Lantronix, Inc. (LTRX) Q2 2017 Earnings Report, Transcript and Summary

Good day, everyone and welcome to the Lantronix Incorporated Second Quarter and Full year 2017 Conference Call. All participants will be listen-only mode. [Operator Instructions]. After today's presentation, there’ll be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to E.E. Wang, Director of Investor Relations. Please go ahead.

Thank you, William. Good afternoon, everyone and thank you for joining the Lantronix fiscal 2017 second quarter conference call. Joining us on the call today are Jeff Benck, Lantronix’s President and CEO and Jeremy Whitaker, Lantronix’s CFO. 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 starting at 08:00 PM Eastern, 05:00 PM Pacific today through February 02, by dialing 877-344-7529 in the United States or for international callers, 412-317-0888 and entering pass code 10099548. 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 the 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-Qs. 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 will now turn the call over to Jeff Benck, President and CEO of Lantronix.

Thanks E.E., and welcome to everyone joining us for this afternoon’s call. As you may have seen from our preannouncement or from the release earlier today, we delivered our best quarter today since I joined the company a year ago. In the December quarter, we achieved revenue of $11.2 million representing 18% year-over-year topline growth and recorded GAAP breakeven earnings per share. Couple this with our fourth quarter of consecutive revenue growth and non-GAAP profitability and it demonstrates solid progress. Contributing to our results in the quarter, our IT management business has shown consistent year-over-year growth through improving deal win rates, competitive takeaways and deeper channel engagement. Q2 was no exception as these actions contributed to the third consecutive quarter of more than a 100% year-over-year growth and the SLC 8000 sales and our channel expansion efforts continue to tract more partners, expanding our reach with more people selling our products. In addition, we continue to make progress in our IOT business. Our IOT products also experienced strong year-over-year growth in Q2, led by a few new design wins for our wired Ethernet product in the commercial and industrial verticals. We also launched a new IOT device gateway the SGX 5150, which we believe will help us more broadly participate in the growing wireless IOT market. Lastly just yesterday, we announced the development of MACH10, a key technology that will enable us to move up the IOT value chain. MACH10 is a multidimensional management software platform designed to help OEMs accelerate IOT application deployment and achieve greater value from the smart connected machines. Overall, we had a nice recovery over the last 12 months, while we fully expected that it would take time for all over changes to have an impact, it's clear that we are moving in the right direction. At the same time, rest assured we are not taking the pressure off ourselves to do more. Before I provide some additional insight on our business, I am going to turn the call over to Jeremy to discuss our financial results from the second quarter.

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 would like to take a few minutes to go over our results for the second quarter of fiscal 2017. In the quarter, we achieved net revenue of $11.2 million, slightly above the range we provided in our preannouncement two weeks ago. This represents growth of 18% when compared to $9.5 million for the second quarter of fiscal 2016. The growth was due to increased sales in both our IOT and IT management product lines. More specifically, our IOT product line increased by 17% as sales of many of our embedded products improved from the year ago quarter. In addition our IT and product line increased by 72% primarily as a result of over 100% growth in our SLC 8000 Advanced Console Manager and to a lesser extent improved traction in our SLB branch office manager. Sequentially, we experienced growth of 3%, primarily driven by our IOT product line. A good portion of the sequential growth can be attributed to a couple of large new wire designs that shipped during the quarter. Sequentially, our IT management product line was down 7% as our SLC 8000 decreased from a recent record high. On a positive note, this decline was partially offset by improved traction in our SLB. Gross profit as a percentage of net revenue was 51.8% for the second quarter of fiscal 2017 compared with 48.1% for the second quarter of fiscal 2016 and 52.1% for the first quarter of fiscal 2017. The improvement from the year ago quarter was primarily due to lower overhead costs and improved product mix. Selling, general and administrative expenses for the second quarter of fiscal 2017 were $3.9 million compared with $3.8 million for both the second quarter of fiscal 2016 and the first quarter of fiscal 2017. Our research and development expenses for the second quarter of fiscal 2017 were $1.9 million compared with $1.7 million for the second quarter of fiscal 2016 and $1.9 million for the first quarter of fiscal 2017. During the second quarter of fiscal 2017, our continued revenue growth and financial discipline helped us to achieve GAAP net income of $41,000 or breakeven earnings per share, a substantial improvement from the same period last year when we recorded a GAAP net loss of $928,000 or $0.06 per share. We also saw sequential improvement from the first quarter of fiscal 2017 when we recorded a GAAP net loss of $104,000 or $0.01 per share. I'm also pleased to report our fourth consecutive quarter of non-GAAP profitability as we achieved non-GAAP net income of $444,000 for the second quarter of fiscal 2017 compared with a non-GAAP net loss of $196,000 for the second quarter of fiscal 2016 and non-GAAP net income of $265,000 for the first quarter of fiscal 2017. Now turning to the balance sheet, cash and cash equivalents increased to $6.7 million as of December 31, 2016, compared with $6 million as of June 30, 2016. Sequentially, net inventories increased slightly from $7.4 million as of September 30, 2016 to $7.6 million as of December 31, 2016. Working capital increased to $9.6 million as of December 31, 2016 compared with $9.1 million as of June 30, 2016. As of December 31, 2016, we had no borrowings outstanding on our line of credit. In summary, we're pleased with the continued progress that we made this quarter, which resulted in achievement of GAAP profitability. Looking forward to next quarter, we expect to maintain our gross margins at around 50%. With respect to operating expenses, we expect spending to be in line with the second fiscal quarter as we continue to drive discipline across the organization. I'll now turn the call back to Jeff.

Thanks Jeremy. As we shared at the start of fiscal 2017, we're focused on three key initiatives this year; driving operational excellence to improve the fundamentals of our business, fueling continued growth in our IT management product line through shared gains and executing on our strategic product roadmap, including investing in new offerings to more broadly participate in the fast growing IOT market. First let's review our progress on operational excellence. Our December quarter results and associated cash generation, demonstrates the impact we can have on our business when we drive topline growth, improve product costs, our discipline and deal pricing and closely manager operating expenses. Our progress is striking when you consider that we went from a $928,000 GAAP net loss in the second quarter of fiscal year '16 to achieving $41,000 of GAAP net income one year later, an improvement of nearly $1 million. Our efforts to rebuild and strengthen our sales team in the Americas paid dividends as that region grew significantly year-over-year in the quarter and outperformed our EMEA and APJ businesses. The revitalization on our Americas sales organization has also helped to drive new opportunities in customer reengagement in our IOT business, which contributed in part to the 17% year-over-year increase in sales of our IOT product line during the second quarter of fiscal 2017. Turning to our second initiative, we experienced substantial year-over-year growth in our IT management business by closing key deals, effective marketing spend and improved channel engagement. Total IT management sales were up 72% year-over-year as the SLC 8000 revenues grew by more than 100% year-over-year for the third quarter in a row. With this level of growth I'm confident that we gain share in the quarter. As Jeremy mentioned, we are also starting to see more demand for our SLB Branch Office Manager solution. In many of our enterprise accounts, the SLB is a natural complement to our SLC 8000, which allows customers to remotely manage their networking and storage equipment in data centers. Our SLB product enables these same customers to remotely manage their distributed sites or branch locations where they are less likely to have IT staff present. We are one of the few IT management suppliers to offer this breadth of management appliances. Now turning to our IOT efforts, we continue to execute on our strategic product development plan. As I stated before, our mission is to deliver secure data access and management solutions that make it easier for companies to access the benefit of the Internet of Things. In line with this vision, in October we launched the SGX 5150, an advanced IOT device gateway. Expanding our IOT product portfolio, featuring multiple interfaces, advanced Wi-Fi, leading-edge management features and true port security, the STX 5150 provides a flexible and secure solution for organizations seeking to connect virtually any business asset to the Internet. Finally, since December of 2015 we have communicated that we are investing for growth in IOT. As many of you are aware Lantronix has historically been focused on end to end connectivity and our solutions have been deployed into millions of OEM machines worldwide. If you've been following us over the last year, you've heard me talk about how we have been identifying new technologies that will help companies simplify their IOT deployment efforts and expand our solutions beyond just hardware. This week we took a major step in this direction with the announcement of MACH10, a new IOT management software platform provided by Lantronix. This OEM centric platform leverages our more than 20 years of first-hand experience as an IOT hardware provider to thousands of OEMs and has been architected from the ground up to address the gaps we see in the marketplace. Today most IOT platforms provide infrastructure to move some data between the device and cloud, leaving the complexity of building applications around the data to the OEM. MACH10 starts where other IOT platform stop by enabling OEMs to quickly and profitably deliver web scale IOT applications and services. We have already started to preview the new platform with our current IOT customers and are pleased with the positive feedback we are receiving and we intend to have customers working with the platform later this year. Now let me wrap up. I am pleased with the strong results we achieved in the first half of fiscal 2017. Our team continues to push full speed ahead. While we have a lot more to accomplish, we are 100% aligned, committed and fully believe that our plan is one that will allow us to win in the marketplace and achieve greater value for our shareholders. That completes our prepared remarks for today. So, I will now turn it over to the operator to conduct the Q&A session. Operator?

We'll now begin the question-and-answer session. [Operator instructions] And our first questioner today is Jaeson Schmidt with Lake Street Capital Markets. Please go ahead.

Hey guys. Thanks for taking my questions and congrats on a really strong quarter. Just wanted to start with the MACH10 product, just curious if you provide some more color around the potential impact to the model longer-term? Are you looking at this as a new additive revenue stream or do you think this will mostly just feel the pull through of your product revenue?

Yes, thanks Jaeson, that's a great question. As we think about the model longer-term, we do see an incremental revenue stream that will come from software. As you know that is a different model in the sense that as we talk about subscriptions on software and how we recognize revenue, some of that will come over time, but it'll also give us an annuity as we build up that customer base. I might also add though you can't hinted at it, we see this software platform adding additional capability to our gateway offerings as well and there is an element of device management of just our own gateways that we will look to provide some of that capability with our gateway solution and not charge for that. But we obviously see a much bigger opportunity that goes beyond our own devices and allows us to play in an IOT management software platform space and really help to solve problems for customers that aren’t even working with us today. So, it's going to take time. We announced the platform and what we were trying to do as the tech preview this week with the intent of getting out there with customers and telling them where we were headed, investors of assets say you guys you were investing in software, give us an idea that problems you're trying to solve and we wanted to start to share more details on that. And then as we get closer to product launch later this year, we'll certainly share a lot more detail on the modeling and how we think about it, but we do see an incremental opportunity there, which will be higher margin, but there will also be expense that goes with supporting that.

Okay. That's helpful. And then you guys have had great success with the SLC 8000 product, just wondering if you could talk about why you're waiting all these design wins, is it performance, is it price, the combination.

Well, I think you can see from our improving margins it's not price. We'll be aggressive when we're competitive with other guys in the space but we really -- it isn't been our price play for us. We frankly in this segment, I think it's a segment that hasn't had a lot of attention in the marketplace and our product is so much newer than a lot of the competition and the SLC 8000 is a modular offering that kind of lets customers start small and pay as they go if they want to add capability to it. And we also have capability like USB, support for USB connections that most of the competition hasn’t had. Few people are starting at add it now. I think they’ve seen our lead there, but it's really been some good differentiation in the platform and coupled with we've done a better job describing the customers the value we bring. We've engaged a channel -- with some channel programs. So, we had more partners helping us there and as you know, we've added some additional sales staff into the field as well, but if we really start the product, we've got a leadership product and that's really helped us be able to get into accounts. When we go into a bake off, I got to say the success rate has been really good and we won some fairly large customers and some of those that have been customers that have done business with us before, but we also look at are we getting incremental wins and we see a host of those happening as well. It is a deal driven business also. Sometimes they come in big chunks sometimes. So, every quarter we're working on what's the next opportunity and is it going to close this quarter or next quarter and how the things move around within the segment, but we've been achieving our goal of share gain, that's for sure because we don't believe the segment's really growing, but with the kind of numbers we've put up, there's no question we're gaining share in the segment.

Okay. That's helpful. And then the last one for me and I'll jump back in the queue, just wonder if you could comment on your thoughts regarding inventory levels at the distributors?

Well, we haven’t, we depending on our model right, we take revenue on sales out for customers that are buying products like our IT management offerings and we have a mix of different distributers that we deal with, but we really -- we look at them. We haven't seen a marked move in inventory. Do you want to add color on that?

Yes, as Jeff was saying we do defer much of our revenue until sell-through. So, we put the inventory of a large portion of our distributors on our books as a deferred cost and inventories and we have seen a slight decline in inventories coming from last quarter, but overall, it's relatively consistent.

Yes, it's within…

Within a couple $100,000.

So, it hasn’t moved tremendous. So, I think we talked about our inventory being up a couple hundred and we haven't seen growth in channel inventory. I don't know if you were getting at maybe we should add say, there is something else you were looking at or just trying to understandable if we're seeing industry trends changing.

No, that answer was very helpful. That's really all I had guys. Thanks a lot.

Yes, no problem. Thank you.

Our next questioner today is Mark Spiegel with Stanphyl Capital. Please go ahead.

Yes. Thank you. Congratulations, really great to see how you guys are turning the company around and as a shareholder for a while I appreciate it. Couple of questions, obviously it seems like most of the growth is coming from the IT management start with plus 72% of the SLC 8000 is up 100%. It would be helpful -- I'd like to know how sustainable that is and I guess one way to determine that would be for you guys to tell us what kind of market share these products have and that will give us slightly how much bigger they can get.

Okay. I can give you -- one thing that's a little challenging here is that Gartner and IDC don't actually track the management console space that the SLC plays into. So, we've been pressing a bit on talking to our partners and distributors that carry multiple lines and as best we can tell we believe we actually have very modest share in the single digit range, probably the mid-single to maybe we're starting to trend up to high single-digits. So, we think there is -- were relatively a pretty small player. Now there are five or six guys in this segment. So, it's distributed a bit. Allison no question is a big gorilla and they might have 40%, 50% share if I was to venture a guess, but where believe we are is in the single digit range. So, we think there is more opportunity there. As we said, it's pretty deal driven but we've certainly seen a bit of a revitalization within the company the opportunity that that represents. We touched on I am not sure you saw or you heard, but the SLB is like the little brother to the SLC and it really goes in the branch environment, but also does remote management and monitoring of infrastructure whether you have storage or services or switches. And we see some interesting opportunities there as well that people might be doing branch rollouts or look at they don't have the IT folks inside and they want to be able to manage that infrastructure. So, it's early yet, but there's definitely a stronger pipeline in that segment too and we think when we couple those together, the IT management space could be pretty interesting for us.

Okay. And then on MACH10 helping is that market opportunity and when are you going to start seeing some revenue from there? I know you said later this year you'll start rolling it out, but I don't know if that's for testing or what? Can you just give us a little color on that?

Yeah, and I am going to be a little cagy because it's a competitive space and it's early, but I can tell you that we will definitely be looking this calendar year to sell product, but it's going to -- some of this is so hinged on an OEM, it's an OEM sell, we're targeting OEM with the software platform. So, they have adoption that they have to do and integration work on their end. So, that makes me a little bit like I don't want folks like folding it into the model in the next quarter right, but we're trying to give a sense that we're already starting to preview the platform to get feedback and work that with customers. The market is absolutely huge. There are a lot of players and software and IOT, but as I and my team have looked at the space, there are so many people that are small companies that you never heard of that are startup, that have got two customers and they don't have the IOT customer installed base that we have and frankly they don't even have all the resources that we have. So, we have explicitly decided with MACH10 that we are going to go after OEM space. We're not trying to sell IOT software to end users. We think the OEMs need help. We think it's complex to develop IOT applications and manage their equipment in the field even as they get an Internet connection. And so many of the solutions today help them get data connected from the device to the cloud but don't provide them the management application and the capability to securely let people get access and you make use of the data that's provided. So, we're not trying to go after the whole space. We understand where we hunt and where we play. We see it as a nice complement to our gateway solutions. So, we think there's plenty of market opportunity, but it's still early yet for us to really forecast to you what we think can become and I think a bigger milestone is what do you guys actually doing to form a launch with pricing and availability and how do we think about what this might look like and we're not quite there yet. But I think we're excited to point that we put this India organization together focused on IOT software. We've had people in our headquarters here in Irvine, focused on software and we just felt like it really was the time now that it's been nine months that we've been spending energy on this to start sharing more about the value proposition and what kind of problem we were solving.

So, when are you doing the formal launch and then I assume OEMs are designing it into their products at that point, but you might not see revenue for a while. When do you start seeing some revenue from this thing? Is it a year from now or is it later this year?

I am really going to withhold predicting a time on it because it's going to depend so much on the OEM time runs. I can tell you that when I'm summer timeframe from an announcement standpoint and we want to make sure that we've got everything ticked and tied and we're ready to go, but that's kind of the timeframe we'll be able to give more clarity as to the complete solution and we have a better world coming up. We'll be doing demos there of it as well. So, we'll start to get more visibility in engaging the community along with analysts and customers this the spring in the summer. So probably…

So, this summer is the formal introduction and then want it takes a year to designing into a product? I am just looking for some ballpark idea here.

I believe we will have customers that are using it this calendar year. I am not going to forecast revenue, but I but see that we'll have customers that are engaged with us this year. And if you think about the revenue, I think us being able to describe to you how many clients are working with us and that kind of stuff be meaningful because with a subscription-based solution, it's going to be revenue over time as you know right.

Yes. All right. Thank you very much and again the work and the results are much appreciated. So, thank you.

Yes, no, thank you. Thanks for the question.

[Operator instructions] Looks like we have no further questioners. So, this will conclude our question-and-answer session. I would now like to turn the conference back over to EE Wang for any closing remarks.

Thank you, William. Before we wrap up, please note that we'll be participating in the upcoming conferences during February. On February 15, we'll be presenting at the Source Capital 2017 Disruptive Growth & Healthcare Conference in New York. Also on February 22, we'll be presenting at the SeeThruEquity 3rd Annual Innovations Conference in Miami Florida. For more information or to request a meeting with management, please contact me at investors@lantronix.com. On behalf of Jeff, Jeremy and myself, we would like to thank everyone for your participation on our call today and we look forward to updating you on our progress, achievements and actions when we report on our third quarter results in late April. Thank you.

The conference has now concluded. Thank you all for attending today's presentation. You may now disconnect your lines.