Lantronix, Inc. (LTRX) Q4 2018 Earnings Report, Transcript and Summary

Good day everyone and welcome to the Lantronix fourth quarter 2018 financial results conference call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. And please note that today's event is being recorded. I would now like to turn the conference over to Shahram Mehraban, Vice President of Marketing with Lantronix. Please go ahead.

Thank you. Good afternoon everyone. I am Shahram Mehraban, Vice President of Marketing at Lantronix. Thank you for joining the Lantronix' fourth 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 and 5 p.m. Pacific today through September 22 by dialing 877-344-7529 or for international callers, 412-317-0888 and entering passcode 10122887. 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-Qs. Lantronix undertakes no obligation to revise or update publicly any forward-looking statements to reflect future events or circumstances. Please note, that during this call the company will discuss design wins which are defined by the company as a verbal or written commitment from a customer to use the company's product in their design or implementation. There is a risk that some of these design wins may not enter into production Also during the 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 Shahram, and welcome to everyone joining us for this afternoon's call. Let me start by recapping what we accomplished in what was a productive fiscal 2018. We laid the foundation for accelerating growth as we launched a number of new products for the IoT market. We continued to invest in our new software offerings and expanded the scope to include an innovative application for managing our IT management products. We won a number of new meaningful embedded designs and expanded our sales and engineering teams with new leadership. From a financial standpoint, we entered fiscal 2019 on even stronger footing as we achieved a full year of GAAP profitability. No question, it was the solid year for us and we entered the new fiscal year with strong momentum. Our fourth quarter revenue was $12 million, which is the highest quarterly revenue we have delivered since I joined the company. 4Q was another quarter of improved gross margins as we expanded them to 57%. We also reported our third consecutive quarter of GAAP profitability, resulting in a full year GAAP profit and delivered our 10th consecutive quarter of non-GAAP earnings. Beyond that, we increased our cash position in the quarter to $9.6 million. In the new fiscal year, we will continue to execute on the strategy that we laid out last year to grow our business with an intent to deliver greater value to our shareholders through three key initiatives. First, growing our IoT Gateway business with our new offerings, second, winning additional share with our enhanced IT management products; and third, closing our hardware offerings with management software based on our MACH10 platform. Before I provide some additional color on our strategy, I am going to turn the call over to Jeremy to discuss our financial results for the fourth quarter and fiscal year.

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 full year and fourth quarter of fiscal 2018. Net revenue for the fourth quarter was $12 million, an increase of 9%, compared with $11 million for the fourth quarter of fiscal 2017 and $11.6 million for the third quarter of fiscal 2018. The sequential increase was due to growth in both our IoT and IT management product lines. Gross profit as a percentage of net revenue reached the highest level in over 15 years at 57.1% for the fourth quarter of fiscal 2018, compared with 51.3% for the fourth quarter of fiscal 2017 and 56.8% for the third quarter of fiscal 2018. The continued improvement in gross margin was a result of lower manufacturing overhead costs and continued pricing discipline. Selling, general, and administrative expenses for the fourth quarter of fiscal 2018 were $4.1 million, compared with $3.7 million for the fourth quarter of fiscal 2017 and $4.2 million for the third quarter of fiscal 2018. Research and development expenses remained consistent at $2 million for the fourth quarter of fiscal 2018. I am pleased to report that we delivered our third consecutive quarter of GAAP profitability. GAAP net income was $752,000 or $0.04 per share during the fourth quarter of fiscal 2018. This compares to a GAAP net loss of $52,000 or zero cents per share during the fourth quarter of fiscal 2017 and GAAP net income of $344,000 or $0.02 per share during the third quarter of fiscal 2018. We also reported our 10th consecutive quarter of non-GAAP profitability as we achieved non-GAAP net income of $1.2 million for the fourth quarter of fiscal 2018 as compared with non-GAAP net income of $388,000 for the fourth quarter of fiscal 2017 and non-GAAP net income of $767,000 for the third quarter of fiscal 2018. Now turning to the full year results. Net revenue for fiscal 2018 was $45.6 million, a 2% increase from $44.7 million during fiscal 2017. Gross profit as a percentage of net revenue for fiscal 2018 improved by 300 basis points to 55.7% as compared with 52.7% for fiscal 2017. Operating expenses for fiscal 2018 were $24.6 million compared with $23.8 million for fiscal 2017. The increase in operating expense was primarily due to strategic investment in engineering, sales and marketing personnel to support our long-term growth plan. For fiscal 2018, we reported GAAP net income of $680,000 or $0.04 per share, a significant reversal from the GAAP net loss of $277,000 or $0.02 per share for fiscal 2017. Non-GAAP net income nearly doubled to $2.9 million for fiscal 2018 when compared to fiscal 2017 when we recorded non-GAAP net income of $1.6 million. Now turning to the balance sheet. Cash and cash equivalents increased to $9.6 million as of June 30, 2018, an increase of $1.5 million as compared to $8.1 million as of June 30, 2017. Net inventories were $8.4 million as of June 30, 2018, compared with $7 million as of June 30, 2017. Working capital improved to $13.5 million as of June 30, 2018, an increase of $3.1 million as compared with $10.4 million as of June 30, 2017. On the corporate development front, I would like to provide some insight on a key element of our long-term growth strategy. Over the last several years, we have made significant strides in improving the operational performance and balance sheet of the company. In addition, the valuation of the company has increased substantially. This has allowed us to increase our focus on identifying potential targets for inorganic growth opportunities. While we can't be specific about the companies that we are targeting, we want investors to know that this is a relatively new element of our strategy that we intend to build out in order to help drive additional growth at the company. Now I will give some insight into gross margin percentage and operating expenses for the first quarter of fiscal 2019. We expect our gross margin percentage to come in at the mid-50s. As for operating expenses, we expect a sequential quarterly increase related to actions we took to more closely align personnel resources with our fiscal 2019 plan. In connection with these changes, we estimate that we will incur severance related charge of approximately $275,000 during the first fiscal quarter. In addition, some of the sequential increase will come from the annual financial audit that has performed during the first fiscal quarter. I will now turn the call back to Jeff.

Thanks Jeremy. To recap fiscal 2018, we made significant progress on the key initiatives that I laid out at the beginning of the year. We grew our active wireless IoT product revenue again in 4Q and it grew into double-digits for the full year. But more importantly, we introduced a number of new wireless Gateway products that rounded out our portfolio. It was a solid year of design win execution where we added a number of new marquee OEM wins. And last quarter, they included a number of net new customers to Lantronix, including a Tier 1 industrial networking company based in Germany who is using our PremierWave 2050 embedded IoT Gateway in their industrial Wi-Fi product line. We are also winning against the competition with our new products. As an example, our most recently introduced wireless IoT Gateway, the xPico 250, was selected by a Tier 1 global leader in the industrial printing for the next generation of their industrial printers displacing the incumbent's product. We are further expanding our reach with new software capabilities and a broader set of system integrators and partners who are taking our products to market. A recent example of this was our announcement of receiving Microsoft Azure IoT certification for our SGX 5150, which was enabled by a new system integrator who bundled our SGX with Azure IoT enablement for Yamaha, who needed a wireless solution for manufacturing equipment on their plant floor. Turning to our second initiative. Our IT management product line grew year-over-year as our SLB Branch Office Manager product sales more than doubled for the year. The SLC 8000 advanced console manager continues to be the lead product in this family. And during the last quarter, we achieved new design wins with customers such as AMD, Flipkart and JD.com. We are also seeing strong demand across the U.S. government with four different agencies placing new orders in the last quarter. Further in fiscal 2018, we started shipping SLCs to Cisco, the global leader in networking, who is using our SLC 8000 product in their manufacturing plants to test their new switches. Having Cisco using the SLC 8000 to build their products is a testament to the quality and leading functionality of our products and reinforces that we have the best offering to help customers manage their enterprise deployment of Cisco switches. Over the last couple of quarters, we have talked about some of the large RFQs we have been competing for in this space. I am happy to report that we recently won two of these opportunities, one with a leading U.S. health insurance provider and one with an Asian e-commerce retailer that will support our continued growth in fiscal 2019. There are a couple more of these still in the pipeline and our expanded sales team is engaging with our partners on new opportunities each month as organizations around the globe deploy new data centers or refresh existing data centers with new Cisco switch deployments. We also made strides in increasing our technology lead over the competition as we introduced a major software update to our SLC 8000 that provide new performance management features as well as enhanced security. Finally, turning to our third initiative which is focused on establishing the foundation of our IoT management software business. During this past year, we continued to make investment in the MACH10 platform and introduced a couple of IoT management software offerings that we discussed on previous calls. Most recently, we announced the early access availability of a third application, this one focused on our IoT management products. ConsoleFlow and its accompanying mobile apps allow network engineers and IT administrators to securely monitor and manage their out-of-band management infrastructure via the cloud. To-date, we have received a very warm reception to this new offering from our existing IT management customers, new prospects and the IT media. In fact, ConsoleFlow was selected by CRN, the top news source for solution providers in the IT channel, as one of the eight cool product launches at Cisco Live US at the end of June. Our investment in the MACH10 technology platform is being leveraged across our products and has allowed us to develop and introduce our ConsoleFlow software offering for our management consoles in record time further extending our IT management platform advantage over the competition. Our priorities for fiscal 2019 remain essentially unchanged. We will focus on growing revenue with our IoT Gateway offerings, growing our IT management product line revenue faster than the market through share gains and expanding our IoT and IT management solution footprint by wrapping our MACH10 management software around our range of products to add an incremental revenue stream over time. Turning to our organization. We added some new exec talent on the team with our new head of sales in the Americas and our new VP of engineering, both who bring deep enterprise OEM experience and software design and selling skills that will augment our capabilities as an organization. Fathi Hakam, our new engineering leader, has a proven track record of running large multisite engineering organizations across the world. His application, software and wireless networking skills will help us transition to a broader solution provider in the IoT space. The current business environment is strong and we see many new IoT and data center projects being kicked off at our customers. We are well positioned with our diversified portfolio to participate in these opportunities. The IoT market is moving through the trough of disillusionment and up the long-term growth curve as many companies are beginning to leverage the benefits of an industrial IoT deployment. The need for wireless technology is growing rapidly and at the same time, we continue to see strong demand for our wired products. As mentioned in previous calls, wired connectivity is still a preferred approach for many industrial IoT use cases and we have been a leader in wired machine-to=machine networking for over a decade. These market conditions are very favorable for Lantronix as we not only have the right offerings to help clients with their networking challenges, but we can also provide more solution than ever before with our expanded software portfolio. These elements are all contributing to why we expect to grow our business organically faster in fiscal 2019 than last year. In addition to our organic growth plan, earlier in the call Jeremy made some comments regarding our corporate development effort. I would like to give further insight into how we are thinking about potential acquisition. For one, we are exploiting companies with synergistic product lines that share a common go-to-market model or who may participate in an adjacent space. Furthermore, this isn't about making a bet on technology without a line of sight to revenue. We expect to target companies that can be accretive to earnings within a reasonably short period of time after taking into consideration cost synergies and integration efforts. That being said, we will also evaluate targets based upon return on invested capital to ensure we are good stewards of any capital deployed in this effort. We look to leverage our management team's significant experience in acquiring and integrating companies as we go down this path. More on this topic in the coming quarters, but we wanted to give you some insight into this new direction for the company. Now let me wrap up. I am thrilled with our performance in fiscal Q4. We delivered our first $12 million revenue quarter in more than 20 quarters. We delivered improved gross profit margins, our third consecutive quarter of GAAP income, resulting in full year GAAP profitability. Taking into consideration the momentum in our business and looking out over the next six months, which is the first half of our fiscal 2019, we anticipate double-digit revenue growth over the first half of fiscal 2018. I am excited about our prospects in the market, our expanded set of offerings and the team we have put in place to capture our fair share of this growing market. I look forward to updating you on our progress at our next earnings call in October. With that, that completes our prepared remarks for today. So I will now turn it back over the operator to conduct our Q&A session.

[Operator Instructions]. And our first questioner today will be Jaeson Schmidt with Lake Street Capital Markets. Please go ahead.

Hi guys. Thanks to you for taking my questions and congrats on a really strong quarter.

Thanks Jason.

Jeff, given your confidence in the IT management momentum continuing in fiscal 2019, should we expect a lot of this growth to come from new customer expansion at existing customers or a little bit of each?

I think it will be a bit of each. And the reason I say that is, couple of these large RFQs that we said we were working that we just got news on winning a couple of those. There will be rollouts that will happen through the year and might even be multiyear rollouts. So we will see some continual business from those. We have already got a number of customers that are using us on a regular basis. But we also are continuing to penetrate new customer, some which drive projects that are one data center rollout. They buy 30 or 50 appliances and then they are done or they are done for a few years. So I think it will be a blend of both. I think what's a little different is, we are winning bigger deals that have a longer horizon that might better – that look to be multi-quarter, and so that just lifts the basis along with the kind of business that we have been winning in the past. So that's kind of how we are thinking about that for the ITM space, IT management space.

Okay. That makes sense. And that relates to my next question on just general visibility. I know you just said some of these deals are extending beyond one quarter, which obviously increases your visibility. But can you just talk about any changes in the overall visibility of the business over the past three months?

I think our visibility, as a team, I think we have gotten better sort of looking to forecast where we are going to be. I think we have been pretty consistent against that. You see us kind of providing at least the topline view for the next six months in believing that we are going to see double-digit growth over last year. That's really a reflection of our belief that we have some visibility to how we can do it with the business. Obviously, the IoT side of the business is embedded, and there is OEM designs that are there. So those, many times, will run multiyear. So that gives us also some insight as to how that happens. But just in general, we still have projects that run, and sometimes customers will buy a couple of quarters or not, so I won't say that there is not still some potential lumpiness, but the broader success that we have, the more we can sort of mitigate that and feel good about the overall trend in the business. So I won't say that it's changed that tremendously, but I think that, it's not like customers are telling us anything different, it's just that we feel good about the market that we are participating in, and then when we look at our own ability to consistently hit the forecast, we feel pretty good that we demonstrated some track record here. So hopefully that helps.

Okay. That's helpful. And looking at gross margin, I know you expected to be in the mid-50s here in September. But longer term, if we look out, how should we think about margins trending, just given the new product launches, the software offering? Where can margins ultimately trend, do you think?

I am going to let Jeremy take a cut at that and then I will add.

Yes. I think longer-term, there is some potential to continue to improve on the margins. A lot of it's going to be driven by mix. Typically our IT management products are at the higher end of the scale and then our IoT wireless products are at the lower end. So depending on the rate of adoption, that could also impact it. And then I think to the extent we have any software revenue layering on top of that, that is also helpful to the margin mix.

Yes. Just maybe to add to his comment, our wireless products are probably a little bit below corporate margin given the OEM embedded nature of that product line. Of course, it doesn't require quite as much marketing. Once we have designed in, we ship with every product. So as we grow our wireless, which we expect that will put some pressure on margins, but then offsetting that we fully intend to participate more in software and we know that comes at a much higher margin. So I would say we feel pretty good about the mid-50s and we moved margins a tremendous amount over the last really 18 months to two years. So things have stabilized a bit, probably don't have quite as much upside as what we have seen in the past, but we still have opportunities with some of the higher value offerings that we are bringing to market. So that's how we are thinking about it.

Okay. That's helpful color. And the last one for me and I will jump back into queue. I know it isn't a big part of the story so much anymore, but the product lines you consider your legacy business, have you seen any sort of stabilization across those products?

Yes, absolutely. In fact, we talked a bit about IT management, but our IoT segment not only has the wireless products where we are putting a lot of investment and energy, but it has our wired Ethernet IoT products in there as well. And we have seen really strong performance from that portfolio. Partly, we gave it a little bit of care and feeding, and we didn't treat it like a lost cousin and I think putting energy with the sales team and with the engineering team on that has paid dividends. XPort, as a product, we have been in market with now for almost a decade and it's really performed well. In fact last year, I think actually before I got here, that product line had been sort of in steady decline. We grew it a lot two years ago, but it grew again last year on what was the year before, we grew 20%. So we also announced that we are going to put a new product in that segment. We already announced XPort Edge, which is the first new offering that we are really viewing as a wired gateway because it brings more security and cloud connectivity to that product family. So it will be the first new offering in the XPort line in what's been more than five years. And we think that that will allow us to continue to drive that and even potentially grow what would have been viewed as a legacy line that was not very exciting. So it's performed well. I think we have got good visibility, feel very good that there is a lot of life left there and that's why we are investing in the new product and it just really supports IoT space. So you were asking questions about IT management, but we grew both sides of the business in Q4 and as we look at the double-digit growth in the first half of this coming year, it will be really broad-based which should be supported by both product lines, the IoT as well as our IT management. And as we said, at this point, MACH10 isn't contributed materially to the revenue, but that's upside as we get that business off the ground.

Okay. Thanks a lot guys.

Thank you. Thanks for the question.

[Operator Instructions]. Okay. And this will conclude our question-and-answer session. I would like to turn the conference back over to Jeff Benck for any closing remarks.

Thank you operator. We look forward to updating you on our progress, achievements and actions when we report our first quarter results in October. We are attending a few conferences in the next few weeks that you can find on our Investor Relations website and we look forward continue updating you on our progress. So with that, this concludes the call. Thanks for joining.

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