Lantronix Inc (LTRX) Q3 2022 Earnings Call Transcript

Good afternoon and welcome to the Lantronix Third Quarter 2022 Earnings Conference Call. All participants will be in a 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 Rob Adams, head of Investor Relations. Please go ahead.

Thank you, and good afternoon, everyone. And thanks for joining the third quarter of fiscal 2022 conference call. Joining us on the call today are Paul Pickle, our President and Chief Executive Officer, and Jeremy Whitaker, our Chief Financial Officer. A live and archived webcast of today's call will be available on the company's website. In addition, you can find the call-in details for the phone replay in today's earnings release. 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 the 10-K and 10-Q. Lantronix undertakes no obligation to revise or update publicly any forward-looking statements to reflect future events or circumstances. Please refer to the news release and the financial information in the Investor Relations section of our website for additional details that will supplement management commentary. 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'll turn the call over to Jeremy Whitaker, our Chief Financial Officer. Jeremy.

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 third quarter of fiscal 2022 before I hand it over to Paul for his commentary. For the third quarter of fiscal 2022, we reported revenue of $32.3 million, an increase of 89%, when compared to $17.1 million for the third quarter of fiscal 2021, and down 4% sequentially as compared to $33.7 million reported in the second quarter of fiscal 2022. The year-on-year increase was driven by organic growth of 32%, in addition to contributions from our recent acquisition of the TN companies. GAAP gross margin was 42.1% for the third quarter of fiscal 2022 as compared with 42.9% in the prior quarter. The sequential decline in gross margin was primarily due to increased supply chain costs, in addition to product mix. While logistics and supply chain costs were higher than our initial expectations due to significant disruptions in the Asia-Pacific region experienced during the quarter, we navigated these issues and delivered revenue above our initial expectations and largely met customer needs. Selling general and administrative expenses for the third quarter of fiscal 2022 were $8.3 million, compared with $5 million for the third quarter of fiscal 2021 and $8.9 million for the second quarter of fiscal 2022. Research and development expenses for the third quarter of fiscal 2022 were $4.5 million compared with $2.5 million in the third quarter of fiscal 2021 and $4.3 million for the second quarter of fiscal 2022. The year-on-year increases in SG&A and R&D were largely driven by the acquisition of the TN companies at the beginning of this fiscal year. GAAP net loss was $3.2 million, or $0.09 per share, during the third quarter of fiscal 2022, compared to a GAAP net loss of $1.2 million, or $0.04 per share, during the third quarter of fiscal 2021. The increase in GAAP net loss was primarily due to earn-out consideration and non-cash charges related to our most recent acquisition. Non-GAAP net income was $2.8 million, or $0.08 per share, during the third quarter of fiscal 2022, compared to non-GAAP net income of $1.5 million, or $0.05 per share, during the third quarter of fiscal 2021. After adjusting for our recent capital raise, which impacted non-GAAP EPS by approximately $0.02 per share this quarter, we are meeting our post-acquisition quarterly target of $0.10 per share. Now, turning to the balance sheet. We ended the March 2022 quarter with cash and cash equivalents of $22.8 million, a decrease of $13.6 million from the prior quarter. Working capital decreased to $51.8 million as of March 31st, 2022, as compared with $62 million in the prior quarter. The decrease in cash and working capital was primarily due to the use of cash to pay down a high-interest loan in January 2022. Net inventories were $33.2 million as of March 31st, 2022, compared with $29.4 million as of December 31st, 2021. Now, turning to our annual outlook, which includes approximately 11 months of contribution from our most recent acquisition. Once again, we exited the quarter with record backlog and strong customer demand. Based upon our current outlook, we expect to see a much stronger fourth quarter. As a result, we are narrowing the range and increasing our annual revenue guidance. For the full fiscal year 2022, we are now targeting annual revenue of $125 million to $129 million, representing growth in the range of 75% to 80%. In addition, we are adjusting our annual earnings target, which includes the full share impact of our recent capital raise, and expect non-GAAP EPS in the range of $0.31 to $0.37 per share, representing growth of 64% to 95%. We continue to believe that without supply chain constraints, we could deliver annual revenue and non-GAAP EPS above the high end of our updated guidance. I'll now turn the call over to Paul.

Thank you, Jeremy. I'm pleased to report another solid quarter to our shareholders today. While our view of component commitments early in the March quarter coupled with expectations for typical government customer seasonality pointed to softness in Q3, thanks to the hard work of our operations team here at Lantronix, we managed to deliver over $32 million in revenue, down only 4% sequentially and we booked well above that rate. Barring supply chain constraints, demand in the March quarter could have shown sequential growth. To that point, shipments late to customer expectations in Q3 totaled just over $7 million, up from $5.7 million as compared to the second quarter. Q3 was uniquely challenging in this regard with the large regional disruptions in the Asia-Pacific region. Even where direct factory dependencies did not exist, we still experienced challenges in both securing components and import-export logistics routes. These disruptions created significant operational challenges and costs, but I am pleased to say that we were able to largely mitigate the disruption and deliver. We view these costs as transitory in a more normalized environment. I am especially pleased to report March results because they were driven by strong organic growth on the order of 32% year-over-year. This is happening for several reasons. First of all, we're now three years into the transformation of Lantronix, and many of the initial assumptions we set forth to improve upon are beginning to show results. We're going to market better. We are more in tune with our customer needs, and we're doing a better job of closing those sales. Secondly, in transforming Lantronix through acquisition, we have acquired pieces of the puzzle necessary to deliver our customers the technologies they need in order to better capitalize on the promise of IoT and accelerate our growth as we look toward our future. Finally, we're fortunate that the age of IoT is being realized, which was spurred and accelerated by COVID and the resulting remote work environment necessitated by supply chain disruptions that have forced companies to maximize every bit of efficiency possible, alongside the rollout of 5G networks. We see continued growth opportunities on the horizon for Lantronix. With that, let's look at our quarter with a little more granularity. While we expected the March quarter to be down sequentially, some product lines did grow in Q3, including our industrial switching products, which grew almost 10% sequentially, which is notable for a traditionally more seasonal quarter. We also saw good growth in the quarter from network interface products and optical communication interfaces. Compute modules, after posting strong results in Q2, were down as expected in March due to component availability, but importantly, professional services were up almost 30% from the prior quarter, and development kit sales almost doubled from the prior quarter. These two items are leading indicators for our Intelligent Edge Compute business and point to strong future revenue growth. Conversely, our remote environment management solutions were down sequentially after several strong quarters of growth. As has been the case historically, some quarter-to-quarter volatility in this product line is expected. All in, we expect a return to growth and anticipate delivering strong double-digit growth for the year. Looking at our Intelligent Edge Compute module business, we expect a return to growth in our fourth quarter, and we look for Edge Compute to be an important growth driver of Lantronix as we look to FY2023 and beyond. We continue to gain traction in this technology area, adding to the designs we've discussed in the past. Looking to fiscal 2023, we continue to expect to begin shipping the Quantum Edge device as we have stated in the past, a large design win, which we conservatively estimate will contribute $10 million to $20 million in revenue for fiscal '23 alone. This brings us significantly closer to achieving our 20% plus annual organic growth target. Additionally, we have received an award for 20,000 additional units for this platform, which more than doubles the previous award. We continue to believe in additional upside potential for Intelligent Edge applications at Lantronix in the years to come. While the near-term has its challenges in the form of supply chain disruptions and related component pricing variations, we continue to view these as transitory. We will navigate these issues as we deliver on the promise of IoT for the benefit of our shareholders. I'll now turn it over to the operator for Q&A.

We will now begin the question-and-answer session. The first question comes from Michael Walkley of Canaccord Genuity. Please go ahead.

Great. Congratulations on a strong quarter, and thanks for taking my question.

Thank you, Mike.

Paul, just starting with the 20,000 additional units ordered, how does that impact that $10 million to $20 million outlook? Does that put it higher than the range or are those 20,000 units more follow-ons into future years?

Yes, that's a great question. At this point, we would say it's probably at the higher end of that range. The details are really associated with the customer's rollout. There is one additional vendor dependency that we have. One of our suppliers has to deliver some boards, and they're experiencing some difficulty. So this production is expected to proceed in stages. At this point, we understand what the customer would like. Their schedules are a lot more aggressive than what we believe they can execute on. So we're still being a little cautious in terms of the rollout and how we see that revenue rolling out over the next fiscal '23. But it could be towards the high end of that range.

Great. That's great to hear. Follow-up question. Can you update us on your strong relationship with Qualcomm? You made some comments about good demand for Intelligent Edge going forward. Can you just update us on that pipeline and your ability to procure supply to support your opportunity funnel?

Sure. The relationship is going really well with Qualcomm. We had several meetings with different regions within Qualcomm to talk about expanding the relationship and chasing more opportunities. They have seen in us a unique ability to make customer applications come alive with the software we developed running on their platform, in addition to the hardware that we have assembled for our customers. So it's going really well. I think this is the area where we really want to continue building core expertise. The computing platforms and architectures that Qualcomm is pushing will define what Edge hardware looks like in the future, and we definitely want to be a part of that process going forward. So it's going really well at this point.

Okay. Thanks. Last question for me and I will jump back in the queue. You mentioned $7 million that you weren't able to ship. It sounds like you did a good job working through tough supply chain issues that are well-known out there. Can you just give us a little more color on what areas are still stretched or problematic from a lead time standpoint and how you see it improving over the June quarter and the second half of the calendar year?

Yeah. In this quarter, we had some significant upside to component availability in the December quarter. March, we didn't have the commitments at the time of the earnings call, but we were able to get some additional supply from Qualcomm. They were very supportive on that front, getting us some additional revenue. Having said that, some of the additional upside we should have been able to shift, we weren't able to shift because we don't necessarily have a manufacturer that was isolated. It is a major import-export hub. We actually saw a cargo carrier set up a new route, with a 747 going from Shenzhen to Hong Kong. If you know anything about geography, that's a ludicrous proposition. But this past quarter, we just had extreme difficulty moving items. So there was a lot of high-touch that made components a bit harder to acquire. Specifically, to your question about where we see difficulties, we see a little bit of easing on the digital side. Processors, Qualcomm has always been supportive, but we didn't have as many as we would like this quarter. Memory is coming in line, with both Flash and CDR. Mixed signals remain, still a bit tough. Some of the ethernet switches are still a bit challenging. As for light at the end of the tunnel, we are starting to see some RTCs that are in very, very short supply, and we're beginning to receive committed scheduling for manufacturers in the January timeframe. So it does feel like we're turning that corner. However, Q3 was a bit unique in terms of its challenges.

Great. Well, congrats again on the strong results. And I'll jump back in the queue.

Thank you.

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

Great execution in this environment. I have a couple of quick questions. I apologize for joining a bit late. Did I hear correctly that we now have a 20,000-unit order in hand?

It's an additional award. The previous award was for 15,000 units, 1,000 prototypes, and 15,000 preliminary production runs, plus 1,000 units of pilot builds. So that 15,000 has now been increased to 35,000. So we got an additional 20,000-unit award for production in the upcoming quarters.

Okay. And is that roughly at the same dollar content as you guys have talked about before? I think it's roughly around $1,500 plus or minus.

Yes, I think that's what we're anticipating. The pilot run is a bit higher at $1,900 content, but we would expect as we enter more volume production to be able to reduce some of that. We're spot buying for some of the early builds, and we're trying to stage as many orders as we can for the production run. We anticipate starting the preliminary production run, recognizing revenue in the December quarter, and then ramping up to target volumes after that.

Great. And I know we are all hoping for lead times on components and logistics to eventually normalize, but did you guys disclose exactly what your backlog was at the end of the quarter?

We did not disclose that. I can say that we did have record starting backlog for Q4. We had a record in terms of quarter-ending total backlog. We stated we added a book-to-bill that was considerably higher than our current quarters revenue. But if you wanted the total backlog at this time, it's on par with where we were last quarter, but the late to CRD number did tick up slightly. Last quarter, we had a late customer request data amounting to $5.7 million. That increased to just above $7 million this time. So we should have had about another $1.4 million to $1.3 million of revenue in the quarter that we weren't able to ship due to that late order.

Great. And then, my last question, you've talked before about being very confident in your 20% CAGR outlook, which you would hope would be conservative dependent on a public rollout of some of these big awards. Now, given a potential bit more clarity on those awards, I understand the supply chain logistics, but that being said, is that still the baseline number that you feel very confident in? Or could that be starting to prove a little too conservative?

That's a tough question, Christian. If I assess the current situation, I'd say I'm on the conservative side, but we are discussing a 15-month outlook at this point. We will provide updated fiscal guidance at the next quarter, but we do feel pretty good about that 20% number at this time. As my former boss used to say, you have to shoot above the hoop in order to get the ball in the basket. So we're definitely aiming higher, while still putting together a prudent outlook.

Great. Congratulations on a solid quarter. Thanks.

Thank you.

The next question comes from Chad TiVo of Needham. Please go ahead.

Hey, it's Chad on for Ryan Koontz, just on margins in the quarter. I think last quarter they were down sequentially, primarily due to a strong Intelligent Edge quarter. It sounds like supply chain may have had a bigger impact this quarter. Is there any way to quantify that impact?

Yeah, I think if we look at our previous performance and gave a PPV number for last fiscal year, it was on the order of $2.1 million in $71 million in revenue. The reality is, it was probably more around $2.4 million. If you think in terms of we've shipped a lot more revenue, in terms of percentage of revenue, it slightly increased. It would be easy to say that the impact this quarter was just above 200 basis points. If you look at total costs, they are substantially higher, and on a positive note, we're managing the OpEx to compensate for that. We've been performing slightly better than expected on the integration of the two companies. If we go back to our August 2nd close, we are still delivering at numbers ahead of expectation, and we have around the July timeframe to execute a few additional integration maneuvers to cut additional costs. So I think we are running a bit ahead of leverage on the P&L where we expect to be. This is a positive, as we're managing the OpEx to offset the pricing pressures we are experiencing from having to go to the stock market for components, but if you say it was a couple of 100 basis points, you wouldn't be far off.

Awesome. That's very helpful. Thanks, guys.

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

Thank you, Danielle. Thank you for joining us today and have a great week.

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