Good day, and welcome to the Lantronix 2019 Second Quarter Results Conference Call and Webcast. 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 this event is also being recorded. And with that, let's turn the conference over to Shahram Mehraban, Vice President of Marketing and IR. Please go ahead.

Good afternoon, everyone. As the operator mentioned, I'm Shahram Mehraban, Vice President of Marketing at Lantronix. Thank you for joining the Lantronix second quarter fiscal 2019 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 company's website at www.lantronix.com. In addition, a phone replay will be available starting at 8:0 p.m. Eastern and 5 p.m. Pacific today through February 24 by dialing (877) 344-7529 in U.S., or for international callers, (412) 317-0888 and entering passcode 10127701. 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 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 products in their designer 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 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. 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. As you may have seen from our press release earlier this afternoon, we delivered another solid quarter of results. In the quarter ending December 31, 2018, we delivered $12.1 million in revenue for a total year-to-date revenue of $24.4 million, representing 11% year-over-year growth for our first half, in line with our guidance of double-digit growth provided back in August. We generated 277,000 of GAAP profits for the quarter and achieved our 12th consecutive quarter of non-GAAP profitability. The key driver to our solid results in the quarter was 14% year-over-year growth in our IoT product line, supported by a strong quarter for both our wired and Wi-Fi products. Turning to our IT Management product line, we had a good quarter for SLC 8000 sales as that product revenue grew double digits year-over-year. However, the total IT Management product line was down 10% year-over-year due to an especially strong SLB quarter in Q2 of last fiscal year, when we delivered products for a large Verizon deployment. I'm also happy to report that last quarter, we took our first orders for one of our applications developed on the Lantronix MACH10 platform. Although not meaningful yet, it is good to start to establish a customer base for our new software products. 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 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'd like to go over our results for the second quarter of fiscal 2019. Net revenue for the second quarter was $12.1 million, an increase of 7% compared with $11.3 million for the second quarter of fiscal 2018 and $12.3 million for the first quarter of fiscal 2019. Gross profit, as a percentage of net revenue, was 55% for the second quarter of fiscal 2019 as compared with 55.7% for the second quarter of fiscal 2018 and 54.9% for the first quarter of fiscal 2019. We were pleased with our ability to maintain gross margin in the mid-50s despite the additional tariff costs of approximately 150,000 that we incurred during the second quarter. Selling, general and administrative expenses for the second quarter of fiscal 2019 were $4.2 million compared with $4.2 million for the second quarter of fiscal 2018 and $4.5 million for the first quarter of fiscal '19. Research and development expenses for the second quarter of fiscal 2019 were $2.3 million compared with $1.9 million for the second quarter of fiscal 2018 and $2.3 million for the first quarter of fiscal 2019. GAAP net income was 277,000 or $0.01 per share during the second quarter of fiscal 2019 compared to GAAP net income of 225,000 or $0.01 per share during the second quarter of fiscal 2018 and a GAAP net loss of 83,000 or $0.00 per share during the first quarter of fiscal 2019. I'm pleased to report our 12th consecutive quarter of non-GAAP profitability as we achieved non-GAAP net income of 790,000 or $0.03 per share for the second quarter of fiscal 2019. This compares to…

Thanks, Jeremy. Now let me provide you with some additional insights into our business. As I mentioned in my opening statement, we grew our IoT product line revenue by 14% as compared to the year-ago period, both wired and Wi-Fi products contributed to that growth. On Wi-Fi, we grew our IoT Wi-Fi product revenue by 35% year-over-year. We also had a solid quarter of design win execution, where we added over a dozen new design wins for our xPico 200 series of embedded IoT Gateways. Furthermore, we closed a number of new project designs using our SGX 5150 IoT Gateway, including net new customers to Lantronix, such as the large food distribution company, Cisco, who is using our SGX wireless gateway in their food distribution and logistics business. Our second initiative continues to be driving share gains for our IT Management product line, which will enable us to grow faster than the out-of-band management market. The revenue for our flagship product in this family, the SLC 8000, grew double digits over the same period last year. The SLC 8000 Advanced Console Manager provides out-of-band management capability to networking equipment and allows IT personnel to maximize the uptime of their IT infrastructure. During the quarter, we continue to roll out SLCs as part of our multi-quarter deployment to UnitedHealthcare, the largest U.S. health insurance provider, and JD.com, a leading Chinese e-commerce company, they both started to deploy in the first quarter. In the second quarter, we also saw a strong demand across Europe for our out-of-band management products from customers such as Vodafone, Inmarsat and the Swedish Defence Administration. We are starting to see the fruits of our efforts over the last year to build out our EMEA IT Management sales team and enhance our channel partnerships in the region. In…

[Operator Instructions] And today's first question will be from Jaeson Schmidt with Lake Street Capital Markets. Please go ahead.

Hey, guys. Thanks for taking my questions. Just wanted to start, Jeff, with your comment on some of these product design wins going to production slower than expected, is this across the whole portfolio or is this really concentrated in one of the segments?

There is probably more design-in from an IoT standpoint. We've been working on some of these designs for quite some time, Jaeson, and we talked about the design-ins with wireless solutions that we've recently introduced some of the new gateways. And from that standpoint, we really believe that many of these would be in production. If you look at the top 10 design wins, let's just say, for example, we anticipated that the majority of those would be in production by second half of our fiscal year, which we just started. A couple of those are, but we've got a lot more that's still have to actually go into production. And we'll see a few happen this quarter. We already have a couple in production, 2 of those 10 and then 2 more will come this quarter, then 3 the following quarter and 3 after that. So it's sort of staged over time. And from that standpoint, we just believe getting those into market, we'll see accelerating growth and that's what we've been looking at. So we felt like we needed to kind of give you an update on that.

No, that's very helpful. And it sounds like reception to the ConsoleFlow has been positive. Can you help us think about how many pilots you currently have in the pipeline? And how we should think about economics of that going forward?

Yes, I mean that number's changing weekly as we get more interest in additional, but today, we've got like 10 active pilots with ConsoleFlow in various stages and we'll continue to look to add more. There has been a really good response. A lot of folks -- obviously, like I said, with those 10 pilots somewhere further along in testing and we hope that we'll see bookings in the next quarter or 2 here and start to see revenue after that. But because the SaaS platform and the way it is, it will be recognized ratably and -- but the nice part, we'll get the recurring revenue from that. But we're pretty -- we're feeling pretty good about the early response, as we indicated.

Okay. And the last one for me and I'll jump back in the queue. I know you mentioned the expected headwinds from tariffs, but is it fair to assume that gross margins should stay within the sort of mid 50% range going forward?

Yes, we kind of see it in the range here. I mean, obviously, we've talked about a couple of hundred thousand of risk on the cost related to tariffs. I think we managed that pretty well last quarter. I mean, we thought there could be risk of 100, we ended up doing about 150,000, so it wasn't immaterial to us but we've been managing it well. I will say the IoT products, at this point, are pretty effectively transitioned so very little risk there. The IT Management stuff, we still have more risk there that we're really representing with that guidance. So yes, I feel like we got in front of that. The good news with this is it's not a - well, we'll see what happens at the end of February, but we've got mitigation plans. So we don't see this being a long-term impact, but in the short term, it definitely impact our margins.

Okay. Thanks a lot guys.

Today's next question will be from Rich Valera with Needham & Company. Please go ahead.

Thank you. Just a follow-up on the guidance question. If you look at each of the segments individually, should we think of both of them being up quarter-over-quarter, if you're willing to give any granularity on that?

We did talk a little bit about - we are probably going to split it out, but we did - we do believe that the IT Management business will recover. It's a little bit of an easier compare as well. So year-over-year -- at least from an year-over-year spectrum, we expect that IT Management segment will grow, where in this quarter, we didn't see that as much. The IoT too is going to be a little bit dependent on some of these ramps and some of the OEM performance. But this is our first - just so we're clear, typically, we had not given guidance and then in the first half of the year, we kind of gave a 6-month range. We're kind of narrowing that this quarter. First time we've really provided a quarterly guidance as well with EPS, just try to give you more visibility and give our investors more insight and how we're thinking about the business. So it's a little bit new to us. And I will say, from a macro standpoint, we see all kinds of things around this as well. And we got the tariffs, we got the government shutdown and some other things but even with all that considered, that was what we tried to articulate when we provided guidance -- how we see the business for the third quarter.

Fair enough. Thanks for that. And then on the IoT, I understand you've had some of these wins maybe ramped a little slower than expected, but you've been talking about a pretty healthy pipeline there. Can you give any color like an update on that pipeline? I think you talked about kind of north of 20 wins at some point, has that - have you been adding to that pipeline? How is that looking?

Yes, we now - like, for our xPico 200, which is the 240, 250, we're now over 35 design wins so it is healthy. The pipeline's very healthy. We've talked also with investors about some of the more marquee wins, wins that can be fully ramped, can be north of the $0.5 million. And when I talked earlier about some of those staging out and was giving you some color on that, that's where I was saying we've had just 2 of those in production and 2 more should go into production this quarter and 3 next and that's the staging that's going on. The only thing I wanted to say here, Rich, is that - like, it's a healthy pipeline and we haven't seen any of those designs, like, get shut down or lost or - we've seen a really good yield and I have been in businesses where you might only see 70%. We're probably seeing 95% of what we're winning actually going to production. So I feel that these are still progressing well, and I haven't really seen any drop-off in that. It's just that our OEMs are building machines and they have to introduce that system and they might have a target and then they'll come back and say, oh, our projects have been delayed 6 months because we got to go through this testing or whatever. A lot of this is not even related anything to our pieces of design, but just that -- it's just taking longer -- the industrial equipment makers, it can take several years to get into production. The good news is once you're in production, you might enjoy that for 5 years, 8 years, 10 years or more. So feel good - we're seeing good progress there. We're seeing good traction in the industrial robot segment, AGVs, good traction factory automation, we've got some weighing scale design wins, transportation systems, medical devices, physical security systems. So a nice cross-section of industrial, medical, transportation vertical wins. So I like the broad-based nature of it and we've got pretty good response. We're just a little bit anxious, you might hear it in our voice, we want to get this thing moving faster, and unfortunately, not all of this is in our control but things are going pretty well from an IoT design-in.

Got it. understood. And then if you could just maybe give a little more color - similar color on the IT Management side? I know you mentioned a couple of specific programs, I believe, that are ramping in this current quarter that you said got you off to kind of a good start in the quarter. Could you give a little more color on what some of those are?

Yes. So some of these are sensitive and multis are competitive. We've done a really -- I think we've done great on the head-to-head RFQs and beating the competition. And UnitedHealthcare was one that we talked about a large insurance company, and now we're a couple of quarters into deployment and mentioning who the customer is, they're largest insurance company in the world. So it's pretty exciting that you're working with a customer like that. We still have a couple of large bids that have been bake-offs that are still in play that haven't been awarded yet. So when I say the delay in some of the projects, we've certainly seen some of the data center projects take longer as well. But we think we're well positioned to continue to win those. We also have for - our SLB business was down a little bit in Q1, that's our branch office product. It was down a little in Q1, but we already received in the first 2 weeks of this quarter a fairly large order for that product for a retail branch rollout for a financial institution that has been - really been doing business with us over the last year. So it's great to see some of these bigger projects, that are multi-quarter, continue to be deployed. They might skip a quarter. If you're buying 80 or 100 of these appliances then you have to go deploy them in the field and it could take time to burn through that and then come back and quarter or 2 later end up deploying more and buying more product and that's great when that happens. Sometimes in the IT Management space, we might deploy 100 units in the data center and then that customer's good for 3 years, but right now, we do have some customers that are doing multi-quarter deployments, which is kind of helpful from seeing continued stability in that product line. This ConsoleFlow that Jaeson asked about is a nice software add. It's definitely got a lot of interest in our installed base of SLC and SLB customers, and we think it's pretty disruptive. The fact that we have the mobile app, the fact that we have VPN free access to our consoles through the cloud interface, no one else has that today. So it's causing us to even hit up some customers that maybe we didn't win 2 years ago and say, "hey, if you thought about this? And they are like, "oh my god, you're untethering my data center from me sitting in the office or being behind firewall. I'm interested. Let's talk about it and look at that. So we feel like there's a lot of good potential there. We'll continue to enhance our software and hardware offerings in that space. And we're trying to give you guys some color on the kind of customers that we're deploying solutions with like UnitedHealthcare, for example. So that gives you a little more color, I hope.

Sure. And just a follow-up on the MACH10 since you mentioned it. Could you say which app you got your first revenue for? Was that actually ConsoleFlow?

Yes, the couple of quarters we got in the quarter were for Lantronix Gateway Central, which is really been able to manage and get telemetry and statistics on our gateways for customers that were a gateway customer. We said that it's not substantial revenue, but it's great to see orders booked. And as we - the Global Device Management App and the ConsoleFlow app, they are more substantial in terms of the level of proof of concept and pilot that goes on with those. So we know -- and some of those, we've been in a lot longer where someone might buy gateway and go, I just want to manage this right away, and they can do an online order for the Gateway Central. But nonetheless, it's still good that people are interested in device management even they're just buying our gateway. So that's kind of -- that's where that initial orders came from.

Makes sense, okay. Thanks for that Jeff.

Sure.

Next question will be from Orin Hirschman with AIGH Investment Partners. Please go ahead.

Hi. Congratulation on solid [ph] progress. In terms of the designs that you mentioned the $0.5 million up $1 million a year, those are all layered on top of that individual amount of the design revenue, correct?

Yes, it's what we do as we look at the potential, like if a customer builds a particular machine and they might - of the particular model, where shipping into might be doing 30,000, 40,000, 50,000 units a year and they're going to be 100% Wi-Fi attached. We'll look at our ASP by that volume and we'll say, okay, is this fully ramped, that would mean 0.5 million in revenue to us or 400,000 or 700,000 in revenue to us. So that is, in fact, how we're looking to that. These are - these - the ones that we've talked about are incremental, they're not like just - I can't say none of the 10 that we talked about - I think one of those may have been an existing customer. So except for that existing customer had us designed in one machine and now we're going in the 4, 5, so there is an expansion there, but most of those are what I would consider incremental like whether an opportunity to add to our revenue. We could have somebody in our total portfolio end-of-life our product as well. We always have that kind of goes into and it goes out of where there's some movement in and out, but we call those out because we really felt like those would be significant growth drivers for us, which would mean incremental.

So while it is taking a little bit longer, I mean, if you have 10 to 20 designs that are each worth a $0.5 million to $1 million or up, some of them bigger, some of them small - let's say smaller, and there's another $10 million to $20 million as full ramp. Again, they have to get to full ramp and they have to all be in production in terms of incremental revenue, which, obviously, can make a huge difference on your EPS, because it kind of add that leverage point.

Well, that's why we've tried to articulate. When we think about longer term growth prospects, we've articulated, and we're guiding a quarter, but as you look out over time, we want to grow faster than 10%, right? So it's predicated on getting those designs and having a kick-in. We haven't articulated to you every single design win and all of that. We've kind of talked about the top 10 just because, to me, they're what -- I would say within my team are needle-movers and meanings that - meaningful. We - as I mentioned on the 240, we've got over 35 design wins, but we might have a customer buying 3,000 or 4,000 units a year. It's great, I love those customers but that's not going to -- you'll need a lot of those. So we talked in context of - and I'm not saying 10 is it, I'm just saying there's a top 10 that we're focused on, on a weekly basis to get those across the line. But we've said it before, there is a lot of leverage in the model. We - when those get in production, particularly on the OEM side, the - we don't have to do additional advertising or marketing or demand-generation efforts. Those designs get pulled along as the customer ships those products. We've done the hard work to design them and we get in but once we are there, those should be just moving on a quarterly basis. So I think you're thinking about it in same kind of way.

Thank you. Two as a quick follow-up. There's non-GAAP EPS projection of the $0.03 to $0.05 in these coming quarters, does that include the impact of the penny or so from - is that before the impact of the penny or that's even after the impact of the penny on the tariffs related?

No, that includes some tariffs.

Yes, the $0.03 to $0.05 non-GAAP diluted earnings per share guidance that we're giving includes the impact of the tariff, yes.

Okay. And finally, just in terms of verticals, I mean, the stickiness that you said in terms of the designs going into production is kind of unheard of in terms of such a high percentage. Is it because the project's a mature project already and they're just adding you in, what's the nature and why - even if they are taking longer, what's nature, why such a high percentage go into production?

Well, I was thinking about it when I said that. That was a number I said in the high 90 or mid-90s or whatever. I mean, that's not a - let me just clarify, that's not like an annualized number, but all I was trying to indicate is that we - when we're as far along and someone's been developing a project for 18 months to 2 years, they're pretty well vested and they're pretty well designed in - were designed in and it's just a question of them getting through that cycle. Wi-Fi, in general, is really complex and there is multi-quarter certifications that have to go along with that. And in some cases, we've had NRE, in other cases, the customer's invested a lot. So I just - I have seen people talk about design wins at the front end. And we could do the same. When you look at the 35 design-ins that I mentioned on 240, we might see a bigger attrition from that. But when I talk about these 10 more significant design wins, those have all been in flight for multi-quarters, more than a year. So it's just when you get that far in, there's a lot less risk of something falling out. So it is a little more complicated answer, and I don't mean to confuse you with that. But I feel like we've seen pretty good yield, as I talked about.

I understand this. I have one more question. Just in terms of IoT for robotics, can you whet our appetite with any of the things? Or I know some of them your probably restricting on.

IoT for robotics?

Yes, in terms of...

Is that what the question was about IoT?

Well, in terms of the customer - things like that?

Yes, we've actually talked about a customer that's already in production, I could talk a little bit more about that and we've got other designs. This automated guided vehicle is kind of a cool space and that is robotics. In fact, I just saw an article this morning about some of the warehouses and how more - less people - more people are shopping online whether that's for groceries or books or sneakers. And what's happening is, instead of people going into store and shopping, you now have personal shoppers that are running around a warehouse filling bags or boxes to ship to you so you don't have to leave your house. Well, there is a great use of robotics for that, where you don't actually have to have someone in the warehouse running around gathering all those goods and putting them in a box and the human capital associated with that. So we've had a number of good design wins because of our roaming support capability with our wireless solutions, where we're seeing wins with companies building these robots. Now, some of the robots can be as small as a Roomba like the vacuum cleaner, that's 4 inches x 12 x 12, some can be the size of - look like a Zamboni in a hockey rink, where they're very large machines that do the grocery picking and put those solutions together so big range. They're also used in the automotive space as well and you see in the factory floors that the movement of materials can be with these automated guided vehicles as well. One of the wins that we are - that's a customer that's continuing to buy from us is called Geek+. Geek+ is a Chinese AGV customer. They make one of these - they make a set of AGVs that are small and they almost look like a swarm, when you look in the warehouse, you might see 20 or 30 of them, that's a pretty interesting video, by the way. Geek+ sells to customer like Alibaba. And they actually, instead of moving along - having operators moved into warehouse to find goods, they actually move the pallets in front of the operators so they can load the box. And then they move these pallets around and that's moving, but the operator is standing still filling the box, taping it up and then shipping it. And so that's a great design and we're really excited about that, that customer, for example, and there's good growth rate. We've also got some industrial AGVs that are -- a couple of the design-ins that we've talked about are in that industrial segment with the AGVs.

Okay, great. Thank you very much.

Sure.

[Operator Instructions] At this time, with no other questions in the queue, this will conclude today's question-and-answer session. I'd like to turn the conference back over to Jeff Benck for any closing remarks.

Thank you, operator. For those of you interested, we will be presenting at the upcoming Roth Conference in March in Dana Point, California and the MicroCap Conference in April in New York City. We look forward to updating you on our progress, achievements and actions when we report our third quarter results in April. Thank you for joining the call today and that concludes the call.

The conference has now concluded. We want to thank everyone for attending today's presentation. And at this time, you may now disconnect.