Q3 2023 Lantronix Inc Earnings Call

Participants

Jeremy R. Whitaker; CFO; Lantronix, Inc.

Paul H. Pickle; President, CEO & Director; Lantronix, Inc.

Robert C. Adams; Head of Corporate Development & IR; Lantronix, Inc.

Jaeson Allen Min Schmidt; Senior Research Analyst & Director of Research; Lake Street Capital Markets, LLC, Research Division

Ryan Boyer Koontz; MD & Senior Analyst; Needham & Company, LLC, Research Division

Scott Wallace Searle; MD & Senior Research Analyst; ROTH MKM Partners, LLC, Research Division

Thomas Michael Walkley; MD & Senior Equity Analyst; Canaccord Genuity Corp., Research Division

Presentation

Operator

Good day, and welcome to the Lantronix Third Quarter Results Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Rob Adams. Please go ahead.

Robert C. Adams

Thank you. Good afternoon, everyone, and thank you for joining for the third quarter fiscal 2023 conference call. Joining us today are Paul Pickle, our President and Chief Executive Officer; and Jeremy Whitaker, our Chief Financial Officer. A live and archived webcast of today's call will be available on the company's website. In addition, you can find the call-in details for the phone replay in today's earnings release.
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-Qs. Lantronix undertakes no obligation to revise or update publicly any forward-looking statements to reflect future events or circumstances.
Please refer to the news release and the financial information in the Investor Relations section of our website for additional details that will supplement management's commentary. 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 will use.
With that, I'll now turn the call over to Jeremy Whitaker, Lantronix's Chief Financial Officer. Jeremy?

Jeremy R. Whitaker

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 2023 before I hand it over to Paul for his commentary.
For the third quarter of fiscal 2023, we reported revenue of $33 million, up 5% sequentially and up 2% from the year ago period. GAAP gross margin improved to 44.4% for the third quarter of fiscal 2023 compared to 43.8% in the prior quarter and 42.1% in the year ago quarter. Selling, general and administrative expenses for the third quarter of fiscal 2023 were $9.9 million compared with $8.3 million for the third quarter of fiscal 2022 and $9.8 million for the second quarter of fiscal 2023. Research and development expenses for the third quarter of fiscal 2023 were $5.1 million compared with $4.5 million for the third quarter of fiscal 2022 and $5.1 million for the second quarter of fiscal 2023.
The year-on-year increases in SG&A and R&D were largely driven by headcount we assumed in the September 2022 acquisition of acquisition Uplogix. GAAP net loss was $3.1 million or $0.08 per share during the third quarter of fiscal 2023 compared to a GAAP net loss of $3.2 million or $0.09 per share during the third quarter of fiscal 2022. Non-GAAP net income was $2.1 million or $0.06 per share during the third quarter of fiscal 2023 compared to non-GAAP net income of $2.8 million or $0.08 per share during the third quarter of fiscal 2022.
Now turning to the balance sheet. We ended the March 2023 quarter with cash and cash equivalents of $12.8 million as compared to $6.8 million in the prior quarter. Working capital was $49.9 million as of March 31, 2023, as compared with $50.6 million as of December 31, 2022. The net inventories were $51.7 million as of March 31, 2023, compared with $49.2 million as of December 31, 2022. The increase in inventories over the last several quarters was primarily due to the purchase of long lead time components to support the ramp of our supply arrangement with Gridspertise and inventory assumed in the September acquisition of Uplogix.
Now turning to our outlook. For the fourth quarter of fiscal 2023, we are targeting revenue of $33 million to $36 million and non-GAAP EPS in a range of $0.06 to $0.08 per share. For fiscal 2024, we are targeting revenue of $175 million to $185 million, and non-GAAP EPS in the range of $0.50 to $0.60 per share.
I'll now turn the call over to Paul. Thank you, Jeremy.

Paul H. Pickle

We are pleased to deliver sequential growth in March. And as you can see in our guidance, we look toward delivering continued sequential growth in our fourth quarter. As you might imagine, we, like our investors, are intensely focused on the state of the economy and our business. In fiscal year 2023, our results have been good, but below our expectations. Results have been hampered by the normalization of demand for our classic products, delays in the QED program, which pushed out those revenues into the following fiscal year, and our distributors who, for the last 3 quarters have been ordering less from us than they are selling through to their customers in order to lean their inventories. But importantly, the table is set for impressive growth in fiscal year 2024.
We have achieved much and we are poised to make significant progress towards our intermediate-term goal of $250 million in annual revenue. I can talk a little bit more about our expectations for FY '24 and beyond later in my prepared remarks, but first, let's report on Q3 2023 results and our expectations for the remainder of the fiscal year.
Turning to our March results. In our fiscal third quarter, embedded IoT Solutions totaled $16.1 million, up 17% sequentially and 5% year-over-year, representing 49% of revenues. Sequential revenue growth was largely driven by our embedded Ethernet and WiFi solutions as well as our embedded compute products. On the Ethernet and WiFi front, improving supply chain dynamics allowed us to shift to pent-up demand. On the compute side, EV and automotive shipments are ramping on schedule, and the opportunity funnel is growing.
Early in customer demand for the Togg electric vehicle platform has exceeded expectations and new engagements with Fisker, Ghost, Renault, Volvo and Daimler contribute to a growing pipeline, which we expect will translate to revenue in late fiscal year 2024 and 2025. Elsewhere within Embedded, we saw some softening in our more classic network interface card products. The customer base for these products is largely federal in nature, and as can be the case with our federal customers from time to time, we are experiencing some delays relative to our forecast.
We are actively working with our public sector partners to address this and are confident that this is a temporary setback. Nevertheless, looking ahead, we see continued strength from embedded wired and wireless products driven by continuing supply chain improvements and steady demand, coupled with compute some growth from EV and automotive.
Turning to Systems Solutions. Revenues here totaled $14 million or approximately 43% of revenues, down 6% sequentially and 6% year-over-year. Within System Solutions, sales of our remote environment management products were up, thanks to increased buying from our communication customers. However, we acknowledge a continued temporary weakness in the financial sector, leading to delayed orders for these products. We expect it to bounce back in the coming quarters. Switch revenues tempered as well after recent seasonal strength.
Looking at software and services, revenues in Q3 were approximately $2.9 million, flat sequentially and up 36% year-over-year. We continue to make progress in selling high-margin recurring revenue with some additional contribution coming from our recent acquisition. ARR from software and services at the end of March remained above $5 million. For fiscal fourth quarter 2023, while we have noted some slowness in our (inaudible) driven business and our distributors continuing focus on leaning out their inventories, we enter Q4 with a record backlog, strong bookings, improving supply chain and logistics dynamics and an expectation of sequential growth.
Turning to fiscal year 2024, we have a strong outlook, and our visibility into demand has never been better. We anticipate delivering over 30% growth during the next fiscal year. We are poised to begin shipping our Quantum Edge device while we pursue a pipeline of opportunities that could drive double-digit growth in electronics over the next several years. Today's customer engagement continues to improve, bringing quality, high-value opportunities into the pipeline. Looking at our top prospects, Lantronix is pursuing more than 40 opportunities that total over $150 million in peak annual revenue in applications such as smart cities, smart grid, EV and automotive as well as security and surveillance and telematics.
This is an incredible departure from the business we inherited 4 years ago, and we are just about to hit our stride. We need only modest performance from our Classic products to meet our growth target due to market share gains and new customer revenue despite a softening macroeconomic environment. We expect to deliver on that pipeline of opportunities I referenced and set the table for more of the same in fiscal year 2025. We look forward to reporting on our results in the near future.
And with that, we'll start our Q&A session. Chad?

Question and Answer Session

Operator

(Operator Instructions) And the first question will be from Mike Walkley from Canaccord Genuity.

Thomas Michael Walkley

And great to see the guidance for next year. I guess, Paul, just you could break down the fiscal '24 guidance for us a little more. You want to call out a contract, but how should we think about the timing of the Gridspertise contract entering fiscal '24, maybe linearity as it ramps? And I think -- and I didn't catch the number, but you said 40 projects of $140 million if you could correct me on that. And how much of that might be considered in fiscal '24, if that's not in the model and it could be upside that it's earlier.

Paul H. Pickle

Okay. Sure. So if we look at the contract, the statement that we made in the past is that it will ship appreciably in FY '24, but we do expect some contribution in FY '25. And it's not the -- there is certainly potential upside to that. We're looking at the total production schedule. If we kind of look at a September quarter start to that production. We would expect that to ramp as you would typically ramp production into December with a strengthening number and then continue over the next several quarters.
And so the $40 million is just really kind of the first step to realizing that contract. But certainly, there's lots of additional opportunity. And so it was 40 opportunities and $150 million, and most of those opportunities, the revenue, we do get some contribution in FY '25, but that's really more of a mass production number that is appreciable in FY '25. And -- but we do have some programs that we've been working on over the past 1.5 years and let's say, even 2 years that do -- if these programs go well, they do provide some additional upside potential in FY '24.
So right now, we're giving a guidance to the midpoint number of $180 million. We feel like that is potentially a conservative number. But right now, that's the current outlook.

Thomas Michael Walkley

Great. And just a follow-up, Paul, you indicated your regular (inaudible) business, you just needed a modest contribution to hit that number. Can you kind of put that in the context of that just slight growth or flat with some inventory clearing at your distributors? Just maybe what's your assumptions to modest help from that side of the business and where -- how long do you think it's going to take your distributors to maybe to draw down inventory to levels they want to have it.

Paul H. Pickle

So right -- you know that last half of the question is pretty interesting. I think (inaudible) would prefer inventory levels of 0. And if we could just drop ship to their customers, that would be preferred. But I think if you compare against last fiscal year that (inaudible) business, we kind of talked about it. It was doing double-digit growth, and it really shouldn't. Historically, you're talking mid-single digits is probably the right number. There's a little bit of an ebb and flow to it. And so we saw that correction in towards the end of the year. It has moderated and it has slowed the past couple of quarters. I'll say the last 3 quarters.
But as of today, we've seen that (inaudible) business booking trend increase a little bit. So we're cautiously optimistic that we see a bottom of that (inaudible) business correction or moderation. And in terms of what we need out of it, honestly, at this point, we could probably tolerate a slight decline in that business and still readily as long as we get execution on new programs, we'll readily hit those numbers.

Thomas Michael Walkley

And last question for me, and I'll pass line. Just you mentioned Togg, it sounds like that's going even above your expectations and some of those other auto manufacturers. Can you remind us how long it might take to transition trials with those into design wins and shipments? Is that more of a 1- to 2-year type thing or even longer?

Paul H. Pickle

Well, we started production with Togg. So we are shipping to them, albeit in modest volumes, but they just started to release those cars to the public or civilians. And so it will take them a little while to ramp up. Things are still moving along quite nicely, but I'm referencing really their deposit program. They sold to the tune of 4x the number of vehicles in preorders than they expected to, and they certainly can't meet all of that demand in the short term. So we're expecting some upsized orders out of them going forward. But that is probably some meaningful revenue that will fold into this next year.
In terms of those other engagements, they really are slated for FY '25 production runs. We'll get some engagement, some level of contribution out of them in FY '24. There is one program that is slated to contribute in the last quarter of FY '24. But most of those engagements -- our engagements probably do go about 1.5 years in length and sometimes a little bit longer. But we've been working on them for quite some time and have been doing some development. So we're comfortable at this point talking about it in terms of FY '25.

Operator

And the next question is from Jaeson Schmidt from Lake Street.

Jaeson Allen Min Schmidt

Paul, in your prepared remarks, you mentioned some improving supply chain dynamics in some product lines. So just curious if due to supply chain headwinds within your revenue that couldn't be fulfilled in March?

Paul H. Pickle

Yes. We had about $1 million that we couldn't meet, we did -- due to supply chain. And a portion of that was due to a customer changing a SKU on us at the last minute. And so it falls in this next quarter. But supply chain is largely pretty good, logistics costs have come down, component costs continue to come down. You're going to see a little bit of support in the gross margin line as a result as those -- that inventory flushes through over the next several quarters. But we do still occasionally have 1 or 2 components per BOM that is problematic. We did see some NXP pushouts this past quarter. But largely, it's okay and it's manageable. But there are a handful that are still somewhat tough.

Jaeson Allen Min Schmidt

Okay. That's helpful. And then you noted record backlog. Curious if you could share that number.

Paul H. Pickle

I don't really want to give a total backlog. Essentially, we've got the -- that contract is now fully in the backlog number. And so it's a rather large number, as you can imagine. But we'll just say that it's -- we're in good shape. Starting backlog for the quarter ticked up nicely. So -- at this point, for Q4, we've got -- we're in a better position than we have been in previous quarters in terms of numbers needed to make the quarter. So things are just overall pretty healthy, good bookings trends in quarter requested bookings trends. So I think we're in pretty good shape.

Jaeson Allen Min Schmidt

Okay. And then just the last one for me. Maybe this is for Jeremy. I mean gross margin ticked up nicely sequentially. How should we think about that trending through rest of this calendar year?

Jeremy R. Whitaker

Yes. I think for the rest of the year, we had kind of expect a similar performance in margins. It could be somewhat impacted by mix. On a positive note, we are seeing logistics costs tempering quite a bit from what we saw earlier in the fiscal year. So I think there is some potential upside from there if that continues and also into the next fiscal year. And then we are starting to see PPV costs coming down. So from a cash standpoint, we are paying a little bit less for inventory, but we're still continuing to amortize off some of those previous costs that we incurred. So I wouldn't expect to see benefit to the P&L from that until we get into the next fiscal year. So we do have some improvements, I think, that are coming. But I would say for the next quarter or so, we'd expect it to be pretty consistent with where we've been.

Operator

The next question will be from Ryan Koontz from Needham.

Ryan Boyer Koontz

I appreciate all the great color on the EV opportunities. I wonder if you could, Paul, reflect on some of the others you've been engaged with, whether it's government, smart city, et cetera. And which ones are performing kind of January plan, where are there some weaknesses and where you see the most opportunity in fiscal '24 for upside?

Paul H. Pickle

Yes. I think the toughest thing about IoT that just about everybody would reflect on nowadays is the fragmentation of the market, you end up in a lot of different use cases. And that's one of the strengths and the capability that we've built is we're able to address a disparate number of opportunities. But there's a few that, that I would highlight, we've got a program going on with AI labs, a bit more enterprise, faster time to revenue on this particular one, but audio/videoconferencing platform that should drive some pretty decent volumes.
And -- so that will be a nice add for us. We continue to work with the New York DOT on a couple of proof of concepts for, let's call it, smart pole applications. Right now, there's not a lot of color that I could give on that program until New York gets a little bit further along. And so it's a bit of an IoT application, think mesh network, surveillance, a number of different things that go into that program with a single pane of glass management backbone attached to it.
So we're pretty excited about that one. There's 750,000 poles in New York City. So it would be significant volume over a number of years. And then obviously, it's got a lot of application and other municipalities. One other one I might highlight, we recently got a new specification and are on the approved vendor list for AT&T to monitor -- attach an IoT device to generators, several different types of generators, assess the status -- the operational status and the health, predictive maintenance with a SaaS platform as well, and those are all attached to base stations in an AT&T network, pretty excited about that one. That one would be fairly near-term revenue as well. But it's a little bit early on in the process. So it's a little bit of customization on the hardware side from our standpoint and then a ramp-up in order to meet their needs, but we're working very quickly to make that happen.
And the only other one I would probably highlight at this point is we've got some engagements with P3. It's an -- it's an android automotive OS company that looks to provide a digital cockpit experience. And as we look at their customers, largely Tier 3-type Tier 2 numbers, we do the hardware for a lot of customers in that market like with an ART, on a Bugatti platform. But they would like to standardize a telematics experience for -- in cockpit, and this gives us an opportunity to do one development and roll it out across several platforms in automotive applications. And it leverages the work that we did at Togg. So we're pretty excited about that one as well.

Ryan Boyer Koontz

That's great stuff. And AT&T stuff you mentioned was that the wireless or wired side?

Paul H. Pickle

It's wireless.

Ryan Boyer Koontz

Got it. And how about -- any quick commentary on the competitive environment? Any changes there? Digi's been firing up some pretty good numbers of late? And just generally, what are you seeing in the space?

Paul H. Pickle

Yes. I think in terms of competitors, there's definitely -- in certain areas, we know that hardware is not a particular business model that we're especially fond of. We don't want to have to compete in commodity spaces. We want to utilize those commoditized hardware platforms or pieces in order to kind of pull through a larger play. It's -- I'd say it's similar to a Digi story and that they're leveraging a much larger product technology base in a particular space. We are making the same inroads, albeit in different verticals and different use cases. But I think anybody that kind of thinks in terms of just providing hardware instead of looking at a software hardware solution or platform solution, bringing in additional pieces.
There's a lot of struggling right now. It kind of comes down to who has the part available in the time line that a customer wants it. And if your lead time is a week longer than somebody else's, then they'll end up picking up whatever is on the shelf. And it feels like a buyer's market nowadays unless somebody is really looking at a total solution. So we think that, that provides us a little bit of ventilation against some of the softening in market demand.

Operator

And the next question is from Scott Searle from ROTH Capital.

Scott Wallace Searle

Paul, just to follow up on that pipeline. I think you said it was $140 million or $150 million. I'm wondering if you could calibrate us in terms of what your win rates have been and the close rates have been on that front? And as well on the software front, I was wondering if you could give us some idea in terms of where are you seeing the highest attach rates right now and the opportunity for that going forward?

Paul H. Pickle

Okay. Yes. So win rates, our win rate is actually really good. But I would caution you to say that it's been fairly early innings. When -- we don't really lose a lot of opportunities that come our way, mostly because when we start talking about them as opportunities and in the pipeline, they're already qualified, they're already funded. And so in a lot of respects, we end up signing statement of work or customization efforts on these programs. And once they do that, it's really kind of -- it's a pretty predictable thing that it will close.
The question is, do they hit their forecast or not. Obviously, (inaudible) was a new customer for us, in 2020 it was a new application. They blew the number out of the park, but largely because COVID happened and everybody got to remote work environments. And aside from that, probably would have been a little bit slower increase. I think Flock also great customer, great program, great ramp, also very opportunistic with a lot of the strike that's going on. People started to focus on security.
So some of it has been fortuitous, but very early innings. But now that we're talking about some of these engagements, our win rates generally are really good. I mentioned Fisker. Fisker is a name that's come around a few times. They're pretty well funded. We'd like to say that third times of the churn, but we're pretty confident that they'll push some volumes as well. But each guy we assess, and I think as we look at FY '25, we're feeling pretty good about this list. Numbers might go up or down. And Scott, I forgot the last question -- last half of that question.

Scott Wallace Searle

Just on the software front, Paul. Where are you seeing the attach rates and the opportunity, both today in terms of where you're getting the attach rates and where you see that looking forward into fiscal '24, '25.

Paul H. Pickle

Yes. The attach rates are going really well in RIM, especially. This is a customer base that prefers on-prem solutions. We have several on-prem solutions. And then we built out a specialized network management tool that really gives them -- it's not just single pane of glass where you're managing your devices. But the reality is it's more of a network management tool that gives you higher order functions, allow you to really drill down on what's happening inside a data center. So specialized tools that deliver what customers need. We see a lot of success there.
On the AT&T front, for instance, that software attachment is going to be largely dependent on the method of security that we implement. And right now, we're going through their network certification. And so far, things are looking pretty good. So we -- the higher order of security that we brought forward. So when you're talking about industrial applications that -- those are the customer care. If you look at the Togg program, we actually built into our platform and OTA function. And so these are the types of things that we have experienced with and we can bring. If you're talking about a low-end IoT application that's deployed in the masses, I'm not sure that we'd have the same level of traction there, but that's not the market that we're targeting.

Scott Wallace Searle

And lastly, if I could. You mentioned on the console server front, right, financial markets has been a vertical that you guys have had success in. I'm wondering if you could provide a little bit more color on when you think there might be a recovery time line associated with that. And lastly, inorganic opportunities. Kind of wondering what you're seeing out there, if there's rationalization in terms of valuations that companies are looking for in this type of market.

Paul H. Pickle

Okay. On the console servers, financial markets, we saw some hesitancy. I think we actually mentioned it on an earnings call 2 quarters ago. And this was before we saw a lot of the banking pressure. I think if you're talking to smaller banking institutions, there is definitely going to be continued ordering hesitancy. We typically deal with larger institutions, Bank of America, American Express. But even in those markets, they're -- we're kind of waiting on the CapEx cycle to loosen up a little bit, have good visibility, and they sit there and say that, "No, it's needed, the deployment is needed, and it's just a matter of timing." So we don't anticipate a long delay. I'd say, in some cases, 1 quarter delay is all that we expect.
On the -- let's call it, strategic alternatives front. Right now, valuations are attractive, but we're still -- we still live in a risk-off environment. So I think going out and getting financing for an asset right now is -- it'd be fairly expensive, and we'd be looking at rates that probably cost of capital that resembles debt of equity. So the good news is we have a couple of different currencies to play with.
I think we would -- let me make clear that we are extremely focused on executing what we're -- currently is our organic growth plan, but we are still kicking the tires on a number of different assets to see if it makes sense. I think for the most part, the market still sees that, "Hey, we're bigger together." I think smaller assets are going to be constrained on capital. And so it makes it a little bit easier to pick things up. But it's -- we'll see how it goes over the next couple of quarters.

Scott Wallace Searle

Paul, one last one. Just -- you talked about the cost of capital. You generated some cash this quarter, but inventories are still pretty elevated. Part of that is related to the Gridspertise. Could you just walk us through how you see that transitioning over the next couple of quarters? Should we start to see that work down with normalization of the supply chain to give you a little bit more flexibility?

Paul H. Pickle

Yes. If you ignore the Gridspertise opportunity and the inventory associated with it, we had inventory levels tick up ever so slightly in the quarter. And so right now, I think it's just indicative of support for some of the growing revenue opportunities and bookings that we saw. I did mention that we had difficulty shipping to about $1 million worth of revenue this past quarter. That's going to flush through this next quarter. And I think if you look at the next 3 quarters, you're going to see that inventory number optimize pretty aggressively. And then as that flows through, we'll get some of the PPPs through, you should see some nice support on the gross margin line as well.

Operator

And 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.

Paul H. Pickle

Well, thank you for joining us, and have a great day.

Operator

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