Lantronix Inc (LTRX) Q2 2021 Earnings Call Transcript

Good day, and welcome to the Lantronix Inc. 2021 Q2 Results Conference Call. All participants will be in listen-only mode. 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 Lantronix's second quarter fiscal 2021 conference call. Joining us on the call today are Paul Pickle, Lantronix's President and Chief Executive Officer; Jeremy Whitaker, Lantronix's 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 8:00 p.m. Eastern, 5:00 p.m. Pacific today through February 18 by dialing 877-344-7529 in the U.S. or for international callers, 412-317-0088 and entering passcode 10151719. 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 of the business highlights for our second quarter of fiscal 2021 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 second quarter of fiscal 2021, we reported $16.6 million in net revenue, an increase of 25% when compared to $13.2 million for the second quarter of fiscal 2020. Sequentially, net revenue was down 3% compared to the $17.1 million reported in the first quarter of fiscal 2021. We exited the second quarter of fiscal 2021 with record backlog, as a result of supply chain constraints driven by component shortages, which affected our ability to shift against the current customer demand and meet our quarterly revenue target. Gross profit as a percentage of net revenue was 42.2% for the second quarter of fiscal 2021 as compared with 51.2% for the second quarter of fiscal 2020 and 48.1% for the first quarter of fiscal 2021. Approximately 500 basis points of the year-on-year decline in gross margin percentage can be attributed to increased manufacturing costs, as a result of component shortages and elevated logistics costs. As the component shortages and logistics costs subside, we expect a large portion of these costs to return to normal levels. Selling, general and administrative expenses for the second quarter of fiscal 2021 remain consistent at $4.9 million. Research and development expenses for the second quarter of fiscal 2021 were $2.4 million compared with $2.3 million for the second quarter of fiscal 2020, and $2.6 million for the first quarter of fiscal 2021. Non-GAAP operating expenses as a percent of net revenue decreased from 47% in the second quarter of fiscal 2020 to 39% in the second quarter of fiscal 2021, demonstrating our synergy capture and leverage in the operating model. GAAP net loss was $1.5 million or $0.05 per share during the second quarter of fiscal 2021 compared to a GAAP net loss of $1.4 million or $0.06 per share during the second quarter of fiscal 2020. Non-GAAP net income was $861,000 or $0.03 per share during the second quarter of fiscal 2021 compared to a non-GAAP net income of $666,000 or $0.03 per share during the second quarter of fiscal 2020. Now turning to the balance sheet. We ended the December 2020 quarter with cash and cash equivalents of $7.6 million, which is consistent with the prior quarter. Working capital improved to $19.4 million as of December 31, 2020 as compared with $18.7 million as of June 30, 2020. Net inventories were $14.3 million as of December 31, 2020 compared with $13.8 million as of June 30, 2020. Now turning to our annual outlook. We are now targeting fiscal 2021 revenue growth of 15% to 25% and non-GAAP EPS growth of 75% to 125%. I'll now turn the call over to Paul.

Thank you, Jeremy. As you may recall from our Q1 earnings call, we entered Q2 with the hope that COVID-19 driven supply chain issues would be on the decline. However, unprecedented component demand has seen our lead times continue to stretch and component costs rise. In addition, the second wave of the virus has ensured that logistics issues persist and expenses — due to an ongoing shortage of commercial flights worldwide remained at three times their normal levels and it remains a challenging environment from an operational standpoint. Recall that in our June 2020 earnings call we noted that lead times stretched for the processing components used in many of our products. We also reported that lead times worsened in the September quarter with our late shipments to customer request date coming in at just over $1 million in revenue. We expected to keep that number flattened in the December quarter, but the component shortage has worsened with some suppliers announcing 50-week lead times. All-in, the continuing supply chain disruptions impacted gross margins by approximately 500 basis points as Jeremy referenced in his opening remarks and pushed over $2 million of revenue out of the quarter. However, we have been taking the steps necessary to mitigate these challenges by placing component orders as soon as these lead times are announced and we can currently expect, we will be able to achieve growth in the second half, albeit somewhat tempered. Partly due to these constraints, we entered our third fiscal quarter with a customer requested hardware backlog 35% higher than the prior quarter. Our demand during the quarter was strong as evidenced by the hardware book-to-bill solidly above one, driven by our intelligent edge computing and remote environment management solutions. As the supply chain disruptions ultimately ease, we expect to turn this booking strength into organic growth. With that, let's delve into some more specifics on the quarter. Turning to our product categories. Our IoT products delivered $13.4 million in Q2, down 8% sequentially, although up 20% year-over-year. While WiFi and Ethernet moderated somewhat after strong results in Q1, solid growth from our device servers led IoT revenues in Q2. On the design front, we were building on our reputation for high performance intelligent edge solutions, and we are seeing an influx of design opportunities. Our team is stretched to capacity, and we are expanding to capitalize on that momentum. While we have shared with you previously some examples of audio and video conferencing designs, we are executing in industrial and automotive design activities as well. For example, during Q2, we signed two significant design contracts. I'd like to share with you here. First off, we entered a contract with Enel, the world's largest manufacturer and distributor of electricity and gas to design their next-generation IoT smart grid analytics and control solution with embedded AI. And in the automotive market, we signed a design contract with Tufts, a design and manufacturer of next-generation electric vehicles to design their infotainment and automotive control console. All-in, we are extremely pleased with the growing pipeline of high volume opportunities we have for our intelligent edge computing solutions. As we look to Q3 and Q4, we continue to expect to ramp up production of our video conferencing compute solutions, and we expect this will drive second half growth for Lantronix with the caveat that delays from key semiconductor suppliers likely back-end load these revenues in our fiscal year. Turning to Remote Environment Management, or REM, revenues totaled $3.1 million, up 29% sequentially and up 69% from a year ago. As we translate recent proof-of-concept activity into design wins and revenue, we expect the growth of remote work and access initiatives driven by the inertia of our ConsoleFlow SaaS solution will drive strong growth over the longer term. With that, I'd like to focus on our acquisition strategy and recent activity. While we are not immune to the effects of the supply chain disruption, thanks to our acquisition strategy Lantronix is in a much better position than it was just one year and two acquisitions ago. Q2 revenues were 25% higher than a year ago, while non-GAAP OpEx came down by 17 percentage points, thanks to our increasing scale and the efficiencies created by the integration of these assets. These are excellent numbers regardless of what is going on in our supply chain. And, of course, we're not done acquiring. We remain focused on acquisition targets which bring scale, strategic value and earnings accretion to our model. And we must also acquire the talent in the technologies to deliver the solutions our customers need and to realize the massive, fragmented opportunity that is IoT. We currently have a strong pipeline of acquisition targets, and we expect to report on our next acquisition in the near term. In sum, despite the disruption, there is still much to celebrate in our second fiscal quarter. Total revenues grew 25% year-over-year, while non-GAAP OpEx came down by 17 percentage points, thanks to our acquisition strategy, despite the headwinds of COVID-19 on the supply chain. We're entering the quarter with record backlog, and we continue to expect the second half ramp of multiple intelligent edge designs. Our design services group is booked to capacity and we are hiring so as to expand our revenue potential. And we have a strong pipeline of acquisition targets on which to execute in the coming quarters. As the supply chain disruptions caused by COVID-19 dissipate and world economies inevitably recover, Lantronix will become an industry leading IoT solutions provider with the depth of products necessary to solve our customers' biggest problems and scale to deliver industry-leading profit margins to our shareholders. That completes our prepared remarks for today. So, I'll now turn it over to the operator to conduct our Q&A session.

We will now begin the question-and-answer session. Our first question today will come from Scott Searle with ROTH Capital. Please go ahead.

Hey, good afternoon. Thanks for taking my questions. Guys, I hope you, your families and your teams are healthy and safe.

Yeah. We are all good here.

Paul, just to dig right in on the component availability issue. I think you said 2 million clipped upside in the quarter, was a million plus last quarter. Is that still largely restricted to processor baseband component availability? Are you seeing in other areas? And then as it relates to the guidance, you still have 25% out there as a potential growth target for the fiscal year. So, it implies a pretty big snap back in the second half of this year. So, what are you seeing in terms of that capacity and component availability loosening up to enable you to get there? And I guess, what would have to get there in terms of driving? Sounds like the video conferencing opportunities rampant, and you've got some other design wins as well, that you just announced. But what has to really kick in to start to move up to those type of 25% growth for the year? Because actually implies, 2 million a quarter above, I think where consensus is.

In the early stages, our focus was solely on processors, specifically discussing Qualcomm processors like the 865, which faced constraints due to capacity issues on lower lithography lines at TSMC. Recently, we've seen these issues expand. When we dispatch an evaluation board or a system on module, it includes not just the processor but also memory and PMIx. We're observing these constraints across various processing nodes, and we've even encountered shortages of oscillators and crystals in the last quarter. The situation has definitely worsened. Previously, we mentioned lead times extending to 25 and then 30 weeks; now, we're experiencing over 34 weeks with Qualcomm. Broadcom has also reported a lead time of 50 weeks. It's clear that the situation has deteriorated overall. While we haven't seen these issues spread significantly into passage yet, there are discussions about it. Regarding our growth in the second half, we were proactive early on, benefiting from customer forecasts. Back in June, we started placing purchase orders to secure our position in the queue for delivery. We do have some critical components, particularly in memory, which are somewhat limiting our ability to deliver complete solutions. However, we do have sufficient work in progress to achieve a reasonable output in the second half. This guidance indicates a minimum growth trajectory for that period, and there’s potential for upside if we can secure additional components for other product areas where we’re not facing such severe shortages.

But it sounds like you're comfortable with sequential increases into the March and the June quarter. And then as component availability loosens up, there could be a little bit more of a springboard demand. Demand is not the issue; it's a supply issue at this point in time.

It's definitely a supply issue. However, we have deliveries scheduled for the latter part of our second half, specifically during our Q4 timeframe. We have firm commitments for that period. I urge you to consider the transition from Q3 to Q4, as we aim to reduce some of the $2 million in delinquencies or late shipments, and focus on achieving the growth in our backlog for Q4.

Gotcha. And lastly, if I could. Since you got Jonathan on the phone, maybe an update in terms of platform development. How things are progressing on that front in terms of recurring revenue opportunities? And Paul, to follow up on your commentary around M&A, if you could talk a little bit about the pipeline, the level of activity, and kind of evaluation expectations? You guys have been very adept at doing good deals. Are the valuation parameters changing now, making things more difficult? Are you pretty comfortable that you're going to be able to get something? It sounds like you've got something near-term in the hopper. Thanks. And I'll get back in the queue.

John, I'll let you take the SaaS question.

Thank you. As Paul mentioned, we're at an early stage in our progress. We've added six new customers and expanded our proof-of-concept opportunities from 20 to 28 globally. We're continuing to grow in this area and are also looking to enhance our development team on the SaaS side. This will help us increase value and functionality while addressing specific customer expectations, particularly around operational efficiency. For example, we're focusing on improving zero-touch provisioning based on customer feedback, which is especially important for clients with over a hundred devices. We're developing multiple roadmaps, and all new products will align with our recurring revenue and SaaS model to ensure we provide comprehensive solutions that address customer needs. Additionally, we're integrating value-added services, such as our newly launched cellular connectivity, to position ourselves as a one-stop shop for management services, engineering, and hardware. We're observing rising interest in opportunities valued over $500,000 when considering the entire customer package.

I'll add to that by saying we have a very different landscape today with our current SaaS product. It still needs a few features that we plan to deliver in the next six months. However, customers are pleased with what they see and are signing up. Regarding mergers and acquisitions, the valuation environment has certainly changed. There's a somewhat inflated environment for raising funds, which impacts companies' decisions about whether to seek funding and operate independently or join a larger entity. While that option exists, it doesn't significantly alter the landscape; it might slightly increase valuation expectations. We remain focused on delivering value for our shareholders and do not feel pressured to pursue an acquisition. Our priority is to find an opportunity that aligns with our identity, adds value to our bottom line, and is strategically important for our future, all while we continue to follow our organic growth plans. Currently, we are actively managing a pipeline with several engagements. We are in a position to take on and integrate an acquisition. We recently captured operational synergies related to Intrinsyc, and our team is prepared to tackle integration challenges efficiently. We are eager to finalize an acquisition and are diligently working the pipeline to make it happen.

Great. Thanks. I'll get back in the queue.

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

Yeah. Hey, guys. Thanks for letting me ask a question. So, Paul, I heard you on the call, a bunch of guidance. Quick question on that. Is your second half guidance in any way dependent upon a pending deal, or is this something that you guys can accomplish? You feel like the backlog swinging a little bit to and I've got a follow up on the M&A side better conditions?

Yeah. Definitely not dependent on a deal. We wouldn't forecast the revenue anticipating getting something done unless we had something definitive.

Understood. And then for my follow-up, in terms of your pipeline, sounds like you're always pretty active. So in terms of competency, would you take on a new competency in IoT, with the pipeline that you have, or is it something that would be additive to just expand the functionality?

That's a great question. We would definitely take on a new competency. We still kind of fall back to that five-layer spec that we call IoT. And we're looking for always to expand our expertise in those middle three layers where we believe that we have to have critical mass in order to really win. So, anything along the comprehend, connect, and compute line, we'll definitely be looking at. We do have some sensor products in the collect layer function. But we don't believe that that's necessarily someplace that we have to build a competency. If we found something that was attractive from a financial standpoint, we'd certainly take a look at it. But great question. I definitely think that we have enough critical mass to service our customers today. What we don't have, we can outsource easily, but we definitely are not afraid to pick up something new.

Understood. And best of luck with the supply stuff. Thank you.

Thank you very much.

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

Hi, guys. Thanks for taking my questions. Paul, just curious if you could comment on any particular end market strengths or weaknesses you're seeing within the IoT segment.

So, I don't think we've observed a significant amount of weakness. One area we are involved in is retail and small business office stacks, which have indeed been weak. When we look at EMEA, I believe it's more of a geographic issue rather than an end market or vertical problem. However, telematics devices, routers, and gateways have experienced some setbacks in EMEA due to the second wave. The situation in the U.K. has really impacted operations. I would be careful about labeling it an end market issue, except for small business office and retail segments, which are definitely struggling and will likely continue to face challenges moving forward. Aside from that, nothing really stands out at the moment.

Okay. That's helpful. And then you mentioned the exiting December with strong backlog acknowledging sort of the supply constraints you've laid out. Just curious if you could comment on how order patterns have been so far if this March quarter.

Order patterns are still somewhat delayed this quarter. Customers are experiencing long lead times, but they are not placing orders. Generally, we have secured backlog in certain areas, but for our turns business, late ordering is significant. We aren't able to process products quickly enough. For example, we ended the quarter with just over $2 million in late shipments based on customer requested dates, which usually get fulfilled in the following month or month and a half. Consequently, we faced late ordering and couldn't respond swiftly at the end of the quarter. The positive aspect is that we can fulfill these orders, and no revenue is lost, only delayed by a couple of months. If this trend continues, it may become a challenge overall, followed by a catch-up period when logistics and manufacturing ease up.

Okay. That makes sense. And then just the last one for me. Jeremy, how should we think about gross margin, sorry, this mid-40% range for the remainder of this fiscal year, a good ballpark.

I believe that's a reasonable target. However, there is a caveat for this quarter, which began slightly in the previous quarter. We are increasing our spending due to component shortages that require us to make spot purchases and secure materials at times for higher prices, leading to higher manufacturing costs and some discrepancies. Comparing margins from the recent quarter to a year ago, we experienced roughly a 500 basis point difference in margin attributed to rising freight and manufacturing costs due to expedite efforts and component shortages. Looking ahead, I expect that as conditions normalize, we should be able to recover most of those costs and return to the mid-40s, possibly even higher. However, in the short term, we may face some pressure in that area. The current situation remains unpredictable. A couple of quarters ago, we thought we would have resolved some of these issues, but it appears the component shortages have worsened. While it's challenging to forecast, I am confident we will return to the mid to upper 40s as we reach a more normal operational state.

Okay. Appreciate that color. Thanks a lot, guys.

Thank you.

Our next question will come from Rich Valera with Needham. Please go ahead.

Thank you. Regarding the record backlog, is it primarily due to your inability to ship, or have you observed an increase in bookings from the September quarter to the December quarter? Are you experiencing a consistent level of demand that is being affected by your shipping challenges, thereby creating a growing backlog?

It's a combination of factors. When we are unable to meet customer request dates, it leads to an increasing backlog. This has grown from $1 million to just over $2 million, which does contribute to the backlog increase. However, we are experiencing strong bookings and do not see any double bookings. Part of this issue is related to the compute side of our business, which has created a favorable backlog situation due to some solid bookings for that product. In terms of the turns business, it is significantly impacting the late customer request dates, which has contributed to the backlog increase. So overall, it's a mix of both circumstances.

Got it. And then is the Remote Management business being affected by the component shortages?

No, not to date. If you look at it, we don't have some of our boxes with high resale values. Therefore, we haven't had a large number of units, and we've successfully managed the inventory for that product. So, it has not impacted us in terms of remote environment management.

And how's the pipeline there? How should we be thinking about that business? I know it's always a little bit chunky, but how are you thinking about that business for the balance of the year?

We're seeing some growth potential in that area. The hardware incorporates ConsoleFlow capability, and the upcoming product updates will add new features to even the existing units, providing us with a solid subscription revenue opportunity. Additionally, we've developed new products that include features customers have been requesting for some time. Therefore, we anticipate a strong pipeline moving forward.

Got it. Perfect. Thanks for taking my questions.

This is being our last question. This will conclude our question-and-answer session. I'd like to turn the conference back over to Paul Pickle for any closing remarks.

Thank you, Grant. I appreciate you guys joining us today. Have a great day.

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