Good afternoon, everyone, and welcome to the Lantronix First Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. Please also note, today’s event is being recorded. And at this time, I would like to turn the floor over to Rob Adams. Sir, please go ahead.

Thank you, and good afternoon, and thanks for joining us for our first quarter of fiscal 2023 conference call. Joining us on the call 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, as well as the company's SEC filings, such as the 10-Ks and 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, 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 first quarter of fiscal 2023 before I hand it over to Paul for his commentary. In September of 2022, we closed the acquisition of Uplogix for $8 million in cash consideration and an additional cash earn-out of up to $4 million if certain revenue targets are met. We funded the acquisition with an increase of $5 million to our existing term loan and available cash. As a result, our first quarter of fiscal 2023 includes approximately two weeks of operating activity related to Uplogix’s acquisition. Although not significant to our first quarter results, the acquisition was accretive to non-GAAP earnings and is expected to be accretive on a go-forward basis. For the first quarter of fiscal 2023, we reported revenue of $31.8 million, an increase of 15% when compared to $27.7 million for the first quarter of fiscal 2022. As expected, revenue was down sequentially as compared to $35.9 million reported in the fourth quarter of fiscal 2022. Our most recent acquisition contributed approximately $400,000 of revenue in the current quarter. GAAP gross margin was 44.1% for the first quarter of fiscal 2023 as compared with 41.9% in the prior quarter. The sequential improvement was related to lower supply chain costs in addition to improved product mix. Selling, general and administrative expenses for the first quarter of fiscal 2023 were $9.2 million, compared with $7.9 million for the first quarter of fiscal 2022 and $9.4 million for the fourth quarter of fiscal 2022. Research and development expenses for the first quarter of fiscal 2023 were $4.5 million, compared with $4 million for the first quarter of fiscal 2022 and $4.9 million for the fourth quarter of fiscal 2022. The year-on-year increases in SG&A and R&D were largely driven by the acquisition of the TN Companies at the beginning of fiscal 2022. However, as a percentage of revenue, expenses were down from the year-ago period. GAAP net loss was $1.7 million or $0.05 per share during the first quarter of fiscal 2023 compared to a GAAP net loss of $2.3 million or $0.08 per share during the first quarter of fiscal 2022. Non-GAAP net income was $2.7 million or $0.07 per share during the first quarter of fiscal 2023 compared to non-GAAP net income of $2.5 million or $0.08 per share during the first quarter of fiscal 2022. Now, turning to the balance sheet. We ended the September 2022 quarter with cash and cash equivalents of $13.1 million as compared to $17.2 million in the prior quarter. Working capital is $50.3 million as of September 30, 2022, as compared with $54.5 million as of June 30, 2022. Net inventories were $45.3 million as of September 30, 2022 compared with $37.7 million as of June 30, 2022. The sequential increase was primarily due to the assumption of inventories in the Uplogix acquisition, and the purchase of components to support the Enel project, which is expected to ramp during the second half of the fiscal year. Now, turning to our revised annual outlook. After adjusting for our recent acquisition of Uplogix, for fiscal 2023, we are increasing our target as follows: revenue of $155 million to $165 million; and non-GAAP EPS in a range of $0.41 to $0.46 per share. We expect the revenue and earnings growth to be more heavily weighted in the second half of the fiscal year, as our two largest design wins are expected to ramp into full production during the second half. I’ll now turn the call over to Paul.

Thank you, Jeremy. While we expected a slower start to our fiscal 2023, I’m pleased to report we made good progress on a number of fronts in the quarter: revenues grew 15% year-over-year; we saw some margin improvement, thanks to lower logistics and supply chain costs; and we acquired a high value-adds systems business. We also laid the groundwork for the remainder of this fiscal year. We have a watchful eye on the economy, and while we do note some caution in bookings patterns as some customers have begun to book orders in later quarters, we entered the December quarter with starting backlog up versus September, and our total backlog is up as compared to last quarter. All-in, we see a return to sequential growth in December, followed by accelerating growth in the second half as we ramp volume production with two of our larger Compute customers. Turning to our product discussion. Embedded IoT Solutions totaled $15.1 million, down 18% sequentially, but up an impressive 22% year-over-year, and representing 47% of total revenues. We saw strength in our NIC and SFP products, which benefited from seasonal strength at key federal customers, but this was offset by a fall-off in Compute due to process or component supply constraints, after a strong performance in our fiscal Q4 June quarter. We currently see Embedded Systems strengthening throughout the year, driven by our Compute products. In Q3 and Q4, we plan to benefit from shipments to electric vehicle customer Togg, which just had the grand opening of its production facility in Turkey. Togg will begin taking shipments this quarter and we expect to be in full swing by the March quarter. Turning to System Solutions, revenues here totaled $14.6 million or 46% of revenues, flat sequentially and up 11% year-over-year. Within System Solutions, switching products saw the strongest growth benefiting from significant interest from our growing Smart City customer base. In addition, our growing Fed business resulted in us benefiting from a stronger Fed buying cycle for network interface products. This strength was offset by lower media converter solution sales which slowed after a strong fiscal year and quarter. For the remainder of fiscal 2023, we expect to see a rapid acceleration of our systems business, led by the ramp, the volume production of the smart grid, quantum edge device, or QED, for our customer Gridspertise. We received our first purchase order for the pilot run in the September quarter and will begin recognizing revenue in the current quarter. We expect to complete a purchase contract for ensuing production this quarter, and we currently expect to ramp the volume against our previously announced production awards in our fiscal Q3 and Q4. Within the Systems Business, we reported approximately $400,000 of revenue from our recent acquisition of out-of-band networking supplier Uplogix, which closed in the middle of September. Uplogix is a key acquisition for us on a number of fronts. Number one, the Uplogix product offering augments our existing out-of-band solutions with high-end, higher port count devices that offer a high degree of automation, control functionality and security, which makes them especially valuable to federal and financial customers. These systems complement our existing portfolio, giving us a broader product offering to address data center applications with increased scale and synergies. Number two, this is a margin-accretive transaction. The Uplogix product margins are in line with our own out-of-band solutions, and our new portfolio brings with it a strong base of recurring software and support revenues. On the whole, this acquisition is expected to be nicely accretive to Lantronix Corporate margins. And lastly, this acquisition delivers engineering synergies and solidifies our product roadmap. Today's data center architectures are changing and our product roadmap was due for a refresh. Acquiring Uplogix is expected to save us an estimated $3 million in next-generation product development. And as we have demonstrated previously, the fragmented IoT market continues to offer value. We were able to acquire this high-margin system supplier at a discount to its last 12-month revenue of $9 million, paying $8 million in consideration. For the remainder of the fiscal year, we are expecting revenues to be over $5 million from this acquisition. Looking at software and services. Revenues in Q1 accounted for 7% of total revenues or approximately $2.1 million. Software and services revenue was down 28% sequentially following a record quarter in Q4, which was driven primarily by pre-production activity for Compute customers, Gridspertise and Togg. We do expect some volatility in this line. In addition, after accounting for the acquisition of Uplogix, we exited Q1 with a high-margin subscription ARR of greater than $5 million. In summary, while Q1 results showed a pause to our growth trend, we are confident in our prospects for the remainder of fiscal 2023. We expect to resume our growth trend in December, led by the resumption of Compute revenues, and we expect that trend to accelerate in the second half of our fiscal year as we recognize volume shipments to Enel and Togg. Our backlog remains healthy. The supply chain is seeing improvement with more easing expected in the New Year, and our acquisition of Uplogix will drive incremental revenues, much of which will come from customers new to Lantronix and to whom we can offer a more comprehensive IoT solutions product offering. That completes our prepared remarks for today. So, I’ll now turn it over to the operator to conduct our Q&A session.

Our first question today comes from Mike Walkley from Canaccord Genuity. Please go ahead with your question.

Great. Thanks, and congrats on the solid start to the year. I guess, Paul, in previous quarters you talked about the supply chain and a metric of customer requested product that you couldn't ship during the quarter. Can you elaborate maybe on how supply might be improving and where that metric might be now?

Yeah. So, the latest CRD shipment came down slightly in the quarter to $8.3 million. I believe this was additional shipments requested in the quarter that we were not able to meet. Overall, the backlog is higher. Total backlog at the end of the quarter was higher than the previous quarter. So, we're seeing some bookings taking place in the out quarters, and so I think that explains a little bit of some of the economics that are going there. But in terms of supply chain, we've had some disappointment on the mixed signal side. I'd say largely some of the digital semiconductor components are more readily available today. Memory certainly has normalized. We're seeing some of those PPVs come down. They take a while to work through the P&L. But some mixed signal components, in particular, are still difficult to get. Analog is still difficult to get. So, TI, ADI, NXP, and Cyprus have also been having some issues with supply as well of late. But overall, I'd say, it continues to improve. We've gotten some easing out of our key suppliers, and I’d expect it to continue to improve as we enter this New Year.

Great, thanks. And as a follow-up question, gross margins were stronger than expected this quarter, and it sounds like Uplogix seems like a good fit, and that's margin accretive also. Any update on how we should think about gross margins? I know there's a lot of moving parts with different projects ramping in the year also.

We still anticipate gross margins in the mid-40% range. As we generate more software revenue, we expect to see that increase. When discussing our ARR figure, we are referring to a business with margins exceeding 90%. The $5 million in ARR will positively impact our P&L. Additionally, regarding supply chain improvements, we saved just over $800,000 this quarter on component sourcing. It takes time for these savings to reflect in the P&L as they accumulate and we work through our inventory. However, this is a positive sign for future improvements. While we are not changing our model at this time, I believe a long-term model where gross margins start with a five is certainly feasible in the near future.

Great. And last question for me and I’ll pass it on. As far as Gridspertise and Togg, do you have revenue for those in that December quarter or is it really the second half of the year where you start to see the uplift from those two big projects? Thank you.

The revenue from Gridspertise is not significant at this time. Gridspertise, which is a subsidiary of Enel formed last September, has some supply chain agreements with its parent company. We anticipate a gradual separation between the two, creating ongoing opportunities for us as there will be internal consumption at Enel and demand in the wider market for Gridspertise products. For the timing of revenue, we will certainly recognize some revenue this quarter from Togg, particularly from the first shipments of SiP modules. We've been acknowledging service agreement revenue with Togg over the past year, but a substantial increase is not expected until the March quarter. The same applies to Gridspertise; we expect to see some minor revenue this December quarter, but the majority will begin in March, with significant growth expected throughout the following year.

Great. Thank you. I’ll jump back in the queue.

Thank you.

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

Congratulations on a strong quarter. Paul, could you clarify how much of your $155 million to $165 million guidance you expect from Togg and Enel? It seems like these projects are set to start ramping up now that the initial phase is underway. I'm curious about the revenue expectations from those two applications. Additionally, I assume you have a clearer idea of your expected shipments for calendar year 2023 compared to what might be shipped by the end of March and into the June quarter. Any insights you could provide would be greatly appreciated.

As we look ahead beyond this fiscal year, while we do provide guidance for the fiscal year, I anticipate continued growth as our programs start to influence fiscal year 2023. For the full fiscal year impact in 2024, I expect this growth trend to persist. I want to be careful not to provide guidance on individual business segments, as I need to be mindful of the competitive landscape. However, we've identified Togg as presenting a potential $50 million opportunity over four years, although this could vary. I'm aware of customer demands and what might be achievable. Previously, we indicated that Enel's impact would start to materialize in the December quarter, and that is occurring, with an expected impact of $10 million to $20 million in fiscal year 2023, which still holds true. Customers' internal timelines seem more aggressive, though they haven't met them due to delays from other suppliers. Based on what we can see, progress is being made this quarter as we've indicated in prior calls. The future trajectory remains uncertain as we are still defining the next-generation design. We're in discussions regarding what that design will entail, including the volume and specifics, which is encouraging as Gridspertise remains in the engineering phase. To summarize, Togg is projected at $50 million over four years, with significant volume anticipated after the second year. Initially, they plan to produce about 30,000 units this year, though their factory has the capacity for up to 167,000 cars annually, making it difficult to predict exact output. Enel aims for 100,000 units per year, but I expect that production will be shared among multiple suppliers when that milestone is achieved.

Great. Thank you for that. And if we kind of look at the core business, ex-acquisitions and large new customer products, what are you thinking about that remaining core business? What do you think that steady growth rate is on a go-forward basis?

That's a great question. Over the past year, we've seen our base business outperform expectations, and I anticipated it might pull back to mid to high single-digit growth around the June quarter. This expectation is incorporated into our guidance for the upcoming fiscal year. We're projecting that the base business will adjust to mid to high single-digit growth, which is still progressing well. We're consistently introducing new products in that area, and they are being well received. This aspect of the business tends to have steady growth without significant fluctuations. Mid to high single-digit growth is what we anticipate it should achieve.

Great. And then one last question if I may. You talked about the nice software-driven margins and the growth expectations for that to continue, and an opportunity not just to have 45% gross margins as a target, but eventually in the not-too-distant future, I think were your words, to be 50%. So, with these large program wins that we just walked through earlier, can we ship a significant amount of revenue to those and still operate the company near a 50% gross margin? Is that what you were trying to say?

So, I’m not saying that. What I’m saying is mid-40%s, definitely I think the answer to the question is mid-40%s, and then as software becomes a larger component, I think we can start to creep that gross margin up. It does take a couple of things. One, software traction. We still have our sights on getting to that hurdle of 10% of company revenues coming from software sales. And when I say software sales, I'm talking about 90% plus margin again. And so, as we kind of enter that stage, obviously we will refine the hardware portfolio to start extracting a higher value dollar as well. And then I expect to benefit from a supply chain easing cost; we got some benefit this quarter from freight as well coming back down. So, a number of things driving the company towards that five handle. But I think you will see some bottom-line profitability changes as well. And so, I believe I said future; I didn't say 'not so distant future,' but I’m thinking in terms of this fiscal year getting past it, operating at mid-40%s and then looking to see some margin expansion beyond that.

Fantastic. No other questions. Thank you.

And our next question comes from Scott Searle from Roth Capital. Please go ahead with your question.

Hey, good afternoon, and thanks for taking my questions. Nice job on the quarter. Hey, Paul, I apologize. I got on the call a little bit late, but I was hoping to dive in on Uplogix. I heard you say $5 million contribution for the year. I’m not sure if there was any contribution in the September quarter. I was wondering if you could provide a little color there, also, the number of employees that came onboard as part of it. And as we kind of think about the gross margin mix going forward, I would think that has an upward bias, but I’m kind of wondering now as we start to have Enel coming into the mix and Togg coming into the mix, should we be expecting a little bit of a step backward before we start marching up into the mid-40%s and higher?

In the quarter, we saw a $400,000 contribution from Uplogix, which is relatively minor. While we mentioned it was immediately accretive in the quarter, its overall impact is not substantial. For this fiscal year, revenue exceeded $5 million. The business had a trailing twelve-month revenue of $9 million, and since we are acquiring it partway through the year, there are seasonal fluctuations to consider. At acquisition, the business had 25 employees. As we integrate, we expect that number to slightly decrease, but we are pleased with the talented team and look forward to incorporating them into Lantronix effectively. The company primarily operates in an outsourced hardware engineering model, which allows us to benefit from our existing resources and contract manufacturing. From an analysis of the bill of materials, we can immediately reduce our cost of goods sold by 30%, leading to an expected increase as we take over the business. However, there is a significant amount of inventory linked to this asset that we must address first. Regarding the overall margin profile, I anticipate mid-40% margins due to the integration of businesses and improved software traction, which should balance out the lower margins from more aggressive ventures. I will exercise caution in highlighting specific business segments, as making public statements could lead to conflicting negotiations in my remarks. Therefore, consider the overall picture; while pursuing a hardware initiative that boosts our top line, we are also seeing positive developments in the high-margin segment. For this fiscal year, I believe we can achieve a blended margin in the mid-40% range unless supply chain improvements occur sooner than expected. Beyond that, we can gradually improve margins with enhanced performance in software and high-margin hardware.

Got you. Very helpful. And, Paul, if I could just to dive in, I think on the guidance for this year, $155 million to $165 million, quick back of the napkin kind of math, implies that those gross margins are kind of in the mid to maybe, I'd say, like sub even 45%. Is that the right ballpark? Or are you expecting to ramp up some sales and marketing and other R&D efforts a little bit more aggressively as we go into fiscal ’23?

I will probably have some things to fund in the second half of the year, but given the revenue profiles, I could have a hard time bringing all that investment to bear. But fundamentally speaking, we're still thinking in terms of a 10% EBITDA margin as we do have a number of good programs. If I look at the pipeline of opportunities that we have, we're chasing well over $200 million of new revenue growth, and some of that is going to require investments, some of it's going to require partial customer buy-in, but things just look pretty good right now. And correct me if I misinterpreted your question on that one. Did I get it right?

Got it. That was perfect. But I guess to just kind of drive on the gross margin front, it just sounds like you're being fairly conservative, right, while 50% is a target, that is certainly not built into the guidance that you're talking about today?

That is correct. So, mid-40%s this fiscal year, and we're starting to see some traction on the high-margin side of the business. So, I think we can start to think in terms of the long term chasing that five handle on the gross margin and some increased profitability. We're not there yet, but we can see a pathway to get there.

Perfect. And lastly, you kind of hit on it in terms of some of the pipeline. I’m wondering if you could provide a little bit more color on that front. I think this year we've gotten bi-optically focused on Enel and Togg, but there's a big pipeline out there that’s building this. I was wondering if you could provide a little bit more color on that front. I guess as part of it, Edge Compute, I think is one of the areas where you had some severe supply constraints recently. How is that doing? And kind of how should we be thinking about that pipeline of business? Timeline, that's deliverable? How are you seeing your win rates? Then we can kind of synthesize what that $200 million type of number looks like over the next couple of years. Thanks.

In the first quarter, we experienced some challenges. In the fourth quarter, we received additional processors, but a Samsung fab issue prevented us from backfilling those in the first quarter. This situation resulted in a boost to fourth-quarter revenue, but we couldn’t backfill in the first quarter, which led to a slight drop in our numbers. The Compute segment was impacted as a result. However, this mix has resulted in a slightly improved margin profile, which aligns with our expectations. Regarding our pipeline, the IoT store is currently experiencing a positive secular trend. There are numerous opportunities emerging that might seem unconventional, where customers aim to reduce truck rolls, which are quite costly. The labor shortage is pushing for remote management solutions. For instance, a client is working on a custom project to enable remote power resets for commercial machines in convenience stores, which could save them nearly $1 million annually. They are looking to implement a system to achieve this. We also have several significant opportunities in Smart Cities and Department of Transportation applications for municipalities. A telematics tracking venture in the Middle East is one of these substantial opportunities. Our out-of-band remote management prospects continue to perform well, though the business can be a bit uneven. We are noticing several seven-digit opportunities with different players, some of which are quite substantial. On the enterprise front, where sales cycles are generally shorter, we continue to see growth in audio/video conferencing applications. We have received a verbal award from a significant project, and we expect to commence development work this quarter, which would also have considerable scale attached—again, in the eight-digit range. Our initiatives in the automotive sector are expanding to other electric vehicle platforms. Overall, I remain optimistic about the growth potential of the company. We are focused on achieving scale and are progressing toward our $250 million target, which we believe can get off to a strong start this year.

Perfect. Thanks so much. Nice quarter.

Thank you.

Our next question comes from Harry Wilmerding from Needham. Please go ahead with your question.

Hey, how's it going? I’m just curious, quickly if you can discuss the general market updates and the dynamics of the market you're seeing, how any changes in macro affect your outlook for certain verticals or geographies?

I would say our markets are largely quite strong. However, I do anticipate some pricing pressure, particularly in EMEA. The decline of the euro against the dollar has increased the cost of goods in that region, which makes me a bit concerned. Still, that area is where most of our short-term growth is coming from. Being involved in applications like smart grid is advantageous as Europe faces an energy crisis, which is driving investment in upgraded infrastructure and self-healing networks. We're fortunate to be in spaces that are receiving investment. That said, I'm somewhat anxious about the currency exchange with Europe and expect some pullback in APAC as well, although the majority of our revenue comes from the U.S. and North America, specifically North America and EMEA. There isn't an overall impact, but we are still encountering numerous opportunities in automation. Companies are looking to save costs, wanting fewer people involved in processes, which leads them to consider technology solutions. This trend looks promising for us.

Great. Thank you so much. I appreciate it.

And our next question is a follow-up from Christian Schwab from Craig-Hallum. Please go ahead with your follow-up.

Hey. Just a quick one. On our $250 million revenue multi-year target, is it safe to assume that you would like to be operating as we kind of think about earnings power of the company at or near the 50% gross margin range by that time frame, is that fair?

Yes.

Great. No other questions. Thanks.

And ladies and gentlemen, with that, we’ll conclude today's question-and-answer session. I’d like to turn the floor back over to the management team for any closing remarks.

Thank you for joining us today, and hope you have a great evening.

And with that, ladies and gentlemen, we'll conclude today's conference call and presentation. We thank you for joining. You may now disconnect your lines.