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Lantronix, Inc. (LTRX) CEO Paul Pickle on Q1 2021 Results – Earnings Call Transcript

Lantronix, Inc. (NASDAQ:LTRX) Q1 2021 Earnings Conference Call November 12, 2020 5:00 PM ET

Company Participants

Amber Tinz – Executive Assistant

Paul Pickle – President and Chief Executive Officer

Jeremy Whitaker – Chief Financial Officer

Jonathan Shipman – Vice President of Strategy

Conference Call Participants

Jaeson Schmidt – Lake Street

Scott Searle – ROTH Capital

Rich Valera – Needham and Company

Operator

Good day, and welcome to the Lantronix 2021 First Quarter Results Conference Call. All participants will be in listen-only mode [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions [Operator Instructions]. Please note this event is being recorded.

I would now like to turn the conference over to Amber Tinz. Please go ahead.

Amber Tinz

Good afternoon, everyone and thank you for joining the Lantronix’s First 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 Web site. In addition, a phone replay will be available starting at 8:00 p.m. Eastern, 5:00 p.m. Pacific today through November 19th by dialing 877-344-7529 in the US or for international callers, 412-317-0088 and entering passcode 10149339.

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 Web site 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 Web site 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.

Jeremy Whitaker

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 first 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 Web site for additional details that will supplement my commentary.

For the first quarter of fiscal 2021, we reported $17.1 million in net revenue, an increase of 35% when compared to $12.7 million for the first quarter of fiscal 2020. Sequentially, revenue was up down slightly compared to the $17.4 million reported in the fourth quarter of fiscal 2020. As discussed on our last call, during the current quarter, we successfully completed the exit of a low margin product line we acquired as part of the Maestro acquisition. In the prior quarter this product line contributed approximately $540,000 in net revenue.

Gross profit as a percentage of net revenue was up to 48.1% for the first quarter of fiscal 2021 as compared with 48.6% for the first quarter of fiscal 2020 and 37.7% for the fourth quarter of fiscal 2020. As expected, gross margin improved sequentially due to lower charges for inventories, improvement in product mix and stronger than expected software licensing revenues. Selling, general and administrative expenses for the first quarter of fiscal 2021 were $4.9 million compared with $4.5 million for the first quarter of fiscal 2020 and $4.7 million for the fourth quarter of fiscal 2020. The year-on-year increase in SG&A was primarily due to additional headcount costs related to the Intrinsyc acquisition.

Research and development expenses for the first quarter of fiscal 2021 were $2.6 million compared with $2.6 million for the first quarter of fiscal 2020 and $2 million for the fourth quarter of fiscal 2020. As expected, R&D expenses increased sequentially due to the timing of product development projects.

Non-GAAP operating expenses as a percent of net revenue decreased from 49% in the first quarter of fiscal 2020 to 40% in the first quarter of fiscal 2021, and were down from 50% of net revenue in the year ago fourth quarter, demonstrating our synergy capture and leverage in the operating model. GAAP net loss was $302,000 or $0.01 per share during the first quarter of fiscal 2021 compared to GAAP net loss of $2.5 million or $0.11 per share during the first quarter of fiscal 2020. As expected, non-GAAP earnings increased sequentially from $0.04 per share or $1.2 million for the fourth quarter of fiscal 2020 to $0.05 per share or $1.7 million for the first quarter of fiscal ’21. This was also significant improvement from the year ago quarter when we reported non-GAAP net income of 7,000 or $0.00 per share.

Now turning to the balance sheet. We ended the September 2020 quarter with cash and cash equivalents of $7.7 million, which is consistent with the prior quarter. Working capital improved to $19.3 million as of September 30, 2020 as compared with $18.7 million as of June 30, 2020. Net inventories were $13.9 million as of September 30, 2020 compared with $13.8 million as of June 30, 2020. On our last earnings call, we transitioned to providing annual operating growth targets for revenue and non-GAAP EPS. Consistent with the guidance we provided on that call, we continue to target fiscal 2021 revenue growth of 20% to 25% and non-GAAP EPS growth of 120% to 160%.

I’ll now turn the call over to Paul.

Paul Pickle

Thank you, Jeremy. In a quarter still marked by the COVID-19 pandemic and ongoing supply disruptions, we focused on profitability and we’re pleased to report 39% non-GAAP earnings growth on a sequential basis, up substantially from breakeven in the year ago quarter. Our revenue performance fell slightly below our expectations for two reasons. In dollar terms, the biggest challenger on revenues in the quarter was the ongoing supply chain disruption and longer lead times for electronic components.

While we ended the quarter expecting supply chain delays could temper results by about $500,000 on the top-line, results reflect approximately $1 million, which pushed into the December quarter. While we had previously expected a resolution to our supply chain disruption could come as early as the September quarter, it is clear to us that it will not resolve in the December quarter. However, we do expect to see some incremental improvement in the December quarter.

Secondly, despite consecutive growth in demand from our Asia-Pacific end markets and continued growth in our North American markets, the EMEA region continued to struggle, dragged down by the onset of the second spike of COVID-19 infections, subsequent lockdowns and customer ordering pattern hesitations. Ultimately, the EMEA territory declined over 17% sequentially. As we endure the European lockdowns in a typically softer December quarter, we don’t expect much in terms of the near term improvement in the EMEA region. Although, our expectation for the Americas and Asia is for continued strength.

Turning our focus to products. Driven by continued strength in our Ethernet and WiFi modules, our IoT product lines contributed just over $14.6 million in Q1 up slightly sequentially, and 43% year-over-year. Within this IoT end market, we saw another uptick of design services activity and we are filling the pipeline with projects expected to generate stronger revenue growth beginning in the second half of 2021 and beyond. While we have called out video conferencing as a major driver of the design services and edge competing products, we also know design activities in the automotive, industrial energy and retail point of sale markets, which are expected to turn into substantial volume and revenue shipments as they roll into production over the course of the next 18 months.

Turning to remote environment management or REM, formerly known as ITM products. Revenues totaled $2.4 million, down 10% sequentially, although, up 4% from a year ago. As we have noted historically, REM can be a bit lumpy from quarter-to-quarter. But we have seen a substantial increase in proof-of-concept activity and our design funnel is filling. One highlight from the quarter was a purchase order from longtime customer Capital One for new hardware as well as SaaS subscriptions to cover new and previously installed hardware. This is a strong validation of our vision for ConsoleFlow software and its opportunity to penetrate not only new opportunities but also the large number of existing deployments of our installed base of devices worldwide. As we continue to convert hardware customers to software subscribers, we expect to continue year-over-year growth in this end market.

Turning to inorganic activity. We remained steadfastly focused on accretive inorganic growth. This is part of our stated strategy here at Lantronix and we are looking at a number of opportunities often in parallel. The IoT industry for all its promises fall in short of investor expectations over the last many years quite simply because it is too fragmented. As such, we see a number of excellent opportunities to acquire quality assets with quality management teams at reasonable valuations, while all the time growing our scale and our ability to give our customers the solutions they need. However, given the recent disclosure from [Italy] that we are in talks and with a Q&A session coming up, we think it is important to note here that as a policy we do not comment on M&A.

In sum, there is much I am pleased with in this first fiscal quarter. We have a good handle on expenses and profitability. We are increasing our customer engagement and our pipeline of opportunities is filling. Design services activity points to a number of high volume opportunities in multiple verticals, which should begin to ramp up in the second half of the fiscal year. And there remain a large number of attractive acquisition opportunities to pursue, which will boost revenue and earnings, improve our market position and strengthen our customer relationships.

As the supply chain disruptions caused by COVID-19 dissipate and world economies inevitably recover, Lantronix will become an industry leading IoT solution supplier with the depth of products necessary to solve our customers’ biggest problems in the scale to deliver industry leading profit margins to our shareholders. We are confident in our prospects and continue to expect strong year-over-year revenue growth for fiscal 2021, up 20% to 25% from 2020 while non-GAAP profits more than double.

That completes our prepared remarks for today. So I’ll now turn it over to the operator to conduct our Q&A session, Brandon.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session [Operator Instructions]. Our first question comes from Jaeson Schmidt with Lake Street. Please go ahead.

Jaeson Schmidt

Paul, I know in the prepared remarks, you noted some supply chain disruptions continuing here in December and EMEA being a bit soft, but just curious if you could just provide some color on what you’ve seen from order patterns here in October and November. Have customers become a bit more cautious just given headlines [Technical Difficulty] COVID whether it’d be elections, any additional help there would be good.

Paul Pickle

Well, I wouldn’t think that it was election related but I’m not giving conjecture on that. But I will say in the EMEA definitely we saw some late quarter ordering happening. And that was a part of the our delinquencies and shipments going up, our inability to supply what that customer demand was. Like we said, we expected to exit the quarter with about 500K in shipment delays, that things that we weren’t able to fulfill in the quarter ended up being a million largely because the EMEA territory we have some just late orders, people just being very cautious. And I think they started to sense that they were having some difficulties economically or continued difficulties, weren’t quite rebounding like they were expecting. And I think that just kind of pushed things a little bit further off. We did see some distributors in EMEA pulling inventories down a little bit. So we actually reported the lower channel inventories and expect that in EMEA and then once again those late orders came in, we were not able to turn those in timely fashion. So little bit of color on that. And I will say, EMEA we’re not seeing so far this quarter, we would expect just kind of a continued sideways trend of what we saw exiting last year.

Jaeson Schmidt

And just a clarification on the comments, you highlighted a number of different end markets, auto, industrial, energy, retail, as far as design activity. But were those also the end markets that drove September as well?

Paul Pickle

No, these are fairly new opportunities. And the nice thing is on the design services side. So I kind of reflect back to the January timeframe. I look at the pipeline of what we had at that point. We really retooled our services offering kind of leveraged both the Intrinsyc acquisition as well as the whole team here at Lantronix, repurposed and re-equipped the sales team to go out and really kind of drive our capability to much broader market. So what we’re seeing is a lot of activity that’s come in since that timeline. It’s been not in our typical end markets. It’s nice to see though. I will say industrial energy is one of those that we’ve historically played in from a hardware standpoint but not from a software standpoint. So it’s nice to see that activity go as well. And then picking up some additional new market opportunities in automotive, as well as there’s some drone activity that we’ve been pulled into as well that you’ll start to see. So it’s nice to see that our capability on the compute side, the compute end markets has really kind of broadened and gone out to a much larger customer base.

Jaeson Schmidt

And just last one from me and I’ll jump back in the queue. Jeremy, gross margin had a pretty big sequential jump. Can you provide some color around that move, as well as if this sort of 49% is the new level here in the near-term?

Jeremy Whitaker

As you may recall on last quarter’s call, we took a pretty significant charge for excess and obsolete inventory related to some in the life products and components that we had. In this current quarter, we didn’t have a similar level of charges. So that definitely helped with the sequential improvement and kind of bringing us back to, I would say, more of a normal rate mark on the product margin line. In addition to that, we did see some benefit on the mix side. We had a strong quarter with our Ethernet module products, which is higher on the scale of our margins and also higher than expected revenue from software licensing, which is also a higher margin product. So the combination of product mix and much lower charges from excess and obsolete inventories, drove the sequential improvement. I think on a go forward basis, we may not have that same level of mix. So I would expect us — to continue to see margins at this level are slightly below depending on the mix we see going forward.

Paul Pickle

We also had 540k of what’s called 0.1% margin business in the number last quarter. We made — decided to exit from. And so we will not be taking that business on a go forward basis. So that obviously gives a little bit of lift. So we did about $2 million in 1% business last year that we exited. So we get a little bit of lift from that.

Paul Pickle

Yes, about 100 basis points as well.

Operator

Our next question comes from Scott Searle with ROTH Capital.

Scott Searle

Directionally, Paul, can you give us an idea by product line, what you’re seeing sequentially as we go into the December quarter? The remote management, sounds like it’s a little bit lumpy but I know there have been some new product introductions. I mean, how is that shaping up? Sequentially, how do we expect the different categories to kind of grow going into the December quarter? And then just to clarify, on the software front, is there a number that you put around that software and licensing in the September quarter to give us sort of an idea about of how that impacts gross margins? And then I have to follow or two.

Paul Pickle

So on directionality, we don’t break out revenue by product line but in order to give you a little bit of color. At this juncture, we’re seeing our services business is typically around 50 points of gross margin. And we’ve pulled in enough products to be at the point where we’re just about fully booked. So we got a little bit of capacity that ended up coming down to the R&D line working on standard R&D components or standard products. And then as they get booked with services, they end up going up to the COGS line. So that was a little bit of a movement that we kind of talked about from an R&D standpoint.

Services is, we anticipate the close to fully booked, if not fully booked go forward basis over the next several quarters. So that will give us a little bit of a lift on those. Our REM products that remote environment management product is typically all over the board if we have a whiteboard or we typically have a strong quarter next quarter. It really comes down to CapEx trends with our end customer. So we have to be a little bit careful in terms of trying to forecast those, because it really kind of comes down to the budget, so when those get approved. But we do have line of sight to a couple of build outs that are happening.

We’ve seen a nice little surge in data center build outs and expansions and even some retooling. So we would anticipate to get a little bit of lift there. The WiFi products continue to be fairly strong. Mostly this is new product revenue that is backfilling some of obsolete component revenue. So I would anticipate continued strength in those products. And then really marching into the first part of 2021, I’ll say Q3. Our fiscal Q3, we expect to get — start to receive some of those Qualcomm processors that we’ve been waiting on, long lead time orders and so you’ll see a little bit of a shift there in terms of compute products.

Scott Searle

Got you, very helpful…

Paul Pickle

On software, we didn’t put a number on it. What we’ve kind of said historically is that that software product typically runs, if you take the software licensing and the SaaS, we’re typically around 750k a year. We definitely saw a boost. I hesitate to kind of say that it won’t continue to be strong, because we’ve gone back and looked at some of our older product lines that are finding ways to make sure that we do a good job on enforcement of those software licenses and we continue to extract value for those. So we might be able to better manage that product over the next several quarters to maximize it. But it’s not new per se.

Scott Searle

And two follow ups, if I could, in terms of internal development trying to move in the direction of recurring revenue and other services. How is that progressing in terms of other subscription offerings and when will we expect that to become a little bit more prominent in terms of the revenue stream? And on the M&A front without commenting specifically on any deals. I know there’s been an active pipeline there. Could you just give us an idea of what the tenure and the conversations are like, more difficult to get deals done valuations kind of how are you feeling about the overall environment right now? Thanks.

Paul Pickle

I’ll take the last one first, I think I’m on the MA front, there’s still plenty of activity out there, there’s still plenty of deals to be had. The conversations are great. I do think that IoT is starting to wake up to the fact that everybody’s starting to — they’ve seen it done where you can do some M&A, drive some value for shareholders. And so you’re starting to see a bit more activity, from my standpoint. I start to see a bit more activity. There’s still plenty of projects that are coming across our desk. I think we’re at a point where we’re being a bit more selective in terms of what we go after. And so plenty to be had but we’d like to make sure that we’re a bit more selective in our offering. So still plenty activity, lots of things happening, still like what we see out there.

And on the SaaS internal development, what I’ve said in the past I think it still remains to be — it still is true that I think we’ll be better prepared to talk about contributions of SaaS revenue around the end of the year. But we started talking about internal targets of getting to about 10% of revenues coming from recurring in about five years’ timeframe. But we’re getting really some affirmation in terms of the strategy from recent customers. And actually, I’ll bump this question over to Jon in terms of how we’re progressing, how he sees it and maybe some of the customer examples on validation. John, do you want take this one?

Jonathan Shipman

From a roadmap perspective, I think we are doing a much better job of internal discipline around focus really understanding what our customer needs and what’s going to drive customer success and really listening to our customers as we develop our roadmap. We’ve seen an increase in POC, proof of concepts, with customers with both new customers and existing customers, driving interest where we didn’t have it before and as well as those customers being excited enough to sit down with us and discuss key features that they’re looking for that we then have integrated into our roadmap or moving forward. So even as we discuss it being early innings, the traction is happening.

And then as far as where we’re going, we just had a press release come out yesterday and social media posts follow up to that around our connectivity services. So now Lantronix products going forward will ship with easily activatable global sims. So all of our customers can quickly get their IoT and RIM devices, get them online and get them activated and using cellular services right out of the box. And so that’s one example of where we’re taking that line to make it even easier for customers to get their solutions moving. As Paul mentioned earlier, a big validation of this, obviously, we can’t talk about the customers in the pipeline, but Capital One, again, is a great example of validation of building over the last year, building a lot of value into our product, customers and potential customers seeing that value and being willing to sit down with us, test with us and eventually become a customer of both hardware and software.

Operator

Our next question comes from Rich Valera with Needham and Company.

Rich Valera

Maybe just to try to summarize what I’ve heard in the prior Q&A prepared remarks with respect to the next quarter. It sounds like you’re expecting revenue to maybe be flat to slightly up, gross margin maybe flat to slightly down, and then I’m not quite clear on OpEx. But I’m just wondering if those are directionally consistent with what you’re thinking and if you have any thoughts on how we should think about OpEx in the current quarter?

Paul Pickle

So OpEx is something that will probably downtick slightly, I don’t think your characterization is all that far off. There’s some, I don’t know that — I wouldn’t say flat to slightly down, I would say flat, just because we definitely see the possibility of becoming an higher and we’re a little bit conservative when it comes to our current customers in EMEA. We might get a little bit of surprise in terms of some of those processors from Qualcomm, getting those into our hands a little bit early, our primary customer that’s ramping up quite nicely, is based in Europe and so that would alleviate some of that. But if I carve that out, EMEA as a whole with the bulk of the revenue is quite soft that revenue came down. I don’t expect it to come — it came down last quarter, I don’t expect it to continue to come down. But we would expect it to be soft at least through December.

And I think from gross margin standpoint, you’re not that far off as we kind of like where the gross margins are but we temper the enthusiasm in terms of stating that this is the new normal. We do expect the capturing synergies that we have been capturing going forward and still continue to see those, so we’re going to get a natural uplift. The software component is continuing to add to those, or contribute to revenue so it does come in at a much higher gross margin and really then it comes down to hardware mix. That’s a little bit difficult to tell at the moment for the December quarter, but we could have — if we get those shipments coming in, it’s obviously a little bit lower gross margin drive down, but then we drive the top line higher. So there’s things that kind of offset each other.

And then the only other color I’d give you Rich is that backlog continues to build, which is uncharacteristic for us. We don’t normally start a quarter with a lot of backlog. But over the last several quarters this has happened, it’s all scheduled, a lot of it’s schedule in Q3. We also have a couple of customers that we’re kind of managing an exit from last year and they have some contractual obligations that happened in the Q3 timeframe as well. So a lot kind of builds into that pipeline and for a nice second half.

Rich Valera

And then just wanted to try to understand and maybe quantify the assumption on headwind from supply chain heading in this current quarter. Sounds like last quarter you expected about 500K and got about a million. What’s the assumption for this quarter in terms of how much supply chain headwind you might have?

Paul Pickle

I think I’m going to exit the quarter with the same amount of about a million dollars that I can’t ship. Historically, we’ve not had this issue where we haven’t been able to meet customer demand. Our operations teams done a fantastic job on the planning and acquiring the components and making sure that products are built and delivered in a timely manner. And while I’ll say supply chain issues really kind of when we talk about supply chain issues, it’s a number of different things. Delinquencies, shipments delinquencies can come from customers ordering too late, component lead times that are too long or manufacturing delays. We don’t have quite the manufacturing delays that we had in the March quarter. We do occasionally see those associated with a couple of our suppliers. And component lead times definitely are stretching out and then customer ordering patterns, especially in EMEA are a good sporadic. So it’s combination of those. I would expect to exit the quarter with balance late again so I’m not expecting much improvement.

Rich Valera

And as you look into next year, and I know it’s a dynamic environment to be sure. But do we expect these kind of conditions are probably going to persist into the early quarters of next year?

Paul Pickle

It really kind of depends on what you’re talking about. If we’re talking Qualcomm processors, I really expect to catch up at some point. TSMC is doing a great job. A lot of our demand is not on the cutting edge process today but our current device services, though, is on that 7-nanometer process. And so I would expect that supply to be tight, maybe we get past the CE bubble with iPhones rolling out and things get a little bit better. But I would always expect that semiconductor component to be fairly long. I would expect everything else to really kind of moderate a bit. And then capacity wise, we’re leveraging our multiple contract manufacturing locations to qualify SKUs in multiple locations, so that we don’t quite have the issues or the encumbrances that we have had this past year. So we’re trying to get ahead of that. And then I think on the ordering patterns as two things that does resolve. There’s a lot of skittishness, it all seems to relate to COVID cases and whether or not you’re a believer or a cynic in that regard, I think we’re making good progress in terms of vaccine, so hopefully that’s easy to a lot of trepidation that’s out there.

Rich Valera

And just one final one, you guys talked about some nice video conferencing related wins last quarter. Just wondering how the progress has been in ramping those? Thank you.

Paul Pickle

We picked up additional purchase orders in this past quarter. So it’s doing quite nicely. We picked up two additional — three additional design services projects on videoconferencing platform. So it’s kind of nice once you’re known for being able to deliver that kind of capability. It tends to be get more projects that’s why some of the expansion in other verticals is really kind of nice to see, because I do think that it lends itself through additional pick up in those particular verticals. So that’s going really nicely. Quite honestly you could sit here and say it’s something that’s been really needed this past year but in reality, most of the video conferencing platforms that we’re on have been more office enterprise type applications. They since switched their sales strategy to cater to more executives at home. And so people are buying those products for their home. But the vast majority of videoconferencing today is done with a laptop or a tablet and despite that, we’re seeing nice volume. And I think as we get into a more normalized environment doesn’t matter if you think that office, retail is going to be cut in half the need for video conferencing platforms in those office locations, whether they’re 30% of the space that they were or 50% of the space that they were, there’s still going to be a large uptick in demand that I believe is going to happen over the next several years.

Operator

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

Paul Pickle

Well, thank you for your time today. I hope you have a fantastic evening.

Operator

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

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