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Edited Transcript of LTRX earnings conference call or presentation 10-Sep-19 9:00pm GMT

Q4 2019 Lantronix Inc Earnings Call

IRVINE Oct 14, 2019 (Thomson StreetEvents) -- Edited Transcript of Lantronix Inc earnings conference call or presentation Tuesday, September 10, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jeremy R. Whitaker

Lantronix, Inc. - CFO

* Paul H. Pickle

Lantronix, Inc. - President, CEO & Director

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Conference Call Participants

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* Jaeson Allen Min Schmidt

Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst

* Richard Frank Valera

Needham & Company, LLC, Research Division - Senior Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Lantronix Inc. 2019 Fourth Quarter Results Conference Call. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to [Amber Tennant], call coordinator. Please go ahead.

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Unidentified Participant, [2]

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Good afternoon, everyone, and thank you for joining the Lantronix Fourth Quarter Fiscal 2019 Conference Call. Joining us on the call today are Paul Pickle, President and Chief Executive Officer; Jeremy Whitaker, Chief Financial Officer; and Jonathan Shipman, Vice President of Strategy. A live and archived webcast of today's call will be available on the company's website. In addition, a phone replay will be available starting at 8 p.m. Eastern, 5 p.m. Pacific today through October 10 by dialing (877) 344-7529 in the U.S., or for international callers, (412) 317-0088 and entering passcode 10134676.

During this call, management may make forward-looking statements, which involve risks and uncertainties that could cause our results to differ materially from management's current expectations. We encourage you to review the cautionary statement 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.

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 do.

With that, I'll now turn the call over to Jeremy Whitaker, Lantronix' Chief Financial Officer.

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Jeremy R. Whitaker, Lantronix, Inc. - CFO [3]

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Thank you, [Amber], and welcome to everyone joining us for this afternoon's call. I'm going to provide the financial results as well as some of the business highlights for our fourth quarter and fiscal year-end before I hand it over to Paul for his commentary. 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 commentary.

For the quarter ended June 30, 2019, we reported $10.2 million in net revenue compared to $12 million for the fourth quarter of fiscal 2018 and $12.3 million for the third quarter of fiscal 2019. While we have navigated well through the operational issues related to U.S.-China trade tensions, including the transition of our contract manufacturing out of China, the ongoing nature of the dispute has decreased our customers' and distributors' certainty in the end-market demand. Tariff concerns and component shortages drove higher-than-normal inventory levels in the channel during the March quarter followed by industry-wide uncertainty in the June quarter.

These macro factors resulted in a decline in sales greater than the guidance we provided on our last earnings call. Having no single end user representing more than 2% of our total sales, we saw a broad-based decline in demand and not customer attrition. We believe this was a temporary slowdown in demand as our end customers and channel partners began to bring down their inventories.

On a positive note, inventory levels of Lantronix product in our channel have been declining throughout the current quarter. And we expect to see improved end-customer demand over the next 2 quarters.

Gross profit as a percentage of net revenue was 56.6% for the fourth quarter of fiscal 2019 as compared to 57.1% for the fourth quarter of fiscal 2018 and 57.4% for the third quarter of fiscal 2019. The sequential decline in margin was primarily due to lower absorption of our fixed manufacturing overhead costs.

Selling, general and administrative expenses for the fourth quarter of fiscal 2019 were $3.6 million compared with $4.1 million for the fourth quarter of fiscal 2018 and $3.9 million for the third quarter of fiscal 2019. The improvement was primarily due to tight operational controls, general expense reduction and lower variable compensation in the current fiscal quarter.

Research and development expenses for the fourth quarter of fiscal 2019 were $2.2 million compared with $2.4 million for the fourth quarter of fiscal 2018 and $2 million for the second quarter of fiscal 2019 as we continue to invest in new product development.

GAAP net loss was $1.5 million or $0.06 per share during the fourth quarter of fiscal 2019 compared to GAAP net income of $752,000 or $0.04 per share during the fourth quarter of fiscal 2018 and GAAP net income of $857,000 or $0.04 per share during the third quarter of fiscal 2019. Included in the GAAP net loss were approximately $1.5 million of expenses related to acquisition, severance and asset impairment costs. I'm pleased to report our 14th consecutive quarter of non-GAAP profitability as we achieved non-GAAP net income of $722,000 or $0.03 per share for the fourth quarter of fiscal 2019. This compares to non-GAAP net income of $1.2 million or $0.06 per share for the fourth quarter of fiscal 2018 and non-GAAP net income of $1.3 million or $0.05 per share for the third quarter of fiscal 2019.

Now turning to the full year results. Net revenue for fiscal 2019 was $46.9 million, an increase from $45.6 million reported during fiscal 2018. Gross profit as a percentage of net revenue for fiscal 2019 improved to 56% as compared with 55.7% for fiscal 2018. Through our mitigation efforts, we're able to limit our tariff exposure to approximately 50 basis points in fiscal 2019. Operating expenses for fiscal 2019 were $26.8 million compared with $24.6 million in fiscal 2018. The increase in operating expenses primarily due to investment in engineering, restructuring charges and expenses related to the acquisition of Maestro.

For fiscal 2019, we reported a GAAP net loss of $408,000 or $0.02 per share compared to GAAP net income of $680,000 or $0.04 per share for fiscal 2018. Included in the GAAP net loss were approximately $1.8 million of expenses related to severance, acquisition and asset impairment costs. Non-GAAP net income increased by 26% to $3.7 million for fiscal 2019 as compared to $2.9 million in fiscal 2018 and non-GAAP net income of $0.16 per share for fiscal 2019 as compared to $0.15 for fiscal 2018.

Cash and cash equivalents were $18.3 million as of June 30, 2019, as compared to $9.6 million as of June 30, 2018. Working capital was $26.7 million as of June 30, 2019, an increase of $13.2 million as compared with $13.5 million as of June 30, 2018. The increases in cash and working capital primarily relates to our September 2018 public offering. In July 2019, we used cash of approximately $5 million for the purchase of Maestro.

Net inventories were $10.5 million as of June 30, 2019, compared with $9.8 million as of March 31, 2019. As discussed on previous calls, we have planned to increase inventories as part of our tariff mitigation strategy, which included moving our contract manufacturing outside of China. Now that the effort is substantially complete, we have established a long-term target of 3 turns per year.

Now turning to our recent acquisition. On July 5, 2019, we acquired 100% of the outstanding shares of Maestro and its subsidiaries for approximately $5 million in cash consideration. To give you some perspective of Maestro's size, they were doing around $10 million a year in revenue at a gross margin of approximately 40% with an approximately 10% operating margin loss. We are in the process of fully integrating the business, identifying and capturing synergies and expect it to be accretive to our non-GAAP earnings during fiscal 2020.

Currently, we're evaluating the fair value of the acquired assets and liabilities, including any identifiable intangible assets. We expect to present a preliminary allocation of the fair value of acquired assets and liabilities and pro forma disclosures in our Form 10-Q filing for the quarter ending September 30, 2019.

Now I'll provide guidance on revenue and earnings for the first quarter and year ended fiscal 2020. For the first quarter of fiscal 2020, we expect net revenue in the range of $12 million to $13 million and a non-GAAP net loss per share at a range of $0.03 to breakeven as we begin to capture synergies from the acquisition. For fiscal year 2020, we expect net revenue growth of 15% or greater and non-GAAP net income per share growth of 30% or greater.

Now a quick housekeeping note as it relates to our next earnings call. To allow sufficient time to complete certain Maestro system integration and purchase accounting activities, we are planning our first quarter fiscal 2020 earnings call for mid-November, which is a couple of weeks later than our normal reporting cycle.

I'll now turn the call over to Paul.

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Paul H. Pickle, Lantronix, Inc. - President, CEO & Director [4]

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Thank you, Jeremy. My first full quarter at Lantronix has been both challenging and exciting. Despite factors such as current trade environment, which are out of our control, our team did an excellent job delivering on non-GAAP profitability in the quarter. While our base business suffered from general macro concerns, our new WiFi products released over the last 3 years saw quarter-over-quarter growth and remain on pace to grow appreciably over the fiscal year. I continue to see an incredible opportunity for Lantronix to build its own world-class franchise, serving a larger higher-growth marketplace and delivering industry-leading profitability.

Over the last quarter, we've had the opportunity to assess each functional group within Lantronix. And while we have a lot to improve upon, there are elements that are working rather well. The company's operations team is nimble and responsive to customer requests while maintaining a very high degree of quality with return rates well below industry norms at 0.04%. Finance has simplified tight controls and transparency not seen in a lot of much larger organizations. Relatively recently, engineering management overhauled the product development process with the goal of trimming development time and increasing efficiency. We will see the benefit of this exercise over the next several quarters.

We've begun more intently working to improve the ROI on our product development efforts. Importantly, Lantronix cannot continue the standard operating practice of throwing resources solely at engineering small iterations of existing products. There is simply too much price competition in the hardware space to justify the developmental expense, and to continue down this path will result in product offering prone to price erosion, cannibalization of existing revenue and addressing too small a market opportunity.

Our recent efforts have focused on improving hardware and software execution through a consolidation of development efforts which has improved our processes and planning, and we are already starting to see those results. Further, we're eliminating parallel efforts on projects where it's conceptually the same and zeroing in on maximum reuse of engineering effort. Doing so will allow us to reduce R&D expense as a percentage of sale and greatly improve ROI.

Using this approach, development of our latest ITM product, to be announced next quarter, is running well ahead of schedule. This product will be released initially as a flagship, along with a broader family of products featuring multiple price point tiers, all with much lower engineering expense than we had seen in the past. Recently, we demonstrated it at Cisco Live running in conjunction with our SaaS platform along with application software, and I'll note that customer interest was high.

While some interest in our software products continues, we are refining the offering to drive the results we expect. In the latest quarter, we have onboarded 2 additional customers with another 20 customers in the proof-of-concept stage. And the pipeline is improving, but we can do better. MACH10 fundamentally has a robust architecture and is an impressive foundation with multiple micro-services for us to build upon, but the front end or customer side of the platform makes it difficult to use and lacks the features that would be typically expected in a software package. It can be difficult for traditionally hardware-focused product team to fully make the turn to value-added software services without the proper focus.

Further, client-side applications like ConsoleFlow or middleware also have some needed functionality but lack others. In addition, there are multiple parallel development efforts resulting in higher expense than necessary when they could have been consolidated into a single modular development effort. These consolidation plans are now underway and will be completed expeditiously as we've added the needed focus.

Strategically, it's important to think of IoT as a multilayered concept, but Lantronix is currently positioned as a single-layer IoT connectivity company. We need to be much more if we are going to provide the solutions our customers are looking for. Our previous road map primarily focused on a narrow segment of IoT connectivity enablement. Going forward, we will add the capability to address other aspects within the connect, collect, compute, comprehend and control functions that are cumulatively known as the IoT spec. In doing so, we will address the larger concept of IoT and, in time, deliver meaningful IoT solutions that add value by solving the customers' problems.

The game plan is simple. We will execute on a revamped product road map driven by ROI metrics, leveraging our technology to grow organically. Furthermore, we see the opportunity to greatly enhance our hardware solutions with our software solutions creating a recurring revenue model. We will also continue to expand into complementary adjacent markets via acquisition, use those products to drive deeper penetration of industry-leading customers and leverage our growing scale to realize a more profitable business model.

As we execute, Lantronix will grow more quickly, drive more profit than it had before. Lantronix will be larger, diversified and better able to weather market volatility while continuing to deliver profit to our shareholders.

Our first acquisition, Maestro Wireless, strategically makes a lot of sense for Lantronix. Whereas Lantronix is a leading supplier of wired and certain wireless IoT solutions, Maestro is complementary in that it specializes in cellular connectivity and mobile tracking solutions. These mobility products added much-needed capability within the connectivity function of IoT by broadening our product portfolio with narrowband IoT wireless and cellular capability.

These products also add much-needed IoT collect function capability with Global Navigation Satellite System receivers and sensor technologies. In addition, their software offering brings with it new capabilities for the management and programming with connected devices. While the software's customer-facing front end is more robust than ours, the MACH10 foundation offers quite a bit more in terms of back-end functionality. As such, we will consolidate the 2 using best practices from both, delivering on a much improved product. This acquisition is completely additive to our current product offering and presents us with new opportunities at our customer base while also bringing new customers to whom we can sell our existing road map products.

Looking at the financials, Maestro did about $10 million in product revenues Jeremy referenced during calendar year 2018 and operated at a loss. While they did have a piece of pass-through distribution revenue that we will exit, the core product revenue was growing nicely. As we integrate and realize synergies, we will have a significant opportunity to improve the profit potential of the combined entity. And while it is prudent to expect that Maestro's current revenue is subject to the same macro uncertainty, we are confident in guiding for the combined company to grow revenue at a rate of 15% or more in 2020. We further expect operating profit to grow at a 30% rate as Lantronix benefits from efficiency of scale and realizes operational synergies. We find targets such as this compelling, and we are circling on a long list of opportunities that will further accelerate our strategic growth plan. Expect more from us here at Lantronix.

As I said earlier, my first full quarter at Lantronix were both exciting and challenging. I look forward to working with the team to deliver on our potential for the benefit of our shareholders.

And that concludes our prepared remarks for today. So I will now turn it over to the operator for our analyst Q&A session. Sean?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question today will come from Jaeson Schmidt with Lake Street.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [2]

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Wondering if you could comment if you're seeing anything out of ordinary from a pricing standpoint in any of your product lines.

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Paul H. Pickle, Lantronix, Inc. - President, CEO & Director [3]

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Seeing anything out of the ordinary on pricing for our product lines?

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [4]

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Correct.

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Paul H. Pickle, Lantronix, Inc. - President, CEO & Director [5]

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Yes. Nothing out of the ordinary. We've done a good job of raising ASPs over the last couple of years. Just making sure that we extract full value for the product lines.

So if we look at some of the newer products from -- that came with the acquisition, I think that there's a little bit of an opportunity for us to drive some greater returns there with the price positioning. But overall, nothing out of the ordinary in terms of the downside.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [6]

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Okay. And regarding the Maestro business, can you share sort of what the historical growth rate for that business was and sort of how we should think about your ability to grow that business going forward?

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Paul H. Pickle, Lantronix, Inc. - President, CEO & Director [7]

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Yes. So if I took just the product revenue -- so if you looked at the business overall, we'd be fairly flat. But you have to remember there, historically, they were a distributor first before they were a products company.

And so if you kind of extract out of that and focus in on just the standard products, they grew rather rapidly, albeit from a 0 basis in the first years. They had a little bit of moderation in 2018. And we expect to see some growth out of the products beyond this first year as some new programs kind of hit.

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Jaeson Allen Min Schmidt, Lake Street Capital Markets, LLC, Research Division - Senior Research Analyst [8]

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Okay. And the final one for me, and I'll jump back in the queue. I know they have a tracking and sensor business, which you alluded to. That's been a market you guys really haven't played in before. Just curious if you could share your thoughts on how you look at that market just given sort of the greenfield opportunity in that broader space.

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Paul H. Pickle, Lantronix, Inc. - President, CEO & Director [9]

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Yes. So I like the space -- I need to clarify. Asset tracking is -- it's been out there probably the longest in IoT land, and it's probably not viewed as a fantastic market in terms of opportunities. The deployment out there is pretty phenomenal. I look at it from -- our business is fairly sticky, the types of customers that we have, but that capability is really quite important because it ties in a complete web services, scripting ability on the client side as well as back end and some analytics in addition to hardware. The hardware is probably less important.

But if you look at what types of applications that hardware and software can enable, those are some of the up and coming: ridesharing apps, motorcycle-sharing apps in India, car-sharing apps. We actually are prototyping car-sharing application for our customer sitting in a parking lot in Germany at the time being. So it's an important capability to have that opens up door in terms of possibilities.

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Operator [10]

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Our next question will come from Richard Valera with Needham & Company.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [11]

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The trade has been an issue for a few quarters. So I just wanted to make sure I understood what caused the slowdown in the June quarter specifically as it related to trade and what gives you the confidence that, that picks up in the next couple of quarters.

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Paul H. Pickle, Lantronix, Inc. - President, CEO & Director [12]

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So I guess, confidence-wise, we have the benefit of the reporting at this juncture with a good portion of the quarter done. So we have the benefit of seeing some of the data, not just purely relying on forecast.

A little bit of commentary, and then, Jeremy, maybe you can jump in here as well. If we kind of look back at inventory numbers, channel inventory numbers, it seems like the fear of tariff implementation kind of caused a run-up on both end customers and in the channel. So we did see an increase in the March quarter. And then with some more of the macro uncertainty that the tariffs might be causing more economic-wise, then we saw a need to kind of mitigate as that uncertainty built. People wanted to kind of draw those inventory numbers down.

It was wholesale. There were some subtleties in it. So if I look at our OEM business, that was primarily an EMEA-based phenomenon. And that would be -- there might be some other fears playing in the way, including Brexit, that could have caused the -- an inventory build-up.

And if you look at ITM, ITM was down in the U.S., but that was -- that business was classically done, a little bit more lumpy and CapEx cycle-dependent. And then I'll note that October 1 is defense cycle fiscal year. So there's some spending that kind of has to happen in the September quarter.

So there were some things that happened that we looked at and said, "Okay. That was a normal anomaly for us." And then there were some larger macro trends that we can attribute to specific things that happened. And then as we went out and looked and touched base with the customers to see what their demand was doing, they assured us that the profits were solid and that the spending would be there. It's just that they were reacting to some mandates to drive down that inventory.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [13]

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Got it. And then on the IoT business, there have been a lot of talk in prior quarters about a number of design wins that you had with customers that were taking longer than expected to ramp. And just wonder if you can provide some commentary on the pipeline of design wins and the status of what was a pretty, I think, meaningful number of design wins that were won but were kind of waiting a revenue ramp.

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Paul H. Pickle, Lantronix, Inc. - President, CEO & Director [14]

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Yes. So we've definitely seen a shift with some of those design wins to production. I'll note one in particular. Actually, we flew a couple of techs to Taiwan to help one customer get his production ramp on start. They were running into technical issues. We solved this, this past quarter. And as noted in the prepared remarks, we did see an increase or growth in the newer WiFi products, which is primarily what we've been talking about in terms of design wins and design accounts. And so that -- we expect that production ramp to look pretty good over the next year.

And I'll just -- one additional note that I'll say on design win. The counts have been pretty good. I think when we get back and look at the dollar amount attached to each win, we need to strive to have -- to start chasing slightly better opportunities. And that's what we're going to take a look at, driving a little bit higher volume.

I do want -- I made a comment regarding channel inventory. We saw a run-up about 2 weeks prior. And Jeremy, if you got some data that you can give an indication what channel inventory has been with respect to IoT currently.

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Jeremy R. Whitaker, Lantronix, Inc. - CFO [15]

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Yes. I think if you look back at our historical inventories, on average, we carry -- our channel typically has 5 to 6 weeks in the channel, at least within -- over the last 12 months. In the March and June quarter, that was probably about 3 weeks higher than normal.

I think one of the positive indicators we're seeing at least this quarter is those inventory levels are beginning to trend down at the distributors. And so that should lead to improved demand from those distributors as they begin to refill the channel. So we are seeing a positive indicator there.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [16]

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Got it. And then I know it's early, Paul. But historically, I think this -- the IoT business you've been talking about is kind of a double-digit growth business. But if you look at the last year and what's seemingly embedded in your organic revenue guidance for this year, it's flat or very modest growth.

So just wondering how you're thinking of that business medium to longer term. Does this have high single-digit, double-digit growth potential? Or how are you thinking about that?

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Paul H. Pickle, Lantronix, Inc. - President, CEO & Director [17]

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Well, I definitely think that the market opportunity is there. And we feel pretty strongly we can address that market opportunity. We're not going to be able to do it the way it's classically been done where we offer a particular widget or one particular piece of the puzzle that is IoT. So it needs to be a little bit more platform-driven, a little bit more comprehensive. So when we go talk to customers and they say, "Hey, I would like to do this," they don't really care how it's done. They just want it done. And so that requires you to take a little bit of a technology-agnostic point of view and address the totality of the problem with the solution set. So that may mean something that we have done in the past, but I do take a little bit of an agnostic approach when it comes to hardware.

And I'll give you one anecdotal -- we've got a couple of platforms that we've been prototyping. One is the mean time before repair, kind of a use case where we have a tire manufacturer that would like to implement a sensor technology, data collection technology to actually track the wear of tires and prompt the user, "Hey, schedule a service appointment to get your tires changed." So this way, they can capture their name-brand tires with -- on a direct car basis rather than having somebody go just shop at Lowe's. That's one use case that we're prototyping right now for somebody.

Another one would be location of industrial equipment in building. Surprisingly enough, there's a lot of wasted man-hours. You can calculate the loss associated with some of these multistory buildings, office buildings, trying to locate industrial cleaning equipment. And we've got a solution that we're putting together for a particular customer that will address that holistically, not just a particular sensor on a floor buffer and somebody else has to worry about the rest of the system.

So hopefully, that gives you a flavor of kind of what I'm talking about. But I do think it can drive double digits.

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Richard Frank Valera, Needham & Company, LLC, Research Division - Senior Analyst [18]

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Right. Okay. One more if I could. Just in reference to your 30% growth of -- and I think it's non-GAAP income. But I'm just going to use EPS as sort of a rough proxy for that. If you were to do 30% increase on your reported EPS from the prior year, that would put you -- or require you to hit around, I think, $0.21 for this coming year. And starting with, let's just call it breakeven in the first quarter, that would have you averaging kind of $0.07 per quarter, which is a pretty hefty level relative to where you've been in the recent past. So just wondering how we should think about the ramp of the earnings as we move through the year assuming we kind of have a breakeven-ish start in the first quarter.

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Paul H. Pickle, Lantronix, Inc. - President, CEO & Director [19]

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So I can answer that question and talk a little bit about how we address the game plan, the M&A playbook, if you will. We're taking an asset that, very clearly, we can harness a lot of synergy from.

In my prepared remarks, I talked about some of the efficiencies in the Lantronix proper business that we'll be addressing. So I don't need to spend more with an acquired business. It's just a matter of transitioning and establishing those budgets and then prioritizing the projects we're going to work on.

There is some transition work that needs to happen. And obviously, if you're starting out -- a very dear friend of mine told me that if you can make $12 in a year, you got to make the first dollar in month 1. So since we're starting off, it is obviously second-half-weighted. But you will see the execution and evidence of that as we execute on the synergy plan.

And so going back to that M&A playbook, it's a 6-month cycle. We're on track to do the integration on finance, the SG&A function. The rest will follow suit as we consolidate.

I'd like to not lose a little bit of progress that we're making on the software front with any massive perturbations in the group. And so as we clean up one thing, it will come off our plate, and we'll move forward very quickly. But you will see those numbers transpire shortly.

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Operator [20]

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This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Paul Pickle for any closing remarks.

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Paul H. Pickle, Lantronix, Inc. - President, CEO & Director [21]

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Thank you very much for your time and hope you have a good day.

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Operator [22]

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