Lantronix, Inc. (LTRX) Q1 2019 Earnings Report, Transcript and Summary

Good afternoon everyone and welcome to the Lantronix 2019 Q1 Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note today's event is also being recorded. At this time, I’d like to turn the conference call over to Shahram Mehraban, Vice President of Marketing. Please go ahead.

Thank you, operator. Good afternoon everyone. Thank you for joining the Lantronix first quarter fiscal 2019 conference call. Joining me today on the call 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 Time or 5 p.m. Pacific Time today through November 25 by dialing 877-344-7529 in U.S. or for international callers by dialing 412-317-0888 and entering passcode 10125322. During this call, management may make forward-looking statements, which involves 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 earlier 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 also 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. Furthermore, during the call, the company will discuss some non-GAAP financial measures. Today's earnings release, which is posted on 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. With that, I’ll 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. It was an eventful quarter for us as we completed a successful public stock offering generating nearly 10 million in net proceeds for the company to be used for corporate purposes, including potential M&A. I’m also excited to welcome over 20 new institutional investors who participated in the recent offering. Also, during the first quarter, we continue to make solid progress on our growth initiatives as we achieved 16% year-over-year top line growth and recorded non-GAAP profitability for the eleventh quarter in a row. I’m very pleased to report that our first quarter revenue was at a near-term high of 12.3 million, which is up sequentially and highest quarterly revenue since I joined the company. On the IT management front, the product line revenue grew 73% year-over-year led by strong branch office SLB product sales. As we had mentioned on previous calls, we believe that we can reignite the growth in our SLB product line and we are seeing the fruits of our renewed focus. Turning to our IoT product line, we grew our revenue 6% year-over-year, thanks to the solid performance from our wireless products, and modest growth in our wired products. We continue to build our design win pipeline for our newest embedded gateways and we are excited that the export hedge, which adds IoT Gateway functionality enhanced security to our leading export product family will become generally available this quarter. Before I provide some additional color on our progress against our strategy, 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 investor relations section of our website for additional details that will supplement my financial commentary. Before getting into the financial results, I would like to take a few minutes to describe our adoption of the new revenue recognition standard, the potential impact of the recent tariff announcements, and the results of our recent capital raise. First, I want to make you aware that we adopted ASC 606 as of July 1, 2019. The primary impact of adopting ASC 606 relates to a shift in the timing of when revenue is recognized for sales made to many of our distributors. Under the new revenue standards, prior to adapting ASC 606, revenue from sales to these distributors was not recognized until the distributor resold the products. Upon adopting ASC 606, we now recognize revenue, including estimates for variable consideration when we transfer control of the products to their distributor. We adopted ASC 606 using the modified retrospective method. Under this approach, the prior year comparative financial information has not been restated and continues to be presented under the accounting standards in effect for the respective periods. Second, as you are probably aware, in late September, President Trump announced a third round of tariffs on Chinese imports, which apply to networking products across the industry, including substantially all of our hardware products sold in the U.S. It is important to note that nearly 50% of our revenue is outside of this U.S., and therefore not subject to the new tariffs. From a financial standpoint, we anticipate approximately 200,000 of tariff-related cost during the next fiscal quarter. Prior to the announcement, we were already executing on a plan to reduce our exposure to China manufacturing. So, we believe we are well-positioned to minimize the ongoing financial impact of the tariffs, although we expect to see a modest near-term impact. We believe we can minimize the long-term impact for the following reasons. For one, our largest contract manufacturer already has the ability to build many of our products in Thailand. In fact, the production line of our largest product family is already up and running in Thailand. To further minimize the tariff impact, we built up inventories of certain products and we also increased product prices on a few product families where necessary to pass on the incremental cost. As we look ahead to next quarter, we believe that we can maintain our gross margin in the mid-50s as we execute on this mitigation plan. And finally, I’m pleased that our recent successful public offering resulted in net proceeds of nearly $10 million. And as Jeff mentioned, we significantly increased our institutional ownership by more than 20 new investors. In addition, we are pleased that we have expanded our analyst coverage with Rich Valera from Needham & Company. With nearly 19 million in cash and 24 million in working capital, we are in an even better position to execute on the inorganic growth strategy that we discussed with you during our August 2018 earnings call. Now, I’d like to go over our results for the first quarter of fiscal 2019. Net revenue for the first quarter was 12.3 million, an increase of 16%, compared with 10.6 million for the first quarter of fiscal 2018, and 12 million for the fourth quarter of fiscal 2018. Gross profit as a percentage of net revenue was 54.9% for the first quarter of fiscal 2019, an improvement of over 200 basis points, as compared with 52.7% for the first quarter of fiscal 2018, and 57.1% for the fourth quarter of fiscal 2018. The sequential decline to the mid-50s was expected as we have been incurring higher raw material costs as we expedited purchases to mitigate the supply risk in a tighter component market. Selling, general and administrative expenses for the first quarter of fiscal 2019 were 4.5 million, compared with 4 million for the first quarter of fiscal 2018, and 4.1 million for the fourth quarter of fiscal 2018. The sequential increase was primarily due to severance-related charges. Research and development expenses for the first quarter of fiscal 2019 were 2.3 million, compared with 2.2 million for the first quarter of fiscal 2018, and 2 million for the fourth quarter of fiscal 2018. GAAP net loss was 83,000 or $0.00 per share during the first quarter of fiscal 2019, which included severance-related charges of 460,000. This represents an improvement of 87% over the first quarter of fiscal 2018 when we reported a GAAP net loss of 641,000 or $0.04 per share. During the fourth quarter of fiscal 2018, we had GAAP net income of 752,000 or $0.04 per share. I am pleased to report our eleventh consecutive quarter of non-GAAP profitability and a year-over-year increase of 189% in non-GAAP net income, as we achieved non-GAAP net income of 883,000 or $0.04 per share for the first quarter of fiscal 2019. This compares to non-GAAP net income of 306,000 or $0.02 per share for the first quarter of fiscal 2018 and non-GAAP net income of 1.2 million or $0.06 per share for the fourth quarter of fiscal 2018. Now, turning to the balance sheet. Cash and cash equivalents increased to 18.9 million as of September 30, 2018, as compared to 9.6 million as of June 30, 2018. Net inventories were 8 million as of September 30, 2018, compared with 8.4 million as of June 30, 2018. In connection with our plan to reduce our tariff exposure, we expect inventory levels to increase in the second fiscal quarter by 500,000 to 1 million. Working capital improved to 24.4 million as of September 30, 2018, an increase of 10.9 million, as compared with 13.5 million as of June 30, 2018. On October 15, we renewed our $4 million revolving line of credit with Silicon Valley Bank. We currently have no balance outstanding on the line of credit. Now, I will give some insight into gross margin percentage and operating expenses for the second quarter of fiscal 2019. As I previously noted, we expect our gross margin percentage to remain in the mid-50s even with the short-term headwinds we are experiencing in connection with the recently announced tariffs. As for spending, we expect non-GAAP operating expenses to be relatively consistent with the prior fiscal quarter. I’ll now turn the call back to Jeff.

Thanks Jeremy. Now, let me provide you with some additional insights into our strategic initiatives. We grew our wireless IoT product revenue as compared to the year ago period. We also had a solid quarter of design win execution where we added a number of new OEM wins, which included a number of new customers to Lantronix, including University of Maryland and McGill University, who are using the SGX 5150 in medical application, and Mission Foods and UPS, who use the SGX in warehousing and logistics segment. Our second initiative continues to be driving share gains for our IT management product lines, which enables us to grow faster than the market. As I mentioned in the opening, our IT management product line grew 73% year-over-year and 15% sequentially, thanks to a solid quarter of shipments for our SLB branch office manager product, with its sales more than doubling from the previous quarter, primarily due to a follow-on order from a major U.S. Bank for the retail branch rollout. The SLC 8000 Advanced Console Manager continues to be the lead product in this family with revenue up 73% over the same period last year. During the last call, I mentioned that we had won two new large opportunities in Q4. One with a leading U.S. health insurance provider, and one with JD.com, an Asian e-commerce retailer. I’m happy to report that we started shipping products to one of these new customers in Q1, and the other one this quarter. Also, as discussed in the last call, we continue to see strong demand across the U.S. government with two different agencies placing follow-on orders for the SLC product in the last quarter. We also had a solid design win quarter as we closed another large RFQ with a leading networking technology company for our SLC 8000 Console Manager that we expect will roll-out in subsequent quarters. We further closed and shipped a new design win for our KVM-over-IP product known as Spider with HP Enterprise, which will be deployed by Foxconn in their manufacturing facility for testing HP's products. Spider is very popular in the IT industry, due to its unique design and this is another example of a large OEM, similar to Intel who is also using our solution in their development test labs. On the software front, we introduced ConsoleFlow Cloud Edition at SpiceWorld, an IT industry event in Austin, Texas in September. ConsoleFlow is a centralized management software built on the MACH10 platform for remote management of Lantronix ITM products and connected IT equipment. I’m especially excited about the Cloud Edition of ConsoleFlow as it allows our ITM customers to access their out-of-band infrastructure from anywhere via web browser or mobile app, hassle free and without a VPN. This is an innovative capability that does not exist in the market today and we believe that it will help us continue to gain share in the out-of-band management market. To date, there is a lot of interest in this new offering with a number of active field trials underway. Now, to update you on our revenue guidance. At the beginning of this fiscal year, I provided guidance for the first half of 2019 that we believe we would experience double-digit growth over the prior year. Taking into account our results for 1Q, and the current outlook for 2Q, we remain on track to meeting this objective. Now, let me wrap up. I'm thrilled with our performance in fiscal Q1. We delivered another quarter of 12 million in revenue with year-over-year double-digit growth. We made great progress on our strategic initiatives in the quarter. We also raised additional capital through our public offering in support of our inorganic growth efforts. We are participating in growth markets. We have a broad set of competitive product lines, providing connectivity, management, and security solutions for the industrial IOT and out-of-band management markets. We believe our expected growth in revenues and above industry average of gross margins combined with our relentless operational discipline will enable us to generate cash and build on an already strong balance sheet. We believe this combination allows us to pursue both organic and inorganic opportunities to accelerate our growth strategy and to deliver increased shareholder value. I look forward to updating you on our progress at our next earnings call in January. That completes our prepared remarks for today. So, I will now turn it over to the operator to conduct our Q&A session. Operator?

[Operator Instructions] Our first question today comes from Jaeson Schmidt from Lake Street Capital Markets. Please go ahead with your question.

Hi, guys. Thanks for taking my questions. Just wanted to start with, I know you mentioned that you talked about the tariff impact, but curious if you’re seeing any significant changes in visibility or lead times given the macro backdrop.

We haven't seen, I mean I don't think our visibility has changed that significantly from where we were before, but given that we fell through Q2 distribution and we used the channel quite a bit, that’s how we compare our visibility a little bit, so I don't see that materially different. In terms of lead times, we have seen some components that have been a little bit more extended and that impacts us a little bit in terms of pricing just because there is tightness in supply in some areas. So, I would say that we think some of that could be potentially tariff driven, although some commodities like memory have been an issue for quite some time. So, that’s kind of what we're seeing now. Obviously, there’s a lot of activity going on in China right now, and a lot of people are trying to figure out what they want to do and how they look to mitigate it, which as you could see from our commentary, we are trying to be pretty proactive on getting in front of it and we’ve already taken a number of steps before the quarter and before the tariff actually took hold and impacted us to down risk or minimize the impact. But that being said, there is still some impact in our second quarter as we’ve guided.

Okay, that’s helpful. And looking at the IT management business, you guys continue to see some really strong momentum there, if I take a step back and think about that business longer-term, what sort of growth rate do you think is achievable just given your continued market share gains?

The market, it’s changing a little bit for us. I would say the market was pretty flat a year ago. I think we're finding new applications, you see the distributed branch office solutions, I think with the deployment of IoT devices everywhere, we’re seeing stronger opportunities at the edge. So, I think that’s driving some potential growth. Also, the deployment of SD-WAN is having an impact out there. So, there’s not a good analyst figure here like, there’s not an IT analyst that covers this space, but as we’ve looked more at the competition, as we’ve looked at potential targets in that space, it feels like it’s not that there is quite a bit of opportunity there. So, could we grow double digits or faster. I think, if we continue to win share the market certainly can support that because as we talked about before Jaeson right, we believe we only have mid-single-digit kind of share position in the out-of-band management segment. We look at some of our other commentators, you know some of the more contemporary competitors are growing pretty nicely in that segment, but there’s number of private companies, so we don't even have complete visibility on that, but we’re looking closely and it’s developing for us, but we think it represents probably a stronger growth opportunity then we did a year ago.

Okay. That makes sense. And the last one from me, and I’ll jump back into queue. I know you mentioned some incremental expenses related to tariffs, but when we think about OpEx for this remaining fiscal year, should we expect any significant upticks in any of the out quarters?

Yes. So, I mentioned on the call that we expected at least non-GAAP operating expenses to remain relatively flat for the upcoming quarter. Looking out beyond Q2, we do have some plans that continue to invest in R&D headcount and resources, although I don't expect that to jump significantly, but it will begin to tick-up in the out quarters.

Okay. Thanks a lot, guys.

[Indiscernible].

[Operator Instructions] Our next question comes from Rich will add from Rich Valera from Needham & Company. Please go ahead with your question.

Thank you. Good afternoon gentlemen. Jeff, it sounds like you’ve had some pretty good recent win success in the IoT space, I’m just wondering if you could give us some color on your kind of pipeline there and how it compared to say year ago, do you feel like you’ve got some kind of momentum building in that IoT pipeline?

Yes, thanks Rich. Our xPico 240 and 250 are two of our new wireless embedded gateways. We've got a very strong pipeline of design wins, you know where it’s North of 20 some design wins in that segment. Interestingly enough, they are not, we’ve been designing for quite some time. I would say, it continues to take a little longer than I anticipated for those to really take hold and to ramp and be in production. We’ve had really good success where we haven't really seen any dies [ph] fall out, which would not be unusual to have something change either with the customer or the solution. So, we’ve seen it continue to progress. I probably would initially would have said, we would have expected some bigger ramp happening in the first half. And I think it has taken a little longer with some of these customers, but we’re excited about design wins in industrial robot space, we have got a couple there. We are excited about the weighing scale segment, it's been pretty strong for us, with some process automation design wins, medical devices is a good segment for us as well. So, I’m excited about the potential that represents, but it’s really, it’s not completely here yet. So, we got to execute, the products now we're starting to, you know we are in production on those new embedded and wireless products, so that’s helpful, but not a lot of our customers are complete yet with their product launches. The one other thing that I might add that we're particularly excited about is, we did a new wired Embedded Gateway, the XPort Edge, and I mentioned in the script that we’ll be actually starting to ship that for production this quarter. And we’re excited about it because it’s first new offering in XPort product line, which has been really a great solid product line for us. And we have got a number of design wins there. In fact, we have one customer there. It looks like they might go to production in this quarter, initial production. So, we think that’s going to add to it as well. And that’s not a wireless product. It’s a wired product, but it’s great if we can take what’s been a very strong legacy business and get new design wins there and bring more security and cloud capability to that XPort family. So, we feel pretty good about that. I still think a lot of the opportunities are in front of us in those new designs.

Sure. And if I could just follow-up on that, what kind of visibility do you have into what’s causing these delays and do you still have conviction that those will be happening? It’s just a matter of them happening a little bit later than you might have thought initially.

Yes, I think it’s more, I mean it’s a factor, Wi-Fi is a little more complex. There is definitely deploying Wi-Fi solutions, it’s probably why we speed customers time to market by doing the certifications and the things that we do. And we have said that we expected a ramp in second half. So, I won't say it’s dramatically different, it’s just industrial IoT takes time, but once they deploy then you enjoy the benefit for 3, 5, 7, 9 years. You know, we’ve had wired solutions that have been in the market approaching a decade. So, I think, I don't think it’s anything out of ordinary. I won't say that they struggled with capabilities that feel like the product is meeting the needs and we're getting some competitive wins from the likes of Redpine and u-blox and guys that we see that offer a richer solution like us. So, I like the competitive dynamic going on, and I feel very confident that the design win pipeline is growing. I just was trying to give a little bit of indication that some of this growth opportunity is still in front of us.

I appreciate that color. And one more for Jeremy, if I could? Can you give us a sense of – I believe you switched to 606 effective in this first quarter, and I would think you would get kind of a one-time perhaps revenue benefit as you switch from recognize on sell-through to sell-in, can you give us a sense of – if that is the case, how much benefit you saw from the 606 switch in the first quarter?

Rich, our results probably would have been different under the old rules. It is pretty difficult to quantify how much of that difference if any was strictly due to a direct benefit of adopting new rules. I’d say that said, prior to adoption, we did take some steps to reduce any potential negative impact of the change. So, for example, you know revenue, inventory in the channel would have been lost upon adoption and then future stock rotations would directly reduce revenue in future quarters under the new standard. So, we did work with our distributors to ensure that they held the right balance and mix of inventory prior to actually adopting. So, I think that’s important to note. And also, we are continuing to monitor inventory in the channel and as of the end of Q1, distributor inventories were at historical norms to what we’ve seen over the last couple of years.

Great. That’s helpful color. Appreciate it. Thanks gentlemen.

Yes, thank you.

Thanks, Rich.

And ladies and gentlemen at this time, I'm showing no additional questions. I like to turn the conference call back over to management for any closing remarks.

Hi, this is Jeff again. So, look, we appreciate everyone taking the time to listen into the call today and participate with us. We look forward to updating you on our progress, achievements, and actions when we report our second quarter results in January. And with that, have a great afternoon and thanks for being on the call.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for joining today's presentation. You may now disconnect your telephone lines.