Lantronix, Inc. (LTRX) Q3 2016 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Lantronix’s Third Quarter Fiscal 2016 Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there'll be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to E.E. Wang, Director of Corporate Marketing and Investor Relations. Please go ahead.

Thank you, Carey. Good afternoon everyone and thank you for joining the Lantronix third quarter fiscal 2016 conference call. Joining us on the call today are Jeff Benck, Lantronix's President and Chief Executive Officer and Jeremy Whitaker, Lantronix's Chief Financial Officer. A live and archived webcast of today's phone call will be available on the Company's website at www.lantronix.com. In addition, a phone replay will be available starting at 08:00 PM Eastern, 05:00 PM Pacific today through May 4, by dialing 877-344-7529 in the US or for international callers, 412-317-0888 and entering pass code 10084529. During this call, management may make forward-looking statements, which involve risks and uncertainties that could cause Lantronix's results to differ materially from management's current expectations. We encourage you to review the cautionary statements and risk factors contained in our earnings release, which was furnished to the SEC today and is available on our website, and in the Company's SEC filings such as its 10-K and 10-Q. Lantronix undertakes no obligation to revise or update publicly any forward-looking statements to reflect future events or circumstances. Also please note that during this call, the Company will discuss some non-GAAP financial measures. Today's earnings release, which is posted in the Investor Relations section of our website, describes the differences between our non-GAAP and GAAP reporting and presents reconciliations for the non-GAAP financial measures that we use. I'll now turn the call over to Jeff Benck, President and CEO of Lantronix.

Thank you E.E. And welcome to everyone joining us for this afternoon's call. Let me start by saying that I am pleased with the early progress we made in the third quarter of fiscal 2016 executing with a sense of urgency against the initiatives we kicked off when I joined the company. First driving operational excellence in our organization; second rationalizing our product roadmap; and third initiating a new strategic direction and starting the investment required to position our company for the growth in the IoT market. Our results for the March quarter reflect the progress we made in stabilizing the business as we grew revenue sequentially, maintain gross profit margins and recorded modest non-GAAP net income. New product revenue grew 21% sequentially and 34% year-over-year driven primarily by growth in sales of our SLC 8000 advanced console manager. Bottom line, we have gotten off to a good start but we have a lot left to do. It will take time for our new efforts to produce results; however, I believe that we are on the right path and have certainly attracted some excellent talent to the team to help us. Before I provide some additional color on our achievements during Q3, I am going to turn the call over to Jeremy to discuss our financial results.

Thank you, Jeff. Please refer to today's news release and the financial information in the Investor Relations section of our website for additional details that will supplement my financial commentary. Now I'd like to take a few minutes to go over our results for the third quarter of fiscal 2016. Net revenue was $10 million for the third quarter of fiscal 2016 compared with $10.4 million for the third quarter of fiscal 2015 and $9.5 million for the second quarter of fiscal 2016. The year-over-year decrease in net revenue was primarily due to the anticipated decline in sales of our legacy product. The overall decline in legacy product was partially offset by 34% growth in new product sales. Year-over-year growth in our new products was primarily due to growing contribution from our SLC 8000, which more than doubled over the same period last year. Gross profit as a percentage of net revenue was consistent at 48% for the third quarter of fiscal 2016 compared with 48.1% for the second quarter of fiscal 2016, and 45.1% for the third quarter of fiscal 2015. Selling, general, and administrative expenses for the third quarter of fiscal 2016 were $3.5 million compared with $3.9 million for the third quarter of fiscal 2015, and $3.8 million for the second quarter of fiscal 2016. Research and development expenses for the third quarter of fiscal 2016 were $1.7 million relatively flat with the year-over-year and sequential quarters. We expect operating expenses to increase by approximately 100,000 to 200,000 during the fourth fiscal quarter as we add sales and marketing resources, and build out a new India team to help drive our redefined IoT product development strategy. Sequential growth combined with reduced expenses helped us to achieve improved operating results. GAAP net loss was $456,000 or $0.03 per share for the third quarter of fiscal 2016 compared with a GAAP net loss of $839,000 or $0.06 per share for the third quarter of fiscal 2015 and a GAAP net loss of $928,000 or $0.06 per share for the second quarter of fiscal 2015. Non-GAAP net income was $189,000 or $0.01 per share for the third quarter of fiscal 2016 compared with a non-GAAP net loss of $357,000 or $0.02 per share for the third quarter of fiscal 2015 and non-GAAP net loss of $196,000 or $0.01 per share for the second quarter of fiscal 2016. While we expect some increase in operating expenses as we invest to support key strategic objectives our focus remains on managing expenses to minimize impact to earnings and cash flow. Now turning to the balance sheet, cash and cash equivalents were $4.1 million as of March 31, 2016 compared with $5 million as of June 30, 2015. Decrease in cash was primarily related to a severance payment to the former CEO and a strategic investment in a software license that we intend to use as part of our IoT software product development efforts. During the third quarter, we reduced inventory by an additional $586,000. Net inventories were $7.3 million as of March 31, 2016 compared with $9.5 million as of June 30, 2015. As of March 31, 2016, our working capital was $7 million. We continue to evaluate our cash and working capital requirements as we develop our plans to invest for growth. I will now turn the call back to Jeff.

Thank you, Jeremy. As I mentioned earlier, our short term plan is centered on three key objectives. First, we are driving operational excellence across the business. During the quarter we completed restructuring efforts that included combining our Japan and Asia-Pacific operations into one region, which we will now refer to as Asia-Pacific Japan, and consolidating some G&A and operations resources at our headquarters. An additional focus has been retooling ourselves in marketing functions to address skill gaps and execution issues. This started with the hiring of a new head of worldwide sales Kevin Yoder, who started in early March. Kevin was most recently running Avago sales in the Americas. So he brings a new level of capability to the role. Kevin has already hit the ground running with his own set of initiatives and has quickly helped us attract new talent to drive our worldwide sales efforts. On the marketing front, the team took action to rationalize the company's [outbound] marketing spend, eliminate low ROI projects, and implement a strategy that emphasizes more focused effort on growth opportunities. Today our marketing resources have been realigned with our new corporate strategy, and I am excited about the new [outbound] marketing campaigns that we have planned for the coming months. We also reorganized our engineering resources to support our new product development strategy. This included making the decision to establish our own engineering lab in Hyderabad, India, that will add additional capacity to the team and critical skills needed to execute our IoT strategy. We have already hired several engineers and are moving quickly to establish the subsidiary. Turning to the second initiative, we completed rationalization of our product road map to allow greater emphasis and investment in business areas where we believe we can drive profitable growth. This meant that we substantially reduced investment in xPrintServer, and eliminated some software releases on our legacy product, which enabled us to free up resources to invest in IoT solutions. One element of our product plan that hasn't changed is our intent to deliver IoT building blocks that play a key role in helping companies IoT enable their machine. In late February we announced launch of PremierWave 2050, a production ready embedded WiFi module designed specifically for simplifying IoT enablement of mission critical industrial application. Featuring enterprise grade security and fifth generation WiFi this product is already in production and ramping with several customers. We also made progress on our third objective to define a new strategic direction that will position Lantronix for growth in the IoT market. Not long after I joined, I launched a small strategy team within the company that has spend considerable time developing an enhanced IoT solution strategy that we would believe will be differentiated in the marketplace. In February, this team was augmented with my recruitment of Sanjeev Datla to the new role of Chief Technology Officer. As mentioned on our last call, Sanjeev has more than 20 years of experience in developing systems, networking and IoT solutions. He has worked closely with our team and leading the effort to define new solutions that will complement our IoT building blocks and solve more of the problems that customers face when trying to implement an industrial IoT project. Suffice to say we have made significant headway in redefining a new IoT strategy that will combine Lantronix’s history of creating enterprise hardened offerings that are easy to deploy with a new secured data access and management software platform designed specifically for enterprise IoT. These new solutions will help companies to simplify their industrial IoT deployments, enable end users to securely access the data generated by their smart machines, and assist OEMs in creating value added business models. Let me wrap up. During the third quarter, we took action to stabilize the business. While it will take time for our changes and new strategy to bear fruit I believe the initial indicators are promising and with the new additions we are building quite a talented team here at Lantronix. I am a strong believer that it starts with getting the right talent in the right roles and then sharing an exciting vision for the future that is focused on solving customer problem. The view of the future has made the team and I increasingly optimistic about the direction Lantronix is headed. Before I open the call for questions I want to thank my colleagues for their continued hard work and support of our new vision, our customers who continue to rely on our products, and finally the existing and new investors who have reached out to me in recent months to offer their support and interest in Lantronix. Operator, we would now like to open the call for questions.

Thank you. [Operator Instructions] Our first question comes from Jaeson Schmidt of Lake Street Capital Markets. Please go ahead.

Hi, guys. Thanks for taking my questions. Just wondering Jeff if you can talk a little bit now that [Indiscernible] time has passed since joining Lantronix, if you could talk about what areas do you think the company is particularly strong in and also where you think there is room for improvement going forward, and then just relatedly, if you wouldn't mind talking about how you view the company's software strategy going forward as well?

Okay, sure. Thanks for the question. Yes, so I am at the point now obviously in my – completing my first full quarter that I have a pretty good feel for how we are doing in particular areas, and some of the changes we have made are really focused on trying to address some of the areas we have had gaps. We clearly from a sales and marketing standpoint needed to approach the marketplace a little bit different. I wasn't thrilled with the way we were covering the geographies with resources. As we mentioned we did some consolidation in Japan and APAC into one region and freed up some resource that we have been pursuing some staffing in the US. It is great to have Kevin on as a new sales leader kind of driving that effort and getting into that in more depth. From a product strategy standpoint there is a couple of things that are very interesting to me. Number one, we have got a pretty exciting new product in the IT management space in the SLC 8000 and it's a product that followed onto a space that we have been in for quite some time, but right now it really looks like we have got some unique differentiation in the marketplace and we are seeing pretty strong demand there. Even though the overall IT management space I would say is not growing at this point, we are seeing quite a bit of traction in the development labs and in areas where we have got some unique capabilities against the competition. So I clearly see us gaining some share there. From a IoT standpoint we have participated in that market and that's been a key focus for the company for quite a while, but we have really been doing building blocks and building blocks for that segment, where we provide a connectivity solution whether it's sort of the Ethernet or Ethernet to WiFi, we have a host of different solutions there. We are seeing some new product ramp in that area with some new offerings. We just announced the PremierWave 2050 at Embedded World, and we have got a number of customers in production that are at the beginning of a ramp there that is promising. I would say the one area we felt that we did – we could do more and that's really where the strategy is looking to take us is in this notion of how do we play a bigger role in IoT in solving more of the problem. There is a pretty complicated stack that you have to deploy if you want to go – if you want to bring your smart machines online and in the past we helped with the connectivity, but we really see an opportunity to really help customers get the data off of those machines and while I don't see us developing software analytics solution or really trying to be the end all be all from an IoT platform perspective because there is a number of competitors in that space, we definitely feel like we live pretty close to the machines and where the data is and we can help customers kind of unlock the data from those – from that equipment and that's where you are going to see us I think look to put more solutions in the marketplace beyond just the building blocks that we develop today. To your question on software development I mean that is an area that we are investing more resource. We just initiated an India lab. We will hire some software skills there. We have already started that effort with a few hires and we are also shifting the focus in the US engineering team to, augmenting our platform with software that will help – be able to move that data from the device into a form that can be used whether you are deploying a broader IoT initiative or you are really just looking to do remote management and access data securely from that equipment. So that's where I see us doing more, investing more in the software around going forward. So hopefully that should give you some framework.

Okay, perfect. I will jump back into queue. Thanks.

Sure.

[Operator Instructions] Our next question is from [Indiscernible]. Please go ahead.

Hi, how are you?

Good Ed. Thanks for joining the call.

Yes, thank you. So I really - I sense a little progress here. The tone of the call and the report smells a little bit like you are making some progress, which is a good thing. Keep it up.

Thank you.

I have a – just – I want to just flush out a little bit more if you can on the PremierWave product, is it part of a bigger solution, is it a product that's a solution in itself, are you replacing other people's existing legacy products, can you just give me a feel for what the functionality of that and how – what is your kind of estimate of what the available market and how far is the visibility out on this product, is it a one year phenomenon, is it a three year phenomenon, that type of things?

Yes, I can start and then maybe Jeremy want to add a little color too. The PremierWave 2050 that we launched is an embedded module that helps...

I am sorry. I am sorry I meant the SLC 8000…

Okay, the SLC 8000 is a console manager that can be used today by customers that are in a data center deployment where they want to manage their IT infrastructure machines in the data center and be able to access those out of band. So it is really an out-of-band management tool and it's a little unique in the market because it is a [one hour] appliance, I guess I would describe it as [one Hour] being 1.75 inches tall and it's an appliance that goes in a rack. Now this – what's unique about our product is it's modular, and you can add serial ports if you want to manage a larger number of machines, but it also support USB, which is a bit unique. No one else in the market has USB added and it has more of the switches than infrastructure moves to USB standard we are finding some unique position that we have got something no one else has, and it's modular so you can mix and match if you want to do 16 ports of USB with 16 ports of RS232 you can do that in our platform. It replaces the product that we called [SLC 3], which has been in the market for quite a long time probably more than five years and Jeremy.

Much, much longer.

Much longer than five years. So it has quite a bit of longevity and our product has really just been introduced a little over a year ago but then we enhanced it with the USB support. So we continue to add capability and in fact we have got some additional enchantments will be announcing in a couple of weeks here at [Indiscernible] in the next week or so here. The other thing that I might say is I mentioned it can go on the data center, where we are seeing a lot of interest in the product is in actually in the development labs and we are finding a lot of developers as they put facilities overseas where they have remote people wanting to get access to the equipment, we are finding that our platform has a lot of performance and we can handle a ton of developers connecting to a port of a particular storage device or switch device or router, we can handle more attachments, which enables more developers to be effective in the engineering space. That's a segment that's growing. I don't have great numbers to share with you in terms of the market size because frankly there is not an analyst tracking this segment now and you can bet I spent time trying to understand that better, but we know it's a multi-hundred million dollar market but it's probably north of a hundred million dollar marketplace let's say just to give you a rough feel. And today we are a small player in this space, but I will say that with the kind of growth we have seen doubling year-over-year that we believe with the new product we are gaining some share in this segment. So I hope that shares a little bit. I think there is…

I just have the quick – the ASP for this product is?

Well, it has a range. The product can range anywhere from $1000 up to $4000 , $5000 if it is completely configured with the full complement of 48 ports and everything that can handle. So it's got quite a range and that was more MSRP that I was giving you.

Right. Okay, thanks.

Our next question is a follow-up from Jaeson Schmidt of Lake Street Capital Markets. Please go ahead.

Hi, guys, I just wanted to talk a little bit about Opex, I know it is supposed to be up kind of $100,000 to $200,000 in June but how should we think about that going forward beyond June?

Yes, this is Jeremy. Currently we are in the middle of our annual planning process for the next fiscal year, and so I think when we come on at the next call we can give a little bit more flavor as to our expected spending for the next fiscal year. But I think at this point that's – going into next quarter is about as comfortable and as far as we want to go with as it relates to spending for that region.

I think Jeremy gave some guidance in the call about a bit of an increase next quarter. As I have mentioned we have hired some additional resources, a new head of sales, a new CTO, and we are adding some additional sales resource. We did do a restructuring that is allowing us to do some of this movement and kind of funded from within, but as we also add the new facility in India, again the restructuring that we have done is helping us there but we still believe that even all that considered that there is a potential that we will need to spend a bit more than we have been spending, and like Jeremy said, we are happy to give you a bit more color as we kind of come through our planning cycle and get into the results at the end of the quarter. And we can maybe then look at whether – how to give you a more of a new fiscal year view as how we are thinking about expenses.

It makes sense. Thanks a lot.

Sure.

Our next question comes from Mark Spiegel of Stanphyl Capital. Please go ahead.

Thank you. Hi guys. Congratulations on it looks like you have at least stabilized things there and the plans seem to make sense. Just a quick question and I guess it's really a Jeremy question, are there any limitations now on your NOLs?

Well, we have I think close to about $80 million plus of NOLs out there and over time some of those NOLs will begin to expire but in the short term I don't see any limitations on those.

What I mean, I mean change in control limitations, I don't know when, over what time Bernard bought his shares, the rule I am talking about, it is section something or other, I forgot the number.

Yes, as far as we are aware we haven't hit any of those criteria because not enough – a change in control didn’t take place as far as we know.

So, just a suggestion that you might want to look at, I don't think you have one, you might want to look at putting in a blocker that would not let it happen?

Okay, we will note that.

You mean like a [Indiscernible].

Yes, well kind of but not one meant to discourage the buyout of the company. It is a kind of thing where the board can rescind at any time and it has an expiration date but it just basically stops someone going from over 4.99 or whatever and just protects them. I mean you are a tiny company and it wouldn't be hard for a small fund even to go over 4.99 and inadvertently kill those and they are actually worth a heck of a lot of money if you guys can get profitable again.

Fair point. I think it's a good discussion for the board. We do talk about all these kind of aspects. So it makes sense. We will go back and look at that.

Okay, thank you. I appreciate it.

Thank you.

Our next question is a follow-up from [Indiscernible]. Please go ahead.

Thanks. So I am going to sort of circle back to the mistake that I made in terms of the PremierWave 2050 because basically I look at you guys as twofold, one is getting the thing stabilized and running efficiently, but two a new product story and so the PremierWave is a new product that was introduced in February. I was a little surprised that it's already embedded into products that are going into production because I thought generally embedded products took a much longer time to sort of be embedded, not that I know this business intimately that I would know that but maybe you can kind of give us a little flavor on that and I am just going to – I am going to give another tag onto Jeremy because I kind of kicked up a little bit, as you guys are starting to grow obviously you need some working capital to do that and whether you need to look externally for some capital to maintain that not right now but at some point in the future so there are two separate questions that I am…?

Let me start on the PremierWave. So a little bit of difference in approach the team took and this frankly was started before I arrived because like you said the design cycle and the development cycle and embedded cycles are a little different. The team with the PremierWave 2050 very early on said let's go after a number of alpha and beta accounts that we would use to kind of help us not develop the product but would be first customers to implement it and to use it. And to help us so that as we come to market we would have, as we announced, we have customers already adopting it and it would be a little bit earlier engagement than we might otherwise. I think historically the company would go and develop an embedded product and then announce it and make people aware and then you would have to wait that nine month cycle to see some traction in it. What I think is better about the approach they took here is that they had engaged early with getting early samples out and making – now we can't handle 50 customers in that. It's more of a think of like 10 customers that you could do that with but it allows us in this case to have several more than two or three that are actually starting to ramp as we come out and then we want to continue to pursue additional customers beyond what we already have design wins for. Not every customer we have got design wins are shipping at and not everyone we want to [are there], but we are – we like the new product. We think it's well positioned in the IoT building block space, but it is still early. So I don't – we are not going to probably be talking about huge revenue coming from it as a contributor yet but it goes into the group of new products. And the other thing I would say about the 2050 is it's a great building block to go into a gateway product and as we look going forward at having more of a software strategy around accessing the data from IoT devices and such, I look at some of these building blocks are going to be a good basis for a solution play that we want to do – that we want to build in. So you will hear more about the 2050 as we go here quarter-to-quarter.

Okay.

Hi, Ed, it is Jeremy. I just wanted to address your question relating to capital, as I mentioned to – mentioned earlier on the call we are in the middle of our annual operating plan process and so we are currently evaluating our cash and working capital requirements for the next fiscal year. In addition to going through that process we do have some sources of capital available to us today. As you are probably aware we have a revolving line of credit with Silicon Valley Bank. It's a $4 million line of which about $1.8 million is available to us as of the March 31 reporting date. And then in addition you are probably aware that we have a registration statement, a shelf registration out there filed with the SEC, which also gives us another alternative means to bringing capital if we deem it necessary. So that we hope gives you kind of an idea of what we are doing in looking at currently.

Okay.

And this concludes our question-and-answer session. I would now like to turn the conference back over to Jeff Benck for any closing remarks.

Thank you, operator. I would like to thank you for your participation on our call today. We look forward to updating you on our progress when we report on our fourth quarter and fiscal 2016 results in late August. Thanks again for attending and this is the end of the call.

The conference has now concluded. Thank you attending today's presentation. You may now disconnect your lines. Have a great day.