Lantronix, Inc. (LTRX) Q1 2020 Earnings Report, Transcript and Summary

Good day, and welcome to the Lantronix Inc. Fiscal 2020 First Quarter Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Amber Tinz. Please go ahead.

Good afternoon, everyone, and thank you for joining the Lantronix First Quarter Fiscal 2020 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 website. In addition, a phone replay will be available starting at 8:00 P.M. Eastern, 5:00 P.M. Pacific today through December 13 by dialing 877-344-7529 in the U.S., or for international callers, 412-317-0088 and entering passcode 10136685. 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 statement 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-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 website, describes the differences between our non-GAAP and GAAP reporting and presents reconciliations for the non-GAAP financial measures that we yield. With that, I’ll now turn the call over 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 first quarter of fiscal 2020 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 quarter ended September 30, 2019 net revenue was at the upper-end of our guidance range as we reported $12.7 million in net revenue compared to $12.3 million for the first quarter of fiscal 2019 and $10.2 million for the fourth quarter of fiscal 2019. Gross profit as a percentage of net revenue was 48.6% for the first quarter of fiscal 2020 as compared with 55.2% for the first quarter of fiscal 2019 and 56.6% for the fourth quarter of fiscal 2019. The sequential decline in gross margin was primarily due to product mix as a result of our recent acquisition. In addition, we expensed $171,000 to cost of goods sold in connection with the amortization of manufacturing profit and inventory that we assumed as part of the Maestro acquisition Selling general and administrative expenses for the first quarter of fiscal 2020 were $4.5 million compared with $4.3 million for the first quarter of fiscal 2019 and $3.6 million for the fourth quarter of fiscal 2019. Research and development expenses for the first quarter of fiscal 2020 where $2.6 million compared with $2.2 million for the first quarter of fiscal 2019 and $2.2 million for the fourth quarter of fiscal 2019. The increases in SG&A and R&D were primarily due to headcount and related costs assumed in the recent acquisition of Maestro. GAAP net loss was $2.5 million or $0.11 per share during the first quarter of fiscal 2020 compared to GAAP net loss of $83,000 or $0.0 per share during the first quarter of fiscal 2019 and a GAAP net loss of $1.5 million or $0.06 per share during the fourth quarter of fiscal 2019. Included in the GAAP net loss, were approximately $1.7 million of acquisition and severance related costs. Non-GAAP net income was at the top of our guidance range as we were break-even, $0.0 per share for the first quarter of fiscal 2020. This compares to non-GAAP net income of $883,000 or $0.04 per share for the first quarter of fiscal 2019 and non-GAAP net income of $722,000 or $0.04 per share for the fourth quarter of fiscal 2019. Cash and cash equivalents were $12 million as a September 30, 2019 as compared to $18.3 million as a June 30, 2019. The decrease in cash was primarily related to our acquisition of Maestro in July, 2019. Working capital was $19 million as of September 30, 2019 as compared with $26.7 million as of June 30 2019. Net inventories were $12.4 million as of September 30, 2019 compared with $10.5 million as of June 30, 2019. The increase was primarily due to inventories assumed in the July acquisition of Maestro. Now turning to our recent announcement of the Intrinsyc acquisition. First, let me recap the terms of the transaction. Under the terms of the agreement, Lantronix will pay approximately $11.5 million in cash and issue approximately 4.3 million shares of its common stock to Intrinsyc shareholders, which equates to total consideration of approximately $26 million. Taking into account their existing cash, this is less than one times the revenue for the last 12 trailing months. The transaction which is subject to approval by the shareholders of Intrinsyc and customary closing conditions has been unanimously approved by the board of directors at both companies and it’s expected to be completed in January, 2020. Following the transaction, Intrinsyc shareholders are expected to own approximately 16% of the outstanding shares of the common stock of Lantronix. Now let me give you some perspective of the total potential contribution that Intrinsyc brings. For the 12 months ended June 30, 2019, their revenue was approximately $25 million, which brings additional scale to the combined entity. From an earning standpoint, we expect the transaction to be accretive to non-GAAP EPS during the first full quarter that it contributes to our operations. Longer term, we are targeting $2 million in annual cost synergies as we integrate supply chains, eliminate redundant public company costs and realize other operating efficiencies. As it relates to financing the transaction, yesterday, we announced that we have secured additional financing for the Intrinsyc acquisition with an amendment to our existing loan and security agreement with Silicon Valley Bank. Per the terms of the agreement, SVB will provide us with a $6 million term loan payable over four years at an interest rate of prime plus one. In addition, we increased our revolving line of credit from $4 million to $6 million to provide access to additional working capital if needed. Assuming that the Intrinsyc transaction closes in January, 2020, we would expect to increase our fiscal 2020 growth rates as previously discussed. Revenue growth target increases from 15% to 25% and non-GAAP EPS growth target increases from 30% to 35%. Now I will provide guidance on revenue and earnings for the second of fiscal 2020. We expect net revenue of $12.5 million to $13.5 million and non-GAAP net income per share of $0.02 to $0.06. I'll now turn the call over to Paul.

Thank you, Jeremy. As you can see, Q1 was a productive quarter for Lantronix. We announced and closed the Maestro acquisition. We moved quickly to begin integrating its product portfolio and realizing synergies. And last week announced an agreement to acquire high-end intelligent edge compute solutions leader, Intrinsyc Technologies Corporation. Internally we focused on revenue execution in macro affected quarter, controlled inventory and expenses and delivered earnings at the high end of our guided range. Our inventory in the channel declined sequentially as customer consumption in our core business improved. And we are optimistic future quarters will see shipments more in line with historical in-market demand. While we haven't seen a step function change in the current economic environment, we are seeing improvement. Digging into the products, we saw a number of positives. On the hardware front, our newer WiFi products continue to gain momentum. During the quarter, two of our larger customers in industrial printer company and a leading manufacturer of weighing platforms have now moved into volume production on products utilizing our xPico 200 WiFi product family. Also our newly released out-of-band products continue to build design momentum with customers engaging in proof-of-concept or POC deployment testing. Turning to software, while still in the early innings, our pipeline continues to grow. After on-boarding two new customers in Q4, we've added another four customers in the past quarter with over 20 customers in the POC stage. We have further refined our software product roadmap to integrate the newly acquired D2Sphere software into Lantronix's SaaS platform. And we are on schedule in consolidating the teams and eliminating parallel development efforts. While it is still early innings, we are executing on our plan and seeing positive results, sequential growth for the combined company, operating expense synergies and significant earnings accretion. In addition to our focus on the core business and the integration of Maestro, we continue to execute on our inorganic growth strategy, resulting in the Intrinsyc acquisition announcement last week. For those that weren't on the conference call last week, I'll give another overview of the Intrinsyc acquisition and why it makes sense for Lantronix. From a strategic standpoint, this is a compelling acquisition. Intrinsyc brings complimentary high-end intelligent edge computing technologies, embedded product design and software capabilities that will expand our embedded hardware portfolio, software engineering, artificial intelligence, and machine learning and rapid prototyping capabilities. Together our complimentary portfolios will enable a more complete IoT solution capability. Over the longer term, the combination of our design teams will allow us to accelerate our IoT product offerings and industry-leading solutions while increasing our ROI. It also diversifies our customer base and expands our customer engagement. This deal also makes good financial sense for Lantronix. Intrinsyc has an impressive track record, having grown at a 26% compound annual growth rates since 2014, while consistently delivering strong EBITDA margin performance. As we leverage their solutions into our global platform, we see continued double-digit growth capability but with improved profitability as a result of the increased scale combined entity. We also see a number of significant synergy opportunities and expect this transaction will be immediately accretive to our non-GAAP earnings in the first full quarter. Like Maestro, Intrinsyc fits the mold, you should expect from our acquisitions. It fills up our IoT stack capabilities, delivers exceptional growth opportunity and drives more profit to the bottom line for our shareholders. Over the last two quarters, we have come a long way. We have focused on executing on our core business while continuing to seek out strategically and financially sound acquisitions. As evidenced by our second quarter earnings guidance, we are already starting to see results. We look forward to reporting on our progress again soon. That completes our prepared remarks for today. So I will now turn it over to Eiley to conduct our Q&A session.

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

Hey guys, thanks for taking my questions. Just want to start with the Maestro business. I’m just curious if you could divulge what the contribution was in the September quarter. And relatedly, what has customer reception been to that business now that it's under the Lantronix umbrella?

Yes. So the customer’s reception has been quite good. I mean, there's a number of things that we bring to the party, namely we take a small supplier to a bigger supplier. I think they liked the financial stability that comes with that natural marriage. Not just that, but also the added capability. So the reception has been quite good from a customer standpoint. So that's going pretty well. We're not going to specifically break out Maestro as a separate entity. We're already integrating the product lines into several other product lines that we have. That's the way you typically do that in order to garner the synergies that we're expecting to see. But I will say, we had kind of – if you go back to what we had kind of mentioned on the last call regarding Maestro, we kind of call them a $10 million company. We judged them flat this next year and I'll say that they're on pace for that.

Okay. That's helpful. And then I know you mentioned that inventory in the channel declined sequentially. Just curious what you think, how much more inventory you think needs to be digested there?

Yes. So inventories – channel inventories in particular came down just under a million bucks, nine and change. So we're at about nine weeks and would like to see it, our target there is seven weeks. We think that's a good healthy number for us to have. We saw a nice little bump obviously with that reduction in, in customer demand. So saw consumption go up in the quarter. It wasn't quite not be what I would call a snap back, but it was nice improved, some strength to that baseline underlying business.

Okay. And the last one from me, and I'll jump back into queue. I know there's lots of moving parts with the acquisitions, but looking at operating expenses, non-GAAP OpEx came in at about $6.3 million in September. How should we think about OpEx trending the rest of this fiscal year?

Yes. So I'd say that you should expect us to pick up some additional synergies or I'll say efficiency in the model. If we look at our integration plan attached to our completed transaction Maestro, we kind of had a six month timeframe that we were looking to really kind of capture the synergies. We're in – really the last quarter would be more refinement after this. And so we expect to pick up some additional efficiency obviously as we close our next acquisition next quarter or in the first quarter calendar year, we look to pick up some additional efficiency. So I would say as a percentage of revenue, you see it improve certainly not increase.

Perfect. Thanks a lot guys.

Our next question comes from Rich Valera [Needham & Company]. Please go ahead.

Thank you. Paul, could you give us an update on the IoT design win pipeline conversion. I know there's been kind of delays that some of your – your wins converting to revenue, but any sense of how that pipeline is, have you seen any more kind of converting and just how you're thinking about that?

Yes. So I wanted to highlight two – a couple of programs go into production. I can highlight a few more, but there were two large ones with our WiFi product that went to production. We got, I'll say unstuck, solve the last little bit of the technical issues associated with those. So those begin to ramp. For the most part the color that I can give you, I still – again, if you reflect on my prepared remarks last quarter I said that we needed to kind of do a better job on the sales front. I will still say that we need to do a better job in engaging with our customer base on the sales front and we’re going to continue to work on that. Having said that, we have begun that process. We are making some progress. We’ve had a couple of our customers that – our long standing customers that haven’t been interested in some of our other products, they’re now starting to express that we’ve had a couple of programs kind of coming back to life. So, overall we’re making progress where I kind of felt like we were stuck before, but I still feel like we can do better.

I appreciate that color. And similar question on the IT management business. We know that’s a chunky business historically, but how should we think about that business relative to where it came in, in the quarter and how that student outlook is for that over the next few quarters?

So, both IoT and ITM were up sequentially. IoT was pretty, pretty much down last quarter, kind of unseasonally down where a couple of things happened. I think we gave a little bit of color in terms of defense. Fiscal year-end we expected it to rebound a little bit. So, it did do that, this past quarter. We were happy to see that. I think as we look at some of the engagements, some of the progress and the consumption that I’m looking at to-date it looks pretty good for ITM. So that one has been, it can be very lumpy. It was very lumpy and, unseasonally down last quarter. But we’re definitely seeing some strength in number and still see some strength going forward.

That’s great. And one more for me, just on the, on gross margin that was a little bit lighter than we were expecting. And I know some of that’s the Maestro impact, but how should we think about gross margins? Was there anything kind of onetime-ish other than the 170,000 you called out in the gross margin? Just in terms of as we look into Q2 and beyond.

Yes. The non-cash charge related to the purchase accounting of 170,000 accounted for probably a little bit over a 100 basis points of margin. I mean, we wouldn’t expect to have at least as it relates to Maestro have that charge again. And so we would expect margins to improve from this quarter back up to the low-50s or right around 50.

Yes. So I think you should see some improvement, especially as we kind of capture some of the operational synergies that were contemplated going forward. You should see those come up. Got it. Okay.

Okay, that’s it for me guys. Thank you.

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

Thank you very much for joining us today. I hope you have a fantastic evening.

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