Lantronix, Inc. (LTRX) Q3 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Third Quarter Fiscal 2012 Lantronix Incorporated Conference Call. My name is Larry and I’ll be your operator for today. At this time all participants are in listen-only mode. Later we will conduct a question and answer session. [Operator Instructions] I would now like to turn the conference over to your host for today Ms. E.E. Wang of Investors Relations for Lantronix. Please proceed.

Thank you, Larry. Good afternoon everyone and thank you for joining Lantronix third quarter fiscal 2012 conference call. Joining us on the call today are Kurt Busch, Lantronix’s Chief Executive Officer, and Jeremy Whitaker, Lantronix’s Chief Financial Officer. A live and archived webcast of today’s call will be available on the company’s website at www.lantronix.com. In addition a phone replay will be available through May 10 by dialing 888-286-8010 in the United States or for international callers 617-801-6888 and entering the passcode 11466881. As a reminder, during the course of this conference call management may forward-looking statements in their prepared remarks and in response to your questions and statements regarding products strategy, marketing plans, and future financial metrics including revenue, profitability, operating expenses, cash flow, and working capital. These forward-looking statements are based on Lantronix’s current expectations and are subject to substantial risks and uncertainties that could cause the company’s results for future business, financial condition, results or operation, or performance to differ materially from the historical results for those expressed or implied in any forward-looking statements made in this conference call. For a more detailed discussion of these and other risks and uncertainties facing our business, see the company’s recent SEC filings including its annual report on Form 10-K filed for the fiscal year ended June 30, 2011 and its quarterly reports on Form 10-Q also for the fiscal quarter ended September 30, 2011 and December 31, 2011, which are available through the investor relations portion of our website at www.latronix.com. Lantronix’s quarterly report on Form 10-Q for the fiscal year ended March 31, 2012 also will be made available through the investor relations portion of our website. Readers and listeners are cautioned not to place undue reliance on any forward-looking statements, which speak only as the date hereof and the company undertakes no obligation to update these forward-looking statements to reflect subsequent events or circumstances. If the company were to update or correct one or more of these statements, investors or others should not conclude that the company will make additional updates or corrections. Also, please note that in addition to GAAP results during this call, the company will also discuss non-GAAP financial measures. The company believes that the presentation of non-GAAP financial measures, when presented in conjunction with the corresponding GAAP measures, provides important supplemental information relating to the company’s financial condition and results of operations. The non-GAAP financial measures disclosed by Lantronix should not be considered a substitute for, or superior to financial measures calculated according to GAAP. Management believes that non-GAAP operating expenses, non-GAAP income or loss, and non-GAAP net income or loss per share are important measures of the company’s business. Management uses these non-GAAP measures to monitor and evaluate ongoing operating results and trends, and to gain an understanding of our comparative operating performance. In addition, certain of our stockholders have expressed an interest in seeing financial performance measures exclusive of impact and matters such as decisions relating to the restructuring, which while important, are not central to the core operations of our business. Non-GAAP financial measures used by Lantronix may be calculated differently from, and therefore may not be comparable to similar non-GAAP information provided by other companies. All financial results and reconciliations should be evaluated carefully. Please refer to our third fiscal quarter 2012 news release posted in the Investors Relations section of our website where we have provided the definitions and reconciliations for the non-GAAP financial measures that we use. I would now like to turn the call over to Kurt Busch, president and CEO of Lantronix, Kurt.

Thank you, E.E. Before Jeremy gets into the details regarding our financial performance for the third quarter of fiscal 2012, I wanted to share with you a few thoughts on our performance during the March 2012 quarter and more recent events. As outlined in our 3 previous conference calls, the key elements of our fiscal 2012 plan are to recruit the right leadership and resources, improve margins, decrease inventory, and ensure that strong financial discipline is in place; develop a new product strategy that is intended to provide innovative new products that will increase market share as well as expand the markets we address; and take action to create a strong market driven product development machine. During the fiscal quarter ended March 31, 2012, we began to see the initial results from the execution of our strategy. These results include the first production shipments of 2 new products; the xPrintServer Network Edition and the PremierWave-XN, meeting our commitment of on average 1 new product released to production per quarter. We announced and began sampling a new embedded product, the xPico, the world’s smallest device server. We increased net revenue from the prior quarter, reduced GAAP operating expenses to the lowest level in 3 years, reduced inventory to the lowest level in 2 years, as well as stabilized working capital. These activities culminated with the achievement of the best financial results the company has seen in 4 quarters. As we reduced GAAP lost to 41,000 and reported non-GAAP net income of 471,000. While we are pleased with the results we have achieved thus far, the management team and I are well aware that our work is just beginning. Continued aggressive execution of our growth plan will be critically important to achieve profitable growth. To that point, last week we completed 2 transactions that will strengthen our balance sheet and provide necessary working capital to allow us to continue to execute and expand our product development strategy. In April, 2012, we completed a private placement with TL Investment, our largest shareholder, which generated approximately $4.4 million in net proceeds. This transaction was priced above market value with no discount. In May, 2012, we completed an underwritten public offering which generated approximately $4.9 million in net proceeds and added 19 new institutional shareholders to our investor base. In conjunction with the public offering, we granted the underwriter a 30-day option to purchase up to 330,000 additional shares of our common stock at $2.50 per share. After giving effect to both transactions, TL Investments’ holding in the company increased slightly from approximately 40.4% to 40.8% of our outstanding common stock. The net proceeds of approximately $9.3 million from these 2 capital transactions, combined with the financial and operational gains we have made in the last 2 quarters, provides Lantronix with a strong foundation for moving forward in our growth strategy and our ultimate objective of creating enhanced value for our shareholders. On that note, I will turn the call over to Jeremy to review our detailed financial results for the March quarter.

Thank you, Kurt. Turning to our financial results for the 3 and 9 months ended March 31, 2012. Net revenue for the 3 months ended March 31, 2012 was $12.1 million, a decrease of 2% compared to $12.4 million for the 3 months ended March 31, 2011. And sequentially, an increase in 16% compared to $10.5 million for the 3months ended December 31, 2011. The year-over-year decrease was due to lower sales of external device enablement and device management products. The sequential increase in that revenue was primarily due to a $1.1 million increase in our device enablement product line as a result of a recovery in embedded sales in our EMEA and America’s regions, and a $0.6 million increase in our device management product line, the majority of which were the result of sales from the xPrintServer Network Edition which we began taking preorders on December 13, 2011. For the 9 months ended March 31, 2012 net revenues were $33.8 million compared to $37.3 million for the 9 months ended March 31, 2011. Gross profit as a percentage of net revenue for the 3 months ended March 31, 2012, was 48.8% compared to 51.4% for the 3 months ended March 31, 2011 and 48.2% for the 3 months ended December 31, 2011. With 3 sequential quarters of margin improvement, we believe that we have made significant progress towards brining margins back in line with our corporate target of 49 to 51%. Gross profit as a percentage of net revenue for the 9 months ended March 31, 2012, was 48.2% compared to 50.6% for the 9 months ended March 31, 2011. GAAP operating expenses were $5.9 million for the 3 months ended March 31, 2012, a decrease of $0.8 million or 12% compared to $6.7 million for the 3 months ended March 31, 2011, and down sequentially by $0.5 million for 7% from $6.4 million for the 3 months ended December 31, 2011. GAAP operating expenses for the 9 months ended March 31, 2012 were $18.9 million compared to $20.4 million for the 9 months ended March 31, 2011. Selling, general, and administrative expenses were $4.1 million for the 3 months ended March 31, 2012, a decrease of $0.9 million of 17% compared to $4.9 million for the 3 months ended March 31, 2011, and down sequentially by $0.4 million or 8% from $4.4 million for the 3 months ended December 31, 2011. This marked the third quarter in a row that we reduced SG&A expenses. For the 9 months ended March 31, 2012, selling, general, and administrative expenses were $13.5 million compared to $15.1 million for the 9 months ended March 31, 2011. Research and development expenses were $1.8 million for the 3 months ended March 31, 2012, which was flat compared with 3 months ended March 31, 2011, and a slight increase from $1.6 million for the 3 months ended December 31, 2011. R&D expenses for the 3 months ended March 31, 2012, increased slightly due to costs associated with new product launches. For the 9 months ended March 31, 2012, R&D expenses were $5.1 million compared to $5.3 million for the 9 months March 31, 2011. Non-GAAP operating expenses were $5.6 million for the 3 months ended March 31, 2012 compared to $5.8 million for the 3 months ended March 31, 2011. The $5.8 million for the 3 months ended December 31, 2011. For the 9 months ended March 31, 2012, non-GAAP operating expenses were $17.5 million, flat with $17.5 million for the 9 months ended March 31, 2011. We may see a slight increase in operating expenses moving forward as we continue to execute on our product development strategy. Assuming a 50% gross margin, we still expect to maintain a quarterly non-GAAP breakeven point at or below $11 million in quarterly net revenue. GAAP net loss was $41,000 for the 3 months ended March 31, 2012 or $0.00 per share compared to a GAAP net loss of $399,000 or $0.04 per share for the 3 months ended March 31, 2011, and sequentially a GAAP net loss of $1.4 million or $0.13 per share the 3 months ended December 31, 2011. GAAP net loss for the 9 months ended March 31, 2012, was $2.9 million or $0.27 per share compared to a GAAP net loss of $1.7 million or $0.16 per share for the 9 months ended March 31, 2011. Non-GAAP net income for the 3 months ended March 31, 2012, was $471,000 or $0.04 per share compared to non-GAAP net income of $691,000 or $0.06 per share for the 3 months ended March 31, 2011, and sequentially a non-GAAP net loss of $629,000 or $0.06 per share for the 3 months ended December 31, 2011. Non-GAAP net loss for the 9 months ended March 31, 2012, was $855,000 or $0.08 per share compared to non-GAAP net income of $1.7 million or $0.16 per share for the 9 months ended March 31, 2011. Now turning to the balance sheet. Cash and cash equivalence as of March 31, 2012 were $1.8 million compared to $5.8 million as of June 30, 2011. As previously mentioned by Kurt, we completed 2 capital transactions in April and May 2012, generating a total of approximately $9.3 million in net proceeds which we believe will strengthen our working capital position. Accounts receivable as of March 31, 2012 were $2.7 million compared to $1.4 million as of December 31, 2011 and $2.9 million as of June 30, 2011. The sequential increase in accounts receivable was due to the sequential increase in net revenue of 16% and the timing of product shipments, which were more heavily weighted towards a second half of the March 2012 quarter. We are beginning to see results from our inventory management efforts which resulted in a reduction of our net inventories to $6.8 million as of March 31, 2012, a decrease of $2.4 million or 26% compared to 9.2 million as of June 30, 2011. While we will continue to optimize our inventory levels, we do not expect to see such dramatic decreases in inventory going forward. And in fact, we could see some decreases in inventories as we put in place stocking levels for product releases and increased demand. Accounts payable were $4.4 million as of March 31, 2012, a decrease of $3.9 million or 47% compared to $8.4 million as of June 30, 2011. Working capital was $2.4 million as of March 31, 2012, compared to $2.4 million as of December 31, 2011, and $5.2 million as of June 30, 2011. The restructuring plan, costs containment measures and inventory reduction initiated by management during the quarter ended December 31, 2011 were instrumental in stabilizing our working capital during the March, 2012 quarter. While stabilizing working capital was a key part of our short-term strategy, it is just as critical for us to have sufficient working capital to execute on our growth strategy. For example, we were supply constrained during the March 2012 quarter, in large part due to insufficient working capital. Our recent fundraising generated an additional cash of $9.3 million and we believe that for the foreseeable future it will provide us with the capital required to execute on our strategy and achieve profitable growth. I’ll now turn the call back to Kurt.

Thank you, Jeremy. Jeremy has just spend the last few minutes giving you the financial details of what occurred during the 3 and 9months ended March 31, 2012. As I stated earlier, the actions we took to instill greater financial and operational discipline over the last 2 quarters have been instrumental in creating the initial positive results that we achieved in the March 2012 quarter. More importantly, we have instilled an entrepreneurial and energized product development mentality that will continue to build momentum as we drive forward towards profitable growth. Our focus from the beginning has been to build a product development machine that leverages its strengths of Lantronix’s existing IP portfolio, its strong sales channel, and its reputation as an innovator in creating M2M solutions that are simple and elegant to use. Earlier this fiscal year, I committed to you that we would launch, on average, 1 new product into production each quarter. In the December quarter we released to production the EDS-MD, a next-generation advanced medical aggregator based on our award winning EDS device enablement product line, specifically designed for the stringent requirements of the medical market. The EDS-MD provides mission-critical device aggregation and allows central and remote management of multiple medical devices. In January we release to production the xPrintServer Network Edition, the first member of an entirely new device management product line that allows Apple iOS users to print to virtually any networked printer. Since its introduction in mid-December, the industry response to this solution has been phenomenal with the xPrintServer Network Edition receiving numerous industry awards and accolades. In addition to being showcased as CES, Embedded World and Mac World, the xPrintServer was demonstrated at the Morgan Stanley Emerging Technology and Media conference in February and the 2012 Roth Capital conference in March. While awards and accolades are valued endorsements that can make potential customers aware of a product and its merits, the proof is in the sales. And I’m happy to report that we’ve been very pleased with the sales response to this product to date. In February 2012 we launched the PremierWave-XN, a next-generation external device server and part of our award winning PremierWave device enablement product family. About the size of a deck of cards, the XN is a dual-band, multiport serial device server offering both Wi-Fi and Ethernet connectivity that enables remote access and easy management of machines over the network and across the Internet. This solution is primarily used in industrial applications. We began sampling this product in January 2012 and released to production at the end of the March 2012 quarter. Also in February 2012 we launched the xPICO, the world’s smallest embedded device server. Smaller than a quarter, the xPICO offers security browser and network capability in a low-cost form factor that will allow us to address new applications that were previously closed to us due to size or price constraints. The xPICO was released to production this April 2012. While the design in cycle for a product like the xPICO was typically anywhere from 9 to 18 months, the longevity of this type of product can be 6 years or longer. For example, this year we celebrate the 10th anniversary of the launch of the xPort product family, which continues to be a strong contributor to our device enablement sales worldwide. In summary since December 2011, we’ve released to production 4 new products demonstrating our commitment to aggressive engineering and market execution. Looking forward to the coming quarters, we expect to release our first device servers with cellular interfaces, our fist analog or sensor device servers, new members of the xPrintServer family as well as additional new members of current product families. Our new products will continue to leverage Lantronix’s strong platforms and bring new levels of functionality and ease of use that will further strengthen and expand our sales opportunity. Today, I am pleased to report that we have achieved many of the initial goals we discussed with investors back in September of 2011. These goals made up the first steps of our strategy and combined with the recent capital transaction, have established the foundation from which we intend to build the Lantronix business moving forward. We intend to build from this foundation and pursue long term value for our shareholders in the same way that we have achieved the positive results Jeremy and I are reporting to you today with a relentless commitment to financial and operational discipline, and an energetic and innovative mind set in bringing to market new products that make sense for both our customers and Lantronix. Before turning the call over for questions, I’d like to thank my Lantronix colleagues, our shareholders, our partners, and our customers for your ongoing support. Operator, we’d like to open the call for questions.

[Operator Instructions] Our first questions comes from the line of Paul Johnson of Nicusa.

Couple questions I guess for Kurt and for Jeremy separate. It sounds like the gross margin was hurt a little bit in the quarter partially because of absorption, partially because of expediting freight. It sounds like you would have shipped more if you’d had more product in stock, is that fair, or you just have to get it there, it was just expensive getting it there?

Yes, we did end the quarter with some unfulfilled backlog. A lot of that likely would have gone into the distribution channel as inventory, and it’s hard to put our arms around how much of that could have been revenue, but we were impacted by supply constraints during the quarter.

Are you confident you’ll be able to get those supply constraints under control in the current June quarter?

Thank you for your question, Paul. We’re doing everything that we can to remove the supply constraints, and actually the working capital raise that we just completed will definitely help in that matter.

That’s our second question, so bounce up there and come back and say another question. Kurt, what was the biggest constraint from not having more liquid working capital? Sounds like being able to meet demand?

Actually, the biggest constraint for the March 2012 quarter, if I understand the question correctly really was on the demand side. So, we did end with some supply constraints as Jeremy said. But we do believe most of that probably would have gone into distribution inventory.

Not necessarily into ultimate revenues, but clearly you had some customers that did not get all the product that they wanted in the quarter?

Exactly.

And part of that is supply change part of it is working capital, both of which you’ve been working on. Obviously the working capital was sort of problem.

That is correct.

Jeremy, not to pin you don’t but it sounds like gross margins would have been higher in the quarter if you hadn’t had the freight acceleration and the lower absorption. Order of magnitude, a lot higher, a little bit higher?

We’re not going to give specifics on that, but it would have been a little bit higher.

So you end the quarter with things that was suggested the quarter could have been a little bit better if you had the working capital frankly?

Yes.

Inventory turns, do you have a target, not necessarily specifics, but you’ve brought inventories down a lot, sort of the lowest level they been in an awfully long time. Is there more to go, or are you sort of where you want to be, and now you just work on the mix of it?

I think at this point we’re about where we want to be. I mean our target is 3 to 4, and as we begin to release new products, and as revenues increase we may need to slightly increase inventory levels. So I think we’re pretty close to where we think we should be in that 3 to 4 range.

Obviously you guys have talked about growing absolute dollars with inventory. You’d like them to go up because you need to, because of your growing revenues. So I assume we should start to think about turns, roughly in here. The level will tract revenue as you grow revenue. Actual inventory dollars could go up?

That is correct. High quality problem, right?

Kurt, on the recent [indiscernible] you guys started talking about a longer term business model, can you kind of review that and the [indiscernible] profitability, things like that?

Actually I’ll [indiscernible] probably should refer everyone on the call to the recent AK, that describes long term model. But I’ll let Jeremy actually walk through the actual numbers.

Was there a specific question that you had on that Paul?

Just to talk about it because you guys have put out now -- - because the new management has been there for a little while. You’ve gotten your sense of the operation. There was lots of progress in terms of operating metrics in the current quarter. Obviously the new products are starting to ship, profitability is going up. You got -- I don’t know, I haven’t looked all the way back, but better operating result than you had in an awfully long time, and now you’re starting to talk about a longer term model. I’d just love to have you walked through it. That’s new news, obviously you’d put it out there was some level of confidence, which I’d love to touch on for a moment if we could?

Sure. You know the basic assumptions we made were, you know, a growth rate in the low to mid-teen’s, and also the assumption in that we bring our margins back up to our corporate historical average of between 49 to 51%. You know, this last quarter we had 48.8%, so we made good progress in getting the margins up to where they needed to be for the target model. And with that sort of revenue growth rate, and that gross margin level, we believe that within the next 1 to 2 years, we can have a target model with, you know, non-GAAP operating income, or non-GAAP incomes of about 3 to 6% compared to, I think, the first half of 2012, which was about negative 6%. So we think there’s quite a bit of leverage in our model. And we do assume some slight increases in OpEx primarily in sales in R&D that will need to be make to support the low to mid-teen revenue growth that we have in this model.

Helpful. Final question, I guess, back to Kurt. Last fall I asked what was the most important metric from the outside we should look for, and you had suggested new products would be an important one from your perspective. Obviously now you’re throwing out, I assume, some profitability measures, not meaning over the next 3 or 6 months, but over the next couple of years. I assume those are the 2 you’d want us to look at continuing new products, shipments and development, as well as increased profitability increase financial metrics.

Yes Paul, actually right now I’d like to emphasize that many of the initial goals that we set out to achieve: basically reduction of inventory, increase of margins, putting the management team and the strategy in place. I think that now is all the foundation along with the recent capital rates, really puts the foundation of Lantronix moving forward. So, now really the way to measure the company is on the financial results, and those financial results are going to be driven by the new product introduction.

Our next question comes from the line of Krishna Shankar of Roth Capital.

Can you talk about, you know, how bookings were during the quarter, and I know that you don’t give guidance, but can you give us some sense based on bookings and what you see in terms of business trends. What kind of good trajectory, what we might expect for the June quarter?

Krishna, we don’t give -- as you know we don’t give guidance, but we can say that our current bookings today are in line with the previous quarter.

Okay. And the growth in the June quarter will be -- - can you describe what will be some of the drivers for growth in the June quarter, between some of the new products that you have and the old products that you’re already shipping? Where will the growth come from?

We’re not giving that level of detail at this point Krishna, I’m sorry.

But you are seeing very good traction with the xPrintServer and now that you have working capital, I guess you could fulfill more demand for the Apple xPrintServer application.

Exactly.

And then, PremierWave XN and xPico I guess that could take 6 to 9 months in terms of getting to volume revenues?

So typically if you review the 3 types of products that Lantronix offers, the embedded product such as the xPico can take anywhere of, let’s say a year to really ramp into decent production volumes. Yet they live for quite some time, say 5 years or 6 years plus. And then the external products such as the PremierWave XN have a qualification cycle, but not quite as long as the design N cycle. So typically you start seeing orders in the 3 to 6 month timeframe and then ramp from there. And then the IP management products such as the xPrintServer, with the results we saw in the previous quarter, you can see revenue in those products pretty much immediately from launch or as soon as these things get into production.

Okay. And then the supply constraints in the March quarter, was that due to some of the issues that we had in Thailand and in the contract manufacturing supply channel, or what kind of supply constraints were these?

These supply constraints were primarily self-generated due to a working capital crunch within the company.

Okay. And then, I missed the part where you talked about the cellular version of the product and then also the sensors. Can you just highlight again the state of development of those 2 new products? The cellular version of PremierWave and then the sensor?

The question is regarding what is our plans for the cellular as well as the analog sensor products. The cellular products and the analog sensor products will be going to full production in this calendar year. The cellular product is very far along in its development. We are currently in beta testing of the cellular products and we expect to go to production in the near future. The analog product is a little bit farther out and we are doing, I’d say, active internal testing on the analog product.

Our next question comes from the line of J.D. Abouchar of GRT Capital.

Just had a question following up on Krishna’s about the analog and cellular markets. Those are big new opportunities for the company. Do we have the distribution channel in place for this? Is this a different sale? How does this affect SG&A and the ability to penetrate those markets?

The cellular product is really an ideal fit for the current distribution channel. We currently sell into our customer base both wired and wireless solutions, which are primarily Wi-Fi solutions, or actually entirely Wi-Fi solutions today. And those customers have been asking us for cellular products today. So the distribution channel is very straight forward. It’s the same value proposition, the same ease of use of Lantronix products, new network interface, same sales channel, and more often than not actually selling more to the same customers. So that’s a very nice fit and a very nice way for us to grow revenue in the near future. The analog sensor products are a little bit different. Many of our current customers are interested in these types of products, so it does fit nicely into the current sales channel. But we will be developing new sale channels that are, somewhat new to Lantronix, but still very much related in selling the analog sensor products. So I think they’re both a nice fit, but there will definitely be some more expansion on the sale side on the analog products. To answer your question on the SG&A area, is we currently believe that we have the sales force to do this, but we are slightly expanding the sales force, we do have some open recs in both sales and engineering today to help with our growth strategy.

Can you quantify maybe the company is working on a pretty thin shoestring there in terms of working capital, and you mentioned on that server affected supply constraints, and therefore to some extent sales. Does it help us though now that you’ve got some working capital being more solid, does that help in just perception and sales going forward and maybe the ability to negotiate better supply contracts, because you have a little bit more visibility and can buy stuff little bit longer term?

We definitely expect it to help in all of those things.

With no further questions, I would like to turn the call back over to management for closing remarks.

Thank you operator. I’d like to thank you all for your participation on our call today. We look forward to updating you on our progress, achievements, and actions when we report our year-end fiscal results.

Ladies and gentlemen, that concludes today’s conference. Thank you for your participation, you may disconnect at this time. Have a great day.