Good afternoon and welcome to the Lantronix 2021 Third Quarter Results Conference Call. All participants will be in a listen-only mode [Operator Instructions] After today's presentation there will be opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Rob Adams, Head of Corporate Development and Investor Relations. Please go ahead..

Thank you. Good afternoon. Thanks everyone for joining the Lantronix third quarter fiscal 2021 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. 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 its 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 today, 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.

Finally, please refer to today's news releases and financial information in the investor relations section of our website for additional details to supplement today's commentary. With that, I'll turn the call over to Jeremy Whitaker, Chief Financial Officer..

Thank you, Rob 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 third quarter of fiscal 2021 before I hand it over to Paul for his commentary.

For the third quarter of fiscal 2021, we reported 17.1 million in net revenue, an increase of 4% when compared to 16.5 million for the third quarter of fiscal 2020. Sequentially, net revenue was up 3% compared to the 16.6 million reported in the second quarter of fiscal 2021.

For the nine months ended March 31, 2021, revenues were up to 20% when compared to the nine months ended March 31, 2020. Once again, we exited the third quarter of fiscal 2021 with a record level of total backlog as a result of increased customer demand and partially due to supply constraints.

Gross profit as a percentage of net revenue was 45.1% for the third quarter of fiscal 2021 as compared with 44.7% for the third quarter of fiscal 2020 and 42.2% for the second quarter of fiscal 2021. The sequential improvement can be attributed to improve product mix from the prior quarter.

That said we continue to face headwinds in our gross margin as a result of components shortages and elevated logistics costs. As a component shortages and logistics costs subside. We expect to see gross margins improve from 200 to 400 basis points from the current levels.

Selling general and administrative expenses for the third quarter of fiscal 2021 remain consistent at 5 million. Research and development expenses for the third quarter of fiscal 2021 were 2.5 million, compared with 2.7 million for the third quarter of fiscal 2020 and 2.4 million for the second quarter of fiscal 2021.

Non-GAAP operating expenses as a percentage of net revenue decreased from 42% in the third quarter of fiscal 2020 to 38% in the third quarter of fiscal 2021 demonstrating our synergy capture and leverage in the operating model.

GAAP net loss was 1.2 million or $0.04 per share during the third quarter of fiscal 2021 compared to a GAAP net loss of 5.2 million or $0.19 per share during the third quarter of fiscal 2020.

Non-GAAP net income was 1.5 million or $0.05 per share during the third quarter of fiscal 2021 compared to non-GAAP net income of 611,000, or $0.02 per share during the third quarter of fiscal 2020.

Now turning to the balance sheet, we ended the March 2021 quarter with cash and cash equivalents of 8.3 million, an increase of 656,000 from the prior quarter. Working capital improved to 19.9 million as of March 31, 2021, as compared to 18.7 million as of June 30, 2020.

Net inventories were 15.1 million as of March 31, '21, compared with 13.8 million as of June 30, 2020. Now turning to our outlook, we are now targeting 2021 revenue growth of 15% to 25%, and non-GAP EPS growth of 100% to 175%. As a reminder, this does not include any contribution from the acquisition that we announced this morning.

I'll now turn the call over to Paul..

Thank you, Jeremy. I'm excited to report to you today on our third quarter results as the fundamentals of Lantronix continue to improve. In our third quarter, revenues resumed a growth trend with a strong customer demand.

Bookings were up considerably with the book to build solidly above one, with consumption of inventory in the channel far outpacing our shipments into distribution.

And once again, we ended the quarter - the current quarter with a new record total backlog levels that as of today are more than four times our historical norms as compared to our fiscal year 2020. In addition, we experienced improved gross margins due to a favorable product mix, not everything's perfect of course.

The component shortages we've been talking about for the last three quarters continued to gate our ability to ship to customer demand, and limited our revenue upside in the quarter.

As of the end of Q3, late to customer requested shipments due to the component shortage pushed approximately $4 million of product into future quarters versus $2 million in the previous quarter. However, our product portfolio is heavily weighted towards products that have been designed in and for which there are no substitutes.

While we could not ship that $4 million of product to our customers in the third quarter, they are anxiously awaiting delivery of our products in the fourth quarter and beyond. On the logistics front, with the rollout of vaccines and commercial air industry is beginning to recover. As it does, we expect our logistics costs to improve.

At the component level, supplier capacity remains tight. Yet we have procured much of the crucial components needed to ship to our contractual obligations over the next couple of quarters and our discussions with suppliers lead us to believe we will see improvement towards the end of the calendar year. As logistics and supply constraints ease.

We expect substantial upside to both revenues and margins as we match our delivery capability to the increased demand. With that, let's delve into some more specifics on the quarter. Turning to our product categories, our IoT products delivered 13.7 million in Q3 up 2% sequentially, and roughly flat year-over-year.

Our Ethernet solutions grew sequentially year-over-year mitigated somewhat by Wi-Fi which had been strong through most of last calendar year. We saw a nice rebound in tracking and cellular or our telematics devices where things picking up in EMEA, as well as impressive growth from our design services group, which grew revenue 72% year-over-year.

As we discussed in the prior quarter, design services was maxed out and we have been increasing capacity to meet the demand coinciding with Qualcomm's recent next generation processor releases.

These services are important not only for the strong margins they provide, but also because they ultimately turn into volume shipment opportunities for Lantronix.

For example, you may remember last quarter we detailed contracts with Enel the world's largest manufacturing distributor of electricity and gas as well as TOGG, a Turkish electric vehicle manufacturer.

Additionally, in Q3, we extended our continuing engagement with Flock Safety, a high growth technology company using computer vision, machine learning and objective evidence to create and deliver automated and unbiased leads for law enforcement.

Flock Safety will utilize Lantronix' recently announced flagship Open-Q 865 System on Module on their next generation design. We continue to be their technology development partner on smart city safety projects, which aim to eliminate crime, protect privacy and mitigate human bias through the use of AI.

In a world debating law enforcement reform technologies such as these are likely to have outsized growth potential. As these projects move from design to production volume Lantronix will have the opportunity to capture sizable production revenues. Along with our design services being completely booked, our opportunity funnel is robust.

And we look forward to converting these opportunities to revenue over the next year. Turning to remote environment management or REM, revenues totaled 3.3 million up almost 7% sequentially, and up 36% from a year ago. Demand for out-of-band products drove this growth augmented by the continuing customer adoption of our SaaS solutions.

With that, I would like to briefly recap our announcement this morning regarding our signing of a definitive agreement to acquire electronics and software business segment of Communication Systems Incorporated. For those investors who may not have yet seen it. This morning, we announced the acquisition.

We held a conference call before the market opened. You can find the replay in the investor relations section of our website. We are excited about this opportunity because quite simply number one, it addresses scale and efficiently - efficiency. The pro forma combination will have an annual revenue in excess of $100 million.

It brings Lantronix a highly complementary product offering, a number of sticky federal municipal customers and exposure to several growing smart city IoT applications.

And due to the complementary nature of the products of substantial $7 million of synergies which we expect to reap over the course of the next 18 months, with much of that occurring on day one.

Our expectation is this acquisition will be immediately accretive to our model upon closing and adding significant non-GAAP EPS upside in its first full year on board roughly doubling our current non-GAAP EPS run rate.

This deal is subject to a CSI shareholder approval, along with other customary conditions, and we expect it should close in the June to July timeframe. As I'm sure you can tell it was a busy quarter for Lantronix.

Despite the continuing difficulties of the supply chain disruption, Lantronix has resumed its growth course, is improving profitability, enters the fourth quarter with record backlog and is targeting a substantial pipeline of high volume opportunities.

Coupled with the addition of our just announced acquisition, we are excited about our growing momentum and prospects. And we look forward to reporting our progress to shareholders over the coming months. With that, I'll now turn it over to the operator for Q&A..

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question will be from Scott Searle with ROTH Capital. Please go ahead..

Hey, good afternoon. Thanks for taking my questions, guys. Good to talk to you again..

Absolutely..

So maybe just a couple of quick cleanup questions and just wanted to make sure I heard the gross margin commentary correctly that with supply chain normalizing you expect 200 to 400 basis point improvement off of what we just saw in the current quarter..

That's correct. Okay. And then for clarification, that would probably take some time to work its way through. I mean, it's really subject to things coming back to normal, right, which nobody has a clear picture of today. But probably over the next, I would say two to three quarters begin to improve..

Yes. So if you need to improve, if you split that 200 to 400 basis points evenly between component increases and logistics costs. We expect to get the logistics portion bit more quickly as we get more of those commercial, international, especially international flights going. The components will obviously come as we ease on the component shortages..

Got you and then Paul, following up with that component shortage comment, I think you said 4 million now cumulatively over the past three quarters.

So it sounds like from your commentary that none of those previous slippages have actually shipped, is that correct? So you still have 4 million outstanding of orders that when product is available, customers still want it and you can ship, is that correct?.

So that's not correct. So in the previous quarters, we've actually been able to take all of the outstanding and ship it almost completely in the very next month. So it's - we were about a month delayed. You can kind of think of it in terms of commitment times being pushed out a month.

So it ballooned a little bit mostly because I think demand has taken a sharp uptick this past quarter notably. And even we're observing that trend continuing at this point in time and this quarter we're seeing substantial backlog being put in place.

This will be the - this is the first quarter we're not going to be able to clear that entire $4 million this quarter, so some of it will bleed into next.

But I think if you kind of look at it, we're seeing kind of unprecedented demand levels, partly because of macroeconomic partly because we've been doing a lot of hard work getting those opportunities in place. But our backlog is now five times what we would call historical normal levels.

And I'm referencing FY '20 what we kind of saw on an average yields four quarters, it's more than five times what it has been. And we're seeing an uptick in production, volume of existing both the legacy business classic business, but then also new programs coming online. So we're not seeing a lot of pull in associated with that.

The customer request dates, delivery dates are staying pretty consistent. So we don't see a lot of double ordering in this pattern. But it just seeing a nice little uptick in demand and with the component lead times, we just can't keep up with this ramp rate..

Got you, Paul, just to clarify those, so 4 million is what you - the incremental demand that is there that you have not been able to satisfy in the most recent quarter?.

In the most recent quarter, so if we referenced the previous quarter, we were about $2 million level, we were able to flush that $2 million, ship it the very next month. And so we've seen the late to CRD accumulate this quarter, balloons another $2 million for total for.

We will not be able to flush the entire $4 million or we don't anticipate we'll be able to flush the entire $4 million this quarter..

Got you, but just to normalize in terms of the demand for the March quarter was over 19 million versus reported 17 million..

That's correct..

Okay, got you and the comment that you made related to the acquisition this morning, doubling EPS in terms of what you're seeing, I just want to go back and clarify that comment.

So is it doubling at what point in time? From the time that the transaction is expected to close in the September quarter? Also what base we kind of think about because there's quite a bit of accretion there when you start to pull out some of the synergies that sound like a big chunk of them start on day one, but I just want to make sure and flesh out that comment a little bit more..

Yeah, it's - so we would say first full quarters, just because we don't know entirely when that's going to close. But if we took our current estimates, I'd say we'd get that in our next fiscal year. It's basically taking a strong $0.20 target from Lantronix.

And at least anticipating another $0.20 in accretion from the target or synergies captured from the target in the first 12 months. And so that's a - it's a ballpark way to look at it. But right now, we think that that's a pretty good conservative outlook..

Okay, very helpful. And lastly, just on the component availability front, obviously it's continuing to persist out there, not just for you, but for the industry in general. Where are you seeing the shortages? It sounds like this continues last year and this year.

It seems like though that REM or out-of-band management solutions have been relatively well insulated, does that continue as well.

And so that remains on an unrestricted growth curve?.

Well, in those in those revenue areas where we're not heavily dependent on large volumes of critical components, that's where we can actually support an uptick in demand. So you take REM for instance, we have quite a bit of whip that's in play. Certainly, that's true for some of our older, mature products that have been pretty steady state.

So we have the ability to respond to an uptick in demand. It's really where we have new production volume that's taking place, customers that are going into production after an anticipated period, and having deeper ramps than what we anticipated.

The good news is we have been talking about this for three quarters, and so we were able to put some extended lead time orders in place all the way back to our last June quarter. And so we'll be able to meet the demand that we anticipate over the next couple of quarters. But the new uptick in demand is going to take a little while to process..

I was going to say, it's got a little flavor on that from the cost standpoint, on those lower volume products that were able to source those materials. That's where we're seeing a little higher expense, because we're doing maybe 1000 units of a box, we can relatively easily go out and source that component. We'll pay a little bit more for it.

So you we're having some expedite costs related to paying a little bit more for some of those components to make sure we can supply the customer..

Yeah, the spot buys really do add up..

Got you and lastly, if I could just on the recurring front, I know it's still early days, but in terms of building out that recurring SaaS model platform, I'm just wondering, any updates in terms of platform development, customer interest, et cetera, on that front? Thanks so much. Nice quarter..

Yeah, thank you very much. Yeah, on the recruiting front, we still call it early innings. We're going to exceed our forecast for this fiscal year that we had for it's a small number. But it's an important milestone for us. So I've been talking about a $750,000 between software licensing and recurring.

We're going to really do more - we expected to close Q4 with being at an annualized flip of about 850k. And for us, it was great validation here. Really, I think we've seen some - a number of signups off late just because of some of the new features that we have rolling out over the next four months.

Zero Touch Provisioning is one of those significant features. So this is just a really out of the box experience. Ease of use, convenience factor for customers and they're eagerly anticipating those, so it's really going well.

I think next year, we certainly anticipate to be able to put a lot more color on it and hopefully report some better indicators there..

[Operator Instructions] The next question will be from Ryan Koontz with Needham & Company. Please go ahead..

Great, thanks for question. One, as many shifts in the competitive landscape are you seeing the bigger players, the Cisco's, the Erickson's now, with their recent acquisition, active in your space at all or are they kind of leave in some of the kind of smaller opportunities maybe more available to you. Thank you..

Yeah, appreciate it.

So we often play a more boutique in niche applications and we don't bump heads with those guys a lot, especially on console management, it's either an internal solution on a Cisco router, but best practice, Department of Homeland Security, I guess certified or suggested would be to have an out-of-band or remote management solution, like an external box like ours.

And so we find that a long time, along those lines of somebody building a data center, using Cisco products, we get pulled along with those. So infrastructure build outs are good for us. It's not necessarily competitive landscape for us. It's something that's very complimentary, and something that we definitely look for.

But I will say off late, I think that they're focusing their time and attention in a couple of key areas.

And I think that gives us some adjacent product opportunities, especially as we round out the product portfolio with products that would be a bit more competitive with a Meraki or a Masa like, come with the biking up the museum, the project name, cut the transition networks, product line..

Okay, that's helpful.

And as far - as you look at kind over the next 12, 18 months, what sort of macro catalysts do you see that are most important here? Obviously smart cities is one, is the 5G build have much of an impact on your kind of opportunities out there?.

Yeah, with without a doubt, what we're seeing is smart cities, 5G those do kind of go hand-in-hand. So 5G just brings connection densities to orders of magnitude higher than what are possible today, especially in densely populated urban areas. And that's where we see a lot of the smart city infrastructure being built out.

So we've seen a lot of activity on the deadline services side with object classification is a particular area that we like and are interested in.

Our team is very familiar with yellow type object classification, you only work once, but allows you to identify an object, classify that in a real time video distributions, stream, categorize that metadata and make it available for advanced analytics. So those go hand-in-hand with connectivity.

And then 5G obviously, is the connectivity place, so very complimentary, and we really liked the space..

Great, appreciate that. Thanks for the questions..

Thank you, Ryan..

Ladies and gentlemen, 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. And once again, thank you for joining us and have a great rest of your day..

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