Good afternoon, and welcome to the Lantronix, Inc. 2020 Q3 Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Amber Tinz.

Please go ahead..

Good afternoon, everyone, and thank you for joining the Lantronix third 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, Lantronix 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 P.M. Pacific today through May 21 by dialing 877-344-7529 in the U.S. or for international callers, 412-317-0088 and entering pass code 10143448.

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 business highlights for our third 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 third quarter of fiscal 2020, net revenue was at the upper-end of our revised guidance range of $15 million to $17 million, which we provided on our Investor Update Call held on March 11, 2020. We reported $16.5 million in net revenue, an increase of 34% when compared to $12.3 million for the third quarter of fiscal 2019.

Sequentially, revenue was up 25% compared to the $13.2 million reported in the second quarter of fiscal 2020. The year-on-year growth was primarily driven by contribution from our acquisitions, although, our growth was significantly tempered by disruptions caused by the COVID-19 pandemic.

Gross profit as a percentage of net revenue was 44.7% for the third quarter of fiscal 2020, as compared with 57.4% for the third quarter of fiscal 2019 and 51.2% for the second quarter of fiscal 2020. The decline in gross profit percentage was primarily due to a change in product mix as a result of our recent acquisitions.

In addition, our margins were negatively impacted by freight and tariff costs related to supply chain mitigation efforts we took in light of the pandemic.

Selling, general and administrative expenses for the third quarter of fiscal 2020 were $5.6 million, compared with $3.9 million for the third quarter of fiscal 2019 and $4.9 million for the second quarter of fiscal 2020.

The year-on-your increase in SG&A was primarily due to additional headcount costs related to the recent acquisitions and an increase in share-based compensation.

Research and development expenses for the third quarter of fiscal 2020 were $2.7 million, compared with $2.4 million for the third quarter of fiscal 2019 and $2.3 million in the second quarter of fiscal 2020.

Non-GAAP operating expenses as a percent of net revenue decreased sequentially from 47% in the second quarter of fiscal 2020 to 42% in the third quarter of fiscal 2020, as we continue to capture synergies and take advantage of the operating leverage from our recent acquisitions.

Looking forward, we expect non-GAAP operating expenses to continue to decline as a percent of net revenue, as we realize synergies from the recent acquisitions. GAAP net loss was $5.2 million, or $0.19 per share during the third quarter of fiscal 2020. Included in the GAAP net loss were $4.3 million of acquisition and severance-related costs.

During the third quarter of fiscal 2019, we reported GAAP net income of $857,000, or $0.04 per share. There were no acquisition or severance-related costs in the comparative period.

I’m pleased to report that despite the significant supply chain and business interruption that we faced last quarter, our team still delivered non-GAAP earnings per share within the $0.02 to $0.06 guidance range that we originally provided on our February 12, 2020 earnings calls.

Non-GAAP net income was $0.02 per share, or $611,000 for the third quarter of fiscal 2020. This compares to non-GAAP net income of $1.3 million, or $0.05 per share for the third quarter of fiscal 2019 and non-GAAP net income of $666,000, or $0.03 per share for the second quarter of fiscal 2020.

Cash and cash equivalents were $7 million as of March 31, 2020, compared to $15.3 million as of December 31, 2019. In January 2020, we used approximately $8.3 million of net cash as partial consideration for the acquisition of Intrinsyc. You may have seen our recent Form 8-K disclosing our receipt and subsequent repayment of the PPP loan.

Although eligible for the financing, we decided to repay the loan in light of our most recent forecast for the fourth quarter and fiscal year 2021, which improved substantially from the time we initially decided to apply for the funding. Working capital was $18.6 million as of March 31, 2020, as compared with $26.7 million as of June 30, 2019.

Net inventories were $15.2 million as of March 31, 2020, compared with $10.5 million as of June 30, 2019. Now turning to our recent acquisition of Intrinsyc, which closed on January 16, 2020. As mentioned earlier in my remarks, Intrinsyc contributed significantly to this quarter’s revenue growth.

In addition, I’m pleased to announce that the acquisition was accretive to our non-GAAP earnings in the quarter and we expect it to be accretive to non-GAAP EPS in our fourth fiscal quarter as well, which will be the first full quarter of combined operations.

As a reminder, we set a target of $2 million in annual cost synergies within a year of closing the acquisition, as we integrate supply chains, eliminate redundant public company costs, and realize other operating efficiencies, and we have already begun to capture some of these savings. I’ll now turn the call over to Paul..

Thank you, Jeremy. We were pleased to report revenues of $16.5 million in Q3, up 25% sequentially and 34% year-over-year in what was a challenging supply-constrained market environment.

As we stated on our last guidance call, end demand held up reasonably well, especially in North America, as we have seen some upside for our connectivity and intelligent edge computing solutions as a result of the increased focus on work from home initiatives at our customers.

As a reminder, we had initially guided for revenues of $18 million for the March quarter and later lowered that expectation as a function of compounding supply chain shortages.

While the supply chain disruptions that tempered Q3 results will persist through – throughout Q4, we entered the quarter with a stronger backlog and order patterns quarter-to-date have also been strong. Despite the supply chain disruption, we focused on controlling what we could last quarter.

Operationally, we anticipated some of the government shutdowns and repositioned the timing of inventory receipts from our contract manufacturers to fulfill customer orders without significant delay. Additionally, we anticipated and transitioned quickly to a work from home environment ahead of India, Germany and California shutdown orders.

These actions minimized the revenue and product development impact seen in the quarter. Lastly, we took steps to accelerate our integration plans and we slowed spending where prudently possible to preserve profitability.

As such, a result of this discipline, we are happy to report profitability at the low-end of our original guidance of $0.02 on a non-GAAP basis. These results are despite paying much higher freight costs and tariffs as we hustled to deliver on demand.

All in, our IoT product lines contributed $13.9 million in Q3, up 25% sequentially and 56% year-over-year. We saw good billings and bookings, driven by an increased demand for our solutions and video conferencing equipment. Our gateway and device server products also performed well in the quarter, driven predominantly by medical applications.

As a reminder, this is an important focus for us, as there is a growing need in medical applications for Internet connected devices. Ethernet modules in our asset tracking and gateway modem solutions softened in Europe and Asia after a strong showing in the December quarter.

Our IT management product revenues totaled $2.4 million, up 32% sequentially and down from $3.2 million a year ago. Other Lantronix product lines were relatively flat for the quarter and with the exception of supply chain-related delays, demand was largely in line with our expectations. Turning to software.

I’m pleased to report the pipeline continues to grow. In the third quarter, we received three new purchase orders activating 24 additional software licenses. We now have 50 customers in the pipeline, up from 27 in the prior quarter.

We also achieved a significant milestone in completing customer security audit against our SaaS platform, unlocking further progress within our medical end market. More importantly, we’ve also further refined our software product roadmap. We’ve completed the integration of multiple system back ends into one, increasing efficiency of resources.

We are now underway in our new software roadmap of refinements, new features and functionality, and new services built on industry expectations and intimate customer feedback. Additionally, progress on a consolidated front-end remains steady, with features continuing to migrate under the ConsoleFlow brand over the next few quarters.

While it still remains early innings in terms of our reoccurring – recurring revenue stream rather, we continue to make progress to that end. Internally, the transformation at Lantronix continues.

While we are focused on integrating our acquisitions and capturing revenue synergies, we continue to reorganize our sales efforts and better aligning support for key distribution and OEM customers.

We’ve also just launched a new value-added reseller, or VAR, channel sales partner program to improve our performance with key strategic channel customers. Early results have been positive, and we have been given several verbal and contractual confirmation – confirmations of awards not seen in our pipeline just one quarter ago.

The opportunity in design win pipelines remain healthy, as the appetite for IoT and remote access solutions accelerates. The emergence of the novel coronavirus and the resulting pandemic has companies, institutions and individuals looking for new and innovative ways to deploy and manage projects, while removing the necessity for physical access.

We are seeing an increased demand for IoT and remote access in the medical space, for example, as hospitals and staff look to increase their ability to access and control a complex ecosystem of machines and devices, while simplifying the day-to-day management.

Lantronix is in a unique position to help out with our portfolio of IoT modems, routers, gateways, device servers, tracking and remote access products, combined with our single pane of glass device management SaaS platform.

In terms of inorganic activity, we continue to pursue additive and accretive acquisitions to increase our SAM and bolster our capability within the IoT stack, while remaining focused on the integration of already completed transactions, realizing synergies and delivering accretion. Getting a little more specific regarding the global supply chain.

It, of course, still has a number of uncertainties. While our China contract manufacturers are running at full capacity today, our Malaysia CM is running at 20% capacity, well below the expected rate this quarter.

In addition, Thailand has implemented a curfew, but we are cautiously optimistic that our Thailand-based contract manufacturing capacity will see minimal impact. That said, any government actions in response to infection rates or resurgent rates cannot be predicted.

The pandemic has led to some weakness in areas of our end markets, where our clients are facing some trepidations about their customer base and are taking a wait-and-see approach. All things considered, our starting backlog in terms of business quarter-to-date leads us to believe we will see strong sequential and year-over-year growth.

And while we have seen no significant order cancellations or delinquencies in collections, we believe it prudent to expect continued disruption in our supply chain will lead to some unpredictability in our financial results. As such, we will be suspending specific revenue and non-GAAP EPS guidance for the June quarter.

Having said that, we currently expect to grow both revenues and earnings sequentially. That completes our prepared remarks for today. So I’ll now turn it over to the operator to conduct our Q&A session.

Grant?.

We will now begin our question-and-answer session. [Operator Instructions] Our first question will come from Rich Valera with Needham. Please go ahead..

Thank you. Good afternoon. So Paul, you mentioned your backlog is quite strong, I guess, heading into this current quarter and you were expecting strong sequential quarter-over-quarter growth. I was hoping you could kind of drill into to what has bolstered the backlog? I know you mentioned some kind of telehealth and medical applications.

Are there any other applications that you think might have gotten a boost because of kind of the work from home and medicine, telemedicine that’s been going on? Or any other color you can add on what help – what sort of bolster that backlog quarter-over-quarter?.

Yes. So we do have – so several of our medical customers, in particular, have some device gateways, where it’s a one-for-one relationship. There was – certainly, respirators, we saw an increase in demand related to that, but it was more than just respirators. It was a bit across the Board when it comes to medical applications.

In general, some of our remote access devices have taken off rather well. Even the KVM product that we’ve seen some legacy purchase orders that have come in the June quarter associated with that product.

So device gateway, device server, remote management type product or access product, in addition to that, we’ve had some – an increase in the flow of services-based contracts that we’ve been giving verbals on and have subsequently closed on as well.

So this is filling in our services pipeline for client development, software development, and attach to that could be hardware upside, as well as we kind of look forward over the next year. So it’s been generally strong. The areas that have been somewhat weaker has been anything associated with distributed data center and retail.

As you would expect, a lot of that has been kind of – been put on pause momentarily. But some of the areas of strength, it’s kind of – they’re outweighing some of those areas of weakness..

That’s great color. Thanks for that.

So it sounds like you’re seeing strength in both the IoT and IT management areas from some of these unique new dynamics, I guess?.

Yes..

And then just on Intrinsyc, so congratulations on the close of that. And it sounds like it contributed meaningfully and we had kind of thought that would be something probably in the range of $5.5 million to $6 million in the quarter.

Can you confirm if that’s kind of in the range of what it contributed in the quarter?.

No. Substantially, while we – I shouldn’t say substantially south of $5 million, but it was between $4 million and $5 million..

Got it. So can you just talk about the dynamics of that business. Obviously, Qualcomm historically a very significant customer there and certainly, I’m sure still is.

Can you just talk about kind of how that businesses, as well as how any non-Qualcomm initiatives you have going on of Intrinsyc or going into sort of growth prospects of that business?.

The Qualcomm, I would call them more of a technology partner, rather than customer. We don’t – we purchase products from Qualcomm and then we feed those into our hardware-based solutions that we’ve developed software on top of and then sell that to our customer base. The Qualcomm relationship is going great.

We’ve had several meetings, where we’re stepping up our engagement. We’ve had some requests from them that – in terms of better penetration geographically and other areas that we’re certainly trying to make sure that we we address those concerns.

And overall, I think, right as they’re starting to launch the 865 processor, it’s really been – this is kind of an exciting time. We’ve got a natural flow of customers that have used products from us before and are looking to kind of step up and use a piece of hardware with more capabilities.

Not to mention we’re – in terms of development, I think that we’re at the very forefront of when it comes to hardware development kits availability. So we expect to capture a lot of that early interest. So that’s going fairly well. In terms of other engagements, I’ve said it before, I’ll say it now.

Certainly, the Qualcomm relationship, I don’t want to disparage that at all, because it’s really important to us. But we do take a bit of a technology as agnostic approach. We obviously want to leverage our core competencies wherever we can when we’re trying to develop a customer solution.

But what we – what technologies we embrace really kind of comes down to that problem statement that the customer has and what is the optimum solution and it could be a number of different things. So we are looking to make sure that we have a broad base of capabilities with which we address those problems..

That’s helpful color. Thanks for taking the question, gentlemen..

[Operator Instructions] Our next question will come from Jaeson Schmidt with Lake Street. Please go ahead..

Hey, guys, thanks for taking my questions. Just curious, you mentioned not seeing any cancellations.

But have you seen any delays or push-outs to programs and deals already won? And just curious if you think those push-outs are into the second-half of this calendar year, or more into calendar 2021?.

So we’ve not seen anything out of the ordinary. We have the minor rescheduling that we’ve had with some customers, but even that has been kind of below the norm in terms of activity. We don’t really see it as a – people trying to pull things in. But things are progressing fairly normally.

And they feel like a natural more increase in some of the organic activity that we were having. I don’t know that I wouldn’t sense that there’s a second-half push-out that might be coming. It doesn’t seem to be the case. Some of the new programs that we’re working on, these are longer-term projects that could span a couple of years.

And so, a lot of the engagement has been fairly good..

Okay, that’s helpful.

And then just curious if you could comment what you’re seeing from a channel inventory standpoint?.

So channel inventory did not go up appreciably in the quarter. We did have two additional partners that came on in Asia. And so these were natural expansions, where we didn’t have good coverage before as part of our sales effort.

So we saw a little bit of an increase associated with some initial stocking buys, but it’s a couple of hundred thousand and so not significant..

Okay.

And then finally, could you quantify how much revenue you think was impacted in the March quarter by supply constraints?.

Yes. It was over $1 million, I’ll say that. If we look at the delinquency and shipments or factory committed shipment dates in the quarter. So it was over $1 million. I took that as a good thing. If we look forward to the June quarter, I don’t know that we’ll be able to clean all of that up.

We might end up exiting the quarter with still some demand that we need to shift. However, I do think that the June quarter will be the trough in terms of difficulty that we have.

I think, as we kind of look at what happened in China, the delay, the shutdown, and the subsequent reopening and how they’re addressing it today, things are a bit more normalized and people are a bit more used to some of the orders or procedures or precautions that they’re taking.

So once we get past and get some good activity out of Malaysia and continued activity out of Thailand, I think, we’ll be able to clean it up shortly. So I do think June will be close to the last of it, but we may exit the quarter with some delinquencies to first factory commit shipment dates..

Okay. I appreciate the color. Thanks a lot, guys..

This will conclude our question-and-answer session. I’d like to turn the conference back to Paul Pickle, CEO, for any closing remarks..

Thank you very much for attending today. I appreciate your time and attention. Thank you..

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