Good day and welcome to the Lantronix Inc. 2020 Q4 Results Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Amber Tinz. Please go ahead.

Good afternoon everyone and thank you for joining the Lantronix's Fourth Quarter Fiscal 2020 Conference Call. Joining us on the call today are Paul Pickle, Lantronix's President and Chief Executive Officer; and Jeremy Whitaker, Lantronix's Chief Financial Officer. A live and archived webcast of today's call will be available on the company's website. In addition, a phone replay will be available starting at 8:00 p.m. Eastern, 5:00 p.m. Pacific today through September 17 by dialing 877-344-7529 in the U.S. or for international callers, 412 317-0088 and entering passcode 10146169. 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 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. 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 use. With that, I will now turn the call over to Jeremy Whitaker, Lantronix's Chief Financial Officer.

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 business highlights for our fourth quarter of fiscal 2020 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 fourth quarter of fiscal 2020, we reported a record high of $17.4 million in net revenue, an increase of 71% when compared to $10.2 million for the fourth quarter of fiscal 2019. Sequentially, revenue was up 5% compared to the $16.5 million reported in the third quarter of fiscal 2020. The year-on-year growth was primarily driven by contributions from our acquisitions despite continuing disruptions in supply chain and customer demand related to the COVID-19 pandemic. Gross profit, as a percentage of net revenue, was 37.7% for the fourth quarter of fiscal 2020, as compared with 56.6% for the fourth quarter of fiscal 2019 and 44.7% for the third quarter of fiscal 2020. While product mix always affects gross margin, we had two issues in the fourth quarter, which lowered gross margins below recent leasing levels. In the fourth quarter, we took a charge for excess and obsolete inventories for certain end-of-life, classic product inventories. This plus increased logistics expense as a result of the COVID-19 pandemic accounted for the majority of the quarterly decline. While we will continue to see elevated logistics expenses as a result of the ongoing pandemic, we expect them to decline sequentially. Given these two factors, we expect gross margins to improve substantially in the upcoming September quarter. Selling, general and administrative expenses for the fourth quarter of fiscal 2020 were $4.7 million compared with $3.6 million for the fourth quarter of fiscal 2019 and $5.6 million for the third quarter of fiscal 2020. The year-on-year increase in SG&A was primarily due to additional headcount costs, related to the recent acquisitions and an increase in share-based compensation. Research and development expenses for the fourth quarter of fiscal 2020 were $2 million, compared with $2.2 million for the fourth quarter of fiscal 2019 and $2.7 million in the third quarter of fiscal 2020. Non-GAAP operating expenses as a percentage of net revenue decreased sequentially from 42% in the third quarter of fiscal 2020 to 32% in the fourth quarter of fiscal 2020. And we're down from 50% of net revenue in the year-ago fourth quarter, as we continue to capture synergies and take advantage of the operating leverage we created from our recent acquisitions. In the upcoming quarter, we expect non-GAAP operating expenses to increase sequentially due to the timing of R&D products and the annual financial statement audit. GAAP net loss was $1.7 million or $0.06 per share during the fourth quarter of fiscal 2020, compared to a GAAP net loss of $1.5 million or $0.06 per share during the fourth quarter of fiscal 2019. Non-GAAP net income was $0.04 per share or $1.2 million for the fourth quarter of fiscal 2020. This compares to non-GAAP net income of $722,000 or $0.03 per share for the fourth quarter of fiscal 2019 and non-GAAP net income of $611,000 or $0.02 per share for the third quarter of fiscal 2020. Now turning to the full-year results. Net revenue for fiscal 2020 was $59.9 million, an increase of 28% from $46.9 million in fiscal 2019. Gross profit as a percentage of net revenue for fiscal 2020 was 44.9%, compared with 56% for fiscal 2019. The decline in gross margin was primarily due to the two acquisitions we completed during fiscal 2020 and the resulting change in product mix. It is worth noting that during the fourth quarter, we exited a single-digit low-margin product line assumed in the Maestro acquisition. It represented about $2.5 million in revenue in fiscal 2020. And while the exit of this product line represents a small revenue headwind going forward, we expect to see an improvement in gross margins as a result in fiscal 2021. Operating expenses for fiscal 2020 were $37.4 million, compared with $26.8 million for fiscal 2019. The increase in operating expenses were primarily due to $8.2 million of costs related to our recent acquisitions of Intrinsyc and Maestro and our efforts to integrate and take advantage of synergies of the combined companies. Non-GAAP operating expenses for fiscal 2020 were 42% of revenue, compared to 49% of revenue in fiscal 2019, as we began to see the benefits of our integration efforts and leverage in the operating model. For fiscal 2020, we reported a GAAP net loss of $10.7 million or $0.42 per share compared to a GAAP net loss of $408,000 or $0.02 per share for fiscal 2019. Included in the 2020 GAAP net loss were approximately $8.2 million of acquisition and severance-related costs. Non-GAAP net income was $2.5 million or $0.09 per share for fiscal 2020 as compared to $3.7 million or $0.16 per share in fiscal 2019. Now turning to the balance sheet. Cash and cash equivalents were $7.7 million as of June 30, 2020, compared to $7 million as of March 31, 2020. Cash grew by approximately $700,000 from the prior quarter, as we generated operating cash flow of approximately $900,000 during the fourth quarter of fiscal 2020. Working capital was $18.7 million as of June 30, 2020, as compared with $26.7 million as of June 30, 2019. The decline in working capital is primarily related to the use of cash for the two acquisitions that we made during fiscal 2020. Net inventories were $13.8 million as of June 30, 2020, compared with $10.5 million as of June 30, 2019. Now I'll provide some guidance on the upcoming quarter and fiscal year. In light of the ongoing uncertainty created by the COVID-19 pandemic, we will not be providing specific quarterly guidance. And we'll transition to providing annual operating growth targets for revenue and non-GAAP EPS. That said, we expect revenue for our first quarter of fiscal 2021 to be flat to slightly up and non-GAAP earnings to increase. For fiscal 2021, we are targeting revenue growth of 20% to 25% and non-GAAP EPS growth of 120% to 160%. I'll now turn the call over to Paul.

Thank you, Jeremy. While we still operate in a world hampered by the COVID-19 pandemic, I'm pleased to report our results to shareholders today. Results which included a record revenue quarter with record year-over-year revenue growth, a significant increase in operating margin, cash flows, and resulting efficiencies related to the realization of synergies in our acquisitions, as well as guidance for 20-plus percent revenue growth in fiscal 2021, while earnings are expected to more than double. Looking back at our first full year here at Lantronix, we have accomplished much of what we set out to do. In terms of inorganic growth, we executed on two acquisitions in fiscal 2020, adding highly strategic cellular mobility, asset tracking, and intelligent edge computing solutions to our product portfolio. With these acquisitions on board, and despite a challenging year for our classic products, Lantronix was able to grow 28% year-over-year in fiscal 2020. We continue to pursue additive and accretive acquisitions to increase our SAM and bolster our capability within the IoT stack, while remaining focused on the integration of already completed transactions. Realizing synergies and delivering accretion through improved operating efficiency for our shareholders. Since fiscal Q4 2019, our non-GAAP operating expenses have fallen from 50% to 32% of revenues as of this most recent quarter and we did this with revenues growing 71% year-over-year over the same timeframe. All-in, our IoT product lines contributed $14.6 million in Q4, up 5% sequentially and 75% year-over-year. Work-from-home initiatives at many of our customers have strengthened backlog and we believe we are still in the early innings of a massive shift toward a remote management model at many of our customers. We are looking for a strong year from our intelligent edge computing solution products, driven by a number of design wins from top-tier videoconferencing customers. Design work has already begun on multiple projects, and while COVID has led to stretched lead-times for the processing components we use, we expect to see an increasing ramp of revenues as the fiscal year progresses. We also saw good billings and bookings activity from our out-of-band and remote management products, as well as our Wi-Fi solutions for medical applications and our cellular connectivity solutions, offset in part by ongoing weakness in our telematics solutions which are tied more heavily to a weaker European and Asian business environment. Our remote environment management previously referred to as ITM product revenues totaled $2.7 million, up 10% sequentially and up 62% from a year ago. Software continues to validate our efforts and bolster our long-term prospects. Interest in our newly integrated single pane of glass SaaS solution continues to grow. Customers are validating the solution. While the annually recurring revenue, software revenue and licensing revenue is still expected to be relatively small at approximately $750,000 annually, we see a steep ramp in these revenues over the next three years. As I hope you can discern from my comments, demand for many of our solutions is growing. While we still face some disruptions in our supply chain due to the pandemic, the situation is improving, and we see the effects dissipating over the next two quarters, at which time we expect our business could grow in line with demand untethered by our supply chain. In aggregate, demand for our products has strengthened and we are increasingly optimistic about our prospects in fiscal 2021. With that, that completes our prepared remarks for today. So, I will now turn it over to the operator, Brent, to conduct our Q&A session.

We will now start the question-and-answer session. Our first question will be from Rich Valera with Needham & Co. Please proceed.

Thank you. Paul, I was wondering if you could drill down into some of the areas you're seeing strength in, particularly videoconferencing. Can you give us a sense of how big that's been recently for you? I know you've been mentioning it more, but it sounds like you've got a number of design wins there. Just how big that could be? And then on the just previously referred to as the IT management company, the out-of-band products, it sounds like maybe there's sort of a sustainable tailwind there due to COVID. You put up a real nice quarter, and it sounds like the bookings and pipeline are quite good there. So, I was wondering if you could talk about maybe the sustainability of the strength you're seeing there as we move beyond this next quarter? And then finally, any other areas that are really notable from a strength standpoint? Thank you.

Sure. While it's disappointing, there are both positive and negative aspects for us. We've experienced significant activity in videoconferencing with design wins, but revenue realization has been slow as we're awaiting product availability. The actual contribution from both services and hardware has been limited so far and is mostly expected in the latter half of the year. We have good visibility on this. One of our customers launched their product in January and initially anticipated shipping about 5,000 units in the first half, which later increased to double and then triple that amount. Unfortunately, we couldn't fulfill these shipments due to extended lead times on certain components, stretching into the March and June quarters. The upside is we haven't seen the revenue yet, but we observe strong demand in bookings and backlog, which should materialize in the second half. Additionally, we've secured more design wins through contracts and have started work on those videoconferencing applications, although we haven't billed for them yet as the billing is milestone-based. For ITM or remote environment management, we've seen a notable increase this quarter. It's been a bit variable in the past, but activity is definitely picking up. Our salesforce is predicting a good year, partly due to the emphasis on remote management, leading us to feel more optimistic about growth compared to our initial low single-digit projections. Wi-Fi performance has been robust, particularly in medical and industrial sectors, with medical applications also enhancing our serial to Ethernet products. Although cellular demand is recovering, telematics continues to be somewhat sluggish. That summarizes the various areas of strength we're observing.

No, that's great. I appreciate that, Paul. And then Jeremy, on the write-down you took to inventory that hit COGS. Can you give us a rough sense of the magnitude of that? And I'm presuming that won't reoccur in the first quarter, is that a correct assumption?

Yes. They're not expecting that at this point. A number of years ago, a decision that was made to purchase some materials for a couple of end-of-life products that we had. And the demand didn't materialize at the level we expected it to a few years ago when those purchase decisions were made. And so based upon that, we needed to write down some of that inventory. Between the write-downs and the increased logistics-related expenses, that's close to 400 or 500 basis points between the two of those. So pretty significant impact on this quarter's gross margin, which we wouldn't necessarily expect to see on a go-forward basis.

Got it. You expect to recover most of that in the first quarter, is that fair?

Correct.

Got it. Perfect.

Yes. Another benefit we anticipate going forward is our exit from a low-margin business that we acquired in the Maestro acquisition. That business operates at a low single-digit margin and generates about $2.5 million a year. So, moving forward, this should also contribute positively to our gross margin.

Yes. We've previously announced that we're going to exit that business. And so this past quarter, we finally fulfilled all our obligations. So there is none of that business in the numbers going forward.

Got it. Can you say how much that business contributed in the fourth quarter? Was it below that on a run rate basis? Was it below the $2.5 million annualized run rate?

It was just in line with that slightly above it, slightly, yes.

Okay. Got it. Okay. That's helpful. And then just on the OpEx. So, obviously, very nice OpEx decline in the just reported quarter. And it sounds like you're expecting them to move up a bit in 1Q. Can you give us Jeremy any sort of sizing on the expected increase and how we should think about OpEx trending in the balance of the year?

Yes. Typically, the spending that fluctuates each quarter is related to various R&D projects and their associated hard costs, such as product certification and other external expenses tied to product development. Additionally, we have our annual audit. Therefore, between these two factors, we could see a spending variation between $300,000 and $500,000 in any given quarter.

Got it. great. Okay. Those all my questions. Thanks very much gentlemen.

Thank you.

Our next question will come from Jaeson Schmidt with Lake Street. Please go ahead, sir.

Yes. Thanks for taking my questions. Just curious if you could comment or provide some additional color on how order patterns have been since quarter end? And if you've seen any meaningful changes in the lead times you're seeing from customers?

Yes, from a supply chain perspective, we definitely deal with long lead time components, which many attribute to COVID and the current macro conditions. We have some processors in production that are subject to these long lead times. Additionally, new processes are being introduced, which naturally come with their own lead times. Some of our new revenue stems from the release of the 865 processor by Qualcomm, and there’s usually a bit of delay during early allocations. When it comes to ordering patterns, we've always operated as a high-turns business and manage to book and ship over 80% of our orders within the same quarter. In reviewing the March and June quarters, we experienced significant demand that led to substantial delinquency numbers for products we couldn't ship. I anticipate that we will see slight improvements by the end of September, but it may take until the end of December to fully resolve the situation. We're currently utilizing multiple build locations—about five—to ensure we can stage and deliver enough products. Freight allocation continues to be a challenge as well. Customers are providing forecasts, but they're placing orders too close to our cycle times, leading to some delinquency issues. However, they recognize their product needs, and we are receiving forecasts, albeit the situation is somewhat disjointed at present. On the plus side, we are able to view longer-term projections from our customers.

Okay. That's helpful. And now that some more time has passed, I know it's a little bit challenging with COVID. But could you just comment on if the two acquisitions have kind of played out as expected or if there have been any significant surprises, positive or negative now that you've had more time with them?

Yes. So the first acquisition that we did really the first year was right on the money of what we expected. There really wasn't any surprises there. I think if I discount for the March quarter, so there was some Asia-based business that just went to 0, I should say near 0 at the end of it because just got turned off in the March quarter with COVID with China largely shutting down. So if I account for that, it still came in just about where we had expected for the first year. Second year looks to be a little bit better than we had originally projected in our financials. Second acquisition it's really quite early innings still. This is our first full quarter with them. So we just closed that in January. And I'll say largely as we look to the first year, I'd say the first calendar year that we looked at a little bit disappointing given March and June. If I normalize a little bit for what was done on their watch in December, I think things kind of coming in right around where we expect our first fiscal year, though they're expected to exceed expectations. So, a little give and take but no real surprises no huge impact. And quite honestly the team is making a more significant contribution than we accounted for initially. So really pretty excited about that one as well.

Okay. And then the last one for me and I'll jump back in queue. I know you mentioned software is still going to be a small contributor. But could you just talk about customer feedback, or how the pipeline as far as the customer engagement has tracked over the past few months?

It's been quite solid. We have learned a lot since we started. When Jon Shipman joined us, we established an operating thesis that moving beyond hardware sales was essential, with software playing a crucial role in our strategy. Our software development was somewhat disjointed, but we've made significant improvements. Fathi Hakam has taken charge of engineering and we've combined our developments into a single software platform back-end. We now have regular code releases and a roadmap for software features aligned with customer requests for the next six months. This collaboration with our customers' feedback is exciting because they see the connection between hardware and software as a solution, with software being an integral part of our hardware strategy. The feedback has been positive, and engagement is high. Our pipeline is growing, and we've secured commitments from customers excited about future features, which are being phased in now. We are integrating additional devices from Medtronic that are already deployed into our single pane of glass. As we roll out product features, we will offer additional microservices for sale on top of subscriptions. Overall, I'm optimistic about our direction, but I want to emphasize that it's still early stages. Currently, we're looking at approximately $750,000 in annual contributions. Over the next three to five years, we aim for recurring revenue to represent at least 10% of our total revenue, and we are actively working towards that goal.

Okay, appreciate the color. Thanks a lot guys.

Thank you.

Our next question will come from Scott Searle with ROTH Capital. Please go ahead.

Hey good afternoon. Thanks for taking my questions. Hey real quick Paul just to clarify some earlier remarks. In terms of some of the supply chain issues, could you quantify how that impacted the June quarter sales and the immediate September quarter outlook? Sounds like it starts to get alleviated post that. But is there a dollar number you could put around that?

I can provide a rough estimate of the percentage impact. If we had all the products needed to meet customer forecasts, I believe our sales for September could be around 5% to 10% higher than what we expect to achieve.

Got you. So if I take that figure of 5% to 10% higher, there's another $600,000-or-so of the terminated product line at Maestro as well that produces a little bit of sequential headwind. So it would look even better?

At least that.

Okay. Hey, looking at the pipeline, could you provide a little bit of color in terms of the size of deals that you're starting to see now? Given the two acquisitions in the past 12 months, the product portfolio and the module portfolio has expanded, you've got cellular, you've got Wi-Fi, you've got Ethernet. You bring now the edge processing component with Intrinsyc. So, are the dollar amounts that you're talking about there getting larger with each customer that you're starting to engage with? And, I guess, are things like out-of-band getting pulled in as well? And how is that, the overall channel kind of shaping up in terms of how you're attacking those opportunities?

That's a great question. The engagements have become significantly larger. For certain product lines, this is particularly evident. For example, when we secure a design services contract, it could be around $750,000, and there are instances of contracts reaching $1.2 million. Additionally, these contracts typically come with hardware sales that amount to several million dollars. Comparing this with last year, prior to acquiring new businesses, our largest customer was approximately $250,000, with most customers below that figure. We are not facing a high risk of customer concentration, and we are now engaging with much larger companies. We are expecting to work with customers generating $3 million to $5 million annually. It's important for us to capture not only the current generation but also the upcoming ones. Our engagements have become much broader, allowing us to discuss more aspects of our solutions, which definitely expands the opportunities available to us.

Got you. Great. I wanted to touch on CBRS. The auctions wrapped up a couple of weeks ago, and there's been a lot of interest in the mid-band spectrum, particularly regarding its shared spectrum capabilities for private networks. Some enterprises were also involved in the bidding. I'm curious if CBRS is influencing your discussions and opportunities related to private networks as you begin to engage with customers.

That's a conversation we've had and something we've considered in the industrial market. The industrial sector, particularly automated warehouses, tends to be quite large and crowded. Assembly lines are especially congested in the 2.4 gig spectrum. Implementing solutions in the 3.5 gig range would be exceptional. Many are focusing on new deployments in the 5-gig space, so CBRS could offer them more options. We're actively engaging with these businesses to explore their implementation needs. We're indifferent to the network they choose, but I've noticed limited movement towards adopting private LTE solutions on CBRS, which seems logical given the advantages. However, specific requirements such as roaming, handoff, and latency concerns currently make Wi-Fi or proprietary network protocols preferable. We're certainly monitoring this situation and considering it for the future. Personally, I appreciate the 3.5 gig option since it allows for the use of cost-effective hardware for private network solutions. That said, we need to keep a close eye on developments, and I don't see it as a major concern at this time.

Okay. Thanks. And Paul, lastly, if I could, just on the M&A front, I know without getting specific, but you had a pretty active pipeline I think in terms of opportunities that are out there. I'm wondering how the current environment with COVID is impacting those discussions, both in terms of a sense of urgency with potential targets, as well as valuation parameters that are starting to be thrown about?

Yes, discussions are still ongoing. It's relatively easy to engage in these conversations. The core idea that we are stronger together remains valid. However, selecting a target has become more challenging due to COVID, which has highlighted that some businesses are significantly affected. We have to consider what their recovery may look like. A deal could seem promising, but they might contribute negatively in the short term. Therefore, we're being cautious to ensure we continue acquiring good businesses with strong fundamentals that will benefit us both in the short term and see significant long-term performance. Currently, I have the advantage of being patient. We anticipate several quarters of growth ahead, allowing us to be selective while still maintaining a healthy pipeline of opportunities. It’s important that we find the right deal at the right price that will add value.

Great. Thanks so much.

Our next question will come from Harsh Kumar with Piper Sandler. Please go ahead.

Yeah. Hey, Paul, good to be talking again. I had a quick question, a basic question actually. If you could summarize for us what total capabilities do you have at this point in time strategically speaking? And then what capabilities do you want to have in the next three to five years? And then I had a follow-up.

It's great to hear from you again, Harsh. We have a strong historical position in serial-to-Ethernet hardware, Wi-Fi, serial-to-Wi-Fi, and serial-to-Bluetooth, which are part of Lantronix's legacy and our classic business. In the past year, we’ve expanded to include cellular capabilities, such as cellular-to-Ethernet bridges, gateways, routers, and low radio options, broadening our portfolio in connectivity. Our in-house firmware team can customize applications for customers to interact with their connected endpoints via web interfaces or cloud-based solutions. This capability spans from full Linux systems to Linux kernels on health and fitness devices and wearables, covering a wide range of use cases. We also have strong camera tuning capabilities, which is why we are selected for many video conferencing applications, including work on the Arrival electric cargo vans recently contracted by UPS. Additionally, we have a software development team in India focusing on SaaS back-end and front-end solutions. Looking ahead, I believe we have the necessary in-house capabilities to handle most customer demands. There may, however, be specific areas such as algorithms and AI analytics that we would bring in externally rather than developing ourselves, as these tools are available. Should we identify any gaps that affect our customers' experience, we want to ensure we address those in-house, positioning ourselves as an extension of our customers’ R&D efforts. Does that provide the clarity you were looking for?

Yes. No. No. No. This is great. And then I had a follow-up. I just kind of ask this to understand, your long-term revenue targets or – not long-term revenue targets, but your full year revenue target of 20-plus percent growth and much more significant like 4x of that, 5x of that in EPS growth. Those are all – I have to ask is, I assume it's organic correct? That doesn't include anything – okay.

They were all organic. We definitely have some targets for inorganic, but right now we only talk about the organic target.

No, I think that's fair. And then in terms of OpEx, what kind of synergies can you see going forward? Like where do you think you can take out some more as you have done so well so far?

I believe our operating expenses will likely remain around 35% of revenue over the next year, with a goal of achieving 10% margins. I think we can potentially go beyond that, aiming for closer to 15% operating margin. Currently, we are reviewing all our actions, assessing how we allocate sustaining engineering resources to different product lines, and determining the continuity of certain programs. This process will involve refining and prioritizing our capital and future investments. Software will continue to be a significant part of our operating expenses, particularly in research and development. With Roger Holiday's arrival, we have a clearer plan for our necessary sales investments for the coming year, which I believe is well allocated. While I don't foresee a substantial increase in investment, a slight refinement could allow for an additional 5% growth when we look two years ahead.

Great. Always a pleasure talking. Thank you.

Likewise. Thank you.

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

Thank you, Brent. I appreciate you guys attending today and hope you have a great evening. Thanks.

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