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Acquisition

12 Months Ended

Jun. 30, 2022

Business Combination and Asset Acquisition [Abstract]

Acquisition

On April 28, 2021, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with Communications Systems, Inc., a Minnesota corporation (“CSI”), pursuant to which we agreed to purchase from CSI the Transition Networks (“TNI”) and Net2Edge businesses of CSI (the “Transaction”). The Transaction closed on August 2, 2021 (the “Closing Date”), with Lantronix acquiring all outstanding shares of the common stock of TNI and all of the outstanding ordinary shares of Transition Networks Europe Limited (such entity, together with TNI, the “TN Companies”) for an aggregate purchase price of up to approximately $32,028,000 consisting of (i) $25,028,000 in cash paid on the Closing Date, plus (ii) earnout payments of up to $7,000,000, payable following two successive 180-day intervals after the Closing Date based on revenue targets for the business of the TN Companies as specified in the Purchase Agreement, subject to certain adjustments and allocations as further described in the Purchase Agreement. Based on preliminary working capital estimates of the TN Companies at the Closing Date, we paid $24,160,000 in cash consideration on the Closing Date. In September 2021, pursuant to working capital adjustments as outlined in the Purchase Agreement, the net cash consideration paid as of the Closing Date was adjusted to approximately $23,651,000.

Concurrently with the closing of the Transaction, CSI and Lantronix entered in a Transition Services Agreement under which CSI performed administrative and IT services, and lease office, warehouse and production space to Lantronix for the TN Companies for a period of up to twelve months.

The acquisition of the TN Companies provides Lantronix with complementary IoT connectivity products and capabilities, including switching, power over ethernet and media conversion and adapter products.

A summary of the purchase consideration for the TN Companies is as follows (in thousands):

Summary of purchase consideration
Cash consideration paid to CSI	$	23,651
Estimated fair value of earnout consideration		393
Total purchase consideration	$	24,044

We recorded the TN Companies’ tangible and intangible assets and liabilities based on their estimated fair values as of the Closing Date and allocated the remaining purchase consideration to goodwill. Our valuation assumptions of acquired assets and assumed liabilities require significant estimates, especially with respect to intangible assets.

Subsequent to the Closing Date, we made certain measurement period adjustments to the preliminary purchase price allocation, based on clarification of information utilized in our analysis and estimates to determine the fair value of assets acquired and liabilities assumed. These adjustments resulted in a net increase to goodwill of $2,498,000, and were driven by the following:

an increase in deferred income tax liabilities of $2,036,000 related to the finalization of our conclusions regarding non-tax-deductible intangible assets acquired,

ii.

an increase in the estimated fair value of earnout consideration of $47,000,

iii.

a decrease in amortizable intangible assets of $440,000,

iv.

an increase in acquired net accounts receivable of $121,000, and

a decrease in acquired net inventories of $96,000

As of June 30, 2022, the measurement period is complete.

The final purchase price allocation is as follows (in thousands):

Schedule of purchase price allocation
Cash and cash equivalents	$	22
Accounts receivable, net		5,277
Inventories, net		7,734
Prepaid expense and other current assets		355
Property and equipment, net		121
Goodwill		4,958
Amortizable intangible assets		10,794
Accounts payable		(1,872	)
Accrued payroll		(9	)
Deferred tax liability		(2,036	)
Other current liabilities		(1,300	)
Total consideration	$	24,044

The factors that contributed to a purchase price resulting in the recognition of goodwill include our belief that the Transaction will create a more diverse IoT company with respect to product offerings and our belief that we are committed to improving cost structures in accordance with our operational and restructuring plans which should result in a realization of cost savings and an improvement of overall efficiencies.

Depending on the structure of a particular acquisition, goodwill and identifiable intangible assets may not be deductible for tax purposes. We have determined that goodwill and identifiable intangible assets related to the Transaction are not deductible.

Acquisition-related costs were expensed in the periods in which the costs were incurred.

The valuation of identifiable intangible assets and their estimated useful lives are as follows:


	Asset Fair Value		Weighted Average Useful Life
		(In thousands)		(In years)
Customer relationships	$	7,467		3.5
Developed technology		1,890		3.5
Order backlog		567		1.0
Trademarks and trade names		870		2.0

The intangible assets are amortized on a straight-line basis over the estimated weighted-average useful lives.

Valuation Methodology

The customer relationships and order backlog were valued using the multi-period excess earnings method, which estimates revenues and cash flows derived from this asset and also considers portions of the cash flows that can be attributed to the use of other supporting assets. The useful lives of customer relationships are estimated based primarily upon customer turnover data. Order backlog was estimated to be substantially fulfilled within a year of the Closing Date.

Developed technology and trademarks and trades names were valued using the relief-from-royalty method. This method is an income approach that estimates the portion of a company’s earnings attributable to an asset based on the royalty rate the company would have paid for the use of the asset if it did not own it. Royalty payments are estimated by applying a royalty rate to the prospective revenue attributable to the intangible asset. The resulting annual royalty payments are tax-affected and then discounted to present value.

Assumptions used in forecasting cash flows for each of the identified intangible assets included consideration of the following:

Historical performance including sales and profitability

Business prospects and industry expectations

Estimated economic life of the asset

Development of new technologies

Acquisition of new customers

Attrition of existing customers

Obsolescence of technology over time

The fair value of earnout consideration was estimated based on applying a Monte Carlo simulation method to forecast achievement of the revenue targets. This method involves many possible value outcomes which are evaluated to establish an estimated value. Key inputs in the valuation include forecasted revenue, revenue volatility and discount rate.

Remeasurement of Earnout Consideration

During the fiscal year ended June 30, 2022, we remeasured the estimated fair value of the earnout consideration to a total of $1,500,000 based on the achievement of certain revenue targets for the business of the TN Companies during the earnout period.

As compared to the originally recorded estimated value of $393,000, the remeasurement of the earnout consideration resulted in an upward adjustment of $1,107,000 that was recorded within our operating expenses in the accompanying consolidated statement of operations for the year ended June 30, 2022.

Supplemental Pro Forma Information (Unaudited)

The following supplemental pro forma data summarizes our results of operations for the periods presented, as if we completed the acquisition of the TN Companies as of the first day of our fiscal year ended June 30, 2021. The supplemental pro forma data reports actual operating results adjusted to include the pro forma effect and timing of the impact of amortization expense of identified intangible assets, restructuring costs, the purchase accounting effect on inventories acquired, and transaction costs. In accordance with the pro forma acquisition date, we recorded in the twelve months ended June 30, 2021 supplemental pro forma data (i) cost of goods sold from manufacturing profit in acquired inventory of $380,000, (ii) acquisition related restructuring costs of $508,000 and (iii) acquisition-related costs of $629,000, with a corresponding reduction in the year ended June 30, 2022 supplemental pro forma data. Additionally, we recorded $3,675,000 of amortization expense in the year ended June 30, 2021 supplemental pro forma data, and a reduction to amortization expense of $242,000 in the year ended June 30, 2022 supplemental pro forma data to represent amortization for the full fiscal year period.

Net sales related to products from the acquisition of the TN Companies contributed approximately 28% of our total net sales for the year ended June 30, 2022. As of the Closing Date, we began to immediately integrate the acquisition into existing operations, engineering groups, sales distribution networks and management structure, making it generally impracticable to determine the post-acquisition net sales and earnings on a standalone basis.

Supplemental pro forma data is as follows:

Schedule of supplemental pro forma data
	Year Ended June 30,
	2022			2021
	(In thousands, except per share amounts)
Pro forma net revenue	$	132,442		$	106,822
Pro forma net loss	$	(5,751	)	$	(5,071	)

Pro forma net loss per share:
Basic and Diluted	$	(0.12	)	$	(0.25	)