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Lantronix, Inc. (NASDAQ:LTRX)

F4Q08 Earnings Call

September 17, 2008 5:00 pm ET

Executives

Reagan Y. Sakai - Chief Financial Officer, Secretary

Jerry D. Chase - President, Chief Executive Officer, Director

Operator

Welcome to the Q4 2008 Lantronix, Inc. earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s conference, Reagan Sakai.

Reagan Y. Sakai

Before we begin I would like to highlight that an archived webcast of this call will be available on the company’s website at www.lantronix.com and an audio playback will be available through October 17. The number to call for the replay is 888-286-8010 or 617-801-6888 for international callers with pass code 93208588.

Please be reminded that during the course of this conference call management will be making forward-looking statements in their prepared remarks and response to your questions concerning among other matters future net revenue, the implementation of new and improved corporate marketing messages, the success of new business lines to create significant value, the acceleration of quarterly comparisons as the year progresses, the increase in device networking sales and the decrease in non-core net revenues, the timing of product releases and future financial performance. These forward-looking statements are based on Lantronix’s current expectations and are subject to a number of risks and uncertainties. Actual results could differ materially as a result of several factors. For a more detailed discussion of these and other risks and uncertainties, see the company’s recent SEC filings including its Form 10K for the fiscal year ended June 30, 2008 and Form 10Q for the third fiscal quarter ended March 31, 2008. Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof and the company undertakes no obligation to update these forward-looking statements to reflect subsequent events or circumstances.

I would now like to introduce Jerry Chase, President and Chief Executive Officer of Lantronix.

Jerry D. Chase

For our fiscal year 2008 ended on June 30, 2008 we are pleased to report annual net revenue growth of 4% driven in large part by a 13% increase in our DeviceLinx for device enablement revenues and continued strong revenue growth in EMEA and Asia. In fiscal year 2009 we intend to continue these positive trends with strong investments in our DeviceLinx business.

We have also begun to see some positive effects from changes in our sales organization and new and creative marketing campaign. ManageLinx continues to hold promise and is currently where we would have predicted it would be in terms of the launch process the last time we spoke.

The restructuring plans we implemented this summer streamlined our organization enabling us to be more responsive to customers, drive profitability and generate positive cash flow. This difficult but necessary step is a reflection of our strong commitment to profitability and positive cash flow. With our financial house in order we can focus our efforts on improving and expanding our product lines and accelerating our growth and profitability. I’ll talk more about these items later in today’s presentation.

Reagan Y. Sakai

Let me first discuss our fiscal year 2008 results. Total net revenue was $57.6 million for fiscal 2008 an increase of $2.3 million or 4% compared to $55.3 million for fiscal 2007. Device networking net revenue was $53.7 million for fiscal 2008 an increase of $5.1 million or 11% compared to $48.6 million for fiscal 2007. Our device networking business is comprised of device enablement products and device management products.

Device enablement net revenue was $45 million for fiscal 2008 an increase of $5.3 million or 13% compared to $39.7 million for fiscal 2007. Device management net revenue was $8.7 million for fiscal 2008 a decrease of $172,000 or 2% compared to $8.9 million for fiscal 2007. Revenues for our device management products were unfavorably impacted by the US economy as a significant majority of these products go to US based customers. This softness in device management products manifests itself in the year-on-year revenue decline in our Americas region.

Net revenue for the Americas region was $33.2 million for fiscal 2008 a decrease of 5% compared to $35 million for fiscal 2007. Net revenue for the Europe, Middle East and Africa or EMEA region was $16.6 million for fiscal 2008 an increase of 19% compared to $14 million for fiscal 2007. Net revenue for the Asia Pacific region was $7.8 million for fiscal 2008 an increase of 22% compared to $6.4 million for fiscal 2007. As a percentage of net revenue the Americas, EMEA and Asia Pacific regions were 58%, 29% and 13% respectively for fiscal 2008 compared to 63%, 25% and 12% respectively for fiscal 2007.

Gross profit margin was 50.5% for fiscal 2008 compared to 51.2% for fiscal 2007. The decrease in gross profit margin percent was primarily due to an increase in inventory reserves in connection with our efforts to simplify our product portfolio by discontinuing slow-moving and nonstrategic products.

Selling, general and administrative expense was $29.3 million for fiscal 2008 compared to $23.2 million for fiscal 2007. Research and development expense was $6.9 million for fiscal 2008 compared to $7.4 million for fiscal 2007. Total operating expenses were $31.7 million for fiscal 2008 compared to $30.8 million for 2007. Operating expenses for fiscal 2008 included a restructuring charge of $757,000.

Net loss computed in accordance with US Generally Accepted Accounting Principles or GAAP was $2.5 million or $0.04 per share for fiscal 2008 compared to a GAAP net loss of $1.7 million or $0.03 per share for the fiscal year ended 2007. The GAAP net loss for the fiscal year ended 2008 included a restructuring charge of $757,000. The GAAP net loss for the fiscal 2007 included a gain on the sale of a long-term investment of $700,000.

In addition to GAAP results we will report adjusted net income referred to as non-GAAP net income or loss. Non-GAAP net income consists of net income excluding share-based compensation, depreciation and amortization, litigation settlements, interest income or expense, other income or expense, income tax provision as well as charges and gains that are driven primarily by discreet events that management does not consider to be directly related to the company’s core operating performance such as restructuring charges.

We believe that the presentation of non-GAAP net income provides important supplemental information to management and investors regarding financial and business trends relating to the company’s financial condition and results of operations.

The non-GAAP financial measures disclosed by Lantronix should not be considered a substitute for or superior to financial measures calculated in accordance with GAAP and the financial results calculated in accordance with GAAP. Reconciliations to those financial statements should be carefully evaluated. The non-GAAP financial measures used by Lantronix may be calculated differently from and therefore may not be comparable to similarly titled measures used by other companies. Lantronix provided reconciliations of the non-GAAP financial measures to the most directly comparable GAAP financial measures in last week’s earnings press release.

For fiscal 2008 we reported non-GAAP net income of $97,000 compared to a non-GAAP net loss of $468,000 for the fiscal 2007.

Let me now discuss our fiscal fourth quarter 2008 results. Total net revenue was $14.7 million for the fourth quarter of 2008 compared to $14.7 million for the fourth quarter of 2007. Device networking net revenue was $14.1 million for the fourth quarter of 2008 an increase of $1.2 million or 9% compared to $12.9 million for the fourth quarter of 2007.

Our device networking business is comprised of device enablement products and device management products. Device enablement net revenue was $12 million for the fourth quarter of 2008 an increase of $2 million or 20% compared to $10 million for the fourth quarter of 2007. This 20% increase follows a 20% increase that we experienced in our third quarter of 2008 when compared to the third quarter of 2007.

Device management net revenue was $2.1 million for the fourth quarter of 2008 a decrease of $774,000 or 27% compared to $2.9 million for the fourth quarter of 2007. Once again, revenues for our device management products were unfavorably impacted by the US economy as a significant majority of these products go to US based customers. This softness in device management products explains the year-on-year revenue decline in our Americas region.

Net revenue for the Americas region was $8 million for the fourth quarter of 2008 a decrease of 15% compared to $9.5 million for the fourth quarter of 2007. Net revenue for the EMEA region was $4.9 million for the fourth quarter 2008 an increase of 30% compared to $3.8 million for the fourth quarter of 2007. Net revenue for the Asia Pacific region as $1.8 million for the fourth quarter of 2008 an increase of 23% compared to $1.4 million for the fourth quarter of 2008. As a percentage of net revenue the Americas, EMEA and Asia Pacific regions were 55%, 33% and 12% respectively for the fourth quarter of 2008 compared to 64%, 26% and 10% respectively for the fourth quarter of 2007.

Gross profit margin was 50.5% for the fourth quarter 2008 compared to 50.8% for the fourth quarter of 2007.

Selling, general and administrative expense was $6.3 million for the fourth quarter of 2008 compared to $5.7 million for the fourth quarter of 2007. The year-on-year increase in expense was primarily due to legal fees, stock-based compensation, consulting, commissions for our international sales teams and recruiting.

Research and development expense was $1.7 million for the fourth quarter of 2008 compared to $1.9 million for the fourth quarter of 2007.

Total operating expenses were $8.8 million for the fourth quarter of 2008 compared to $7.6 million for the fourth quarter of 2007. Operating expenses for the fourth quarter of 2008 included a restructuring charge of $757,000. Non-GAAP operating expenses were $7.6 million for the fourth quarter of 2008 compared to $7.2 million for the fourth quarter of 2007. More importantly, the restructuring actions that we implemented in June and July will result in average quarterly savings of approximately $750,000 to non-GAAP operating expenses.

GAAP net loss was $1.4 million or $0.02 per share for the fourth quarter of 2008 compared to a GAAP net loss of $89,000 or $0.01 per share for the fourth quarter of 2007. The GAAP net loss for the fourth quarter of 2008 included a restructuring charge of $757,000. Non-GAAP net loss was $70,000 for the fourth quarter of 2008 compared to a non-GAAP net income of $363,000 for the fourth quarter of 2007.

As I mentioned a few moments ago, we have reduced our annual non-GAAP operating expenses by approximately $3 million or $750,000 per quarter. We believe these actions will greatly enhance our ability to drive quarterly non-GAAP profitability and combined with our continued balance sheet management this will result in positive cash flow.

Turning to the balance sheet, cash and cash equivalents were $7.4 million as of June 30, 2008 compared to $7.6 million as of June 30, 2007. Net accounts receivable were $4.2 million as of June 30, 2008 an increase of $755,000 compared to $3.4 million as of June 30, 2007. Three quarters ago we set out to better manage our inventories and I’m happy to report that net inventories were $8 million as of June 30, 2008 a decrease of $3 million or 27% compared to $11 million as of June 30, 2007. Correspondingly, accounts payable were $7.7 million as of June 30, 2008 a decrease of $3.3 million or 30% compared to $11 million as of June 30, 2007. Our working capital was $5.7 million as of June 30, 2008 compared to $5.6 million as of June 30, 2007.

During 2008 we announced that we had entered into an amendment to our loan and security agreement with Silicon Valley Bank which provides for a three-year $2 million term loan and a two-year $3 million revolving credit facility. The addition of the $2 million term loan allows us to be more timely with our supply chain partners. This is an integral part of an ongoing initiative to optimize our supply chain with regards to cost, quality and timeliness.

This concludes my prepared remarks. I would now like to turn the call back to Jerry.

Jerry D. Chase

As I mentioned in my opening remarks, our DeviceLinx business grew at 13% this past fiscal year. We were particularly pleased with the performance of Xport which continues its quarter-over-quarter growth performance. In the fiscal fourth quarter we recognized record revenue on the Xport product line. This was on top of record Xport revenue for the third quarter and the quarter before that.

This brings us to the first topic I’d like to discuss with you, an update on our DeviceLinx product line. DeviceLinx is our bread-and-butter business, and as you would expect it will receive the bulk of our attention and investment dollars in the coming year. We believe we have outpaced market growth with our DeviceLinx product line but there are more things we can do to be disruptive, increase the performance of our platforms, make them easier to use and gain market share.

Our customers have been telling us they want to see greater processing power, more flash, more ramp in popular Lantronix form factors. They also want to see more enabling applications that allow them to develop specific solutions for their verticals. They want greater accessibility to our platforms via Linux, and they want more wireless options. We have already started working in many of these key areas. You can expect us to continue to working closely with our partners and customers to incorporate these elements into our products in the coming year.

Though DeviceLinx is our flagship product family, we continue to invest in our other product families with an eye toward future growth, which bring us to ManageLinx. ManageLinx continues to show promise and we continue to appropriately invest in its development and launch. Since we spoke last ManageLinx has completed beta testing in the field, it has been released to production and it’s now in trial at a number of large customer sites. This is on pace with what we discussed last time. ManageLinx continues to perform well and deliver on the promise of an easy-to-install highly secure solution for communicating through the firewall and enabling remote product service business models.

With the high price of fuel and transportation, the value proposition of ManageLinx becomes even more compelling. ManageLinx continues to hold the potential to be the glue that ties Lantronix’s products together into a cohesive whole that enables cross product line sales.

The immediate first ManageLinx application is called VIP Access which offers customers a best-of-breed highly secure method of communicating with and controlling specifically designated equipment behind firewalls. The current schedule calls for release of version 1.1 at the end of October which layers additional powerful enhancements onto the product including a software key activation infrastructure.

Version 2.0, the follow on release due in April of 2009, will begin the regular two time per year cycle of introducing value-added applications. These releases will support new product sales and will also target our install base for upsell opportunities.

The sales cycle for ManageLinx is in the range of nine to 12 months so we still have our work cut out for us before ManageLinx becomes a meaningful part of our revenue picture. In the meantime you can expect us to work diligently but invest prudently.

During the last quarter we implemented significant changes in our sales force that are starting to bear fruit in terms of greater focus on our customers. We organized our US sales force3 into three geographies, each under the leadership of a strong regional director responsible for selling our entire product line. We also strengthened our inside sales team focusing them on increasing our top line performance with a large number of customers with smaller individual needs. This also allows our outside sales force to give more attention to larger opportunities.

As I mentioned earlier we are also getting more focused on our marketing efforts. Maintaining and growing our lead in technological performance allows us to focus on what our customers are really interested, which is business solutions. Going forward you will see our marketing messages focus intently on how we solve networking challenges with simple-to-deploy high-quality application-friendly quick time-to-market solutions.

On top of networking challenges a serious issue that many customers face today is how to reduce energy costs while still going about their daily business. With our ability to connect and control anything via the Internet, Lantronix’s products are a natural part of the solution to this pressing problem. Therefore, another key element to our marketing message will be to show clearly and specifically how our product lines save time and money.

Recently you may have noticed that we are using our website and the Internet much more to reach existing and potential customers. On a recent trip to the UK one of our partners told us they might not always have the time to read written collateral but they can almost always find the time to watch a three to five minute video. Partners around the world echoed the same sentiment which led us into video marketing.

We’ve had a lot of fun creating useful videos in a number of languages that address our customers’ information needs. Reflecting our focus on our growing international markets we have videos in Mandarin, Japanese, French, Hebrew, German and more. Going forward you can expect to see more videos, more case studies and more social networking outreach. This will be part of disciplined quarterly marketing campaigns focused around specific objectives but we are encouraged with the results of our initial efforts. We’re at the beginning and we’ve got a lot of work to do. We look forward to updating you further on our next conference call.

Reagan will now provide you with our thoughts on profitability and cash flow for upcoming quarters.

Reagan Y. Sakai

For the first fiscal quarter of 2009 ending September 30, 2008 our non-GAAP profitability break-even point ranges from $12.8 million to $13.4 million in quarterly revenue. After the first quarter and taking into account the full impact of our recent restructuring, our non-GAAP profitability break-even point will range from $12.5 million to $12.9 million in quarterly revenue.

To summarize and re-emphasize, these are not revenue guidance ranges but are intended to provide guidance on our quarterly non-GAAP break-even points with regard to quarterly revenue. We expect to do better than non-GAAP break-even and we fully expect to drive positive cash flow.

This concludes my prepared remarks. I’d now like to open the call to questions.

Question-and-Answer Session

Operator

There are no questions in the queue at this time.

Jerry D. Chase

Since there are no additional questions, we would like to thank everybody for their participation on the call today and we look forward to speaking with all of you next quarter. Thank you.

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