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

Jaeson Schmidt - Lake Street Capital Markets Nehal Chokshi - Maxim Group.

Good day, everyone. And welcome to the Lantronix Second Quarter Fiscal year 2018 Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] Please do note that today's event is being recorded. I would now like to turn the call over to E Wang, VP of Marketing. Please go ahead..

Thank you. Good afternoon, everyone, and thank you for joining the Lantronix's second quarter fiscal 2018 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 the company's website at www.lantronix.com. In addition, a phone replay will be available starting at 8 p.m. Eastern, 5 p.m. Pacific today through February 1 by dialing 1-877-344-7529 in the U.S. or for international callers, 412-317-0888, and entering passcode 10115345.

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. And welcome to everyone joining us for this afternoon's call. I'm pleased with how our team executed in the second quarter.

We continue to make great progress on strengthening our business as we grew revenue 7% sequentially, achieved solid year-over-year gross margin improvement, delivered our eighth consecutive quarter of non-GAAP profit, and recorded our strongest GAAP profitability in 10 years.

We also generated cash for the fifth quarter in a row and our improved operating margins helped us to increase our cash position to $8.4 million. On IT management front, the business grew 42% year-over-year in the quarter, thanks to record sales of our SLB branch office manager.

As we have mentioned on previous call, we believe that we could reignite the growth in this product line and we are starting to see the fruit of our renewed sales focus. In second quarter, we closed two major deals and rolled out SLB's to one of the top three banks in the U.S., as well as one of the top three U.S. mobile network operators.

We also made great progress in the quarter on our IoT initiatives, by launching MACH10 Global Device Manager, and our xPico 200 family of embedded IoT gateways.

In fact, we achieve general availability of the xPico 240 and started shipping production units of this Wi-Fi IoT Gateway to our first customer, who manufactures automated guided vehicles or AGVs. These AGVs are being deployed to move packages and warehouses for one of the largest Chinese e-commerce companies.

This industrial customer achieved production publication with the xPico 240 at a record pace, which bodes well for the potential of this new wireless IoT Gateway family. Before I provide some additional color on our business, I will now turn the call over to Jeremy, to discuss our financial results for the second quarter..

Thank you, Jeff. Please refer to today's news release and our financial information in the investor relations section of our website for additional details that will supplement my financial commentary. Now I would like to take a few minutes to go over our results for the second quarter of fiscal 2018.

Net revenue for the second quarter of fiscal 2018 was $11.3 million compared with $11.2 million for the second quarter of fiscal 2017 and $10.6 million for the first quarter of fiscal 2018. The sequential increase was primarily due to growth of IT management product line, driven by record sales of our SLB.

Gross profit as a percentage of net revenue was 55.7% for the second quarter of fiscal 2018, compared with 51.8% for the second quarter of fiscal 2017 and 52.7% for the first quarter of fiscal 2018. The year-over-year improvement in margin was a result of lower costs, tighter pricing discipline and lower charges for excess and obsolete inventories.

Selling, general and administrative expenses for the second quarter of fiscal 2018 were $4.2 million, compared with $3.9 million for the second quarter fiscal 2017 and $4 million for the first quarter of fiscal 2018.

Our research and development expenses for the second quarter of 2018 were $1.9 million compared with $1.9 million for the second quarter of fiscal 2017 and $2.2 million for the first quarter of fiscal 2018.

I am pleased to report that through a combination of improved top-line, record gross profit margin and disciplined spending that we delivered GAAP net income of $225,000 or $0.01 per share during the second quarter fiscal 2018.

This compares to GAAP net income of $41,000 of $0.00 per share during the second quarter of fiscal 2017 and the GAAP net loss of $641,000 or $0.04 per share during the first quarter of fiscal 2018.

We also maintained our non-GAAP earnings strategy, with our eighth consecutive quarter of non-GAAP profitability as we achieve non-GAAP net income of $689,000 for the second quarter of fiscal 2018.

An improvement of 55% as compared with non-GAAP net income of $444,000 for the second quarter of fiscal 2017 and non-GAAP net income of 306,000 for the first quarter of fiscal 2018. Now turning to the balance sheet, cash and cash equivalents increased to $8.4 million at the December 31, 2017 compared with $8.1 million as of June 30, 2017.

Net inventories were $7.1 million as of December 31, 2017 compared with $7 million as of June 30, 2017. Working capital improved to $11 million as of December 31, 2017 compared with $10.4 million as of June 30, 2017 Now I'll give some insight into gross margin and operating expenses for the third fiscal quarter.

We expect gross margins to remain in the range of what we have seen during the last couple of quarters. We expect operating expenses to increase sequentially about few hundred thousand due to the annual reset of employment taxes in the U.S. and the addition of new resources to meet our 2018 operating plan. I'll now turn the call back to Jeff..

Thanks, Jeremy. Now let me provide you with an update on our three strategic initiatives for this fiscal year. First, to increase the number of IoT wireless gateway design wins; second, to continue our share gain momentum with our IT management products; and lastly to establish our IoT software business with the launch of MACH10 or IoT platform.

On our first initiative, we continue to make great progress by launching our latest embedded IoT gateway the XPico 240 in early December. As mentioned earlier, we began shipping production units to our first customer, who is shipping their new product with our wireless solution.

We have achieved a number of additional design wins for XPico 240 and expect to close more this quarter and next. We also started sampling XPico 250 product in December which adds Bluetooth connectivity to the XPico 240 feature set and opens up additional used cases expanding our addressable market.

We are also pleased with the progress on our SGX5150 IoT device gateway. During this past quarter, we have seen an initial ramp of SGX5150 with one of our strategic OEM customers, who is using our device to wirelessly connect their high value medical equipment to hospital networks.

Further, we have seen more engagement within the system integrators channel, with multiple proof of concepts and pilots in the manufacturing vertical. The SGX5150 is being used to connect factory tools and machinery to access data securely for used cases such as predictive maintenance and yield optimization using the Microsoft Azure platform.

In addition, we've made good progress in the resource management integrator channel, working very closely within OEM who has qualified our gateways to work with their controllers deployed in the field, which will help us scale our business in that segment. While more of our development spend is focused on Wi-Fi.

We are finding that wired connectivity is still the preferred technology of choice for many industrial IoT applications, and we have seen solid demand and an increased pipeline of design wins for our xPort wired Ethernet products.

This increased interest in our wired offerings has reinforced the importance of these core products and supports continued investment in this space. To that end, we will be sharing some exciting enhancements to our wired roadmap in the coming months.

Now turning to our second initiative, we continue to drive shared gains with our IT management products enabling us to grow faster than the market over the past year. Our flagship SLC 8000 offering recovered well in second quarter and saw 47% sequential growth.

We continue to add new customers every quarter and we are engaged in the several larger enterprise RFPs tied to data center refreshes and Cisco switch deployments that represents significant opportunities for us to continue our growth trajectory. As discussed on our last quarter conference call.

We've been investing further in leadership enhancements to our IT management product family.

In fact, earlier this week, we announced some innovative functionality that we added to our SLC 8000 offering that allows IT managers and administrators to not only manage their switching infrastructure, but now also monitor the performance of their network at the same time.

We are developing further enhanced capabilities for IT management products that we will be unveiling later this year. Finally, moving to our third initiative, which is focused on establishing our IoT software business, during the second quarter, we launched MACH10 global device manager at the IoT Solutions World Congress in Barcelona, Spain.

We received strong reception and great coverage following our announcement at the event where we've partnered with the industrial internet consortium and we're part of their industrial IoT pavilion.

MACH10 Global Device Manager is a ready to use IoT application suite that enables OEMs and system integrators to quickly deliver secure and robust web scale device management for their connected machines. We are engaged in several large company proposals and running active field trials.

We are finding that the time it takes to evaluate our solution and integrate into the OEM products is similar to the design cycle of our OEM hardware offerings.

While this has implications for a potentially slower time to revenue than initially thought, we understand the OEM design and the cycle well and appreciate the importance of continued investment and support of OEMs in this space.

We are continuing to invest in the MACH10 technology platform with plans to offer new SaaS offerings for our line of IoT Gateways and IT Management hardware in the coming months.

These SaaS offerings will enhance our hardware products and give us a competitive advantage, while making us more strategic to our OEM customers, as we provide a larger piece of their IoT solution. I will share more on these new offerings as we progress during the year.

Now, let me wrap up, I'm very pleased with our performance in fiscal Q2 and the momentum we carry into the second half. We delivered revenue growth and record gross margins, which resulted in 6% non-GAAP operating margins and GAAP profitability, once again, demonstrating the leverage in our business model.

We are clearly making progress on our key initiatives throughout the first half of our fiscal year with the recent wireless product launches to ramp on our new gateway products and the share gains and IT Management. I look forward to updating you on our progress as we continue our journey. That completes our prepared remarks for today.

So now I'll now turn it over to the operator to conduct a Q&A session.

Operator?.

Thank you, sir. We will now begin the question-and-answer session. [Operator Instructions] And our first question today will be Jaeson Schmidt with Lake Street Capital Markets. Please go ahead..

Hey guys, thanks for taking my questions. I just wanted to start on the IT Management side.

You guys have shown some really strong traction over the past few quarter here, just curious if you could talk a little bit about how big the customer pipeline currently is, what kind of visibility you have going forward there? And more so why you guys are finding so much except there?.

Yeah, sure. Hi it's Jeff. Thanks, Jaeson for the question. We did have a good quarter for IT Management business. It recovered nicely I mean first quarter we were - we have - I think we had mentioned the deal that moved out of the quarter which we closed early in October.

Couple contributing factors, are SLB which is our branch office solution had a really great record quarter, had a couple really large deployments that rolled out in the quarter, which of course we've working on for multiple quarters.

But specifically, to your question, we look for that business to continue to improve over what the last year, albeit we don't expect it to be record necessarily this quarter, but we do think in general that will be a nice contributor to family of offerings. We also liked the pipeline on the SLC 8000.

We've got - I don't have the specific number in front of where we got a number of deals obviously that we are working at any given time.

We also I mentioned in the script that we have a couple of very large enterprise RFPs, which are proposals that we're in the proof of concept on, we can't always count that we're going to win every one of those, but some of these are pretty meaningful. So, we feel pretty good about our position.

And then we also just announced an enhancement to our SLC 8000 and it gives us the network performance capability that the competition in its space doesn't have. And that has the opportunity to actually replace another appliance that might be in the data center and expand our used case.

So, when you add all that together, we feel pretty good about the IT Management business and what we've been able to do, we had growth in the first half, we look for it to grow on a full year basis as well. The rest kind of comes down to how we execute on some of these big deals..

Hey there.

How should we think about the size of the enterprise potential deals compared to the current ones you've already won? Not so much specific amounts but are these double the opportunity for you guys or how should we think size wise going forward?.

They all vary a little, there is one of them just off-hand is in similar size to what we might see, what might have already seen. One of them is very large would be many multiples of some of the deals that we've seen recently. But even in our own, we might have a small customer deploy five to 20 appliances.

We might have a customer deploy a 100, if they're going across more than one data center or a big deployment larger company. But we've also seen them in the multiple hundreds. And usually when that happens, you see it happen over a number of quarters. So, there is some good continual momentum that comes from that.

But a couple of these are pretty significant. So, they definitely need a mover if we were to win that. Again, we're not, it's a competitive space we think we stuck up well, but we feel pretty about the pipeline..

Okay. And the last one from me and I'll jump back into queue. I know you mentioned gross margin will stay in the range, you've seen through this fiscal year.

How should we think about it longer term? Are these newer products and kind of overall mix helping full gross margin higher or is there really just the pricing environment and some improved efficiencies being the primary drivers?.

I think it's a number of factors which we kind a talked about. We've been focused on cost. We've been trying to be smart about our pricing strategies. We feel pretty good about the sustainability, which is why you see us continue to kind of tick up our guidance a little bit there. Jeremy said, we see it in the range of last few quarters.

The last few quarters were higher than a year ago quite a bit. So we said north of 50 earlier in the year, we're probably in the little, a couple of points above that. And we have the potential to do that. I think we feel like it's pretty sustainable.

I will say as our IoT business grows and some of the wireless solutions might be a little lower margin maybe than some of our other offerings. But some of our core products like the IT Management family is above gross margin, and so it kind of balances off quite well. Of course, our wireless Ethernet export is also kind of above corporate margin.

And then as we build the software business that I will come with associated higher margin. But we do have other business where we're going to be more aggressive. And some of the Wi-Fi embedded business is likely to be on the outside of that. But we feel pretty good about this has been inching up nicely here and it's sustainable..

Okay. Thanks a lot, guys..

Cool. Thanks, Jaeson..

[Operator Instructions] And our next questioner today will be Nehal Chokshi with Maxim Group. Please go ahead..

Thanks for taking the question and congrats on the gross margin results and strong profitability results and the sustainability that you're talking about, the things that you're doing that's allowing that gross margin expand.

On the MACH10 product offering, I think you mentioned that you do expect to roll this out as a software as a service and not bundled in as part of the IT management solutions, is that correct.

Did I hear that correct?.

Yeah, that is correct. We - you referenced IT Management. And we've really - the first offering global device management's really tied really supports our IoT products more directly.

But it's not required, like we can have customers that our interest - in fact we do have some customers engaging us that have their own - already have their own IoT offering but need a software solution for device management. We certainly expect to leverage our own customers that are buying our hardware already.

But we do see this really as an enterprise license agreement and that's way we're approaching the market. And we really see this ultimately an independent product line. We do intend to expand the use of it across more of our hardware offerings like IT management. And we'll talk more about that in the coming quarters as we continue to invest there.

But right now, we just launched last quarter formally and we're engaging with a number of customers and learning as we go in the space. And we're excited about it, but we know it takes it's going to take - we've got to continue to focus on and continue the investments as we develop this product line..

So the discussions that you're having with your customers, as they look to - I presume they are beta at this point in time. They haven't deployed it in production yet.

Is that correct?.

Yeah, we haven't driven any revenue, yes, that is true. We really - we're calling it pilot maybe not beta anymore, because the product is launched formally. But we have a scheduled pricing strategy that allows you to do a trial period without paying for it and then converting to a development license and then ultimately go into production.

So, it is an OEM product, because the product is very much focused on industrial OEMs that are looking to provide an IoT software solution for not only our gateways or gateway they're using potentially but also for the machines connected to that. So, the development cycles that goes with that that's much like the designing of our Wi-Fi solutions.

And so, there is a time period associated and we recognize the developers. Or we want the commitments and we want them to be invested with us, but then as they come to market we'll see it annuity as they launch with our solution and deploy it with their platforms..

And have you had discussions as far as what will be pricing metric i.e. X dollars per device that MACH10 manages. How have you guys..

We have talked about that, we are approaching a more with an enterprise I'll give you this much, it's competitive. So I'm sensitive about being very specific. But there are a lot of players out there that are a couple of bucks of device per month or whatever. We've taken more of an interference licensed approach thing to development tool.

It's a tool you use to deploy with your solutions. And from that standpoint we look at it as there is an investment associated with it, but then we're not so much concerned about, if I'm deploying 100 devices or 1000 that you get me on the per price solution. And that's kind of how we're approaching it.

But the deals will vary a bit depending on the particular end user and their intended use and what they're deploying it with..

And then the strength that you're seeing in the overall business, do you feel like that's correlated at all with the MACH10 development that you've had in the pipeline? Has that been a driver of increased traction at all?.

It's certainly for our existing customers that we've engaged. We've become more strategic because we can talk about the broader solution. We're not just talking about selling them an embedded gateway or a device gateway. Now we can talk about a broader IoT solution.

And I've directly heard customers say, well I have to think about you guys differently because you are becoming more strategic, as I look to partner with you on more than just the hardware. But in terms of - I don't know that's been a huge needle mover yet.

In fact, I view MACH10 as a bit of - it's a bit of a wild card for us, because I don't think investors in general are valuing that. Of course, we haven't delivered the revenue yet. So there is expectations and hope there. But certainly from our standpoint, we don't feel like that's totally baked in.

The strength that we've seen in the business is frankly just takes - come from the focus and our sitting on all cylinders. We've made a ton of changes over the last year in terms of getting the right team on the field, changes in sales, changes in marketing. Our engineering pipeline has gotten better. And we've got better product.

So, there is a lot of factors that have contributed to it here. I do think having a strategy that talks about IoT solutions and being able to offer more to the OEMs we sell to is helping maybe tangentially. But it's hard to directly correlate that..

Great. Well, congratulations..

Okay. Thank you very much..

[Operator Instructions] And it looks there are no further questions. So this will conclude the Q&A session. I would like to turn the conference back over to Jeff Benck for any closing remarks..

Thank you, operator. We look forward to updating you on our progress achievements and actions when we report our third quarter results in late April. So, with that, this ends our call..

And the conference is now concluded. Thank you for attending today's presentation and you may now disconnect..