Good day, ladies and gentlemen and welcome to the Lantronix, Inc. 2023 Q2 Results Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Rob Adams, Investor Relations. Please go ahead, sir..

Thank you. Good afternoon, everyone. Thank you for joining the second quarter fiscal 2023 conference call. Joining us on the call today are Paul Pickle, 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 and details for the phone replay in today’s earnings release. During this call, management may make forward-looking statements, which involve risks, 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 it is also 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 use.

With that, I will now turn the call over to Jeremy Whitaker, Lantronix Chief Financial Officer..

Thank you, Rob and welcome to everyone joining us for this afternoon’s call. I am going to provide the financial results as well as some of the business highlights for our second quarter of fiscal 2023 before I hand it over to Paul for his commentary.

For the second quarter of fiscal 2023, we reported revenue of $31.5 million compared to $33.7 million for the second quarter of fiscal 2022. Sequentially, revenue was down 1%. GAAP gross margin was 44% for the second quarter of fiscal 2023 which is consistent with the prior quarter and about a 900 basis point improvement from the year ago quarter.

Selling, general and administrative expenses for the second quarter of fiscal 2023 were $9.8 million compared with $8.9 million for the second quarter of fiscal 2022 and $9.2 million for the first quarter of fiscal 2023.

Research and development expenses for the second quarter of fiscal 2023 were $5.1 million, compared with $4.3 million for the second quarter of fiscal 2022 and $4.5 million for the first 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 Uplogix.

GAAP net loss was $2.6 million or $0.07 per share during the second quarter of fiscal 2023 compared to a GAAP net loss of $2.4 million or $0.08 per share during the second quarter of fiscal 2022.

Non-GAAP net income was $1.4 million or $0.04 per share during the second quarter of fiscal 2023 compared to non-GAAP net income of $3.3 million or $0.10 per share during the second quarter of fiscal 2022.

Now turning to the balance sheet, we ended the December 2022 quarter with cash and cash equivalents of $6.8 million as compared to $13.1 million in the prior quarter. With our recently announced contract, we expect to receive aggregate prepayments of $20 million during the next 6 months.

Working capital was $50.6 million as of December 31, 2022, as compared with $54.5 million as of June 30, 2022. Net inventories were $49.2 million as of December 31, 2022, compared with $37.7 million as of June 30, 2022.

The increase was primarily due to the purchase of components to support the recently announced contract, which is expected to ramp during fiscal 2024. Now turning to our annual outlook. For fiscal 2023, we are targeting revenue of $135 million to $145 million and non-GAAP EPS in a range of $0.27 to $0.33 per share.

I will now turn the call over to Paul..

Thank you, Jeremy. We continue to make progress in transforming Lantronix in Q2 and after finalizing the largest contract in the history of the company, which we announced two weeks ago, the pieces are falling into place.

For those who didn’t see the announcement subsequent to the close of the December quarter, Lantronix finalized the largest contract in its history, a $40 million smart grid compute platform utilized by one of the world’s leading energy distributors. We expect to ship against the contract substantially over the course of fiscal 2024.

This contract validates our capabilities and is but one that provides substantial visibility into our fiscal 2024 growth prospects. Against the backdrop of continued supply chain easing, executing on delivery of the product will accelerate us towards our intermediate goal of $250 million in annual revenue.

The opportunity pipeline in excess of $200 million, we are at capacity with our current resources and our longer-term outlook is looking bright.

Looking for more immediately at Q3 and Q4, a while our Lantronix classic business has normalized after a strong run post COVID, we are bolstered by a backlog that remains just off all-time highs, a slowly improving supply chain and a decidedly lean inventory channel, implying a return to growth.

With that, let’s turn our focus now to December results. In our fiscal second quarter, embedded IoT Solutions totaled $13.7 million, down 9% sequentially and 12% year-over-year, representing 43% of total revenues.

The decline in revenues was largely driven by our embedded Ethernet and WiFi solutions where demand was healthy, but supply disruptions continue to gate our ability to shift to customer demand. On the positive side, compute revenues grew nicely quarter-over-quarter. Security and surveillance compute revenues were steady.

Enterprise revenues were up and automotive began to contribute. In terms of outlook, we currently see embedded systems strengthening throughout the remainder of the year, driven largely by our compute products with some contribution expected from Ethernet and WiFi supply chain limitations eased.

Shipments to electric vehicle customer to continue according to plan, and the factory in Turkey was reportedly unaffected by the recent earthquake in the country. Turning to Systems Solutions, revenues here totaled $14.9 million or approximately 47% of revenues, up 2% sequentially though down 9% year-over-year.

Within System Solutions, switches remained a strong contributor, and we continue to see a good funnel of activity that bodes well for the remainder of the year. Remote environment management or REM products also grew in the December quarter thanks in part to the acquisition of Uplogix in mid-September.

While we continue to see a good funnel of activity for REM, we have seen weakness in the financial sector resulting in push out of proof of concepts. Also within IoT systems, routers, gateways and trackers were up nicely in the December quarter as we were able to catch up on some opportunities as supply came in.

For the remainder of fiscal 2023, we expect to see continued growth led by switches of rebounded in remote management solutions and continued strength in routers, gateways and trackers. Looking at software and services. Revenues in Q2 were approximately $2.9 million, up 41% sequentially and 71% 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 December quarter totaled just over $5.2 million.

In summary, we look forward to a resumption of growth for the remainder of the fiscal year, thanks to solid bookings, a backlog that remains near record highs a strong opportunity funnel and a slowly improving supply chain.

While there is still much to focus on for the remainder of the fiscal year, we can’t help but anticipate our fiscal 2024 as we shift to the largest customer contract in history, we have excellent visibility into solid revenue growth and fast-growing funnel with opportunities to keep the ball rolling. That completes the prepared remarks for today.

So I’ll turn it over to the operator to conduct our Q&A session..

Thank you. [Operator Instructions] Our first question comes from Scott Searle with ROTH MKM. Please go ahead..

Hi, good afternoon. Thanks for taking my questions. Paul, really appreciate hearing a lot of the color and the breakdown of the different business units. Maybe to dive in on the Gridspertise contract that was announced.

I was wondering if you could provide a little bit more color in terms of how we should expect that to ramp up? Is that going to extend into fiscal ‘25? And kind of I think this was supposed to be the first phase of that relationship. What do you see color the horizon there as well? And then I’ve got a couple of follow-ups..

Yes. I think we have a schedule in the contract that we have, and we have a target by the customer. This should come out of the gate in our Q1 fiscal Q1 quite strong and ramping quite nicely into the December quarter. In terms of follow-on engagement, we are at this point, talking about additional SKUs.

And certainly, this is just the first step and the fulfillment of what we’ve been developing over the past couple of years with them. And they have done a phenomenal job bringing this product to market. The market is quite excited. That’s part of the reason for the delay.

In fact, as they launch a product, they have been getting a lot of feedback from the DSOs out there, the customers that would use this, and it’s prompted some SKU changes, feature changes that we’ve now shifted direction and started focusing on.

So we’ve got a firm product launch at this point, certainly anticipate that this is just the first bit of success that we will have here, and this will certainly take us beyond 2024..

Perfect. And Paul, just to emphasize, I think what you just said is that you’ve got firm ship dates here, right? So you’ve got very, very good visibility to fiscal ‘24 at this point. And I think in your opening monologue, you said that this was one contract that provide some visibility.

I was wondering if you could give us some details or maybe a little bit more color in terms of what else is giving you comfort as we’re looking into fiscal ‘24..

Yes. We have – we really have quite a large pipeline of opportunities. Some of these opportunities we work on for 1.5 years, 2 years before they fulfilled at this point, we’ve been working on quite a few. Not to get into specifics until we’re ready to announce them, but there is quite a few new opportunities in automotive, especially EV platforms.

We’ve been doing – we’re taking the success that we experienced at Tag and are parlaying that into other vehicle platforms. Out of band, we’ve been working on some POCs with some new product definition. We’ve got some new SKUs coming out with our recent acquisition on a new technology platform. With a new software tool that we’re deploying.

So that’s quite promising. Not quite the needle mover that a Gridspertise would be but certainly up there. And then smart city engagement, still probably early innings, but there is been a couple of discussions on some IoT applications in smart cities that are right up our alley.

It’s a little bit of a take off of what we did for the smart grid applications, compute platform along with some distributed IoT devices to help in the management in large municipalities. So – that one is like an 8-digit opportunity over the life of the program. It’s still early innings.

We’ve got a lot of work to do there, but it’s nice to be engaged in opportunities that are this large. If I were to reflect on 3 years ago, we didn’t have anything like this in our pipeline..

Perfect. And if I could just then shift over to supply chain and then I’ll get back in the queue. But your inventories are up. It sounds like part of that is related to preparation for Gridspertise. But I’m wondering if you could talk about some of the other aspects in terms of how the supply chain is going.

It sounds like you’re continuing to see issues on the WiFi front. And what you’re seeing in terms of your customers, it sounds like the channel for your customers that you’re selling is pretty lean at this point in time, so you expect sort of a recovery as we’re going into March and June here.

So I wonder if you could give us the kind of holistic view of what you’re seeing in terms of coming in the door and what your customers have on their premise and how we should expect things to ramp over the next couple of quarters?.

Yes, that’s a great question. I don’t think it’s dissimilar to what you might see if you were paying a couple of CMs or other suppliers.

Everybody’s turns have kind of worsened and it’s really an artifact of orders being placed, the demand being there and the supply chain is starting to ease, we can collect probably 95% of the BOM or even as high as 99% of the BOM, but there is one or two problem components that prevent you from going to manufacturing building and then getting that inventory brought down.

So if I were to take out a new, that’s kind of a special case, we’re going to receive some prepayments for those components. We acquired a bit of inventory with the Uplogix.

So we saw a little bit of a jump in the inventory numbers associated with acquired inventory if I dismiss all that and just look at the rest, if we really do have one or two problematic components that are preventing us from really turning that inventory into sales and thus cash.

So Cypress was a bit of a difficult one from a chipset standpoint that slowed down our WiFi shipments. We saw some improvements that came in and had some slightly better shipments of chipsets in December. That allowed us to turn that revenue in this quarter.

It’s getting better, but having said that, we still have some problematic components here and there. Some of the critical ones are still 36 all the way up to 52 weeks. But for the most part, supply chain is getting a lot better.

In terms of channel inventory, we saw this quarter, I think it’s a little bit of hesitancy in terms of what people think the market might be doing. But as we look at the POS out of the channel versus what we sold into the channel, there was quite a bit of disparity, a lot more product exited the channel.

And so it came down about 2 weeks of channel inventory. It’s really good, healthy numbers. So at some point, they are going to have to re-up..

Perfect. And I apologize, I got one more follow-up. On the $20 million prepayment, nice to see that, that’s going to kind of make the balance sheet look a lot better. But I expect that your inventory levels are going to start to work down as well.

So we should start to see a little bit of a reversal of working capital here over the next couple of quarters to help out on the cash portion of the balance sheet? Thanks..

So that money, that prepayment coming in, it will be on the balance sheet as a deposit it won’t offset inventory. So you won’t see those turn quickly. I think we will make marginal improvements, but expect inventory to get better over the next three quarters or so.

Do you want to give any color on that, Jeremy?.

Yes. As Paul mentioned, it will be a customer deposit liability and then we will lead that liability off as we ship against the orders from Gridspertise. And then also the turn kind of also dictate when we will build a bit of inventory and then that will obviously come off the books when we ultimately ship it to them..

Great. Thanks. I will get back into queue..

Thank you..

The next question comes from Mike Walkley with Canaccord Genuity. Please go ahead..

Great. Thanks for taking my question. And congratulations on getting the Gridspertise deal signed.

Just following up on Scott’s questions, can you update us, you’ve shared in the past, just given some of those troubled components, customer-requested product that you couldn’t deliver in the quarter due to the couple of those components you couldn’t quite get?.

Yes. And so WiFi was a big portion of it. We started to have – we have some problematic components in terms of the ASIC, just waiting for process on a foundry.

WiFi is the biggest one of biggest product line that we have a backlog that’s associated with new blocks GNSS, some cellular modems, cellular chipsets, also WiFi cards that we incorporate, subassemblies that we incorporate into our systems business is doing a little bit better.

So if I were to look at the suppliers of those problematic components, it does – it’s still mixed signal RF analog mixed signal, I should say, TI is still – we’re still having some issues associated with those, ADI and the like. It’s the same culprits, if you will..

Okay. Great. And then just on the Gridspertise contract, it sounds like you expect to ship most of that $40 million in fiscal ‘24.

But when you’re working with them, do you think you’ll have follow-on orders to keep growing or keep at least flat levels in the future years?.

So this is – so the answer to that is just a straightforward yes. And just to give you an idea of the scope of the program, so Gridspertise is a subsidiary that’s now partially owned by Enel. A PE firm purchased roughly a 50% consideration valued at $1 billion. And this is the flagship product for them.

So if you look at Enel’s consumption they are talking about 1.2 million substations, approximately 40% of those would use a device like this. And then there are other markets rather than just captive usage. So, they would like to get to a run rate of roughly 100,000 a year. I think it’s safe to say that we wouldn’t participate in all of that business.

And eventually, over time, it will take a little bit different shape for us. There is a recurring component of it for us and we are really in the very early innings of this product launch. So, we are pretty excited to see what happens after this.

And yes, this contract, we definitely anticipate that we will be fulfilling the bulk of this in FY ‘24 and there could be some upside to that, but certainly we would anticipate some FY ‘25 contribution as well..

Great. That’s helpful. Last question for me. I will jump in the queue.

Can you update us just on Tag and how that opportunity is going and some of these other car opportunities you talked about in EV, are they similar size or even bigger than the Tag opportunity?.

Yes. So, Tag is going really well. We shipped in December, and we are shipping this quarter as well. Things are moving along as planned. They had their factory opening on October 29th. That program went off without a hitch. We are still in development mode on that platform. We are still implementing software features.

We have not finalized the firmware image yet, but we are we are holding. It’s not daily meetings, meetings at least twice a week, tracking the progress and integrating our hardware and software into the total vehicle platform. It’s going rather well, but we are at a breakneck pace, nose down, head down, I should say, at the moment.

In terms of follow-on opportunities, what’s been interesting is I think, with the EV revolution, you are starting to see a lot more players out there and a platform that’s starting to standardize. So, the hardware that we developed for Tag, for instance, is Lantronix IP. We do get to go out there and resell that.

The ASIL certifications that we got on the hardware, we will attempt to sell across a broad market, sell license across a broader market. And it has really opened up other automotive opportunities. So, I could name a few half a dozen at the moment, but it’s still a little bit early for us in terms of those engagements.

And so we are going to continue to work on those, let them incubate and we will announce those at a later date. But this should be a nice space for us. I think it’s a market that we can exploit without having to become a full-blown automotive supplier with all the infrastructure that’s necessary there for a number of reasons on a partner front.

So, expect us to give more details as the automotive platforms continue to mature..

Great. Thanks for taking my questions..

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

Hi. Good afternoon. Thanks for the question opportunity.

So, with this upsizing on the Gridspertise deal, how should we think about gross margin puts and takes for ‘24, with the upside, is there a little margin pressure there that we should factor in?.

Not at this moment. When we kind of look at the business on an aggregate basis, we still feel comfortable with the mid-40s margin through this year. And then I would anticipate as we would continue to grow our ARR at this point, just over $5 million.

And just as a reminder, when we talk about recurring revenue, we are talking about 85% plus gross margin revenue. As we grow that number, continue to grow it, we would expect it to offset any scale that might come with a particular opportunity.

But this opportunity, in particular, with Gridspertise, we don’t expect it to be margin dilutive to the corporate number, and we expect to be able to offset that with other high-margin areas and hopefully make some improvements in gross margins as we look at FY ‘24..

Got it. That’s super helpful, Paul. And on the go-to-market side, it sounds like the companies reoriented a bit around chasing some of these longer – bigger deals and longer sales cycles, I am sure.

Can you reflect on any changes you have made either geographically or the types of channels you use to go after these larger deals, and how to fix, how you think about your go-to-market strategy?.

Yes. It’s been a wholesale overhaul. If I compare against 3 years ago, we roughly had pretty much 100% of revenue that ran through channel. Today, it’s probably on the order of 64% runs through the channel. We are starting to launch on a direct basis, larger opportunities.

We would like to strike a healthy balance, but we have reoriented the entire sales team into a channel management sales team as well as a business development team that exclusively targets what we would affectionately refer to as big game hunting. And it’s working out.

We are actually looking at ways that we can engage with customers on customized development opportunities become a technology partner extension to their business. And if we look at it, I think the value proposition is the complexity and the skill set necessary to have in-house to unlock the potential of today’s semiconductor ICs is just pretty vast.

And most customers don’t have the full talent in order to be able to do that, so they have to parse that out. That’s been an opportunity for us and we need to make sure that we are leveraging our value proposition for return.

We still have to make some gains, I think on a go-to-market standpoint in terms of being able to bring more standardized IP R&D reuse, it would allow us to build a bit more of a scalable business model instead of something that’s so customized. But that is the nature of IoT today. Every engagement requires some customization.

And we just – we are looking to try to take platforms. We have already developed leverage at least 85% reuse and do a little bit of customization on the top. And that’s the sweet spot that we have been able to exploit. It’s a good question. Thank you..

Alright. You’re welcome.

A quick follow-up to this also in the relationship with Qualcomm there, how is that evolving, any changes in that regard?.

Well, it continues to get better. We really see this as a key partner. Qualcomm is a key partner, just like some of our other chipsets, Qualcomm, in particular, is has seen value in what we do. We are able to enable applications where they don’t really quite have the ability to go address a diversified market. And like I said, IoT is pretty young.

I think they recognized IoT as their future, but at the same time, it’s pretty fragmented. So, they require partnerships like what we have. And that one just – I believe that it’s going to continue to be important to us. I think we are going to be a bit more ingrained and alongside what their market targets are.

We will start to share strategic plans and start to go off and get those – catch those opportunities together. So, expect us to be able to continue to build on that. I might have some news on that on exactly what that engagement looks like over the next couple of quarters..

Great. Thanks a lot..

The next question comes from Christian Schwab with Craig-Hallum Capital Group. Please go ahead..

Hey. Great. Thanks for taking my question. Paul, as we think about the business, ex large contracts.

What do you think the core business growth rate should be over the next 2 years to 3 years?.

It’s a great question. So – and I will draw a little bit of contrast. As we kind of talked about before, FY ‘22, it grew far more than what it really should have. And we expected it to moderate shortly after the fiscal year was done, and it has.

So, normally, that business, we get a mid maybe high-single digits growth out of it, the markets that it kind of targets, those well-established industrial markets, probably mid-single digit growth CAGR and so that’s really what the business should do. We do have some older product lines that are marching down in its useful product life cycle.

But we have got a few of them in sustained mode. We have got a few of them where we are not investing anymore and redirecting funds into higher growth opportunities like the compute business, like REM and like software to be frank..

Okay. That’s great. That’s my only question. Thank you..

Thank you..

This concludes our question-and-answer session. I will now turn the conference back over to Mr. Paul Pickle for any closing remarks..

Alright. Well, thank you for joining us today. I hope you have a great evening and a great week. Thank you..

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