Lantronix, Inc. (LTRX) Q2 2020 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the Lantronix Q2 2020 Results conference Call. [Operator Instructions]. Please note, today's event is being recorded. I would now like to turn the conference over to Amber Tinz. Please go ahead, ma'am.

Good afternoon, everyone, and thank you for joining the Lantronix Second Quarter Fiscal 2020 Conference Call. Joining us on the call today are Paul Pickle, Lantronix President and Chief Executive Officer; Jeremy Whitaker, Lantronix Chief Financial Officer; and Jonathan Shipman, Vice President of Strategy and Marketing. 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 p.m. Pacific today through March 12 by dialing 877-344-7529 in the U.S. or for international callers, 412-317-0088 and entering pass code 10139087. 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-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 use. With that, I'll now turn the call over to Jeremy Whitaker, Lantronix 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 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 second quarter of fiscal 2020, net revenue was at the upper end of our guidance range as we reported a $13.2 million in net revenue compared to $12.1 million for the second quarter of fiscal 2019 and $12.7 million for the first quarter of fiscal 2020. Gross profit as a percentage of net revenue was 51.2% for the second quarter of fiscal 2020 as compared with 55% for the second quarter of fiscal 2019 and 48.6% for the first quarter of fiscal 2020. The year-over-year decline in gross margin was primarily due to product mix as a result of our July 2019 acquisition of Maestro. Selling, general and administrative expenses for the second quarter of fiscal 2020 were $4.9 million compared with $4.2 million for the second quarter of fiscal 2019, and $4.5 million for the first quarter of fiscal 2020. The year-on-year increase in SG&A was primarily due to additional head count related to the recent acquisition and an increase in share-based comp. Research and development expenses for the second quarter of fiscal 2020 were $2.3 million compared with $2.3 million for the second quarter of fiscal 2019, and down from $2.6 million in the first quarter of fiscal 2020. GAAP net loss was $1.4 million or $0.06 per share during the second quarter of fiscal 2020 compared to GAAP net income of $277,000 or $0.01 per share during the second quarter of fiscal 2019, and a non-GAAP and a GAAP net loss of $2.5 million or $0.11 per share during the first quarter of fiscal 2020. Included in the GAAP net loss were $858,000 of acquisition and severance-related costs. Non-GAAP net income was below the midpoint of our guidance range, and up sequentially as we reported $0.03 per share or $666,000 for the second quarter of fiscal 2020. This compares to non-GAAP net income of $790,000 or $0.03 per share for the second quarter of fiscal 2019 and non-GAAP net income of $7,000 or $0 per share for the first quarter of fiscal 2020. Cash and cash equivalents and restricted cash were $15.3 million as of December 31, 2019, as compared to $18.3 million as of June 30, 2019. In January 2020, we used approximately $11 million of this cash balance to fund the acquisition of Intrinsyc. Working capital was $23.3 million as of December 31, 2019, as compared with $26.7 million as of June 30, 2019. Net inventories were $11 million as of December 31, 2019, compared with $10.5 million as of June 30, 2019. Now turning to our recent acquisition of Intrinsyc, which closed on January 16, 2020. Let me give some perspective of the potential contribution that Intrinsyc brings. For the 12 months ended December 31, 2019, revenue was approximately $25 million, which brings additional scale to the combined entity. From an earnings standpoint, we expect the transaction to be accretive to non-GAAP EPS in our fourth fiscal quarter, which will be the first full quarter of combined 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. Intrinsyc finished the calendar year strong with a little over $7 million in sales for the quarter ended December 31, 2019. This business typically has a stronger second half seasonality. And as we look ahead, we expect a typical slower seasonal first half. In addition, it should be noted that the first 15 days of January will not be included in our financial results for the March 2020 quarter. Now I will provide guidance on revenue and earnings for the third quarter of fiscal 2020. We expect net revenue of $18 million, plus or minus 10%, 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. Three quarters into the transformation of Lantronix, we are pleased with our progress, including this quarter's top line results as compared to our forecast. While the macroeconomic environment has not shown significant improvement since our last report, we were able to drive revenues of $13.2 million, up 4% sequentially and towards the high end of our guidance. EPS was $0.03 within our guided range, however, lower than the midpoint. While non-GAAP operating expenses were down sequentially, they came in higher than our initial expectations. We remain focused on our integration plans and are otherwise on schedule. We continue to add the talent necessary to take Lantronix to the next level. You may have seen in the news recently that we hired a new VP of Sales and Business Development, Roger Holliday, to drive our go-to-market processes. Roger is a veteran of the technology industry, and we've worked side-by-side for the last 20 years. I am confident in his ability to lead our sales efforts while we also integrate teams from recent and future acquisitions. We saw good growth in our IoT products this past quarter, primarily driven by our Ethernet modules and our newer WiFi products that continue to gain momentum during the second quarter due to customer production ramps. Looking at newly acquired product lines, we saw sequential growth from router and asset tracker solutions and our newly launched fourth generation tracker products had a strong initial ramp, partially offset by lower modem revenues. While we are seeing good results with our newer and acquired products, the older Lantronix products did not see the same success in Q2. Revenues here were flat sequentially, and they have been below historical norms for the past few quarters. Distributor inventories were also flat sequentially and continue to sit at an appropriate level of about 9 weeks. For the last three quarters, we have been cautiously optimistic Lantronix legacy products would return to prior revenue levels as compared to a year ago. To date, we have not yet seen it and have adjusted our outlook accordingly, at least until the broader economy improves more significantly. As such, our guidance for the March quarter and fiscal 2020 incorporates a more modest mix of revenue expectations for our legacy products. Should we see an improvement in consumption relative to our newly revised expectations, it would drive upside to our model. Turning to software. I am pleased to report the pipeline continues to grow. In the second quarter, we added three more customers bringing the total to nine. And I should add that those were paying customers. We now have 27 customers in the POC stage, up 7 from the prior quarter. More importantly, we have also further refined our software product road map. We've integrated the newly acquired D2Sphere software back in, into the Lantronix's SaaS platform, and we are developing a new consolidated front end with additional micro services planned for rollout over the next few quarters. In sum, we continue to see good growth opportunities for Lantronix. While the progress towards the resolution of trade disputes between the U.S. and China is a positive potential for our customer base, the full effect of the COVID-19 virus on our supply chain and on end market demand is as of yet unknown. Currently, the extension of the Lunar New Year holiday has delayed our supply chain, although our contract manufacturers forecast to catch up by the end of the quarter. That said, our greater than 25% year-over-year revenue growth expectations for fiscal 2020 have been exceeded, and our new target growth range is 30% to 35%. However, given our more muted near-term expectations for the older, higher margin Lantronix products, we now expect fiscal year 2020 EPS will be flat to up 10% year-over-year from fiscal 2019. On the M&A front, we continue to focus on capturing additional value-added technologies and products within the IoT stack. This will make us more valuable to our customers, bringing a deeper, more profitable engagement with our end markets. We are pleased to report that our acquisition of Intrinsyc closed in the middle of January as planned, and we have already begun the integration of this exciting business. From our strategic standpoint, this is a compelling acquisition. Intrinsyc brings complementary, 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 complementary 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 offering and industry-leading solutions while increasing our ROI. It also diversifies our revenue 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 rate 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 of the combined entity. We are now 3 quarters into the transformation of Lantronix, a transformation from a small connectivity-only supplier to a larger, faster-growing IoT solutions supplier with a strong grasp of the value-added technologies within the IoT stack. As we continue to execute, we expect to outgrow and out-profit our peers. 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 the operator to conduct our Q&A session.

[Operator Instructions]. Today's first question comes from Jaeson Schmidt of Lake Street.

I just want to start with the strength in the IoT business. Curious if you could comment on if there's any particular markets that you're seeing strength from or if certain markets have been stronger than others?

Well, we saw a nice uptick in our tracker business. We kind of talked about that. I think we had a product that we've just recently released and had a nice initial ramp. That was our fourth-generation product, utilizing LTE cat in one. So for the most part, trackers, we're doing fairly well. Pretty steady contribution coming from our gateways. Modems is a little bit more of a heritage business, not necessarily something that we'll be continuing to do a lot of development. And so it's not surprising that it was a little bit lower. Our Ethernet modules was really quite strong. So that came back quite nicely, had nice little uptick. And so for the most part, if we look at it, that's kind of the balance of what we saw with a little bit of color in terms of what was offsetting to the other growth numbers.

Okay. And then just shifting gears to the IT management business. Is some of that softness that you saw in December just typical order lumpiness?

Yes, it's not appreciably down below what is typical in this cycle. So last quarter was an upcycle for us. This quarter was a downcycle for us. It's within the range or the norm of which it kind of bounces back and forth. So I would just call it, typical. We did have a little bit more - I think, if you look at some of the products that are rolling off a little bit. We had Spider - our Spider product, KVM product was a little bit lower as well as some of our SLB product. Those kind of fell out the norms, if I slice up that category a little bit more. But for the most part, it was pretty normal.

Okay. And last one for me, and I'll jump back into queue. I know there are just a number of moving parts here. But what sort of OpEx run rate level should we think about going forward? I think on a pro forma basis in December, $6.2 million in pro forma OpEx?

Yes. So at least the classic Lantronix business, before taking into consideration the acquisition, because, obviously, we're going to add costs bringing on Intrinsyc into the picture. But for the Lantronix business, we're continuing to work through the cost synergies from the Maestro acquisition. So in general, as we - over the next couple of quarters, we continue to expect to see synergies from that integration. So that part of the business should begin to decline slightly, at least in the OpEx. But then, on top of that, you have to layer on the historical business from Intrinsyc on top of it.

Yes. And if you kind of want to think about it on a go-forward basis, just think about steady improvement as a percentage of revenue over the next probably 9 months. We have some transition costs in there associated with the latest acquisition that will take us through the June time frame or out 6 months, I should say. And so if you kind of think beyond that, we'll make steady improvements as we kind of complete some of the integration plan for Maestro. Then over the next 6 months, we'll start to continually pull out some of the costs associated with Intrinsyc. So steady improvement over the next 9 months or so.

[Operator Instructions]. Today next question comes from Rich Valera, Needham & Company.

This is Nate on for Rich. So first, wanted to look - looking at the quarter, I was wondering if the IoT design wins from last quarter impacted - impact the results at all, particularly if the two large WiFi wins that went into production were performing as expected? Or if there's any color there that you could - that would be helpful.

Yes. We called out that one, in particular, in the prepared remarks, to just kind of say that we're definitely in production on those. They continue to ramp up. The newer WiFi products are definitely filling in some of the older historical business fall off. So that's going rather well. And that was one of the contributors that we saw this quarter that came in pretty strong for IoT.

Great. And then just looking at gross margins. So gross margins, I think, rebounded nicely in the quarter. And I think, potentially slightly better than as expected. And I was wondering if there is any color there regarding the outperformance? Or if that was just a result of the product mix?

Mostly product mix. We are making improvements and refining our operations. But if I point to the Maestro acquisition, while we're slightly ahead of our plans, the model that we use to justify the acquisition. So things are going rather well there in terms of pulling out costs and driving the efficiencies. We've had some small delay in some of the integration activity, but some of that was pretty - was anticipated because we built a conservative model. But most of those are on track. Really, all of them are on track with just a slight 2, 3-month push out. So we'll see improvement, I think, further improvement. Now obviously, we're folding in a business that's not doing 51 points of margin. So expect combined business to end up in the 40s at some point this quarter, and then we'll make steady improvement on driving some efficiency there.

Great. Just last question for me. So I know on the prior call, you discussed making improvements on the sales front. I know you added personnel this quarter. And then thinking about the time of acquisition, there is also the mention of significant cross-sell opportunity regarding Intrinsyc. And so I was wondering kind of the dynamics at play in the sales initiatives, balancing both new personnel as well as cross-sell and Intrinsyc.

Yes. That's a great question, and I'll see if I can give you a good answer in a short period of time. It's a complex one for us, though, in particular. The revenue synergies, first of all, they're not in our financial model, when we kind of talk about the combined entity and what we see happening over the fiscal year. So we're not necessarily planning on those revenue synergies, but I think that there's lots of opportunity. 36% of the world's SoMs, SoCs are consumed in Europe, and it's a fraction, a small fraction let's say, less than 10% of Intrinsyc's revenue overall. Certainly, expect that to change over this next year, but it didn't really have much in terms of sales resources in EMEA, and we have a team there. The team is looking forward to selling the product. So it really does expand the opportunity for us pretty considerably since we have several engineering sites in Europe as well as support services there in addition to the sales team. Lantronix has products that kind of go across the board. We've got products that are kind of one-to-many from a sales front. And that's where a lot of our sales processes need to be revamped. We were kind of a bit too reliant, I think, on recurring revenue or repeat orders from customers that had bought in the past. The good news is that those customers trust the products. They continue to buy the product. So that's a great base to build off of. Happy to have that. But we can do a much better job blocking and tackling. And I think Roger Holliday is - in particular, he was brought in to address some of the organizational and process initiatives that we have in place and wanted to kind of implement in order to move the ball forward. So I think going forward, it will take that team a little while to get organized, but we're already starting to see in terms of new opportunities. I'll give you one little - one additional anecdote. So at the last QBR that we had, I was particularly pleased to see the EMEA presentation. The opportunity funnel is really filling in with all of the Maestro product opportunities. I'm starting to see that grow and increase, and it's a testament to what can happen if you just have a larger sales force that's giving good product, the presence in front of customers. So that's happening in North America as well. And then we expect to see the same thing happen with the Intrinsyc business, our intelligent edge solutions business. So overall, I have high hopes. I have high confidence in Roger to be able to turn that around, and we'll be reporting on that progress over the next few quarters.

[Operator Instructions]. This concludes the question-and-answer session. I'd like to turn the conference back over to Paul Pickle for any closing remarks.

Thank you, guys, very much for attending today, and hope you have a great day.

Thank you, sir. Today's conference has now concluded, and we thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.