The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this report. In addition to historical information, the discussion in this report contains forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those anticipated by these forward-looking statements due to factors including, but not limited to, those factors set forth under Part I, Item 1A "Risk Factors" and elsewhere in this report.

Overview

We design, develop and market devices that make it possible to access, manage, control and configure electronic devices over the Internet and other networks. We are a leader in providing innovative networking solutions. We were initially formed as "Lantronix," a California corporation, in June 1989. We reincorporated as "Lantronix, Inc.," a Delaware corporation in May 2000. Our products are sold to distributors, OEMs, VARs, and systems integrators, as well as directly to end users.

Fiscal Year 2008 Financial Highlights and Other Information

A summary of the key factors and significant events which impacted our financial performance during the fiscal year ended June 30, 2008 are as follows:

· Net revenues were $57.6 million for the fiscal year ended June 30, 2008, an increase of $2.3 million, or 4.1%, compared to $55.3 million for the fiscal year ended June 30, 2007. The increase was primarily the result of a $5.1 million, or 10.5%, increase in our device networking product lines offset by a $2.8 million, or 41.9%, decrease in our non-core product lines.

· Gross profit as a percentage of net revenues was 50.5% for the fiscal year ended June 30, 2008 compared to 51.2% for the fiscal year ended June 30, 2007. The decrease in gross profit margin percentage was primarily attributable to an increase in certain inventory reserves in connection with a review of our product offerings as part of our effort to simplify our product portfolio by discontinuing slow-moving and non-strategic products.

· Loss from operations was $2.6 million, or 4.5%, of net revenues for the fiscal year ended June 30, 2008 compared to $2.4 million, or 4.4%, for the fiscal year ended June 30, 2007. The loss from operations for the fiscal year ended June 30, 2008 included a restructuring charge of $757,000.

· Net loss was $2.5 million, or $0.04 per basic and diluted share, for the fiscal year ended June 30, 2008, compared to $1.7 million, or $0.03 per basic and diluted share, for the fiscal year ended June 30, 2007. The net loss for the fiscal year ended June 30, 2008 included a restructuring charge of $757,000. The net loss for the fiscal year ended June 30, 2007 included a gain on the sale of long-term investment of $700,000.

· Cash and cash equivalents were $7.4 million as of June 30, 2008 compared to $7.6 million as of June 30, 2007.

· Net accounts receivable were $4.2 million as of June 30, 2008 compared to $3.4 million as of June 30, 2007. Annual days sales outstanding ("DSO") in receivables were 24 days for the fiscal year ended June 30, 2008 as compared to 21 days for the fiscal year ended June 30, 2007. Our accounts receivable and DSO are primarily affected by the timing of shipments within a quarter, our collections performance and the fact that a significant portion of our revenues are recognized on a sell-through basis (upon shipment from distributor inventories rather than as goods are shipped to distributors).

· Net inventories were $8.0 million as of June 30, 2008 compared to $11.0 million as of June 30, 2007. Annual inventory turns were 3.0 for the fiscal year ended June 30, 2008 as compared to 2.8 for the fiscal year ended June 30, 2007.

Recent Accounting Pronouncements

In September 2006 the FASB issued SFAS 157, "Fair Value Measurements" ("SFAS 157"), which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. In February 2008 the FASB approved FASB Staff Position 157-2, "Effective Date of FASB Statement No. 157," which delays the effective date of SFAS 157 for non-financial assets and liabilities to fiscal years beginning after November 15, 2008. We are currently evaluating the impact, if any, that SFAS 157 may have on our future consolidated financial statements related to non-financial assets and liabilities.

Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants and the SEC did not or are not believed by us to have a material impact on our present or future consolidated financial statements.

Critical Accounting Policies and Estimates

The preparation of financial statements and related disclosures in accordance with accounting principles generally accepted in the U.S. requires us to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenues and expenses during the reporting period. We regularly evaluate our estimates and assumptions related to net revenues, allowances for doubtful accounts, sales returns and allowances, inventory valuation, valuation of deferred income taxes, goodwill and purchased intangible asset valuations, warranty reserves, restructuring costs, litigation and other contingencies. We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected.

We believe the following critical accounting policies require us to make significant judgments and estimates in the preparation of our consolidated financial statements:

Revenue Recognition

We do not recognize revenue until all of the following criteria are met:
persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; our price to the buyer is fixed or determinable; and collectibility is reasonably assured. A significant portion of our sales are made to distributors under agreements which contain a limited right to return unsold product and price protection provisions. Therefore, the recognition of net revenues and related cost of revenues from sales to distributors are deferred until the distributor resells the product. Net revenues from certain smaller distributors for which point-of-sale information is not available, is recognized approximately one month after the shipment date. This estimate approximates the timing of the sale of the product by the distributor to the end user.

When product revenues are recognized, we establish an estimated allowance for future product returns based on historical returns experience; when price reductions are approved, we establish an estimated liability for price protection payable on inventories owned by product resellers. Should actual product returns or pricing adjustments exceed our estimates, additional reductions to revenues would result.

Our products typically carry a one- or two-year warranty. In addition, certain products that were sold prior to August 2003 carry a five-year warranty. Although we engage in extensive product quality programs and processes, our warranty obligation is affected by product failure rates, use of materials or service delivery costs that differ from our estimates. As a result, additional warranty reserves could be required, which could reduce gross margins. Additionally, we sell extended warranty services, which extend the warranty period for an additional one to three years, depending upon the product. Warranty net revenues are recognized ratably over the warranty service period.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Our allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts, the aging of accounts receivable, our history of bad debts and the general condition of the industry. If a major customer's credit worthiness deteriorates, or our customers' actual defaults exceed our historical experience, our estimates could change and impact our reported results.

We also maintain a reserve for uncertainties relative to the collection of officer notes receivable. Factors considered in determining the level of this reserve include the value of the collateral securing the notes, our ability to effectively enforce collection rights and the ability of the former officers and Lantronix director to honor their obligations.

Inventory Valuation

Our policy is to value inventories at the lower of cost or market on a part-by-part basis. This policy requires us to make estimates regarding the market value of our inventories, including an assessment of excess and obsolete inventories. We determine excess and obsolete inventories based on an estimate of the future sales demand for our products within a specified time horizon, generally three to twelve months. The estimates we use for demand are also used for near-term capacity planning and inventory purchasing and are consistent with our revenue forecasts. In addition, specific reserves are recorded to cover risks in the area of end of life products, inventory located at our contract manufacturers, deferred inventory in our sales channel and warranty replacement stock.

If our sales forecast is less than the inventory we have on hand at the end of an accounting period, we may be required to take excess and obsolete inventory charges, which will decrease gross margin and net operating results for that period.

Valuation of Deferred Income Taxes

We have recorded a valuation allowance to reduce our net deferred tax assets to zero, primarily due to historical net operating losses and uncertainty of generating future taxable income. We consider estimated future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. If we determine that it is more likely than not that we will realize a deferred tax asset, which currently has a valuation allowance, we would be required to reverse the valuation allowance that would be reflected as an income tax benefit at that time.

Goodwill and Purchased Intangible Assets

The purchase method of accounting for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of the net tangible and intangible assets acquired, including in-process research and development. The amounts and useful lives assigned to intangible assets impact future amortization. If the assumptions and estimates used to allocate the purchase price are not correct, purchase price adjustments or future asset impairment charges could be required.

We perform goodwill impairment tests on an annual basis, and more frequently if events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Goodwill impairment testing requires us to compare the fair value of each reporting unit to its carrying amount, including goodwill, and record an impairment charge if the carrying amount of a reporting unit exceeds its estimated fair value. The determination of a reporting unit's fair value requires significant judgment and is based on management's best estimate, which generally considers the unit's expected future earnings. If actual results are not consistent with our assumptions and judgments used in estimating fair value, we may be exposed to additional goodwill impairment losses. As of June 30, 2008, we have $9.5 million of goodwill reflected in our consolidated balance sheet.

We evaluate purchased intangible assets when indicators of impairment, such as reductions in demand or significant economic slowdowns, are present. Reviews are performed to determine whether the carrying values of these assets are impaired based on a comparison to the undiscounted expected future cash flows. If the comparison indicates that there is impairment, the expected future cash flows using a discount rate based upon our weighted average cost of capital is used to estimate the fair value of the assets. Impairment is based on the excess of the carrying amount over the fair value of those assets. Significant management judgment is required in the forecast of future operating results that is used in the preparation of expected discounted cash flows. It is reasonably possible that the estimates of anticipated future net revenues, the remaining estimated economic lives of the products and technologies, or both, could differ from those used to assess the recoverability of our purchased intangible assets. In the event they are lower, additional impairment charges or shortened useful lives of certain purchased intangible assets could be required. As of June 30, 2008, we have approximately $382,000 of purchased intangible assets reflected in our consolidated balance sheet.

Fiscal Years Ended June 30, 2008 and 2007

Net Revenues by Product Line

The following table presents net revenues by product line:

                                   Years Ended June 30,
                                  % of Net                    % of Net             Change
                      2008        Revenues        2007        Revenues         $            %
                                          (In thousands, except percentages)
Device enablement   $ 44,993           78.1 %   $ 39,734           71.9 %   $  5,259        13.2 %
Device management      8,694           15.1 %      8,866           16.0 %       (172 )      (1.9 %)
Device networking     53,687           93.2 %     48,600           87.9 %      5,087        10.5 %
Non-core               3,899            6.8 %      6,706           12.1 %     (2,807 )     (41.9 %)
Net revenues        $ 57,586          100.0 %   $ 55,306          100.0 %   $  2,280         4.1 %

The increase in net revenues for the fiscal year ended June 30, 2008 compared to the fiscal year ended June 30, 2007 was primarily a result of an increase in net revenues from our device enablement products offset by a decrease in our non-core and device management products. The increase in our device enablement products for the fiscal year ended June 30, 2008 compared to the fiscal year ended June 30, 2007 was primarily due to an increase in sales of our embedded and external device enablement products. We are no longer investing in the development of our non-core product lines and we expect net revenues related to these products to continue to decline in the future as we focus our investment in our device networking product lines.

Net Revenues by Geographic Region

The following table presents net revenues by geographic region:

                             Years Ended June 30,
                             % of Net                    % of Net           Change
                 2008        Revenues        2007        Revenues       $            %
                                   (In thousands, except percentages)
Americas       $ 33,167           57.6 %   $ 34,950         63.2 %   $ (1,783 )     (5.1 %)
EMEA             16,644           28.9 %     14,002         25.3 %      2,642       18.9 %
Asia Pacific      7,775           13.5 %      6,354         11.5 %      1,421       22.4 %
Net revenues   $ 57,586          100.0 %   $ 55,306        100.0 %   $  2,280        4.1 %

The decrease in net revenues in the Americas region for the fiscal year ended June 30, 2008 compared to the fiscal year ended June 30, 2007 was primarily attributable to a decrease in sales of non-core and device management products offset by an increase in sales of device enablement products. The increase in net revenues in the EMEA ("Europe, Middle East and Africa") region for the fiscal year ended June 30, 2008 compared to the fiscal year ended June 30, 2007 was primarily due to an increase in sales of our device enablement products. The increase in net revenues in the Asia Pacific region for the fiscal year ended June 30, 2008 compared to the fiscal year ended June 30, 2007 was primarily attributable to an increase in sales of device enablement products.

Net Revenues by Significant Customer

The following table presents net revenues by significant customer and a related
party as a percentage of net revenues:

                                              Years Ended June 30,
                                             2008              2007

Top five customers (1)                            38 %              34 %
Tech Data                                         13 %               8 %
Ingram Micro                                       8 %              12 %
Related party                                      2 %               2 %

(1) Includes Ingram Micro and Tech Data.

An international customer, transtec AG, is a related party due to common ownership by our largest stockholder and Lantronix director, Bernhard Bruscha.

Gross Profit

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

The following table presents gross profit:

                              Years Ended June 30,
                             % of Net                    % of Net           Change
                 2008        Revenues        2007        Revenues        $         %
                                  (In thousands, except percentages)

The decrease in gross profit margin percentage for the fiscal year ended June 30, 2008 compared to the fiscal year ended June 30, 2007 was primarily attributable to an increase in certain inventory reserves in connection with a review of our product offerings as part of our effort to simplify our product portfolio by discontinuing slow-moving and non-strategic products.

Selling, General and Administrative

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

The following table presents selling, general and administrative expenses:

                                Years Ended June 30,
                                % of Net                % of Net            Change
                      2008      Revenues      2007      Revenues        $             %
                                       (In thousands, except percentages)
Personnel-related
expenses            $  13,663               $  12,521               $   1,142           9.1 %
Professional fees
& outside
services                2,569                   2,704                    (135 )        (5.0 %)
Advertising and
marketing               2,959                   3,234                    (275 )        (8.5 %)
Facilities              1,600                   2,042                    (442 )       (21.6 %)
Share-based
compensation              847                     922                     (75 )        (8.1 %)
Depreciation              368                     288                      80          27.8 %
Other                   1,886                   1,532                     354          23.1 %
Selling, general
and
administrative      $  23,892       41.5%   $  23,243       42.0%   $     649           2.8 %

In order of significance, the increase in selling, general and administrative expense for the fiscal year ended June 30, 2008 compared to the fiscal year ended June 30, 2007 was primarily due to: (i) an increase in personnel-related expenses as a result of severance charges related to the departure of the former president and chief executive officer and other former employees; offset by (ii) a decrease in facilities expenses as a result of lower insurance and other allocated facility costs, (iii) a decrease in advertising and marketing spending due to the timing of product launches and more focused marketing spending and
(iv) a decrease in professional fees & outside services.

Research and Development

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

The following table presents research and development expenses:

                                  Years Ended June 30,
                                 % of Net                % of Net             Change
                      2008       Revenues      2007      Revenues        $              %
                                        (In thousands, except percentages)
Personnel-related
expenses            $   5,102                $   5,308               $    (206 )        (3.9 %)
Facilities                876                      666                     210          31.5 %
Professional fees
& outside
services                  209                      519                    (310 )       (59.7 %)
Share-based
compensation              341                      378                     (37 )        (9.8 %)
Depreciation               57                       41                      16          39.0 %
Other                     359                      450                     (91 )       (20.2 %)
Research and
development         $   6,944        12.1%   $   7,362       13.3%   $    (418 )        (5.7 %)

The decrease in research and development expenses for the fiscal year ended June 30, 2008 compared to the fiscal year ended June 30, 2007 was primarily due to:
(i) a decrease in professional fees & outside services and (ii) a decrease in personnel-related expenses.

Restructuring Charges

The following table presents restructuring charges:

                                  Years Ended June 30,
                                 % of Net                % of Net           Change
                       2008      Revenues      2007      Revenues        $          %
                                      (In thousands, except percentages)

During the fourth fiscal quarter ended June 30, 2008, we implemented a restructuring plan to optimize our organization to better leverage existing customer and partner relationships to drive revenue growth and profitability. As part of the restructuring plan, 10 employees from the senior-level ranks of the sales, marketing, operations and engineering groups were terminated.

Interest Expense, Net

The following table presents interest expense, net:

                                     Years Ended June 30,
                                    % of Net                  % of Net              Change
                         2008       Revenues       2007       Revenues          $          %
                                            (In thousands, except percentages)

The increase in interest expense, net, is primarily due to interest expense related to the addition of capital leases during the fiscal year ended June 30, 2008 and lower yields on cash deposits.

Other Income, Net

The following table presents other income, net:

                               Years Ended June 30,
                              % of Net                % of Net            Change
                    2008      Revenues      2007      Revenues         $           %
                                     (In thousands, except percentages)

Other income, net, for the fiscal year ended June 30, 2008 is primarily due to $104,000 of income recognized on the sale of marketable securities. Other income, net, for the fiscal year ended June 30, 2007 is primarily due to $700,000 of income recognized on the sale of our investment in Xanboo.

On July 1, 2007, we adopted Financial Accounting Standards Board Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109" ("FIN 48"). In connection with the adoption of FIN 48, we recognized an adjustment of approximately $226,000 to the beginning balance of accumulated deficit on our consolidated balance sheet. Our continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. As of June 30, 2008, we had recorded $153,000 of uncertain tax positions including approximately $75,000 of accrued interest and penalties related to these uncertain tax positions.

At July 1, 2007, our fiscal 2001 through fiscal 2008 tax years remain open to examination by the Federal and state taxing authorities. However, we have net operating losses ("NOLs") beginning in fiscal 2001 which would cause the statute of limitations to remain open for the year in which the NOL was incurred.

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

                         Years Ended June 30,
                        2008              2007

Effective tax rate           4.5 %           2.0 %

We utilize the liability method of accounting for income taxes as set forth in Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." The tax benefit is the result of a reduction in estimated foreign taxes and penalties. The federal statutory rate was 34% for all periods. The difference between our effective tax rate and the federal statutory rate resulted primarily from the effect of our domestic losses recorded without a tax benefit, as well as the effect of foreign earnings taxed at rates differing from the federal statutory rate. We record net deferred tax assets to the extent we believe these assets will more likely than not be realized.

. . .