E.E. Wang - Director, Corporate Marketing and IR Jeff Benck - President and CEO Jeremy Whitaker - CFO.

Jaeson Schmidt - Lake Street Capital Markets.

Good afternoon, and welcome to the Lantronix Incorporated Fiscal Year 2017 Fourth Quarter Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there’ll be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to E.E. Wang. Please go ahead..

Thank you, Brian. Good afternoon, everyone, and thank you for joining the Lantronix fourth quarter and fiscal 2017 conference call. Joining us on the call today are Jeff Benck, Lantronix President and CEO; and Jeremy Whitaker, Lantronix CFO. 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 8:00 p.m. Eastern, 5:00 p.m. Pacific today, through August 30th by dialing (877) 344-7529 in the United States; or for international callers (412) 317-0888, and entering passcode 10111393.

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-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 reconciliations for the non-GAAP financial measures that we use. I’ll now turn the call over to Jeff Benck, President and CEO of Lantronix..

Thanks, E.E, and welcome to everyone joining us for this afternoon’s call. Today, we will be covering our results for our fourth quarter and recapping what’s been a very productive fiscal 2017 for the Company.

I’m proud of our team’s execution in what has been a challenging environment due to the retooling we took on to get the right people, products and processes in place for the future.

In fiscal 2017, we transitioned from a company that was focused on stabilization to one that has delivered 10% revenue growth and a sixth consecutive quarter of non-GAAP profitability. At the same time, we continue to make strategic investments in support of our IoT strategy and solution roadmap while keeping expenses in check.

As we enter fiscal 2018, we will continue our journey to move up the value chain in the industrial IoT market with an intent to deliver greater value to our shareholders. We have a lot we want to accomplish in the new fiscal year and our focus will be on driving three key initiatives.

First, growing our wireless IoT gateway business; second, continuing our share gain momentum in the market with our IT management products; and lastly, establishing our IoT software business with the launch of MACH10, our IoT platform.

We believe we have the right strategy in place to enable the Company to capitalize on the opportunity the industrial IoT market represents. Before I provide some additional insight on our business, I’m going to turn the call over to Jeremy to discuss our financial results from 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’d like to take a few minutes to go over our results for the fourth quarter and fiscal year ended June 30, 2017.

Net revenue for the fourth quarter of fiscal 2017 was $11 million compared with $10.5 million for the fourth quarter of fiscal 2016, and $11.5 million for the third quarter of fiscal 2017. The year-over-year growth was due to increased sales in both our IoT and IT management product lines.

More specifically, our IoT product line increased by 8%, primarily due to increased sales in our Americas region. In addition, our ITM product line increased by 28%, primarily due to sales growth of our SLC 8000 advanced console manager solution.

Gross profit, as a percentage of net revenue was 51.3% for the fourth quarter of fiscal 2017, compared with 47% for the fourth quarter of fiscal 2016 and 55.5% for the third quarter of fiscal 2017.

The improvement from the year ago quarter was primarily due to improved product mix, as some of our higher-margin products, such as the SLC 8000 and XPort contributed to a larger portion of our net revenue. Looking forward to next quarter, we expect to continue to maintain gross margins above 50%.

Selling, general and administrative expenses for the fourth quarter of fiscal 2017 were $3.7 million compared with $3.4 million for the fourth quarter of fiscal 2016 and $4.4 million for the third quarter of fiscal 2017.

Our research and development expenses for the fourth quarter of fiscal 2017 were $2 million compared with $1.8 million for the fourth quarter of fiscal 2016 and $2.1 million for the third quarter of fiscal 2017.

Looking ahead to the September quarter, we expect operating expenses to increase due to actions we started this summer to more closely align resources with our fiscal 2018 plan. In connection with these changes, we estimate that we will incur a charge of approximately $500,000, primarily consisting of severance related costs.

In addition, we have opened a number of new employee requisitions to add new skills to support our fiscal 2018 initiatives.

During the fourth quarter of fiscal 2017, we recorded a GAAP net loss of $52,000 or $0.00 per share, this compares to a GAAP net loss of $247,000 or $0.02 per share during the fourth quarter of fiscal 2016 and a GAAP net loss of $162,000 or $0.01 per share during the third quarter of fiscal 2017.

I am also pleased to report our sixth consecutive quarter of non-GAAP profitability, as we achieved non-GAAP net income of $388,000 for the fourth quarter of fiscal 2017 compared with non-GAAP net income of $121,000 for the fourth quarter of fiscal 2016 and non-GAAP net income of $484,000 for the third quarter of fiscal 2017.

Now, turning to the full year results. Net revenue for fiscal 2017 was $44.7 million, a 10% increase from fiscal 2016 when we recorded $40.6 million. Gross profit as a percentage of net revenue for fiscal 2017 improved to 52.7% compared with 47.7% for fiscal 2016.

Operating expenses for fiscal 2017 were $23.8 million compared with $21.3 million for fiscal 2016. The increase in operating expense was primarily due to increased personal-related costs and strategic investment in our engineering sales and marketing resources to support our long-term growth plan.

For fiscal 2017, we reduced our GAAP net loss by 86% to $277,000 compared with a GAAP net loss of $2 million for fiscal 2016. Non-GAAP net income for fiscal 2017 was $1.6 million, a substantial improvement over fiscal 2016 when we recorded non-GAAP net income of $238,000. Now, turning to the balance sheet.

Cash and cash equivalents increased to $8.1 million as of June 30, 2017 compared with $6 million as of June 30, 2016. Net inventories were $7 million as of June 30, 2017 compared with $6.6 million as of June 30, 2016.

And overall, we continue to see improvement in working capital as it increased to $10.4 million as of June 30, 2017 compared with $9.1 million as of June 30, 2016. In summary, we’re pleased with the continued progress that we made in fiscal 2017 and believe that we have made many of the changes needed to deliver long-term growth.

I’ll now turn the call back to Jeff..

Thanks, Jeremy. During fiscal 2017, we made significant progress on the key initiatives that I laid out at the beginning of the year.

These were, first, driving operational excellence to improve the financial results of our business while making room for investment in our growth initiatives; second, accelerating growth in our IT management product line through deal wins and market share gain; and third, executing on our strategic product roadmap, including investing in new offerings to more broadly participate in the fast-growing IoT market.

Let’s begin with the review of our progress on operational excellence. Over the past year, we implemented a number of improvements throughout our organization including product cost reductions, focused improvement in sales and marketing execution, better deal closure rates and closely managed spending.

Our full year results reflected the impact of consistent execution as we recorded double-digit revenue growth, improved margins and achieved $1.6 million in non-GAAP profitability.

This progress is all that more striking when you consider that over the last year we invested a substantial amount of resources in our business between adding new engineering, sales and marketing resources; building an IoT software lab; and introducing several new IoT and ITM solutions.

Our efforts to rebuild our sales team in the Americas, paid dividends in fiscal 2017. The revitalized team drove new opportunities and better customer engagement, resulting in 20% annual growth in this region.

During the second half of fiscal 2017, we took action to restructure our EMEA sales team, put in place a new leader and hired new sales managers to focus on specific product segments. While this transition may impact our near-term results, we expect the actions and investments we have taken to pay dividend as we get further into fiscal 2018.

Turning to our second initiative. We achieved 76% annual growth in our IT management business, as we won some important competitive deals and added more than 30 new customers in fiscal 2017. The June quarter marked our fifth consecutive quarter of year-over-year sales growth in this product line.

More importantly, we are gaining market share and more companies are seeking us out because they have determined that a modular out-of-band management solution is required to address their expanding needs. Turning to our third initiative. We continue to execute on our strategic product development plan.

Our mission is to deliver secure data access and management solutions for the industrial IoT. Over the past year, I talked several times about our focus on defining new technologies that will help companies simplify their IoT deployment efforts and expand their own solutions beyond just hard work.

During fiscal 2017, we made significant strides on the product development front, including we launched the new external IoT device gateway, the SGX 5150, which allows OEMs and system integrators to Wi-Fi enable virtually any device or machine, even if it’s already deployed in the field.

In March, we previewed the xPico 200 family, our entry line of wireless embedded IoT gateways. The xPico 240 is already sampling the largest number of potential customers we have had for new wireless embedded product.

Building a new IoT software lab in India, this team has been instrumental and the rapid progress we made on the development of our MACH10 platform. In may, we announced the beta availability of MACH10, our IoT software platform, designed specifically to simplify the process for OEMs to develop and deploy web-based applications and services.

Our strategic priorities for fiscal 2018 are, first, growing our wireless IoT gateway business; second, continuing to drive share gains with our IT management products; and third, establishing our IoT software business. Let me now go into more detail on these initiatives. Turning to our first initiative.

We have a number of exciting new wireless IoT gateways in the market now in various levels of qualification with our OEM customers that we expect will bear fruit as we get into the second half of fiscal 2018.

We’ll continue to build out our wireless solution portfolio to enable us to become the trusted source for OEMs, seeking a one-stop-shop for industrial IoT Wi-Fi connectivity. Our second initiative is to continue to drive share gains with our IT management products that will enable us to grow faster than the market.

In support of this plan, we have expanded our reseller base by more than 35 new resellers worldwide in fiscal 2017. At the same time, we continue to add new capabilities to our flagship SLC 8000 management console, widening the gap to the competition in this space.

We’re also encouraged by the number of our RFQs for large enterprise data center rollouts where we believe our modular solutions provide a differentiated alternative to the status quo. Finally, our third initiative is to establish our IoT software business.

With more than 25 years as an innovator in delivering products that have enabled industrial OEMs to connect millions of devices worldwide, we have a unique vantage point into the challenges of OEM space and building a web scale IoT application environment.

We also bring unique experience in understanding how to exploit the intersection between IT and operational technology. With the upcoming launch of our MACH10 IoT software platform, we’re adjusting the challenges OEMs face and moving up the IoT value chain in the process.

Since launching our beta release, we’re seeing that the MACH10 introduction has allowed us to engage with our OEM customers on a different strategic level. We’re getting greater insight into their product directions and discussing how Lantronix solutions can play a part in helping these companies advance their IoT strategies.

We appreciate that no one in this space can provide the complete solution by themselves, so the IoT ecosystem is important. And as such, we’re spending more time with the relevant partners, consortiums, industry analysts, ISVs and system integrators to build out solutions that will expand our reach.

Let me provide some color on our near-term outlook as we enter the new fiscal year.

While we took the right steps in fiscal 2017 to set the stage for further growth in fiscal 2018, we believe that for the first half of the year, our quarterly revenues will be relatively consistent with the June quarter, as it will take time for OEM design wins based on our new products to come to market.

While things may progress quicker than we anticipate, we appreciate the time it takes for these offerings to come to market through our OEMs. Now, let me wrap up. As we start fiscal 2018, I’m excited about how we’re positioned for the year. We have new wireless IoT gateways launching this fall that are already generating significant interest.

We’re poised to achieve double-digit growth in the IT management business with more customers seeking us out, based on our industry-leading offerings. And with the anticipated launch of our new MACH10 software platform, we’re gaining higher strategic visibility among our customers and other key stakeholders in the industrial IoT marketplace.

Today, Lantronix is a different company than the one I joined just 20 months ago due to the changes that we made in products, processes and people. Rest assured, we’ve got a compelling vision for moving up to IoT value chain and a roadmap that supports it. We’re more focused and we’ve modified our processes to drive consistent outcomes.

Most importantly, we have an experienced leadership team in place to guide our teams to success. Our results in fiscal 2017 put us on a stronger footing, as we reverse three years of revenue decline and put us at a revenue level not seen since fiscal 2014.

Furthermore, thanks to our cash generation, we now have the financial means to invest as needed in our future.

Of course, we still have to make cost trade-offs, and we may have minor setbacks along the way, but we as the conviction in our beliefs that we understand what’s needed to this Company to get to the next level, and we’re maniacal about executing our plan. I’ll look forward to updating you on our progress as we continue the journey.

That completes our prepared remarks for today. So, I’ll now turn it over to the operator to open up the lines for our Q&A session.

Operator?.

We will now begin the question-and-answer session. [Operator Instructions] And our question comes from Jaeson Schmidt with Lake Street Capital Markets. Please go ahead..

Hi, guys. Thanks for taking my questions. I just wanted to start with the MACH10 product.

How should we think about the potential revenue opportunity there? Is it mainly going to be used to facilitate pull-through on the product side? And what are some of the goalposts investors should be looking forward on that product line?.

Thanks, Jaeson. It’s Jeff here. Yes. So, the focus of MACH10 right now, as you can imagine, we’re in beta and we’re anxious to get the product formally in the market, and we will be looking to do that before the end of this calendar year. So, that right now is our immediate focus.

As you think about revenue, we -- obviously, at that point when we’re formally in the production, then we will start collecting revenue for the product. But because it’s going to be enterprise license agreement structure, it will be recognized ratably as customers get on the platform.

And given that it’s targeted OEMs, it will have some OEM cycle time associated with their adoption and their development of it. So, as we look at this fiscal year, we will clearly be looking to the backend of this fiscal year before we see any real contribution, and it will ramp as we go through time.

We are also, beyond just developing an application, a global device management application that customers can get started with, we also see the ability for us to use the platform as an extension or a feature of some of our products. And as such, there will be other ways for us to potentially monetize the MACH10 investment.

As you can imagine, some of our products, we might want to just provide device management as a feature to a particular gateway. But, our real goal here is for customers to leverage MACH10 to manage their own devices in the marketplace..

Okay. That’s helpful. And then, just looking at gross margin. I know, it was down in the June quarter.

Was that largely just due to mix and lower revenue?.

Hey, Kevin or -- sorry, Jaeson. Yes. This is Jeremy. So, margins were down sequentially, primarily due to some E&O charges that we took in the fourth quarter. The product mix was relatively consistent sequentially.

So, the standard margin is still -- was still relatively consistent but we did take some E&O charges, which impacted it and resulted in the decline sequentially..

Okay.

And then, longer term, how should we think about gross margin trending? I mean, obviously, with some of these newer products, that should help pull it higher, but any sort of midterm target we should be thinking about?.

Yes. We continue to believe that we will be able to sustain margins above 50% in the near-term..

If you look out in time, there is no question that softer margins will be higher and could help to take us in a higher direction. But, as we also look to grow our wireless business, some of the wireless embedded products will be on the lower end of our gross margin spectrum for the Company.

So, we want to grow both of those, so they might have some cancelling effect. But as you’ve seen. We improved margins this fiscal year 500 basis points, which I think is pretty good progress by the team. We don’t anticipate a big take up in the new year. But, as Jeremy said, we want to -- we would like to stay above 50%.

And we will see what progress we make with cost and -- cost reductions and pricing discipline that we’ve demonstrated in fiscal 2017 and how that helps us in 2018..

Okay. That makes sense. And then, just the last one for me and I’ll jump back into queue. For the September and December quarter, it sounds like revenue is going to be around that $11 million range.

Is that largely jut due to some of the newer product sampling and then eventually rolling out in the latter half of fiscal 2018, so really just timing of orders or have you seen a pause in demand across any of the products?.

We have a pretty broad portfolio of products. I think you’re absolutely right that we clearly have some design wins that were designed in on some projects that have to go through the development cycle, and some of those we look to actually accelerate -- or come into market in the second half of the fiscal year.

So, we do think that some of it is timing. Just, I think we -- I know we mentioned that in the script as well. We clearly still have a legacy product line that did quite well in fiscal 2017. We know there’ll be ups and downs in that. Our new products have demonstrated growth and it’s been able to offset that.

But just when we take everything in the context, we wanted to give some visibility into how we’re thinking about the first half. We still see FY 2018 being a growth year. But, we also I think beat folk’s expectations in 2017 with 10% growth, so you’re coming off a much higher base now. And we’ve seen a level of stabilization in the business.

And demand trends still seem encouraging. When you think about our IT management products, we see a number of large deals that we’re participating in. I think we mentioned in the script that there are some RFQs that we’re pretty excited about that could be very meaningful. Of course, we got to go win that business.

We had a great track record adding 30 new customers in 2017 to do that. But that’s still some business to win in front of us. We see opportunities in the Wi-Fi portfolio. And it’s a bit early yet on MACH10.

So, just taking it all in the context and looking at where our design wins are and how they may -- to how they may ramp, we feel that that’s the way we see the business today..

[Operator Instructions] This concludes our question-and-answer session. I would like to turn the conference back over to E.E. Wang for any closing remarks..

Thanks, Brian. Just one quick announcement before we sign off. Jeff and Jeremy will be presenting tomorrow at the 2017 Southern California Investor Conference in Newport Beach, California.

We will have an updated investor presentation up on the website for investors who are interested in looking at that, and you can also access the webcast through our website at www.lantronix.com. Thank you. And we look forward to updating you on our progress, achievements and actions when we report on our first quarter results in late October..

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect..