Lantronix Inc (LTRX) Q4 2023 Earnings Call Transcript

Hello, and welcome to the Lantronix 2023 Q4 Results Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Robert Adams. Please go ahead.

Thank you. Good afternoon, everyone, and thank you for joining the Fourth Quarter Fiscal 2023 Conference Call. Joining us on the call today are Jeremy Whitaker, our interim CEO and Chief Financial Officer; and Jacques Issa, our Vice President of Marketing. 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 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 10-K 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, Lantronix's Interim CEO and 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 fourth quarter and fiscal year 2023 before I provide our financial targets for fiscal 2024 and an update on our CEO search. For FQ4 2023, we reported revenue of $34.9 million, up 6% sequentially and down 3% from the year-ago period. The sequential growth of 6% was largely a function of a strong quarter for our Embedded Solutions products, led by an embedded compute sale of approximately $3.4 million to an in-flight infotainment customer. We also experienced continued contribution from our electric vehicle customer, Togg. System Solutions were relatively flat quarter-over-quarter and included $1.4 million in revenue from the delivery of QED pilot production units to Gridspertise. We saw a weaker quarter in out-of-band products as our larger financial customers continued to exhibit cautious spending patterns. We expect out-of-band to improve against the backdrop of the upcoming Fed buying season. Sales here should increase in the September and December quarters, adding a boost to gross margins. At Q4 2023, Software and Services revenues were down sequentially, a function of lower design services revenue. However, there was an ebb and flow to these design projects, and we expect improvement going forward. GAAP gross margin was 39.5% for FQ4 2023 compared to 44.4% in the prior quarter and 41.9% in the year-ago quarter. The decline in gross margin was primarily a function of product mix, with the biggest variances being higher embedded compute sales and lower out-of-band sales as a percentage of revenue during FQ4 2023. For FQ1 2024, we expect our sales mix to normalize, with lower compute sales and gross margins closer to the mid-40s. GAAP SG&A expenses for FQ4 2023 were $8 million compared with $9.4 million in the year-ago quarter and $9.9 million in the prior quarter. The decline in GAAP SG&A was primarily due to lower share-based compensation expense and a focus on cost containment. R&D expenses for FQ4 2023 were $4.9 million, flat with the year-ago quarter and down from $5.1 million in the prior quarter. GAAP net loss was $1.7 million or $0.05 per share during FQ4 2023 compared to GAAP net income of $2.5 million or $0.07 per share in the year-ago quarter. Non-GAAP net income was $2.2 million or $0.06 per share during FQ4 2023 compared to non-GAAP net income of $2.8 million or $0.08 per share in the year-ago quarter. Now turning to the balance sheet. We ended FQ4 2023 with cash and cash equivalents of $13.5 million, an increase of $650,000 from the prior quarter. Working capital was $50.2 million as of FQ4 2023 and remained steady with the prior quarter. Net inventories were $49.7 million as of FQ4 2023, a decrease of $2 million from the prior quarter. The balance of inventory includes nearly $10 million of long lead time components that were prepaid by a customer. We expect to consume these components during fiscal 2024 as we deliver on the customer agreement. Now turning to the first quarter and fiscal year 2024. We expect that revenue in the first quarter will be down sequentially as the revenue growth in FQ4 2023 was largely a function of a significant shipment to the customer deploying in-flight infotainment systems. We don't expect this customer to contribute at a similar level in the upcoming quarter. That said, we remain confident about the fiscal year ahead of us, and expect to deliver upon the fiscal 2024 guidance that we provided during our previous earnings call. We entered fiscal 2024 with record backlog, a cautious but relatively steady demand environment, and new compute designs moving into production. Compute solutions, both embedded and at the system level, are expected to drive much of the growth in fiscal 2024 and beyond, led by smart grid deployments, intelligent vehicles, and enterprise video. As we have previously discussed, Gridspertise is our lead smart grid customer with the QED, an all-in-one edge computing platform providing electric grid operators with real-time insights and automated control of distributed energy resources. Since our last call, we've made substantial progress on getting the QED into production, which will allow us to realize the more than $40 million in revenue that we have in current backlog for Gridspertise during fiscal 2024. Specifically, we completed the shipment of substantially all of the QED units under the pilot production contract during FQ4 2023 and are ready to start mass production in the upcoming December-ended quarter. All component shortages that would gate deliveries in fiscal 2024 have been resolved. On the demand side, Gridspertise recently increased their fiscal 2024 production order by over $0.75 million and are currently negotiating the first follow-on purchase order, which we would expect to drive continued growth from this customer in fiscal 2025. Furthermore, we received the final deposit that was due under the initial production contract for a grand total of $20 million in deposits paid to us thus far. Based upon these factors, we are confident in the program and our ability to begin volume production of the QED in FQ2 2024, which would result in a meaningful revenue contribution during that quarter, leading to a full production ramp in the second half of fiscal 2024. More specifically, our current production forecast indicates that we would deliver approximately $5 million in FQ2 2024. We would double that amount in Q3 and deliver the balance in Q4. Our lead EV customer, Togg, is also progressing well. During FQ4 2023, we received a significant order from Togg that was double their current run rate and greater than what we had previously anticipated for fiscal 2024. In addition, we continue to engage a handful of other EV opportunities with design services that have the potential to transition to meaningful supply arrangements. We're also seeing traction with other compute designs. For example, we have a high-volume enterprise video collaboration design expected to ramp in FQ3 2024. Furthermore, with the recent Qualcomm announcement of their QCS-8550 with increased computing for edge AI processing and WiFi 7 connectivity, we have had multiple engagements with customers interested in using that solution for various compute-intensive applications such as autonomous mobile robots, industrial drones, and edge AI boxes. Now I'd like to provide the specifics for our fiscal 2024 guidance. With the backdrop of a record backlog, a cautious but relatively steady demand environment for our system solutions and new compute designs going into production, we anticipate delivering over 30% growth during fiscal 2024 and are reiterating our annual target of revenue in a range of $175 million to $185 million and non-GAAP EPS in the range of $0.50 to $0.60 per share. Now I'll provide a brief update on our CEO search. In June 2023, the Board engaged a third-party firm to conduct a candidate search. We're well along in the process and have begun performing in-person interviews. While it is difficult to pinpoint the exact timing, I do expect that we'll identify a qualified candidate before the calendar year-end. That completes our prepared remarks for today. So I'll now turn it over to the operator to conduct our Q&A session.

Today's first question comes from Scott Searle with ROTH MKM.

It's great to see the positive outlook for fiscal '24. Jeremy, I would like to get some details about the gross margins. It seems that the changes in the June quarter are mainly due to product mix, and you anticipate a recovery back to the levels we've seen in recent quarters, particularly with the rebound in out-of-band and other products. Is that right?

Yes, that would be correct. We had a really strong compute quarter, and our out-of-band was actually down sequentially. The compute being on the lower end of our margin scale and the out-of-band on the higher end of the scale. For FQ1, we're expecting that to kind of flip, where we're going to see much more contribution from out-of-band and lower contribution from compute. And the result of that would likely be returning to gross margins closer to the mid-40s.

Great. And then just looking at the top line, I thought I heard September sequentially down a little bit. Just want to clarify that. But then you start to see the ramp-up in the contribution from Gridspertise ramping up. I think you said $5 million in December, going to $10 million in the March quarter. I want to clarify that because it really implies, right, that you continue to see that big ramp-up over the course of the year and the contribution on that front. I'm wondering, two things on top of it. Gross margin profile, how is that going to impact you guys in the back half of the fiscal year? And then the follow-on contract, I'm wondering what other color you could provide around that in terms of the magnitude, size, and timing related to that?

Yes, I believe you are accurately describing our expectations for the year. Regarding margins, we anticipate maintaining levels in the mid- to low-40s, much like what we experienced in fiscal '23. Although the introduction of grid will slightly reduce our margins, it is close to our corporate average. However, we are benefiting from lower supply chain costs and reduced purchase price variances, which should help balance out some of the lower gross margin we expect from Gridspertise.

Great. And lastly, if I could. You talked about some of the other opportunities in different verticals, like Togg, etc. But I'm not sure if I heard a number in terms of the opportunity pipeline. I think last quarter, you talked about $150 million plus in opportunities. I'm wondering if there's a number that you would put on it.

Yes. That number has continued to grow. We're still pursuing a large number of opportunities greater than what the company has seen in the past. A lot of that is in applications such as smart cities, smart grid, EV, automotive, as well as security and surveillance.

The next question comes from Mike Walkley with Canaccord Genuity.

Great job on reiterating the guidance as we approach the Gridspertise ramp-up. Regarding Gridspertise, you mentioned your early discussions about the follow-on contract. If those negotiations are successful and we look toward fiscal '25, could we expect at least another $40 million? Or do you anticipate growth beyond that, given a full year of production compared to just ramping up throughout the year?

Yes. I think on the high end, we would grow year-on-year with Gridspertise based upon the units that they have and the pricing that we're currently talking about. And so yes, we do have a really good, I think, opportunity to continue the business with Gridspertise and to grow it year-on-year.

Great. That's helpful. And then as Gridspertise ramps or as you look at your mix throughout the year, Jeremy, is there anything to call out on gross margins? I know you're saying Q1 should bounce back kind of to that mid-40-ish. Is that a good way to think about for the full year? Or is there any puts and takes, how we should think about gross margin throughout the year based on your pipeline?

Yes. With the models that we put together and based upon our current forecast, the gross margin profile for the full fiscal year looks pretty close to what we had in fiscal '23. And like I said, as I mentioned previously, we do see some benefit from greater absorption as revenue increases from some of our fixed costs. And also, we are seeing quite a bit of relief in both logistics and purchase price variances, which should start showing themselves as we get into Q2 and the second half of the fiscal year. I think in addition to that, just on the operating margin, there's also quite a bit of leverage in the business. And so as we do grow the top line, we don't expect to add OpEx at a similar level, which would allow us to exit the year with an EBITDA margin in the mid-teens.

Great. That's helpful. As you think about the ramp in the model. I guess, last question for me, just on Embedded, very strong quarter due to that shipment, and you talked about it down sequentially. Is this a business that builds from there? And do you think it grows year-over-year? Or is most of the growth coming from IoT systems in 2024?

On the Embedded compute side, we anticipate that the next few quarters will be somewhat slow. We have several new design wins starting to ramp up in Q3, which should contribute to growth in that area. However, the overall growth is being driven by the compute business. Gridspertise is considered part of the compute business, even though it is not an embedded product, and this opportunity came to us through our design services with the Qualcomm processor.

Great. Thanks for taking my question. I'll pass the line.

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

So I just wanted to verify that you guys still believe you can do $50 million over the next few years with Togg. Is that still the production goal?

Yes. And if anything, it's gotten better. We just received this quarter a follow-on order from Togg, which was much greater than we had initially anticipated. So they're on track, if not doing better than what we've indicated previously.

Fantastic. And then my final question is like a follow-up to the first question, I think, from Scott. There's about 40 projects that you kind of highlighted before that could contribute $150 million of the annual revenue. Are any of those projects in your expectations for next fiscal year?

There are a couple that could help fiscal '24. I would say the vast majority of them would be projects that we'd be winning in fiscal '24 and then most likely contributing to revenue in fiscal '25. I think more about the future with that pipeline, although some of them have a high likelihood of closing and contributing in the current fiscal year as well.

The next question comes from Ryan Koontz with Needham.

Yes. Focusing on the near term, it appears you have a promising pipeline and contracts in light of the current business environment. Are you still managing inventory in distribution? Additionally, there was some commentary from Qualcomm regarding general softness in industrial IoT. Could you compare your pipeline with the near-term dynamics? That would be helpful.

Yes. Regarding channel inventories, we have observed a decline in inventory with our distributors over several quarters. This quarter, however, we did see a slight increase, but it remains within our historical norms. We are not experiencing elevated inventory levels at our distributors. Some customers have indicated that they have inventory they need to manage, but this is not a widespread issue among our distributors. Similar to many companies that faced supply shortages during COVID, there was a tendency to hold more inventory due to delivery challenges. We previously highlighted some weaknesses in certain business areas as we emerged from the COVID period. However, the majority of our growth drivers for fiscal '24 are linked to significant programs we've secured, particularly with Gridspertise and Togg, where we have orders that will facilitate this growth. Moreover, we are seeing new demand stemming from some of our recent product launches in connectivity. Notably, we have a promising opportunity with AT&T that we mentioned in our last call, which has made good progress over the past quarter and will contribute to our growth next year.

That's great to hear. And a quick follow-up on the competitive front. Any changes? I've heard about a few new entrants coming at this with industrial hard and type products in areas that you play out of Europe and other spots. Are you seeing much of an impact? Or is it a pretty stable competitive landscape?

Yes. I think we're not necessarily seeing any new entrants at this point. With our out-of-band product, with our recent acquisition of Uplogix, we think we've got a market-leading product there. On the Qualcomm side with the design services, I think we have a great ability there to differentiate ourselves. And so not necessarily seeing anything new in those areas today.

Thank you. This concludes our question-and-answer session. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.