Lantronix, Inc.

Good day and welcome to the Lantronics Inc. 2021 Q2 Results Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your touchtone phone. To withdraw your question, please press star, then two. Please note this event is being recorded. I'd now like to turn the conference over to Amber Tins. Please go ahead.

Good afternoon, everyone, and thank you for joining the Landtronic Second Quarter Fiscal 2021 Conference Call. Joining us on the call today are Paul Pitreault, Landtronic's President and Chief Executive Officer, Jeremy Whitaker, Landtronic'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 p.m. Eastern, 5 p.m. Pacific today through February 18th by dialing 877-344-7529 in the U.S. or for international callers, 412-317-0088 and entering passcode 101-51719. 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. Lantronics 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'll now turn the call over to Jeremy Whitaker, Landtronic'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 ship against 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 remained 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. Gap net loss was $1.5 million, or $0.05 per share, during the second quarter of fiscal 2021, compared to a gap 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 3 cents per share during the second quarter of fiscal 2021 compared to a non-GAAP net income of 666,000 or 3 cents 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 dearth of commercial flights worldwide, remained at three times their normal levels. In all, it remains a challenging environment from an operations 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. 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 booked to build solidly above 1, driven by our intelligent, edged, computing and remote environment management solutions. As the supply chain disruptions ultimately ease, we expect to turn these bookings 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 Wi-Fi and Ethernet modulated somewhat after strong results in Q1, Solid growth from our device servers led IoT revenues in Q2. On the design front, we are 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 inked 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 TOG, a design and manufacturer of next-generation electric vehicles, to design their infotainment and automotive control consoles. 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 to drive second-half growth for Lantronics, 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, buoyed by the inertia of our console flow 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, Lantronics is in a much better position than it was just one year and two acquisitions ago. Q2 revenues were 25% higher than the year-ago quarter, 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 are not done acquiring. We remain focused on acquisition targets, which brings scale, strategic value, and earnings accretion to our model. And we must also acquire the talent and the technologies to deliver the solutions our customers need and to realize the massive but 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 a 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, Lantronics 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 will now turn it over to the operator to conduct our Q&A session. Grant?

We will now begin the question-and-answer session. To ask your question, you may press star then one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the key. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question today will come from Scott Sierra. 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. Just to dig right in on the component availability issue, I think you said $2 million clipped upside in the quarter. It was $1 million plus last quarter. Is that still largely restricted to processor or baseband component availability or you're 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 opportunity is 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 that type of 25% growth for the year? Because it actually implies $2 million and a quarter above, I think, where consensus is.

Yeah, understood. So on the first part of your question, so in the early days, it was just processors. So we talked about Qualcomm processors. We talked about the 865s. Largely, it was related to capacity constraints on the low lithography lines at TSMC. This past quarter, we've seen it expand. You know, when we ship an eval board or a SOM, it's not just the processor, it's memory, it's PMICS, and we're starting to see those constraints all across multiple processing nodes. And even we had oscillator and crystal shortages this past quarter. Definitely has gotten worse. Qualcomm was at, you know, in our previous calls, we talked about going to 25 weeks and then 30 weeks. We're at 34-plus with them. And then Broadcom just announced 50 weeks. And so it's just gotten worse, and it seems to be a bit across the board. I don't know that we've seen it spread quite into passives yet, but, you know, there's some talk about that. In terms of, you know, how we get... That second half growth, you know, so the fact that we were on this early on and we had the benefit of some forecasts coming out of our customers. So back in June, we were actually, that June quarter of 2020, we were placing purchase orders and putting things in place to make sure that we got into the queue and were able to deliver. So, you know, we do have some long pole in the tent components, especially as it relates to memory. And so that's tempering it a little bit. You know, we can get the processors, but we can't get necessarily some of the other components that we need to deliver on the total solutions. But we have enough product in WIP to still be able to deliver, you know, a decent number in the second half. And so that range really is indicative of, you know, if we're, I think we safely see a minimum growth trajectory for the second half as guided. and then I think we can see some upside if we get some things in other product areas that come in. It won't necessarily depend on shipping out compute modules, for instance, but it would be dependent on delivering on some of the other products where we don't have the extreme shortage.

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

It's definitely a supply issue, but, you know, I don't know. I know we have deliveries coming in the back half, the back end of our second half. So our Q4 timeframe, we've got firm commitments in that timeframe. So I would caution you to think in terms of just the step function, you know, Q3 and Q4, but definitely as we look towards that second half, hopefully we can take a little divot out of that $2 million of delinquencies or late CRD, as we like to call it, and then deliver on the increased growth of the backlog that we have on the books for the Q4 time frame.

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 valuation expectations. You guys have been very, very adept at doing good deals. You know, are the valuation parameters changing now, making things more difficult? are you pretty comfortable that you're going to be able to get something? Sounds like you've got something near a term in the hopper. Thanks, and I'll get back in the queue.

All right, John, I'll let you take the SAS question.

Sure, thank you. Yes, it's still, you know, as Paul said, early innings, or as I think that the snowball rolling and gathering snow, we added an additional six new customers and expanded our proof of concept pipeline from 20 to 28. opportunities worldwide. So we continue to expand there. We also are looking at continue adding resources to our development team on the SAS side to not only add additional value and functionality today, but to also work with customers to meet specific customer expectations around customer operational efficiency and hearing back. An example of this is zero touch provisioning. While we have a system today, And it's okay. It's not great. And listening to our customers, it's important that we add this value for all customers, but it's very critical for customers over 100 devices and beyond. And so we're working on multiple roadmaps, and every new product we have coming out is going to be tied into our recurring revenue and SaaS model to make sure we're adding full solution value to our customers and really understanding what they're trying to solve and that we're tackling that from a SaaS software perspective, value-added services perspective, like our cellular connectivity we just launched. So we've really become a one-stop shop for management services, engineering services, and hardware. And we're continuing to see increased interest from opportunity sizes over 500,000 and total opportunity size when we look at the complete package with a customer.

Yeah, and I'll just tag on to that. It's a very different landscape that we have today with the current SaaS product. It still requires a couple of feature sets that we will be delivering on the next six months, but right now customers are liking what they see, and we're getting them to sign up. So on the M&A front, in terms of valuations, the environment's definitely changed a little bit. There's a bit of a frothy money-raising environment, I think, to put it lightly. And so companies that were possibly looking at acquisition have a judgment call to make whether or not they'd be better off raising funds and going it alone or being part of a larger entity. And I will say that that Well, that is another option for them on the table. I don't know that that changes so much the landscape. It's making maybe some of the valuation expectations push up a little bit, and we have a tendency to look for the value for our shareholders, so I don't expect us to feel like we have to complete an acquisition. We're going to make sure that we find something that fits with who we are and delivers that accretion to the bottom line and is really strategically important for our future while we continue to work on our organic plants inside. In terms of immediacy, we're always actively working a pipeline with multiple engagements. I think at this point, we're certainly at a point where we can take on an acquisition and integrate it. Our last operational synergies were captured here in this last quarter related to intrinsic, and so the team's really ready to take on the challenge of doing an integration and executing on it quite quickly. So we're certainly ready to get one done, and we're working a pipeline to ensure that we do.

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 about your second half guidance. I have a 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? Do you feel like, based on the backlog and supply coming, swinging a little bit your way? And then I've got a follow-up on the M&A side about a previous question.

Yeah, definitely not dependent on a deal. We wouldn't forecast the revenue, you know, 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 with an IoT with the pipeline that you have, or is it something that would be additive to one of the competencies that you probably have already and 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 stack that we call IoT and we're looking for, you know, 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 will definitely be looking at. We do have some sensor product 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 Jason Schmidt with Lake Street. Please go ahead.

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

So I don't know that we've seen a ton of weakness. All right. So the one area that we do play into is is retail, small business office stacks. Those obviously have been a weak area. If we look at EMEA, I think it's a second wave. I don't know that it's so much an end market, you know, vertical, so much as a geographic problem, but definitely the telematics devices, routers, gateways – Those had a little bit of a setback in EMEA with the second wave. Just the whole scare of the U.K. really kind of shut everything down. And so I'd hesitate to call it an end market with the exception of small business office and retail, small business office stacks. Those definitely are suffering, continue to suffer. I would expect would continue to suffer going forward. But other than that... You know, nothing stands out offhand.

Okay, that's helpful. And then you mentioned 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 this March quarter.

Yeah, so ordering patterns are, you know, still – I think what we have going on with our customers, they're still a little bit late in the quarter. So, you know, customers are seeing the long lead times, but at the same time, they're not placing orders. You know, and this is a general comment because in some areas we definitely have secured backlog. But as a general comment for our turns business, we are seeing late ordering being a significant component. We're not able to turn the product. You know, if I can give you an anecdote, you know, we exited the quarter with, you know, just over $2 million of late shipments to customer request dates. Those typically get, you know, fulfilled, almost all fulfilled in the following month or month and a half. And then, you know, we end up having late ordering, just can't respond fast enough at the end of the quarter with the turns business to turn it. So good news is, is we're, We're able to fulfill it. We're not losing those sockets. No revenue is lost. It's just delayed, and it gets pushed to the right by a couple of months. If that continues to build, then obviously it produces a headwind overall, and then there's a catch-up period that happens where it does snap back as logistics and manufacturing become a little bit easier.

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

Yeah, I think that's a decent target. The one caveat would be this quarter, and it started a little bit in the quarter before, is that we are spending more As it relates to the component shortages where we're having to go out and do spot buys and secure materials, sometimes at higher prices, which is creating, you know, higher manufacturing costs and some variances. And so, you know, when we can, when I look at margins, this is the quarter we just completed versus a year ago, we had probably 500 basis point difference in margin just related to increase freight and increase manufacturing costs related to expedites and component shortages. So until that, you know, I think longer term, I would expect as things normalize that we would be able to recover most of that and get back to, you know, the mid 40s, even a little bit higher than that. But in the short term, there's going to be a little bit of pressure on that, I think, That continues. It's hard to predict. I think two quarters from now we thought we'd be through some of this stuff, and it actually seems to have gotten worse now with component shortages actually getting worse. So it's hard to predict, but longer term I definitely think we'll get back to those mid to upper 40s as we get more to a normal state.

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

Thank you. Our next question will come from Rich Valera with Nino. Please go ahead.

Thank you. As it relates to the record backlog, is that more a function of your inability to ship or have you actually seen bookings picking up from the September quarter to the December quarter? Is there kind of building bookings momentum or are you just kind of seeing relatively steady demand and just your inability to ship is creating a rising backlog?

It's a little bit of both. So obviously when you can't deliver the customer request date, that builds into a starting backlog. And the fact that it went from $1 million to just over $2 million, it is definitely partially responsible for the increased backlog. Having said that, we are having strong bookings. Don't see double bookings in there, but part of it is related to You know, if you look at that compute side of the business, it definitely has, it sets up for nice backlogs. So we've gotten some nice bookings that have happened for that particular product. As you look at the turns business, you know, the turns business is really responsible for, you know, the late to CRD and what has caused that pushup. So it's a little bit of both.

Got it. And then is the remote management business being affected by the component shortages?

Not to date. If you look at it, some of our boxes are pretty high resale, and so not a ton of units, and we've definitely been able to manage the inventory with that product, so it has not affected us for 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... How are you thinking about that business for the balance of the year?

It's definitely chunky, but we're expecting to see some growth in it. What we've been building into all of the hardware is console flow capability, and with the new console flow products, the code drops that are coming out, it has a tendency to take even the boxes that have been deployed and kind of breathe new features into them. It gives us a nice subscription opportunity, revenue opportunity, And then we have some new products that have some features in them that customers have been asking for for a while. And so it'll be a little bit of both, but we see a nice little pipeline going for us.

Got it. Perfect. Thanks for taking my questions.

This 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. Appreciate you guys joining us today. Have a great day.

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