Lantronix, Inc. (LTRX) Q1 2018 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the Lantronix, Inc. First Quarter Fiscal 2018 Results Conference Call. [Operator Instructions] Please also note that this event is being recorded. I would now like to turn the conference over to Ms. E. E. Wang. Please go ahead.

Thank you, Andrea. Good afternoon, everyone, and thank you for joining the Lantronix First Quarter Fiscal 2018 Conference Call. Joining us on the call today are Jeff Benck, Lantronix' President and Chief Executive Officer; and Jeremy Whitaker, Lantronix' 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 starting at 8 p.m. Eastern, 5 p.m. Pacific today through November 2 by dialing 877-344-7529 in the United States or for international callers, 412-317-0888, and entering passcode 10113433. During this call, management may make forward-looking statements, which involve risks and uncertainties that could cause Lantronix' 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-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. Jeff?

Thanks, E.E., and welcome to everyone joining us for this afternoon's call. During the first quarter, we continued to make progress on strengthening our business as we achieved strong year-over-year gross margin improvement, recorded non-GAAP profitability for the seventh quarter in a row and generated cash for the sixth quarter in a row. Net revenue during the first quarter came in slightly below our expectations, attributed primarily to a few IT Management transactions not closing in the quarter. I'm pleased to report that we have subsequently closed the largest of these opportunities in early October. On the IoT front, we continue to perform well on our existing products family as we recorded 8% year-over-year growth in the first quarter. As I said on our last call, our key initiatives for fiscal 2018 are: first, increasing the number of IoT wireless gateway design wins; second, continuing our share gain momentum with our IT Management products; and lastly, establishing our IoT software business with the launch of MACH10, our IoT platform. I'm pleased with the progress on these imperatives. First, we are increasing the number new IoT wireless design wins that will enable our growth in this product family over the coming year and beyond. I'm particularly excited about how our XPico 240 and 250 are being received prior to launch. Second, we are participating in a number of new IT Management opportunities, including some sizable RFQs for out-of-band [ph] management solutions involving new data center builds. We also already closed some significant ITM business in October that sets us up well for growth in the second quarter. Finally, on October 4, we launched our first MACH10 product offering, Global Device Manager. A ready-to-use IoT application suite designed to enable OEMs and system integrators to quickly deploy life cycle management for their connected devices. Before I provide some additional color on our business, I'm going to turn the call over to Jeremy to discuss our financial results for the first quarter.

Thank you, Jeff. Please refer to today's news release and the financial information in the Investors 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 first quarter of fiscal 2018. Net revenue for the first quarter of fiscal 2018 was $10.6 million compared with $10.9 million for the first quarter of fiscal 2017 and $11 million for the fourth quarter of fiscal 2017. The year-over-year decrease was primarily due to lower sales of our IT Management products. We had some large orders that pushed out during the first quarter. And on a positive note, a couple of these orders were booked and shipped earlier this month. Turning to our IoT product line. Net revenue increased by 8% from the year ago quarter as our wired ethernet products continued to perform well. Gross profit as a percentage of net revenue was 52.7% for the first quarter of fiscal 2018 compared with 52.1% for the first quarter of fiscal 2017 and 51.3% for the fourth quarter of fiscal 2017. The improvement from the year ago quarter was primarily due to improved product mix as some of our higher margin products, such as the export, contributed to a larger portion of our net revenue. Selling, general and administrative expenses for the first quarter of fiscal 2018 were $4 million compared with $3.8 million for the first quarter of fiscal 2017 and $3.7 million for the fourth quarter of fiscal 2017. Our research and development expenses for the first quarter of fiscal 2018 were $2.2 million compared with $1.9 million for the first quarter of fiscal 2017 and $2 million for the fourth quarter of fiscal 2017. Operating expenses increased in line with our expectations due to actions we initiated earlier this summer to more closely align resources with our fiscal 2018 plan. In addition, we began moving a portion of our operations team from a high-cost location in Hong Kong to a lower-cost location closer to our contract manufacturers in China. These actions resulted in a charge of $527,000 during the first fiscal quarter of 2018. We recorded a GAAP net loss of $641,000 or $0.04 per share during the first quarter of fiscal 2018, which included severance and related charges of $527,000. This compares to a GAAP net loss of $104,000 or $0.01 per share during the first quarter of fiscal 2017 and GAAP net loss of $52,000 or $0.00 per share during the fourth quarter of fiscal 2017. I'm also pleased to report our seventh consecutive quarter of non-GAAP profitability, as we achieved non-GAAP net income of $306,000 for the first quarter of fiscal 2018 compared with non-GAAP net income of $265,000 for the first quarter of fiscal 2017 and non-GAAP net income of $388,000 for the fourth quarter of fiscal 2017. Now turning to the balance sheet. Cash and cash equivalents increased to $8.2 million as of September 30, 2017, compared with $8.1 million as of June 30, 2016. Net inventories were $7.3 million as of September 30, 2017, compared with $7 million as of June 30, 2017. Working capital was $10.2 million as of September 30, 2017, compared with $10.4 million as of June 30, 2017. Now I will give some insight into gross margin and operating expenses for the second fiscal quarter. Over the last year, the team has shown meaningful progress in driving gross margin improvement through a combination of pricing discipline, cost reductions and improved product mix. Looking forward to next quarter, we expect to continue to benefit from this work and maintain gross margins in a range of 50% to 53%. We expect operating expenses to come down sequentially, and at the same time, we are continuing to invest in resources to meet our 2018 operating plans. I'll now turn the call back to Jeff.

Thanks, Jeremy. Now let me provide some additional insight into our 3 strategic initiatives for this fiscal year. Turning to our first initiative: growing our wireless IoT Gateway business. We continue to make progress in achieving early design wins, and we expect these will bear fruit as we get into the second half of fiscal 2018 and beyond. These include new customers and applications such as weighing scales, industrial robots, automotive testing, industrial security, resource management, industrial printers and more. The wide range of these applications is testimony to Lantronix' reputation as a company that creates industrial solutions that are smart and easy to deploy. We're particularly excited about the early interest in our newest embedded gateway offerings, the xPico 240 and 250, and have doubled the number of evaluation kits because we're oversubscribed. Further, we've already received indications of several design wins earlier than we anticipated. Rest assured, the team is very focused on getting our first xPico 200 products into production by the end of 2017. Our second initiative is to continue to drive share gains with our IT Management products, enabling us to grow faster than the market. We exited Q1 with some sizeable design wins and an increasing pipeline of qualified IT Management opportunities. We believe these will translate to a return to growth in the second quarter and will put us back on track as we enter into calendar 2018. In fact, we just shift to a leading cellular provider the largest unit order of our SLB branch office solution since I started with the company. We are also investing in some innovative offerings for IT Management product family as we believe we can leverage our IoT management software to leapfrog the competition in this space. Finally, our third initiative is to establish our IoT software business. During the first quarter, we completed development of the initial release of our first IoT application, leveraging our MACH10 platform. This led to the launch of MACH10 Global Device Manager on October 4 at the IoT Solutions World Congress in Barcelona. MACH10 Global Device Manager is a ready-to-use IoT application suite that enables OEMs and system integrators to quickly deliver secure and robust web scale device management for their connected machines. An Automation World article recently talked about how device management is a trend that is changing the OEM business model. MACH10 Global Device Manager addresses this key trend by enabling OEMs and system integrators to proactively improve the user experience, receive real time feedback from connected devices and create new business models. This may be anything from making sure that a machine has the latest firmware or a security patch to being able to address the performance issue with the connected device in real time. We're excited to be able to provide web scale IoT applications like Global Device Manager that help speed up an industrial OEM's time to delivery and unburden them from the skills and resources required to build and maintain these types of tools for their connected products. We appreciate that no one in this space can provide the complete solution by themselves, so the IoT ecosystem is important to us. As such, we are spending more time with relevant partners, consortiums, independent software vendors and system integrators to build out solutions and expand our reach. During the first quarter, we continued to make progress in this area as we joined the Kepware Alliance and became a technology partner in the Control Systems Integrators Association. More recently, we are an exhibitor in the industrial Internet consortium's IoT pavilion at the IoT Solutions World Congress. Look for us to continue to add partners and join industry associations, as appropriate, to support our industrial vertical strategy. Now let me wrap up. As we closed out the calendar year, I'm excited about the progress we've made, and I like how we're positioned for fiscal 2018. We have new wireless IoT gateways launching this fall that are already generating significant interest. We are poised to drive further growth in the IT Management business, with more customers engaging us based on our industry-leading offerings. And with the launch of our first MACH10 IoT software solution, we are gaining higher strategic relevance among our customers in the industrial IoT marketplace. Bottom line, we are making progress on our initiatives, and the fundamentals of our business remain solid, from our operational efficiency to our balance sheet to our growing team around the world. We believe we are well positioned to deliver increased value for our shareholders. We look forward to updating you on our progress as we continue our journey. That completes our prepared remarks for today. So now I'll turn it over to the operator to conduct a question-and-answer session.

[Operator Instructions] Our first question comes from Jaeson Schmidt of Lake Street Capital Markets.

Just want to start quickly. I know on the last call you had indicated that you expected kind of that $11 million revenue level through both fiscal Q1 and fiscal Q2, has there been any change to those expectations?

No change in expectations, but we – as you saw from the revenue that we reported this quarter, we fell a few a few hundred thousand short of that kind of level. We talked specifically that it was attributed to our IT Management business, and as we've discussed before, it's deal-driven. But thankfully, while the timing isn't always predicted, this was a business that we continue to compete for. And in fact, we closed some – a few deals already in October that would've helped, would would've closed that GAAP to our expectations.

Okay. And going off that IT Management, is – can you remind us what your addressable market opportunity is there? And what you think your market share currently is?

There's not – unfortunately there's not good – Gartner and IDC don't track the market, but we believe that the market is a triple-digit kind of number, north of $100 million for the entire marketplace that we play in. So it's meaningful, and you would say, well, IT Management represents something around a quarter of our business that we're maybe a high single-digit – mid- to high single-digit percent market share in that space. Which is, Jason, why we felt like even though the market is pretty mature and may not represent a lot of growth, with the success we've had and the growth that we've seen, we certainly gained share over the last year. I would say with our – with the results in Q1, we didn't gain share in Q1, but we're anticipating some nice recovery in Q2, which we already sort of talked about.

Okay. And then looking at MACH10, I know it's commercially available now. Can you just talk a little bit about how the customer pipeline is shaping up? What the response has been so far? Or even quantitatively, how many customers do you think might be moving to commercial trials over the next year?

Yes, so we're excited to announce the first application, the Global Device Management app. Really excited about the problems that we can solve with it and how it'll help speed customers getting in the market with this kind of a solution versus developing it completely on their own. And it's a good starting point to showcase the power of the MACH10 platform. We obviously have a number of customer engagements at various staging – at various stages. Some of the example are folks that are doing medical device equipment, we've got some resource management customers. We're working on customers that are in the energy space, some customers in power distribution. So it's across a number of industrial applications in a variety of verticals. As we've kind of said before, it's good that we're kind of commercially available because we can actually say the first release is out and it's ready for production. But that being said, it is an OEM product with a development cycle that the OEM customer has to engagement with. So while we're really excited about the prospect, we know that it won't be a meaningful contributor this fiscal year. But I will like to be able to – as we get further along, be able to give more color on what customers – or how they're leveraging it and taking advantage of it and be able to give you more color as to how that's progressing. We have seen – we've obviously disclosed at this point dozens of customers, and we've got a number of customers that we're working with on – we're kind of moving now from beta into eval because the first product is released. And we continue to see the pipeline grow, but it's a little early at this point to talk about when someone might actually be launching because it's not – they have their development cycle and we're continuing to work with them on that.

[Operator Instructions] Our next question comes from George Melas of MKH Management.

Maybe a first quick question for Jeremy. The restructuring and severance charge, is it all related to the relocation of the office, as you mentioned, from Hong Kong to China? Or are there some other elements to it?

Yes, that restructuring cha goes across a different number of functions throughout the company. What we did and – with the Hong Kong team, and on the operations side, it was just one component of it. So we had some of that impacting our development team and also sales marketing and G&A as well.

Okay. Is there way you...

Just to give a little more insight to that. As we started this activity last quarter, which is where we talked about the fact that there would be – actually before the end of last quarter, in the last earnings call, we talked about the likely charge that we'll be taking here. But we also looked at kind of what we needed, where we needed resources to meet our fiscal '18 objectives and make sure that we had people aligned with the biggest opportunity. And so it was a little bit broader than just the operations team that we talked about specifically. Although, we did get a closer facility there, so that was meaningful enough to talk about. But we really kind of looked across multiple functions as we decided where we wanted to place resource against the opportunities we were investing in.

Yes, yes. No, I think you guys warned us very well about it. Is there a way to break it down to $527 million between SG&A, R&D and maybe even cost of goods sold? Or is that too granular?

We don't typically break it out into that level of detail. I mean, maybe you can give a sense of ops piece of it.

Yes. Just to kind of – at least from a margin standpoint to help you there. There was about $60,000 related to – that was specifically related to the operations. And then actually, when we file our Form 10-Q tomorrow, there'll be some additional detail on the MD&A there. I've got that here in front of me as well. So about $155,000 was related to SG&A and about $314,000 related to research and development.

Okay, great. And can you help me understand a little bit what is a beta really mean in the context of a OE [ph] product, of an embedded product? It's not like – yes, I'd love to understand that a little bit better.

Yes, on – the term that we use, we've used both on the hardware and software side. Typically, before a product goes to production and is fully qualified and tested and we've resolved any defects or bugs that we might uncover as we go throw our validation phase, we'll make it available to customers because the OEM cycle takes time for customers to test. And sometimes they are evaluating to decide if they want to deploy the solution or integrate it. Sometimes they'll need to do testing with their own products or as they develop our solutions into their own OEM machine. And so we typically keep it in a beta phase, which means that it just send a signals to the customer that it's not production-ready yet but it's far enough along that we've done some level of testing and that they can start to work with it. But it means that it's not fully production-qualified. And that's kind of why I said, once MACH10 is now announced, now you sort of move more to an evaluation phase because the product is formally released and we have completed the testing and say that what we intended to develop and what we intended to provide to the customers is now been qualified and ready to go. So that's typically what that means.

Okay. And during that beta period, do you get a lot of feedback from customers as well?

Yes, we do. I mean, that's one reason we like to open up the product to both our IoT hardware and software solutions, because we learn in that phase as well. And since we're not done with our own development and testing, we can make alterations, we can prioritize certain features, we can go address issues that might come up. And so it's part of a sophisticated development process to be able to use that as a feedback mechanism as to whether the product is meeting the objectives that we set up as we embarked on the product definition.

Okay. And then maybe just sort of a landscape question there. Your customers that are evaluating now the MACH10, the application and the platform, how many comparable or – comparable is probably the wrong word, but how many sort of competing platform are there in the marketplace?

That's an interesting question. There are literally more than 100 IT applications – or IoT platforms in the market. But they're not all – we're not competing with all of them. But if you do just a search on IoT applications, a ton of people will come up. Some people are addressing the consumer space, some people are focused on white box like washer and dryers. We're very much focused on the industrial vertical. We're very much focused on industrial customers that already kind of know us and the kind of solutions that we put together. And we also are targeting OEMs. Some of the IoT platforms out there are targeting end users only and not really designed for a machine maker, where – because our customer set is really industrial equipment makers, we're talking the solution that works for them to manage and connect with their machines and then also be able to provide that access and visibility to their end users. And that multi-tendency capability, that multiple user capability, it's not embodied in a lot of competitive platforms. A lot of the competitive platforms are like a remote control, but they're not really intended to give the access to not only the equipment maker but their end user downstream. Now I will say, in some of the early engagements, we've heard about they're evaluating other folks. Typically it's a couple, it's not the hundreds I talked about. They might reference the fact that there is a few people they're evaluating. And oftentimes, they play back to us, yes, we see the unique attributes you guys provide, that you're really targeting the OEM interface and that's – and we know you – that you guys have been in that space 25 years. And there's the mix. Some of the early customers are folks that are buying hardware, maybe gateways or connectivity products from us, and then there's some – there are customers here that are brand-new to us that don't know us but basically have maybe either heard of us or saw the marketing collateral we've credit around MACH10 and are engaging us. And they're just looking for software, maybe not looking for hardware as well. But I think the analyst community certainly sees us as the unique because we do provide both hardware solutions as well as a software platform now.

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Jeff Benck for any closing remarks.

Thank you, operator. We look forward to updating on our progress, achievements and actions when we report our second quarter results in late January. Thanks a lot for attending the call today. And at this point, this ends the call. Thank you.

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