Lantronix Inc Q2 FY2022 Earnings Call

Good day and welcome to the Lantronix 2022 Second Quarter results conference call. All participants will be in a listen-only mode. Should you need assistance, please signal the conference specialist. 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 Rob Adams, Investor Relations. Please go ahead.

Thanks, Betsy. Good afternoon, everyone, and thank you for joining the second quarter fiscal 2022 conference call. Joining us on the call today are Paul Pickle, President and Chief Executive Officer, Jeremy Whitaker, Chief Financial Officer, and Jacques Issa, Vice President of Marketing. 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 PM Eastern, 5:00 PM Pacific today through February 17th by dialing 877-344-7529, or for international callers, 412-317-008, and enter passcode 3413427. 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-Qs. 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 report and presents reconciliations for the non-GAAP financial measures that we use. With that, I'll now turn the call over to Jeremy Whitaker, Lantronix Chief Financial Officer.

Thank you, Rob. 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 fiscal 2022, before I hand it over to Paul for his commentary. Please refer to the 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 2022, we reported record revenue of $33.7 million, an increase of 103% when compared to $16.6 million for the second quarter of fiscal 2021. The year-on-year growth was driven by contribution from our recent acquisition and organic growth of 57%. Sequentially, net revenue was up 22% compared to $27.7 million reported in the first quarter of Fiscal 2022. GAAP gross margin was 42.9% for the second quarter of fiscal 2022, as compared with 45% in the prior quarter. The sequential decline in GAAP gross margin was primarily due to product mix. Selling general and administrative expenses for the second quarter of Fiscal 2022 were $8.9 million compared with $4.9 million for the second quarter of Fiscal 2021, and $7.9 million for the first quarter of Fiscal 2022. Research and development expenses for the second quarter of fiscal 2022 were $4.3 million compared with $2.4 million for the second quarter of fiscal 2021, and $4 million for the first quarter of fiscal 2022. The increase in SG&A and R&D was impacted by increased headcount and operating costs related to the recent acquisition. We've made good progress in implementing our synergy plan, and as a result, non-GAAP operating expenses as a percentage of revenue declined sequentially and from the year-ago quarter. GAAP net loss was $2.4 million or $0.08 per share during the second quarter of Fiscal 2022, compared to a GAAP net loss of $1.5 million or $0.05 per share during the second quarter of fiscal 2021. The increase in GAAP net loss was primarily due to costs related to our recent acquisition. Non-GAAP net income was $3.3 million or $0.10 per share during the second quarter of fiscal 2022, compared to non-GAAP net income of $861 thousand, or $0.03 per share during the second quarter of fiscal 2021. Now turning to the balance sheet, we ended the December 2021 quarter with cash and cash equivalents of $36.4 million, an increase of $26 million from the prior quarter. During November of 2021, we raised $32.6 million in an offering and sale of 4.7 million common shares at a price of $7.50 per share. In January of 2022, we used $12 million of the proceeds to pay down a high-interest second-lien term loan facility that we used as partial consideration for our recent acquisition. Working capital improved to $64.2 million as of December 31, 2021, as compared with $32.2 million as of the prior quarter. Net inventories were $29.4 million as of December 31, 2021, compared with $26.6 million as of September 30, 2021. Now, turning to our annual outlook, which includes approximately 11 months of contribution from our recent acquisition. We exited the December quarter with strong customer demand and backlog. We continue to believe that without supply chain constraints, we could deliver annual revenue and non-GAAP EPS above the high end of our guided range. Based upon forecasted improvements in the supply chain and our current outlook, we expect to see a much stronger fourth quarter, and as a result, we are increasing our annual revenue guidance. For fiscal year 2022, we are raising our annual revenue target to a range of $112.5 million to $127.5 million, representing growth in the range of 57% to 78%. In addition, we are adjusting our annual earnings target to take into account our recent capital raise and expect non-GAAP EPS in the range of $0.32 to $0.40 per share, representing growth in a range of 68% to 111%. I will now turn the call over to Paul.

Thank you, Jeremy. I am especially pleased to report record results to our shareholders here today. During the second quarter, we made progress on several fronts. Number one, we reported record revenues of $33.7 million, up 22% sequentially, and 103% year-over-year. Excluding our most recent acquisition, organic revenue grew an impressive 47% year-over-year and 21% sequentially. Number three, we continued to move high-potential Edge Compute projects through the pipeline, and we currently expect that volume production on multiple projects will drive our growth well into next fiscal year. Number four, the team did a fantastic job navigating supply chain constraints, and we were able to meet some of the upside demand and backlog that we experienced in the September quarter. And finally, we successfully completed a secondary equity offering, raising almost $33 million to fund our growth, pay down high-interest rate debt, and potentially fund our next acquisition. With the headlines out of the way, let's get into some detail on second quarter results in our outlook. As I've pointed out, revenues of $33.7 million were a new record. Q2 benefited from a full quarter of contribution from our most recent acquisitions and incremental one more month than in Q1. Removing these newly acquired revenues from the equation, organic growth was 22% on a sequential basis and a remarkable 47% year-over-year. We saw broad strength in our business in the second quarter, notable contributors included our remote environment management products, Wi-Fi, cellular tracking, and device service solutions. The largest upside came from our Intelligent Edge products, where product revenues more than doubled from Q1 levels. Benefiting from our recent execution and bolstered by our strong relationship with Qualcomm, demand for Intelligent Edge Compute Solutions continues to grow, and the opportunity funnel is very healthy. We are in the process of expanding our capacity to meet this influx, and we're selectively focusing on those programs that offer the strongest revenue potential. To capture this growth potential, however, we must also continue to navigate ongoing supply chain constraints, and we're pleased to report we made some progress on this front in Q2. After exiting Q1 with over $6 million in customer-requested products that we could not deliver on, we managed to draw down that surplus a few hundred thousand dollars sequentially to about $5.7 million. While the decrease is relatively small, this is the first time in more than a year that we have been able to bring that number down. In this environment, securing components for upside in a given quarter does not necessarily translate to an ability to do it repeatedly. Each product and its related supply chain has its own set of circumstances, and we feel it is prudent to temper the upside potential in our outlook, but we will continue to navigate the situation and deliver upside whenever possible. Our current belief is that the shortages will continue to linger, especially for semiconductor products built on older high-reliability processes, but we are cautiously optimistic that the supply chain constraints are beginning to ease. Finally, as Jeremy detailed earlier, we were able to successfully complete an equity offering in Q2 which increased the company's cash balance by $32.6 million. Since that time, we have used $12 million to pay down an expensive second-lien loan, thus eliminating a double-digit coupon that was poised to rise with interest rates. The remainder of these funds will serve as a source of working capital to enable our growth, allowing us to procure long lead-time components for crucial shipments and potentially leaving us in a stronger position. In summary, I'm pleased with our results in the second quarter. We navigated a supply environment that continues to be difficult, and we're able to deliver another quarter of record revenues. We grew at an impressive rate organically. We improved our balance sheet and put in place the capital to fund the next leg of our growth. That completes our prepared remarks for today, so I will now turn it over to Betsy to conduct our Q&A session.

Thank you. We will now begin the Question and Answer session. At this time, we will pause momentarily to assemble our roster. The first question comes from Scott Searle with Roth Capital. Please go ahead.

Good afternoon. Thanks for taking my questions. Nice job on the quarter, guys.

Thank you.

Maybe just to start quickly on the financial front, I was wondering if you could quantify a little bit the supply chain impact on gross margins; in terms of expedites, incremental component costs. I know there's a mix issue in the quarter. If you could flush that out a little bit in terms of component costs maybe versus mix, and I've got a couple of follow-ups.

Yes, Scott, this is Jeremy, so yeah, most of the sequential decline was driven by mix. We had a record quarter with our Intelligent Edge solution products. They more than doubled from the previous quarter. And even probably more than that from the year-ago quarter. In this product group, margins are on the lower end of the scale as you look at our various products from a margin standpoint. So that said, we are still feeling the pressure from component shortages and price increases, but it was more a matter of mix this quarter than it was necessarily a change in costs, because those costs have been relatively consistent over the last several quarters.

And Jeremy, if I could to follow up on the OpEx front, it was up sequentially. You had a full quarter of impact from Transition Networks. So I think versus two months in the prior quarter. Is that the only impact in there? Is there anything else? Is this the base level that we should be thinking about extrapolating going forward into the second half of fiscal '22?

Yes. Due to the higher than anticipated revenue this quarter, we also incurred a greater amount of variable costs. Therefore, as revenue stabilizes, we can expect to see a corresponding decline in variable costs as well.

Yes, costs as a percentage of revenue may take some time to stabilize, but I wouldn't consider this a baseline in dollar terms. We are currently in a growth phase and have several strong programs we plan to source and fund. Therefore, I anticipate our spending will increase in dollar terms as revenue rises, while we will continue to enhance our efficiency as a percentage of revenue.

Got you. And Paul, maybe to jump in on the supply chain, it sounds like you guys have been doing a pretty good job on that front, but could you provide a little bit more color in terms of what areas are still problematic from a lead time standpoint? And then maybe just from an end-market standpoint, I think last quarter you talked about some larger opportunities related to Intelligent meters. If you could flush out where some of the bigger opportunities are for you over the next couple of quarters and levers to move things up or down. Thanks.

Okay. So yeah, reflecting on some of the comments I made last quarter, I believe I said last quarter that Qualcomm would not be the long pole in the tent. So at this point, with additional upside, we've managed to secure a lot of the other components around the Qualcomm processors. We were able to get some additional shipments in the quarter, but that does not necessarily mean it will translate to additional shipments in the March quarter timeframe. So we've got some good visibility on some upside potential, possibly in Q4, and Qualcomm in particular on processors are scrambling to try and get those deliveries to us. But at this point, it's mostly spot market buys. I have to say I did dive into the Rolodex last quarter to try and source some additional upside demand. When we go out and look for it, we're able to find it, but the tough components or the exotic substrates, as mentioned before, pop-memory in particular, even though the chips are in relatively good supply and then flash. So processors, flash, memory, and then some WiFi chipsets, and then I will say Ethernet switches are starting to creep up as a shortage here that we're able to navigate, but are definitely getting a little more difficult. I think it's more related to certain suppliers. So if we go outside of those suppliers, we're able to get those. One other point, I will say that we did qualify some additional vendors on platforms this past quarter, which gave us more optionality. That will be a planned shift in strategy as we kind of look forward to production in future quarters. In terms of end markets, we've secured a couple of compute projects that are more in the AR space, but still not consumer electronics; more industrial safety type applications. Automotive, of course, remains strong, smart utility, and some additional projects we are picking up in Smart cities related to security cameras. ARR is a new contract that we picked up recently.

Thank you. Nice quarter.

Thank you, sir.

The next question comes from Christian Schwab with Craig-Hallum Capital Group. Please go ahead.

Hey, great quarter, guys. So do you have a record backlog or another record backlog, but a backlog number or did you leave it, did I miss that?

Yes. We provided backlog information last quarter due to a significant increase. Our order rates tripled along with several requests from customers, resulting in an increase from $27 million to $39 million, not including the $3 million of acquired backlog. We felt it was important to share this information last quarter. However, it's not something we want to overemphasize. That said, as of today, it's valued at $50 million. It has grown despite a notable rise in revenue during the quarter. While it continues to increase, we do not intend to focus too much on it moving forward.

Great. And then do you have any update on the new smart grid energy customer, when that was supposed to kind of maybe start kicking in the second half and drive more material revenue growth in the Fiscal '23 timeframe? Is everything on track?

I’d say it’s on track to our expectations as customers are driving some aggressive schedules. They’re still driving those schedules. There are some consigned components that need to come into the platform. Our customers had some difficulty procuring those components. So we've stepped in and been able to secure them to ensure that the program continues to move forward. Happy to say we just finished a three-day workshop talking about what the next generation looks like. Just for additional color, comparing the commentary from last quarter, we talked about a $10 million to $20 million contribution in fiscal year starting to impact the December quarter. I’d say we’re probably a bit more confident in the upper end of that range, and so far things are going pretty nicely.

Okay. Great. That's good news. And then, I guess, on my last question, I mean, the typical organic growth that you're seeing is quite material, and our backlog we talked about being north of $50 million. You've got a bunch of new programs here; what do you see as the true organic growth rate of this business minus the acquisitions that could be realized over time?

This is where I'd probably take a more conservative position, but I think that we can continue to drive 20% plus. Now I'll caveat that. I don't think that is on the entirety of the business; we have not really worked the due roadmaps that we acquired with the business that we closed on August 2nd, so we need to turn that around. But looking at what we've done so far, 20% plus is probably conservative. I'm factoring in that we're in just an extraordinary demand growth phase that could very well continue through next year. If you look at that smart meter program that is not or I should say smart utility program, it's currently not in backlog; that would obviously add considerable growth potential of 20% plus. So I think that's a good number; even in a more normalized environment, I think we can manage to drive that level of performance.

Great, fantastic. No other questions. Thank you.

The next question comes from Ryan Koontz with Needham. Please go ahead.

Thanks for taking the question. What if you contrast really your core organic business and the acquired Transition Networks business as it relates to the different market verticals you're seeing strength across the two, and how is your progress coming along on your cross-selling strategies? Thanks.

The cross-selling strategy. I'll talk about that one first. I will say that we're pleasantly surprised. We kept a good portion of the sales team that came with the Transition Networks assets. They are doing a phenomenal job. These guys are picking up the product lines from Lantronix Proper; there's natural pull-through opportunities. We thought that potential was there, but I don't know that we put a lot of emphasis on it at the beginning of the acquisition. But I have to say that team is performing quite well, so I'm pretty happy about that. I'd still say a little bit more muted from an organic growth rate, though, in terms of the rest of the business right now. The Compute business is really growing at a staggering rate with a couple of key customer programs, and we expect that to continue. So newly acquired business, if I contrast that, I would say 10% plus is probably a reasonable expectation. Maybe we'll get to a point where we can confidently drive a steady 15%, but right now addressing that with 20% plus is even approaching 25% on the newer, more compute-oriented solutions that we have.

Okay. How about touch base on the different verticals across the two businesses and how they are different or similar?

Yes, we have two sales teams that can sell the entire portfolio without separating the business. It makes sense to combine the product offerings. While we have two distinct sales approaches, we have also assigned some account responsibilities to the acquired sales team. I don't want to imply that there are two different organizations, but within the verticals, the sales strategies differ. For instance, smart cities operate at a slower pace and have some cyclicality, with stronger performance in the September and December quarters, followed by a pullback in March as government spending approaches its fiscal year-end. This sector has longer sales cycles but tends to result in more stable customers. Looking forward, we expect significant growth in smart utilities. In contrast, current growth is primarily driven by enterprise, municipal applications, and security sectors.

Bravo, Paul. Thank you very much.

Thank you.

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

Thank you, Betsy. Thank you for joining us today, and have a great evening.

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