Just a few weeks ago, I called property-technology company Latch (LTCH 1.70%) my favorite stock to buy and hold for the long term. It's still a promising company. But the company reported financial results for full-year 2021 on Feb. 24, and management changed a very important number in its long-term financial guidance.
With its new guidance, Latch is no longer a no-brainer investment opportunity. It's suddenly fighting an uphill battle to become a market-beating stock. Here's why cash flow matters for Latch.
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Latch's 2021 results
Latch manufactures smart-lock devices and provides operating software for the devices on a subscription basis. It signs contracts for these products with landlords, and this is recorded under bookings. When Latch physically installs a lock or provides a month of operating-software service, then money can be recorded as revenue.
In 2021, Latch generated revenue of $41.4 million and bookings of $360.2 million, up 129% and 118%, respectively, from 2020.
Latch was brought public via a special purpose acquisition company (SPAC). SPACs commonly provide longer-term financial guidance than other newly public companies. From the original SPAC presentation, we see that Latch forecasted $49 million in revenue and $308 million in bookings for 2021.
Delays in new-build construction is why Latch's 2021 revenue lagged the original guidance. Locks are among the last pieces of hardware installed, and delays tangibly affect revenue recognition. By contrast, bookings are far outpacing original guidance, suggesting strong future revenue.
In short, I believe investors can look past revenue shortfalls because the situation is out of Latch's hands. Bookings, on the other hand, are more within Latch's control and exceeding expectations. That's good.
Latch's new profitability guidance
In its original guidance, 2021 was supposed to be Latch's worst year for cash flows. The company guided for negative free cash flow of $79 million. However, the reality was far worse. As Latch defines free cash flow, it had negative free cash flow of over $110 million.
Moreover, Latch has now given refreshed guidance for 2022. Management sees revenue of $75 million to $100 million, well below its SPAC presentation guidance of $173 million. And it hasn't given new free-cash-flow guidance, guiding instead for negative earnings before interest, taxes, depreciation, and amortization (EBITDA) of $180 million to $160 million. For perspective, this is far worse than its adjusted EBITDA loss of $102 million in 2021.
Since management is forecasting a substantial drop in adjusted EBITDA profitability, I believe it's safe to assume that Latch's free cash flow will also be worse in 2022 compared to 2021 and light years away from where management said they'd be by this point.
Why this is a big problem
As of the end of 2021, Latch had cash, cash equivalents, and available-for-sale securities (short-term investments) of around $284 million. That might sound like a lot but not when you're running at a greater than $100 million annual loss.
I was extremely bullish on Latch because hardware revenue precedes software revenue. Hardware revenue comes with negative gross margins -- registering a loss from the get-go. Software revenue's gross margin is north of 90%, extremely lucrative.
Based on the SPAC presentation guidance, Latch would have arrived at free-cash-flow profitability before cash ran out. It was predicting to turn the corner in 2023. And accelerating free cash flow from there made the stock look like a steal from today's valuation. However, positive free cash flow in 2023 is predicated on the assumption of improvement in 2022. That assumption for 2022 is now gone, calling 2023 into question.
Can Latch become profitable before its cash runs out? This is suddenly a legitimate question based on management's updated guidance.
Latch could take on debt. But with interest rates rising, this isn't going to be as appealing as it once was. Moreover, Latch stock is currently down 70% from its high. Therefore, it's not a good time to raise money by issuing more stock either.
What I'm doing with Latch stock
Prior to full-year 2021 results, I was an aggressive buyer of Latch stock. I'm not a seller today, but I'm also no longer a buyer.
When I own a stock, it's because I believe it can beat the market over the next five years. I buy more of a stock I already own when I believe its long-term business prospects have improved. In my opinion, that's not the case right now with Latch.
However, all companies -- including the greatest investments of our time -- are eventually challenged in some way and see their stock prices fall. Great companies find ways to overcome. Latch is certainly climbing an uphill battle if it can't turn a profit in timely fashion. But if it overcomes, it's a promising opportunity, which is why I'll keep holding the stock I have.
