. For example, a directive in the European Union banned 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 demanded 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 revenue might not grow at the rate we anticipate, and it could decline.
 
 
 
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Environmental regulations such as the Waste Electrical and Electronic Equipment (“WEEE”) directive may require us to redesign our products and to develop compliance administration systems.
 
Various countries have begun to require companies selling a broad range of electrical equipment to conform to regulations such as the WEEE directive and we expect additional countries and locations to adopt similar regulations in the future. New environmental standards such as these could require us to redesign our products in order to comply with the standards, and require the development of compliance administration systems. We have already invested significant resources into developing compliance tracking systems, and further investments may be required. Additionally, we may incur significant costs to redesign our products and to develop compliance administration systems, which in turn could have an adverse effect on our gross profit margin. If we cannot develop compliant products in a timely manner or properly administer our compliance programs, our net revenue may also decline due to lower sales, which would adversely affect our operating results.
 
If our research and development efforts are not successful, our net revenue 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 the research and development of those products. On the other hand, if we do not invest sufficiently in research and development, we may be unable to maintain our competitive position. The continuing effects of the economic recession could require cost-containment measures, which could force us to reduce our investment in research and development and put us at a competitive disadvantage compared to our competitors.
 
We expect the average selling prices of our products to decline and raw material costs to increase, which could reduce our net revenue and gross margins and adversely affect results of operations.
 
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 also 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 or in response to price increases by our suppliers, resulting in lower gross margins. Further, as is characteristic of our industry, the average selling prices of our products have historically decreased over the products’ life cycles and we expect this pattern to continue. If any of these were to occur, our gross margins could decline and we might 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 subject to a wide range of claims and lawsuits in the course of our business. Any lawsuit may involve complex questions of fact and law and may require the expenditure of significant funds and the diversion of other resources. The results of litigation are inherently uncertain, and adverse outcomes are possible.
 
In addition, the contested proxy could involve expensive litigation.
 
Our products may contain undetected software or hardware errors or defects that could lead to an increase in our costs, reduce our net revenue 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 might have to refund the purchase price for the units. 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 revenue 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.
 
 
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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.
 
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 four manufacturers in Asia: Venture Electronics Services, Uni Precision Industrial Ltd., Universal Scientific Industrial Company, LTD and Hana Microelectronics, Inc. In addition, two independent third party foundries located in Asia manufacture substantially all of our large scale integration chips. 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.
 
Due to the downturn in the economy, which has put some suppliers out of business, we have been experiencing higher component shortages. 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 revenue 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 revenue or we may be unable to fulfill customer orders, thus reducing net revenue and therefore earnings.
 
 
 
 
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Our international activities are subject to uncertainties, which include international economic, regulatory, political and other risks that could harm our business, financial condition or results of operations.
 
The following table presents sales by geographic region as a percentage of net revenue:
 
    Three Months Ended December 31,      
          % of Net         % of Net   Change  
   
2010
   
Revenue
 
2009