Iteris, Inc. (NASDAQ:ITI) Q3 2023 Earnings Call Transcript February 2, 2023
Operator: Good day and welcome to the Iteris Fiscal Third Quarter 2023 Financial Results Conference Call. At this time, all participants have been placed on a listen-only mode. And we will open the floor for your questions and comments after the presentation. Please note, this event is being recorded. I would now like to turn the conference over to Todd Kehrli of MKR Investor Relations, please go ahead.
Todd Kehrli: Thank you, operator. Good afternoon, everyone and thank you for participating in today’s conference call to discuss Iteris’s financial results for its fiscal 2023 third quarter ended December 31, 2022. Joining us today are Iteris’s President and CEO, Mr. Joe Bergera and the company’s CFO, Mr. Doug Groves. Following their remarks, we’ll open the call for questions from the company’s covering sell-side analysts. Before we continue, we’d like to remind all participants that during the course of this call, we may make forward-looking statements regarding future events or the future performance of the company, which are statements based on current information are subject to change and are not guarantees of future performance.
Iteris is not undertaking an obligation to provide updates to these forward-looking statements in the future. Actual results may differ materially from what is discussed today and no one should assume that at a later date the company’s comments from today will still be valid. Iteris refers you to the documents that the company files from time-to-time with the SEC, specifically the company’s most recent forms 10-K, 10-Q and 8-K, which contain and identify important risk factors that could cause actual results to differ materially from those that are contained in any of the forward-looking statements. As always, you will find the webcast replay of today’s call on the Investors section of the company’s website at www.iteris.com. Now, I’d like to turn the call over to Iteris’s, President and CEO, Mr. Joe Bergera.
Joe, please proceed.
Joe Bergera: Superb. Thank you, Todd and good afternoon to everyone. I appreciate you joining us today. Before we begin our regular earnings commentary, I want to make some remarks about today’s announcement that Kerry Shiba will be joining Iteris as SVP and Chief Financial Officer effective February 3, 2023. Kerry brings significant, highly relevant experience that we believe will be particularly valuable with Iteris having achieved a critical inflection point and now poised for its next stage of growth. I look forward to Kerry joining our team tomorrow and working with him to execute our business strategy and, of course, to increase shareholder value. Unfortunately, with Kerry’s arrival we’ll be saying goodbye to Doug Groves.
Doug has made a huge contribution to Iteris over the past three years, which have been extremely challenging due to unanticipated global events largely outside our control. And I cannot imagine a better partner than Doug to navigate the complexities of COVID-19 and the associated global supply chain crisis. To ensure an orderly transition, Doug has committed to serve as a senior adviser for four months, which will allow him to contribute to the preparation of our 10-K and other critical projects. Of course, I wish Doug the very best in his future endeavors. Now let’s turn our attention to our third quarter results. For the fiscal 2023 third quarter, Iteris reported record total revenue of $40.7 million, representing a 27% increase year-over-year.
The growth was due to strong demand for our products and services and the progress of our supply chain improvement program, which began to normalize the underlying economics of our Vantage sensor product lines. More specifically, our product gross margins improved 2,640 basis points on a sequential basis as we began shipping products with the alternative circuit boards that were released to production in our second quarter. In a few minutes, I’ll provide more color on our supply chain initiatives. Despite concerns about a potential slowdown in the broader economy, customer adoption of the ClearMobility platform remains very positive. In the third quarter, we reported strong total net bookings of $41.1 million, representing a slight increase over the prior year.
We were pleased with the results given the combination of an unusual prior period comparison and the impact of seasonal holidays, which tend to cause procurement delays. This is the fifth quarter in a row that we reported bookings of more than $40 million. Although not included in our third quarter bookings results, I’m pleased to share that Iteris has received a Notice of Intent to Award a multi-year, multi-element contract from a public agency in Southern California. We do not normally comment on notices to award. However, this award is unique for two reasons. First, it includes a healthy mix of both products and services, demonstrating the progress of our cross-sell efforts. And second, we expect at least a portion of this project to be funded by the Infrastructure Investment and Jobs Act, making this our first notable award to include IIJA funding.
It is likely to take a couple of quarters before this opportunity progresses from Notice of Award to sign contracts, at which time we’ll provide additional information. Due to our sustained strong sales pipeline velocity and total net bookings, we ended the December 31 period with a record total ending backlog of $112.2 million, representing a 22% increase year-over-year. As always, our reported total net bookings and ending backlog figures reflect firm customer orders. The total value of customer contracts, which varies from quarter-to-quarter, averages on a historical basis, about 200% of our total lending backlog. In the fiscal 2023 third quarter, product revenue increased 44% and year-over-year to a record $22.9 million, demonstrating continued market share gains.
We believe our sensor portfolio continues to take market share due to excellent sales execution, and superior product performance. And in the third quarter, we extended our product performance lead with further enhancements to our AI-based object classification, detection system scalability and security framework. Due to our strong market position, we continue to win virtually every large competitively sourced detection sensor, fixed travel time sensor and cellular CV2X sensor initiatives across the country. For example, in the third quarter, our sensors were selected for the following representative smart mobility initiatives, full high-definition AI-based detection for Phase 2 of the Coachella Valley Smart Region Program with an order value of $4.5 million.
This is likely the largest single deployment of this form of detection technology in the nation to-date. Cellular V2X or CV2X sensors to extend coverage on the I-4 between Tampa and Orlando as part of the Florida Regional Advanced Mobility Elements or FRAME program. This is another in a series of Iteris sensor purchases related to the I-4 FRAME program. Travel time and CV2X sensors will be deployed as part of an I-275 design build project near Tampa, Florida, video-based sensors for intersection detection to replace in-ground wired lubes throughout the city of Meridian, Mississippi and video-based sensors for intersection detection to replace prior implementation of our competitors’ video sensors across the traffic corridor in Richmond, Virginia.
These representative third quarter orders demonstrate Iteris’ ability, as we’ve discussed previously, to successfully execute on the following five dimensions to expand our market footprint. First, we are executing on our strategy to maximize our win rate of large scale modernization initiatives like CVAG that drive region-wide standardization of our sensor portfolio. Second, we are leveraging our leadership in intersection detection to penetrate adjacent categories, including the emerging C-V2X category as we did with the I-4 FRAME and I-275 deals in Florida. Third, we’re attaching annual recurring revenue to each new Vantage Apex system and sense Spectra CV sensor has occurred with the CVAG and Florida orders. Fourth, we’re capturing a disproportionate share of migration revenue as customers similar to Meridian continue to replace legacy in-ground detection with advanced sensors; and fifth, we continue to display above-ground detection vendors, such as we did in Richmond due to our superior product performance, total cost of ownership and customer success model.
Since our last earnings call, we released to production four more alternative circuit boards that will enable further reductions in our aftermarket component purchases, better optimization of our component inventory, additional improvements in our manufacturing linearity and enhanced purchasing power with traditional supply sources. This brings us to a total of six alternative circuit boards released to production from the inception of our supply chain improvement program. In a moment, Doug will comment on the implications of these new alternative circuit boards on our fourth quarter purchase price variance and product gross margins going forward. Now I want to review the performance of our service lines of business. Fiscal 2023 third quarter total service revenue was $17.8 million, representing a 10.5% increase year-over-year.
In addition, we recorded $16.1 million in net service bookings, of which 41% will be recognized in the future as annual recurring revenue. Notable new customer agreements include a combined $1.8 million in orders to extend our managed services activities for the Virginia Department of Transportation, a $1.3 million subscription agreement for clear data from the Utah Department of Transportation, a $1.3 million task order for the second phase of a project to develop and support a smart county plan for the San Bernardino County Transportation Authority, $1 million task order from the Florida Department of Transportation District 7 for arterial performance monitoring and management activities, $1 million combined — a series of awards worth a combined $1 million for a subscription agreement for ClearGuide, including ClearGuide SPM from various agencies in the US and Canada and a clear data subscription for a non-disclosed value from a confidential commercial customer.
Additionally, we saw an acceleration in the attach rate of connected services or annual recurring revenue to our infrastructure sensors. At this time, we have over 3,000 intersections in 2,000 travel time and C-V2X sensors, which are either connected or in process of being connected to our ClearMobility Cloud. To sustain market share growth, we continued in the third quarter to enhance our Software-as-a-Service, Data-as-a-Service and cloud-enabled managed service solutions. For example, we introduced a new safety-related data set that customers can access on a subscription basis, through our clear data application programming interface and we integrated this new data set into our mobility intelligence software ClearGuide to address new Vision Zero and State Streets for all use cases.
Given the strength of our value proposition, we also began to introduce strategic price increases on certain of our Software as a Service offers. So in summary, we are pleased with our third quarter record total revenue and record total ending backlog, as well as the progress we made on our supply chain improvement program and the associated sequential improvement in cost of goods sold and adjusted EBITDA. With various financial metrics trending in a favorable direction, we believe Iteris achieved an important financial inflection point in the third quarter, consistent with our prior expectations. On that note, I’d like to turn the call over to Doug to provide more color on our third quarter financials, after which I will further discuss our fourth quarter expectations.
Doug Groves: Thanks, Joe. Good afternoon, everyone. As a reminder, please see the company’s 10-Q filing and press release, which are posted on our IR website for a further description of matters under discussion during the call today. As Joe mentioned and as we expected, the third quarter was an inflection point in our hardware business, as we began to see the benefits of our supply chain management improvement plan really take hold. We continue to face supply chain challenges on certain components again this quarter, but the impact on the top and bottom line were not as severe as the last several quarters. To that point, we only spent approximately $970,000 in inventory purchases from the secondary markets, i.e., brokers, which was down from $8.4 million in Q2.
The impact from previously purchased broker parts in prior quarters was an increase in cost of goods sold of $3.9 million in this quarter, but was down significantly from $7.8 million in the prior quarter. From a revenue standpoint, the amount of unshipped backlog decreased from $900,000 at the end of Q2 to $100,000 in Q3. The orders that didn’t ship in the current quarter are expected to ship in Q4. As Joe mentioned, our ongoing supply chain initiatives are improving the situation, which is why we expect the fourth quarter hardware gross margins to be back to the low 40% range compared to only 20.6% in the first three quarters of this year. Demand for our products and services continues to be strong as evidenced by a record backlog of $112.2 million, which was up 22% over the prior year third quarter.
Now, I’ll move on to the details of the third quarter results. Total revenue for the fiscal 2023 third quarter increased 27.1% to $40.7 million compared to $32 million in the same quarter a year ago. Our gross margins in the third quarter decreased 560 basis points to 29.1% compared to 34.7% from the same quarter last year. Adjusting for the net increase in component costs of approximately $2.4 million quarter-over-quarter, the gross margins would have been 35% or up 30 basis points compared to the same prior year quarter. Turning to our revenue mix. The product revenues increased 44% to $22.9 million compared to $15.9 million in the same quarter last year. This strong demand underscores our market-leading position in the sensor market. And as Joe noted, we continue to win on all large sensor deals.
Product gross margins decreased 440 basis points and were 30.1% compared to 34.5% for the same quarter last year. However, the product gross margins did increase 2,640 basis points over the second quarter, as our supply chain improvement program continued to make great progress, and we continue to deplete the high-cost inventory on our balance sheet from previous quarters. Our service revenues increased 10.5% to $17.8 million compared to $16.1 million in the prior year quarter, primarily driven by stronger software and managed services revenue. In the third quarter, 23% of total revenue was annual recurring revenue. This was down from prior quarters as the revenue mix changed with product revenue outpacing the services revenue. And as a reminder, our annual recurring revenues are comprised of our software and managed services revenues.
Service gross margins decreased 700 basis points to 27.8% compared to 34.8% from the same quarter last year. This was primarily due to a change in our licensing fee structure for third-party data providers on our SaaS platforms and more than usual subcontractor content on our professional services revenue, which tends to be at very low margins. Operating expenses in the third quarter were up $900,000, at $14 million in the current quarter. General and administrative expenses were down $400,000, or 7.4%, while R&D was up $100,000, driven primarily by the circuit board redesign efforts. Sales and marketing costs increased $1.2 million, which was related to increases in our sales and product support headcount to support the higher sales this year and going forward.
Photo by Austin Distel on Unsplash
We reported a GAAP operating loss in the third quarter of $2.2 million compared with a GAAP operating loss of $2 million in the same quarter a year ago. The operating loss was solely attributable to the higher component costs, as previously mentioned. With progress being made on the circuit board redesigns, we’re anticipating spending less than $600,000 in broker market components in Q4, which is down 38% when compared to Q3. The GAAP net loss from continuing operations in the third quarter was $2 million or a loss of $0.05 per share, which compares to a net loss from continuing operations of $2.4 million, or $0.06 per share in the same quarter a year ago. Adjusted EBITDA for the third quarter was a loss of $400,000 or 1% of revenue, which compares to EBITDA of approximately $100,000 or 0.3% of revenue in the third quarter of last year.
The GAAP operating loss, GAAP net loss and adjusted EBITDA loss were driven by the supply chain issues, as previously noted. With the supply chain improvement plans outlined by Joe, we anticipate a continued improvement in our supply chain position in the coming quarters, since it will take additional time for the redesign of the key circuit boards to ship through to our customers. With six alternative circuit boards released to production inception to date, this has largely mitigated our need to procure components in the broker markets as previously mentioned. These key redesign activities should return the product gross margins to about 40% in the fourth quarter of this year and improved progressively as the hardware sales volumes increase and additional new circuit boards are introduced.
Turning to liquidity and capital resources. Cash was $10.2 million at the end of the third quarter, and working capital was approximately $24.7 million. The $2.2 million increase in cash from the second quarter was a result of the improved profitability due to the lower component costs. With the expectation that fourth quarter parts purchased in the broker market will continue to decrease, this will further improve our working capital, and we would expect our ending cash balance this fiscal year to be in the range of $12 million to $14 million, as the profitability improves — continues to improve and improve — and our circuit board redesigns continue to progress. Lastly, we spent $134,000 in purchases of property and equipment in the third quarter, and we still expect the full year CapEx to be less than 1% of revenues, reflecting our asset-light business model.
In summary, we continue to be laser-focused on our supply chain challenges and our multipoint supply chain recovery plan is progressing well, which will return our Vantage sensor gross margins back to historical levels. Lastly, as Joe mentioned, at the beginning of the call, this will be my last earnings call with Iteris. I want to thank all of our investors and sell-side analysts for all the support I’ve received over the last three years. I certainly hope I cross paths with many of you in the future, in my yet to be finalized next endeavor. With that, I’ll turn the call back over to Joe. Joe?
Joe Bergera: Great. Thank you, Doug. The smart mobility infrastructure management market represents significant long-term opportunities due to favorable secular trends and historic new investment from the IIJA and despite the challenges of COVID and the subsequent supply chain constraints, we’ve continued to strengthen Iteris’ position in this dynamic market over the last several quarters. Therefore, given the strength of our position, this large dynamic market, we remain extremely optimistic about the growth opportunity in front of Iteris despite potential challenges in the broader economy. To realize this opportunity, Iteris will continue to deliver on an aggressive solutions road map that includes the following fourth quarter planned releases.
A new connected vehicle safety alert for our Spectra CV sensor that is targeted at both public and private sector markets. New safety features for our Vantage Apex sensors will further enhance our safe street for all value proposition. New scalability features for Vantage Apex that will enable us to better price differentiate based on certain intersection characteristics. New safety analytics and connected vehicle reporting features for ClearGuide, our mobility intelligence application and new features to enhance the connected vehicle-based transit signal priority solution that we are scheduled to pilot in Florida this spring. We believe these new releases will drive the further adoption of our ClearMobility platform, enhance the cross-sell of our ClearMobility offerings and improve the monetization of our mobility data sets.
In addition, we’ll continue to execute against our supply chain improvement program with the release to production of four more alternative circuit boards in the fourth quarter. Upon the release of those boards, we will have achieved all of the objectives of the fiscal 2023 supply chain improvement program to be reviewed on our June 1, 2022 earnings call. More importantly, the release of these boards will further reduce our dependence on broker purchase parts, which, as Doug mentioned, we estimate will be less than $600,000 in our fourth quarter. Given these dynamics for the fiscal 2023 fourth quarter, we anticipate revenue to increase approximately 18% year-over-year, EBITDA margins to improve more than 900 basis points on a sequential basis and net cash flow to be in the range of $1.5 million to $3.5 million.
As a result, we’re raising the low end of our full year fiscal 2023 revenue guidance with the new range being $152 million to $155 million. And we’re lowering the high end of our full year adjusted EBITDA guidance with the new range being negative 2% to negative 3%, and full year fiscal 2023 revenue, reflecting the impact of global supply chain constraints on our fiscal 2023 year-to-date results. In closing, the last several quarters have been difficult due to COVID and subsequent global supply chain constraints. However, we continue to execute against our platform-centric business strategy and extended our leadership position in the smart mobility and structure management market. Additionally, our global supply chain improvement program is not only generating significant near-term benefits but lasting value for the company.
Therefore, we believe Iteris remains poised to create significant shareholder value as outlined by our Vision 2027 operating plan. With that, we’ll — we’d be delighted to respond to any questions or comments. Operator, are there any questions from our covering analysts?
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