- --------------------------------------------------------------------------------

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, 2001

[_] 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: 333-37508

----------------------------

LANTRONIX, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 33-0362767
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)

15353 Barranca Parkway Irvine, California 92618
(Address of principal executive offices and zip code)

(949) 453-3990
(Registrant's telephone number, including area code)

----------------------------

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(D) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]

As of January 31, 2002, 52,771,640 shares of the Registrant's common stock
were outstanding.

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LANTRONIX, INC.

FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2001

INDEX

Page
----

PART I. FINANCIAL INFORMATION .......................................................................... 1

Item 1. Financial Statements. .......................................................................... 1

Condensed Consolidated Balance Sheets at December 31, 2001 (unaudited) and June 30, 2001 ....... 1

Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months Ended
December 31, 2001 and 2000 ..................................................................... 2

Unaudited Condensed Consolidated Statements of Cash Flows for the Three and Six Months Ended
December 31, 2001 and 2000 ..................................................................... 3

Notes to Unaudited Condensed Consolidated Financial Statements. ................................ 4

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations .......... 8

Item 3. Quantitative and Qualitative Disclosures About Market Risk. .................................... 22

PART II. OTHER INFORMATION .............................................................................. 22

Item 1. Legal Proceedings .............................................................................. 22

Item 2. Changes in Securities and Use of Proceeds....................................................... 22

Item 3. Defaults Upon Senior Securities ................................................................ 23

Item 4. Submission of Matters to a Vote of Security Holders ............................................ 23

Item 5. Other Information .............................................................................. 23

Item 6. Exhibits and Reports on Form 8-K. .............................................................. 23

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

LANTRONIX, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)

December 31, June 30,
2001 2001
---- ----
(Unaudited)

ASSETS
------

Current assets:
Cash and cash equivalents ............................................... $ 38,649 $ 15,367
Short-term investments .................................................. 9,872 1,973
Accounts receivable, net ................................................ 8,812 15,979
Other receivables........................................................ 3,990 1,805
Inventories ............................................................. 16,284 10,788
Deferred income taxes ................................................... 4,503 2,231
Prepaid income taxes .................................................... 622 973
Prepaid expenses and other current assets ............................... 3,025 2,000
---------- ----------
Total current assets ................................................ 85,757 51,116
Property and equipment, net .................................................. 7,014 5,492
Goodwill and other purchased intangible assets, net .......................... 79,243 55,601
Long-term investments ........................................................ 6,981 2,424
Officer loans................................................................. 4,131 4,131
Other assets ................................................................. 1,080 780
---------- ----------
Total assets ........................................................ $ 184,206 $ 119,544
========== ==========

LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------

Current liabilities:
Accounts payable ........................................................ $ 5,374 $ 5,698
Accrued payroll and related expenses .................................... 1,284 1,243
Other current liabilities ............................................... 3,560 3,742
---------- ----------
Total current liabilities ........................................... 10,218 10,683
Deferred income taxes ........................................................ 11,108 5,895

Stockholders' equity:
Common stock .............................................................. 5 4
Additional paid-in capital. ............................................... 174,682 109,871
Employee notes receivable ................................................. (790) (790)
Deferred compensation ..................................................... (8,719) (10,020)
Retained earnings (accumulated deficit) ................................... (1,829) 4,052
Accumulated other comprehensive loss ...................................... (469) (151)
---------- ----------
Total stockholders' equity .......................................... 162,880 102,966
---------- ----------
Total liabilities and stockholders' equity .......................... $ 184,206 $ 119,544
========== ==========

See accompanying notes.

LANTRONIX, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)

Three Months Ended Six Months Ended
December 31, December 31,
-------------------- --------------------
2001 2000 2001 2000

Net revenues (A) ................................................................... $ 16,439 $ 12,465 $ 32,708 $ 24,502
Cost of revenues (B) (C) ........................................................... 7,524 5,689 15,194 11,038
-------- -------- -------- --------

Gross profit ....................................................................... 8,915 6,776 17,514 13,464
-------- -------- -------- --------

Operating expenses:
Selling, general and administrative (C) ....................................... 7,695 5,659 15,274 10,652
Research and development (C) .................................................. 1,956 1,021 4,048 2,073
Stock-based compensation (C) .................................................. 829 674 2,028 1,337
Amortization of purchased intangible assets ................................... 524 363 809 726
-------- -------- -------- --------
Total operating expenses ........................................................... 11,004 7,717 22,159 14,788
-------- -------- -------- --------
Loss from operations ............................................................... (2,089) (941) (4,645) (1,324)
Interest income (expense), net ..................................................... 479 671 1,015 1,186
Other income (expense), net ........................................................ 7 79 (328) (13)
-------- -------- -------- --------
Loss before income taxes and cumulative effect of accounting change ................ (1,603) (191) (3,958) (151)
Benefit for income taxes ........................................................... (432) (140) (632) (77)
-------- -------- -------- --------
Loss before cumulative effect of accounting change ................................. (1,171) (51) (3,326) (74)
Cumulative effect of accounting change, net of income taxes of $1,049 (Note 2)...... - - (2,557) -
-------- -------- -------- --------

Basic and diluted loss per share ................................................... $ (1,171) $ (51) $ (5,883) $ (74)
======== ======== ======== ========
Basic and diluted loss per share before cumulative effect of
accounting change ................................................................ $ (0.02) $ (0.00) $ (0.07) $ (0.00)
Cumulative effect of accounting change per share ................................... - - (0.05) -
-------- -------- -------- --------
Basic and diluted net loss per share ............................................... $ (0.02) $ (0.00) $ (0.12) $ (0.00)
======== ======== ======== ========
Weighted average shares (basic and diluted) ........................................ 51,261 36,709 49,374 35,058
======== ======== ======== ========

(A) Includes net revenues from related parties.................................... $ 172 $ 1,302 $ 371 $ 2,093
======== ======== ======== ========
(B) Cost of revenues includes the following:
Amortization of purchased intangible assets ............................... $ 560 $ - $ 898 $ -
======== ======== ======== ========
(C) Excludes stock-based compensation as follows:
Cost of revenues .......................................................... $ 49 $ 14 $ 75 $ 25
Selling, general and administrative expenses .............................. 679 578 1,509 1,149
Research and development expenses ......................................... 101 82 444 163
-------- -------- -------- --------
$ 829 $ 674 $ 2,028 $ 1,337
======== ======== ======== ========

See accompanying notes.

LANTRONIX, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

Six Months Ended
December 31,
2001 2000
---- ----

Cash flows from operating activities:
Net loss .................................................................................... $ (5,883) $ (74)
Adjustments to reconcile net loss to net cash used in operating activities:
Cumulative effect of accounting change ................................................. 2,557 -
Depreciation ........................................................................... 1,225 234
Amortization of purchased intangible assets ............................................ 1,707 406
Stock-based compensation. .............................................................. 2,028 1,337
Provision for doubtful accounts ........................................................ 464 220
Revaluation of strategic investment .................................................... 500 --
Loss on disposal of asset .............................................................. -- 20
Changes in operating assets and liabilities, net of effect from acquisitions:
Accounts receivable ................................................................... 1,313 (2,829)
Other receivables...................................................................... (2,185) -
Inventories ........................................................................... (2,118) (3,413)
Prepaid expenses and other current assets ............................................. 9 209
Other assets .......................................................................... (1,004) (465)
Accounts payable. ..................................................................... (2,705) 317
Other current liabilities ............................................................. (71) (407)
---------- ---------
Net cash used in operating activities ....................................................... (4,163) (4,445)
---------- ---------
Cash flows from investing activities:
Purchase of property and equipment, net ................................................ (2,625) (1,985)
Purchase of minority investments, net .................................................. (4,318) --
Acquisition of businesses, net of cash acquired ........................................ (3,393) 324
Purchase of held-to-maturity investments ............................................... (12,184) (28,015)
Proceeds from sale of held-to-maturity investments ..................................... 1,975 --
---------- ---------
Net cash used in investing activities ....................................................... (20,545) (29,676)
---------- ---------
Cash flows from financing activities:
Net proceeds from underwritten offerings of common stock. .............................. 47,085 53,713
Net proceeds from other issuances of common stock ...................................... 869 143
---------- ---------
Net cash provided by financing activities ................................................... 47,954 53,856
Effect of foreign exchange rates on cash. ................................................... 36 7
---------- ---------
Increase in cash and cash equivalents ....................................................... 23,282 19,742
Cash and cash equivalents at beginning of period. ........................................... 15,367 1,988
---------- ---------
Cash and cash equivalents at end of period. ................................................. $ 38,649 $ 21,730
========== =========

See accompanying notes.

LANTRONIX, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2001

1. Basis of Presentation

The condensed consolidated financial statements included herein are
unaudited. They contain all normal recurring accruals and adjustments which, in
the opinion of management, are necessary to present fairly the consolidated
financial position of Lantronix, Inc. and its subsidiaries (collectively, the
"Company") at December 31, 2001, and the consolidated results of its operations
and cash flows for the three and six months ended December 31, 2001 and 2000.
All intercompany accounts and transactions have been eliminated. Effective July
1, 2001, the Company changed its accounting method for recognizing revenue on
sales to distributors (note 2). Also effective July 1, 2001 the Company elected
to early adopt SFAS 142 as a result, the Company will no longer amortize
goodwill and certain intangible assets deemed to have indefinite lives. 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, 2001 are not
necessarily indicative of the results to be expected for the full year or any
future interim periods.

The accompanying unaudited condensed consolidated financial statements do
not include certain footnotes and financial presentations normally required
under generally accepted accounting principles. Therefore, these financial
statements should be read in conjunction with the audited consolidated financial
statements and notes thereto for the year ended June 30, 2001, included in the
Company's Annual Report on Form 10-K filed with the Securities and Exchange
Commission ("SEC").

2. Cumulative Effect of Accounting Change

Effective July 1, 2001, the Company changed its accounting method for
recognizing revenue on sales to distributors. Recognition of revenue and related
gross profit on sales to distributors is now deferred until the distributor
resells the product. Previously, the Company recognized revenue from these
transactions upon shipment of product to the distributor, net of appropriate
estimates for possible returns and allowances.

Management of the Company believes that this accounting change is a
preferable method because (1) it better reflects the substance of the
transactions considering the Company's recent entry in the semiconductor
marketplace and the changing business environment; and (2) the new accounting
method is consistent with other companies in the Company's industry and,
therefore, will better focus the Company on end customer sales and provide
greater comparability in the presentation of financial results among the Company
and its peers.

The cumulative effect prior to fiscal 2002 of the accounting change was a
charge of $3.6 million ($2.6 million or $0.05 per share, net of income taxes of
$1.0 million) and was recorded as of July 1, 2001.

The estimated unaudited pro forma effects of the accounting change are as
follows (in thousands, except per share amounts):

Three Months Ended Three Months Ended Six Months Ended
September 30, December 31, December 31,
2001 2000 2001 2000 2001 2000
---- ---- ---- ---- ---- ----

As reported:
Net revenues $ 16,863 $ 12,037 $ 16,439 $ 12,465 $ 32,708 $ 24,502
======== ======== ======== ======== ======== ========
Loss before cumulative effect of
accounting change $ (1,822) $ (23) $ (1,171) $ (51) $ (3,326) $ (74)
Cumulative effect of accounting change, net of
income taxes of $1,049 - - - - (2,557) -
-------- -------- -------- -------- -------- --------
Net loss $ (1,822) $ (23) $ (1,171) $ (51) $ (5,883) $ (74)
======== ======== ======== ======== ======== ========
Loss per share before
cumulative effect of accounting change $ (0.04) $ (0.00) $ (0.02) $ (0.00) $ (0.07) $ (0.00)
Cumulative effect of accounting change - - - - (0.05) -
-------- -------- -------- -------- -------- --------
Basic and diluted net loss per share $ (0.04) $ (0.00) $ (0.02) $ (0.00) $ (0.12) $ (0.00)
======== ======== ======== ======== ======== ========

Pro forma amounts reflecting the accounting
change applied retroactively:
Net revenues $ 16,269 $ 11,644 $ 16,439 $ 12,161 $ 32,708 $ 23,805
======== ======== ======== ======== ======== ========
Net loss $ (2,058) $ (214) $ (1,171) $ (192) $ (3,326) $ (406)
======== ======== ======== ======== ======== ========
Basic and diluted net loss per share $ (0.05) $ (0.01) $ (0.02) $ (0.01) $ (0.07) $ (0.02)
======== ======== ======== ======== ======== ========

3. Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, Business
Combinations ("SFAS No. 141"), effective for acquisitions consummated after June
30, 2001, and SFAS No. 142, Goodwill and Other Intangible Assets ("SFAS No.
142"), effective for fiscal years beginning after December 15, 2001. Under the
new rules, goodwill and certain intangible assets deemed to have indefinite
lives will no longer be amortized but will be subject to annual impairment
tests. Other intangible assets will continue to be amortized over their useful
lives.

The Company has elected to early adopt the rules set forth in SFAS No. 142
on accounting for goodwill and other intangibles effective as of July 1, 2001.
For the six months ended December 31, 2001, early adoption resulted in
non-amortization of goodwill of $3.5 million or $0.07 per share based on the
weighted average shares outstanding for the six months ended December 31, 2001.

The transition provisions of SFAS No. 142 require that the Company complete
its assessment of whether impairment may exist as of the date of adoption by
December 31, 2001 and complete its determination of the amount of any impairment
as of the date of adoption by June 30, 2002. Any impairment that is required to
be recognized when adopting SFAS 142 will be reflected as the cumulative effect
of a change in accounting principle as of July 1, 2001. The Company has
completed its initial assessment and concluded that goodwill arising from the
acquisition of United States Software Corporation (USSC) having a carrying
amount of approximately $5.8 million as of July 1, 2001 may be impaired. The
Company expects to complete its determination of the amount of the impairment
charge, if any, to be reflected as a cumulative effect of a change in accounting
principle during the third fiscal quarter ending March 31, 2002.

In August 2001, the Financial Accounting Standards Board issued SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which
supersedes SFAS No. 121 and the accounting and reporting provisions of
Accounting Principles Board Opinion No. 30, "Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions." This
statement retains certain requirements of SFAS No. 121 relating to the
recognition and measurement of impairment of long-lived assets to be held and
used. Additionally, this statement results in one accounting model, based on the
framework established in SFAS No. 121, for long-lived assets to be disposed of
by sales and also addresses certain implementation issues related to SFAS No.
121, including the removal of goodwill from its scope due to the issuance of
SFAS No. 142. SFAS No. 144 is effective for fiscal years beginning after
December 15, 2001, and interim periods within those fiscal years. The Company
does not anticipate any adjustment to the carrying value of its long-lived
assets resulting from the adoption of SFAS No. 144 on its consolidated
financial position and results of operations.

4. Business Combinations

On October 18, 2001, the Company completed the acquisition of Synergetic
Micro Systems, Inc. (Synergetic). This acquisition has been accounted for under
the purchase method of accounting. The consolidated financial statements include
the results of operations of the acquisition of Synergetic after its acquisition
date. A summary of the transaction is outlined below:

Shares Reserved Total Shares
Date Shares For Options Issued or Cash
Company Acquired Acquired Business Issued Assumed Reserved Consideration
-------- -------- ------ ------- -------- -------------

Embedded network communications
Synergetic......... Oct. 2001 solutions provider 2,234,715 615,705 2,850,420 $ 2.7 million

Allocation of Purchase Consideration

The Company is in the process of obtaining an independent appraisal of the
fair value of the tangible and intangible assets acquired in order to allocate
the purchase price in accordance with SFAS No. 141. The Company does not expect
that the final allocation of purchase price will produce materially different
results from those reflected herein. The preliminary purchase price was
allocated as follows based upon management's best estimate of the tangible and
intangible assets (in thousands):

Net Tangible
Assets Purchased Deferred Deferred Tax Total
Company Acquired Acquired Goodwill Intangibles Compensation Liabilities Consideration
-------- -------- ----------- ------------ ----------- -------------
<c>
Synergetic.......................... $ 178 $13,521 $11,100 $203 $(5,213) $19,789

The consideration for the purchase transaction was calculated as follows:
a) common shares issued were valued based upon the Company's stock price for a
short period just before and after the companies reached agreement and the
proposed transaction was announced and b) employee stock options were valued in
accordance with FIN 44. Net tangible assets acquired in

connection with the purchase transaction include the acquisition costs incurred
by the Company. Additionally, the net tangible assets reflect an outstanding
note payable and credit facility aggregating $626,000, which was paid in full by
the Company in connection with the terms of the merger agreement.

Pro Forma Data

The pro forma statements of operations data of the Company set forth below
gives effect to the acquisition of Synergetic as if it had occurred at the
beginning of fiscal 2001. The following unaudited pro forma statements of
operations data includes the amortization of purchased intangible assets and
stock-based compensation. This pro forma data is presented for informational
purposes only and does not purport to be indicative of the results of future
operations of the Company or the results that would have actually occurred had
the acquisition taken place at the beginning of fiscal 2001 (In thousands,
except per share data):

Three Months Ended Six Months Ended
------------------ ----------------
December 31, December 31,
------------ ------------
2001 2000 2001 2000
---- ---- ---- ----

Net revenues. ......................................... $18,187 $13,140 $37,013 $25,733
Loss before cumulative effect of accounting change. ... $(2,105) $ (449) $(4,174) $(1,205)
Cumulative effect of accounting change. ............... - - $(2,557) -
Net loss. ............................................. $(2,105) $ (449) $(6,731) $(1,205)
Loss per share before cumulative effect of accounting
change. ............................................. $ (0.04) $ (0.01) $ (0.08) $ (0.03)
Cumulative effect of accounting change per share. ..... - - $ (0.05) -
Net loss per share. ................................... $ (0.04) $ (0.01) $ (0.13) $ (0.03)

5. Net Loss per Share

Basic net loss per share is calculated by dividing net loss by the weighted
average number of common shares outstanding during the period. Diluted net loss
per share is calculated by adjusting outstanding shares assuming any dilutive
effects of options. However, for periods in which the Company incurred a net
loss, these shares are excluded because their effect would be to reduce recorded
net loss per share. The following table sets forth the computation of net loss
per share (In thousands, except per share amounts):

Three Months Ended Six Months Ended
December 31, December 31,
2001 2000 2001 2000
---- ---- ---- ----

Numerator:
Loss before cumulative effect of accounting change $ (1,171) $ (51) $ (3,326) $ (74)
Cumulative effect of accounting change - - (2,557) -
--------- --------- --------- --------
Net loss $ (1,171) $ (51) $ (5,883) $ (74)
========= ========= ========= ========
Denominator:
Weighted-average shares outstanding 51,842 36,709 49,955 35,058
Less: Non-vested common shares outstanding (581) - (581) -
--------- --------- --------- --------
Denominator for basic and diluted loss per share 51,261 36,709 49,374 35,058
========= ========= ========= ========
Loss per share before cumulative effect of
accounting change $ (0.02) $ (0.00) $ (0.07) $ (0.00)
Cumulative effect of accounting change per share - - (0.05) -
--------- --------- --------- --------
Net loss per share $ (0.02) $ (0.00) $ (0.12) $ (0.00)
========= ========= ========= ========

6. Inventories

Inventories are stated at the lower of cost (first-in, first-out) or market and
consist of the following (In thousands):

December 31, June 30,
2001 2001
---- ----
(Unaudited)
Raw materials. ................................... $ 5,529 $ 6,752
Finished goods ................................... 12,936 6,526
-------- --------
18,465 13,278
Reserve for excess and obsolete inventory ........ (2,181) (2,490)
-------- --------

$ 16,284 $ 10,788
======== ========

7. Long-term investments

In September and October 2001, the Company purchased convertible promissory
notes from Xanboo Inc. (Xanboo) totaling $3.0 million. The notes have a ten year
maturity and provide for automatic conversion into the next round of equity
securities of Xanboo that raises at least $5.0 million. The notes accrue
interest at 8% per annum. (Note 11)

Throughout fiscal 2002, the Company loaned $1.2 million to Premise Systems
Inc (Premise). The notes commencing in September 2001 bear interest at the rate
of 9.0% per annum. (Note 11)

The Company periodically reviews its investments for which fair value is
less than cost to determine if the decline in value is other than temporary. If
the decline in value is judged to be other than temporary, the cost basis of the
security is written down to fair value. During the six months ended December 31,
2001, the Company recorded a $500,000 write-down of a strategic investment. This
amount is included within the condensed consolidated statement of operations as
other expense.

8. Stockholders' Equity

In July 2001, the Company completed a public offering of 8,534,000 shares
of its common stock, including an underwriter's over-allotment option to
purchase an additional 534,000 shares, at an offering price of $8.00 per share.
The Company sold 6,000,000 shares and selling stockholders sold 2,000,000 shares
of the primary offering. Additionally, the Company sold 400,500 shares and
selling stockholders sold 133,500 shares of the over-allotment option. The
Company received net proceeds of approximately $47.1 million in connection with
this offering.

9. Comprehensive Loss

SFAS No. 130, Reporting Comprehensive Income (Loss), establishes standards
for reporting and displaying comprehensive income (loss) and its components in
the condensed consolidated financial statements. Other comprehensive loss
includes foreign currency translations adjustments and net unrealized losses on
investments. The components of comprehensive loss are as follows (In thousands):

Three Months ended Six Months ended
------------------ ----------------
December 31, December 31,
------------ ------------
2001 2000 2001 2000
---- ---- ---- ----

Net loss $(1,171) $ (51) $ (5,883) $ (74)
Other comprehensive loss:
Change in net unrealized loss on investment (183) -- (343) --
Change in accumulated translation adjustments (2) 13 25 7
------- ----- -------- -------
Total comprehensive loss $(1,356) $ (38) $ (6,201) $ (67)
======= ===== ======== =======

10. Litigation

From time to time, the Company has received letters claiming that their
products infringe upon patents or other intellectual property of third-parties.
On July 3, 2001, Digi International, Inc., filed a complaint in the United
States District Court for the district of Minnesota claiming patent infringement
and alleging that Lantronix directly and/or indirectly infringes upon Digi's
U.S. Patent No. 6,047,319 by making, using, selling and or offering for sale
certain of Lantronix's Multiport device servers, including the ETS line of
products, coupled with a device driver called the Comm Port Redirector Software.
Digi alleges that the Company has willfully and intentionally infringed Digi's
patent, and its complaint seeks injunctive relief as well as unspecified
damages, treble damages, attorney's fees, interest and costs. On August 17,
2001, the Company filed its answer to the complaint, asserting affirmative
defenses, and counterclaiming for a declaratory judgment that the patent in
issue is invalid. The Court has scheduled a pre-trial conference for February
19, 2002, in which discovery parameters and a trial date will likely be set.
Based on the facts known to date, the Company believes that the claims are
without merit and intends to vigorously defend the suit.

From time to time, the Company is subject to legal proceedings and claims
in the ordinary course of business. The Company currently is not aware of any
such legal proceedings or claims that it believes will have, individually or in
the aggregate, a material adverse effect on its business, prospects, financial
position, operating results or cash flows.

11. Subsequent Events

On January 11, 2002, the Company completed the acquisition of Premise, a
developer of client-side software applications. Prior to the acquisition, the
Company held shares of Premise representing 19.99% ownership interest and in
addition held convertible promissory notes of $1.2 million with interest accrued
thereon at the rate of 9.0%. The convertible promissory notes were converted
into equity securities of Premise at the closing of the transaction. The Company
agree to issue an aggregate of 1,063,371 shares of its common stock in exchange
for all remaining outstanding shares of Premise common stock and reserved
875,000 additional shares of common stock for issuance upon exercise of
outstanding employee stock options and other rights of Premise. Pursuant to the
Acquisition Agreement, 106,337 of such shares will be held in escrow to secure
certain indemnification obligations, and 531,686 of such shares will be held in
escrow pending achievement of certain performance obligations. The Company
intends to issues those shares on or around February, 18, 2002. In connection
with the acquisition, the Company expects to record a one-time charge for
purchased in-process research and development expenses related to the
acquisition in its third fiscal quarter ending March 31, 2002.

In January 2002, Xanboo (Note 7) completed a $13.0 million equity round. As
a result, the Company's $3.0 million investment in Xanboo convertible promissory
notes were converted into shares of Xanboo preferred stock. In addition, the
Company purchased $4.0 million of Xanboo preferred stock in January 2002. The
Company currently holds an 18.73% ownership interest in Xanboo.

In January 2002, the Company entered into a two-year line of credit with a
bank in an amount not to exceed $20.0 million. Borrowings under the line of
credit bear interest at the prime rate or the LIBOR rate plus 2.0%. The Company
is required to pay a $100,000 facility fee of which $50,000 was paid upon the
closing and $50,000 is to be paid in January 2003. The Company is also required
to pay a quarterly unused line fee of .125% of the unused line of credit
balance. The line of credit contains customary affirmative and negative
covenants. To date the Company has not borrowed against this line of credit.

Effective January 2, 2002, the Company entered into revised employment
agreements with the Company's Chief Executive and Chief Financial Officers. The
agreement with the Chief Executive Officer provides that employment is at-will
and sets forth a revised annual base salary of $325,000, a signing bonus of
$206,250, and incentive compensation of up to 100% of his annual base salary.
Pursuant to this agreement, the Chief Executive Officer was granted 300,000
options that will vest over the next four years. The agreement with the Chief
Financial Officer provides that employment is at-will and sets forth a revised
annual base salary of $262,500, a signing bonus of $144,722, and incentive
compensation of up to 100% of his annual base salary. Pursuant to this
agreement, the Chief Financial Officer was granted 250,000 options that will
vest over the next four years. Upon termination or resignation due to a change
in control, the Chief Executive Officer and Chief Financial Officer will
continue to receive their annual base salary with benefits and bonuses for a
period of 2 years following termination or resignation.

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations

You should read the following discussion and analysis in conjunction with
the Unaudited Condensed Consolidated Financial Statements and related Notes
thereto contained elsewhere in this Report. The information in this Quarterly
Report on Form 10-Q is not a complete description of our business or the risks
associated with an investment in our common stock. We urge you to carefully
review and consider the various disclosures made by us in this Report and in
other reports filed with the SEC, including our Registration Statements on Form
S-1, our Annual Report on Form 10-K for the year ended June 30, 2001 and our
subsequent reports on Form 8-K, that discuss our business in greater detail.

The sections entitled "Factors That May Affect Future Results of
Operations" set forth below, and similar discussions in our other SEC filings,
discuss some of the important factors that may affect our business, results
of operations and financial condition. You should carefully consider those
factors, in addition to the other information in this Report and in our other
filings with the SEC, before deciding to invest in our company or to maintain or
increase your investment.

This report contains forward-looking statements which include, but are not
limited to, statements concerning projected net revenues, expenses, gross profit
and income (loss), the need for additional capital, market acceptance of our
products, our ability to consummate acquisitions and integrate their operations
successfully, our ability to achieve further product integration, the status of
evolving technologies and their growth potential and our production capacity.
These forward-looking statements are based on our current expectations,
estimates and projections about our industry, management's 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. We undertake no obligation to revise
or update publicly any forward-looking statements for any reason.

Overview

Lantronix designs network-enabling and system management solutions
consisting of hardware and software that permit almost any electronic device to
be accessed, managed, controlled over the Internet, intranets or other networks.
Since our inception in 1989, we have developed an array of network-enabling
products including external Device Servers, embedded Device Servers, Multiport
Device Servers, Print Servers and other products. Beginning in fiscal year 1999,
we began to experience an increase in sales of our Device Servers reflecting our
focus on this higher margin product line. At the same time, we began to
experience a decline in sales of Print Server and other products as we shifted
resources to our Device Server business, which we believe represents a greater
opportunity for long-term growth. We believe sales in our Device Server business
will continue to represent an increasing percentage of our net revenues in the
future. Our strategy for continuing to increase sales of our Device Server
product line involves a two-fold approach. First, we have and intend to continue
substantially increase our research and development expenditures to enhance our
Device Server product line and develop new products. Second, we intend to grow
our Device Server business through strategic acquisitions, investments and
partnerships, which we believe will support our product lines and allow us to
secure additional intellectual property, increase our customer base and provide
access to new markets.

Our products are sold to original equipment manufacturers (OEMs), value
added resellers (VARs), systems integrators and distributors, as well as
directly to end-users. One of our distributors, Ingram Micro, accounted for 9.4%
of our net revenues for the six months ended December 31, 2001, compared to
13.2% for the six months ended December 31, 2000. Another distributor, Tech
Data, accounted for 10.3% of our net revenues for the six months ended December
31, 2001, compared to 10.9% for the six months ended December 31, 2000. Transtec
AG, an international OEM and related party due to common ownership by our
Chairman and major stockholder, accounted for 1.1% of our net revenues for the
six months ended December 31, 2001, compared to 8.5% for the six months ended
December 31, 2000. There was no outstanding accounts receivable balance due from
Transtec AG at December 31, 2001. Xanboo, a company that we currently hold an
18.73% ownership interest in accounted for $586,000 of our net revenues for the
six months ended December 31, 2001. Xanboo's outstanding accounts receivable
balance at December 31, 2001 was $586,000. There were no revenues or outstanding
receivable balances due from Xanboo for the six months ended December 31, 2000.

In July 2001, we completed a public offering of 8,534,000 shares of our
common stock, including an underwriter's over-allotment option to purchase an
additional 534,000 shares, at an offering price of $8.00 per share. The Company
sold 6,000,000 shares and selling stockholders sold 2,000,000 shares of the
primary offering. Additionally, the Company sold 400,500 shares and selling
stockholders sold 133,500 shares of the over-allotment option. The Company
received net proceeds of approximately $47.1 million in connection with this
offering.

On October 18, 2001, we completed the acquisition of Synergetic, a provider
of embedded network communication solutions. In connection with the acquisition,
we paid cash consideration of $2.7 million and issued an aggregate of 2,234,715
shares of our common stock in exchange for all outstanding shares of Synergetic
common stock and reserved 615,705 additional shares of common stock for issuance
upon exercise of outstanding employee stock options and other rights of
Synergetic. Portions of the cash consideration and shares issued will be held in
escrow pursuant to the terms of the acquisition agreement.

On January 11, 2002, we completed the acquisition of Premise, a developer
of client-side software applications. Prior to the acquisition, we held shares
of Premise representing 19.99% ownership and in addition held convertible
promissory notes of $1.2 million with interest accrued there-on at the rate of
9.0%. The convertible promissory notes were converted into equity securities of
premise at the closing of the transaction. We issued an aggregate of 1,063,371
shares of our common stock in exchange for all remaining outstanding shares of
Premise common stock and reserved 875,000 additional shares of common stock for
issuance upon exercise of outstanding employee stock options and other rights of
Premise. Pursuant to the acquisition agreement, 106,337 shares will be held in
escrow to secure certain indemnification obligations, and 531,686 of such shares
will be held in escrow pending achievement of certain performance obligations.
The transaction was exempt from registration pursuant to section 4 (2) of the
Securities Act of 1933, as amended. In connection with the acquisition, we
expect to record a one-time charge for purchased in-process research
and development expenses related to the acquisition in its third fiscal quarter
ending March 31, 2002.

In September and October 2001, we purchased convertible promissory notes
from Xanboo totaling $3.0 million. The notes had ten year maturities and
provided for automatic conversion into the next round of equity securities of
Xanboo that raises at least $5.0 million. The notes accrue interest at 8% per
annum. In January 2002, Xanboo completed a $13.0 million equity round which
resulted in the convertible notes converting into preferred stock of Xanboo. We
also purchased an additional $4.0 million of Xanboo preferred stock. We
currently hold an 18.73% ownership interest in Xanboo.

Effective July 1, 2001, we changed our accounting method for recognizing
revenue on sales to distributors. Recognition of

revenue and related gross profit on sales to distributors is now deferred until
the distributor resells the product. Previously, we recognized revenue from
these transactions upon shipment of product to the distributor, net of
appropriate estimates for possible returns and allowances.

Our Management believes that this accounting change is a preferable method
because (1) it better reflects the substance of the transactions considering our
recent entry into the semiconductor marketplace and the changing business
environment; and (2) the new accounting method is consistent with other
companies in our industry and, therefore will better focus us on end customer
sales and provide greater comparability in the presentation of financial results
among us and our peers.

We grant certain distributors limited rights to return products and provide
price protection for inventories held by certain resellers at the time of
published price reductions. Prior to July 1, 2001, the date of the change in
accounting method for recognizing revenue for sales to distributors, we recorded
an estimated allowance for future product returns for sales to distributors
based on historical returns experience when the related revenue was recorded and
provided for appropriate price protection reserves when pricing adjustments were
approved. Recognition of revenue and related gross profit on sales to
distributors is now deferred until the distributor resells the product. We
recognize revenue for sales to OEM's and VAR's at the time of shipment and
record an estimated allowance for future product returns based on historical
returns experience.

Revenue from licensed software is recognized at the time of shipment,
provided that we have vendor-specific objective evidence of the fair value of
each element of the software offering, collectibility is probable and the
delivered software provides the required technology revenue from post-contract
customer support and any other future deliverables is deferred and recognized
over the support period or as contract elements are delivered.

Stock-based compensation primarily relates to deferred compensation
recorded in connection with the grant of stock options to employees where the
option exercise price is less than the estimated fair value of the underlying
shares of common stock as determined for financial reporting purposes, as well
as the fair market value (Determined using the Black-Scholes opton principal
model) of the vested portion of non-employee stock options determined . Deferred
compensation also includes the value of employee stock options assumed in
connection with acquisitions of businesses calculated in accordance with current
accounting guidelines. Deferred compensation is presented as a reduction to
stockholders' equity and is amortized over the vesting period of the related
stock options, which is generally four years. At December 31, 2001, a deferred
compensation balance of $8.7 million remains and will be amortized as follows:
$1.6 million in the remainder of fiscal 2002, $3.0 million in fiscal 2003, $2.6
million in fiscal 2004, $1.4 million in fiscal 2005 and $174,000 in fiscal 2006.
The amount of stock-based compensation in future periods will increase if we
grant stock options where the exercise price is less than the quoted market
price of the underlying shares or if we assume employee stock options in
connection with additional acquisitions of businesses. The amount of stock-based
compensation actually recognized in future periods could decrease if options for
which deferred compensation has been recorded are forfeited.

On February 6, 2002, the Company announced and began implementing a plan to
restructure it operations in response to the current economic climate and to
integrate and consolidate recent acquisitions. In connection with this plan, the
Company expects to record in the third fiscal quarter ending March 31, 2002 a
one-time restructuring charge of approximately $3.0 million.

Statement of Operations for the Three and Six Months Ended December 31, 2001
compared to the Three and Six Months Ended December 31, 2000 follow. The three
and six months ended December 31, 2001 and 2000 pro forma columns reflect the
results as if the change in distributor revenue recognition had been applied
retroactively. The pro forma results are used for comparative purposes in the
following discussion of our results of operations.

Three Months Ended Three Months Ended Six Months Ended Six Months Ended
December 31, 2001 December 31, 2000 December 31, 2001 December 31, 2000
As Reported Pro Forma As Reported Pro Forma As Reported Pro Forma As Reported
----------- --------- ----------- --------- ----------- --------- -----------

Net revenues ........................... $ 16,439 $ 12,161 $ 12,465 $ 32,708 $ 32,708 $ 23,805 $ 24,502
Cost of revenues ....................... 7,524 5,583 5,689 15,194 15,194 10,809 11,038
-------- -------- -------- -------- --------- -------- --------

Gross profit ........................... 8,915 6,578 6,776 17,514 17,514 12,996 13,464
-------- -------- -------- -------- --------- -------- --------

Operating expenses:
Selling, general and
administrative ..................... 7,695 5,659 5,659 15,274 15,274 10,652 10,652
Research and development ........... 1,956 1,021 1,021 4,048 4,048 2,073 2,073
Stock-based compensation ........... 829 674 674 2,028 2,028 1,337 1,337
Amortization of purchased
intangible assets .................. 524 363 363 809 809 726 726
-------- -------- -------- -------- --------- -------- --------
Total operating expenses ............... 11,004 7,717 7,717 22,159 22,159 14,788 14,788
-------- -------- -------- -------- --------- -------- --------
Loss from operations ................... (2,089) (1,139) (941) (4,645) (4,645) (1,792) (1,324)
Interest income (expense), net ......... 479 671 671 1,015 1,015 1,186 1,186
Other income (expense), net ............ 7 79 79 (328) (328) (13) (13)
-------- -------- -------- -------- --------- -------- --------
Loss before income taxes and
cumulative effect of accounting
change ................................ (1,603) (389) (191) (3,958) (3,958) (619) (151)
Benefit for income taxes ............... (432) (197) (140) (632) (632) (213) (77)
-------- -------- -------- -------- --------- -------- --------
Loss before cumulative effect of
accounting change ..................... (1,171) (192) (51) (3,326) (3,326) (406) (74)
Cumulative effect of accounting
change, net of income taxes of $1,049 . - - - - (2,557) - -
-------- -------- -------- -------- --------- -------- --------

Net loss ............................... $ (1,171) $ (192) $ (51) $ (3,326) $ (5,883) $ (406) $ (74)
======== ======== ======== ======== ======== ======== ========

The following table sets forth certain statement of operations data expressed as
a percentage of total net revenues on a pro forma basis as if the change in
distributor revenue recognition had been applied retroactively:

Three Months Six Months
Ended Ended
December 31, December 31,
------------ ------------
2001 2000 2001 2000
---- ---- ---- ----

Net revenues .............................................................. 100.0% 100.0% 100.0% 100.0%
Cost of revenues .......................................................... 45.8 45.9 46.5 45.4
------ ------ ------ ------
Gross profit .............................................................. 54.2 54.1 53.5 54.6
------ ------ ------ ------
Operating expenses:
Selling, general and administrative ....................................... 46.8 46.5 46.7 44.7
Research and development .................................................. 11.9 8.4 12.4 8.7
Stock based-compensation .................................................. 5.0 5.5 6.2 5.6
Amortization of purchased intangible assets ............................... 3.2 3.0 2.5 3.0
------ ------ ------ ------
Total operating expenses .................................................. 66.9 63.5 67.7 62.1
------ ------ ------ ------
Loss from operations ...................................................... (12.7) (9.4) (14.2) (7.5)
Interest income (expense), net ............................................ 2.9 5.5 3.1 5.0
Other income (expense), net ............................................... - 0.7 (1.0) (0.1)
------ ------ ------ ------
Loss before income taxes and cumulative effect of accounting change ....... (9.8) (3.2) (12.1) (2.6)
Benefit for income taxes .................................................. (2.6) (1.6) (1.9) (0.9)
------ ------ ------ ------
Loss before cumulative effect of accounting change ........................ (7.1) (1.6) (10.2) (1.7)
Cumulative effect of accounting change, net of income taxes of $1,049 ..... (-) (-) (7.8) (-)
------ ------ ------ ------
Net loss .................................................................. (7.1)% (1.6)% (18.0)% (1.7)%
====== ====== ====== ======

Net Revenues

Net revenues increased $4.3 million, or 35.2%, to $16.4 million for the
three months ended December 31, 2001 from $12.2 million for the three months
ended December 31, 2000. Net revenues increased $8.9 million, or 37.4%, to $32.7
million for the six months ended December 31, 2001 from $23.8 million for the
six months ended December 31, 2000. The increase was primarily attributable to
an increase in net revenues of our Multiport Device Server and Device Server
products, partially offset by a decline in our Print Server and other products.
Multiport Device Server net revenues increased $3.1 million, or 108.4%, to $5.9
million, or 35.9% of net revenues, for the three months ended December 31, 2001
from $2.8 million, or 23.3% of net revenues, for the three months ended December
31, 2000. Multiport Device Server net revenues increased $8.4 million, or
145.9%, to $14.1 million, or 43.2% of net revenues, for the six months ended
December 31, 2001 from $5.7 million, or 24.1% of net revenues, for the six
months ended December 31, 2000. The increase in our Multiport Device Server net
revenues is primarily attributable to the acquisition of Lightwave
Communications Inc. (Lightwave). Device Server net revenues increased $1.8
million, or 21.5%, to $10.1 million, or 61.7% of net revenues, for the three
months ended December 31, 2001 from $8.3 million, or 68.6% of net revenues, for
the three months ended December 31, 2000. Device Server net revenues increased
$1.4 million, or 8.8%, to $17.5 million, or 53.6% of net revenues, for the six
months ended December 31, 2001 from $16.1 million, or 67.7% of net revenues, for
the six months ended December 31, 2000. Device Server net revenues for the three
months ended December 31, 2001 and 2000 includes $548,000 and $238,000,
respectively, of software revenue generated from USSC. Device Server net
revenues for the six months ended December 31, 2001 and 2000 includes $909,000
and $238,000, respectively, of software revenue generated from USSC. In
addition, Device Server net revenue for the three and six months ended December
31, 2001 includes $972,000 of Destiny LX chip revenue. No Destiny LX chip
revenue was recorded for the three and six months ended December 31, 2000. The
increase in our Device Server net revenue is primarily due to an increase in our
Embedded Device Servers offset by a decrease in our External Device Server. This
change between Embedded and External is consistent with our expectations as our
customers shift to an Embedded solution. Print Server and other net revenues
decreased $583,000, or 59.3%, to $400,000, or 2.4% of net revenues, for the
three months ended December 31, 2001 from $983,000, or 8.1% of net revenues, for
the three months ended December 31, 2000. Print Server and other net revenues
decreased $896,000, or 45.9%, to $1.1 million, or 3.2% of net revenues, for the
six months ended December 31, 2001 from $1.9 million, or 8.2% of net revenues,
for the six months ended December 31, 2000. The decreases in our Print Server
and other products net revenues are due to a more rapid transition to our
Multiport Device Server and Device Server products.

Net revenues generated from sales in the Americas increased $5.3 million,
or 64.7%, to $13.4 million, or 81.4% of net revenues, for the three months ended
December 31, 2001 from $8.1 million, or 65.2% of net revenues, for the three
months ended December 31, 2000. Net revenues generated from sales in the
Americas increased $9.9 million, or 58.5%, to $26.8 million, or 81.9% of net
revenues, for the six months ended December 31, 2001 from $16.9 million, or
69.0% of net revenues, for the six months ended December 31, 2000. Our net
revenues derived from customers located in Europe decreased $1.0 million, or
28.2%, to $2.6 million, or 16.0% of net revenues, for the three months ended
December 31, 2001 from $3.7 million, or 29.3% of net revenues, for the three
months ended December 31, 2000. Our net revenues derived from customers located
in Europe decreased $1.3 million, or 20.5%, to $5.0 million, or 15.4% of net
revenues, for the six months ended December 31, 2001 from $6.3 million, or 25.8%
of net revenues, for the six months ended December 31, 2000. Our net revenues
derived from customers located in Europe as a percentage of total net revenues
decreased due to the acquisition of Lightwave which primarily sells in the
Americas. Our net revenues derived from customers located in other geographic
areas decreased slightly to $434,000, or 2.6% of net revenues, for the three
months ended December 31, 2001 from $683,000, or 5.5% of net revenues, for the
three months ended December 31, 2000. Our net revenues derived from customers
located in other geographic areas decreased to $887,000, or 2.7% of net
revenues, for the six months ended December 31, 2001 from $1.3 million, or 5.2%
of net revenues, for the six months ended December 31, 2000.

Gross Profit

Gross profit represents net revenues less cost of revenues. Cost of
revenues consists primarily of the cost of raw material components, subcontract
labor assembly from outside manufacturers and associated overhead costs.
Additionally, cost of revenues for the three and six months ended December 31,
2001 consisted of $560,000 and $898,000, respectively, of non-cash amortization
of acquisition-related charges. No charges were recorded for the three and six
months ended December 31, 2000. We pay Gordian, Inc., an outside research and
development firm, a royalty based on the sale of certain of our products. As a
result, a royalty charge is included in cost of revenues and is calculated based
on the related products sold. Gross profit increased by $2.3 million, or 35.5%,
to $8.9 million, or 54.2% of net revenues, for the three months ended December
31, 2001 from $6.6 million, or 54.1% of net revenues, for the three months ended
December 31, 2000. Gross profit increased by $4.5 million, or 34.8%, to $17.5
million, or 53.5% of net revenues, for the six months ended December 31, 2001
from $13.0 million, or 54.6% of net revenues, for the six months ended December
31, 2000. For the three months ended December 31, 2001 and 2000, Gordian
royalties were $431,000 and $488,000, respectively. For the six months ended
December 31, 2001 and 2000, Gordian royalties were $847,000 and $1.0 million,
respectively. The increase in gross profit was mainly attributable to the
significant increase in the Multiport Device Server product. The decrease in
gross

profit as a percentage of net revenues for the six months ended December 31,
2001 is primarily attributable to non-cash amortization of acquisition-related
charges, volume-pricing agreements and competitive pricing strategies.

Selling, General and Administrative

Selling, general and administrative expenses consist primarily of
personnel-related expenses including salaries and commissions, facility
expenses, information technology, trade show expenses, advertising, and
professional fees. Selling, general and administrative expenses increased $2.0
million, or 36.0%, to $7.7 million, or 46.8% of net revenues, for the three
months ended December 31, 2001 from $5.7 million, or 46.5% of net revenues, for
the three months ended December 31, 2000. Selling, general and administrative
expenses increased $4.6 million, or 43.4%, to $15.3 million, or 46.7% of net
revenues, for the six months ended December 31, 2001 from $10.7 million, or
44.7% of net revenues, for the six months ended December 31, 2000. This increase
is due primarily to increased depreciation of fixed assets, increased
personnel-related costs and facilities costs from the acquisitions of USSC,
Lightwave and Synergetic as well as hiring of sales personnel, and increased
legal and other professional fees. We expect selling, general and administrative
expenses in absolute dollars will decrease in the foreseeable future as a result
of our planned restructuring announced February 6, 2002 and decrease as a
percentage of net revenues. Selling, general and administrative expenses will
include the signing bonuses for the Chief Excecutive and Chief Financial Officer
totaling $351,000 in the third fiscal quarter of 2002.

Research and Development

Research and development expenses consist primarily of salaries and the
related costs of employees, as well as expenditures to third-party vendors for
research and development activities. Research and development expenses increased
$935,000, or 91.6%, to $2.0 million, or 11.9% of net revenues, for the three
months ended December 31, 2001 from $1.0 million, or 8.4% of net revenues, for
the three months ended December 31, 2000. Research and development expenses
increased $2.0 million, or 95.3%, to $4.0 million, or 12.4% of net revenues, for
the six months ended December 31, 2001 from $2.1 million, or 8.7% of net
revenues, for the six months ended December 31, 2000. This increase resulted
primarily from increased personnel-related costs due to the acquisition of USSC,
Lightwave and Synergetic, as well as hiring of senior management and expenses
related to new product development.

Stock-based Compensation

Stock-based compensation generally represents the amortization of deferred
compensation. We recorded approximately $885,000 of deferred compensation for
the six months ended December 31, 2001. Deferred compensation represents the
difference between the fair value of the underlying common stock for accounting
purposes and the exercise price of the stock options at the date of grant.
Deferred compensation is presented as a reduction of stockholders' equity and is
amortized ratably over the respective vesting periods of the applicable options,
which is generally four years. Stock-based compensation increased $155,000, or
23.0%, to $829,000, or 5.0% of net revenues, for the three months ended December
31, 2001 from $674,000, or 5.5% of net revenues, for the three months ended
December 31, 2000. Stock-based compensation increased $691,000, or 51.7%, to
$2.0 million, or 6.2% of net revenues, for the six months ended December 31,
2001 from $1.3 million, or 5.6% of net revenues, for the six months ended
December 31, 2000. The increase in stock-based compensation primarily reflects
stock options assumed in three purchase transactions that were accounted for in
accordance with FASB Interpretation No. 44, Accounting for Certain Transactions
Involving Stock Compensation--An Interpretation of APB Opinion No. 25. We expect
to incur additional stock-based compensation in future periods as a result of
the continued amortization of deferred compensation related to these and other
stock option grants.

Amortization of Purchased Intangible Assets

In connection with the two purchase transactions completed during fiscal
2001 and the one purchase transaction completed during the second fiscal quarter
of 2002, we recorded approximately $14.2 million and $11.1 million, of
identified purchased intangible assets, respectively. Goodwill is recorded as
the difference, if any, between the aggregate consideration paid for an
acquisition and the fair value of the net tangible and intangible assets
acquired. We obtained independent appraisals of the fair value of tangible and
intangible assets acquired in order to allocate the purchase price. Purchased
intangible assets are amortized on a straight-line basis over the economic lives
of the respective assets, generally three to seven years. The amortization of
purchased intangible assets increased $161,000, or 44.4%, to $524,000, or 3.2%
of net revenues, for the three months ended December 31, 2001 from $363,000, or
3.0% of net revenues, for the three months ended December 31, 2000. The
amortization of purchased intangible assets increased $83,000, or 11.4%, to
$809,000, or 2.5% of net revenues, for the six months ended December 31, 2001
from $726,000, or 3.0% of net revenues, for the six months ended December 31,
2000. In addition, approximately $560,000 and $898,000 of amortization of
purchased intangible assets have been classified as cost of revenue for the
three and six months ended December 31, 2001, respectively. No comparable
amortization of purchased intangible assets was classified as cost of revenue
for the three and six months ended December 31, 2000.

We have elected to early adopt the rules set forth in SFAS No. 142 on
accounting for goodwill and other intangibles effective as of July 1, 2001. For
the six months ended December 31, 2001, early adoption resulted in
non-amortization of goodwill of $3.5 million or $0.07 per share based on the
weighted average shares outstanding for the six months ended December 31, 2001.

The transition provisions of SFAS No. 142 require that we complete in
assessment of whether impairment may exist as of the date of adoption by
December 31, 2001 and determine the amount of any impairment as of the date of
adoption by June 30, 2002. Any impairment that is required to be recognized when
adopting SFAS No. 142 will be reflected as the cumulative effect of a change in
accounting principle as of July 1, 2001. We have completed an initial assessment
and concluded that goodwill arising from the acquisition of United States
Software Corporation (USSC) having a carrying amount of approximately $5.8
million as of July 1, 2001 may be impaired. We expect to determine the amount
of the impairment charge, if any, to be reflected as a cumulative effect of a
change in accounting principle during the third fiscal quarter ending March 31,
2002.

Interest Income (Expense), Net

Interest income (expense), net consists primarily of interest earned on
cash, cash equivalents, short-term and long-term investments. Interest income
(expense), net was $479,000 and $671,000 for the three months ended December 31,
2001 and 2000, respectively. Interest income (expense), net was $1.0 million and
$1.2 million for the six months ended December 31, 2001 and 2000, respectively.
The decrease is primarily due to lower average investment balances and interest
rates for the three and six months ended December 31, 2001 compared to December
31, 2000, as a result of the acquisitions of USSC, Lightwave and Synergetic as
well as loans to Premise Systems and Xanboo.

Other Income (Expense), Net

Other income (expense), net was $7,000 and $79,000 for the three months
ended December 31, 2001 and 2000, respectively. Other income (expense), net was
$(328,000) and $(13,000) for the six months ended December 31, 2001 and 2000,
respectively. The increase in other expense for the six months ended December
31, 2001 is primarily attributable to the $500,000 revaluation of a strategic
investment, less gains on foreign currency translation.

Provision for Income Taxes

The Company utilizes the liability method of accounting for income taxes as
set forth in Financial Accounting Standards Board ("FASB") Statement No. 109,
Accounting for Income Taxes.

Liquidity and Capital Resources

Since inception, we have financed our operations through the issuance of
common stock and through net cash generated from operations. We consider all
highly liquid investments purchased with original maturities of 90 days or less
to be cash equivalents. Cash and cash equivalents consisting of money-market
funds and commercial paper totaled $38.6 million at December 31, 2001.
Short-term investments consist of investments maturing in twelve months or less
and totaled $9.9 million at December 31, 2001. Long-term investments consist of
investments in debt securities of two privately held companies, Premise Systems
and Xanboo, and other investments maturing in more than twelve months. Long-term
investments totaled $7.0 million at December 31, 2001. Subsequent to December
31, 2001, we completed the acquisition of Premise Systems. Our convertible
promissory notes of Xanboo were converted into Xanboo Preferred Stock interest
as a result of Xanboo completing a $13.0 million equity round. In addition, we
purchased $4.0 million of preferred stock Xanboo in January 2002. We currently
hold a 18.73% ownership interest in Xanboo.

Our operating activities used cash of $4.2 million for the six months ended
December 31, 2001. We incurred a net loss of $5.9 million, which includes
amortization and depreciation of $2.9 million, amortization of stock-based
compensation of $2.0 million, the cumulative effect of a change in accounting
method $2.6 million and the revaluation of a strategic investment of $500,000,
all of which are non-cash. This was reduced by increased inventories of $2.1
million, increased other receivables of $2.2 and decreased accounts payable of
$2.7 million offset by a decrease in accounts receivable of $1.3 million. The
increase in inventories and the decrease in accounts receivable are primarily
attributable to our change in accounting method for recognizing revenue on sales
to distributors. As described above, recognition of revenue and related gross
profit on sales to distributors is now deferred until the distributor resells
the product. The increase in other receivables was primarily due to increased
receivables from our contract manufacturers and convertible notes to Premise.
The decrease in accounts payable was primarily due to a reduction of Synergetic
liabilities subsequent to the acquisition.

Our investing activities used $20.5 million of cash for the six months
ended December 31, 2001. We used $3.4 million, net of cash acquired, to acquire
Synergetic in October 2001. We used $10.2 million to invest in held-to-maturity
investments in debt securities, net of $2.0 million in proceeds from the sales
of securities. We used $3.0 million to purchase convertible promissory notes
with ten year maturities that automatically convert into the next round of
equity securities of Xanboo. These notes were converted into preferred stock of
Xanboo in January 2002. We also purchased an additional $4.0 million of
preferred stock of Xanboo in January 2002. We acquired Premise in January 2002.

We also used $2.6 million to purchase property and equipment, primarily computer
hardware and software pertaining to Oracle software enhancements, support of our
international operations and a software package to support our sales force.

Cash provided by financing activities was $48.0 million for the six months
ended December 31, 2001, primarily related to the net proceeds from our
secondary public offering completed in July 2001. Cash provided by financing
activities was $53.9 million for the six months ended December 31, 2000,
primarily related to the net proceeds from our initial public offering in August
2000.

In January 2002, we entered into a four-year line of credit with a bank in
an amount not to exceed $20.0 million. Borrowings under the line of credit bear
interest at the prime rate or the LIBOR rate plus 2.0%. We are required to pay a
$100,000 facility fee of which $50,000 was paid and $50,000 is to be paid in
January 2003. We are also required to pay a quarterly unused line fee of .125%
of the unused line of credit balance. The line of credit contains customary
affirmative and negative covenants. To date we have not borrowed against this
line of credit.

We believe that our existing cash, cash expected to be generated from
operations and any available borrowings under our line of credit facility 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 revenues and research and development and
infrastructure investments as well as our intentions to make strategic
acquisitions or investments in other companies, which will affect our ability to
generate additional cash. If cash generated from operations and financing
activities is insufficient to satisfy our working capital requirements, we may
need to borrow funds through bank loans, sales of securities or other means.
There can be no assurance that we will be able to raise any such capital on
terms acceptable to us, if at all. If we are unable to secure additional
financing, we may not be able to develop or enhance our products, take advantage
of future opportunities, respond to competition or continue to operate our
business.

Factors That May Affect Future Results of Operation

You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only ones facing our company. Our business operations may be impaired by
additional risks and uncertainties that we do not know of or that we currently
consider immaterial.

Our business, results of operations or cash flows may be adversely affected
if any of the following risks actually occur. In such case, the trading price of
our common stock could decline, and you may lose all or part of your investment.

VARIATIONS IN QUARTERLY OPERATING RESULTS, DUE TO FACTORS INCLUDING CHANGES
IN DEMAND FOR OUR PRODUCTS AND CHANGES IN OUR MIX OF NET REVENUES, COULD CAUSE
OUR STOCK PRICE TO DECLINE.

Our quarterly net revenues, expenses and operating results have varied in
the past and might vary significantly from quarter to quarter in the future. 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
price. Our short-term expense levels are relatively fixed and are based on our
expectations of future net revenues. If we were to experience a reduction in net
revenues in a quarter, we would likely be unable to adjust our short-term
expenditures. If this were to occur, our operating results for that quarter
would be harmed. If our operating results in future quarters fall below the
expectations of market analysts and investors, the price of our common stock
would likely fall. Other factors that might cause our operating results to
fluctuate on a quarterly basis include:

. changes in the mix of net revenues attributable to higher-margin and
lower-margin products;

. customers' decisions to defer or accelerate orders;

. variations in the size or timing of orders for our products;

. short-term fluctuations in the cost or availability of our critical
components, such as flash memory;

. changes in demand for our products generally;

. loss or gain of significant customers;

. announcements or introductions of new products by our competitors;

. defects and other product quality problems; and

. changes in demand for devices that incorporate our connectivity
products.

IF WE MAKE UNPROFITABLE ACQUISITIONS OR ARE UNABLE TO SUCCESSFULLY
INTEGRATE ANY FUTURE ACQUISITIONS, OUR BUSINESS COULD SUFFER.

We have in the past and intend to continue in the future to acquire
businesses, client lists, products or technologies that we believe complement or
expand our existing business. In October 1998, we acquired ProNet GmbH, a German
supplier of industrial application Device Server technology. In December 2000,
we acquired USSC, a company that provides software solutions for use in embedded
technology applications. In June 2001, we acquired Lightwave, a company that
provides console management solutions. In October 2001, we acquired Synergetic,
a provider of embedded network communication solutions. In January 2002, we
acquired Premise Systems, a developer of client-side software applications.
Acquisitions of this type involve a number of risks, including:

. difficulties in assimilating the operations and employees of acquired
companies;

. diversion of our management's attention from ongoing business concerns;

. our potential inability to maximize our financial and strategic position
through the successful incorporation of acquired technology and rights
into our products and services;

. additional expense associated with amortization of acquired assets;

. maintenance of uniform standards, controls, procedures and policies; and

. impairment of existing relationships with employees, suppliers and
customers as a result of the integration of new management employees.

Any acquisition or investment could result in the incurrence of debt and
the loss of key employees. Moreover, we often assume specified liabilities of
the companies we acquire. Some of these liabilities, such as environmental and
tort liabilities, are difficult or impossible to quantify. If we do not receive
adequate indemnification for these liabilities our business may be harmed. In
addition, acquisitions are likely to result in a dilutive issuance of equity
securities. For example, we issued common stock and assumed options to acquire
our common stock in connection with our acquisitions of USSC, Lightwave,
Synergetic and Premise Systems. We cannot assure you that any acquisitions or
acquired businesses, client lists, products or technologies associated therewith
will generate sufficient net revenues to offset the associated costs of the
acquisitions or will not result in other adverse effects. Moreover, from time to
time we may enter into negotiations for the acquisition of businesses, client
lists, products or technologies, but be unable or unwilling to consummate the
acquisition under consideration. This could cause significant diversion of
managerial attention and out of pocket expenses to us. We could also be exposed
to litigation as a result of an unconsummated acquisition, including claims that
we failed to negotiate in good faith, misappropriated confidential information
or other claims.

In addition, from time to time we intend to invest in businesses that we
believe present attractive investment opportunities, or provide other synergetic
benefits. In September and October 2001, we paid an aggregate of $3.0 million to
Xanboo for convertible promissory notes, which have converted, in accordance
with their terms, into Xanboo preferred stock. In addition, the Company
purchased an additional $4.0 million of preferred stock of Xanboo. The Company
currently holds a 18.73% ownership interest in Xanboo. These investments are
speculative in nature, and there is a significant chance we will lose part or
all of our investments.

STOCK-BASED COMPENSATION WILL NEGATIVELY AFFECT OUR OPERATING RESULTS.

We have recorded deferred compensation in connection with the grant of
stock options to employees where the option exercise price is less than the
estimated fair value of the underlying shares of common stock as determined for
financial reporting purposes. We have recorded deferred compensation net of
forfeitures within stockholders' equity of $885,000 at December 31, 2001 and a
total of $14.2 million of deferred compensation through fiscal 2001, which is
being amortized over the vesting period of the related stock options, which is
generally four years. A balance of $8.7 million remains at December 30, 2001 and
will be amortized as follows: $1.6 million in the remainder of fiscal 2002, $3.0
million in fiscal 2003, $2.6 million in fiscal 2004, $1.4 million in fiscal
2005, and $174,000 in fiscal 2006.

The amount of stock-based compensation in future periods will increase if
we grant stock options where the exercise price is less than the quoted market
price of the underlying shares. The amount of stock-based compensation
amortization in future periods could decrease if options for which accrued, but
unvested deferred compensation has been recorded are forfeited.

WE PRIMARILY DEPEND ON THREE THIRD-PARTY MANUFACTURERS TO MANUFACTURE ALL
OF OUR PRODUCTS, WHICH REDUCES OUR CONTROL OVER THE MANUFACTURING PROCESS. IF
THESE MANUFACTURERS ARE UNABLE OR UNWILLING TO MANUFACTURE OUR PRODUCTS AT THE
QUALITY AND QUANTITY WE REQUEST, OUR BUSINESS COULD BE HARMED AND OUR STOCK
PRICE COULD DECLINE.

We primarily outsource all of our manufacturing to three third-party
manufacturers, APW, Inc., Irvine Electronics and Express Manufacturing. We
recently entered into a relationship with Uniprecision in China, and we intend
to transition a significant portion of our workload to this manufacturer during
approximately the next three months. 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 third-party 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 in required volumes, at acceptable quality,
quantity, yields and costs, or in a timely manner, our business would be
seriously harmed. We may also experience unforeseen problems as we attempt to
transition a significant portion of our manufacturing requirements to
Uniprecision. We do not have a significant operating history with either of
these entities and if these entities are unable to provide us with satisfactory
service, or we are unable to successfully complete the transition, our
operations could be interrupted. 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.
In addition, a natural disaster could disrupt our manufacturers' facilities and
could inhibit our manufacturers' ability to provide us with manufacturing
capacity on a timely basis, or at all. If this were to occur, we likely would be
unable to fill customers' existing orders or accept new orders for our products.
The resulting decline in net revenues would harm our business. In addition, we
are responsible for forecasting the demand for our individual products by
regional location. 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 expedite
charges which would increase our cost of sales or we may be unable to fulfill
customer orders thus reducing net revenues and therefore earnings.

WE MIGHT BECOME INVOLVED AND ARE CURRENTLY INVOLVED IN LITIGATION OVER
PROPRIETARY RIGHTS, WHICH COULD BE COSTLY AND TIME CONSUMING.

Substantial litigation regarding intellectual property rights exists in our
industry. There is a risk that third-parties, including current and potential
competitors, current developers of our intellectual property, our manufacturing
partners, or parties with which we have contemplated a business combination will
claim that our products, or our customers' products, infringe on their
intellectual property rights or that we have misappropriated their intellectual
property. In addition, software, business processes and other property rights in
our industry might be increasingly subject to third-party infringement claims as
the number of competitors grows and the functionality of products in different
industry segments overlaps. Other parties might currently have, or might
eventually be issued, patents that infringe on the proprietary rights we use.
Any of these third parties might make a claim of infringement against us.

From time to time we have received letters claiming that our products
infringe upon patents or other intellectual property of third-parties. On July
3, 2001, Digi International, Inc. filed a complaint in the United States
District Court for the district of Minnesota claiming patent infringement and
alleging that Lantronix directly and/or indirectly infringes upon Digi's U.S.
Patent No. 6,047,319 by making, using, selling, and/or offering for sale certain
of Lantronix's Multiport device servers, including the ETS line of products,
coupled with a device driver called the Comm Port Redirector Software. Digi
alleges that Lantronix has willfully and intentionally infringed Digi's patent,
and its complaint seeks injunctive relief as well as unspecified damages, treble
damages, attorneys fees, interest and costs. On August 17, 2001, Lantronix filed
its answer to the complaint, asserting affirmative defenses, and counterclaiming
for a declaratory judgment that the patent in issue is invalid. The Court has
scheduled a pre-trial conference for February 19, 2002, in which discovery
parameters and a trial date will likely be set. Based on the facts known to
date, Lantronix believes that the claims are without merit and intends to
vigorously defend this suit.

Although we believe that the claims or any litigation arising there from
will have no material impact on us or our business, the litigation is in the
preliminary stage, and we cannot predict its outcome with certainty. The
litigation process is inherently uncertain and we may not prevail. Moreover,
patent litigation is particularly complex and can extend for a protracted time,
which can substantially increase the cost of such litigation. In the event the
Digi litigation is not resolved at a preliminary stage, the cost of defending
the claim will be substantial. In addition, the Digi litigation will likely
divert the efforts and attention of some of our key management and technical
personnel. Should the outcome of the litigation be adverse to us, we would be
required to pay monetary damages to Digi and we could be enjoined from selling
those of our products found to infringe Digi's patent unless and until we are
able to negotiate a license from Digi which may not be available on acceptable
terms or at all. If we are required to pay significant monetary damages, are
enjoined from selling any of our products or are required to make substantial
royalty payments pursuant to any such license agreement, our business would be
harmed. This litigation, or other similar litigation brought by us or others,
could result in the expenditure of significant financial resources and the
diversion of management's time and efforts.

In addition, from time to time we could encounter other disputes over
rights and obligations concerning intellectual property. We cannot assume that
we will prevail in intellectual property disputes regarding infringement,
misappropriation or other disputes. Litigation in which we are accused of
infringement or misappropriation might cause a delay in the introduction of new
products, require us to develop non-infringing technology, require us to enter
into royalty or license agreements, which might not be available on acceptable
terms, or at all, or require us to pay substantial damages, including treble
damages if we are held to have willfully infringed. In addition, we have
obligations to indemnify certain of our customers under some circumstances for
infringement of third-party intellectual property rights. If any claims from
third-parties were to require us to indemnify customers under our agreements,
the costs could be substantial, and our business could be harmed. If a
successful claim of infringement were made against us and we could not develop
non-infringing technology or license the infringed or similar technology on a
timely and cost-effective basis, our business could be significantly harmed.

IF WE ARE UNABLE TO CONTINUE USING INTELLECTUAL PROPERTY DEVELOPED BY
GORDIAN, INC. WE COULD LOSE THE RIGHTS TO VALUABLE INTELLECTUAL PROPERTY AND OUR
BUSINESS WOULD BE HARMED.

Gordian, Inc. developed intellectual property used in our Micro Serial
Server, or MSS, Print Servers and ETS and LRS lines of Multiport Device Server
products. These products represent a substantial portion of our net revenues. We
pay royalties based on the gross margin of certain of our products incorporating
Gordian Developed Technology. For the six months ended December 31, 2001 and
2000, we paid Gordian approximately $847,000 and $1.0 million in royalties,
respectively. Under the terms of an agreement dated February 29, 1989, between
Gordian and US, Gordian owns the rights to the intellectual property developed
by it. Our agreement with Gordian may be terminated by either Gordian or
ourselves with 30-days written notice. We have offered to purchase the Gordian
developed intellectual property that we will need to continue selling our MSS
products. Gordian and Lantronix have agreed to use the services of a neutral
third party to establish a reasonable price for intellectual property. Gordian
has expressed its intent to terminate its relationship with us in the event we
are unable to agree upon a price for this intellectual property. In the event we
are unable to continue using the Gordian Developed Technology we might be
prevented from marketing some or all of our MSS line of products in the future.
This would result in the loss of customers and net revenues, which would harm
our business.

THERE IS A RISK THAT OUR OEM CUSTOMERS WILL DEVELOP THEIR OWN INTERNAL
EXPERTISE IN NETWORK-ENABLING PRODUCTS, WHICH COULD RESULT IN REDUCED SALES OF
OUR PRODUCTS.

For most of our existence we primarily sold our products to VARs, system
integrators and OEMs. Although we intend to continue to use all of these sales
channels, we have begun to focus more heavily on selling our products to OEMs.
Selling products to OEMs involves unique risks, including the risk that OEMs
will develop internal expertise in network-enabling products or will otherwise
provide network functionality to their products without using our Device Server
Technology. If this were to occur, our stock price could decline in value and
you could lose part or all of your investment.

TERRORIST ATTACKS OR THREATS OR ATTACKS, AND BUSINESS INTERRUPTIONS CAUSED
BY SUCH ATTACKS, NATURAL DISASTERS AND ELECTRICAL BLACKOUTS IN THE STATE OF
CALIFORNIA COULD ADVERSELY AFFECT OUR BUSINESS.

Interruptions in business, a decline in demand in our products, or a
general economic decline resulting from actual or threatened terrorist attacks
or military action could harm our business. Adverse effects could include, but
are not limited to, physical damage to our facilities, and disruptions caused by
trade restrictions imposed by the United States or foreign governments. In
addition, a general economic downturn in any of our target markets or general
disruption of the financial markets caused by such attacks could substantially
harm our business. Moreover, our operations are vulnerable to interruption by
fire, earthquake, power loss, telecommunications failure and other events beyond
our control. We do not have a detailed disaster recovery plan. Our facilities in
the State of California may be subject to electrical blackouts as a consequence
of a shortage of available electrical power. In the event these blackouts
continue or increase in severity, they could disrupt the operations of our
affected facilities.

WE INTEND TO CONTINUE TO DEVOTE SIGNIFICANT RESOURCES TO OUR RESEARCH AND
DEVELOPMENT, WHICH, IF NOT SUCCESSFUL, COULD CAUSE A DECLINE IN OUR REVENUES AND
COULD HARM OUR BUSINESS.

We intend to continue to devote significant resources to research and
development in the coming years to enhance and develop additional products. For
the six months ended December 31, 2001, research and development expenses
comprised 12.4% of our net revenues. If we are unable to develop new products as
a result of this effort, or if the products we develop are not successful, our
business could be harmed. Even if we do develop new products that are accepted
by our target markets, we do not know whether the net revenue from these
products will be sufficient to justify our investment in research and
development.

IF A MAJOR CUSTOMER CANCELS, REDUCES, OR DELAYS PURCHASES, OUR NET REVENUES
MIGHT DECLINE AND OUR BUSINESS COULD BE ADVERSELY AFFECTED.

Our top five customers accounted for 30.4% and our top ten customers
accounted for 37.8% of our net revenues for the six months ended December 31,
2001. Tech Data and Ingram Micro, domestic distributors, accounted for 10.3% and
9.4% of our net revenues for the six months ended December 31, 2001,
respectively. The number and timing of sales to our distributors have been
difficult for us to predict. For the six months ended December 31, 2001, large
individual sales to the distributors, as well as sales to other customers, have
occurred in the last weeks or even days of a quarter, which has resulted in a
substantial portion of the net revenues for that quarter being realized in the
last month of the quarter. The loss or deferral of one or more significant sales
in a quarter could harm our operating results. We have in the past, and might in
the future, lose one or more major customers. If we fail to continue to sell to
our major customers in the quantities we anticipate, or if any of these
customers terminate our relationship, our reputation, the perception of our
products and technology in the marketplace and the growth of our business 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 Server Technology. Our sales are usually completed
on a purchase order basis and we have no long-term purchase commitments from our
customers.

Our future success also depends on our ability to attract new customers,
which often involves an extended process. The sale of our products often
involves a significant technical evaluation, and we often face delays because of
our customers' internal procedures used to evaluate and deploy 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 on a timely basis or at all. This would cause our net revenues to
decrease and could cause the price of our stock to decline.

THE AVERAGE SELLING PRICES OF OUR PRODUCTS MIGHT DECREASE, WHICH COULD
REDUCE OUR GROSS MARGINS.

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. In the future, we expect competition to increase,
and we anticipate this could result in additional pressure on our pricing. In
addition, our average selling prices for our products might decline as a result
of other reasons, including promotional programs and customers who negotiate
price reductions in exchange for longer-term purchase commitments. In addition,
we might not be able to increase the price of our products in the event that the
price of components or our overhead costs increase. If this were to occur, our
gross margins would decline.

NET REVENUES FROM OUR LEGACY PRODUCTS, WHICH INCLUDE OUR PRINT SERVERS,
SWITCHES, HUBS AND OTHER PRODUCTS, HAVE DECREASED SIGNIFICANTLY AND WE EXPECT
THAT NET REVENUES FROM THESE LINES OF PRODUCTS WILL CONTINUE TO DECLINE IN THE
FUTURE AS WE FOCUS OUR EFFORTS ON THE DEVELOPMENT OF OTHER PRODUCT LINES.

Since 1993, net revenues from our legacy products have accounted for a
significant portion of our net revenues but have declined significantly
recently. For example, revenues from our legacy products were approximately $1.0
million or 3.2% of our net revenues, compared to $1.9 million or 8.2% of our
total net revenues for the six months ended December 31, 2001 and 2000,
respectively. We anticipate that net revenues from our legacy products will
continue to decline in the future as we plan to continue to focus on the
development of our current Device Server and Multiport Device Server product
lines. We do not know if this transition in product development will be
successful. We do not know whether our new product lines will be accepted by our
current and future target markets to the extent we anticipate. If the expected
decline in net revenues attributable to our legacy products is not offset by
increases in net revenues from our Device Server and Multiport Device Server
lines of product, our business could be harmed.

NEW PRODUCT INTRODUCTIONS AND PRICING STRATEGIES BY OUR COMPETITORS COULD
ADVERSELY AFFECT OUR ABILITY TO SELL OUR PRODUCTS AND COULD REDUCE OUR MARKET
SHARE OR RESULT IN PRESSURE TO REDUCE THE PRICE OF OUR PRODUCTS.

The market for our products is intensely competitive, subject to rapid
change and is significantly affected by new product introductions and pricing
strategies of our competitors. We face competition primarily from companies that
network-enable devices, companies in the automation industry and companies with
significant networking expertise and research and development resources. Our
competitors might offer new products with features or functionality that are
equal to or better than our products. In addition, since we offer an open
architecture, our customers could develop products based on our technology that
compete with our offerings. We might not have sufficient engineering staff or
other required resources to modify our products to match our competitors.
Similarly, competitive pressure could force us to reduce the price of our
products. In each case, we could lose new and existing customers to our
competition. If this were to occur, our net revenues could decline and our
business could be harmed.

INABILITY OR DELAYS IN DELIVERIES FROM OUR COMPONENT SUPPLIERS COULD DAMAGE
OUR REPUTATION AND COULD CAUSE OUR NET REVENUES TO DECLINE AND HARM OUR RESULTS
OF OPERATIONS.

Our contract manufacturers and we are responsible for procuring raw
materials for our products. Our products incorporate components or technologies
that are only available from single or limited sources of supply. In particular,
some of our integrated circuits are available from a single source. From time to
time in the past, integrated circuits we use in our products have been phased
out of production. When this happens, we attempt to purchase sufficient
inventory to meet our needs until a substitute component can be incorporated
into our products. Nonetheless, we might be unable to purchase sufficient
components to meet our demands, or we might incorrectly forecast our demands,
and purchase too many or too few components. In addition, our products use
components that have in the past been subject to market shortages and
substantial price fluctuations. From time to time, we have been unable to meet
our orders because we were unable to purchase necessary components for our
products. We rely on a number of different component suppliers. Because we do
not have long-term supply arrangements with any vendor 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.

OUR INTELLECTUAL PROPERTY PROTECTION MIGHT BE LIMITED.

We do not rely on patents to protect our proprietary rights. We do rely on
a combination of laws, such as copyright, trademark and trade secret laws, and
contractual restrictions, such as confidentiality agreements and licenses, to
establish and protect our proprietary rights. Despite any precautions that we
have taken:

. laws and contractual restrictions might not be sufficient to prevent
misappropriation of our technology or deter others from developing similar
technologies;

. other companies might claim common law trademark rights based upon use
of that precede the registration of our marks;

. policing unauthorized use of our products and trademarks is difficult,
expensive and time-consuming, and we might be unable to determine the extent of
this unauthorized use;

. current federal laws that prohibit software copying provide only limited
protection from software pirates; and

. the companies we acquire may not have taken similar precautions to
protect their proprietary rights.

Also, the laws of other countries in which we market our products might
offer little or no effective protection of our proprietary technology. Reverse
engineering, unauthorized copying or other misappropriation of our proprietary
technology could enable third parties to benefit from our technology without
paying us for it, which could significantly harm our business.

UNDETECTED PRODUCT ERRORS OR DEFECTS COULD RESULT IN LOSS OF NET REVENUES,
DELAYED MARKET ACCEPTANCE AND CLAIMS AGAINST US.

We currently offer warranties ranging from 90 days to five years on each of
our products. Our products could contain undetected errors or defects. If there
is a product failure, we might have to replace all affected products without
being able to book revenue for replacement units, or we may have to refund the
purchase price for the units. Because of our recent introduction of our line of
Device Servers, we do not have a long history with which to assess the risks of
unexpected product failures or defects for this product line. Regardless of the
amount of testing we undertake, some errors might be discovered only after a
product has been installed and used by customers. Any errors discovered after
commercial release could result in loss of net revenues and claims against us.
Significant product warranty claims against us could harm our business,
reputation and financial results and cause the price of our stock to decline
operations are vulnerable to interruption by fire, earthquake, power loss,
telecommunications failure and other events beyond our control. We do not have a
detailed disaster recovery plan. Our facilities in the State of California may
be subject to electrical blackouts as a consequence of a shortage of available
electrical power. In the event these blackouts continue or increase in severity,
they could disrupt the operations of our affected facilities.

BECAUSE WE ARE DEPENDENT ON INTERNATIONAL SALES FOR A SUBSTANTIAL AMOUNT OF
OUR NET REVENUES, WE FACE THE RISKS OF INTERNATIONAL BUSINESS AND ASSOCIATED
CURRENCY FLUCTUATIONS, WHICH MIGHT ADVERSELY AFFECT OUR OPERATING RESULTS.

Net revenues from international sales represented 18.1% and 31.0% of net
revenues for the six months ended December 31, 2001 and 2000, respectively. Net
revenues from Europe represented 15.4% and 25.8% of our net revenues for the six
months ended December 30, 2001 and 2000, respectively.

We expect that international revenues will continue to represent a
significant portion of our net revenues in the foreseeable future. Doing
business internationally involves greater expense and many additional risks. For
example, because the products we sell abroad and the products and services we
buy abroad are priced in foreign currencies, we are affected by fluctuating
exchange rates. In the past, we have from time to time lost money because of
these fluctuations. We might not successfully protect ourselves against currency
rate fluctuations, and our financial performance could be harmed as a result. In
addition, we face other risks of doing business internationally, including:

. unexpected changes in regulatory requirements, taxes, trade laws and
tariffs;

. reduced protection for intellectual property rights in some countries;

. differing labor regulations;

. compliance with a wide variety of complex regulatory requirements;

. changes in a country's or region's political or economic conditions;

. greater difficulty in staffing and managing foreign operations; and

. increased financial accounting and reporting burdens and complexities.

Our international operations require significant attention from our
management and substantial financial resources. We do not know whether our
investments in other countries will produce desired levels of net revenues or
profitability.

OUR EXECUTIVE OFFICERS AND TECHNICAL PERSONNEL ARE CRITICAL TO OUR
BUSINESS, AND WITHOUT THEM WE MIGHT NOT BE ABLE TO EXECUTE OUR BUSINESS
STRATEGY.

Our financial performance depends substantially on the performance of our
executive officers and key employees. We are dependent in particular on
Frederick G. Thiel, who serves as our President and Chief Executive Officer, and
Steven V. Cotton, who serves as our Chief Operating Officer and Chief Financial
Officer. We are also dependent upon our technical personnel, due to the
specialized technical nature of our business. If we lose the services of Mr.
Thiel, Mr. Cotton or any of our key personnel and are not able to find
replacements in a timely manner, our business could be disrupted, other key
personnel might decide to leave, and we might incur increased operating expenses
associated with finding and compensating replacements.

WE MIGHT BE UNABLE TO HIRE AND RETAIN THE SKILLED PERSONNEL NECESSARY TO
DEVELOP OUR OPERATIONS, SALES, TECHNICAL AND SUPPORT CAPABILITIES IN ORDER TO
CONTINUE TO GROW, WHICH COULD HARM OUR BUSINESS.

Our business cannot continue to grow if we do not hire and retain qualified
technical personnel. Competition for these individuals is intense, and we might
not be able to attract, assimilate or retain highly qualified technical
personnel in the future. In addition, we need to continue to hire and retain
operations, sales and support personnel. Our failure to attract and retain
highly trained personnel in these areas might limit the rate at which we can
develop, which would harm our business.

THE MARKET FOR OUR PRODUCTS IS NEW AND RAPIDLY EVOLVING. IF WE ARE NOT ABLE
TO DEVELOP OR ENHANCE OUR PRODUCTS TO RESPOND TO CHANGING MARKET CONDITIONS, OUR
NET REVENUES WILL SUFFER.

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. The demand for network-enabled products
is relatively new and can change as a result of innovations or changes. For
example, industry segments might adopt new or different standards, giving rise
to new customer requirements. Any failure by us to develop and introduce new
products or enhancements directed at new industry standards could harm our
business, financial condition and results of operations. These customer
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, or could
decline.

Item 3. Quantitative and Qualitative Disclosure About Market Risk

Interest Rate Risk. Our exposure to interest rate risk is limited to the
exposure related to our cash and cash equivalents and our credit facilities,
which are tied to market interest rates. As of December 31, 2001, we had cash
and cash equivalents of $48.5 million, which consisted of both domestic and
foreign cash and short-term investments with original maturities of 90 days or
less. We believe our short term investments would decline in value by only
insignificant amounts if interest rates increase, and therefore, such change in
valve would not have a material effect on our financial condition or results of
operations.

Foreign Currency Risk. We sell products internationally. As a result, our
financial results could be harmed by factors such as changes in foreign currency
exchange rates or weak economic conditions in foreign markets.

Investment Risk. At December 31, 2001, our investments in two privately
held companies totaled $5.9 million, both of which can still be considered in
the start-up or development stages. These investments are inherently risky as
the market for the technologies or products they have under development are
typically in the early stages and may never materialize. We could lose our
entire initial investment in these companies. Approximately $2.9 million of our
investment risk is in Premise Systems which we acquired in January 2002.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

From time to time we have received letters claiming that our products
infringe upon patents or other intellectual property of third-parties. On July
3, 2001, Digi International, Inc., filed a complaint in the United States
District Court for the district of Minnesota claiming patent infringement and
alleging that Lantronix directly and/or indirectly infringes upon Digi's U.S.
Patent No. 6,047,319 by making, using, selling and or offering for sale certain
of Lantronix's Multiport device servers, including the ETS line of products,
coupled with a device driver called the Comm Port Redirector Software. Digi
alleges that Lantronix has willfully and intentionally infringed Digi's patent,
and its complaint seeks injunctive relief as well as unspecified damages, treble
damages, attorneys fees, interest and costs. On August 17, 2001, Lantronix filed
its answer to the complaint, asserting affirmative defenses, and counterclaiming
for a declaratory judgment that the patent in issue is invalid. The Court has
scheduled a pre-trial Conference for February 19, 2002, in which discovery
parameters and a trial date will likely be set. Based on the facts known to
date, Lantronix believes that the claims are without merit and intends to
vigorously defend this suit.

Item 2. Changes in Securities and Use of Proceeds

On October 18, 2001, the Company completed the acquisition of Synergetic, a
provider of embedded network communication solutions. In connection with the
acquisition, the Company paid cash consideration of $2.7 million and issued an
aggregate of 2,234,715 shares of its common stock in exchange for all
outstanding shares of Synergetic common stock and reserved 615,705 additional
shares of common stock for issuance upon exercise of outstanding employee stock
options and other rights of Synergetic. The transaction was exempt from
registration pursuant to section 4(2) of the Securities Act of 1933, as amended.
Portions of the cash consideration and shares issued will be held in escrow
pursuant to the terms of the acquisition agreement as well as various employee
share repurchase agreements.

On January 11, 2002, we completed the acquisition of Premise, a developer
of client-side software applications. Prior to the acquisition we held shares of
Premise representing 19.99% ownership and in addition held notes receivable of
$1.2 million. We agreed to issue an aggregate of 1,063,371 shares of its common
stock in exchange for all remaining outstanding shares of Premise common stock
and reserved 875,000 additional shares of common stock for issuance upon
exercise of outstanding employee stock options and other rights of Premise.
Pursuant to the acquisition agreement, 106,337 of such shares will be held in
escrow to secure certain indemnification obligations, and 531,686 of such shares
will be held in escrow pending achievement of certain performance obligations.
We intend to issue these shares on or around February 18, 2002. The transaction
was exempt from registration pursuant to section 4 (2) of the Securities Act of
1933, as amended. In connection with the acquisition, the Company expects to
record a one-time charge for purchased in-process research and development
expenses related to the acquisition in our third fiscal quarter ending March 31,
2002.

Item 3. Defaults upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

None

Item 5. Other Information

None

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

Exhibit
- -------
Number Description of Document
- ------ -----------------------

2.1* Agreement and Plan of Reorganization by and among Lantronix, Inc.,
S Company Acquisition Corporation, and Synergetic Micro Systems,
Inc.

* Incorporated by reference to exhibit 5.1 previously filed with
Lantronix's Report on Form 8-K, originally filed September 20,
2001.

10.1 Employment Agreement between Lantronix, Inc. and Fred Thiel

10.2 Employment Agreement between Lantronix, Inc. and Steve Cotton

10.3 Loan and Security Agreement between Silicon Valley Bank and
Lantronix, Inc., United States Software Corporation, Lightwave
Communications, Inc. and Synergetic Micro Systems, Inc.

18 Letter from Ernst & Young LLP re: Change in Accounting Method

(b) Reports on Form 8-K

Date Item Reported On
- ---- ----------------

September 20, 2001 Lantronix announced it had entered into an agreement to
acquire Synergetic Micro Systems, Inc.

SIGNATURES

Pursuant to the requirements of the Securities Act of 1934, as amended,
Lantronix has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Irvine, State of
California, on the 14th day of February, 2002.

LANTRONIX, INC.

By: /s/ STEVEN V. COTTON
--------------------------------------
Steven V. Cotton
Chief Financial Officer and Chief
Operating Officer