Lantronix, Inc. (LTRX) Q4 2019 Earnings Report, Transcript and Summary

Good day and welcome to the Lantronix Incorporated 2019 Fourth 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 Tint [ph], call coordinator. Please go ahead.

Good afternoon everyone and thank you for joining the Lantronix fourth quarter fiscal 2019 conference call. Joining us on the call today are Paul Pickle, President and Chief Executive Officer; Jeremy Whitaker, Chief Financial Officer; and Jonathan Shipman, Vice President of Strategy. A live and archived webcast of today’s call will be available on the company’s website. In addition, a phone replay will be available starting at 8:00 P.M. Eastern, 5:00 P.M. Pacific today through October 10 by dialing 877-344-7529 in the U.S., or for international callers 412-317-0088 and entering passcode 10134676. 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 on 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 over the call to Jeremy Whitaker, Lantronix’s Chief Financial Officer.

Thank you, Amber and welcome to everyone joining us for this afternoon’s call. I’m going to provide the financial results, as well as some of the business highlights for our fourth quarter and fiscal year-end before I hand it over to Paul for his commentary. Please refer to today's news release and financial information in the investor relations section of our website for additional details that will supplement my commentary. For the quarter ended June 30, 2019, we reported $10.2 million in net revenue compared to $12 million for the fourth quarter of fiscal 2018 and $12.3 million for the third quarter of fiscal 2019. While we have navigated well through the operational issues related to U.S./China trade tension including the transition of our contract manufacturing out of China, the ongoing nature of the dispute has decreased our customers and distributors' certainty into end market demand. Tariff concerns and components shortages drove higher than normal inventory levels in the channel during the March quarter, followed by industry-wide uncertainty in the June quarter. These macro factors resulted in a decline in sales greater than the guidance we provided on our last earnings call. Having no single end user representing more than 2% of our total sales, we saw a broad based decline in demand and not customer attrition. We believe this was a temporary slowdown in demand as our end customers and channel partners began to bring down our inventories. On a positive note, inventory levels of Lantronix product and our channel have been declining throughout the current quarter and we expect to see improved end customer demand over the next two quarters. Gross profit as a percentage of net revenue was 56.6% for the fourth quarter of fiscal 2019 as compared to 57.1% for the fourth quarter of fiscal 2018 and 57.4% for the third quarter of fiscal 2019. The sequential decline in margin was primarily due to lower absorption of our fixed manufacturing overhead costs. Selling, general and administrative expenses for the fourth quarter of fiscal 2019 were $3.6 million compared with $4.1 million for the fourth quarter of fiscal 2018 and $3.9 million for the third quarter of fiscal 2019. The improvement was primarily due to tight operational controls, general expense reductions and lower variable compensation in the current fiscal quarter. Research and development expenses for the fourth quarter of fiscal 2019 were $2.2 million compared with $2.4 million for the fourth quarter of fiscal 2018 and $2 million for the second quarter of fiscal 2019 as we continue to invest in new product development. GAAP net loss was $1.5 million or $0.06 per share during the fourth quarter of fiscal 2019 compared to GAAP net income of $752,000 or $0.04 per share during the fourth quarter of fiscal 2018 and GAAP net income of $857,000 or $0.04 per share during the third quarter of fiscal 2019. Included in the GAAP net loss were approximately $1.5 million of expenses related to acquisition, severance and asset impairment costs. I'm pleased to report our 14th consecutive quarter of non-GAAP profitability as we achieve non-GAAP net income of $722,000 or $0.03 per share for the fourth quarter of fiscal 2019. This compares to non-GAAP net income of $1.2 million or $0.06 per share for the fourth quarter of fiscal 2018 and non-GAAP net income of $1.3 million or $0.05 per share for the third quarter of fiscal 2019. Now turning to the full year results. Net revenue for fiscal 2019 was $46.9 million, an increase from $45.6 million reported during fiscal 2018. Gross profit as a percentage of net revenue for fiscal 2019 improved to 56% as compared with 55.7% for fiscal 2018. Through our mitigation efforts we're able to limit our tariff exposure to approximately 50 basis points in fiscal 2019. Operating expenses for fiscal 2019 were $26.8 million compared with $24.6 million in fiscal 2018. The increase in operating expenses primarily due to investment in engineering, restructuring charges and expenses related to the acquisition of Maestro. For fiscal 2019, we reported GAAP net loss of $408,000 or $0.02 per share compared to GAAP net income of $680,000 or $0.04 per share for fiscal 2018. Included in the GAAP net loss were approximately $1.8 million of expenses related to severance, acquisition and asset impairment costs. Non-GAAP net income increased by 26% to $3.7 million for fiscal 2019 as compared to $2.9 million in fiscal 2018 and non-GAAP net income of $0.16 per share for fiscal 2019 as compared to $0.15 for fiscal 2018. Cash and cash equivalents were $18.3 million as of June 30, 2019 as compared to $9.6 million as of June 30, 2018. Working capital was $26.7 million as of June 30, 2019, an increase of $13.2 million as compared with $13.5 million as of June 30, 2018. The increases in cash and working capital primarily relates to our September 2018 public offering. In July 2019, we use cash of approximately $5 million for the purchase of Maestro. Net inventories were $10.5 million as of June 30, 2019 compared with $9.8 million as of March 31, 2019. As discussed on previous calls, we plan to increase inventories as part of our tariff mitigation strategy, which included moving our contract manufacturing outside of China. Now that the effort is substantially complete, we have established a long-term target of three turns per year. Now, turning to our recent acquisition. On July 5, 2019, we acquired 100% of the outstanding shares of Maestro and its subsidiaries for approximately $5 million in cash consideration. To give you some perspective of Maestro size, they were doing around $10 million a year in revenue at a gross margin of approximately 40% with an approximately 10% operating margin loss. We are in the process of fully integrating the business, identifying and capturing synergies and expect it to be accretive to our non-GAAP earnings during fiscal 2020. Currently, we are evaluating the fair value of the acquired assets and liabilities, including any identifiable intangible assets. We expect to present a preliminary allocation of the fair value of acquired assets and liabilities and pro forma disclosures in our form 10-Q filings for the quarter ending September 30, 2019. Now, I'll provide guidance on revenue and earnings for the first quarter and year ended fiscal 2020. For the first quarter of fiscal 2020, we expect net revenue in the range of $12 million to $13 million and a non-GAAP net loss per share in the range of $0.03 to breakeven as we begin to capture synergies from the acquisition. For fiscal year 2020, we expect net revenue growth of 15% or greater and non-GAAP net income per share growth of 30% or greater. Now, a quick housekeeping note as it relates to our next earnings call. To allow sufficient time to complete certain Maestro system integration and purchase accounting activities, we are planning our first quarter fiscal 2020 earnings call for mid November, which is a couple of weeks later than our normal reporting cycle. I will now turn the call over to Paul.

Thank you, Jeremy. My first full quarter at Lantronix has been both challenging and exciting. Despite factors such as current trade environment which are out of our control, our team did an excellent job delivering on non-GAAP profitability in the quarter. While our base business suffered from general macro concerns, our newer WiFi products released over the last three years saw quarter over-quarter-growth and remain on pace to grow appreciably over the fiscal year. I continue to see an incredible opportunity for Lantronix to grow and build a world class franchise, serving a larger higher growth marketplace and delivering industry-leading profitability. Over the last quarter I have had the opportunity to assess each functional group within Lantronix and while we have a lot to improve upon, there are elements that are working rather well. The company's operations team is nimble and responsive to customer requests while maintaining a very high degree of quality with return rates well below industry norms at 0.04%. Finance has exemplified tight controls and transparency not seen in a lot of much larger organizations. Relatively recently, engineering management overhauled the product development process with the goal of trimming development time and increasing efficiency. We will see the benefit of this exercise over the next several quarters. We began more intently working to improve the ROI on our product development efforts. Importantly, Lantronix cannot continue the standard operating practice of throwing resources solely at engineering small iterations of existing products. There's simply too much price competition in the hardware space to justify the development expense, and to continue down this path will result in product offering prone to price erosion, cannibalization of existing revenue and addressing to small market opportunities. Our recent efforts have focused on improving hardware and software execution through a consolidation of development efforts which has improved our processes and planning and we are already started to see those results. Further, we're eliminating parallel efforts on projects where conceptually the same and zeroing in on maximum reuse of engineering efforts. Doing so will allow us to reduce R&D expenses as a percentage of sales and greatly improve ROI. Using this approach development of our latest ITM product to be announced next quarter is running well ahead of schedule. This product will be released initially as a flagship, along with a broader family of products featuring multiple price point tiers, all with much lower engineering expense than we have seen in the past. Recently, we demonstrated this at Cisco Live running in conjunction with our SaaS platform, along with application software and I'll note that customer interest was high. While some interest in our software products continues, we are refining the offering to drive the results we expect. In the latest quarter, we have on boarded two additional customers with another 20 customers in the proof-of-concept stage and the pipeline is improving, but we can do better. MACH10 fundamentally has a robust architecture and is an impressive foundation with multiple microservices for us to build upon. But the front end or customer side of the platform makes it difficult to use and likes the features that would be typically expected in a software package. It can be difficult for traditionally hardware focused product teams to fully make the turn of value added software services without the proper focus. Further, client side applications like ConsoleFlow, or middleware also have some needed functionality, but lack others. In addition, there are multiple parallel development efforts resulting in higher expense than necessary when they could have been consolidated into a single modular development efforts. These consolidation plans are now underway and will be completed expeditiously as we've added the needed focus. Strategically, it's important to think of IoT is a multi-layered concept, but Lantronix is currently positioned as a single layer IoT connectivity company. We need to be much more if we are going to provide the solutions our customers are looking for. Our previous roadmaps primarily focused on a narrow segment of IoT connectivity enablement. Going forward, we will add the capability to address other aspects within the connect, collect, compute, comprehend, and control functions that are cumulatively known as the IoT stack. And doing so we will address the larger concepts of IoT and in time, deliver meaningful IoT solutions that add value by solving your customers problems. The game plan is simple. We will execute on a revamped product roadmap driven by ROI metrics, leveraging our technology to grow organically. Furthermore, we see the opportunity to greatly enhance our hardware solutions with our software solutions creating a recurring revenue model. We will also continue to expand into complimentary adjacent markets via acquisition, use those products to drive deeper penetration of industry leading customers and leverage our growing scale to realize the more profitable business model. As we execute Lantronix will grow more quickly drive more profit than it is before. Lantronix will be larger, diversified and better able to weather market volatility while continuing to deliver profit to our shareholders. Our first acquisition Maestro wireless strategically makes a lot of sense for Lantronix. Whereas Lantronix is a leading supplier of wired in certain wireless IoT solutions, Maestro is complimentary and that it specializes in cellular connectivity and mobile tracking solutions. These mobility products added much needed capability within the connectivity function of IoT by broadening our product portfolio with narrowband IoT wireless and cellular capability. These products also add much needed IoT collect function capability with Global Navigation Satellite System receivers and sensor technologies. In addition their software offering brings with it new capabilities for the management and programming of connected devices. While the software is customer facing, front end is more robust than ours the MACH10 foundation offers quite a bit more in terms of backing functionality. As such, we will consolidate the two using best practices from both delivering on a much improved product. This acquisition is completely additive to our product -- current product offering and presents us with new opportunities at our customer base while also bringing new customers to our existing and roadmap products. Looking at the financials. Maestro did about $10 million in product revenues, Jeremy referenced, during calendar year 2018 and operated at a loss. While they did have a piece of pass-through distribution revenue that we will exit, their core product revenues growing nicely. As we integrate in real life synergies, we will have a significant opportunity to improve the profit potential the combined entity. And while it is prudent to expect that Maestro's current revenue is subject to the same macro uncertainly, we are confident guiding for the combined company to grow revenue at a rate of 15% or more in 2020. We further expect operating profit to grow at 30% rate as Lantronix benefits from efficiencies of scale and realize its operational synergies. We find targets such as these compelling and we are circling on a long list of opportunities that will further accelerate our strategic growth plan. Expect more from us here at Lantronix. As I said earlier, my first full quarter at Lantronix was both exciting and challenging I look forward to working with the team to deliver on our potential for the benefit of our shareholders. And that concludes our prepared remarks for today. So, I will now turn it over to the operator for our analyst Q&A session. Sean?

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

Hey, guys. Thanks for taking my questions. I'm wondering if you could comment if you're seeing anything out of the ordinary from a pricing standpoint in any of your product lines.

Okay. Seeing anything out of the ordinary on pricing for our product lines?

Correct.

Yeah, nothing out of the ordinary. We've done a good job of raising ASPs over the last couple years, just making sure that we extract full value for the product lines. So, if we look at some of the newer products from -- that came with the acquisition, I think that there's a little bit of an opportunity for us to drive some greater returns there with price positioning, but overall nothing out of the ordinary in terms of the downside.

Okay. And regarding the Maestro business, can you share sort of what the historical growth rate for that business was and sort of how we should think about your ability to grow that business going forward?

Yeah. So, if I took just the product revenue, so if you look at the business overall, would look fairly flat, but you have to remember there historically they were a distributor first before they were a products company. And so, if you kind of extract out of that and focus in on just the standard products, they grew rather rapidly, albeit from a zero basis in the first years. They had a little bit of moderation in 2018. And we expect to see some growth out of the products beyond this first year, some new programs kind of hit.

Okay. And the final one for me, and I'll jump back into queue. I know they have tracking and sensor business, which you alluded to. That's been a market you guys really haven't played in before. Just curious if you could share your thoughts on how you look at that market, just given sort of the greenfield opportunity in that broader space.

Yeah. So, I like the space. And I need to clarify, you know, asset tracking is -- it's been out there probably the longest in IoT land and it’s probably not viewed as a fantastic market in terms of opportunity to -- deployment out there is pretty phenomenal. I look at it from -- our business is fairly sticky, the types of customers that we have. But that capability is really quite important, because it ties in a complete web services, scripting ability on the client side, as well as back end and some analytics. In addition to hardware, the hardware is probably less important. But if you look at what types of applications that hardware and software can enable, those are some of the up and coming, you know, ridesharing apps, motorcycle sharing apps in India, car sharing apps. We actually -- our prototyping car sharing application for customers sitting in our parking lot in Germany took time being. So, it's an important capability to have that opens up the door in terms of possibilities.

Okay. Thanks a lot guys.

Our next question will come from Richard Valera with Needham & Company. Please go ahead.

Thank you. The trade has been an issue for a few quarters. So, I just wanted to make sure I understood what caused the slowdown in the June quarter specifically as it related to trade and what gives you the confidence that that picks up in the next couple of quarters.

So, I guess, confidence wise is the -- the benefit of reporting at this juncture with a good portion of the quarter done. So, we have the benefit of seeing some of the data and not just purely relying on forecast. A little bit of commentary and then Jeremy, maybe you can jump in here as well. If we kind of look back at inventory numbers, channel inventory numbers, it seems like the fear of tariff and implementation kind of causing the run-up on both end customers and in the channel. So, we did see an increase in the March quarter. And then with some more of the macro uncertainty that the tariffs might be causing more economic wise, then we saw a need to kind of mitigate as that uncertainty built, people wanted to kind of draw those inventory numbers down. It was wholesale. There were some subtleties in it. So, if I look at our OEM business that was primarily an EMEA based phenomenon, and that would be -- there might be some other fears playing in the way including Brexit, that could have caused us an inventory build up. And if you look at ITM, ITM was down in the U.S., but that was that business has classically been a little bit more lumpy and CapEx cycle dependent. And then I'll note that, October one is defense cycle fiscal year, so there's some spending that kind of has to happen in the September quarter. So, there were -- there were some things that happened as we look at and said okay, that was a normal anomaly for us. And then there were some larger macro trends that we can attribute this specific things that happened. And then, as we went out and looked, you know, and touched base with the customers to see what their demand was doing, they assured us that the sockets were solid, and that the spending would be there was just they were reacting to some mandates to draw down that inventory.

Got it. And then on the IoT business, there has been a lot of talk in prior quarters about a number of design wins that you had with customers that were taking longer than expected to ramp. And just wonder if you can provide some commentary on the pipeline of design wins and the status of what was a pretty I think meaningful number of design wins that were won, but were kind of waiting a revenue ramp.

Yeah. So, we've definitely seen a shift to some of those design wins to production. I will note one in particular -- actually, we flew a couple of techs to Taiwan to help one customer get his production ramp on [floor] [ph], they were running into technical issue. We solved this, this past quarter. And as noted in the prepared remarks, we did see an increase or growth in the newer WiFi products, which is primarily what we've been talking about in terms of design wins and design counts, and so that we expect that production ramp to look pretty good over the next year. And I'll just -- one additional note that I'll say on design wins, the counts have been pretty good. I think we go back and look at the dollar amounts attached to each win, we need to strive to have -- to start chasing slightly better opportunities and that's what we're going to take a look at -- driving a little bit higher volumes. I do want -- I made a comment regarding channel inventory. We saw run up about two weeks prior and Jeremy's got some data that he can give me an indication what channel inventory is doing with respect to IoT, currently.

Yeah. I think if we look back at our historical inventories on average, we carry -- our channel typically has five to six weeks in the channel, if you least within -- over the last 12 months. In the March and June quarters, that was probably about three weeks higher than normal. And I think one of the positive indicators we're seeing at least this quarter is those inventory levels are beginning to trend down at the distributors, and so that should lead to improved demand from those distributors as they begin to refill the channel. So, we are seeing a positive indicator there.

Got it. And then I know it's early, Paul, but historically I think this -- the IoT business been talked about as kind of a double-digit growth business. But if you look at the last year and what's seemingly embedded in your organic revenue guidance for this year, it's flat or very modest growth. So, just wondering how you're thinking of that business medium to longer term, does this have high single digit, double-digit growth potential? Or how are you thinking about that?

I definitely think that the market opportunity is there. And we feel pretty strongly we can address that market opportunity. We're not going to be able to do it the way it's classically been done where we offer a particular widget or one particular piece of the puzzle that is IoT. So, it needs to be a little bit more platform driven, a little bit more comprehensive. So, when we go talk to customers they say, hi, I would like to do this. They don't really care how it's done, they just want it done. And so that, that requires you to take a little bit of a technology agnostic point of view, and address the totality of the problem with a solution set. So that may mean something that we have done in the past. But I do take a little bit of an agnostic approach when it comes to hardware. And I'll give you one anecdotal -- we've got a couple of platforms that we've been prototyping. One is mean time before repair kind of use case where we have a tire manufacturer that is, would like to implement a sensor technology, data collection technology to actually track order of tires and prompt the user, hey, schedule a service appointment to get your tires changed. So, this way they can capture their name brand tires, with -- on a direct car basis rather than having somebody go just shop at Lowe's. That's one use case that we're prototyping right now for somebody. Another one would be location of industrial equipment in buildings. Surprisingly enough there's a lot of wasted man hours, you can calculate the loss associated with some of these multi storey buildings, office buildings trying to locate industrial cleaning equipment. And we've got a solution that we're putting together for a particular customer that will address that holistically, not just a particular sensor on a floor buffer and somebody else has to worry about the rest of the system. So, that’s -- hopefully, that gives you a flavor of kind of what I'm talking about. But I do think it can drive double-digits.

Right. Okay. And one more if I could. Just in reference to your 30% growth. And I think it's non-GAAP income, but I'm just going to use EPS as sort of a rough proxy for that. If you were to do 30% increase on your reported EPS from the prior year that would put you or require you to hit around I think $0.21 for this coming year. And starting with -- let's just call it breakeven in the first quarter that would have averaging kind of $0.07 per quarter, which is a pretty hefty level relative to where you've been in the recent past. So, just wondering how we should think about the ramp of the earnings as we move through the year, assuming we kind of have a breakeven-ish start in the first quarter.

So, I can answer that question and talk a little bit about how we address the game plan, the M&A playbook, if you will, we're taking an asset that very clearly we can harness a lot of synergy from. In my prepared remarks I talked about some of the efficiencies in Lantronix proper business that we will be addressing, so I don't need to spend more with an acquired business. And it's just a matter of transitioning and establishing those budgets and then prioritizing the projects we're going to work on. There is some transition work that needs to happen. And obviously, if you're starting out at zero -- a very dear friend of mine told me that if you're going to make $12 in a year, you got to make the first dollar in month one. So, since we're starting off at zero, it is obviously second half weighted. But you will see the execution and evidence of that as we execute on the synergy plans. And so going back to the M&A playbook, it's a six-month cycle. We're on track to do the integration on finance, the SG&A function, the rest will follow suit as we consolidate. I'd like to not lose a little bit of progress that we're making on the software front with any massive perturbations in the group. And so, as we clean up one thing, it'll come off our plate and we'll move forward very quickly, but you will see those numbers transpire shortly.

Okay. Thank you for taking the questions.

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

Thank you very much for your time, and hope you had a good day.

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