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Lantronix, Inc. (NASDAQ:LTRX)

F3Q2014 Earnings Conference Call

April 30, 2014, 17:00 PM ET

Executives

Kurt F. Busch - President and CEO

Jeremy Whitaker - CFO

E.E. Wang Lukowski - IR

Analysts

Krishna Shankar - ROTH Capital Partners

Operator

Good day, ladies and gentlemen, and welcome to the Fiscal 2014 Third Quarter Conference Call. My name is Sheena, and I'm your operator today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session toward the end of this conference. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.

Now, I'd like to turn the call over to your host, E.E. Wang. Please proceed, ma'am.

E.E. Wang Lukowski

Thank you, Sheena. Good afternoon, everyone, and thank you for joining the Lantronix fiscal 2014 third quarter conference call.

Joining us on the call today are Kurt Busch, Lantronix's Chief Executive Officer; and Jeremy Whitaker, Lantronix's 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 7:00 p.m. Eastern, 4:00 p.m. Pacific today through May 7 by dialing (888) 286-8010 in the United States, or for international callers, (617) 801-6888 and entering passcode 86190554.

During this call, management may make forward-looking statements which involve risks and uncertainties that could cause Lantronix's results to differ materially from management's current expectations. We encourage you to review the cautionary statements and risk factors contained in the earnings release, which was furnished with 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 reconciliation for the non-GAAP financial measures that we use.

I would now like to introduce Kurt Busch, President and CEO of Lantronix. Kurt?

Kurt F. Busch

Thank you, E.E, and thank you to everyone joining us this afternoon. I'm pleased to report that during the third quarter of fiscal 2014, Lantronix grew revenue by 6% sequentially and achieved its third consecutive quarter of non-GAAP profitability driven by new product development and expansion of our sales channels.

Simply put, we're executing on our plan and our plan is working. We're happy with the strength of our pipeline and the progress we've made converting opportunities into wins with Tier 1 customers. Sales from new product introductions continue to contribute to total revenue growth.

As mentioned in today's news release, we had our first major customer design win move into production with the xPico embedded device server. Enterprise Solutions sales in our EMEA, Asia Pacific and Japan regions are up 15% for the year-to-date, a result of our international sales and distribution channel expansion initiatives.

Our continuing efforts to improve operational efficiencies have resulted in Lantronix's third quarter of sequential gross margin improvement. Overall, we recorded 6% sequential revenue growth. We believe that our efforts will ultimately lead to long-term sustainable growth and profitability.

Before I go into more details on our progress and expectations, I'd like to turn the call over to Jeremy to go over our financial highlights. Jeremy?

Jeremy Whitaker

Thank you, Kurt. 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 take a few minutes to go over the highlights of our results for the third quarter of fiscal 2014 ended March 31, 2014.

Net revenue for the third quarter of fiscal 2014 was 11.6 million compared to 12.2 million for the third quarter of fiscal 2013 and 11.0 million for the second quarter of fiscal 2013. The year-over-year decrease in net revenue was primarily due to a continued general decline in sales of our mature OEM products, and a decrease in unit sales of xPrintServer Home and Network editions.

The decrease in net revenue was partially offset by sales from new products and sales channel expansion efforts. The sequential growth in net revenue was primarily due to an increase in OEM Modules sales that benefited from new Tier 1 customers initial production run using the xPico platform.

Enterprise Solutions sales decreased in part due to weakness in the Americas distribution channel. This decline was partially offset by increased Enterprise Solutions sales in the EMEA region where we have been expanding our sales and distribution channels.

Gross profit margin for the third quarter of fiscal 2014 was 50.9% compared to 46.2% for the third quarter of fiscal 2013 and 49.6% for the second quarter of fiscal 2014. The improvement in gross profit margin is primarily due to a combination of operational improvements and lower inventory reserves costs.

Gross profit margin was within our long-term target model range of 49% to 51% for the third consecutive quarter. Selling, general and administrative expenses for the third quarter of fiscal 2014 were 4.2 million compared to 4.7 million for the third quarter of fiscal 2013 and 4.1 million for the second quarter of fiscal 2014.

The year-over-year decline in SG&A expenses was primarily due to a decrease in advertising costs. As we expected, SG&A expenses increased sequentially as a result of increased trade show costs during the March quarter.

Research and development expenses for the third quarter of fiscal 2014 were 1.8 million compared to 1.7 million for the third quarter of fiscal 2013 and 1.6 million for the second quarter of fiscal 2014.

Total operating expenses for the third quarter of fiscal 2014 were 6.0 million compared to 6.4 million for the third quarter of fiscal 2013 and 5.7 million for the second quarter of fiscal 2014. In part, the sequential increase in operating expenses was due to increased payroll taxes in the U.S. as a result of the annual FICA tax reset.

GAAP net loss was 130,000 for the third quarter of fiscal 2014 or $0.01 per share compared to a GAAP net loss of 801,000 or $0.05 per share for the third quarter of fiscal 2013, and sequentially a GAAP net loss of 323,000 or $0.02 per share for the second quarter of fiscal 2014.

Non-GAAP net income for the third quarter of fiscal 2014 was 331,000 or $0.02 per share compared to a non-GAAP net loss of 388,000 or $0.03 per share for the third quarter of fiscal 2013, and sequentially non-GAAP net income of 191,000 or $0.01 per share for the second quarter of fiscal 2013.

Now turning to the balance sheet. Cash and cash equivalents as of March 31, 2014 were 5.9 million compared to 5.2 million as of June 30, 2013. Net inventories were 7.6 million as of March 31, 2014 compared to 8.7 million as of June 30, 2013.

As discussed on previous calls, our revenue has a history of fluctuating from quarter to quarter due to the nature of our project-based sales cycle that oftentimes has a significant impact on our quarterly operating results. The quarterly lumpiness we experience is further exaggerated due to the current size and scale of our business.

For the upcoming fourth quarter, we expect operating expenses to be relatively consistent with the third quarter ended March 31, 2014. That said, we expect to continue to manage our spending based upon revenue expectations with a primary focus on driving long-term revenue growth while preserving working capital and maintaining fiscal discipline.

I'll now turn the call back to Kurt.

Kurt F. Busch

Thank you, Jeremy. Our results for the third quarter reflect a steady progress we have made throughout fiscal 2014 and executing on our strategic plan to drive Lantronix towards sustainable, long-term growth and profitability. Through disciplined and innovative product development, expansion of sales channels worldwide and continued fiscal and operational discipline.

During the quarter, we reported one of our first large xPico sales as a Tier 1 customer moved from the design win phase to initial production. This project was accelerated into production with the assistance of our newly launched professional service offering. The positive development in our OEM Modules business reinforce our belief that as we make progress in converting more design wins into production, we should see stabilization in this business and ultimately top line growth for this product line.

Our third quarter results also reflect our efforts to expand our sales channels worldwide. This is most evident in the 15% increase in year-to-date Enterprise Solutions revenue in the EMEA, Asia Pacific and Japan regions. In addition to increased revenue contribution from across the spectrum of our Enterprise Solutions, we are tracking opportunities from new Tier 1 customers worldwide in a variety of verticals with medical device, energy and remote management applications driving our early successes.

As our sales and new product initiatives continue to develop worldwide, we expect an overall growth trend in our Enterprise Solutions product line. During the March quarter, we began shipment of our xPrintServer Cloud Print Edition, the latest member of the Lantronix award-winning xPrintServer mobile printing product family. Currently, the only Google certified print server, this new mobile printing solution enables Google cloud print users to wirelessly print to their existing printers from a variety of devices such as Chromebooks, laptops and Android smartphones and tablets.

The launch of this new xPrintServer allows Lantronix to address a large segment of the mobile printing market that has been underserved. We believe this product along with our xPrintServer Office Edition for Apple iOS devices will continue to create enterprise opportunities in verticals such as retail, education, hospitality and more.

For the second year in a row, Lantronix was the mobile print sponsor for Macworld in San Francisco. Lantronix provided mobile print stations throughout the conference allowing attendees to experience first-hand the ability to print from iOS devices without wires or additional applications. At the embedded world 2014 conference in Nürnberg, Germany, we demonstrated how our solutions enable customers to quickly, securely and cost-effectively leverage the power of the Internet of Things.

These demos included the xPico Wi-Fi solution that allow for the secure and quick deployment of end-to-end connectivity for Arduino and Raspberry Pi based devices. The PremierWave-powered humanoid robot developed by Kondo in Japan, a Wi-Fi-enabled autonomous quad copter drone and Google universal analytics support for Lantronix PremierWave product families allowing simple and inexpensive cloud-based analytics for IOT applications.

All these demonstrations were targeted reinforcing the Lantronix key value proposition, but we make it easy for our customers to quickly and securely leverage the power of the Internet of Things. Our solutions provide our customers with the freedom to choose the best platforms, cloud partners and analytics to implement their connective solutions. We continue to manage our revenue and product development efforts with fiscal and operational discipline. These efforts resulted in our achieving improved gross margin and non-GAAP income for the third quarter in a row.

As we move forward, we continue to focus on expanding and deepening our relationships with customers, partners and distributors worldwide so that we can deliver our rugged, secure and easy to deploy solutions. We believe continued execution to our strategy will enable us to deliver sustainable, long-term top line growth, profitability and enhance value for our shareholders. Before I turn the call over for questions, I would like to thank my Lantronix colleagues, our shareholders, our partners and our customers for your ongoing support.

Operator, we'd like to open the call for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). Our first question is from Krishna Shankar with ROTH Capital. Please proceed.

Krishna Shankar - ROTH Capital Partners

Yes. Kurt and Jeremy, congratulations on the results. I had a couple of questions on the OEM business. It's good to see the Tier 1 customer move to production of the xPico. Can you give us some sense of that opportunity? What vertical market that is targeted at?

Kurt F. Busch

Sure. First of all, thanks for calling in Krishna. This is a design in the security vertical. Basically, it's an access control application that the xPico goes in.

Krishna Shankar - ROTH Capital Partners

Okay.

Kurt F. Busch

For you information, the security vertical has traditionally been one of Lantronix largest vertical areas for our wired, device-enabled Lantronix.

Krishna Shankar - ROTH Capital Partners

Okay. And do you have other such OEM products which would be helpful for your new professional services organization could potentially move to production faster? I mean are there any other things like this in the pipeline where you're hopeful?

Kurt F. Busch

Sure. So we put the professional service organization in place to really do exactly what we did with the xPico. This was a customer that had a design that would have taken them quite some time to get to production if we didn't bring the Lantronix engineering services in play. So our goal and our plan is to have the engineering services assist our customers to go to production with a wide variety of Lantronix solutions.

Krishna Shankar - ROTH Capital Partners

And will this be kind of a revenue-generating segment or will it mainly support your new product design wins and customer development, or will you actually get service revenues from this new group?

Kurt F. Busch

To give you kind of an order of magnitude for this OEM Module, the revenue for products was about 90% of the deal and professional services was about 10% of the deal. So we definitely do get revenue from it and we'll be a revenue generator. But the main purpose is to accelerate our product sales with our customers.

Krishna Shankar - ROTH Capital Partners

Okay. And then you said that you still have a decline in the older kind of legacy OEM products. Can you give us some sense for when that decline might stabilize and when we may start to see overall growth in the OEM Module business?

Kurt F. Busch

We're not really predicting an exact time when we see that that decline will reverse, but we are expecting sometime in calendar '15 the continued ramp of xPico as well as the ramp of the xPico Wi-Fi should be stabilized in the OEM products.

Krishna Shankar - ROTH Capital Partners

Okay. And then on the Enterprise Solutions, it sounds like the xPrint, Home and Network Edition for the [app-ware] (ph) platform declined. Is that just kind of seasonal or what do you see happening in that market?

Kurt F. Busch

We see it in the Home market more and more home printers are available with AirPrint. So that product is not going to be a main focus for us on the xPrintServer product line moving forward. We think it's a good product and we'll continue to have it, but the market for that space is not as growing nearly as well as the enterprise and OEM market for the xPrintServer is. We think that the main space for the xPrintServer pipelines both the Google and the Apple products are really in enterprise applications as well as retail and those types of applications as opposed to really the Home.

Krishna Shankar - ROTH Capital Partners

Okay. And then finally, can you comment on the macro environment? Last year from the March to the June quarter, how much did you grow sequentially? And can you talk about the macro environment and how that could potentially shape the June quarter, given your new products and what you see in the macro?

Jeremy Whitaker

I can comment on the change in the year-ago period from Q3 to Q4. Q3 fiscal '13 we did about 12.2 million in revenue and in the following quarter we did about 11.1 million in revenue.

Krishna Shankar - ROTH Capital Partners

Okay. But was that I mean seasonally or typically would have a better – in terms of seasonality, the June quarter would be better than the March quarter or what are seasonal trends?

Jeremy Whitaker

There's not a lot of seasonality in our business, Krishna.

Krishna Shankar - ROTH Capital Partners

Okay.

Kurt F. Busch

Krishna, I probably should maybe just elaborate on that is I feel that the business right now is being driven primarily by new Tier 1 designs going into production. And the format for that is typically you see a peak in the first quarter when they go to production then followed by a valley, then followed by a ramp. In the last couple of quarters we have benefited by several Tier 1 customers going into production over the last three quarters. And I think that that is probably the bigger drive of revenue for Lantronix right now as opposed to changes in macro environment. That being said, of course if there's a sudden decrease or increase in either direction, we could see a change. But we're really being driven by Tier 1s going to production today.

Krishna Shankar - ROTH Capital Partners

Okay. And then how are the international distribution efforts coming along? Anything to report there in terms of updates and how that's coming along?

Kurt F. Busch

Sure. We're actually really excited about that. So if you look at year-to-date – this year year-to-date versus last year, we're up 15% in the EMEA, APAC and Japan regions. So the work that we've been doing there to expand our international distribution and sales and marketing efforts looks to be working, and we're going to be continuing to build that out.

Krishna Shankar - ROTH Capital Partners

Okay, great. Thank you.

Kurt F. Busch

Thanks, Krishna. Thanks for calling in.

Operator

Thank you for your question. (Operator Instructions). Sir, we have no further questions at this time. Therefore, I'll turn the call back to Kurt Busch for closing remarks.

Kurt F. Busch

Thank you, operator. I'd like to thank you all for participation on our call today. We look forward to updating you on our progress, achievements and actions when we report on our fourth quarter and fiscal 2014 in late August.

Operator

Thank you for joining today's conference. This concludes the presentation. You may now disconnect and have a very good day.

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